Editor's Note:
State Bar Ethics Opinions cite the applicable California Rules of Professional Conduct in effect at the time of the writing of the opinion. Please refer to the California Rules of Professional Conduct Cross Reference Chart for a table indicating the corresponding current operative rule. There, you can also link to the text of the current rule.
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May an insurance company retain its in-house counsel to represent insureds in litigation brought by third parties pursuant to the policy?
In-house counsel for an insurer may represent insureds in litigation without violating the prohibition against aiding the unauthorized practice of law set forth in rule 3-101(A). However, the attorneys must be certain that the insurance company does not control or interfere with the exercise of professional judgment in representing insureds, that any fees are not split with the insurance company or any other third parties, that cases involving conflicts of interest are referred to outside counsel, and that the firm name used by in-house counsel is not false, deceptive or misleading.
Rules 2-101(A), 2-102, 2-107, 3-101(A), 4-101, 5-102(B) and 6-10l of the Rules of Professional Conduct of the State Bar of California.
Business and Professions Code sections 6125, 6160 et seq.
The Committee has been asked whether an insurer may appoint in-house counsel to defend the interest of its insureds against claims brought by third parties pursuant to the insurance policy. The insurer (hereinafter "Insurance Company") proposes to establish a Law Division. The attorneys in the Law Division will hold themselves out as a law firm practicing under the name of one or more of the attorneys in the firm. Insurance Company will decide the "firm name" to be used. All attorneys comprising the Law Division will be salaried employees of the Insurance Company. All personnel matters of each Law Division (hiring, firing, compensation, etc.) will be handled by Insurance Company's personnel department.
It is proposed that the Insurance Company will retain the Law Division to provide a defense to certain of its insureds. Insurance Company will have the right to assign individual cases either to the Law Division or to outside counsel. Insurance Company intends to assign a percentage of cases to the Law Division, with more complex cases being assigned to outside firms. The motivation is economic. It is believed that the cost of the Law Division providing a defense will be substantially less than the cost of retaining outside counsel to provide such a defense.
Attorneys and other time keepers in each Law Division will bill their time to particular files in the same manner as an outside law firm. Statements will be rendered by the Law Division to the Insurance Company and income will be credited to the Law Division with a corresponding expense charged to the Insurance Company on its books. In theory, the Law Division seeks to operate as an independent law firm. All correspondence and pleadings emanating from the Law Division will be on the "firm's" letterhead. However, individual clients, i.e., insureds, will not be informed that the attorneys comprising the Law Division are employees of Insurance Company.
The Law Division in effect operates as "in-house" counsel for Insurance Company. The question arises as to whether Insurance Company, by retaining its in-house counsel to represent third parties, is engaging in the unauthorized practice of law.
Business and Professions Code section 6125 states that "no person shall practice law in this state unless he is an active member of the State Bar." Rule 3-101(A) provides that:
"A member of the State Bar shall not aid any person, association, or corporation in the unauthorized practice of law."
Although it is now commonplace for insurance carriers to retain outside law firms to defend insureds in litigation, whether an insurance carrier's in-house counsel may perform such a role has never been decided in California. Several earlier California decisions concluded that a corporation can "neither practice law for it nor hire lawyers to carry on the business of practicing law." (People ex rel, Los Angeles Bar Association v. California Protective Corporation (1926) 76 Cal.App. 354 [244 P. 1089].) In California Protective Corp., a corporation contracted with its patrons to employ attorneys on their behalf and to furnish the patrons with legal services for a specified annual fee.
