McKennon Law Group, Author at McKennon Law Group

Are insureds entitled to communications between an insurance company’s in-house counsel and the claims handlers that might otherwise be protected by the attorney-client privilege? Following a new ruling by the Ninth Circuit Court of Appeals, if the claimant is insured under an ERISA plan, the answer might be “yes.”

For decades, courts, including the Ninth Circuit, have recognized a “fiduciary exception” to the attorney-client privilege in the context of ERISA. Courts have required production of legal advice given to plan fiduciaries when they are acting as fiduciaries for the benefit of the beneficiaries. This “fiduciary exception” has however been subject to exceptions.

In Stephan v. Unum Life Insurance Company of America, __ F.3d __, 2012 U.S. App. LEXIS 19139, 2012 WL 3983767 (9th Cir. September 12, 2012), for the Ninth Circuit for the first time addressed whether the fiduciary exception applies to insurance companies in the ERISA context. The Court ruled that, in an ERISA case, a claimant is entitled to conduct discovery regarding communications between claims handlers and in-house counsel in an attempt to determine whether the insurer’s decision was improperly influenced by a conflict of interest. Following the Third Circuit’s ruling in Wachtel v. Health Net, Inc., 482 F.3d 225 (3d Cir. 2007), the court held that the ERISA “fiduciary exception” to the attorney-client privilege did not apply to communications made while the claim is still being evaluated.

Unlike most cases involving long-term disability insurance, the dispute in Stephan was not over whether the claimant was entitled to benefits, but rather the amount of those benefits. Following a bicycling accident that left him quadriplegic, Unum calculated Stephan’s earnings using only his monthly salary, but not his annual bonus. Given that Stephan’s bonus was 1 ½ times his salary, Unum’s interpretation of the Plan terms to exclude to bonus resulted in a substantial cost savings for the insurer. Stephan, with the full support of his employer, who provided evidence that the bonus was not a discretionary addition to his income, but rather the “main portion” of his compensation, sued Unum to have the bonus included as part of his monthly earnings.

On cross motions for summary judgment, the District Court applied the abuse of discretion standard of review and held that Unum’s interpretation of the Plan was not an abuse of discretion. The District Court also denied Stephan’s motion to compel discovery of a series of internal memoranda created by Unum’s in-house counsel regarding Stephan’s claim. Stephan appealed both rulings.

As to the issue of the proper standard of review, the Ninth Circuit ruled that District Court’s decision to apply the abuse of discretion standard of review was proper, rejecting the plaintiff’s arguments that an agreement between Unum and the California Department of Insurance prohibits the discretionary authority provision, as well as the argument that the discretionary provision is contrary to California state law and public policy and is therefore void. However, the Ninth Circuit criticized the District Court’s failure to consider evidence showing that Unum’s decision might have been improperly influenced by a conflict of interest.

The district court held that “Unum’s conflict of interest did not weigh heavily upon its decision-making process in this case and therefore does not tip the scale towards a finding of an abuse of discretion.” In reaching this conclusion, the district court erred by failing to apply traditional principles of summary judgment; denying Stephan’s motion to compel discovery of certain internal memoranda between Unum’s claim analyst and its in-house counsel; and ignoring evidence that Unum has a history of biased decision making that indicates that its conflict of interest in this case ought to be given more weight.”

Similarly, the Ninth Circuit criticized the District Court’s refusal to compel the production of certain documents that Stephan sought in an effort to demonstrate that Unum’s decision was influenced by its conflict of interest. Specifically, “Stephan sought to discover a series of internal memoranda created between December 2007 and February 2008 by Unum’s in-house counsel, at the request of Unum’s claims analyst.” Acknowledging that ordinarily such documents would fall under the attorney-client privilege, Stephan argued that because Unum is a fiduciary of the ERISA Plan, the fiduciary exception to the privilege permits his discovery of the documents.”

The Ninth Circuit agreed with the District Court’s finding that the fiduciary exception applies to wholly insured ERISA plans, but disagreed with the District Court’s application of the doctrine. The District Court refused to compel the production of the documents because “the interests of plaintiff and defendant had sufficiently diverged at the time the disputed memoranda were created.” However, after reviewing the documents, the Ninth Circuit ruled that they merely “offer[ed] advice solely on how the Plan ought to be interpreted,” and did not address any potential civil or criminal liability Unum might face. The Ninth Circuit further noted that the documents “were prepared to advise Unum claims analysts about how best to interpret the Plan, and were communicated to the analysts before any final determination on Stephan’s claim had been made.” (Emphasis added.) In discussing the issue, the Ninth Circuit rejected the conclusion of Wachtel, expressing its view that the justifications for the fiduciary exception did not support excluding insurers from the fiduciary exception:

ERISA has broad disclosure requirements: It requires that “every employee benefit plan . . . afford a reasonable opportunity to any participant whose claim for benefits has been denied for a full and fair review by the appropriate named fiduciary of the decision denying the claim.” 29 U.S.C. § 1133. Because “[t]he opportunity to review . . . pertinent documents is critical to a full and fair review,” Ellis v. Metropolitan Life Insurance Co., 126 F.3d 228, 237 (4th Cir. 1997), the regulations implementing this provision require that upon request, a claimant be provided all “information relevant to the claimant’s claim for benefits,” 29 C.F.R. § 2560.503-1(h)(2)(ii). Neither the statute nor the regulations provide any reason why the disclosure of information is any less important where an insurer, rather than a trustee or other ERISA fiduciary, is the decisionmaker.

