We all know the maxim that “bad facts make bad law.”  Two years after J.R. Marketing, LLC prevailed in the Court of Appeal concerning its dispute with its commercial general liability insurer, Hartford, it ran out of luck before the California Supreme Court in its fight over important Cumis counsel issues.  Hartford Cas. Ins. Co. v. J.R. Marketing, LLC, 190 Cal. Rptr. 3d 599, 2015 DJDAR 9111 (Cal. Aug. 10, 2015).  This is a must read for every lawyer in California that acts as Cumis counsel.

The High Court held an insurance company can sue independent counsel (i.e., Cumis counsel) directly for reimbursement of unreasonable or unnecessary legal charges counsel billed it to defend its insured.  This decision may dramatically change the entire Cumis counsel landscape.  Previously, an insurer could only sue its insured for reimbursement of defense fees.  The High Court’s decision, no doubt, will have a chilling effect on how Cumis lawyers represent their clients.  They will fear subsequent fee litigation from the insurer.  One has to wonder if “independent counsel” will truly be independent anymore.  Quite possibly, this case will practically (though not legally) relegate Cumis counsel to a similar role as an insurance company’s panel counsel, who has to pander to the “hand that feeds them” even though, under the law, Cumis counsel has two clients, the insured and the insurer.

The facts of this case were unique because Cumis counsel racked-up a whopping $15 million in legal bills under a court order it drafted that allowed it to bill the insurer without any fear whether or not the bills would be immediately paid in full.  Hartford had issued J.R. Marketing a commercial general liability policy that covered business-related defamation and disparagement.  J.R. Marketing was sued in Marin County (and other liability actions) for interference with business relationships, defamation, unfair competition and other business-related torts.  It tendered the defamation lawsuit to Hartford under the policy.  Hartford denied any duty to defend or indemnify.

J.R. Marketing sued Hartford for breaching the insurance policy.  Hartford, only after the coverage action was filed, agreed to defend under a reservation of rights but only prospectively.  It refused to pay J.R. Marketing’s legal bills back to the date of tender, and it also refused to provide Cumis counsel in place of its own panel defense counsel.  The trial court in the coverage action found Hartford breached it duty to defend by failing to provide and pay for Cumis counsel from the date of tender.

A few months later, because Hartford still had not paid Cumis counsel’s bills violating the trial court’s summary adjudication order, the trial court entered an enforcement order in the coverage action.  The order, drafted by J.R. Marketing’s Cumis counsel, Squire Sanders, required Hartford to promptly pay all of Squire Sanders’s past defense invoices within 15 days and to pay “all future defense costs” in the defamation action “within 30 days of receipt.”  The order stated Hartford breached its duty to defend by failing to honor it until ordered to do so by the court and by thereafter failing to pay counsel’s submitted bills in a timely fashion.  The order further stated that Squire Sanders’s bills had to be reasonable and necessary and that, to “the extent Hartford seeks to challenge fees and costs as unreasonable or unnecessary, it may do so by way of reimbursement after resolution of the” underlying defamation action.  The trial court’s order did not specify from whom Hartford could seek reimbursement, i.e. from its insured, J.R. Marketing or from Squire Sanders.

After the defamation suit ended, Hartford filed a cross-complaint in the coverage action for “reimbursement pursuant to the enforcement order,” unjust enrichment and other claims.  It directly sued Cumis counsel, Squire Sanders, as well as its insured J.R. Marketing.  “The cross-complaint asserted that Hartford was entitled to recoup from the cross-defendants a significant portion of some $15 million in defense fees and expenses, including some $13.5 million Hartford paid to Squire Sanders pursuant to the enforcement order.”

Squire Sanders, representing itself and J.R. Marketing, demurred to Hartford’s cross-complaint.  It argued, among other things, that an insurer has no direct claim against an insured’s independent counsel for reimbursement.  The trial court agreed and “concluded that Hartford’s right to reimbursement, if any, was from its insureds, not directly from Cumis counsel.”  The appellate court affirmed the decision.  It rejected Hartford’s argument that an insurer has a right to recover directly from Cumis counsel unreasonable and excessive fees it pays counsel because counsel (and not just the insured) is unjustly enriched in that scenario.

The California Supreme Court reversed.  The Court was very careful to narrowly frame the issue before it because it did not want its holding to apply to all Cumis counsel cases, just ones where the insurer had a reimbursement right rooted in a trial court order.  It therefore stated the issue in great detail as:

From whom may a CGL insurer seek reimbursement when: (1) the insurer initially refused to defend its insured against a third-party lawsuit; (2) compelled by a court order, the insurer subsequently provided independent counsel under a reservation of rights . . . to defend its insured in the third party suit; (3) the court order required the insurer to pay all “reasonable and necessary defense costs,” but expressly preserved the insurer’s right to later challenge and recover payments for “unreasonable and unnecessary” charges by counsel; and (4) the insurer now alleges that independent counsel “padded” their bills by charging fees that were, in part, excessive, unreasonable, and unnecessary?

