Defense lawyers' professional responsibilities: Part II--contested coverage cases

Pryor, Ellen S

INTRODUCTION

Despite extensive study,1 the professional responsibilities of insurance defense

counsel remain controversial.2 Much of the debate centers on cases in which liability insurers deny or dispute the existence of coverage for claims filed against their insureds. Carriers often provide defense lawyers in these cases despite their coverage doubts, and questions naturally arise concerning these lawyers' responsibilities to carriers and insureds.

The most basic question is whether defense lawyers can ethically represent carriers and policyholders jointly when coverage is disputed. Even if joint representation is proper, though, defense lawyers' particular responsibilities also must be fixed. Must defense lawyers obtain informed conflict waivers before starting out? If so, what must lawyers tell clients when seeking them? May defense lawyers give carriers access to confidences imparted by insureds? What about letting policyholders in on communications from insurers? Does the permissibility of sharing information depend on whether a particular communication strengthens or weakens the case for coverage? What about seeking a dismissal of a claim upon which insurance coverage depends when other uncovered claims would be left alive? If a motion for partial summary judgment would leave a policyholder in court but without a paid defense, may a defense lawyer ethically file one?

These questions and others relating to lawyers' duties in contested coverage situations receive disproportionate attention in casebooks, treatises, and advisory opinions.3 What accounts for this is not the number of contested coverage cases, but the intense fears they generate: fears that insurers will use their control of the defense to shift liability from covered claims to uncovered ones; fears that defense lawyers will help insurers exploit policyholders because insurers pay their bills; and fears that policyholders will be helpless to protect themselves from the combined assault of insurers and defense lawyers.

These fears may justify the attention devoted to contested coverage cases, but they do not explain why, after almost a century of study, so little consensus exists regarding defense lawyers' professional duties.4 To account for this, one must look at the conclusions commentators and courts have reached and the arguments offered in support. Many analyses are long on citations but short on substance. A particularly glaring defect is the common failure to ground answers in the legal and economic structure of the tripartite relationship-the relationship that includes the carrier, the policyholder, and the defense lawyer.

This Article clarifies defense lawyers' duties in contested coverage cases by starting with the structure of the tripartite relationship and working outward. Rather than cataloguing the many answers that particular questions about legal ethics have received, this Article works from basic and fairly simple premises toward answers that are more complicated but that are nonetheless clear and defensible. In this way, this Article seeks to resolve the dilemmas and difficulties that defense lawyers face when, because of uncertainty about coverage, it is hard to know whether the ox at risk of being gored in the liability suit belongs to the carrier or the insured.

We have used this approach successfully in prior articles that, like this one, were produced as part of a project sponsored by the International Association of Defense Counsel and the Defense Research Institute. The earlier articles, which appeared in the Duke Law Journal and the Texas Law Review, addressed lawyers' responsibilities in full-coverage cases and excess-exposure cases, respectively.6 This Article completes the triptych by examining coverage disputes.

I. THE ROAD ALREADY TRAVELED: FULL COVERAGE AND EXCESS EXPosuRE CASES

The analysis of disputed coverage cases presented in this Article builds on our prior study of full coverage and excess exposure cases. A full coverage case is

one in which insurance coverage is both clear and clearly sufficient to cover any likely loss on the claim against the insured. An excess exposure case is one in which the insured might bear some of the financial responsibility for a covered loss because the policy limits are relatively low or because the insured must cover a deductible or self-insured retention.

A. ONE CLIENT OR TWO? THE PARTICIPANTS DECIDE.

In both full coverage and excess exposure cases, a crucial initial question is: Whom does the defense lawyer represent? The possible answers are the insured only, the carrier only, or both the insured and the carrier. Although authorities have endorsed all three options, the right answer for any given representation depends on the agreement reached when the lawyer was retained. A defense lawyer who agreed to represent only a carrier or only an insured has one client; a lawyer who agreed to represent both has two clients. Although lawyers and judges continue to fight about this, more and more academics are convinced,7 and the final version of the Restatement (Third) of the Law Governing Lawyers reflects this by endorsing the consensual view.8

The usual and customary arrangement, we contend, is that the lawyer agrees to represent both the carrier and the insured. A carrier will want a lawyer to represent its interests when defending a lawsuit because it is financially at risk for the outcome. Its power to hire a lawyer derives from its status as a corporation-- indeed, like all corporations, insurance carriers can only conduct their business affairs through agents retained to act for them.

It is harder to explain how a carrier can hire a lawyer for an insured. Ordinarily, one person has no authority to hire a lawyer for another. Carriers have this power because insureds give it to them. Standard liability contracts entitle insurers to control the defense of claims, among other ways, by hiring and giving orders to defense lawyers who are empowered to speak in court for insureds. By submitting a complaint to a carrier and demanding a covered defense, a policyholder authorizes an insurer to appoint its attorney.

B. THE ORDINARY DUTY OF LOYALTY APPLIES

When defense counsel represents both a carrier and an insured, the ordinary duty of loyalty governing multiple client representations applies. The lawyer must give each client unqualified loyalty, meaning that the lawyer may not harm one for the benefit of the other when handling the representation. All lawyers with multiple clients are subject to this "no subordination rule" (NSR).

Not all authorities agree that NSR should or does apply to the tripartite relationship of insured-lawyer-insurer. Some endorse an alternative that we call the "primary client rule" (PCR).9 Under PCR, defense counsel must side with the insured in conflict situations. We refer to the policyholder as the "primary client" because, on this approach, its interests trump those of the insurance company whenever a conflict arises.

We reject PCR for many reasons, the simplest being the lack of need for it. NSR completely protects insureds from disloyalty by prohibiting defense lawyers from acting to their detriment without their consent. The cases most often cited in support of PCR show this. In Employers Casualty v. Tilley10 and Parsons v. Continental National American Group,11 the two leading cases, the ordinary duty of loyalty (NSR) required the defense lawyers to obtain the policyholders' informed consent before acting to their detriment.

C. DON'T USE ETHICS RULES TO SOLVE INSURANCE PROBLEMS

Proponents of PCR seem to think the rule is needed to protect policyholders from improper behavior by insurers. For example, a carrier might pressure

defense counsel to try a case despite the risk to the insured, to work up a case in a way that prejudices the insured's interest in preserving coverage, or to forego cost-effective defensive activities. This effort to use the law governing lawyers to discourage misconduct by insurers reflects a conceptual blunder. Insurers' efforts to apply improper pressures (as distinct from lawyers' reactions to these pressures) are governed by insurance law, not the law of professional responsibility. Professional responsibility law regulates the conduct of lawyers. Insurance law, an enormous body of rules that includes state regulatory regimes, contractual agreements, common law, and diverse statutes, regulates the conduct of insurers.12 If and when an insurer does something wrong, the place to find the remedy is there.

Insurance law also is the place to look for information about the rights and responsibilities of policyholders and insurers inter se. For example, to ask whether a policyholder may forfeit coverage by failing to help a carrier defend a lawsuit is to pose a question of insurance law. It is to make an inquiry concerning which the law of lawyering has nothing to say.

Unfortunately, when one examines insurance law, one frequently finds that the rights and responsibilities of carriers and policyholders are unclear, undecided, or different in different jurisdictions. Occasionally, the immaturity of insurance law impedes the resolution of defense lawyers' quandaries. For instance, in Part V we will address a situation in which defense counsel is asked to file a motion for partial summary judgment. If the motion is granted, the covered claim will be dismissed and the policyholder will be left without a paid defense on the claims that remain. The view we will espouse is that, before filing the motion, defense counsel should disclose the proposed course of action and give the policyholder time to object. This answer may seem incomplete or unsatisfying because a crucial piece of information is missing, namely, whether the insured would breach the contractual duty to cooperate by refusing to go along. This is a matter of insurance law that is not yet resolved.

The aim of this Article (and of those that preceded it) is to sort out defense lawyers' responsibilities, not to fill gaps in insurance law. Consequently, we will not take a normative position on insurance law questions here. Instead, we will canvass the plausible answers to unsettled insurance law issues and see whether the differences between them have any bearing on what defense lawyers should do. This approach preserves the generality of our project while still enabling us to give concrete answers of value to lawyers everywhere.

D. BUT RECOGNIZE THAT INSURANCE LAW "BLEEDS INTO" PROFESSIONAL RESPONSIBILITY LAW

Having said that insurance law is one thing and the law of lawyering another, we hasten to add that the former colors the latter in many ways. This becomes clear the moment one asks why defense lawyers appointed by insurers have authority to appear for policyholders in court. They have it because insurers give it to them, having first acquired it contractually from their insureds.

It is true, then, that an insurance contract does not directly govern a defense lawyer's responsibilities,13 but it would be wrong to think that the two are wholly unrelated. Insurance companies forge links between the insurance law and the law of lawyering when they hire defense lawyers. For example, the scope of a defense lawyer's representation of an insured is limited to the defense of a liability suit because a carrier's power to appoint a lawyer is no broader than this. A defense lawyer cannot be responsible for asserting an insured's affirmative claims or for entering into a settlement that commits the insured's money (at least not without the separate consent of the insured). A liability contract does not authorize an insurer to commission a lawyer to perform these services.

Insurance law also sheds light on the propriety of a lawyer's decision to share with a carrier information received from an insured. In co-client representations, the ordinary rule of professional responsibility is that a lawyer may not keep material information secret from one client at the request of the other. However, the default rule may be modified by agreement. This naturally leads one to ask whether qualifying agreements exist in garden-variety insurance defense representations. Study of insurance contracts and insurance company behavior makes it clear that they do not. Standard contracts anticipate a free and open flow of relevant information to insurers, and neither carriers' litigation management guidelines nor their actions when hiring attorneys suggests the existence of any restrictions. Consequently, the baseline of open communication is preserved.

Insurance law also settles the right of carriers to take charge of defensive representations. Because they are corporations with pre-existing financial interests in covered lawsuits, insurance companies can be co-clients of the lawyers they hire to defend their policyholders. However, to be a co-client is not necessarily to have the power to control the conduct of a joint agent unilaterally. Any co-client can tell a lawyer what to do. Consequently, knowing only that carriers are co-clients, one would conclude that they have no more power to instruct defense lawyers than insureds do. Yet, as a practical matter, defense lawyers rarely take instructions from insureds. Most look exclusively to insurance companies for marching orders. The reason for this is obvious:

insurance contracts entitle carriers to control the defense, and controlling the defense means making litigation decisions. A fundamental understanding that the vast majority of defense lawyers share when being retained is that insurers control defensive representations. This is another respect in which insurance law "bleeds into" the law that governs attorneys.

E. THE PURPOSE OF INSURANCE DEFENSE REPRESENTATIONS IS TO MINIMIZE LOSSES ON LIABILITY CLAIMS

Insurance contracts also color defense lawyers' responsibilities by defining the objectives of legal representations. All agency relationships have aims, typically to advance or protect a principal's interests as the principal has defined them. When co-principals jointly hire an agent, the objective normally is to maximize a common interest. This is true, for example, when co-owners of property hire an agent to sell it. Their desire, which they commission the agent to satisfy, is to obtain the highest possible sales price.

Before defense lawyers are hired, insurance carriers and policyholders commit themselves to the goal of minimizing losses on covered claims. Liability contracts embody these commitments. Standard primary insurance contracts transfer liability exposures from policyholders to carriers while also equipping carriers to minimize the payouts they are required to make. For example, the Commercial General Liability Policy form entitles the company to control the defense and to investigate and settle claims. It also requires the insured to help the company avoid losses by providing early notice of claims, by forwarding legal documents and records, by providing information, by helping identify and enlist witnesses, and by refraining from compromising claims without the carrier's consent.14

Defense lawyers are agents that carriers employ to satisfy their contractual duties to insureds and to exercise some of the powers primary insurance contracts give them. Consequently, a defense lawyer's job is to further the joint interest in loss minimization that the policyholder and the carrier share. To accomplish this, a defense lawyer need only defend a liability suit competently and zealously. This is what defense lawyers understand their assignment to be, and it is what the vast majority of them do.

II. AN INTRODUCTION TO COVERAGE CONTESTS

Having reviewed our prior writings and set out the basics of the tripartite relationship, we now move to new terrain: defense lawyers' responsibilities in cases where insurers contest coverage. To begin the inquiry, it is essential to define the subject matter more concretely: What is a coverage contest?

A. DEFINING COVERAGE CONTESTS AND IDENTIFYING THEIR SOURCES

A "coverage contest" exists when an insurance carrier contends that its policy does not cover a claim asserted against an insured or reserves its right to make this assertion at a future point in time. The term "uncovered claim" refers to the particular claim for which coverage is or may be denied. Because complaints often assert many claims against policyholders, some of which may be covered and some of which may not, coverage contests can exist even when coverage for some asserted claims is clear. For example, a complaint may allege negligence, which is covered, and assault, which is not. If the carrier denies coverage of the assault claim, a coverage contest will exist and the assault charge will be the uncovered claim.

One might contend that excess exposure cases also involve uncovered exposure since the insured will be liable for a verdict in excess of policy limits. If one reads the definitions carefully, however, one will see that "policyholder exposure to loss" and "coverage contest" are not the same thing. In an excess exposure situation, the claim asserted in the complaint is covered-it falls within the ambit of the coverage provisions. The carrier is responsible for defense costs and for the liability, even though its responsibility for the latter is limited to the amount it agreed to pay. In a coverage contest, the carrier asserts that the claim falls outside the coverage provisions. In other words, it denies that it must bear either defense costs or the liability. The latter might be true, for example, when the insured is on the hook for punitive damages, which are frequently not covered at all.15

Coverage questions have many sources. Some stem from an insured's pre-loss conduct, such as a misrepresentation in the policy application.16 Others stem from conduct following a loss, such as the insured's failure to give notice or refusal to cooperate in the defense.17 Most commonly, however, they occur because insurance contracts contain boundaries that separate covered claims from everything else. It is the function of both affirmative coverage provisions

and negative coverage exclusions to set these boundaries. For example, coverage provisions require carriers to cover losses stemming from property damage and bodily injury, which differ from mere economic loss. Exclusions extinguish coverage that would otherwise exist, such as for property damage or bodily injury caused by pollution or inflicted intentionally by the insured.18

It is no accident that insurance contracts draw these lines. Policyholders and carriers have significant interests in knowing which risks are being transferred. A liability policy that covers losses stemming from pollution is far more expensive, far harder to obtain, and far more valuable than a policy that does not because it covers a much larger financial risk. Lines also are needed to create manageable risk pools. To gain the benefit of the law of large numbers (the law that enables carriers to predict losses accurately across risk portfolios), insurers must pool risks that are significantly similar to each other. By using standard insurance forms that tailor coverages clearly and narrowly, insurers create the similarities they need.19

If coverage boundaries have an upside, they have a downside as well. Any written boundary will have a periphery of meaning that is unclear. Even policy limits have a degree of vagueness. Consequently, any boundary is a potential source of coverage disputes. A coverage question is an uncertainty about whether a specific loss or exposure falls inside or outside the covered risk.