The rationale prohibiting a corporation from retaining attorneys to provide legal services to third parties was premised on the personal relationship of trust and confidence between attorney and client which would be undermined by a corporation undertaking to furnish its members with legal advice, counsel and professional services. (People v. Merchants Protective Corp. (1922) 189 Cal. 531, 538 [209 P. 363].) The court in Merchant Protective Corp. concluded that an attorney "in such case, owes his first allegiance to his immediate employers the corporations and owes, at most but an incidental, secondary, and divided loyalty to the clientele of the corporation."1
The foregoing case law, however, has not outlasted the evolution of prepaid medical and legal service programs which, under these authorities, would theoretically violate the prohibition against corporations practicing law. In recent years the judicial attitude toward group legal and health insurance plans has been greatly relaxed. For example, rule 2-102, which is discussed below, now permits the participation of attorneys in legal service programs under conditions which do not permit the group or its agents or members to interfere with the attorney's duties to the client. (1 Witkin, Cal. Procedure (3rd ed. 1985) Attorneys, 288, pp. 326-327.)2 Underlying these developments is the recognition that an attorney may be hired by a corporation to represent third parties without compromising the lawyer's independent professional judgment if appropriate safeguards are taken.
That a corporation can retain lawyers to provide legal services to third parties is also consistent with the generally accepted recognition that an attorney's relationship with a client is that of an independent contractor and not an employee. (Associated Indemnity Corp. v. Industrial Accident Comm'n (1943) 56 Cal. App.2d 804 [133 P.2d 698].) Similarly, an attorney retained by an insurance carrier to conduct the defense of a suit against its insured is considered an independent contractor. (Merritt v. Reserve insurance Co. (1973) 30 Cal.App.3d 858, 880 [110 Cal. Rptr. 511].)
Although never expressly decided in California, the decisional law in other states recognizes that an insurer which retains lawyers to represent the interests of its insureds in litigation in accordance with its duty to defend the insured does not engage in the unauthorized practice of law because of its right to defend its own direct financial interest in the litigation. (Liberty Mutual Insurance Co. v. Jones (1939) 130 S.W.2d 945; Strothers v. Ohio Casualty Insurance Co. (1939) 5 Ohio Supp. 362.) Since a corporation cannot appear in court except through a licensed attorney (Woodruff v. McDonald Rest. (1977) 75 Cal. App.3d 655 [142 Cal. Rptr. 367]), an insurer would be powerless to defend its legitimate interests, and those of its insureds, without retaining counsel.
Turning to the facts at hand, the question is whether Insurance Company may retain the services of its in-house counsel to handle the defense of a litigation against the insured. While Insurance Company has attempted to distance itself from the practice of Jaw by creating a distinct entity with a separate identity, the fact remains that the attorneys involved will continue to be employed by Insurance Company as salaried employees. However, the mere fact that the lawyers are employees of Insurance Company does not necessarily compromise the attorney's independent professional judgment.
First, as discussed above, Insurance Company has its own legitimate interest to protect. The corporation is not simply performing legal services for others, but it is also protecting its own legal interest, and it is not disputed that a corporation may retain counsel to protect its own interests. (See Woodruff v. McDonald Rest., supra, 75 Cal.App.3d 655.)
Decisions in other states support the conclusion that staff counsel for an insurer may also represent insureds in liability suits. In Coscia v. Cunningham (1983) 250 G.A. 521 [299 S.E.2d 880], the Georgia Supreme Court refused to disqualify defense counsel who was employed by the insurer as in-house counsel. (See also, In Re Allstate Ins. Co. (1987) 722 S.W.2d 947.) The court noted that the insurer was protecting its own financial interest which was consistent with that of the insured since there was no dispute over coverage under the policy. (See Goldenberg Corporate Air, Inc. (1983) 189 Conn. 504 [457 A.2d 296]; Joplin v Denver-Chicago Trucking Co. (8th Cir. 1964) 329 F.2d 396; Torres v. Nelson (1984) 448 So.2d 1058; Mallen, A New Definition of Insurance Defense Counsel, (Jan. 1986) Insurance Counsel Journal at page 108.).
Second, in absence of a conflict of interest between the insureds and Insurance Company, it cannot be presumed that simply because the attorneys handling defense cases are salaried employees of Insurance Company that they will act unethically or will otherwise sacrifice their professional obligations to the insureds in favor of Insurance Company. The determinative factor is whether the Insurance Company's in-house counsel can maintain professional independence comparable to that of an outside law firm. Under the facts of this opinion, with one reservation, we believe they can.
