No One Can Serve Two Masters: The Washington Supreme Court Confirms That Insurer-Appointed Defense Counsel Owes Ethical Duties Solely to the Policyholder. Insurance Policyholder Advocate

When claims are made against parties that have liability insurance coverage, insurance companies frequently have a duty to defend under their policies. The insurer selects the lawyers to defend the claim, pays their bills, and (at times) provides, or attempts to provide, input into the defense. Often, insurance companies hire defense counsel with whom they have a long or close relationship, who therefore are beholden to the insurance company for future business. This can lead to an awkward situation when the insurer's interests and those of the policyholder are not completely aligned, such as (1) when the insurer has asserted coverage defenses that turn on facts being litigated in the underlying action or (2) where a litigation tactic is good for the policyholder but not necessarily the insurer (e.g., admitting or contesting a fact that bears on liability or coverage).

Most jurisdictions make clear that defense counsel's client, in the context of a claim where insurance is involved, is the policyholder—and not the insurance company—although some courts have found that the lawyer also owes duties to the insurance company as a third party beneficiary (sometimes referred to as a tri-partite relationship). But even in jurisdictions where defense counsel's only client is the policyholder—and therefore only its interests are to be considered in conducting the litigation—defense lawyers and policyholders sometimes struggle with the issue of whether, and if so to what extent, the insurer's interests are be taken into account. After all, a lawyer who gets a lot of business from an insurance company likely will want to maintain a good relationship with the insurer, even though (1) his only client is supposed to be the policyholder (and his only duties run to the policyholder), and (2) the interests of the insurer and the policyholder can easily diverge in litigation if the insurer asserts coverage defenses or the policyholder and the insurer disagree about how to conduct the litigation (including, for example, filing summary judgment motions that could eliminate covered claims and settlement decisions).

In a recent case, Stewart Title Guar. Co. v. Sterling Savings Bank, (Wash. October 3, 2013) (http://www.courts.wa.gov/opinions/pdf/870870.pdf), the Supreme Court of Washington held that a lawyer defending a policyholder has no duties to the insurer, despite the fact the insurer hired the law firm and, arguably, the law firm's work was performed in part to benefit the insurer, which was ultimately liabile for the claim under its title insurance policy. Rather than skirting around the issue, as some courts have done, and treating the insurer as a third-party beneficiary of the work, the court established a clear rule: the only client whose interests the lawyer must serve—indeed, can serve—are those of the policyholder.

In Stewart Title, a contractor asserted a lien priority claim against Sterling Savings Bank ("Sterling Savings"), which had lent money to a property developer. Sterling Savings held a title insurance policy issued by Stewart Title ("Stewart Title"). Sterling Savings tendered the lien claim to Stewart Title, which hired a law firm, Witherspoon, Kelley, Davenport & Tolle ("Witherspoon"), to defend Sterling Savings. The lien case was ultimately resolved in favor of the contractor after Witherspoon, acting on behalf of Sterling Savings, stipulated to the contractor's lien priority over the Sterling Savings loan and entered into a settlement with the contractor that resulted in a payment of the contractor's lien. Id. at 2-4.

After the lien case was resolved, Stewart Title sued Witherspoon for malpractice, asserting that Witherspoon had improperly failed to raise an equitable subrogation defense against the contractor. Id. at 4. The trial court found that Witherspoon had a duty to Stewart Title due to its role as Sterling Savings' insurer, but granted summary judgment to Witherspoon on the basis that the equitable subrogation defense was not viable under the circumstances and Washington law. Id. at 4-5. The Supreme Court of Washington accepted review and affirmed the trial court's summary judgment grant, but on a completely different basis.

The court held that, Witherspoon's "only client was Sterling" (id. at 5) and accordingly that Witherspoon owed no duties whatsoever to Stewart Title, even though Stewart Title ultimately bore potential liability under its title insurance policy for the lien priority claim asserted against Sterling Savings. Reviewing the test it had previously articulated in Trask v. Butler, 123 Wn.2d 835, 872 P.2d 1080 (Wash. 1994) (which addressed whether third parties can bring malpractice claims against attorneys), the court focused primarily on whether, under the first factor in Trask, the work performed by defense counsel was intended to benefit the third party suing the attorney (here, Stewart Title). The court found that the interests of Sterling Savings and Stewart Title were not sufficiently aligned for Witherspoon to owe a duty to Stewart Title, and accordingly that Witherspoon's work was not "intended to benefit" Stewart Title. Stewart Title at 8 (emphasis in original). The court noted, among other things, that finding a duty of care by defense counsel to an insurer merely because it pays the bills would violate Washington's Rule of Professional Conduct 5.4(c), which states: "A lawyer shall not permit a person who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer's professional judgment in rendering such legal services." Id. at 9 and n.3.

The Washington Supreme Court also rejected Stewart Title's argument that Witherspoon failure to keep Stewart Title informed about the litigation gave rise to a malpractice claim. The court held that a duty to keep a third party informed—even if it existed and was breached—could not support a malpractice claim against Witherspoon by Stewart Title because Witherspoon did not owe a duty of care to a non-client. Id. at 10-11.

Accordingly, the court affirmed the trial court's summary judgment in favor of Witherspoon on Stewart Title's malpractice claim. In its discussion, the court noted that a few states have found a duty of some sort running from defense counsel retained by an insurer to the insurer. Id. at 8 n.2 (citing cases from Arizona and California). However the court focused on the significant conflicts that can arise between an insurer and a policyholder in the defense of an action, concluding that in such circumstances the sole client of defense counsel must be the policyholder, and therefore that defense counsel's ethical duties run only to its actual client, the policyholder.

In this author's opinion, the Washington Supreme Court resolves this thorny issue in the only sensible way. Defense counsel must be free to make decisions about how to conduct litigation that benefit its client, the policyholder (including matters such as what facts to admit, what defenses to assert, whether to file motions for summary judgment on covered claims, etc.), even if those decisions are not necessarily in the interest of the insurer. No attorney can properly serve two masters, nor should he or she ever be asked to do so in circumstances where their interests might not be completely aligned. While an insurer in most circumstances will benefit from the work done by defense counsel, when defense counsel makes litigation decisions that benefit the policyholder—but may be against the insurer's wishes or interests—its judgment should not be subject to second guessing by the insurer in subsequent malpractice litigation. As the ethics rules in most states make clear, a lawyer must zealously represent its client, and having to weigh the interests of two parties—a client and a non-client–when those interests may not be completely in sync puts defense counsel in an impossible position.

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