B. COVERAGE CONTESTS AND INTEREST CONFLICTS

In our prior articles, we identified conflict sources that may divide carriers and insureds in full coverage cases and excess exposure cases.20 These included the policyholder's pre-occupation with uninsured side effects of litigation, such as damage to reputation; disagreements stemming from asymmetrical exposure to defense costs; the carrier's concern with external issues, such as the desire to placate or punish a particular plaintiffs' attorney; strategic jockeying; differing attitudes toward risk; and differing exposures to loss.21 These conflict sources can be active in contested coverage cases, too.

Contested coverage cases also present unique difficulties stemming from the uncertainty over financial responsibility for losses, their distinguishing feature. From an insurer's perspective, the amount that it is economically rational to spend defending or settling a claim is a function of many things, including the amount the insurer stands to lose at trial. When coverage is clear, this amount is the portion of the expected judgment (the predicted loss at trial should the defendant lose discounted by the probability of losing) that falls within the policy limits. In full-coverage cases, the policy limits exceed the size of the expected judgment, so the insurer bears the entire judgment-risk and will make litigation investments accordingly. When excess exposure exists, part of the expected loss at trial rests with the insured and the carrier's incentive to spend money is diminished.

When coverage is disputed, a new factor must be considered, namely, the probability that the insurer will escape responsibility for the judgment by winning the coverage case. Predictably, this probability will reduce an insurer's willingness to absorb claim-related costs. If the expected judgment is $500,000 but the likelihood of coverage is only 50%, then the insurer's expected loss really is just $250,000, with the remaining $250,000 being the expected loss for the insured. Predictably, and in the absence of other incentives (such as those supplied by the law of bad faith), the new discount would lead the carrier to reject an offer to settle for $400,000, an offer the insurer would rationally accept if coverage were clear.22

The carrier's interest in bearing defense costs will be weakened for the same reason. Suppose that a marginal investment of $10,000 in defense costs would reduce the expected loss at trial by $15,000. Because the expected gain exceeds the expected cost, an insurer on the hook for the entire judgment would rationally make the investment. However, when the probability of winning the coverage dispute is 50%, half of every marginal dollar in expected savings benefits the policyholder, not the insurer. From the insurer's perspective, the return on the $10,000 outlay is only $7,500, too little to justify the expense.23

Recent precedents entitling insurers who win coverage disputes to recoup defense costs from insureds may alleviate this problem.24 This new doctrinal

development encourages carriers to think conditionally when making litigation decisions. Instead of being driven by the simple probability of winning the coverage dispute, the carrier faces one scenario if it wins and a second if it loses. In the former event, it recovers the amount it spent defending the uncovered claim. In the latter event, it recovers nothing from the policyholder but does enjoy 100% of the reduction in the expected judgment.

Continuing the example begun above, suppose again that a marginal investment of $10,000 would reduce the expected loss at trial by $15,000, and that the probability of winning the coverage case is 50%. Now add in the following condition: if the insurer wins the coverage dispute, it recovers all $10,000 from the insured. From the carrier's perspective, the dominant strategy now is to spend the $10,000. If the carrier wins the coverage dispute, it gets the money back. If it loses, it gains the entire benefit of the expected savings of $15,000 in the underlying liability case.

Unfortunately, the possibility of recovering defense costs from the policyholder does not align the interests of the two perfectly. Problems will remain. First, because the new doctrine of defense-cost recoupment does not perfectly track litigation investments in uncovered claims, insurers' marginal incentives to spend money are imperfect too. Second, many policyholders have insufficient assets to cover defense costs. When these policyholders are defendants, there is no realistic possibility of fee recoupment.

A third problem-strategic abuse of the defense to improve the odds of winning the coverage dispute-would persist even if the rules governing fee recoupment were perfect. In the preceding discussion we assumed that the odds of winning the coverage dispute were fixed at 50%. By making this assumption, we avoided a difficulty that many authorities regard as the most severe problem associated with coverage disputes: the possibility that a carrier may use its control of the defense to manipulate its chances of being forced to indemnify the insured.25 If this possibility exists, then a cartier may rationally focus its efforts on maximizing its chances of escaping liability entirely instead of pursuing the goal embodied in the insurance contract, namely, that of minimizing the amount recovered by the liability claimant.

Consider the litigation decision described in the following table.

Row 1 shows that the loss-minimizing approach is Defense Strategy B ($750,000

This example is hypothetical. We chose the numbers to sharpen the conflict between the carrier and the insured and thereby to illuminate the possible importance of the insurer's right to control the defense. In a real case, a carrier may be unable to affect its prospects in the coverage case this dramatically. Other factors also will vary, including the stakes and the costs that different defensive strategies entail.

That said, for present purposes, a hypothetical example is fine. Our aim is the limited one of identifying the general features of conflicts between carriers and insureds that are unique to contested coverage situations. The hypothetical makes the structure of one such conflict clear.

Obviously, the possibility of choosing litigation strategies with an eye to manipulating coverage odds can further distort settlement incentives. In the example described previously, the expected judgment at trial was $500,000. However, it was economically irrational for the carrier to pay more than $250,000 in settlement because its odds of winning the coverage case were 50%. If the carrier could improve its chances in the coverage action to, say, 75% by defending the liability action strategically, its settlement ceiling would further decrease, to $125,000 on these facts. The carrier's marginal incentive to bear defense costs may be impacted for similar reasons, especially in the absence of fee recoupment.

In sum, disputed coverage cases can create distinctive conflicts by undermining carriers' defense and settlement incentives even when policy limits exceed expected losses. Moreover, the greater the carrier's odds of winning the coverage dispute, the greater the distorting effect. Finally, when a carrier can manipulate these odds by strategically abusing its control of the defense, in theory the incentive to choose loss-minimizing defensive strategies can disappear. A carrier could even make itself better off by defending a lawsuit in a manner that it expects to yield a larger loss at trial than an alternative strategy.

C. SOME COVERAGE CONFLICTS ARE NOT ETHICALLY TROUBLING

The conflicts just discussed may be serious insurance problems, but, in principle, they need not worry legal ethicists at all. If insurers refused to provide paid defenses in all contested coverage situations, policyholders would have to hire their own attorneys to represent them alone. Having only one client, these lawyers' duties would be clear.

Liability carriers often disclaim coverage outright-usually to policyholders' dismay-but they are not always free to do so, even when their doubts about the existence of coverage are right. In most jurisdictions, an insurer's duty to defend depends not strictly on coverage but on the so-called "eight corners" or "complaint allegation" approach.26 Under this approach, an insurer must provide a defense whenever a plaintiff's petition contains any allegation that, if proven true, would result in an award of damages within the scope of the insurer's indemnity obligation.27 Many petitions include such allegations precisely for the purpose of keeping insurers on the hook for defense costs, even though, given the facts, the claims that are within the scope of the policy are likely to fail. Moreover, the laws of many states hold that if even one claim falls within the

scope of coverage, the carrier must defend the entire case. It cannot provide a paid defense for some claims while excluding others, and it must continue to defend the entire action as long as the potentially covered claim remains alive.

When coverage contests arise, insurers also can avoid many ethical issues by providing independent counsel-counsel who, although paid by the insurer, represents only the insured. Like an insured's personal attorney, independent counsel has only one client-the insured-and, thus, has a straightforward mission-to minimize the insured's risk. Insurers do provide independent counsel in some situations, but, as Part IV will explain, they are not always legally required to and they often refuse. Moreover, even when policyholders are entitled to independent counsel, they may waive this right and frequently do.28 Consequently, a defense lawyer may wind up with two clients in a disputed coverage case even when the right to independent counsel is available.

The cases that interest us, then, are the tricky ones in which coverage is contested, and a defense lawyer concurrently represents the carrier and the insured. These are the cases we will focus on in the remainder of this Article.

III. INSURER CONTROL OF THE DEFENSE

Before turning to the ethical responsibilities of insurance defense counsel in cases containing allegedly uncovered claims, it is important to address a question relating to a liability carrier's defense obligation: When must an insurer provide independent counsel for an insured?29 A brief examination of the law on this topic is necessary for two reasons. First, as we will argue later, in a contested coverage situation defense counsel retained by the insurer to conduct a joint defense has an

obligation to alert the insured to the possible existence of a right to independent counsel.30 A brief sketch of this right will aid in understanding the reasons for this conclusion. Second, in many jurisdictions, the duty to provide independent counsel rests on an account of interest conflicts between carriers and policyholders in disputed coverage cases. The duty exists because a single lawyer is thought to be unable to jointly represent a carrier and an insured. By studying the case law governing the right to independent counsel, one can learn what judges have said about the ethical propriety of joint representations when coverage is disputed.

A. THE BASICS OF THE RIGHT AND DUTY TO DEFEND

To understand the insurer's defense obligation in a contested coverage case, one must examine the relevant language of the liability insurance policy and learn how this language has been fleshed out in full-coverage situations. Standard individual and commercial lines policies give the insurer the duty to defend any suit filed against the insured that seeks damages covered under the policy.31 Under the so-called "complaint allegation" or "eight corners" rule prevailing in most jurisdictions, this duty requires an insurer to provide a defense whenever the insurer would be responsible for a damages award on one or more of the theories asserted in a complaint.32 If one or more claims against the insured would be covered, then the insurer must usually defend the entire case. This is so even though coverage for other claims clearly would not exist.33 Thus, an insurer is not excused from its defense obligation merely because most of the claims are not covered or even because the covered allegations are without factual support. Rather, the insurer may deny a defense altogether only if none of the allegations in the complaint against the policyholder triggers a defense obligation under the eight-corners rule.

Standard policies also give insurers the right to defend and, via cooperation clauses, obligate insureds to support the defense.34 In full-coverage cases, these provisions have been held to allocate to the insurer control over the defense of the suit against the insured. The insurer may select defense counsel, direct the strategy of the defense and settlement, and settle claims within policy limits without the further consent of the insured.35

B. THE IMPACT OF COVERAGE CONTESTS ON THE CARRIER'S RIGHT TO CONTROL THE DEFENSE

Does the presence of a coverage issue alter an insurer's duty to provide a defense or its right to control it? Nothing in the insurance policy itself suggests any qualifications. Yet, in many jurisdictions, insurers are obligated to yield control of the defense and to fund independent counsel for the insured in some uncovered claim cases. The term "independent counsel", as usually employed in this body of jurisprudence, refers to counsel funded by the insurer but whose only client is the insured.36

Jurisdictions with independent counsel requirements can be grouped into two categories. The first contains states that recognize a right to independent counsel whenever coverage is contested. Courts in these states usually do not hold that an insurer must offer independent counsel at the outset. Rather, they allow insureds to "reject" a joint defense offered pursuant to a reservation of rights, and to insist on legal representation by lawyers who represent only them.38 Typically, the insured is entitled to select independent counsel, but some states allow insurers to select them, subject to the understanding that the insurer is but a third-party payer.39 Limits on the range of choice an insured may have or the range of fees a carrier is required to offer may also exist. We will call jurisdictions in this category "reject-the-defense" states.

The second category contains jurisdictions that recognize a right to independent counsel only in a subcategory of disputed coverage situations. Although the doctrine varies in subtle ways across the states, the general idea is that a policyholder can demand independent counsel when the defense of the liability action has the potential to influence the outcome in the coverage suit.40

The most prominent example of this approach is the so-called "Cumin" rule in California. Arguably, the label, which derives from a case, San Diego Federal Credit Union v. Cumin Insurance Society, Inc.,41 no longer is apt. Later decisions and a statutory enactment considerably narrowed the right Cumin recognized.42 Currently, the Cumin approach requires an insurer to provide independent counsel to the insured when a conflict of interest exists, but not every refusal to admit coverage generates a conflict. Under the statute, a conflict exists when an insurer disputes coverage and the "outcome of that coverage issue" is capable of being "controlled by counsel first retained by the insurer."43 In other words, as discussed previously, the manner of defending the liability suit must have the potential to impact the policyholder's odds in the coverage dispute.

To illustrate, suppose the complaint against the insured asserts negligent misrepresentation and fraud and that the insurance policy excludes coverage for fraud. In this situation, the manner of defending the case may affect the ultimate coverage issue. Defense counsel might, e.g., request an allocation in the jury verdict between fraud damages and misrepresentation damages instead of seeking a general verdict. Alternatively, defense counsel might move to dismiss the negligence claim by asserting a privity defense, leaving the fraud claim intact. Even if the findings in the underlying suit are not given collateral estoppel effect

in the coverage suit, the factual and strategic shaping that takes place in the underlying suit could affect the coverage outcome.44

In other situations where coverage is disputed, the manner of controlling the defense cannot impact the coverage issue. For example, suppose the insurer contests coverage of liability for an automobile accident on the ground that the insured failed to give timely notice of the occurrence. The defense of the accident case cannot be manipulated in a way that favors the insurer's coverage defenses, so independent counsel is not required. Many jurisdictions follow a version of this independent counsel rule. For convenience, we will refer to them all as Cumis jurisdictions.45

Whichever rule applies, when a carrier provides independent counsel, its ability to control the defense is impaired. A lawyer who represents only a policyholder cannot receive instructions from an insurer. The third-party payer rule, a version of which is in force in every jurisdiction, prohibits lawyers from allowing non-client payers to interfere with attorney-client relationships. This constraint significantly limits a non-client carrier's ability to control its exposure to liability-related losses because it prevents such a carrier from telling a defense lawyer what to do. Because most carriers attach great value to the right to control the defense, most also want to be co-clients, not third party payers, whenever they can. Insurers are reluctant to provide defense lawyers who represent policy-- holders alone.

C. LAWS GOVERNING INSURERS' RESPONSIBILITIES DO NOT DERIVE (DIRECTLY) FROM ETHICS RULES

Most courts46 and commentators47 conceptualize independent counsel require

ments as insurance law creations that derive from lawyers' codes. For example, in Mosier v. Southern California Physicians Ins. Exchange,48 the court stated that the California independent counsel rule "is based on ethical standards, not on insurance concepts."49 Yet, the Cumis statute is not part of California's code for lawyers. It is part of that state's body of insurance law.

If insurance law creates an independent counsel requirement, then it must be self-evident that ethics rules alone cannot account for it. Lawyers' codes govern lawyers, not policyholders or insurers, and state bar associations have no power to regulate the business of insurance. Consequently, the observation that a conflict rule prohibits a lawyer from jointly representing a carrier and an insured cannot by itself establish any duty on the part of a carrier at all. It can establish only that the lawyer must withdraw from the representation or decline to enter into it unless both parties waive the conflict after being properly informed, and the lawyer may still have to withdraw even then.50

To get from the ethical premise that a conflict exists to the insurance law conclusion that separate counsel is required, one must separately examine insurance law. There are three separate ways that an independent counsel requirement grounded in insurance law can be justified. First, one can contend that insurance law should buttress lawyers' conflict rules by incorporating them and adding new sanctions against carriers. The effect of this tactic is to cast insurance companies as monitors of defense lawyers' compliance with ethics rules in contested coverage situations.

The trouble with this argument is that it requires factual predicates that are unproven. To see this, one need only assume that defense lawyers comply with conflict rules perfectly. If the assumption were correct, it would be senseless to have carriers monitor defense lawyers' conduct. To defend an independent counsel requirement as a buttress for ethics rules, one must believe that defense lawyers violate conflict rules too often. One also must believe that the benefits of insurer monitoring exceed the costs. Unfortunately, little is known about the violation rate or the consequences of monitoring by insurers. Consequently, the

assertion that independent counsel regimes are desirable methods of ensuring ethical representation for policyholders is merely conjectural.

Second, one could contend that insurance law should create a duty to provide independent counsel because carriers that contest coverage have defective defense-related incentives. This type of argument has been used to support the imposition of other duties on insurers, including the duty to act reasonably when considering within-limits settlement demands. On this approach, an independent counsel requirement is a solution to a problem of insurance microeconomics, not a problem of legal ethics.51

The outline of the supporting micro-economic analysis is easily traced. Insurance contracts create structures for minimizing losses. Usually, the structures work well because carriers have incentives to save money. In coverage contests, however, carriers' incentives can be distorted. Instead of profiting (solely) by minimizing payouts, insurers can gain by spending less than a single holder of unlimited liability would on defense and settlement, and by using their control of the defense strategically to escape having to cover losses. Because these abuses are hard to spot and harder to prove, neither a breach of contract action nor a bad faith remedy will discourage them sufficiently. A better solution is an independent counsel rule that enables policyholders to protect themselves by giving them control of the defense.52

Like the first argument, this second one also rests on empirical claims that are of uncertain validity and that are certainly unproven. To see this, one need only recall that in excess exposure cases insurers' defense- and settlement-related incentives also are imperfect because there too insurers face responsibility for less than all of the liability exposure to the claimant. Yet, there is no independent counsel requirement for excess exposure cases. Nor, in many states, is independent counsel required in all cases involving uncovered claims. The Cumis statute, for example, expressly excludes matters involving uncovered punitive damages claims from its ambit. To defend the policy of requiring independent counsel in only certain situations, one must draw a line between incentives that are flawed but acceptable and incentives that are flawed and unacceptable. Yet, without empirical evidence regarding the marginal impact of coverage contests on insurers' conduct and the costs and benefits of independent counsel regimes, any such line can only seem ad hoc.

Readers may see the preceding point more clearly if it is framed in a general way. A coverage conflict adds a new discount factor to a rational insurer's calculations. This is an analytical matter explained above. Yet, to point out that a

rational insurer would consider a new factor is not to establish that the marginal impact of the factor on an insurer's conduct would be great or small. Impact requires an empirical assessment. Nor does the analytical point show that an independent counsel requirement would make things better rather than worse. All public policies entail both benefits and costs, and the latter may exceed the former. Only an empirical study could establish the truth.

Third, and finally, one can defend existing independent counsel regimes by arguing that, as a matter of insurance law, there is no prohibition on joint representations at all. Instead, there is a set of procedures for handling practical problems that arise when other law prevents a joint defense from proceeding. The procedures are needed because, even when other law prevents them from using the same lawyer, an insurer and a policyholder still have to respond to a liability action in a coordinated way. Someone has to select a defense lawyer, bargain over fees, pay the lawyer, and assume control. Someone has to fill the role of client. Someone has to investigate liability claims and consider settlement opportunities. Someone has to decide whether to appeal following a loss at trial. Someone has to be responsible for minimizing the total cost of responding to the liability action all along the way. An independent counsel regime determines how important practical issues like these are to be handled when an ethics rule prevents the principals from working with a defense lawyer in the usual and customary way.

From this perspective, an independent counsel regime is a gap-filler. It meets a need that parties fail to provide for in liability contracts by establishing special litigation management procedures, and the measure of its goodness is its ability to realize the aim of the liability contract by minimizing claim-related expenses. Professional responsibility law determines when co-client representations are forbidden, and insurance law governs the terms on which carriers and policyholders will work together when the ethical prohibition applies.

California's Cumis statute is very much a gap-filler. It requires a carrier to appoint a defense lawyer when a conflict of interests exists. This makes it clear that an interest conflict does not extinguish a carrier's duty to defend. The statute also provides that the insured will pick the lawyer (unless the parties agree otherwise) and that the lawyer will represent solely the insured. These are not the only imaginable arrangements. The carrier could select the lawyer, and the lawyer could represent the carrier instead of the insured. The statute also entitles the carrier to insist that the lawyer chosen by the insured have "at least five years of civil litigation practice" and "errors and omissions coverage."53 It obligates the carrier to pay the lawyer the same rates panel attorneys receive. It gives the insurer the right to insist on binding arbitration when fees are disputed. It requires the lawyer (and the policyholder) to give the carrier "all information concerning the action except privileged materials relevant to coverage disputes, and timely to

inform and consult with the insurer on all matters relating to the action."54 It explains how claims of attorney-client privilege are to be handled. It requires independent counsel to cooperate with the carrier's own attorney and obligates the parties to allow both lawyers to participate in all aspects of the underlying litigation. These are practical matters that must be handled when, because of an ethical difficulty, a defense lawyer cannot represent a carrier and an insured jointly.55

The gap-filler approach also makes sense of an omission from the Cumis statute, namely, the absence of any provision penalizing an insurer for using dependent counsel in a conflict situation. A sanction might be needed if the statute's purpose were to encourage carriers to monitor defense lawyers' compliance with ethics rules. However, if the statute's purpose is to fill a gap in the liability contract, there is no obvious reason to punish an insurer for a defense lawyer's failure to recognize that a joint representation is improper. The lawyer should bear responsibility in the usual way, but the insurer should be allowed to rely on the lawyer's judgment. This is what most clients do when hiring attorneys, namely, rely on them to handle conflicts properly.

By letting ethics rules determine when joint representations may proceed, the gap-filler approach also accounts for the fact that some states make independent counsel available in a broader range of cases than others. Different jurisdictions often treat conflicts differently. In Texas, a lawyer may represent Client 1 in Lawsuit A while also representing Client 2 against Client 1 in unrelated Lawsuit B.56 No other state is as permissive. In New Jersey, a lawyer who represents a driver and a passenger as co-clients in accident-related litigation against a third party may be disqualified automatically.57 No other state is as restrictive.

Different conclusions are reached partly because different jurisdictions have different conflict rules. A deeper problem that would survive under uniform rules is that conflicts come mainly in shades of gray.58 According to the Model Rules of Professional Conduct, a conflict exists when "the representation of [one] client may be mnaterially limited by the lawyer's responsibilities to another client."59 According to the Restatement (Third) of the Law Governing Lawyers, "[a] conflict of interest in involved if there is a substantial risk that the lawyer's

representation of the client would be materially and adversely affected ... by the lawyer's duties to another current client."60 These standards are irreducibly vague. It is not surprising that judges called upon to apply the phrase "may be materially limited" or "substantial risk [of] ... material[] and adverse[] affect[]" reach divergent conclusions in many areas, including insurance defense.

We will say more about interest conflicts in contested coverage cases below. For now, it suffices to note that we adopt the "gap-filler" approach. In our view, independent counsel regimes are insurance law solutions to practical problems that arise when other laws prevent joint defensive representations from proceeding. They are not insurance law prohibitions on joint representations, and they do not derive directly from the ethics rules. They are common law glosses on contractual defense clauses designed to accommodate special situations that liability contracts fail to address.

IV. TAKING IT FROM THE TOP: A DEFENSE LAWYER'S RESPONSIBILITIES AT THE START OF A CONTESTED COVERAGE CASE

Having set the insurance law background and clarified both the difference and the relationship between insurance law and legal ethics, we will now examine a defense lawyer's professional responsibilities at the start of a contested coverage case. The subjects will be: the carrier's power to hire the defense lawyer; the scope of the representation; initial conflicts of interest analysis; defense counsel's role in advising the insured about the right to independent counsel; and defense lawyers' knowledge of the law governing insurance coverage.

A. THE CARRIER'S AUTHORITY TO RETAIN DEFENSE COUNSEL

That a carrier can retain a lawyer for itself is beyond dispute. An insurance company is a corporation with the power to hire agents. It can hire lawyers to advise it on all manner of topics, including matters relating to policyholders' liability and insurance coverage.61

A carrier's authority to hire counsel for a policyholder does not derive from its corporate status but must be conferred by an insured. In full coverage cases and excess exposure cases, a policyholder confers authority by purchasing insurance authorizing a carrier to defend and by submitting a complaint pursuant to the policy.62

The process often works the same way in a contested coverage case. In the simplest such case, the insured, believing that the complaint is covered, notifies the carrier of the claim and requests a defense. Because the liability contract links

the duty to defend with the right to defend, the submission activates both. It therefore seems natural to imply that the policyholder consents to carrier control, including appointment of a defense lawyer whom the carrier will control.

When coverage is disputed, however, something else occurs: the carrier or the policyholder (usually the carrier) raises the coverage issue. Often, this happens before defense counsel is retained when a carrier sends a policyholder a letter reserving its right to contest coverage for a loss.

When the insured sounds the alarm first, it may do so by submitting a demand for independent counsel along with the complaint. Product manufacturers sometimes do this when they receive new complaints that are related to old ones for which a carrier denied coverage or reserved its rights in the past. The object of submitting the new complaint is to put the carrier on notice of the new claim. This preserves the policyholder's ability to assert a bad faith claim when the carrier issues a new coverage denial or, if the carrier is offering a paid defense subject to a reservation of rights, to have the case referred to the same attorneys who are handling the related matters.

Whatever the facts, a request for a defense coupled with a demand for independent counsel cannot impliedly authorize a carrier to hire a defense lawyer subject to the usual arrangements. The demand for independent counsel establishes that the policyholder does not agree to be represented by counsel controlled by the insurer. The inference that the carrier can select the lawyer it wants also may be negated.

To be clear, we are talking now about what may be inferred from a demand for a covered defense when an insured requests independent counsel. We are neither saying nor assuming that a policyholder has a right to independent representation. Policyholders who want independent lawyers are not necessarily entitled to them.63 The point is not that a policyholder is right; it is that one cannot infer consent to X when a policyholder submits a demand for a policy defense and, along with it, requests ~X.

For defense counsel, the importance of an insured's demand for independent counsel is that it casts doubt upon the carrier's authority.64 In particular, it forces counsel to ask whether the carrier can hire a lawyer to represent its insured and, if so, on what terms. Technically, the answers to these questions depend on the content of the policyholder's communications with the carrier, but in this situation a prudent defense lawyer will not rely on technicalities. When dealing with a policyholder who requested independent counsel, a prudent defense lawyer will review the terms of the retention and confirm that the policyholder

accepts them.65 By memorializing a policyholder's consent, a defense lawyer can gain an important layer of protection against a claim of having acted without authority or otherwise improperly.

Policyholders rarely demand independent counsel right out of the box, that is, when submitting complaints to carriers for consideration. Usually, they forward complaints without adornment. Coverage disputes surface later when carriers send letters denying coverage or reserving their rights.66 Often, these same letters notify insureds that their complaints have been referred to particular defense lawyers. This is when policyholders desiring independent counsel make their requests.

This scenario requires one to consider two issues: what should a defense lawyer do when a carrier offers a qualified defense?; and what should a defense lawyer do when a policyholder subsequently requests independent representation?

Fundamentally, the problem a defense lawyer faces when the right to deny coverage has been reserved concerns a carrier's authority to hire counsel for an insured. Depending on the reasons for the reservation and the law of the jurisdiction, a carrier may or may not have this power. Again, though, a prudent defense lawyer will address this problem straightforwardly by discussing the terms of the retention with the policyholder and memorializing the policyholder's agreement. Upon receiving the referral from the carrier and learning that the insurer has reserved its rights or is actively contesting coverage, defense counsel should discuss with the insured the fact of appointment, the scope of the representation, and the insured's possible right of independent counsel. If the insured agrees to representation on these terms-and assuming that a conflicts analysis has not led to the conclusion that a waiver must be obtained-the possible infirmity of the insurer's authority to retain defense counsel for the insured will have been finessed.

A dispute might remain concerning the date the joint representation actually commenced (the alternatives being the date of the referral and the date of the conference with the insured), but this technical issue will matter for few

purposes, given the insured's ratification of the appointment. For example, suppose defense counsel had to take a defense-related step, such as filing an appearance in court, before meeting with the insured. If counsel communicates with the insured promptly thereafter and discloses the action in the initial conference, the insured's acceptance will ratify the conduct, eliminating any concerns about the lawyer's authority.

If the policyholder rejects representation by defense counsel, then the lawyer must withdraw (unless and until the carrier and the policyholder work out their disagreement and approach the lawyer again). If the lawyer took any defenserelated steps before meeting with the insured, the general exception for exigent conduct should protect the lawyer from liability, assuming the actions were properly performed. However, the lawyer also may have a duty to take corrective measures, such as withdrawing as counsel of record for the insured. To minimize the risks associated with these post-rejection activities, a defense lawyer should inform the carrier and the policyholder of the intent to take them, giving both an opportunity to voice any concerns.

