STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY v. HANSEN (2015)

OPINION

The Federal District Court for the District of Nevada certified two questions to this court concerning Nevada's conflict-of-interest rules in insurance litigation. The first question asks whether “Nevada law require [s] an insurer to provide independent counsel for its insured when a conflict of interest arises between the insurer and the insured.” The second asks whether, if the first question is answered affirmatively, this court would “find that a reservation of rights letter creates a per se conflict of interest.”

We conclude that Nevada law requires an insurer to provide independent counsel for its insured when a conflict of interest arises between the insurer and the insured. Nevada recognizes that the insurer and the insured are dual clients of insurer-appointed counsel. When the insured and the insurer have opposing legal interests, Nevada law requires insurers to fulfill their contractual duty to defend their insureds by allowing insureds to select their own independent counsel and paying for such representation. We further conclude that an insurer is only obligated to provide independent counsel when the insured's and the insurer's legal interests actually conflict. A reservation of rights letter does not create a per se conflict of interest.

FACTS AND PROCEDURAL HISTORY

Our consideration of the facts in this case is limited to those in the certification order. In re Fontainebleau Las Vegas Holdings, 128 Nev., Adv. Op. 53, 289 P.3d 1199, 1207 (2012). In this case, the federal district court's November 19, 2013, certification order incorporated by reference the facts set forth in its December 12, 2012, order.

While leaving a house party, Stephen Hansen was injured in an altercation with other guests. The other party guests tried to prevent Hansen and his friends from leaving the party by sitting on or standing around their vehicle. Eventually Hansen and his friends were able to leave the party in their vehicle, but they later had to stop at the gated exit of the residential subdivision. While stopped at the gate, the vehicle of another party guest, Brad Aguilar, struck the vehicle in which Hansen was riding. Hansen filed a complaint against Aguilar and others in Nevada state district court alleging both negligence and various intentional torts.

Aguilar was insured by State Farm Mutual Automobile Insurance Company.² State Farm agreed to defend Aguilar under a reservation of rights. The reservation of rights letter reserved the right to deny coverage for liability resulting from intentional acts and punitive damages.

Aguilar admitted to negligently striking the other vehicle, and the district court granted summary judgment in favor of Hansen on the negligence claim. Aguilar then agreed to a settlement with Hansen, in which he assigned his rights against State Farm to Hansen.

Hansen filed this lawsuit in the United States District Court for the District of Nevada, alleging that State Farm, in its representation of Aguilar, breached a contract, contractually or tortiously breached an implied covenant of good faith and fair dealing, and violated the Nevada Unfair Claims Practices Act. Hansen also asked for declaratory relief based on the stipulated judgments and assignment of rights. State Farm moved for summary judgment, arguing that Aguilar's assignment of rights to Hansen was void because it violated Aguilar's insurance contract. Hansen responded that, even if Aguilar violated the insurance contract, State Farm's prior breach terminated Aguilar's obligations under the contract.

The federal district court found that State Farm breached its contractual duty to defend Aguilar because it did not provide Aguilar with independent counsel of his choosing. The court said that State Farm's interests conflicted with Aguilar's interests because the insurance policy only covered Aguilar if he acted negligently; the policy did not cover intentional tortious acts. The court therefore applied the rule from San Die go Navy Federal Credit Union v. Cumis Insurance Society, Inc., 162 Cal.App.3d 358, 208 Cal.Rptr. 494, 506 (Ct.App.1984), superseded by statute as stated in United Enters., Inc. v. Superior Court, 183 Cal.App.4th 1004, 108 Cal.Rptr.3d 25 (App.2010), which states that an insurance company must provide independent counsel if its interests conflict with the insured's. Because State Farm did not comply with the Cumis rule, the district court found that State Farm violated its contractual duty to defend Aguilar.

State Farm moved for reconsideration. The federal district court granted, in part, State Farm's motion and certified these questions to this court. We accepted the certified questions under NRAP 5 because they present issues of first impression in Nevada.

DISCUSSION

The right to insurer-provided independent counsel

RPC 1.7(a) states the general rule that “a lawyer shall not represent a client if the representation involves a concurrent conflict of interest.” But when an insurer provides counsel to defend its insured, a conflict of interest may arise because the outcome of litigation may also decide the outcome of a coverage determination—a determination that may pit the insured's interests against the insurer's. For example, an insurer will want the litigation outcome to determine coverage in a way favorable to the insurer, such as by deciding that the insured's acts were intentional and therefore not covered. Conversely, the insured will want to be found negligent so that the insurer will pay his liabilities. By reserving the right to determine coverage after litigation, the insurer hopes that the litigation outcome effectively determines coverage on its behalf and in its favor. The insurer-provided lawyer will have a relationship with both the insured and the insurer, who each have legal interests opposing the other.

The Cumis rule says that, in order to avoid a conflict of interest resulting when an insurer reserves its rights to determine coverage, an insurer must satisfy its contractual duty to provide counsel by paying for counsel of the insured's choosing. Cumis, 208 Cal.Rptr. at 506. The issue here is whether the Cumis rule, or some alternative, applies in Nevada.

Courts rejecting the Cumis rule have not recognized the existence of a conflict of interest in such cases. These courts have reasoned that the sole client is the insured and, therefore, counsel only owes a duty to the insured. See Finley v. Home Ins. Co., 90 Hawai‘i 25, 975 P.2d 1145, 1152–53 (Haw.1998).³ True, some courts have mentioned other rationales, such as that professional ethics rules will keep counsel honest and that insureds have other remedies against unethical counsel. See id. But the main rationale is still that there is no conflict: The sole client is the insured, not the insurer. See id. at 1153.

Nevada, in contrast, is a dual-representation state: Insurer-appointed counsel represents both the insurer and the insured. See Nev. Yellow Cab Corp. v. Eighth Judicial Dist. Court, 123 Nev. 44, 52, 152 P.3d 737, 742 (2007). In Nevada Yellow Cab, this court explicitly adopted the rule of dual representation, which is the same rule applied by the California courts and addressed in Cumis. See id. at 51–52, 208 Cal.Rptr. 494, 152 P.3d at 741–42 (citing Unigard Ins. Grp. v. O'Flaherty & Belgum, 38 Cal.App.4th 1229, 45 Cal.Rptr.2d 565, 568–69 (Ct.App.1995)); Cumis, 208 Cal.Rptr. at 498. We held that an attorney-client relationship exists between insurer-appointed counsel and the insurer. Nev. Yellow Cab, 123 Nev. at 52, 152 P.3d at 742.

Because Nevada is a dual-representation state, counsel may not represent both the insurer and the insured when their interests conflict and no special exception applies. RPC 1.7. This suggests that the Cumis rule, where the insurer must satisfy its contractual duty to provide counsel by paying for counsel of the insured's choosing, is appropriate for Nevada.

Amici curiae American Insurance Association, the National Association of Mutual Insurance Companies, and Property Casualty Insurers Association of America suggest two alternative approaches that are supposedly consistent with Nevada's rule of dual representation.⁴ First, they suggest the primary-client model, where representation switches from dual-client to single-client (the insured, primary client) as soon as a conflict arises. But RPC 1.9(a) prohibits “[a] lawyer who has formerly represented a client in a matter” from representing a client “in the same or a substantially related matter in which that person's interests are materially adverse to the interests of the former client unless the former client gives informed consent, confirmed in writing.” Therefore, the primary client model appears to be unworkable in a dual representation jurisdiction.

As a second alternative, amici suggest the contract model, where amici argue that no conflict of interest exists when an insurer selects an insured's counsel and contractually instructs counsel that only the insured is a client. But this may not eliminate the lawyer's conflict of interest because the lawyer is selected by and receives compensation from someone with legal interests opposed to the lawyer's client. This approach may violate the spirit of RPC 1.8(f), which says that “[a] lawyer shall not accept compensation for representing a client from one other than the client unless ․ [t]here is no interference with the lawyer's independence of professional judgment or with the client-lawyer relationship.” When counsel is both selected and paid by a third party with legal interests directly opposed to the client's, there is a legitimate question whether counsel can be truly independent.⁵ For instance, the attorney might have an incentive to act favorably toward the insurer in order to garner future business.

