Examining subrogation and malpractice

In a typical third-party claim, an insurer hires counsel to defend its insured in a separate, underlying lawsuit. Sometimes, in a less common scenario, the insured’s counsel is ineffective, perhaps even negligent, and a considerable verdict is entered against the insured. Assuming the insured’s policy provides coverage, the insured is generally not responsible for paying this verdict. Rather, this responsibility falls on the insurer.

An interesting situation arises when the insured has both primary and excess coverage. The primary insurer hires the insured’s counsel, and that insurer pays its share of the verdict. The excess insurer is also responsible for the verdict, and often pays significantly more than the primary insurer. In situations in which the verdict is a result of the negligence of the insurer’s counsel, what recourse does the excess insurer have to recoup its payments? Can the excess insurer sue the insured’s counsel, hired by the primary insured, for legal malpractice?

Insurer’s subrogation rights

If hired counsel improperly or inadequately defends the insured, a legal malpractice claim may arise against the attorneys or firm hired by the primary insurer. But who can assert that claim? The insured, who has direct privity of contract and an attorney-client relationship, but what about the insurers that actually bore the injury from counsel’s negligence?

The answer to this question lies in the doctrine of subrogation, which is the substitution of another person who succeeds the rights in relation to the debt or claim in place of the creditor or claimant. In the case of insurance, subrogation allows an insurer that paid indemnity coverage or defense costs to step into in the insured’s position and pursue a full recovery from the person or entity primarily responsible for the loss.

Oftentimes, an insurer will use subrogation to pursue a legal malpractice claim on their behalf. In this regard, nearly all jurisdictions in the United States permit some form of legal malpractice action by an insurer against the firm it retains to defend an insured.

Excess insurer claims

The excess insurer pays amounts above those covered by primary insurance, and at times, those amounts are significant. The question in cases involving payments made by an excess insurer is whether the excess insurer may bring an action for legal malpractice against an attorney or law firm hired by the primary insurer.

State laws vary on whether excess insurers may pursue legal malpractice claims against attorneys who represented their insureds. The following cases demonstrate various bases used by courts to allow or disallow an excess insurer’s claim for legal malpractice against hired counsel.

Certain courts have determined that an excess insurer may not bring an action against hired counsel for legal malpractice. For example, in Continental Casualty Co. v. Pullman, Comley, Bradley & Reeves, the plaintiff excess insurer instituted an action against the insured’s defense counsel after paying over $10 million dollars in satisfaction of a verdict against the insured.

The excess insurer argued that an attorney-client relationship existed between itself and the law firm because: (i) it was the intended and foreseeable beneficiary of the law firm’s legal services for the insured; (ii) an actual attorney-client relationship existed between them; and (iii) it was entitled to sue the firm under principles of equitable subrogation.

The United States Court of Appeals for the Second Circuit rejected these arguments. The Court determined that the plaintiff could not be a third-party beneficiary because the primary purpose of the transaction was not to benefit the excess insurer. The Court also noted that, although most states recognize an action for equitable subrogation, the public policy of Connecticut opposed the notion of holding attorneys liable to parties with whom they are not in privity in this situation. There was also no attorney-client relationship, as the attorney owed his allegiance to the insured, not the insurance company that retained him.

A similar result was reached in St. Paul Surplus Lines Ins. Co. v. Remley. Here, the United States District Court for the Eastern District of Missouri held that an excess insurer could not maintain an equitable subrogation action against a law firm due to the “extreme” nature of the remedy of equitable subrogation, and the potential conflict of loyalty for the attorney to its direct client.

In St. Paul Ins. Co. v. AFIA Worldwide Ins. Co., the United States Court of Appeals for the Fifth Circuit affirmed a Louisiana district court’s decision to dismiss an excess insurer’s legal malpractice claim against the insured’s defense counsel. The court reasoned that the relationship between attorney and client is one of principal and agent. As a result, absent any privity of contract, an attorney only makes himself liable to a third party if he exceeds the limits of his agency, or where fraud or collusion has been established.

The Kentucky Court of Appeals also rejected an excess insurer’s argument that it should it should be permitted to maintain a legal malpractice action against the insured’s defense counsel. The Court noted that allowing such an action, based upon theories of equitable subrogation, would undermine the preservation of traditional attorney-client relationships.

The Court also held that the excess insurer was not an intended or foreseeable beneficiary of the legal services provided by counsel to the insured. The excess insurer had no contractual relationship with the law firm, and the law firm’s employment was not directly or primarily intended to benefit the excess insurer.

All hope is not lost for excess insurers, as other courts have allowed such claims to proceed against hired counsel. In National Union Ins. Co. v. Dowd & Dowd, P.C., the plaintiff excess insurer brought a legal malpractice action against the insured’s defense counsel after the entry of a verdict requiring the excess insurer to pay $5 million dollars. The Court held that, although no attorney-client existed between the excess insurer and law firm and the excess insurer was not a third-party beneficiary, an excess insurer could be equitably subrogated to the insured’s legal malpractice claim.

The Court noted that equitable subrogation has been applied to prevent injustice and shift the economic burden upon those responsible for the loss. In addressing public policy concerns echoed by other jurisdictions regarding a potential strain on the attorney-client relationship, the Court reasoned that its decision simply allows an excess insurer to enforce duties that the attorney already owes to the insured. The court further noted that attorneys committing malpractice should not “enjoy a windfall merely because the insured contracted for excess insurance coverage.”

In American Centennial Ins. Co. v. Canal Ins. Co., the Texas Supreme Court ruled that an excess insurer was permitted to bring a legal malpractice suit against the primary insurer and insured’s defense counsel through equitable subrogation. In so holding, the Court noted that no new burdens are placed on a defense attorney, who already has a duty to defend the insured.

The Court reasoned that to burden the excess insurer with a significant loss caused by attorney negligence, while relieving the attorney from consequences of malpractice, would produce an inequitable result that should not arise simply because the insured contracted for excess coverage.

In Ohio Cas. Ins. Co. v. Southland Corp., the United States District Court for the Eastern District of Pennsylvania also permitted an excess insurer to maintain a legal malpractice action through equitable subrogation. Despite acknowledging that many states have limited subrogation due to the public policy concerns of the attorney-client relationship, the Court determined that the Pennsylvania Supreme Court removed any public policy obstacle for a malpractice subrogation claim when it elevated the policy of protecting clients’ rights over the policy of protecting the personal nature of the attorney-client relationship.

The Court also held that the lack of privity was not an issue because the subrogee stands in the shoes of the insured and does not maintain his own action. The Court reasoned, as the assignment of legal claims was permitted, so too should be the subrogation of those claims.

There is a compelling argument to permit an excess insurer to pursue a legal malpractice claim against an insured’s hired counsel. In addressing this issue, courts have used the same considerations, such as public policy and the attorney-client relationship, but have reached different conclusions. Ultimately, whether any remedy is available to an excess insurer depends on the jurisdiction in which the action is brought.

Dawn Cohen (dcohen@timoneyknox.com) is a member of Timoney Knox, LLP’s Insurance Industry Practice Group and routinely handles all matters involving insurance litigation, including coverage disputes and cases involving bad faith and suspected insurance fraud. Matthew Malamud (MMalamud@timoneyknox.com) is also part of the firm’s Insurance Industry Practice Group, focusing on complex first-party insurance coverage disputes, bad faith allegations and investigations of suspected insurance fraud.