CALLAHAN GAUNTLETT v. INDUSTRIAL INDEMNITY COMPANY (1992)

OPINION

Callahan & Gauntlett, a law firm, appeals from an order denying its petition to compel arbitration of attorney's fees.   The primary question presented is who must determine (a) whether an insurer has a duty to defend an insured and (b) whether a conflict of interest exists between the insurer and insured, so as to require the submission of the matter to binding arbitration under Civil Code section 2860.¹

FACTS

Watercloud Bed Company, Inc. manufactures and sells waterbeds.   Richard La Bianco is Watercloud's president.   In April 1987, Somma Mattress Company sued Watercloud in federal court claiming Watercloud manufactured and sold a particular line of waterbeds for which Somma held a patent.   Watercloud and La Bianco retained Callahan ² and other attorneys to defend it in the action.

Defense of the lawsuit was tendered to Aetna Casualty and Surety Company and Industrial Indemnity Company, insurers who had issued comprehensive general liability insurance policies to Watercloud.   Aetna sent Watercloud a letter agreeing to defend, but reserving its rights to deny coverage, refuse to pay for the defense, and to seek reimbursement from Watercloud in the event a determination was made that its policy did not cover Watercloud's liability.   Initially, Industrial Indemnity denied coverage.   Later, it agreed to defend Watercloud and to indemnify it for any damages incurred for slander of title, but also reserved all of its rights under the policy.

In October 1987, a meeting was held between the attorneys for Watercloud and the insurers' representatives and it was agreed Industrial Indemnity and Aetna would pay Callahan $182.50 per hour for its defense of Watercloud.   However, the duration of the agreement was not clear.   Callahan understood the fee agreement would continue throughout the lawsuit.   The insurers asserted the fee agreement would last only until January 1, 1988, when it would be reviewed “in light of the recently passed legislation,” an apparent reference to the enactment of section 2860.   Nonetheless, it appears each insurer made fee payments to Callahan after January 1.

Ultimately, both Industrial Indemnity and Aetna concluded no defense was owed to Watercloud under their policies.   In March 1988, Industrial Indemnity withdrew its defense.   Shortly thereafter, Aetna filed a declaratory relief action against Watercloud and Industrial Indemnity in federal court seeking a declaration of noncoverage under its policy or a declaration of Industrial Indemnity's obligation to contribute to the insured's defense.   On November 30, 1988, the district court entered an order in Aetna's suit, finding Industrial Indemnity and Aetna owed a duty to defend Watercloud under their policies.

In a letter to Callahan dated December 5, Aetna's counsel stated:  “[T]he dispute between Aetna Casualty and Watercloud is and has been, over the issue of the reasonable [sic ] of the fees charged by Callahan ․ and its predecessor Callahan & Assoc.   As you know, the proper forum for the resolution of such a dispute is arbitration pursuant to ․ section 2860.   Aetna Casualty proposes the matter be placed before [an arbitrator] for prompt resolution․”   Callahan later accepted Aetna's offer to arbitrate the fee dispute.   For reasons not clear from the record, Industrial Indemnity was not made a party to the arbitration, so Aetna withdrew from it.   Nevertheless, a hearing before an arbitrator was convened without either Aetna or Industrial Indemnity present, and an award of $871,673.50 was entered in favor of Watercloud for the payment of past and future fees to Callahan.

Thereafter, Aetna joined an excess insurer, Pacific Indemnity Company, as a defendant in the declaratory relief action.   Pacific Indemnity successfully moved to realign the parties to have the insurers on one side of the litigation and the insureds on the other, thereby defeating federal diversity jurisdiction.   Aetna's declaratory relief action was then dismissed.   The federal court's November 30 order never became final, and was later held by the district court to be null and void.

Callahan sought to confirm the “arbitration award” in superior court and Aetna removed the action to federal court.   On July 20, 1989, the district court denied enforcement of the award, finding the arbitration was based on its November 30 order which became invalid after dismissal of the declaratory relief action.   Callahan brought yet another action in federal court in the name of its insured against Aetna only, seeking to “correct” the arbitrator's award and confirm it.   The district court again denied the request.

Callahan also filed an action in superior court against the insurers contending, in part, that the insurers owed a duty to defend which they denied, and requesting a determination of the insurers' rights, obligations and liabilities.   That action is apparently still pending.

In February 1990, Callahan filed another document in superior court entitled “Notice of Motion and Motion on Petition to Compel Arbitration and Appoint Arbitrator re:  Dispute Concerning Attorneys' Fees,” seeking an order compelling arbitration to determine the amount of attorneys' fees and costs payable by Aetna and Industrial Indemnity, plus prejudgment interest.   Callahan did not seek a determination by the arbitrator that the insurers owed a duty to defend nor that a conflict of interest existed between the insurers and the insured.   The court denied the motion and petition and entered an order dismissing the proceeding.   Callahan filed its appeal from that ruling.³

DISCUSSION

I. Procedural Issues ***

II. Who Determines The Prerequisites For a Section 2860 Arbitration

Callahan argues the trial court erred in construing section 2860.   The insurers' agreement to defend Watercloud under a reservation of rights requires them to pay Callahan's attorneys' fees.   Also, in the absence of explicit contrary terms, Callahan claims section 2860 supplies the agreement between the insurer and independent counsel for arbitration of disputes concerning attorneys' fees, and that it did not waive its right to collect fees for services rendered to Watercloud.   The insurers argue that in the absence of findings they have a duty to defend and a conflict of interest exists between the insurer and the insured, Callahan cannot, either in its own right or as the insureds' assignee, invoke the arbitration provisions of section 2860.

Callahan does not contend it has a written contract with the insurers entitling it to arbitration.   It relies exclusively on section 2860.   Thus, the question is who may make the threshold determinations required to invoke section 2860.

