Originally published in Corporate Counsel, March 2010.

When policyholders challenge their insurance companies' claims handling practices, insurance companies often play a game of Russian Roulette, using attorneyclient privilege to shield their factual claim investigations from disclosure and policyholder criticism. By claiming that an attorney performed the claims-handling function, the insurance company may waive the privilege and blow the top off its putative protection, exposing the facts (good and bad) underlying a coverage denial to the cold light of day.

Insurance companies take another deadly spin in the game of chance when they invoke the advice of counsel defense. This occurs when an insurance company – usually unwillingly – claims that its coverage denial was based on the advice of coverage counsel and therefore reasonable, for purposes of defending against allegations of bad faith. Once the insurance company places its attorney's advice at issue, however, the privilege may be waived.

When conducting discovery in coverage litigation, a policyholder should not be deterred when the denial letter was written by John Doe, Esq. instead of John Doe, Claims Department Representative. Nor should a policyholder assume that attorney activity on a privilege log, claims log, or involvement of an attorney in internal communications regarding coverage, will automatically be protected from disclosure. Determining whether an attorney is acting as a claims handler or legal advisor is a fact inquiry that looks to the dominant purpose of the attorney's function.

There are many reasons why an insurance company would pass off its claims handling function to an attorney: experience, knowledge, the desire to protect sensitive information, reliance on the advice of counsel defense in bad faith litigation, or simply protecting a claims employee from being deposed. Indeed, a recent insurance industry publication tailored to claims adjusters characterized a deposition as a "Maalox moment that may be about as much fun as a root canal."

The Lawyer in The Claims Handling Function

Insurers cannot shield claims files from disclosure on the basis of the work-product privilege by having lawyers handle claims. For the workproduct doctrine to apply, the investigation must be outside of standard claims handling process. For attorney-client privilege to apply, the attorney must provide legal advice and not conduct a factual investigation.

Insurance companies commonly use lawyers for two primary purposes (1) to perform the business function of addressing coverage issues (adjusting claims, supervising the claims process, or monitoring the investigation of claims), or (2) to be the litigator litigating a coverage dispute. Before the coverage dispute, the lawyer is acting as claims adjuster that investigates the claims, analyzes them, and determines whether payment should be made and if so, at what amount. At some point, the lawyer turns into a coverage lawyer that does not make such business decisions. If the matter could be handled by a layman just as easily as a lawyer, the matter may not be privileged.

Under the same rationale, documents in a claims file created by or for an insurance company as part of its ordinary course of business, are not afforded work-product protection, even if prepared by a lawyer. Courts often presume that documents prepared by or for an insurer prior to a coverage determination are prepared in the ordinary course of the insurer's business and are not afforded work-product protection.

Similarly, documents created after the insurance company's retention of counsel are not necessarily afforded work-product protection where the insurance company continues to investigate the claim without denying coverage. The hiring of outside counsel does not, by itself, indicate a determination to litigate. Therefore, insurance companies cannot claim that investigative documents are privileged because they were prepared in anticipation of litigation before a coverage denial, because claims investigations often continue after outside counsel is hired.

The Insurance Industry Recognizes Waiver in Investigatory Circumstances

Even the insurance industry affirms this challenge to the privilege that is traditionally raised by policyholders. Recently, AIU, an insurance company similarly situated to a policyholder in coverage litigation, sued its reinsurer, TIG, alleging that TIG had breached the reinsurance contracts at issue by failing to indemnify AIU for its share of settlement payments in an underlying matter. In an attempt to compel production of TIG's claims files and challenge TIG's assertion of the attorneyclient and work-product privileges, AIU argued (in the same manner that a policyholder would argue in bad faith litigation against an insurance company) that TIG's counsel was acting as a claims investigator, and not as a lawyer.

Ultimately, on a motion to reconsider, AIU court found that certain documents were, in fact, privileged, but it was only after a detailed and fact intensive inquiry into the nature of the claimed privileges and documents at issue. Nonetheless, this case is noteworthy because it highlights the insurance industry's recognition of this challenge to the privilege.

Uncovering Bad Faith

To prove bad faith, a policyholder must show how the insurance company processed the claim, how the claim was considered, and why the insurance company took the action that it did. Once it has made this factual inquiry, the policyholder must also show the absence of a reasonable basis for denying benefits of the policy and the insurance company's knowledge or reckless disregard, or the lack of a reasonable basis for denying the claim. An insurance company's intentional denial, failure to process, or failure to pay a claim without a reasonable basis can give rise to a bad faith lawsuit. Therefore, some courts find that an insured's claim of bad faith may also be the basis for disclosure of privileged insurance company communications, in what is referred to as the bad faith exception.

The Advice of Counsel as Shield

An insurance company in bad faith litigation can also waive the attorney-client privilege when it asserts its good faith due to its reliance on its counsel's advice. Insurance companies commonly defend bad faith or malicious claim handling allegations giving rise to punitive damages by providing evidence that the insurance company relied on the advice of competent counsel. This is an implied waiver, whereby the insurance company voluntarily puts its state of mind and attorney advice at issue. In such circumstances, the policyholder is entitled to discover communications between the lawyer and insurance company, which relate to the advice on denial of coverage.

When an insurance company makes factual assertions in defense of a claim, which incorporate the advice and judgment of counsel, it cannot deny a policyholder the opportunity to uncover the foundation for those assertions in order to contradict them. The policyholder should be entitled to test the reasonableness of the attorney's opinion and the insurance company's reliance on the opinion.

What to Do

Do not be fooled by the involvement of the insurance company's lawyer in handling, or litigating a claim. As a policyholder, you are entitled to discovery to prove your bad faith claim. If an attorney was involved in the insurance company's investigation of the claim, push for the information and shift the burden to the insurance company to tell you why the information is privileged.

Caroline R. Hurtado is a shareholder in the Ventura, California office of Anderson Kill. Ms. Hurtado has extensive experience in policy enforcement, errors and omissions and business litigation. Ms. Hurtado's background and experience in handling complex business transactions ensures maximum benefits for clients.

About Anderson Kill & Olick, P.C.

Anderson Kill & Olick, P.C. practices law in the areas of Insurance Recovery, Anti-Counterfeiting, Bankruptcy, Commercial Litigation, Corporate & Securities, Employment & Labor Law, Real Estate & Construction, Tax, and Trusts & Estates. Best-known for its work in insurance recovery, the firm represents policyholders only in insurance coverage disputes, with no ties to insurance companies and no conflicts of interest. Clients include Fortune 1000 companies, small and medium-sized businesses, governmental entities, and nonprofits as well as personal estates. Based in New York City, the firm also has offices in Greenwich, CT, Newark, NJ, Philadelphia, PA, Ventura, CA and Washington, DC. For companies seeking to do business internationally, Anderson Kill, through its membership in Interleges, a consortium of similar law firms in some 20 countries, assures the same high quality of service throughout the world that it provides itself here in the United States.

Anderson Kill represents policyholders only in insurance coverage disputes, with no ties to insurance companies, no conflicts of interest, and no compromises in it's devotion to policyholder interests alone.

The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations