How Insurers Challenge Fees Owed to Independent Counsel

by Gary W. Osborne and Dominic S. Nesbitt

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Where a liability insurer owes a duty to defend an insured against a third-party claim, the question of who gets to pick the defense counsel arises. Generally speaking, the insurer has this selection right. There are, however, several important exceptions to this general rule which allow the insured to select an attorney who is "independent" of the insurer. ^[1]

When an insured exercises its right to independent counsel, issues invariably arise concerning the amount of fees and costs which the insurer has to pay. This article discusses the propriety of three techniques used by insurers to control, and challenge, the fees and costs billed by an insured's independent counsel.

A. Hourly Rates

California Civil Code Section 2860(c) limits the attorney "rates" an insurer must pay to independent counsel, as follows:

The insurer's obligation to pay fees to the independent counsel selected by the insured is limited to the rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended. This subdivision does not invalidate other different or additional policy provisions pertaining to attorney's fees. . . .

The foregoing statutory language governs the "financial" relationship between an insurer and its insured's independent counsel. It provides, simply, that insurers need only pay independent counsel the same "rates" they pay other lawyers to defend similar actions in the same locale.

While this rule appears straightforward enough, there are nonetheless several important issues for independent counsel to consider when negotiating fee agreements with a client's insurer.

1. Contemplate periodic rate increases

Insurers typically impose a "panel rate" on independent counsel without discussing, or contemplating, that the rate may be increased at some future point in time. Independent counsel should request, in writing, that the rate be increased in line with any increases paid to the insurer's panel counsel.

2. Verify the rates the insurer is paying its panel counsel

Insureds and their independent counsel should ask the insurer to verify, in writing, that the rate offered equates to the highest rate currently being paid to panel counsel to defend similar actions in the same geographic area. Insurers arguably have an implied-in-law duty to disclose the rates they pay to panel counsel. Otherwise, how is an insured to verify that the rate offered by the insurer is correct?

3. Section 2860 limits "rates" only, not "costs"

The reference only to "rates" in the statute indicates that there is no limitation on the insurer's duty to pay "costs" incurred by independent counsel. See, Gray Cary Ware & Freidenrich v. Vigilant Ins. Co., 114 Cal.App.4th 1185 (2004).

4. Section 2860 only applies to insurers with a "duty to defend"

Section 2860 by its own terms applies only where "the provisions of a policy of insurance impose a duty to defend" on the insurer. See, Cal. Civ. Code §2860(a) (italics added). Consequently, section 2860 – and its rate limitation provision – has no application to a policy of insurance ( e.g., a typical Directors and Officers policy) which only obligates the insurer to "indemnify" the insured against defense expenses. See, e.g., National Union Fire Ins. Co. of Pittsburgh, PA v. Stiles Professional Law Corporation, 235 Cal.App.3d 1718, 1727 (1991). Arguably, an insurer with a duty to "indemnify" defense expenses has no legal basis for reducing the hourly rates of its insured's defense counsel.

5. Argue that the statutory language permits reference to the attorney rates insurers pay to defend themselves

Insurers typically argue that they pay independent counsel no higher rates than they pay to their panel counsel to defend other insureds against similar actions. Since such rates are usually deeply discounted, independent counsel is thus forced to either accept these lower "panel rates" or look to the insured to make up the rates differential. However, the language of Section 2860 – limiting rates to those paid by the insurer "in the ordinary course of business" to defend "similar actions" – arguably permits reference to the far higher rates insurers typically pay lawyers when defending themselves in business litigation.

B. Audits and "Billing Guidelines"

Despite the absence of any mention in Section 2860 of so-called "billing guidelines", it is common practice for insurers to insist upon independent counsel's chapter-and-verse compliance with such guidelines. Oftentimes, legal auditors are then brought in to scrutinize the bills, and adjust down any fee or cost entries they determine are not in compliance. Such practices by insurers, and their auditors, are arguably unlawful.

1. Insurer "billing guidelines" don't apply to independent counsel

While no California case has yet addressed the issue, billing guidelines should not apply to independent counsel since there exists no statutory or contractual basis for requiring their compliance. They are not mentioned in section 2860 nor in standard insurance policies. ^[2]

Billing guidelines are intended to apply to an insurer's panel counsel. This is often reflected in the language of the guidelines themselves. Panel counsel agree to comply with the billing guidelines as a condition of their employment. However, such a condition does not exist for independent counsel who are hired by the insured, not the insurer.

2. Insurer "billing guidelines" are not a measure of the "reasonableness" of independent counsel's fees and costs

While insurers obviously have no duty to pay unreasonable fees and costs, the proper measure of reasonableness are not insurer billing guidelines. In fact, such guidelines are designed solely to minimize litigation costs for insurers, often at the expense of providing the insured a full and complete defense.

