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A Case for the Bad Apple Clause in Flat Fee Agreements re: The Uninsured Exposure Situation
By Kenneth W. Maxwell
An earlier article discussed basing flat fee contracts for insurance defense cases on a large inventory of uniform cases. But, any large insurance defense inventory will include cases that require considerable more work than reasonably predicted. Unless anticipated, these anomalies may spoil the flat fee deal. To prevent “bad apples” from “spoiling the bunch,” consider exempting them from the flat fee agreement. Of course, it will be up to the contracting parties to identify cases that merit “bad apple” treatment. This article suggests that insurance defense cases with substantial uninsured exposure may be one such “bad apple.” |
The rules of litigation engagement change when a substantial conflict of interest exists or threatens to arise between the defending carrier and its insured. Such a conflict of interest arises if the litigation may expose the insured to damages not covered by insurance. In those situations, ethics rules may limit the information defense counsel may share with the carrier or even may transfer certain litigation decisions from the carrier to the insured. A litigation result that is catastrophic to the insured may subject the defending carrier to subsequent bad faith litigation, extra contractual damages, and possibly punitive damages. Given the added exposure to both insured and carrier, these cases almost always demand more time, greater supervision, and increased involvement from higher-priced attorneys. A few of the reasons for this are discussed below.
Difficult Settlements. Insurance laws pressure carriers to search for dispositions that protect their policy holders against uninsured exposure. A carrier may not eliminate its defense duty with a partial settlement; if it settles one claim, it must settle them all. Often, the desire to eliminate uninsured exposure, standing alone, will not lead to settlement. Rather, these cases settle only if the defense attorney is able to bridge the gap between the available insurance and the plaintiff’s expectations for recovery. The larger and the more important the uninsured damages, the more difficult the case will be to resolve short of trial.
Protracted litigation may be the only tool available to adjust an opponent’s expectations. The plaintiff bolsters its case, attacks the defenses, and may try to set up the carrier for bad faith exposure in hopes of getting an assignment of the insured’s bad faith case if the case is tried. On the other hand, the defense will vigorously attack the plaintiff’s theories and damages, and in particular the claims for uninsured damages, or try to convince the plaintiff to abandon hope of recovering damages not covered by insurance. Of course, this argument is persuasive only to the extent the insured lacks the means to satisfy a judgment against it. These issues add complexity to the case.
Tied Hands. Ethical rules may prevent the insurance defense lawyer from using traditional litigation tactics to simplify the case. For example, the lawyer may not “litigate her client out of coverage.” Even if possible to do so, the lawyer may not defeat the claims upon which the carrier’s duty to defend exists unless and until she has also defeated the other claims. This can increase the time the defense lawyer invests in a particular case, especially if the covered claims cannot be defeated by motions practice.
Unfamiliar Waters. Flat fee agreements assume the flat fee lawyers will see the same issues repeatedly. Repetition translates into experience and leads to efficiency. However, claims for uninsured damages may introduce foreign issues and complicated theories that require research and the attention of senior lawyers. This drives up the cost of defense.
No Corner Cutting. Flat fee agreements promote strategic corner cutting. For example, motions with only small chances of success may not be filed or certain witnesses may not be deposed. In cases with adequate insurance, this tactic may not harm the policyholder because the risk of increased indemnity is born exclusively by the decision-maker. However, the law does not tolerate corner cutting that may harm an insured. Most states impose a duty of equal consideration on a defending carrier, which requires it to make strategy decisions that impact the insured as if the carrier were similarly situated. If the carrier would not cut a corner in a comparable situation where it was the defendant, it probably cannot cut that corner when defending its policyholder.
The Cost of Two Masters. With personal exposure, the insured probably will become more involved in the litigation than if it had no such exposure. Some insureds will hire private counsel or, if allowed, insist upon Cumis counsel. While this contribution is generally beneficial to the defense, it may also increase the costs of defense. A lawyer with two masters will spend more time on the file.
Collateral Issues. Collateral issues may impact the litigation. Disputes may arise between the policyholder and the carrier. The policyholder may initiate bad faith litigation against the carrier. The carrier may bring a declaratory judgment action against the insured. While these issues may be collateral to the defense, they still typically result in increased time by the defense lawyer.
For these and other reasons, cases involving uninsured exposure probably do not belong in a flat fee inventory made up of cases dealing with fully insurable losses. The fact that it is impossible during contract negotiations to predict how and how often these issues may arise does not mean a flat fee arrangement is not possible. Rather, the contracting parties may consider a “bad apple” clause that exempts uninsured-exposure cases from the flat fee.
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Kenneth W. Maxwell is a co-owner of Bauman Loewe Witt & Maxwell PLLC (“BLWM”). Among other clients, BLWM represents insurance companies in large property subrogation, insurance defense litigation, insurance coverage and first party work in the western United States. Mr. Maxwell has worked with insurance companies handling subrogation cases under various contingency fee arrangements. He has also defended insured clients on flat and traditional fee arrangements. Mr. Maxwell combined his knowledge and experience into a series of articles on the topic of flat fee agreements. Future articles will explore in detail the ideas introduced in this article.