B. THE SCOPE OF THE REPRESENTATION

We said above that a defense lawyer should discuss the scope of the undertaking with a policyholder when a carrier offers a qualified defense. Our aim in this section is to clarify what the lawyer should say. The discussion assumes that the carrier asked the lawyer to represent both the policyholder and the carrier as co-clients. What is the possible scope of defense counsel's representation of each client? Consider first the relationship involving the carrier. Its scope depends on the retainer agreement. When hiring a lawyer for itself, a carrier can authorize a lawyer to provide whatever range of services it desires.68 In theory, a carrier could even ask the same lawyer to provide services relating to both defense and coverage. Although this particular combination of responsibilities is ill advised and would likely subject the carrier to serious penalties under insurance law,69 the important point for present purposes is that the scope of a lawyer's representation of a carrier is whatever the two agree that it shall be. Factually, the ordinary agreement is that the lawyer will provide services and advice relating to the defense of the liability suit against the insured. Settlement-related responsibilities often are added to a defense lawyer's assignment as a case proceeds. Coverage-- related responsibilities are uniformly excluded.

The scope of defense counsel's representation of the other client, the insured, also will be limited to the defense of the claim, for the simple reason that a carrier

has no authority to appoint a lawyer with a broader commission.70 The carrier's authority flows from the defense clause and can be only as broad as the clause itself. Because the clause concerns only the defense of suits seeking covered damages, the scope of a defense lawyer's assignment on behalf of an insured cannot include additional responsibilities, at least not without a policyholder's separate authorization.

Because the context is contested coverage cases, it is particularly important to note that a lawyer retained by a carrier cannot be responsible for giving a policyholder coverage advice. A carrier has no authority to assign a lawyer this responsibility. Even if one were to assume that a policyholder asked a carrier to appoint a lawyer with coverage responsibilities when requesting a defense, problems would remain. A standard liability contract does not obligate a carrier to honor such a request or to pay for coverage-related services for an insured. Nothing in the language or structure of the insuring promise-whether in the duty to defend or the duty to indemnify-entitles a policyholder to these benefits,71 and no court has held otherwise.72 The carrier's sole obligation would be to provide a paid defense.

Still, when being retained by a carrier in a qualified-defense situation, a defense lawyer's object should be clarity. The lawyer should understand what the carrier is hiring the lawyer to do, both for itself and for its insured. Normally, the carrier will want the lawyer to protect both clients by zealously defending the liability case. With this clear, the lawyer can then give the policyholder a concise explanation of the scope of the representation, including a statement that services relating to coverage are excluded. If the insured rejects the proffered defense on the terms agreed to with the carrier, the lawyer will know to refrain from acting for either client in the liability matter until the principals resolve their disagreement.

An insured can always obtain coverage-related services by purchasing them directly. This raises the possibility that an insured will ask a defense lawyer to provide coverage advice, with the understanding that the policyholder will pay for it. Any experienced defense lawyer would know to decline this request. Defense counsel has no obligation to accept it, and any such expansion would raise serious practical and ethical difficulties. It also might require a carrier's

consent because a single client cannot unilaterally change the scope of a joint representation. When an insured requests help with coverage, a defense lawyer should direct the insured to someone else.

C. INITIAL CONSIDERATION OF INTEREST CONFLICTS

Defense counsel faces several other issues at the outset of the joint representation. Chief among them is whether a joint representation is ethically permissible, with or without an informed conflict waiver. Does a lawyer asked to defend both a carrier and an insured in a disputed coverage situation confront an interest conflict?

It may help to make the problem more concrete. Suppose that a plaintiff's complaint against a policyholder asserts two theories of liability. The first theory, coverage for which is admitted, will fail if the defendant shows that an employee was acting outside the course and scope of his employment when an accident occurred. The second liability theory, the uncovered claim, is immune to this affirmative defense. The carrier has agreed to defend the entire lawsuit subject to a reservation of rights concerning the second claim.

On these facts, there is an obvious divergence of economic interest between the carrier and the insured. Although both prefer winning the liability case to losing it, if the risk of loss ripens into the fact of an adverse judgment, the carrier prefers to lose on the second theory and the policyholder prefers to lose on the first. These opposing second-order preferences exist because each party is better off if the other bears the loss. The questions at hand are whether a defense lawyer can represent both clients jointly given the conflict and whether a conflict waiver is required.

As a predicate for answering the first question, it is important to realize that not all differences or disagreements between clients trigger the conflict of interest rules.73 One person may love rock music. Another may hate it. One person may stand to make money if the stock market rises. Another may profit from a market decline. These differences of opinion or economic interest would not prevent persons from being co-clients in a case in which both were charged with liability for personal injuries caused by an explosion. In the liability action, both would have the same object, namely, minimizing the loss to the claimant. Because a single lawyer could protect this shared interest, a joint defense could ethically proceed.

All co-clients have some opposing interests, if only the economic one of paying a smaller portion of a joint lawyer's fee. The distinction between interests that are conflict-relevant and other interests is therefore indispensable. Without it, multiple-client representations would always trigger the conflict rules.

It remains to determine how the distinction ought to be drawn. The matter is

one of some moment. A sorting criterion that assigns many interests to the conflict-relevant category will cause the rules to be triggered more often than a more selective criterion would. At stake is the frequency with which lawyers must seek conflict waivers and the costs this entails.

As a general matter, prevailing law uses legal duties and the scope of the representation to distinguish conflict-relevant interests from others. Conflict-- relevant interests are those that a lawyer is charged to protect. Conflict-irrelevant interests are those that a lawyer is free to ignore. Consider the basic conflict provision found in the Restatement (Third) of the Law Governing Lawyers. It states that a conflict exists when "there is a substantial risk that the lawyer's representation of the client would be materially and adversely affected ... by the lawyer's duties to another current client...."74 On this definition, a lawyer must owe Client 2 a duty which, if performed, would cause the lawyer to handle less effectively a matter within the scope of the representation of Client 1. Rule 1.7(b) of the Model Rules of Professional Conduct employs essentially the same conceptualization. According to it, a conflict exists when "the representation of [one] client may be materially limited by the lawyer's responsibilities to another client." Again, a duty owed to Client 2 must threaten to reduce the efficacy of a lawyer's efforts when acting within the scope of the representation of Client 1.

According to the rules, then, an interest conflict requires a duty/representation incompatibility. Upon reflection, it is clear that one could replace this formula with a representation/representation incompatibility. That is, one could say that a conflict exists when an action that would advance the representation of Client 2 would impede the representation of Client 1. The substitution is equivalent because "[a] lawyer's duties are ordinarily limited to matters covered by the representation."75 To say that a lawyer has a duty to protect an interest is to say that the interest falls within the agreed scope of a representation.76 This is why lawyers can often avoid conflicts by carefully limiting the range of services they agree to provide when accepting new engagements.77

The scope of a defense lawyer's undertaking normally encompasses only the defense of a liability claim. Consequently, for an interest conflict to exist between a carrier and a policyholder, there must be a substantial risk that a step taken to advance the defense of the carrier or policyholder would impede the defense of the other.

Some commentators and cases contend that all contested coverage cases contain tensions of this sort.78 This is not so. The existence of a coverage disagreement often adds little or nothing to the conflict potential of a representation that is limited to the defense of a liability suit. This is the case when the facts upon which the existence of coverage depends have nothing to do with the liability claim and will not be adjudicated in the liability suit. Consider a personal injury case stemming from an automobile accident in which an insurer, although providing and paying for a defense, reserved the right to deny coverage: because the policyholder cancelled the policy and stopped paying premiums before the accident occurred. If the clients' only interests are minimizing the loss to the claimant and those relating to coverage, no conflict is possible. There is no action for a defense lawyer to take when defending one client that could possibly cause the lawyer to defend the other less successfully. Actions reasonably calculated to minimize the expected loss in the liability action could only make both clients better off.

A leading treatise on legal malpractice agrees:

Objectively, a conflict exists when the issue upon which the clients' interests diverge is within the scope of the attorney's retention. The dilemma is that competent representation of one client on the issue necessarily will be adverse to the interests of the other. A coverage issue rarely presents an objective conflict of interests if counsel's retention is limited to defending the liability claim.79

To leap from coverage disagreement to conflict of interests is to move too quickly from premise to conclusion. In our judgment, jurisdictions that employ the "reject the defense" doctrine commit this error. Not all coverage contests create ethical conflicts for defense lawyers. Therefore, when a carrier reserves its rights, the need for an independent counsel regime need not arise because ordinary defensive arrangements may be employed. States that entitle policyholders to demand independent counsel in all contested coverage situations read lawyers' conflict rules too broadly.

The example used at the start of this section presents a harder case. There, a showing that an employee was acting outside the course and scope of his employment when an accident occurred would defeat the first theory of liability against the policyholder but not the second. The trouble is that the second theory is not covered by insurance. Successful use of the "course and scope" defense

could therefore leave the policyholder to face the second theory without the benefit of a paid defense or indemnity protection.

One could argue that even this predicament does not create a conflict for a defense lawyer, the reason being that the lawyer has no duty to protect the policyholder's interest in maintaining insurance coverage. A defense lawyer's engagement is limited to defending the liability. Because the lawyer has no coverage-related responsibilities, it would seem to follow a fortiori that coverage-related duties extending to Client A could not possibly limit the lawyer's ability to provide a zealous defense for the benefit of Client B. On the duty/representation conceptualization discussed above, even this coverage dispute seems not to generate a conflict because a defense lawyer has no coverage-related duties.

If valid, the argument just made would lead to the conclusion that no conflict exists even when coverage and liability actions are related. Suppose, as in Table 1, that the carrier could increase its chances of winning the coverage action from 50% to 80% by choosing Defense Strategy A, but that Strategy B minimizes the expected loss at trial. On the duty/representation approach, no conflict seems to exist because the defense lawyer has no duty to take account of the coverage-- reducing potential of Strategy A. The lawyer's job is to defend both clients zealously, which the lawyer does by recommending Strategy B and minimizing the payment to the tort plaintiff. No coverage-related duty to either client could possibly prevent the lawyer from doing this because the lawyer has none. For the same reason, the lawyer could recommend the liability-minimizing strategy even if that strategy endangered the existence of coverage for the insured.

On the facts just described, most courts and commentators would conclude that a conflict exists. They would say that the lawyer must refrain from taking a step that would adversely impact the policyholder's interest in maintaining coverage unless the policyholder gives informed consent. They would not say that the lawyer may ignore this interest merely because the scope of the representation encompasses only the defense of the liability suit.80 On the two-clients view that we endorse, they would reach the same conclusions vis-a-vis the carrier.

The majority view is correct, we now believe, for a subtle reason. It is true, indeed canonical, that a lawyer's duty is to advance a client's interests as a client defines them. It also is true that the agreed object of a joint defensive representation is to advance the clients' shared economic interest by minimizing the loss. Yet, it does not follow that the propriety of a defense lawyer's conduct is always to be assessed by asking whether the lawyer acted in a manner reasonably calculated to realize the identified goal. This is the malpractice standard, not the

standard for determining whether a lawyer acted disloyally. An action that is reasonably calculated to achieve the object of a representation can be disloyal.

To be clear, the duty of loyalty does connect to the scope of a representation. Only when acting within the defined scope must a lawyer consider the impact an action may have on a client. But the range of interests that a lawyer must respect encompasses both the primary interest in achieving the agreed goal of a representation and other, secondary interests as well. A policyholder's interest in preserving coverage and a carrier's interest in defeating it are secondary interests. They are not the interests defense lawyers sign on to advance. But they are interests nonetheless. Consequently, when acting within the scope of a defensive representation, defense lawyers must respect them. They must not knowingly act in ways that endanger clients' coverage-related interests without informing clients and obtaining consents.

We can now return to the example that opened this discussion with hope of finally determining what the lawyer should do. Recall that the first theory of liability can be defeated by showing that an employee caused an accident while acting outside the course and scope of his employment, and that the second theory will survive this showing and is not covered by insurance. Eliminating the first theory would therefore leave the policyholder in court but without a paid defense or liability coverage. Because the step of asserting the affirmative defense is one the lawyer would take when acting within the scope of the professional engagement, an adverse affect on a secondary (coverage-related) interest implicates the duty of loyalty. The step may be reasonably calculated to minimize the loss to the claimant, but it may be disloyal even so. Knowing of the coverage-related risk to the insured, the lawyer should refrain from asserting the defense unless and until the insured's informed consent is secured.

That the conflict can be waived is clear. As a general matter, professional responsibility law prohibits few concurrent client conflicts per se. About the only thing it completely forbids a lawyer from doing is representing clients who are on opposite sides of the same lawsuit. Other conflicts can be waived with clients' informed consent, as long as a lawyer reasonably believes that both clients can be represented effectively.81

Here, the possibility of representing both clients effectively is patent. The act of asserting the affirmative defense furthers the goal of minimizing the loss to the claimant. It therefore advances an interest that a client may rank above the interest in preserving coverage. Whether the client does so is a question of fact.82

The Cumis statute confirms the waivability of conflicts that trigger a right to independent counsel. It provides specific language for policyholders to use when forsaking the right to independent counsel in these situations, and it places no

limits on the contexts in which the right may be waived. For reasons previously explained, the statute should not contain this provision. Lawyers' codes, not insurance law, govern the waivability of ethical conflicts. For present purposes, though, the important point is that the statute preserves the option that exists under the professional responsibility rules of waiving the conflict and using customary defensive arrangements, including dependent counsel.

D. WHAT MUST DEFENSE COUNSEL KNOW ABOUT COVERAGE?

In the preceding discussion we assumed that the lawyer understood the impact the affirmative defense could have on the existence of coverage for the insured. This assumption freed us from having to consider an issue that, despite being exceptionally important, is never discussed: What, if anything, must a defense lawyer know about insurance? Anyone familiar with the debate over defense lawyer's responsibilities should recognize the importance of this question. If defense lawyers must protect policyholders' interests in maintaining coverage, must they also know enough insurance law to spot coverage dangers and avoid them? On the other hand, if defense lawyers need not know about coverage, how can they be liable for failing to respect the coverage-related interests of carriers and insureds?

In this section, we will make two points. First, as a general matter, a defense lawyer has no duty to know anything about insurance law or coverage. A defense lawyer's job is to handle a liability suit; consequently, he or she need only know things that bear on this task. Second, defense lawyers often have actual knowledge of coverage risks, and this knowledge requires them to warn clients before taking steps that may harm them. When dealing with policyholders, these warnings should include notice of the possible right to independent counsel.