Section 2860 provides:  “(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․  [¶] (c) ․ This subdivision does not invalidate other different or additional policy provisions pertaining to attorney's fees or providing for methods of settlement of disputes concerning those fees.   Any dispute concerning attorney's fees not resolved by these methods shall be resolved by final and binding arbitration by a single neutral arbitrator selected by the parties to the dispute.”  (Emphasis added.)

 A duty to defend and a conflict of interest between the insurer and insured are separate and distinct conditions precedent to the invocation of section 2860.   An insurer's duty to pay for independent counsel to represent an insured in litigation was first announced in San Diego Federal Credit Union v. Cumis Ins. Society, Inc. (1984) 162 Cal.App.3d 358, 208 Cal.Rptr. 494.  Cumis itself presupposes the insurer's duty to defend and the existence of a conflict of interest between the insurer and the insured.   Citing Tomerlin v. Canadian Indemnity Co. (1964) 61 Cal.2d 638, 39 Cal.Rptr. 731, 394 P.2d 571, the Cumis court concluded:  “If the insurer must pay for the cost of defense and, when a conflict exists, the insured may have control of the defense if he wishes, it follows the insurer must pay for such defense conducted by independent counsel.”  (Id., 162 Cal.App.3d at p. 369, 208 Cal.Rptr. 494, emphasis added;  see also Native Sun Investment Group v. Ticor Title Ins. Co. (1987) 189 Cal.App.3d 1265, 1277–1278, 235 Cal.Rptr. 34.)

In United States Fidelity & Guaranty Co. v. Superior Court (1988) 204 Cal.App.3d 1513, 252 Cal.Rptr. 320, the court stated:  “[S]ection 2860, subdivision (b), tells us when a conflict may exist, i.e., when there is a reservation of rights and first counsel chosen by the insurer can control the outcome of the coverage issue.   It also tells us certain circumstances where a conflict of interest does not exist.   Its language, however, does not preclude judicial determination of conflict of interest and duty to provide independent counsel such as was accomplished in Cumis so long as that determination is consistent with the section.”  (Id. at p. 1525, 252 Cal.Rptr. 320.)   Therefore, the court concluded that “Prompt filing of a declaratory relief action is an appropriate procedure for determining the application of the Cumis principles in a given case․   Likewise, when the insurer refuses to honor the insured's request for Cumis counsel, such a declaratory relief action can be filed by the insured to establish the right to independent counsel.”  (Id. at p. 1526, 252 Cal.Rptr. 320.)   Here, such declaratory relief actions have been filed by both the insurers and by Callahan seeking to establish insurance coverage.   But, no such actions have been filed or orders made determining the duty to defend or the existence of a conflict.

 Callahan contends the insurers' agreement to defend Watercloud under a reservation of rights compels them to pay its attorneys' fees.   Not surprisingly, Callahan cites no case authority in support of that proposition.  Section 2860 provides merely that a conflict of interest may exist where an insurer agrees to defend under a reservation of rights, assuming, of course, there is a duty to defend.   Thus, the statute requires a determination of the existence of a duty to defend and a conflict of interest between the insurer and the insured before there is a right to arbitrate the reasonableness of fees.   We believe that where the existence of the threshold requirements is disputed, the resolution of those elements should be satisfied through a judicial determination, not through arbitration.  (See United States Fidelity & Guaranty Co. v. Superior Court, supra, 204 Cal.App.3d at p. 1525, 252 Cal.Rptr. 320.)

 While the parties might stipulate to the duty to defend and to a conflict, it cannot be said there is such an agreement here merely because the insurers defended the action under a reservation of rights.   In federal court, Callahan continually rejected the insurers' efforts to arbitrate the fee dispute, contending the insurers were not entitled to arbitrate pursuant to section 2860.   When Callahan finally accepted the offer to arbitrate, Industrial Indemnity was inexplicably excluded from the process, causing Aetna to withdraw from the arbitration.   Thus, there was no agreement which would satisfy the requirements of section 2860.⁴

 Here, there has been no determination of a duty to defend or of the existence of a conflict between the insured and Aetna and Industrial Indemnity.   Callahan did not even seek that determination in its petition to compel arbitration.   Thus, the threshold requirements for the invocation of section 2860 have not been met and Callahan is not entitled to compel arbitration.

DISPOSITION

The appeal is treated as a petition for a writ of mandate.   The petition is denied.   Respondents shall recover their costs.

FOOTNOTES

1.   All statutory references are to the Civil Code unless otherwise specified.

2.   Prior to January 1, 1988, Callahan & Gauntlett was known as Callahan & Associates.   It contends there was no change in personnel nor in the form of the entity after the name change.

3.   The underlying patent infringement action was settled, apparently after the Ninth Circuit Court of Appeals affirmed a judgment in a companion lawsuit.  (See Somma Mattress v. Amtec Flotation Sleep Systems, Inc. (Fed.Cir.1990) 907 F.2d 157.)Following the filing of the notice of appeal in this case, both Aetna and Industrial Indemnity filed petitions for writs of mandate in other actions, naming Watercloud, the insurers and Callahan as real parties in interest.   After those petitions were denied by this court, the Supreme Court granted petitions for hearings and those matters, too, are pending.

FOOTNOTE.   See footnote *, ante.

4.   Arbitration under section 2860, subdivision (c) would be appropriate “[w]here insurer and insured unconditionally agree independent counsel is warranted and where independent counsel is actually retained․”  (Truck Insurance Exchange v. Dynamic Concepts, Inc. (1992) 9 Cal.App.4th 1147, 1150, 11 Cal.Rptr.2d 873.)

MOORE, Associate Justice.

SILLS, P.J., and SONENSHINE, J., concur.