Rule 2-102(A) is instructive on the degree of independence that must exist between the Insurance Company and the Law Division. Rule 2-102 authorizes attorneys to participate in a "bona fide" program, activity, or organization that furnishes, recommends or pays for legal services, including but not limited to, group, pre-paid and voluntary legal service organizations . . ." Under rule 2-102(A), an attorney's participation in such an organization, program or activity is not permitted if the organization or operation allows any third person, organization or group to interfere with or control the performance of the member's duties to his or her clients; allows an improper division of legal fees in violation of rule 3-102; or violates rule 2-101.
While rule 2-102(A) is generally recognized to apply to legal service programs, its concepts could as easily apply to any organization that supplies legal services, including liability insurers. Although we decline to decide in this opinion that rule 2-102(A) was intended to apply to insurers, the Committee believes that the guidelines set forth in rule 2-102(A) are sound and may be followed this context.
In considering rule 2-102(A), attorneys working within the Law Division should be sensitive to the possibility that the Insurance Company may directly or indirectly seek to interfere with or control the performance of the member's duty to his or her client. However, the Committee recognizes that, in absence of a conflict of interest between the insurer and the insured, Insurance Company is entitled to control the defense of litigation and may in many circumstances dictate defense and settlement strategy. (Merritt v. Superior Court (1973) 34 Cal.App.3d 858.)
Attorneys working within the Law Division should be alert that the Law Division does not become a front or subterfuge for lay adjustors or other unlicensed personnel to practice law. Non-attorney personnel working under the attorney's supervision must be adequately supervised. (See rule 6-101; Black v. State Bar (1972) 7 Cal. 3d 676, 692 [103 Cal.Rptr. 288.) The Law Division must attempt to function as a separate law firm as much as possible (e.g., to protect confidential attorney-client files under Bus. & Prof. Code 6068, subd. (e.)
Steps must also be taken to guarantee that illegal fee splitting with Insurance Company does not occur. Apparently, the formal procedures for supplying statements for services rendered to the Insurance Company by the Law Division such that "income" will be credited to the Law Division and a corresponding expense charged to the Insurance Company is an attempt to avoid fee splitting. However, the possibility of fee splitting appears remote since the source of the fees is Insurance Company itself. The Insurance Company is not rendering legal services for profit; rather, the cost of retaining counsel to defend insureds (whether through in-house or outside counsel) constitutes an expense item to Insurance Company.3
An attorney retained by an insurer to represent the interest of its insured in litigation owes fiduciary obligations to both the insurer and the insured. (Lysick v. Walcom (1968) 258 Cal.App.2d 136 [65 Cal.Rptr. 406]; American Mutual Liability Insurance Co. v. Superior Court (1974) 38 Cal.App.3d 579 [113 Cal.Rptr. 561]) In absence of a coverage dispute between the insured and the insurer, the two have a common interest:
"Both the insured and the carrier have a common interest in defeating or settling the third party's claim. If the matter reaches litigation the attorney appears of record for the insured and at all times represents him in terms measured by the extent of his employment.
"In such a situation, the attorney has two clients whose primary, overlapping, and common interest is the speedy and successful resolution of the claim and litigation. Conceptually, each member of the trio, attorney, client, insured, and client-insured has corresponding rights and obligations founded largely on contract, and as to the attorney, by the Rules of Professional Conduct, as well The three parties may be viewed as a loose partnership, coalition or alliance, directed toward a common goal, sharing a common purpose which lasts during the pendency of the claim or litigation against the insured." American Mutual Liability Insurance Co. v. Superior Court (1974) 38 Cal. App.3d 579, 591-92 [113 Cal.Rptr. 561, 571].
When the interests of the insurer and the insured diverge to the point that a conflict of interest is deemed to exist, the attorney must advise both the insurer and the insured of the conflict and must, in absence of written consent of both parties, withdraw from the representation. The insured may be entitled to be represented by independent counsel at the insurer's expense. (San Diego Naval Federal Credit Union v. Cumis Insurance Society, Inc. (1984) 162 Cal.App.3d 358.)