1. A DEFENSE LAWYER HAS NO GENERAL DUTY TO KNOW COVERAGE LAW OR TO SPOT COVERAGE ISSUES

In principle, every liability suit could be an opportunity for a defense lawyer to apply his or her knowledge of coverage law. Consider a case in which an injured worker sues his employer, alleging violations of a federal tort statute that applies only if the worker was a "seaman."83 The employer notifies the carrier of the suit, and the carrier retains defense counsel to represent the insured and the insurer in the case. Soon thereafter, the general liability insurer realizes that it has a possible defense to both coverage and liability: the worker was not a seaman but a regular "longshoreman." A longshoreman has no right to sue under the federal tort statute but must seek relief via a state-level no-fault workers' compensation scheme. Unfortunately for the employer, the general liability policy does not cover

workers' compensation benefits and the employer has no separate insurance for them. If the insurer wins the liability action by proving that the claimant was not a seaman, the employer will lose coverage and wind up paying workers' compensation benefits with its own dollars.

Many authorities contend that, in a situation like this one, a defense lawyer must protect an insured's interest in maintaining coverage. For this to happen, however, the defense lawyer must know how the seaman/longshoreman determination affects the existence of insurance coverage for the liability claim against the insured.

Must a defense lawyer possess sufficient familiarity with coverage law to spot coverage problems and avoid them? If the carrier decides not to send the policyholder a reservation of rights letter before moving to dismiss the federal tort claim, must the defense lawyer know enough insurance law to identify the threat to coverage?

To answer affirmatively is to assert that a defense lawyer has a duty to know about coverage law. A few authorities seem to reach this conclusion, though without arguing for it. Consider the discussion in the Restatement (Third) of the Law Governing Lawyers of the often-cited rule that a defense lawyer cannot give a carrier adverse, coverage-related information received from an insured:

When there is a question whether a claim against the insured is within the coverage of the policy, a lawyer designated to defend the insured may not reveal adverse confidential client information of the insured to the insurer concerning that question without explicit informed consent of the insured. That follows whether or not the lawyer also represents the insurer as co-client and whether or not the insurer has asserted a "reservation of rights" with respect to its defense of the insured.84

Although the comment requires the lawyer to withhold adverse coverage-related information, it does not say how the lawyer is supposed to recognize this information for what it is. Worse, it even strips away the best source of protection for the lawyer by saying that secrets must be kept even when the insurer has not sent a reservation of rights letter to the insured. Under the comment, there is no safe harbor for lawyers who communicate adverse, coverage-related information to insurers without recognizing its explosive potential.85

When drafting the comment just quoted, the authors of the Restatement apparently assumed that defense lawyers know enough coverage law to recognize adverse, coverage-related information when it comes across their desks. Yet, it is fair to ask, what if a lawyer lacks this expertise? Many defense lawyers know only bits and pieces of coverage law. It is easy for them to miss coverage problems that experts would spot. Moreover, no defense lawyer routinely has access to a policyholder's insurance application. This is a serious difficulty for those who would require defense lawyers to withhold all adverse coverage-related information. The cause of a coverage loss often is a liability-- related investigation that uncovers information that either was not disclosed or was falsified in an insurance application. To protect a policyholder from this fate, a defense lawyer without access to the application would have to withhold an enormous quantity of information from an insurer.86

Although some authorities assume that defense lawyers know coverage law, we see no basis for concluding that they have a legal duty to possess this information. To the contrary, it seems straightforward that a defense lawyer has no duty to study coverage law or to know anything in particular about coverage at all. Matters relating to coverage fall outside the scope of the lawyer's representation of the carrier and the insured. A defense lawyer's job is to defeat a liability claim. To perform this task, a defense lawyer must know many things, but the law of insurance coverage is not one of them. Consequently, neither the duty to provide competent representation nor any other duty requires a defense lawyer to bone up on coverage law or to master coverage-related facts.

The basic legal point is clear. The duty of competence, also called the duty of care, extends only to matters that fall within the scope of the representation. Section 16 of the Restatement (Third) of the Law Governing Lawyers repeats states this explicitly. It requires a lawyer to "act with reasonable competence and diligence" but only "in matters within the scope of the

representation."87 Defense lawyers sign on to defend lawsuits in which liability is claimed. They do not agree to provide coverage advice, and they can minimize losses to claimants without knowing anything about coverage at all. Lawyers retained by defendants on a first-party basis do this every day. The duty of care only requires defense lawyers to educate themselves sufficiently to handle defense-related tasks.

One could generate an affirmative duty to know about coverage by showing that, to provide a competent defense, defense counsel must know about the potential coverage issues in a case and be able to handle them. But it is difficult to think of any systematic way in which knowledge of coverage issues could enhance a lawyer's ability to defend a liability claim. How would knowing what the insured disclosed or did not disclose when applying for insurance help reduce damages or liability? How would knowing whether the insured paid premiums when due affect this? How could the timeliness of the policyholder's notice to the insurer bear on the defense? Facts and law bearing on the existence of insurance coverage can have nothing to do with the merits of liability claims. This may explain the absence of any case holding that the duty of competence requires a defense lawyer to know about coverage.

In practice, when coverage disagreements arise, the task of defending the claim is given to one lawyer while that of assessing coverage is assigned to others. Both the carrier and the policyholder make this separation and then pit their coverage lawyers against each other, leaving the defense lawyer completely outside the coverage case.88 This practical separation reflects the underlying analytical distinction. Liability is one thin; coverage is something else.

The argument thus far has shown that the duty of competence does not require defense lawyers to learn anything in particular about insurance coverage. From this it follows that a lawyer who inadvertently compromises either client's coverage-related interests while acting in a manner reasonably calculated to advance the defense should bear no liability to the client who is harmed. For example, suppose that a defense lawyer sends an insurer an answer to an interrogatory in which a policyholder admits that a vehicle was being used for business purposes. Shortly thereafter, the carrier withdraws coverage, claiming fraud in the application. Unbeknownst to the lawyer, the policyholder stated that the vehicle was used exclusively for personal transportation when applying for

insurance. The lawyer should owe the policyholder nothing because the act of communicating the information was reasonable given the lawyer's assignment-- the defense of the liability suit.

We do not deny that policyholders and carriers have legitimate coverage-- related interests that they may want to protect and concerning which they may desire legal services. We assert only that it is not a defense lawyer's job to provide these services and, therefore, that a defense lawyer need not be a competent coverage lawyer. When the principals desire legal representation on coverage, they must hire other attorneys.

Many people want defense lawyers to provide coverage-related services for insureds because they believe that insureds cannot afford to purchase this advice separately. This humanitarian impulse is laudable, but efforts to implement it via defense lawyers are not. There should be arrangements to protect vulnerable policyholders when carriers wrongfully withhold insurance benefits. And, in fact, there are. However, these arrangements do not operate via defense lawyers. They involve regulators, who make and enforce requirements for companies engaging in the business of insurance. They also involve plaintiffs' lawyers, who handle bad faith and other consumer protection cases. This is as it should be. To defend liability suits effectively and efficiently, defense lawyers must enjoy the trust and confidence of insurers and insureds. If they focus on minimizing payouts to liability claimants, neither carriers nor policyholders will have reason to question their sincerity. But once they become coverage advocates, their character and their judgments will become suspect.

The duty of loyalty, as an alternative to or in combination with the duty of competence, also could require attorneys to learn coverage law and facts. In the preceding section we recognized that some disputed coverage cases create conflicts that must be disclosed. How are defense lawyers to identify these conflicts and educate clients appropriately without becoming coverage experts? Might a coverage-ignorant defense lawyer who misses a conflict be considered incompetent?

There is little authority linking the duty of loyalty and the duty of competence in the manner just suggested, and none of it is specific to insurance defense.89 The Model Rule that sets out the duty of competence does not mention the duty of loyalty; nor does any such reference appear in the official comments to the rule. The Model Rules governing conflicts return the favor by ignoring the duty of competence. Neither the conflict rules nor their comments discuss it. The Restatement (Third) of the Law Governing Lawyers repeats this pattern of separation. It lists the duty to "avoid impermissible conflicting interests" and the duty to "[a]ct . . . with reasonable competence" in separate sub-parts of its

statement of lawyers' duties to clients in general, and neither the general statement nor the specific provisions connects them.90

Some conflict rules do condition their prohibitions on knowledge, however. Examples include Model Rules 1.8 and 1.9, both of which prohibit lawyers from "knowingly" performing certain acts. Curiously, though, the Model Rules' general conflict rule, which applies to concurrent multiple-client representations, omits this limitation. The asymmetry is not explained. The Restatement is more consistent. The comment to sec 121, entitled "Basic Prohibition of Conflict of Interest," establishes a knowledge condition that applies across the board. The comment provides that "[t]he propriety of a lawyer's action should be determined based only on facts and circumstances that the lawyer knew or should have known at the time of undertaking or continuing a representation. It should not be evaluated in light of information that became known only later and that could not reasonably have been anticipated."91 Unfortunately, the comment does not say whether the "should have known" standard requires a defense lawyer to be sufficiently expert in insurance coverage to spot particular conflicts.

Ordinarily, one would interpret this "should have known" standard by saying that, when it comes to coverage issues, individual defense lawyers must display the degree of "skill and knowledge normally possessed by members of [their] profession."92 In this particular context, this approach is troubling. Many defense lawyers specialize in particular liability areas. They handle predominantly automobile accident cases, medical malpractice cases, admiralty cases, or cases of some other kind. Consequently, their knowledge of insurance tends to be limited to aspects that are relevant to the areas in which they practice. Lawyers who defend environmental cases may know all about the limited and absolute pollution exclusions, but lawyers who handle professional malpractice cases predictably will not. To complicate matters further, some defense lawyers intentionally keep themselves ignorant of insurance issues. They justify doing so on the ground that they do not want coverage-related matters to distract them from defensive concerns. Finally, there are large areas about which most defense lawyers are ignorant. Few have access to information contained in insurance applications, premium payment histories, claim histories, notices of occurrences, or other aspects of policyholders' ongoing relationships with insurers. Even insurance contracts themselves may not be received or may arrive long after

representations commence. The core of insurance-related knowledge that all experienced defense lawyers possess at all times probably is very small.

It is difficult, then, to generate a general obligation on the part of defense lawyers to know anything in particular about insurance law or insurance-related facts. Neither the duty of competence nor the duty of loyalty establishes one. Because defense lawyers collectively know so much about insurance, this conclusion may be surprising. Yet, we all learn many things that we have no duty to know. No case holds that defense lawyers have a duty to be generally educated about coverage, and no case should.

2. A DEFENSE LAWYER WHO KNows ABOUT A COVERAGE ISSUE SHOULD ALERT A CLIENT

Although defense lawyers can minimize losses to claimants without knowing coverage law or being otherwise able to spot coverage issues, many know something about coverage law and have some ability to appreciate the importance of coverage-related facts. Some defense lawyers even have coverage practices on the side or work with lawyers who do coverage work. Consequently, the possibility of actual knowledge must be admitted and its importance assessed.

Actual knowledge is important, first, for the reason explained above. A lawyer who knows that a defense-related act poses a coverage-related risk to a client, be it a policyholder or an insurer, would violate the duty of loyalty by acting without the client's informed consent. This is so even if the act is reasonably calculated to minimize the loss at trial.

Actual knowledge also can be important for another reason. Although it is true, as we previously explained, that a lawyer has no duty to deliver services falling outside the scope of the representation, a lawyer who knows that a client has an unmet legal need should alert the client to it and advise the client to get help.

A California appellate court dealt with these issues in Nichols v. Keller,93 a legal malpractice case in which the plaintiff contended that the defendants failed to advise him of the possibility of asserting tort claims in addition to a claim for workers' compensation. The court concluded that the plaintiff stated a cause of action even though the lawyers had agreed to handle the workers' compensation claim only. "[E]ven when a retention is expressly limited," the court concluded, the attorney may still have a duty to alert the client to legal problems which are reasonably apparent, even though they fall outside the scope of the retention. The rationale is that, as between the lay client and the attorney, the latter is more qualified to recognize and analyze the client's legal needs. The attorney need not represent the client on such matters. Nevertheless, the attorney should inform the client of the limitations of the attorney's representation and of the possible need for other counsel.94

A defense lawyer who spots a coverage issue, be it one that favors the carrier or the insured, is in the same position as any other attorney who observes that a client has an unmet or even unrecognized legal need. If another lawyer would have a duty to bring such a discovery to a client's attention, a defense lawyer does too. Defense lawyers are subject to the ordinary rules of professional responsibility.

The duty to warn clients about unmet legal needs thus flows from the duty to give information, not from the duty of care. As explained previously, the duty to communicate requires an attorney to tell a client everything the client reasonably needs to know to make informed decisions regarding the representation. One such decision concerns the scope of the lawyer's undertaking. Should it remain the same throughout a representation or change? To answer, a client must understand the consequences of inaction, one of which is that a particular lawyer will not address a particular legal need.

Moreover, although lawyers understand that their engagements are limited, many clients do not. Indeed, when it comes to policyholders' misunderstandings, coverage is hardly unique. A policyholder facing multiple suits may think that a single defense lawyer will handle all of them when the lawyer was hired to defend only one. A policyholder facing related civil and criminal proceedings may not realize that insurer-appointed defense counsel will not defend the criminal case. A policyholder with claims against others may mistakenly expect a defense lawyer to assert them. Telling a client about an unmet legal need often is a valuable way of helping a client understand what a lawyer will and will not do.

The duty to warn is neither onerous to fulfill nor a serious source of exposure to liability. It applies only when a lawyer actually knows that a client has a legal problem that the lawyer has not been retained to handle and that, insofar as the lawyer is aware, the client has taken no steps to address. Much of the time, educating the client will be more nearly a pleasure than a duty. If the client likes the lawyer, the client may ask the lawyer to do the additional work.

If the duty to educate depends upon the possession of actual knowledge of a client's legal needs, then insurance defense lawyers will often have to remind clients that they are retained only to defend cases. As stated above, some defense lawyers know a lot about insurance coverage and can spot coverage issues well. And all defense lawyers can identify situations in which policyholders may have counterclaims or other affirmative claims that defense lawyers are not engaged to handle. In these situations, defense lawyers should identify the issues and tell policyholders that they must employ other attorneys or come to a separate agreement with defense counsel concerning them.95 We reserve for later the

question of whether the duty to communicate requires a defense lawyer to share the information at issue with the other client, be it the carrier or the insured.

E. INITIAL COMMUNICATION WITH THE INSURED

In Part III, we determined that a coverage contest may or may not create an interest conflict for a defense lawyer. The existence vel non of a substantial risk of an adverse effect on the representation of a client is a question of fact particular to a given case. Speaking generally but without meaning to prejudge the conclusion on a particular set of facts, the likelihood of a conflict is greater when the liability action and the coverage action are connected than when they are discrete. When a decision to employ one defensive strategy rather than another can influence the odds of winning the coverage case, the inference that a conflict exists will be hard to resist.

