United States: Centex Homes v. St. Paul Fire And Marine Insurance Company

In Centex Homes v. St. Paul Fire and Marine Ins. Co., 19 Cal.App.5th 789 (January 22, 2018), the California Third District Court of Appeal affirmed the entry of summary adjudication in favor of St. Paul Fire and Marine Insurance Company ("St. Paul") in connection with a claim by Centex Homes that it was entitled to the appointment of independent counsel in connection with the defense of a construction defect lawsuit filed by homeowners living in two residential developments in Rocklin, California. St. Paul issued a general liability policy to its named insured, Ad Land Venture ("Ad Land"). In that regard, Ad Land agreed to include Centex as an additional insured under its policy for liability arising out of work performed on behalf of Centex at the developments at issue in the construction defect lawsuit filed against Centex.

Centex tendered the defense of the construction defect lawsuit to St. Paul. In response St. Paul issued a reservation of rights regarding the absence of coverage for damage sustained by Ad Land's work and damage caused by the work of other subcontractors not insured by St. Paul. St. Paul also reserved its right to reimbursement of costs incurred defending uncovered claims. St. Paul appointed attorney David Lee to represent Centex and to defend against the construction defect lawsuit.

Centex filed a cross-complaint against subcontractors, including Ad Land, alleging breaches of written, oral and implied contracts to indemnify, defend, and obtain insurance, as well as causes of action for equitable indemnity, contribution, and declaratory relief. The cross-complaint included a cause of action for declaratory relief against St. Paul that sought a declaration that Centex was entitled independent counsel under California Civil Section 2860 because St. Paul's reservation of rights created significant conflicts of interest.

The defense counsel appointed by St. Paul, David Lee, did not prosecute the cross-complaint filed by Centex against the subcontractors. Rather, Lee was only retained to defend Centex against the plaintiffs' lawsuit. St. Paul hired the Aguilera firm to defend the seventh cause of action alleged in the Centex cross-complaint regarding its alleged right to independent counsel. Thereafter, St. Paul filed a motion for summary adjudication in connection with such cause of action contending that Centex was not entitled to independent counsel. The trial court granted St. Paul's motion.

In affirming the trial court's entry of summary adjudication in favor of St. Paul, the Court of Appeal explained the law governing the right to independent counsel. The Court of Appeal stated as follows:

B. The Right to Independent Counsel

"Generally, an insurer owing a duty to defend an insured, arising because there exists a potential for liability under the policy, 'has the right to control defense and settlement of the third party action against its insured, and is ... a direct participant in the litigation.' [Citations.] The insurer typically hires defense counsel who represents the interests of both the insurer and the insured." (Long v. Century Indemnity Co. (2008) 163 Cal.App.4th 1460, 1468 [178 Cal. Rptr. 3d 483].)

"[S]ection 2860 and California case law provide Centex, as an insured, with the right to obtain independent counsel paid for by [St. Paul], as Centex's insurer, whenever their competing interests create an ethical conflict for counsel." (Centex Homes v. St. Paul Fire & Marine Ins. Co. (2015) 237 Cal.App.4th 23, 30 [187 Cal. Rptr. 3d 542] (Centex I.) Section 2860 provides in relevant part:

"(a) If the provisions of a policy of insurance impose a duty to defend upon an insurer and a conflict of interest arises which creates a duty on the part of the insurer to provide independent counsel to the insured, the insurer shall provide independent counsel to represent the insured unless, at the time the insured is informed that a possible conflict may arise or does exist, the insured expressly waives, in writing, the right to independent counsel.

"(b) For purposes of this section, a conflict of interest does not exist as to allegations or facts in the litigation for which the insurer denies coverage; however, when an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim, a conflict of interest may exist."

Under section 2860, subdivision (b) and the relevant case law, "not every reservation of rights entitles an insured to select Cumis counsel." (Dynamic Concepts, Inc. v. Truck Ins. Exchange (1998) 61 Cal.App.4th 999, 1006 [71 Cal. Rptr. 2d 882].) Whether independent counsel is required "depends upon the nature of the coverage issue, as it relates to the issues in the underlying case." (Blanchard v. State Farm Fire & Casualty Co. (1991) 2 Cal.App.4th 345, 350 [2 Cal. Rptr. 2d 884].) "There must ... be evidence that 'the outcome of [the] coverage issue can be controlled by counsel first retained by the insurer for the defense of the [underlying] claim.'" (Gafcon, Inc. v. Ponsor & Associates (2002) 98 Cal.App.4th 1388,1421 [120 Cal.Rptr. 2d 392].) "It is only when the basis for the reservation of rights is such as to cause assertion of factual or legal theories which undermine or are contrary to the positions to be asserted in the liability case that a conflict of interest sufficient to require independent counsel, to be chosen by the insured, will arise.'" (Id. at pp. 1421-1422.)