Similarly, the obligation that an ERISA fiduciary act in the interest of the plan beneficiary does not differ depending on whether that fiduciary is a trustee or an insurer. There is therefore no principled basis for excluding insurers from the fiduciary exception. Accordingly, because the advice was given before the interests of Unum and the claimant became adverse, the Court ruled that the fiduciary exception to the attorney-client privilege applied.

Finally, while the Ninth Circuit remanded the ruling on the underlying claim decision to the District Court, the Court of Appeals offered a detailed analysis of the Plan language and controlling case law suggesting that there is ample evidence that Unum’s decision was likely tainted by a conflict of interest and the decision to exclude Stephan’s bonus from the calculations of the LTD benefits was improper and should be overturned.

This plaintiff-participant friendly decision has some very beneficial statements and holdings and should be referred to by attorneys for plan participants/beneficiaries.

In Lee v. West Coast Life Insurance Company, 2012 U.S. App. LEXIS 15768 (9th Cir. July 31, 2012), the Ninth Circuit Court of Appeals ruled that a stakeholder insurance company cannot use an interpleader filing to shield itself from tort liability for its negligent actions. With this holding, the Court of Appeals confirmed that “where the stakeholder may be independently liable to one or more claimants, [an] interpleader does not shield the stakeholder from tort liability, nor from liability in excess of the stake.”

In 1998, West Coast Life Insurance Company issued a policy on the life of Steve Lee, Sr. Over the next ten years, West Coast received numerous change of ownership and change of beneficiary forms from members of the Lee family. However, in 2005, West Coast’s Director of Policy Administration gave erroneous instructions regarding who should sign particular forms, and in what capacity those forms should be signed. Assuming that West Coast had properly instructed them in completing those forms, the Lee family made several subsequent changes to the policy’s ownership and beneficiaries. When Mr. Lee died in 2009, West Coast realized that the 2005 changes were not properly executed, and informed certain members of the Lee family that they were not entitled to the life insurance benefits.

With West Coast’s discovery, two groups of the Lee family claimed that they were entitled to the life insurance proceeds: the named beneficiaries prior to the 2005 changes and the named beneficiaries at death. That first group of Lee family members (the pre-2005 beneficiaries) filed suit against West Coast for breach of contract and breach of the covenant of good faith and fair dealing. West Coast filed a counterclaim-in-interpleader, deposited the life insurance proceeds, plus interest, with the Court, and added the other members of the Lee family (the post-2005 beneficiaries) as counterclaimants. The post-2005 beneficiaries then filed counterclaims for negligence and declaratory relief against West Coast, as well as cross-claims against the pre-2005 beneficiaries.

Eventually, the members of the Lee family settled their disputing claims to the life insurance proceeds, with the pre-2005 beneficiaries receiving $290,000, and the post-2005 beneficiaries collecting the remainder of the funds. This did not end the litigation however, as the post-2005 beneficiaries maintained that West Coast was liable to them for the insurance proceeds allocated to the pre-2005 beneficiaries, as well as for attorneys’ fees incurred in litigating the cross-claims against them.

Following a bench trial on stipulated facts, the district court issued judgment in West Coast’s favor, ruling that the post-2005 beneficiaries failed to allege any cognizable damages flowing from West Coast’s alleged negligent conduct, and therefore it did not need to address the merits of the post-2005 beneficiaries’ negligence claims. Specifically, the district court “concluded that attorney’s fees are not recoverable in interpleader actions absent a showing of bad faith.” In overturning the district court’s ruling, the Ninth Circuit explained that while an interpleader does protect “the stakeholder from being obliged to determine as this peril which claimant has the better claim … interpleader protection generally does not extend to counterclaims that are not claims to the interpleaded funds.”

Here, the post-2005 beneficiaries “alleged that West Coast’s negligent actions in 2005 caused the instant controversy, and claim damages flowing from that negligence.” Thus, because their “damages flowed not from West Coast’s filing of an interpleader complaint but from its alleged negligent conduct,” the post-2005 beneficiaries were not required to show that West Coast acted in bad faith. Accordingly, because interpleader protection does not extend to counterclaims that are not claims to the interpleaded funds, West Coast could be liable for its negligent actions.

Based on this ruling, an insurance company cannot use an interpleader filing as a shield to protect itself from liability for its own negligent (or for that matter bad faith) actions. When the insurance company is not blameless with respect to the underlying controversy, it can face tort liability from a party that claims an interest in the disputed funds. In fact, an insurance company can face liability for negligence, and can even be liable for certain attorneys’ fees incurred in such an action.

For the year 2012, Robert J. McKennon has been rated AV Preeminent in Insurance Law by his peers, an achievement of Martindale Hubbell’s highest rating in legal ability and ethical standards. Mr. McKennon will be featured in the August 2012 issues of Corporate Counsel magazine and The National Law Journal, both of which will feature the 2012 Top Rated Lawyers in Insurance Law.