Because not every coverage disagreement creates a conflict for an attorney, a defense lawyer need not obtain an informed conflict waiver every time a carrier reserves its rights. Regardless, a lawyer should always communicate with an insured after being retained. Lawyers' codes and agency law require an attorney to give a client all the information reasonably needed to make educated decisions regarding the representation.96 One such decision is whether to accept or reject representation by carrier-appointed defense counsel on the stipulated terms. To make this decision intelligently, a policyholder must know the terms.

By saying that a lawyer must communicate information to an insured, we do not imply that an insured must be asked to waive anything. No waiver is required absent a conflict. The only question is whether the insured wishes to proceed with the representation as it was structured when the carrier and the lawyer created it. If the insured wants to continue, fine. Otherwise, if the policyholder rejects the

defense, the lawyer must withdraw. The lawyer must give the insured sufficient information to make this decision.

What information should the lawyer provide? The general answer is: everything of importance relating to the engagement. This includes several matters that have been discussed already: the fact of being hired by the carrier; the goal of minimizing the payment to the liability claimant; the identity of the client(s); the agreement to look to the carrier instructions; the carrier's financial responsibility for legal fees and expenses; and the duty to refrain from favoring one client over the other. It also includes matters taken up below. One is the "no secrets" rule requiring defense counsel to give the carrier all information relevant to the investigation, defense, or settlement of the liability action, regardless of the source from which it is received. Another is the right to independent counsel. Having described the law governing this right above, we turn to it directly.

F. INFORMING THE INSURED ABOUT THE POSSIBLE RIGHT TO INDEPENDENT COUNSEL

Most jurisdictions require insurers to provide independent counsel-counsel who represents only the insured-in some or all contested coverage cases. It remains to consider what, if anything, a defense lawyer should tell a policyholder about the independent counsel option after being retained.

Having concluded above that a defense lawyer has no duty to know anything in particular about insurance law, a logical implication would seem to be that a defense lawyer has no duty to educate a policyholder about the independent counsel option. How can a defense lawyer have a duty to provide information that the lawyer is not obligated to know?

The conclusion that a defense lawyer can be ignorant of insurance law was reached when examining the duties of competence and loyalty. The duty of competence did not require insurance expertise because a lawyer can defend a liability suit without it. The duty of loyalty did not require it because the core of knowledge that most or all defense lawyers have about insurance law is narrow.

The duty at issue here is the duty to communicate, which requires a lawyer to be an educator. A lawyer must tell a client everything the client reasonably needs to know to make an informed decision regarding a representation,97 and the decision to accept or reject representation on the terms offered by a carrier is a policyholder's to make. Obviously, an insured would reasonably want to know about alternative arrangements that might be offered if the first offer were rejected. Consequently, an insured would want to know about the duty to provide

independent counsel. It is one thing to be left out in the cold after rejecting a standard defense; it is something else entirely to be outfitted with a new lawyer whom one directly controls.

Unfortunately, the contours of the duty to appoint independent counsel are not always clear. They vary from state to state, and they are not fully developed in some jurisdictions. To determine whether a carrier would have to appoint independent counsel for a particular policyholder in a particular situation, a defense lawyer could have to make a legal or factual investigation. This possibility raises several practical issues. Must a defense lawyer acquire information about the independent counsel right so as to be able to educate an insured? If so, must a carrier pay a defense lawyer for the time this inquiry requires? If not, may a defense lawyer bill an insured, or must the lawyer provide the service for free? Moreover, even after studying the matter a defense lawyer may make a mistake. Carriers, not defense lawyers, decide whether independent counsel will be engaged. A defense lawyer who advises a policyholder that a carrier will appoint independent counsel must expect to be drawn into a rancorous debate if the carrier fails to come through.

A way out of this conundrum comes into view when one focuses on what defense lawyers actually know, as opposed to what they are required to know. Although few defense lawyers are coverage experts, most know that when a carrier reserves its rights to deny coverage, a right to independent counsel sometimes exists. They may not be able to describe its contours very well, but they know that policyholders sometimes are entitled to it. Consequently, and building upon the idea that actual knowledge fosters a duty to warn, one could plausibly contend that when coverage is contested, defense lawyers should tell policyholders that a right to independent counsel may exist while also advising them to obtain advice on the matter from someone else. It would be hard to fault a lawyer for handling the issue this way.

The shift to actual knowledge provides an easy answer but not a completely satisfying one. One really wants to know whether defense lawyers have a duty to know about the independent counsel option, at least to the point of being able to tell policyholders in contested coverage cases that the option may exist. Although the matter is hardly free from dispute, cases like Nichols v. Keller require an affirmative answer. These cases hold that the duty to communicate is broader than the duty of care: the latter is limited to matters within the scope of the representation; the former extends to a client's legal needs more generally. It is especially likely to apply when a client's needs relate to the scope of the representation (without actually falling within it) and are of a sort that lawyers in a particular practice area encounter frequently. It being easier for the lawyer than the client to recognize the client's legal options and unmet needs, the duty to communicate requires a lawyer to provide readily available information that a client reasonably needs to know, even when the needs at issue are not those the lawyer agreed to handle.

While recognizing the existence of this responsibility, the limiting language of Nichols must be appreciated as well. The duty to alert a client to a legal option or an unmet need requires only a warning. A lawyer must tell a client, for example, that the client may have tort claims against third parties as well as a claim for workers' compensation. The lawyer need neither evaluate the strength of the tort claims nor agree to handle them. Being limited in these ways, the duty to warn ordinarily will require a lawyer to pass along information that a typical lawyer in a given practice area is likely to know. It should not require special education, in other words. The duty to warn should not require lawyers to know about options and needs that, being unrelated to their practice areas, require specialized knowledge that they do not ordinarily possess.

To satisfy this limited duty to warn, a defense lawyer must know that a carrier has reserved its rights to contest coverage or issued a coverage denial. Consequently, a defense lawyer should routinely ask an employing carrier to send a copy of any reservation of rights letter along with the case file. This guideline makes sense for several reasons. First, a reservation of rights letter is a signal that a defense lawyer should obtain an insured's ratification to the terms of the representation. Even when ratification is not needed because an insured did not request an independent defense, by reviewing the terms of the engagement a defense lawyer will gain a layer of protection against a malpractice charge. Second, by reading a reservation of rights letter, a defense lawyer may learn that a carrier agreed to provide independent counsel. If the lawyer believes that both the carrier and the insured are clients, this information will establish that someone is confused. The lawyer will then be in a position to revisit the terms of the representation with both clients and come to an accurate understanding.

Third, and finally, a reservation of rights letter is a "conflicts clue," i.e., an indication that one of the clients, or both, may have special interests in the conduct of the defense. Having stated above that a coverage contest does not an ethical conflict make, we understand that this point requires some explaining. The essential insight is fairly simple: Although a coverage dispute does not prevent a lawyer from defending a policyholder and a carrier concurrently, ethical conflicts arising in the course of the representation may have this effect, and the disagreement over coverage makes it more likely that such conflicts will arise. We discuss this point further below.

V. A LAWYER'S DUTIES DURING THE DEFENSIVE REPRESENTATION

In previous discussions we showed that a joint defense is permissible in a contested coverage case, although a conflict waiver may be required. In this section, we examine defense counsel's duties during the joint representation. We begin by observing that a carrier and an insured may have no disagreements. Even a "substantial risk" of an adverse effect (when there is one) will not always prevent a representation from proceeding harmoniously. Consensus may even be more likely when coverage is contested than when it is full because both the carrier and the insured will have incentives to reduce the claimant's recovery. In full coverage cases, insureds can be difficult to motivate because they have little or nothing at stake.

Still, the possibility of disagreement in contested coverage cases cannot be gainsaid. This is partly because, as explained in Part ILB, the conflict sources that operate in full coverage and excess exposure cases may foment dissension in contested coverage cases too. An insured may disagree with a carrier's approach to defense or settlement because the insured sympathizes with the plaintiff, has a familial or business relationship with the plaintiff, fears reputational damage, is afraid to testify, or fears an excess judgment.98 Having discussed how lawyers should handle these conflicts in prior works, we merely note them here.

A. CONFLICTS STEMMING FROM COVERAGE-RELATED SOURCES

Certain conflicts are unique to lawsuits in which coverage is disputed. The connection between liability and coverage is the source of many of these. As already explained, when liability and coverage are related, a carrier may be able to manipulate the defense in a manner calculated to improve its chances of prevailing in the coverage dispute. Strategizing of this sort is inconsistent with the duty to defend, which requires a carrier to seek to minimize the loss to the liability claimant.

Suppose a defense lawyer determines that additional depositions are needed to prepare for trial and recommends taking them. Now suppose that the carrier, which is controlling the defense, denies the request, claiming the cost of additional discovery exceeds the likely gain. In a full coverage case, this decision would not be troubling because only the carrier's money would be at risk. However, because coverage is contested, an error in judgment committed by the insurer may mean a larger loss for the insured. The possibility also exists that the carrier's decision is wrong but not "mistaken." As in the example described by Table 1, the carrier may intentionally choose an inferior defensive strategy that minimizes its expected loss by maximizing its prospects in the coverage case. When coverage and liability overlap, a carrier's real reason for denying the request for depositions may be to avoid gathering testimony that will help the insured in the coverage dispute.

In the example just described, there are two sources of danger for the insured. First, the policyholder may suffer if the carrier makes an innocent mistake. Because the odds are less than one hundred percent that the loss is covered, any error in judgment that increases the expected loss at trial also increases the expected payment from the insured. Second, strategic abuse of control may harm the insured even if the expected loss at trial remains unchanged. By taking a step

in the liability suit that improves its chances in the coverage case, an insurer shifts exposure from itself to the insured, again increasing the insured's expected loss.

The combination of dangers bears on the responsibilities of the defense lawyer. To protect an insured adequately, it is not enough for a defense lawyer to keep an eye out for acts of strategic abuse. Although strategic conduct matters to an insured, other conduct does too. When coverage is disputed, an insured has a financial interest in every decision a carrier (or a lawyer) makes.

The focus on strategic conduct is too narrow for another reason. In a disputed coverage situation, neither an insurer nor a defense lawyer (nor a policyholder, for that matter) has economic incentives that correlate precisely with changes in the expected judgment.99 Moreover, the corrosive effects of defective incentives on judgment can be hard to spot. Decision makers, including professionals, are likely to regard both their judgments and their motives as sound long after defective incentives have done their work.100

Because all decisions can be second-guessed and a policyholder's interest in all decisions is heightened, it makes no difference whether good judgment, bad judgment, or strategic thinking led the carrier to reject the lawyer's request to take depositions. What matters is that the decision has the potential to affect the insured. Moreover, this would be true if the carrier had come down the other way and authorized additional discovery. The policyholder might be better off without the depositions than with them. The witnesses' statements could strengthen the liability case or weaken the prospects for a finding of coverage.

When a carrier agrees with a defense lawyer, the possibility of error does not disappear. Two heads may be better than one, but even they are not infallible. The possibility of strategic abuse also remains. Although we have great regard for defense lawyers and have found that they strongly desire to protect insureds, the possibility of collusion, tacit or express, between a defense lawyer and an insurer cannot be excluded. Nor can the possibility of harm be eliminated even when a defense-related decision is sound.

Because a policyholder has an interest in every decision, a lawyer should communicate with an insured much more fully when coverage is contested than when it is admitted. It is not enough, in our judgment, for a lawyer to alert an insured when the lawyer thinks the controlling carrier blundered or acted

strategically. The lawyer should communicate with the policyholder as often and as fully as with the insurer because each client's money is on the line. By keeping the policyholder "in the loop," the defense lawyer enables the policyholder to complain about any decision that it dislikes.

The lawyer also should be candid with both clients about the reasons supporting his or her recommendations and should limit these reasons to defense-related concerns. If and when additional depositions and other defensive measures have the potential to reduce the expected loss at trial, the lawyer should recommend them and explain why. Otherwise, the lawyer should reject options that are likely to cost more than the value they return.

By focusing ruthlessly on the defense and communicating frequently and clearly with both clients, a defense lawyer does the job he or she agreed to perform. A defense lawyer also may reduce the likelihood of disputes between a carrier and an insured who may be suspicious of each other's motives when a defense is qualified. Although they share an interest in defeating the claimant, they have opposing interests in the allocation of any loss (including defense costs in jurisdictions that allow fee recoupment). Consequently, their need for a trustworthy and objective defense attorney is especially dear. Such a lawyer can add a valuable element of stability to a co-client relationship.

Even if a lawyer is a tower of strength, independence, and objectivity, a carrier and a policyholder still will disagree over the conduct of the defense occasionally. The carrier may agree with a defense lawyer and the policyholder may dissent. The policyholder may agree with the lawyer and the carrier may dissent. Or, both may disagree with the defense lawyer (and agree or disagree with each other, as the case may be). How should a defense lawyer act in these situations?

The first thing a defense lawyer should realize is that a disagreement over litigation tactics is not the end of the world. Differences of opinion in multiple client representations are as common as grass and usually no more dangerous. When they arise, a lawyer should educate the clients and listen to their views. Usually, the frank recognition and discussion of a disagreement sets in motion a process of refining opinions and reaching a consensus on the course of action to pursue. Defense lawyers can and should play leading roles in this process. Their training and experience enable them to understand many issues better than the clients. They also can be more dispassionate and objective than the clients because they do not stand accused of wrongdoing and their money is not on the line.

When talking over disagreements, a defense lawyer may side with one client and against the other. Although the observation may seem banal, a defense lawyer does not violate the "no subordination rule" (NSR) by doing so. By taking a position, a defense lawyer attempts to help both clients find a way to achieve the goal they share, namely, minimizing the trial loss. No duty to either client prevents a defense lawyer from being open and honest, even though this frequently means saying that, in the lawyer's judgment, one client is right and the other is wrong. To the contrary, the duty to offer each client the benefit of his or her independent professional judgment requires this.

The educational process will resolve many disagreements. Either the client or the lawyer may change their minds. Bad faith law makes agreement even more likely when a defense lawyer offers clear and cogent reasons for a recommendation-an insurer will think twice before rejecting a reasonable recommendation because a record of having overruled the lawyer could hurt it in a bad faith case.

The educational process can continue until a decision is required. For example, a deadline for deposing witnesses may be imminent, and a decision on whether to take additional discovery may have to be made. This is when push comes to shove. A course of action must be chosen despite the clients' inability to come to terms.