California law is settled that "there is no entitlement to independent counsel where the coverage issue is "independent of, or extrinsic to, the issues in the underlying action [citations]."' [Citation.] Stated otherwise, 'where the reservation of rights is based on coverage disputes which have nothing to do with the issues being litigated in the underlying action, there is no conflict of interest requiring independent counsel.'" (Gafcon, Inc. v. Ponsor & Associates, supra, 98 CaI.App.4th at p. 1422.)

"A mere possibility of an unspecified conflict does not require independent counsel. The conflict must be significant, not merely theoretical, actual, not merely potential." (Dynamic Concepts, Inc. v. Truck Ins. Exchange, supra, 61 Cal.App.4th at p. 1007.) A case by case analysis is required: "The potential for conflict requires a careful analysis of the parties' respective interests to determine whether they can be reconciled (such as by a defense based on total nonliability) or whether an actual conflict of interest precludes insurer-appointed defense counsel from presenting a quality defense for the insured. As the court noted in Native Sun Investment Group v. Ticor Title Ins. Co. [(1987)] 189 Cal.App.3d (1265,] 1277 (235 Cal. Rptr. 34], insurer-appointed defense counsel may obviate any potential conflict involving uncovered claims by "proceed[ing] diligently to litigate the matters that he was charged with on behalf of his client [the insured]." (Id. at pp. 1007-1008.)

The Court of Appeal also rejected Centex's argument that a potential conflict of interest triggered a right to independent counsel. Rather, the Court of Appeal held that in order for an insured to be entitled to independent counsel, the conflict must be substantial.

Centex also relied on Rule 3-310(C)(1) of the Rules of Professional Conduct in arguing that it was entitled to independent counsel. Such rule requires the appointment of independent counsel in the event of any potential conflict. However, the Court of Appeal noted that Rule 3-310(C)(1) did not require the appointment of independent counsel where an insurer acted as an indemnitor only. In addition, the Court of Appeal explained why Rule 3 – 310(C)(3) did not did not entitle Centex to independent counsel in connection with the defense of the underlying construction defect lawsuit as follows:

Before this clarification regarding rule 3-310(C)(3) was added, formal opinion No. 1995-139 of the California State Bar Standing Committee on (Professional Responsibility and Conduct (hereinafter State Bar Opinion 1995-139) addressed the issue of to whom an attorney owes duties when he or she acts as insurance defense counsel and is hired by an insurer to represent the insured. The committee noted that rule 3-310 "may seem at odds with some case law dicta" assuming no separate written disclosure to the insurer and insured other than the insurance contract itself. (State Bar Opinion No. 1995-139, supra, at p. *3.) The committee explained that "while insurer is indeed a client in some respects—the ongoing relationship with the member, the payment of fees, etc.—it is a client whose rights under case law are clearly limited." (Id. at p. *4.) "Where a member complies with the mandates of this opinion to protect the interests of the insured, his or her additional compliance with rule 3-310 is not necessary for two reasons: First, given the unusual, perhaps unique, interrelationship of insurer, insured and counsel, the contract of insurance itself, drafted by the insurer for its own benefit, provides more than adequate disclosure under rule 3-310(8)(3) to the insurer. Second, the 'potential conflict' trigger of rule 3¬310(0)(1) is never pulled because, as seen infra, when such a conflict manifests itself, case law resolves any potential conflict in that matter by mandating a resolution in favor of the represented insured and against the non-represented, non-party insurer. Put another way, case law instructs that ultimately, there can be no conflict between insurer and insured since, as discussed infra, the insured will always prevail where an issue is created between them. Thus, the notice to and waiver by the insured is superfluous." (Id. at pp. *4-*5, fn. omitted.) Centex suggests we ignore this "background information." Instead, we conclude it is consistent with our understanding that rule 3-310(C)(1.) does not alter the settled law regarding when independent counsel is required.

The Court of Appeal went on to hold that defense counsel appointed by St. Paul could not control the outcome of any of the coverage issues identified in St. Paul's reservation of rights letter. In addition, the Court of Appeal rejected Centex's argument that St. Paul controlled both sides of the litigation, i.e., the defense of Centex against the construction defect lawsuit and the prosecution of its cross-complaint against various subcontractors, including Ad Land. The Court of Appeal noted that attorney Lee was not retained to prosecute the Centex cross-complaint nor was Lee involved in the defense of St. Paul against Centex.

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