Several types of recurring situations may give rise to a conflict of interest: (1) a settlement offer at or within policy limits where there is a substantial likelihood of an excess judgment (Merritt v. Superior Court (1973) 34 Cal.App.3d 858, 871-873 [110 Cal. Rptr. 511]); (2) a suit against the insured alleging alternative theories of recovery, the outcome of which will determine whether the claim is covered (See San Diego Naval Federal Credit Union, supra, 162 Cal. App. 3d 358, 365); and (3) representation of the insured in the third party suit while representing the insurer in a coverage action against the insured (Executive Aviation inc. v. National Ins. Underwriters (]971) 16 Cal.App. 3d 799).
If any of the foregoing circumstances exist, counsel for the Law Division should refrain from representing either party without the consent of both. (See rule 5-102(B).) Attorneys for the Law Division should never represent insureds while simultaneously advising Insurance Company on the coverage aspects of such representation. (See San Diego Naval Federal Credit Union, supra, 162 Cal. App.3d 358.)
Rule 2-101(A) prohibits a "communication," which is defined as a message concerning the availability of a member of the bar for professional employment, which is untrue, false, deceptive, or misleading. In our Formal Opinion 1982-66, we concluded that trade names are "communications" within the meaning of rule 2-101 and may be regulated to ensure that they are not misleading or deceptive to the public.
In Formal Opinion No. 1986-90, we considered whether a law office comprised of separate sole practitioners who shared office space, but who were neither partners nor incorporated, could advertise as a single entity without identifying themselves as separate, individual practitioners. We concluded that use of such a firm name would be misleading in that the public would tend to believe that the firm was a partnership or corporation. We also pointed out the potential liability that would result because the firm would be viewed as the legal equivalent of a partnership or a partnership by estoppel. (Blackmon v. Hale (1970) 1 Cal. 3d 548 [83 Cal. Rptr. 194]; Redman v. Walters (1979) 88 Cal.App.3d 448 [152 Cal. Rptr. 42].)
In the present context, the use of a firm name, other than "Law Division," or an equivalent thereof, would be misleading in that clients of the Law Division -- i.e., insureds -- would be misled as to the relationship between the Insurance Company and its attorneys. Clients would be unaware that the individual attorneys were employed by the Insurance Company and would assume that the entity was a separate law firm. For this reason, the letterhead used must indicate the relationship between the firm and the Law Division. For example, the letterhead could contain an asterisk identifying the firm as the Law Division for Insurance Company.
In-house counsel for an insurer may represent insureds in litigation without violating the prohibition against aiding the unauthorized practice of law set forth in rule 3-101(A). However, the attorneys must ensure that the insurance company does not control or interfere with the exercise of professional judgment in representing insureds, that any fees are not split with the insurance company or any other third parties, that case involving conflicts of interest are referred to outside counsel and that the firm name used by in-house counsel is not false, deceptive, or misleading.
This opinion is issued by the Standing Committee on Professional Responsibility and Conduct of The State Bar of California. It is advisory only. It is not binding upon the courts, The State Bar of California, its Board of Governors, any persons or tribunals charged with regulatory responsibilities or any member of the State Bar.
1 This prohibition also extended to corporations which sought to provide medical services on behalf of third parties. (Pacific Employers Insurance Co. v. Carpenters (1935) 10 Cal. App.2d 592 (holding that a corporation could not engage, directly or indirectly, in the practice of legal, medical or dental professions for profit by "engaging professional men to perform professional services for those with whom the corporation contracts to furnish such services.").) (See Parma, Corporations: Unlawful Practice of Law (1927) 15 Cal. L. Rev. 243)
2 The change in judicial attitude is also reflected in the authorization of law corporations to practice law. (See Bus. & Prof. Code, 6160 et seq.) Each shareholder, director and officer of a professional corporation must be an attorney. (Bus. & Prof. Code, 6065.) (See also, Bus. & Prof. Code, 6165, 6161; Law Corporation Rules of State Bar of California, Rule IV(A)(4).)
3 To the extent that the insurance policy may provide that the deductible portion of the policy is chargeable as against legal expenses incurred by the Law Department, care should be taken to ensure that such payment properly corresponds to the costs of providing legal services to the insured. To avoid fee splitting, it is imperative that the insurance company not profit from the collection of the deductible.
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