A defense lawyer's primary objective in this situation should be self-- protection. Having thoroughly assessed the pros and cons of the available options and communicated a recommendation to the clients, the lawyer will have taken the most important steps in the direction of satisfying the duty of care. An obvious further step is memorializing the basis for the recommendation and the effort to educate the clients, if this has not yet been done.

To guard against a charge of disloyalty, a defense lawyer must refrain from acting to a client's detriment without obtaining informed consent. The precise manner of addressing this problem depends on the facts. For simplicity, we assume that the carrier has rejected the lawyer's recommendation, as in the example involving the depositions, and that, in the lawyer's opinion, the carrier's preferred course of action endangers the insured. In this situation, the lawyer should seek the policyholder's informed consent before allowing the deadline for deposing the witnesses to expire. If consent is not forthcoming, the lawyer must withdraw.

We considered an analogous problem in our article on excess exposure situations. The question was: How should a defense lawyer act when a carrier's conduct of the defense exposes a policyholder to an enlarged loss at trial? We answered as follows:

A defense lawyer who believes that an instruction received from an active co-client may harm a passive co-client has the same duty that any other lawyer would have in this situation, namely, the duty to tell the endangered co-client and to obtain his or her informed consent before proceeding.

If a defense lawyer believes that a carrier's strategy choices expose a policyholder to harm, the lawyer's duty is clear: inform the policyholder and advise the policyholder to get separate counsel before doing what the company wants. The lawyer should not second-guess the carrier's decision for the benefit of the insured but should instead act as the carrier instructs unless the policyholder says nay.... If the policyholder objects, the lawyer should refrain from acting and let the two clients sort out the matter for themselves.

This is a straightforward application of the ordinary conflict rule, which prevents a lawyer from acting to a client's detriment without first obtaining his or her informed consent.101

We hold the same view of a defense lawyer's responsibilities in a disputed coverage situation. When a defense lawyer believes that a carrier, by rejecting a defensive recommendation, increases the expected loss at trial and thereby exposes a policyholder to harm, the lawyer should obtain the insured's consent before proceeding.

In relevant respects, excess liability cases and disputed coverage cases pose similar difficulties. In both, there is a risk that the insured will wind up paying the claimant. In an excess liability situation, the insured is responsible for any part of the judgment that exceeds the policy limits. When coverage is disputed, the insured may be responsible for the entire trial loss. Consequently, in both situations a decision by a carrier that increases the expected loss to the claimant threatens the policyholder with harm. Before conforming to the carrier's wishes, a defense lawyer should therefore notify the policyholder of the risk and let the policyholder decide whether to allow the lawyer to proceed.

After hearing from the defense lawyer, the policyholder may well ask the defense lawyer for advice on the conflict waiver. In our article on excess exposure, we recommended that the lawyer "advise the policyholder to get separate counsel before doing what the company wants."102 We renew the recommendation here. A defense lawyer is free to tell a client anything the client wants to know about the predicted impact of a decision on the outcome of a liability suit. But a defense lawyer should not help a client decide whether or not to waive a disagreement over the course of action to be pursued. By doing so, a lawyer puts at risk the very protection he or she seeks to gain, for the client can always claim to have been unduly influenced by the lawyer when making the decision.

The claim of undue influence will seem more plausible when one considers that a policyholder's refusal to waive a conflict forces a defense lawyer to withdraw from representation. Withdrawal ends the flow of fees from the carrier. Consequently, a lawyer who encourages an insured to waive a conflict can be painted as having acted for selfish reasons in a subsequent action alleging disloyalty.

A final reason for maintaining distance is that the decision to waive the conflict may have coverage-related implications. Although few cases address the relevant points, the insured's duty to cooperate and the carrier's right to control the defense relegate the insured to a passive position. By refusing to waive a conflict,

an insured may be found by a court to have become active, in breach of the insurance agreement.103 Obviously, the consequences of violating the insurance agreement can be severe.

A policyholder may not understand the possible coverage-related implications of a refusal to waive a conflict. This is a subject concerning which an insured should receive advice from a coverage attorney, not a defense lawyer. However, a defense lawyer should alert a policyholder to the need for coverage advice, as required by the duty to warn.

What if the policyholder not only refuses to waive the conflict but instructs the defense lawyer to take the depositions and even agrees to pay for them? Although the policyholder's willingness to pay may seem to resolve the deadlock, it really just puts the conflict in a different form. Now, instead of being asked to defend the case in a manner that endangers the insured, the defense lawyer has conflicting orders. The carrier has instructed the lawyer not to depose the witnesses; the policyholder has given the opposite instruction.

Ordinarily, a lawyer who receives conflicting orders from co-clients must withdraw from the representation. Withdrawal is the only course that enables the lawyer to avoid violating at least one client's instruction. Withdrawal also is required when a lawyer is discharged. This is relevant because, as explained in Part IV.A, a defense lawyer is retained with the understanding that the carrier will give orders and the policyholder will not. By instructing the lawyer to take the depositions, the policyholder asserts a power that it does not possess and thereby commits a material breach of the retainer contract.104 Unless the carrier and the lawyer ratify the breach, the consequence is termination. A material breach of a retainer agreement works a constructive discharge.is

Before taking the depositions as the policyholder wishes, then, a defense lawyer must obtain a carrier's approval. This may or may not be forthcoming because the decision turns on more than just the opportunity to obtain additional evidence for free. First, the carrier may worry that the witnesses' statements will

provide ammunition for the claimant in the liability case. Not every witness whose testimony is expected to strengthen the defense turns out to make a positive contribution. Second, the carrier may fear that the policyholder is setting it up for a bad faith claim. If the depositions turn out to have some value, as in all likelihood they will, this will strengthen the insured's argument that the carrier should have paid for them. In a bad faith action, its record of having refused to pay will be a black mark. Third, the carrier may believe that the policyholder is seeking to use the defense to improve its prospects in the coverage dispute. When the liability suit overlaps with the coverage case, in principle both clients can use control of the defense strategically. Needless to say, a defense lawyer should not help a carrier weigh these considerations.

Our discussion of the example involving the depositions contains a recipe for handling conflicts in contested coverage cases more generally. Consider an issue that has received much attention in the literature: May a defense lawyer recommend the filing of a meritorious motion to dismiss a coverage-supporting claim given that the motion, if granted, would leave the insured in court without a paid defense on the remaining uncovered claims?106 In our judgment, the lawyer's position should be dictated by an objective consideration of the defense-related merits. How much will it cost to prepare the motion? How likely is the motion to prevail? What impact will a successful motion have on the expected loss to the claimant at trial? If the merits favor the motion, the lawyer should recommend it. Otherwise, the lawyer should not.

The possibility that the motion may deprive the policyholder of a paid defense should not influence the lawyer's defense-related recommendation, even though the insured may care about this greatly. The shared objective of the joint representation is loss-minimization. A defense lawyer's job is to make recommendations that are reasonably calculated to achieve this goal. The duty to communicate may require the lawyer to alert the policyholder to the possible impact on coverage, and the duty of loyalty may prevent the lawyer from filing the motion if the policyholder objects. However, the duty that governs strategy recommendations is the duty of care, which requires lawyers to make recommendations designed to further clients' objectives as clients define them. The common goal of a defensive representation is to defeat a liability claim. A defense lawyer should therefore recommend strategies with this goal in mind.

This manner of proceeding puts the burden on the carrier and the insured of objecting to the defense lawyer's defense-related recommendations. If the lawyer recommends against filing the dispositive motion but the carrier insists that this

be done, the lawyer's task is straightforward: do as the carrier instructs after communicating with the insured, explaining the defense-related risks, warning of the coverage-related risk, and receiving a conflict waiver. If the policyholder refuses to waive the conflict, refrain from acting, educate the clients about the defense-related merits, and tell them that withdrawal will be the only option if they fail to resolve their disagreement.

If the lawyer recommends filing the motion and the carrier agrees, the manner of proceeding is essentially the same: educate the policyholder about the defense-related merits, warn the policyholder about the coverage-related risk, and follow the carrier's marching orders unless the policyholder objects. In the latter event, continue to educate, refrain from acting until the clients come to terms, and tell them that if they remain at loggerheads, the only option will be to withdraw.

B. POLICYHOLDERS CAN WAIVE COVERAGE-RELATED CONFLICTS

We previously determined that policyholders can waive the conflicts that entitle them to independent counsel at the start of defensive representations. Here we will consider whether lawyers can accept policyholders' waivers of conflicts that arise in the course of a dependent representation in a contested coverage case. An affirmative answer is clearly correct.

According to the Restatement (Third) of the Law Governing Lawyers, a client can waive a conflict by giving informed consent in all but three circumstances: when "the representation is prohibited by law"; when "one client will assert a claim against the other in the same litigation"; and when "in the circumstances, it is not reasonably likely that the lawyer will be able to provide adequate representation to one or more of the clients."107 The first limitation, which applies to a limited number of contexts where laws other than the ethics rules prohibit joint representations, is irrelevant. So is the second. Even when coverage is disputed, no claim runs between the carrier and the policyholder in the suit where they are jointly represented.

This leaves the third restriction, which prohibits a joint representation when "a reasonable and disinterested lawyer would conclude that one or more of the affected clients could not consent to the conflicted representation."108 Because this standard is murky,109 some court somewhere may apply it and find that a

particular defense-related conflict was unwaivable. But this should not occur. First, when a policyholder and an insurer are "sophisticated in the use of lawyers" or "advised by independent counsel," all waivers should be enforced.110 Second, waivers also enjoy a presumption of validity in other contexts. "[I]n most circumstances concern for client autonomy warrants respecting a client's informed consent."111 Third, Comment f to sec 134 of the Restatement expressly gives a defense lawyer the option of obtaining an informed waiver when coverage is disputed. It states that "[t]he lawyer should either withdraw or consult with the client-insured (see sec 122) when a substantial risk that the client-insured will not be fully covered becomes apparent." Section 122 is the waiver provision.

The preceding should convince most readers that carriers and policyholders can waive decisional conflicts in disputed coverage situations. However, courts are highly protective of insureds, and judges are reluctant to enforce waivers that they regard as misguided. It is therefore worth considering the reasons policyholders can have for waiving disagreements.

Some reasons that may motivate policyholders to waive conflicts are insurance-based. As stated previously, standard form insurance policies typically give insurers control of the defense. They also contain cooperation clauses that require policyholders to help carriers investigate, defend, and settle claims. 112 If a court were to construe a policyholder's refusal to waive a conflict as an attempt to divest the carrier of control or as an act of non-cooperation, the decision to withhold consent would jeopardize the existence of coverage.

We are not asserting that a court would read a refusal to waive a conflict this way. To defeat coverage on the ground of non-cooperation, the breach must be substantial and material,ls and it must follow a request for assistance that is fairly precise! 14 Our point is only that the risk of a non-cooperation finding could

motivate an insured to waive a conflict. Some insureds may think it worse to incur even a small risk of losing coverage than to allow a carrier to file a motion for partial summary judgment, to depose a witness, or to take other steps. For them, conflict waivers are rational.

A second consideration is that many policyholders would rather do almost anything other than manage a lawsuit personally. They want, expect, and pay insurers to perform this service for them.115 As one of us wrote previously,

Insureds are likely to find it particularly difficult to select, bargain with, and monitor defense counsel. Most insureds participate in litigation infrequently. Often, they cannot tell bad lawyers from good ones, and they cannot distinguish bad lawyering from bad luck. By contrast, insurance companies are archetypal repeat players in litigation. They see the same kinds of claims over and over. They form long-term relationships with lawyers that encourage lawyers to act responsively, cooperatively, and economically. And they can often tell the difference between misconduct and misfortune. Given a company's relative advantages, both parties profit by giving the company exclusive control over defense counsel.116

Many of these benefits flow to insureds in contested coverage cases, and they are especially valuable to unsophisticated insureds. The tasks of selecting good lawyers, monitoring their performance, and motivating them to produce good results are especially onerous for policyholders who are not litigation-savvy. They also divert policyholders' resources away from the activities that policyholders usually invest them in. Presumably, these lines of business are more valuable to many policyholders than litigation. Why take these burdens upon oneself when, by waiving a conflict, a policyholder can shift them to an insurer?

A third factor that may influence an insured's decision is that the right to independent counsel may or may not exist in a given situation under a particular legal regime. Many states have rudimentary bodies of insurance law under which the right to independent counsel is a gray area. Moreover, in the situations we are considering, the policyholder is thinking of changing horses in midstream, that is, of switching from carrier-controlled counsel to independent counsel after the defense of the liability suit is underway. Consequently, issues involving waiver of the right and the possibility of prejudice to the carrier may have to be considered that do not exist when independent counsel is chosen at the outset.117 Rather than pay for legal advice on the independent counsel right and tolerate the uncertainty associated with efforts to invoke it, a policyholder may prefer to waive a conflict and allow the existing joint defense to proceed.

The main objection to the enforceability of conflict waivers must be that many insureds lack the resources needed to obtain legal counsel on the issues they face and cannot realistically be expected to sort through them alone. The admitted murkiness of insurance law confirms this factual contention. If lawyers may have difficulty reaching firm conclusions on the availability of independent counsel, how can unsophisticated policyholders do better?

The only response needed to this objection is that it is generic. The problems it points to-lack of legal sophistication and insufficient resources to obtain separate counsel-exist in all realms of legal activity. Indeed, they likely are worse in areas like family law, criminal law, and tort litigation (on the plaintiffs' side) than in insurance defense. Yet, as a society we have not prohibited waivers by unsophisticated clients across the board, and it would be unacceptably paternalistic to do so. Consequently, the conclusion that unsophisticated policyholders can waive conflicts in contested coverage cases is the only one to reach.

VI. CONFIDENTIALITY

Thus far, we have written little about the duty of confidentiality,118 even though in discussions of defense lawyers' responsibilities the topic usually receives a lot of ink. The topic also transcends the division between contested coverage situations and others. Even in full coverage cases, defense counsel may acquire information that is adverse to an insured's interests or that an insured does not want disclosed.119

As explained in Part IV.D, an earlier phase of this research addressed the duty of confidentiality in full-coverage contexts. The view expressed there was that insurance defense representations employ a baseline of free and open communication of information bearing on the investigation, defense, or settlement of a liability suit. As a general matter, no co-client is entitled to have a lawyer withhold material information from another.120 There is no reason to make insurance defense representations an exception to this rule.121

It is appropriate to require all lawyers with multiple clients, defense lawyers included, to disclose the "no secrets" rule and to ensure that co-clients understand what they are getting themselves into.122 When coverage is contested, a prudent defense lawyer will obtain and memorialize an insured's ratification of this arrangement. Having been told that secrets will not be kept from an insurer and accepted this arrangement, an insured will later be unable to claim surprise.