The proper measure of "reasonableness" is the developed common law in this area. ( See, ABA Disciplinary Rule No. 2-106; see also, California Rule of Professional Conduct No. Rule 4-200; see also, Glendora Community Redevelopment Agency v. Demeter, 155 Cal. App. 3 ^rd 465, 474-481 (1984); People ex rel. Dept. of Transportation v. Yuki, 31 Cal. App. 4 ^th 1754, 1767 (1995) ["[C]ourts have developed general rules to guide the exercise of that discretion in determining a reasonable fee."].) Such common law requires the examination of numerous factors in determining reasonableness such as: (1) the novelty and difficulty of the questions involved and the skill requisite to perform the legal service properly; (2) the fee customarily charged in the locality for similar legal services; (3) the amount of the fee in proportion to the value of the legal services performed; (4) the amount involved and the results obtained; and (5) the experience, reputation, and ability of the lawyer or lawyers performing the services.

Insurer billing guidelines do not supplant the common law in measuring the reasonableness of independent counsel's fees and costs.

3. Ethical implications of insurer "billing guidelines."

Even for panel counsel, complying with insurer "billing guidelines" can impact upon their ethical obligations to their clients. For this reason, one California appellate court has questioned "the wisdom and propriety" of billing guidelines, stating,

[W]e question the wisdom and propriety of so-called "outside counsel guidelines" by which insurers seek to limit or restrict certain types of discovery, legal research, or computerized legal research by outside attorneys they retain to represent their insureds where there is a potential for an uncovered claim. Some guidelines go so far as to call for the use of paralegals, rather than attorneys, to respond to "routine" discovery requests or prohibit the retention of experts or the filing of certain pretrial motions until shortly before trial. Under no circumstances can such guidelines be permitted to impede the attorney's own professional judgment about how best to competently represent the insureds. If the attorney's representation is to be limited in any way that unreasonably interferes with the defense, it is the insured, not the insurer, who should make that decision.

Dynamic Concepts, Inc. v. Truck Insurance Exchange, 61 Cal.App.4 ^th 999, fn. 9 (1998). (Emphasis in the original.)

Furthermore, ethical considerations may actually prohibit independent counsel, who has no attorney-client relationship with the insurer, from complying with billing guidelines to the extent that such compliance would interfere with his or her exercise of professional judgment. (ABA's Canon No. 5, ["A lawyer should exercise independent professional judgment on behalf of a client."]; see also, ABA's Ethical Consideration No. 5-1, ["The professional judgment of a lawyer should be exercised, within the bounds of the law, solely for the benefit of his client and free of compromising influences and loyalties. Neither his personal interests, the interests of other clients, nor the desires of third persons should be permitted to dilute his loyalty to his client."]; see also, ABA's Disciplinary Rule No. 5-107 (B) ["A lawyer shall not permit a person who recommends, employs, or pays him to render legal services for another to direct or regulate his professional judgment in rendering such legal services."])

C. Allocation

"Allocation" is another common technique utilized by insurers to reduce the fees and costs billed by independent counsel. For example, where an insured is both a defendant and plaintiff in the same lawsuit, the insurer will often argue that the independent counsel's fees should be allocated one-half to defense (payable by the insurer) and one-half to prosecution (payable by the insured). Or where independent counsel defends both an insured defendant and a non-insured defendant in the same lawsuit, the insurer may try to allocate one-half of the fees to the defense of the insured and one-half to the defense of the non-insured.

Such arbitrary allocations are most likely inappropriate for two reasons. First, fees and costs which are "inextricably linked" to both prosecuting an insured's action and defending a covered cross-action must be paid by the insurer. See, California v. Pacific Indemnity, 63 Cal.App.4 ^th 1535, 1548-1549 (1998). This rule parallels the common law rule of apportionment that is applied in non-insurance cases. See, e.g., Reynolds Metals Company v. Alperson, 25 Cal.3 ^rd 124, 129-130 (1979).

Second, an insurer is required to pay fees and costs which are "reasonably related" to the defense of its insured. See, Safeway Stores v. National Union Fire Ins. Co., 64 F.3 ^rd 1282, 1289 (9 ^th Cir. 1995). Thus, where independent counsel also represents non-insured defendants, it is only appropriate to allocate to the extent this joint representation results in an increase in the fees and costs billed. Id., at 1287, citing Raychem Corp. v. Federal Ins. Co., 853 F. Supp. 1170, 1180 (N.D. Cal. 1994).

D. Conclusion

It is our hope that by using some of the arguments and suggestions set forth in this article, insureds and their independent counsel can successfully resist their insurer's attempts to inappropriately limit rates and/or to discount fees and costs via billing guidelines, audits and allocation.

©Copyright 2004 Osborne & Nesbitt LLP

The views and opinions expressed in these materials are solely those of the authors. While these materials are intended to provide accurate and authoritative information in regard to the subject matter covered, they are designed for educational and informational purposes only. Nothing contained herein is to be construed as the rendering of legal advice for specific cases, and readers are responsible for obtaining such advice from their own legal counsel. Use of these materials does not create an attorney-client relationship between the user and the author.