The Court emphasized again, “We granted Hartford’s petition for review, which raised a narrow question: May an insurer seek reimbursement directly from counsel when, in satisfaction of its duty to fund its insureds’ defense in a third party action against them, the insurer paid bills submitted by the insureds’ independent counsel for the fees and costs of mounting this defense, and has done so in compliance with a court order expressly preserving the insurer’s post-litigation right to recover ‘unreasonable and unnecessary’ amounts billed by counsel?” [Emphasis added].

To that very narrow issue the High Court responded:

We conclude that under the circumstances of this case, the insurer may seek reimbursement directly from Cumis counsel. If Cumis counsel, operating under a court order that expressly provided that the insurer would be able to recover payments of excessive fees, sought and received from the insurer payment for time and costs that were fraudulent, or were otherwise manifestly and objectively useless and wasteful when incurred, Cumis counsel have been unjustly enriched at the insurer’s expense. [Emphasis added].

As alluded to earlier, bad facts make bad law.  The Court could not ignore the fact that the law firm acting as independent counsel, Squire Sanders, had racked up $15 million in legal bills defending the insured!  Moreover, the Squire firm had written its own meal-ticket.  It drafted the proposed order adopted by the trial court finding the defendant insurance company owed a duty to defend its insured through independent counsel.  But Squire Sanders did not stop there.  It included language in the order requiring Hartford to pay all of its legal bills in the case within thirty days, no questions asked, and that Hartford could not challenge any of the bills until after the underlying liability action had ended. The Squire firm’s aggressive and expensive litigation tactics completely unchecked by anyone, and the fact that the firm had drafted the very order permitting that highly advantageous scenario to them, lead the High Court to decide it had to allow a direct reimbursement action by Hartford against Squire Sanders.  It could not allow $15 million in legal bills to stand without affording Hartford an opportunity to contest their reasonableness.

Unfortunately, the extreme facts of J.R. Marketing may forever change the Cumis counsel landscape, and not in a good way.  While the Supreme Court was careful to clarify its holding was limited to the unusual facts of the case before it, its opinion unrealistically downplays the chilling effect it will have on Cumis counsel’s ability to zealously represent their client’s interests independent from the influence of its insurer.

We emphasize that our conclusion hinges on the particular facts and procedural history of this litigation.  . . . We . . . express no view as to what rights an insurer that breaches its defense obligations might have to seek reimbursement directly from Cumis counsel in situations other than the rather unusual one before us in this case.

While firms acting as independent counsel will try to zealously defend their clients and look out solely for their interests (as the law requires), the threat of fee litigation looming over their heads by insurance companies will shape Cumis counsel’s strategy.  Cumis lawyers will consider whether the insurance company is likely to challenge their defense strategies as unnecessary in a subsequent reimbursement action for fear of having to re-pay large legal bills.  They are likely to decide how to defend the case based not just on their client’s best interests but, on their own and the insurer’s too.

If insurance companies had a record of integrity and looking out for their insured’s interests (and the lawyers that defend them), the Court’s opinion might work.  But they don’t.  They have a well-earned reputation of unreasonably nitpicking lawyer’s bills, refusing to pay for necessary legal work, demanding to pay antiquated hourly rates rather than market rates, employing auditing firms paid on a commission by how much of a lawyer’s bills they cut, and by trying to impose unreasonable billing guidelines on law firms.  Cumis firms therefore will make legal strategy decisions against that backdrop.  They will decide strategy based not only on whether they think legal work is necessary to their client’s defense, but, the possibility that the insurer paying their bills will file an expensive reimbursement action against them that unreasonably challenges their fees.

In the proceedings below, the trial court and the appellate court held a breaching insurer has no right to seek reimbursement directly from Cumis counsel.  The lower court’s opinion enhanced the ability of independent counsel retained by insureds to vigorously prosecute their clients’ cases without fear of a possible action for reimbursement by insurers.  It sent a strong message: insurers who reserve their rights and refuse to fund the defense of Cumis counsel take a big chance that they will be stuck paying those fees without any real ability to challenge them.

The California Supreme Court obliterated that vitally important message and sent its own.  Cumis lawyers better carefully scrutinize their bills and only perform legal work that is absolutely reasonable and necessary to defending their clients because, if they cross the line, they will end up with a huge legal bill of their own.  This decision, no doubt, will have a chilling effect on how Cumis lawyers represent their clients.

This decision would appear to undermine the purpose of the Cumis doctrine codified in Civil Code section 2860: when the insurer has a conflict with its insured on how to defend the underlying liability case because the outcome of a reserved coverage issue can be controlled by how it is defended, the insurer must pay for an independent defense lawyer chosen by and with allegiance solely to its insured to defend the case.  How can a lawyer be truly independent from the client’s insurer and solely dedicated to protecting the insured’s interests when the insurer has the power to question every defense decision the lawyer makes and recoup legal fees that were arguably not wisely spent?  Even the most ethical, skilled lawyer will measure each strategy decision he makes not just by whether it will benefit his client’s defense but by whether an insurer may have room to argue against the strategy.  What is the silver lining?  Perhaps the courts will indeed limit this holding to its very unique facts and confine its application.  We can only hope.