The "no secrets" rule applies only to information that is relevant to the objectives of the defensive representation. A defense lawyer who possesses information relating solely to coverage (or solely to any other subject not related to the defense) need not pass it along to either a carrier or an insured.123

Defense lawyers sometimes acquire coverage-related information that also relates to liability, damages, or some other aspect of the defense. For instance, the insured may confess that he wanted to hurt the claimant when he swung his fist. This is when defense counsel's duties seem to clash. The information is relevant

to the defense. It bears on the likelihood of a liability finding and damages. Consequently, it must be communicated. However, if given to the carrier, it also may destroy coverage. Typically, insurance policies do not cover losses stemming from conduct that was intentional.124 The duty of loyalty to the insured client therefore seems to prevent counsel from sharing this information.

Although many authorities have addressed this situation, no consensus has emerged. Some say that a defense lawyer may not reveal adverse, coverage-- related information to the insurer without the informed consent of the insured.125 Others say that counsel must withdraw.126 Still others direct defense lawyers not to withdraw and to withhold the information without telling carriers or seeking their consent.127

The Restatement (Third) of the Law Governing Lawyers seems to take inconsistent positions on this issue. In 60, it forbids a lawyer representing co-clients from withholding relevant information at the request of the communicating client.128 Instead of keeping a secret, the lawyer must withdraw and, when doing so, must exercise reasonable discretion when deciding whether to communicate the information.129 yet, in 134, it requires defense lawyers to withhold coverage-related information from insurers-without waiting for

policyholders to ask and whether or not the information also relates to the defense-and it does not mandate withdrawal.130

For reasons explained previously, a general rule requiring defense lawyers to identify and withhold all coverage-related information from insurers is both unwarranted and unworkable. Defense lawyers are retained to defend liability suits, not to protect interests relating to coverage. Few are coverage experts, and fewer still have access to all the documents that are needed to recognize when information bears adversely on coverage. Defense lawyers also are entitled to charge for legal services, but carriers will not pay them to render coverage assistance to insureds and many insureds either cannot pay or will not, believing that carriers should bear these costs.

In our view, a defense lawyer who knows or believes that defense-related information may also bear adversely on the existence of coverage has a duty to warn the insured of the possible consequences before communicating it to the insurer. This is but a particular application of the general duty to warn discussed in Part IV. The lawyer should then remind the insured about the baseline of open communication, explain that the information will be shared unless the policyholder objects, and advise that separate counsel be brought in to help the insured make this decision. It is important to realize that, whatever the policyholder decides, there are likely to be coverage-related implications. If the information is shared, the carrier may withdraw coverage. If the lawyer is told to withhold the information, a material breach of the cooperation clause may occur and a material breach of the tripartite relationship certainly will.131 Consequently, the defense lawyer will have to withdraw.

Readers who believe that insurance companies reject claims too freely may

object to our approach on the ground that it exposes insureds to wrongful coverage denials. We do not take issue with the predicate factual claim. We do not know whether liability insurers deny coverage too frequently, too infrequently, or about as often as they should. We are not even aware that insurers' track records have been studied rigorously. However, even assuming that carriers wrongly deny coverage hundreds of times every day, we would not change our conclusion. Wrongful denials of insurance coverage are problems to be dealt with by insurance law. The proper agents for monitoring carriers' conduct are regulators and plaintiffs' attorneys acting for policyholders who have bad faith claims. To cast defense lawyers as insurers' monitors would be to distort their role fundamentally. Lawyers are agents. Their job is to advance their clients' interests as their clients define them.132 In the defense context, the interests are those both clients share in minimizing the loss to the claimant. Defense lawyers have no responsibilities relating to coverage.

The concern that carriers deny coverage too frequently is misplaced for a second reason. In both this section and the real world, discussion of the propriety of secret-keeping has proceeded on the basis of the factual assumption that the information at issue bears adversely on the existence of coverage for the insured. Given this, in the cases where secrets might be kept, some basis for a coverage denial necessarily exists. In other words, a decision to deny coverage would not be wholly arbitrary. The cases at issue are therefore ones in which the coverage issue merits close consideration.

In an extreme case, the policyholder may even have intentionally defrauded the insurer. For example, a policyholder might tell a defense lawyer that he or she lied when applying for insurance or when reporting the facts of an occurrence so as to obtain insurance coverage. In such a situation, may a defense lawyer help a policyholder maintain the flow of benefits from an insurance company by withholding information from the insurer-client? We think not. Although the lawyer may not have to communicate the information, at least the lawyer must refrain from assisting the conduct and withdraw. Because some of the benefits of the fraud flow to the lawyer as fees, the danger of being found to be complicit in it should lead any reasonable attorney to follow this course.

VII. SETTLEMENT

In a contested coverage situation, a defense lawyer may or may not have settlement-related responsibilities. The answer depends initially on whether the carrier asked the lawyer to become involved in settlement when being retained. Nowadays, most carriers state in their litigation management guidelines that they

reserve settlement-related responsibilities for themselves. Because insurers are entitled to use claims professionals (and other in-house employees) to negotiate deals, it is entirely proper for a defense lawyer to handle only litigation issues.233

A more controversial issue is whether a defense lawyer must or even may provide settlement-related services to an insured. Many commentators seem to assume that settlement falls within the scope of a defense lawyer's representation of an insured. After studying the matter carefully, however, one must come out the other way. Standard policies do not empower insurance carriers to appoint settlement lawyers for insureds. They give carriers the right and duty to defend lawsuits, an assignment carriers can complete without appointing lawyers with settlement-related responsibilities for anyone.134 To acquire settlement responsibilities to a policyholder, a defense lawyer must acquire them directly from the insured.

Presumably, a carrier will understand that a defense lawyer is not its agent for settlement. A policyholder may not, however, and this is something that should be explained. Policyholders have important settlement-related interests. They may settle claims at their own expense and contribute dollars to settlements negotiated by insurers. When coverage is disputed, either may be a desirable course. Policyholders also may want to pressure carriers to settle by threatening to sue them for bad faith. These are matters concerning which policyholders may need legal assistance.

The natural question at this point is whether a lawyer can agree to perform settlement-related tasks for a carrier or an insured without incurring impermissible conflicts or a need for a conflict waiver. By itself, the mere assumption of responsibilities would not seem to create a conflict. For example, after agreeing to handle settlement, a defense lawyer might succeed in having a case dismissed on the merits before any negotiations take place. Moreover, counsel's goal when handling settlement should be the same as that of the joint defense, namely, to minimize the amount that must be paid to the liability claimant to get rid of the case. Consequently, neither an unwaivable conflict nor any conflict at all need arise when defense counsel acquires settlement-related responsibilities to a carrier or an insured.

There are, however, disclosure issues to be addressed. We assumed above that settlement-related services were excluded from the scope of the retention initially and that both clients understood this. If the carrier or the insured later adds these responsibilities (with the lawyer's consent), must the lawyer tell the other client? The answer is yes, for the same reason that the duty to communicate required the lawyer to convey information about the original scope. A client can decline to be

represented by an attorney at any time. Because changes in a lawyer's responsibilities can influence a client's decision, a client must be alerted to them.

Having said that both clients must be informed, we would not say that both must consent. When principals are jointly represented, absent an agreement to the contrary all must approve changes in the terms of the joint undertaking. However, strictly speaking, tasking the lawyer with settlement-related responsibilities to one of the clients does not change the joint representation, which concerns only the defense. It adds a new set of duties that run to only the client who hired the lawyer for the purpose.

Despite this, we discourage defense lawyers from undertaking settlement-- related responsibilities for one client when the other objects. Very few cases address these precise issues, and it should be easy for the clients to find other settlement representatives, especially when the client seeking assistance is the insurer. Also, even when a representation is limited to defending a liability suit, a lawyer can provide both clients with much of the information and assistance they will need to evaluate settlement opportunities. Finally, an objection shows that settlement is a sensitive topic for one of the clients. The client may feel that the lawyer is too strongly pro- or anti-settlement, or that settlement negotiations will inevitably involve the lawyer in coverage-related issues because the attractiveness of settling depends partly on the amount each client must pay. Whatever the reason, an objection is a signal of danger and should not be disregarded.

An interesting question is whether an insured would risk a loss of coverage by refusing to waive its objections to a carrier's use of defense counsel for settlement. The policyholder could not be accused of interfering with the carrier's right to control the defense because defense and settlement are separate. However, the duty to cooperate extends to "the investigation, settlement or defense of [any] claim or suit."135 Consequently, an argument along the lines traced in Part V could be made that an insured would breach the duty to cooperate by objecting.

To this point, we have focused on preliminaries. The really difficult conflict issues are likely to arise after defense counsel becomes involved in settlement. The fundamental problem is the need to allocate financial responsibility for a deal between the carrier and the insured. As the Restatement (Third) of the Law Governing Lawyers observes when discussing clients aligned as co-defendants, "[e]ach would usually prefer to see the plaintiff defeated altogether, but if the plaintiff succeeds, each will often prefer to see liability deflected mainly or entirely upon other defendants."136 Still, the Restatement also states that

allocation-related conflicts can be waived with informed consent, so the tension need not be fatal.137

Unfortunately, the Restatement says little about the role defense counsel may play in the bargaining process. Can the lawyer permissibly attempt to persuade the insurer that a proposed settlement within the policy limits is reasonable? Can the lawyer urge the policyholder to contribute its dollars and make a settlement happen by arguing that the carrier may win the coverage dispute? These and other practical questions have to be faced. Otherwise, for all parties concerned, the decision to involve a defense lawyer in settlement negotiations will be a high risk, low reward proposition.

We discussed some of these questions in the excess exposure context in a prior work. There, we emphasized, first, the difference between a case evaluation and an assessment of the advisability of settlement. The former is a permissible defense-related activity. The latter is an all-things-considered judgment that has serious potential to create conflicts. We also discouraged defense lawyers from acquiring discretion to settle for any amount between $X and $Y as contrasted with authority to settle for a particular amount and an instruction to act accordingly. An exercise of discretion is highly likely to necessitate a compromise of competing interests, the insurer wanting to save money on the policy and the insured wanting a guaranteed resolution within policy limits. By representing either client on settlement in an excess exposure situation, a defense lawyer incurs a substantial risk of encountering interest conflicts that must be disclosed and intelligently waived.138 Finally, a lawyer may never disregard an instruction from either co-client to refrain from settling. If the clients insist upon giving conflicting instructions, the lawyer must withdraw.

The existence of a coverage issue complicates the picture in two ways. First, both clients have an interest in settlement negotiations at all dollar levels until the coverage issue is resolved or they agree on an allocation. Second, both clients may allow their interests in the coverage dispute to color their judgment about opportunities to end the liability suit. The carrier may want to reject a reasonable settlement demand because it expects to win the coverage case; the insured may fear losing coverage and may argue in favor of an unreasonable settlement opportunity in the hope of getting the liability case resolved while coverage doubts remain. Predictably, each will want defense counsel to take its side against the other as negotiations proceed.

All these tensions can be disclosed and waived, and a defense lawyer can cleave to the straight and narrow when negotiating a settlement in a contested coverage case. The lawyer can bargain for the smallest possible dollar amount

and leave all other matters to the carrier and the insured. But a lawyer who undertakes this assignment in a setting where interests conflict so strongly should be careful to make full disclosures, to educate the clients about the limited role to be played, and to memorialize everything. The lawyer also should tell both clients about all important developments, especially the presentation of demands. Both clients have a financial interest in the outcome in this situation, and both may wish to take advantage of any opportunity to end the litigation.

The safer course in a disputed coverage case is for defense counsel to let someone else handle settlement. The defense lawyer can freely talk with other persons appointed by the carrier and the policyholder to handle this task. Both the principals and their agents are entitled to complete information about the liability case and to the lawyer's case evaluation. A defense lawyer can provide valuable services to settlement-minded clients without incurring the risk of litigation that responsibility for settlement negotiations entails.

CONCLUSION

We have tried to give lawyers rules to live by when defending liability suits in contested coverage cases. We hope and believe that our recommendations are practicable and right, and we are certain that they are systematic. When fleshing out the ethical norms applicable to defense counsel in contested coverage cases, we have grounded our analysis in the economic and legal structure of the tripartite relationship. Because both insurance and agency law are contract-based, it is critical to understand the participants' desires and the plans they make for realizing them. A lawyer's job is to advance a client's interests as a client defines them. To posit defense lawyers' responsibilities without reference to insurance agreements would be to ignore the joint interest in minimizing the loss on a liability claim that the clients previously defined.

When one starts with the promises carriers and policyholders exchange and the tasks they hire defense lawyers to perform, one immediately sees that a defense lawyer is a specialized agent with a defined mission. The mission is not to provide coverage advice to either client. Nor is it to police either client's compliance with the terms of the liability insurance contract. Other actors play these roles. The analysis of interest conflicts, the duty of competence, and other professional responsibilities must reflect the specialized role that defense lawyers are asked to play.

Our method of studying the tripartite relationship also has brought to the surface important issues that have received little or no scholarly examination elsewhere. One such issue concerns the status of independent counsel regimes, which, we argue, exist for the purpose of filling gaps in insurance law. A second relates to defense counsel's obligation to advise the insured about the possible right of independent counsel, a duty we affirm. A third addresses the unarticulated assumption that defense lawyers have an affirmative duty to know about coverage law. Careful reflection on this issue leads to the conclusion that no such duty arises.

Many conclusions in this Article comport with mainstream doctrinal approaches but rest on rationales that differ somewhat from those usually given. Our analysis of interest conflicts in cases where the manner of defending the liability case can influence the outcome of the coverage action fits this description. Other conclusions are likely to be controversial, including our contention that contested coverage cases do not always require informed consent waivers at the start of the defensive representation. All the conclusions in this Article, however, are grounded in a systematic account139 of the tripartite relationship and the respective roles of insurance law and the law of professional responsibility. This deeper grounding, we believe, correctly separates questions of insurance law from questions of professional responsibility, and helps defense lawyers figure out how to proceed when the latter arise.

ELLEN S. PRYOR* AND CHARLES SILVER**

* Professor of Law and University Distinguished Teaching Professor, Southern Methodist University Dedman School of Law.

** Co-Director, Center for Lawyers, Civil Justice, and the Media, and Cecil D. Redford Professor, University of Texas School of Law.

Copyright Georgetown University Law Center Fall 2001
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