The Wednesday July 11, 2012 edition of the Los Angeles Daily Journal featured Robert McKennon’s and Scott Calvert’s article entitled: “Equitable Relief in the Ninth Circuit Just Got Better for Consumers.” In it, Mr. McKennon and Mr. Calvert discuss two important Ninth Circuit rulings allowing certain equitable relief to ERISA plan participants that have definite pro-consumer holdings. The article is posted below with the permission of the Daily Journal.

The Ninth Circuit Court of Appeals in a recent decision held that an insurer’s duty of good faith and fair dealing, which is implied in every contract of insurance, may be violated by the insurer’s failure to attempt to effectuate a settlement within policy limits after liability of its insured has become reasonably clear. In essence, the Court found that an insurer’s unreasonable refusal to attempt to effectuate settlement after the evidence reasonably indicates that the insured’s liability will be in excess of the policy limits constitutes bad faith.

In Du v. Allstate Insurance Company et al., 2012 U.S. App. LEXIS 11755, May 11, 2012 (9th Cir. 2012), the victim was injured in an accident caused by the insurer’s insured, who then obtained a judgment against the insured. The insured assigned his bad faith claim to the victim, who argued in the District Court that the insurer breached the covenant of good faith and fair dealing when it did not attempt to effectuate settlement of the victim’s claims after it became reasonably clear that the insured’s liability to the victim was in excess of the policy limits. The victim requested a jury instruction that such a failure by the insurer could constitute bad faith. The District Court rejected the victim’s request.

On appeal, the Ninth Circuit found that the District Court legally erred in holding that, as a matter of law, bad faith liability could not be premised on an insurer’s failure to effectuate settlement in the absence of a reasonable demand. In so finding, the Court noted the long standing principal that the duty of good faith and fair dealing “requires the carrier to consider in good faith the interests of the assured equally with its own and evaluate settlement offers within policy limits as though it alone carried the entire risk of loss.” See Merritt v. Reserve Ins. Co., 34 Cal. App. 3d 858 (1973). The Court, however, affirmed the District Court’s judgment and found that the District Court did not abuse its discretion in refusing to give the requested instruction in this case because there was no evidentiary foundation for the victim’s assertion that the insurer should or could have made an earlier settlement offer to the insured. The Court found that the requested jury instruction was proper, however, the facts of this case did not warrant such an instruction.

Despite the Court’s ultimate finding in this case, this decision by the Ninth Circuit reaffirms the courts’ willingness to extend bad faith liability under a multitude of circumstances wherein an insurer acts unreasonably and places its own interests ahead of its insured.

In Health Net, Inc. v. RLI Insurance Company, et al., the California Court of Appeal, Second District, reversed a trial court’s entry of judgment on a Motion for Summary Judgment finding some coverage for Health Net, Inc. (“Health Net”) in connection with numerous lawsuits filed against it arising under the Employee Retirement Income Security Act of 1974 (“ERISA”). Health Net brought suit against four of its insurers (one primary and three excess carriers) seeking a declaratory judgment that the insurers had a duty to defend and indemnify Health Net in over 20 underlying actions involving Health Net’s insurance plans provided by employers, which plans were subject to the requirements of the ERISA. The parties, however, directed their attention to two specific underlying actions, as the amount of indemnity sought in those actions would far exceed the combined policy limits of the defendant insurers. Relying on a policy exclusion for “dishonest acts,” the trial court granted summary adjudication to the insurers with respect to Health Net’s claim for reimbursement of its defense costs and the costs of settling the specified underlying actions. The parties subsequently settled their dispute regarding the remaining underlying actions, and summary judgment was granted in favor of the insurers. Health Net appealed the ruling.

On appeal, the Court of Appeals first addressed whether the two underlying actions at issue sought damages covered by Health Net’s insurance policies. The court concluded that the great bulk of the claims asserted in the underlying actions were not covered, but there was a potential for coverage for some of them. The court held that in the “Insuring Agreement” of the applicable policies, including a “HMO/PPO/Managed Health Care Professional Liability” policy, did not provide coverage for the insured’s contractual obligations, even if the insured committed a wrongful act in its failure to pay such benefits.

Second, the court addressed the “dishonest acts” exclusion, and considered whether it barred, as a matter of law, coverage for all of the otherwise covered claims in the underlying actions. The court concluded that, while the “dishonest acts” exclusion was triggered with respect to the underlying actions, the exclusion barred coverage only for those claims alleging dishonest acts, not the entirety of the underlying actions. As some claims for indemnity and defense costs relating to the two underlying actions at issue remained, the court reversed the summary judgment.

Because the court concluded that the “dishonest acts” exclusion relied upon by the trial court excluded some, but not all, of the underlying claims, some of which might potentially allege a covered loss, it remanded the case to the trial court “to determine whether and to what extent there is any merit to the claim of coverage.”

Under ERISA, Communications with In-House Counsel Before a Final Claims Decision are Not Privileged and are Subject to Discovery to Show a Conflict of Interest

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