In sum, Nevada, like California, recognizes that the insurer and the insured are dual clients of insurer-appointed counsel. Where the clients' interests conflict, the rules of professional conduct prevent the same lawyer from representing both clients. California's Cumis rule is well-adapted to this scenario. It requires insurers to fulfill their duty to defend by allowing insureds to select their own counsel and paying the reasonable costs for the independent counsel's representation. Cumis Ins. Society, Inc., 162 Cal.App.3d 358, 208 Cal.Rptr. 494, 506. We find this approach more workable than the alternatives presented by amici. Therefore, we answer the first certified question in the affirmative: When a conflict of interest exists between an insurer and its insured, Nevada law requires the insurer to satisfy its contractual duty to provide representation by permitting the insured to select independent counsel and by paying the reasonable costs of such counsel.⁶

The effect of a reservation of rights

Jurisdictions are divided on whether a reservation of rights creates a per se conflict of interest. Some jurisdictions apply a per se rule that a reservation of rights creates a conflict of interest between the insured and insurer-appointed counsel. See Patrons Oxford Ins. Co. v. Harris, 905 A.2d 819, 825–26 (Me.2006).⁷ Courts in these jurisdictions have reasoned that, if an insurer could control the case under a reservation of rights, it could insist on full litigation. The insurer would thereby expose the insured to the risk of personal liability and then seek to deny coverage if the verdict is unfavorable to the insured. See id. at 826. Courts see it as unfair to give insurers an opportunity for a second bite of the apple. See id.

Other jurisdictions look to the facts of the case to determine whether there is an actual conflict.⁸ Courts in these jurisdictions stress that the point of the Cumis rule is to enforce conflict-of-interest rules, so the focus should be on whether there is actually a conflict. See, e.g., Fed. Ins. Co. v. MBL, Inc., 219 Cal.App.4th 29, 160 Cal.Rptr.3d 910, 920 (Ct.App.2013). Courts must therefore consider whether a conflict of interest exists and not simply look for a reservation of rights. See id.

For example, in California, the codified Cumis rule requires an actual conflict of interest; it does not apply to every case in which there is a reservation of rights. “[W]hen 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.” Cal. Civ.Code § 2860(b) (West 2014) (emphasis added). There are two elements: (1) a reservation of rights and (2) that the outcome of the coverage determination can be controlled by counsel in the underlying defense of the claim. See id.; Travelers Prop. v. Centex Homes, No. C 10–02757 CRB, 2011 WL 1225982, at *8 (N.D.Cal. Apr.1, 2011) (applying Cal. Civ.Code § 2860(b) to determine whether conflict existed). But even after laying out those two elements, the statute uses the word “may,” implying that it is still an issue of fact whether a conflict of interest actually exists.

What, then, is the standard that a trial court must apply when looking at whether the facts of the case create a conflict of interest? In California, courts apply the rules of ethics: “[T]he Cumis rule is not based on insurance law but on the ethical duty of an attorney to avoid representing conflicting interests. For independent counsel to be required, the conflict of interest must be significant, not merely theoretical, actual, not merely potential.” MBL, 160 Cal.Rptr.3d at 920 (internal quotations omitted). Therefore, even when (1) there is a reservation of rights and (2) insurer-provided counsel has control over an issue in the case that will also decide the coverage issue, courts must still determine whether there is an actual conflict of interest. This means that there is no conflict if the reservation of rights is based on coverage issues that are only extrinsic or ancillary to the issues actually litigated in the underlying action. See id.

We conclude that the California approach, that a reservation of rights does not create a per se conflict, is most compatible with Nevada law. Courts must inquire, on a case-by-case basis, whether there is an actual conflict of interest. This approach follows Nevada law: We have held that dual-representation is appropriate as long as there is “no actual conflict.” See Nev. Yellow Cab, 123 Nev. at 51, 152 P.3d at 741. And we have approvingly cited opinions holding that “joint representation is permissible as long as any conflict remains speculative.” Id. Moreover, because the Cumis rule derives from rules of professional conduct, see MBL, 160 Cal.Rptr.3d at 920, it follows that the appropriate standard is whether there is an actual conflict under RPC 1.7. Therefore, an insurer is obligated to provide independent counsel of the insured's choosing only when an actual conflict of interest exists. A reservation of rights does not create a per se conflict of interest.

By the Court, CHERRY, J.:

We concur: HARDESTY, C.J., and SAITTA, PICKERING, DOUGLAS, and GIBBONS, JJ.