THE COMPLEX INSURANCE COVERAGE REPORTER – SEPTEMBER 2021

When Can Liability Insurers Sue Appointed Underlying Defense Counsel for Malpractice?

By: Peter Mooney and Sara Mirsky

Insured gets sued. Insurer hires defense counsel to represent insured. Defense counsel takes over the case, and eventually, the case ends. Most of the time, the carrier and its insured will be satisfied with the result. There may be occasions, however, when the outcome is plainly undesirable.

Maybe there was an unusually large verdict that was unanticipated, or the case settled for what is seen as an inflated amount after a critical defense failed. In assessing the situation, the insurer may believe defense counsel mishandled the claim. This scenario raises a related thorny question: when can an insurer assert a legal malpractice claim against the attorney it appointed to defend the insured?

The Florida Supreme Court Weighs In

The Florida Supreme Court recently had occasion to address this very issue. In Arch Insurance Company v. Kubicki Draper, LLP, 2021 Fla. LEXIS 898 (Fla. June 3, 2021), an insurer (Arch) hired a law firm to represent its insured (an accounting firm charged with malpractice) in an underlying lawsuit. Arch did so pursuant to the defense provisions of a professional liability policy. The policy also included the following subrogation clause:

To the extent of any payment under this Policy, we [Arch] shall be subrogated to all your [insured’s] rights of recovery therefor against any person, organization, or entity and you shall execute and deliver instruments and papers and do whatever else is necessary to secure such rights. You shall do nothing after any loss to prejudice such rights.

Shortly before trial, the underlying lawsuit settled. Arch then sued defense counsel, alleging that the firm committed malpractice by failing to raise certain defenses (Arch alleged that the failure to timely assert a statute of limitations defense greatly increased the cost of settlement). Arch advanced various theories against the firm including legal malpractice, subrogation, assignment, third-party beneficiary and breach of contract.

A Florida trial court and an intermediate appeals court both determined that Arch lacked standing to sue. They reasoned that Arch was not in privity with the firm. The appeals court in turn certified this “question of great public importance” to the Florida Supreme Court.

The Florida Supreme Court agreed that the firm was in privity with the insured as the client rather than Arch. Nevertheless, it found that an insurer that is contractually subrogated to its insured’s rights under a policy has standing to bring a legal malpractice action against retained defense counsel: “Where an insurer has a duty to defend and counsel breaches the duty owed to the client insured, contractual subrogation permits the insurer, who—on behalf of the insured—pays the damage, to step into the shoes of its insured and pursue the same claim the insured could have pursued.” Id. at *9.

In so holding, the court remarked that it was aware of the public policy concerns that caution against assigning legal malpractice claims to prevent creating an incentive for frivolous suits. It noted, however, that the contractual subrogation provided under the Arch policy actually advances public policy by keeping “premium rates down by allowing the insurers to recover indemnification payments from the tortfeasor who caused the injury.” Id. at *12-13. Further, the court found that public policy concerns do not exist here because “[t]he subrogated claim originates by contract from the insured to the insurer, the same entity who hired the lawyer in the first instance.” Id. at *13.

When Does an Insurer Have Standing to Sue for Malpractice?

The Arch case focused on contractual subrogation as the basis for finding the insurer had standing to sue. Courts have also found an insurer could bring a malpractice claim under several other theories, including:

  • the tripartite relationship theory (under which the insurer and insured are both considered clients);
  • as third-party beneficiary (finds the insurer is the direct beneficiary of counsel’s actions);
  • equitable subrogation (an appeal to “justice” whereby a court may allow a malpractice claim to proceed); and
  • the Restatement (Third) of the Law Governing Lawyers (provides that underlying counsel owes the insurer a duty of care).

As discussed further below, a majority of states may permit an insurer to bring a malpractice suit against underlying defense counsel under one or more of these theories.[1]

The Tripartite Relationship Theory. Many states have permitted an insurer to bring a malpractice suit under the tripartite relationship theory, including Alaska, Arizona, Arkansas, California, Florida, Illinois, Indiana, Kentucky, Minnesota, New York, South Carolina, Utah, Virginia and West Virginia. Under this theory, courts have found that underlying counsel owed a fiduciary duty to both the insurer and the policyholder. These cases have emphasized that an insurer ­­may sustain a malpractice claim only if the malpractice is the “proximate cause of damages to the insurer,” and the interests of the insurer and insured are completely aligned. See, e.g., Sentry Select Insurance Company v. Maybank Law Firm, LLC, 2019 S.C. LEXIS 12, at *4 (S.C. Mar. 6, 2019) (permitting lawsuit to proceed where insurer-selected defense counsel failed to timely answer requests for admission and insurer was required to settle for allegedly inflated amount); Home Indemnity Company v. Lane Powell Moss & Miller, 43 F.3d 1322 (9th Cir. 1995) (Under Alaska law, an insurer could sue for malpractice when underlying counsel made misrepresentations regarding settlement discussions. Because there was no reservation of rights in place, no conflict of interest existed between the insurer and insured.).

