Australia: Reserving rights: how to effectively inform insureds of potential conflict

Last Updated: 17 May 2017
Article by Alexander Morell

How should Australian lawyers approach the task of dual representation of insured and insurer? A recent American decision serves as a timely reminder for insurers that conflicting interests between an insured and insurer is a serious issue which may arise for solicitors who act as coverage and defence counsel.

The US decision

In America, the Supreme Court of South Carolina recently handed down a decision in the case of Harleysville Group Ins. v Heritage Group Communities Inc. (2017) which was highly critical of an insurer who failed to properly reserve its right to dispute coverage whilst simultaneously defending legal proceedings. The Supreme Court of South Carolina also found deficiencies in the "reservation of rights" letters which had failed to inform the insureds that a potential conflict of interest may have existed. As a result, the letters were held to be ineffective and the insurer was precluded from contesting coverage.

The existence of a conflict of interest

Potential conflicts can and will arise during the course of acting for both insured and insurer, especially when that role includes advising the insurer in relation to coverage. This is especially so in the situation where a solicitor is provided with confidential information by an insured during the defence of a matter that gives rise to an entitlement of the insurer to deny indemnity under the policy of insurance.

Informed consent and reservation of rights

Many insurers would be excused for thinking that the "sacred" reservation of rights letter is effective in discharging practitioners professional obligations and obtaining the waiver of any privilege the Insured would otherwise wish to maintain over its communications with defence counsel. However, the tripartite relationship is more problematic than that. Especially in circumstances where defence counsel must defend a proceeding already on foot, while at the same time investigating issues relevant to coverage.

Requiring an insured to waive privilege at this initial stage does not mean that defence counsel is then free to only concern itself as to whether the insurer "wishes" to extend coverage. The defence of the matter and investigation into coverage is inter-related. Crucially, the insured's interest in the defence is inextricably linked to whether it will have insurance coverage for the claim. To use a "two hats" analogy, solicitors must wear one hat and advise whether an insurer is bound to extend coverage and at the same time wear another hat to protect the insured's clear interest in accessing cover.

Should a solicitor appointed by the insurer cease to act for one or both of the parties when there is an "actual" or "potential" coverage conflict?

The position in Australia is that where an insurer raises any question such as its obligation to indemnify the insured, the solicitor cannot continue to act for both without clearly advising both parties that the actual conflict exists and that independent legal advice should be obtained. The courts are unlikely to extend the implied waiver to such circumstances of actual conflict. The solicitor's professional obligations stipulate that a practitioner may only continue to act for the "insured client" after having obtained the informed consent of the insured to do so. In particular, the insured must be informed that privilege in communications between it and defence counsel is waived, and the information may be relied upon by the insurer in determining coverage.

These issues are relevant considerations not just to defence counsel, but to the insurer and their insured. In practice, without the appropriate consent from an insured, a solicitor/client relationship will most likely be found to co-exist where prejudice has occurred such that solicitors are later precluded from continuing to act for the insurer in proceedings brought by an insured seeking indemnity.

In CI & D Industries v Keeling (1997) NSWSC (unreported), the New South Wales Supreme Court considered this very issue. Solicitors were appointed to protect the interests of insurers and the insured. As per usual they wrote a reservation of rights letter to the insured. The solicitors filed an appearance and defence on behalf of the Insured in the personal injury proceeding. However, they subsequently advised that the insured was not entitled to indemnity under the policy. The Insured filed a cross claim in the proceeding and sought orders restraining the solicitors from continuing to act for the insurer or disclosing information obtained during the course of their investigations.

His Honour, Justice Abadee found that a solicitor/client relationship existed in the circumstances and because the solicitors had ineffectively advised the insured of the insurer's intention that privilege between defence counsel and the insured be waived, the solicitors were precluded from continuing to act for the insurer.

His Honour rejected the submission that unless and until indemnity was confirmed a solicitor and client relationship did not arise. His Honour granted the relief sought by the insured and ordered that the solicitors be prevented from acting for the insurer in the cross claim proceedings for indemnity or acting for the insurer in relation to the claim for indemnity.

Lessons for insurers

The Keeling decision illustrates how an ineffective reservation of rights letter will affect an insurer who may be unable to retain the panel solicitors it has appointed, which significantly increases the costs of litigation.

For the reservation of rights to be effective, the reservation must be unambiguous and clearly state that the insured is requested to waive legal professional privilege as between it, defence counsel and the insurer. The insured should also be advised that it is entitled to seek and obtain its own legal advice regarding the matter. In short, the policy of insurance does not override a practitioner's professional obligations.

The conventional approach in Australia is able to be maintained so long as insurers recognise that there is always a real risk of conflict arising where lawyers act as both coverage and defence counsel.

Importantly, the "reservation of rights" letter is only effective to the extent that it negates what would otherwise always constitute a potential for conflict in acting for two parties. Australian courts have found that once an insurer forms a view that the policy may or does not cover the insured, then the solicitor must advise the insured and seek its consent to continue to act for both parties. Given that solicitors' fiduciary obligations apply outside of the policy of insurance, it would be brave for an insurer to rely solely on the terms of the policy as an effective waiver of privilege by the insured.

The take home message being that if solicitors remain diligent in their duties to advise both parties of any "actual" conflict, should it arise, then there is no reason why the tripartite relationship between insured, insurer and defence counsel cannot continue to be maintained.

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Alexander Morell
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