Third-Party Beneficiary. Under the third-party beneficiary theory, a court may allow a malpractice suit if an insurer can show that it was “the intended beneficiary of the relationship between the client and the attorney.” Grinell Mutual Reinsurance Company v. Franks, Gerkin & McKenna, 2000 U.S. Dist. LEXIS 12636, at *13 (N.D. Ill. Aug. 24, 2000). In Grinell, the court found that under Illinois law, the insurer could proceed on its claim against underlying counsel because if counsel “had put forward a successful defense . . . [the insured] would not have been found liable and [the insurer] would have no indemnity obligations.” Id. at *13-14. The theory has also been supported by courts in Florida and Arizona. See Hartford Insurance Company of the Midwest v. Koeppel, 629 F. Supp.2d 1293 (M.D. Fla. 2009); Paradigm Insurance Company v. Langerman Law Offices, P.A., 200 Ariz. 146 (2000). Note that the Florida Supreme Court in Arch, supra at *10 n.5, declined to address any third-party beneficiary arguments.

Equitable Subrogation. Courts allowing a malpractice claim to advance under an equitable subrogation theory have often found that shifting the responsibility for a monetary loss to the responsible attorney surpasses any concerns regarding the “commercialization” of malpractice lawsuits. For example, in Atlanta Internal Insurance Company v. Bell, 438 Mich. 512 (1991), an insurer brought a malpractice action against defense counsel for failure to raise a comparative negligence defense in a wrongful death action. The court allowed the insurer to move forward with the malpractice claim under an equitable subrogation theory because “[t]o hold that an attorney-client relationship exists between insurer and defense counsel could indeed work mischief, yet to hold that a mere commercial relationship exists would work obfuscation and injustice. The gap is best bridged by resort to the doctrine of equitable subrogation to allow recovery by the insurer.” Id. at 521. Courts applying the law of the following states have found that insurers have standing to bring a malpractice claim through equitable subrogation: Illinois, Massachusetts, Michigan, New York, Pennsylvania and Texas.

If a state has a law that prohibits the assignment of malpractice claims, courts have found that the subrogation of malpractice claims would likely be precluded. It has been reasoned that allowing the assignment or subrogation of malpractice claims “would encourage commercialization of claims, and would force attorneys to defend themselves against persons to whom no duty was ever owed. Moreover, the legal profession is debased by such commercialization, because it could (1) encourage unjustified lawsuits; (2) generate increased malpractice lawsuits, burdening the profession, the court system and (to the extent malpractice premiums would inevitably rise and be passed to the consumers) the public; and (3) promote champerty.” Kracht v. Perrin, 1990 Cal. App. LEXIS 388, at *8 (Cal. Ct. App. 4th Dist. Apr. 23, 1990) (citation omitted). Courts applying the law of the following states have found that there is no right for an insurer to bring a malpractice claim through equitable subrogation: Arizona, Arkansas, California, Colorado, Connecticut, Florida, Indiana, Kentucky, Louisiana, Minnesota, Missouri and Ohio.

The Restatement (Third) of the Law Governing Lawyers. Some courts look to the Restatement (Third) of the Law Governing Lawyers, Section 51 to “recognize an additional or substitute cause of action by the insurer as a non-client beneficiary of the firm’s legal services.” Gen. Sec. Ins. Co. v. Jordan, Coyne & Savits, LLP, 357 F.Supp. 2d 951 (E.D. Va. 2005) (allowing insurer to sue counsel for malpractice when counsel failed to make an appearance in an underlying lawsuit). Specifically, the Restatement provides that “a lawyer designated by an insurer to defend an insured owes a duty of care to the insurer with respect to matters as to which the interests of the insurer and insured are not in conflict, whether or not the insurer is held to be a co-client of the lawyer.” Courts in Florida, Pennsylvania, South Carolina and West Virginia have cited the Restatement when finding that an insurer could bring a malpractice claim against defense counsel.

Conclusion

These theories create a complicated set of considerations for a court to examine when determining whether to permit an insurer’s legal malpractice claim. If an insurer believes that malpractice has occurred, its ability to bring a lawsuit will greatly depend on which state’s law applies, the relationship between the parties and relevant policy language.

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[1] The focus of this article is on primary liability insurer-appointed defense counsel. Jurisdictions have varied on whether an excess insurer can bring a malpractice claim against defense counsel it did not select. Compare National Union Ins. Co. v. Dowd & Dowd, P.C., 2 F. Supp. 2d 1013 (N.D. Ill. 1998) (permitting excess insurer’s malpractice suit against counsel selected by self-insured policyholder to proceed under equitable subrogation theory); and American Centennial Ins. Co. v. Canal Ins. Co., 843 S.W.2d 480, 484 (Tex. 1992) (“recognizing an excess carrier’s right to bring an equitable subrogation action against . . . defense counsel”); with St. Paul Surplus Lines Ins. Co. v. Remley, 2009 U.S. Dist. LEXIS 59434 (E.D. Mo. July 13, 2009) (rejecting excess insurer’s attempt to sue counsel hired by primary insurer because of the “extreme” nature of equitable subrogation and any potential conflicts such a suit would create). We additionally note that there is at least one example of a court permitting an insurer to pursue a malpractice claim against counsel that the insured selected but the insurer approved. St. Paul Fire & Marine Ins. Co. v. Birch, Stewart, Kolasch & Birch, LLP, 379 F. Supp.2d 183 (D. Mass. 2005).