Next Year’s Issue’ The Resolution of Last Year’s Problem: Use of Staff Counsel

At year end it is a common practice for many insurance attorneys to peek at the likely new issues for the forthcoming year. Not surprisingly, most of the really big issues that arise in any given year are not the ones that we anticipate. Even so, there are often issues that, due to new cases or statutes or other events, give little doubt but that they will be on central stage in the near term. This year there is at least one nagging problem that will likely to come to a head in Texas, if not in several other jurisdictions, in the coming year.

The issue I am referring to is the use of staff counsel by insurance companies to defend insureds. Staff counsel are attorneys who are employed directly by the insurance company as opposed to an outside law firm. Carriers use the practice to reduce costs and ensure that cases are properly defended as the carrier may be responsible for paying any judgment or settlement up to policy limits. Policy-holder coverage attorneys, consumer groups and some state agencies have railed against this practice for years. Many states, at least twenty at present, have upheld the practice, though a few (particularly Kentucky and North Carolina) have rejected the practice as violating professional ethics by compromising the independent judgment of the attorneys. Notably, actual instances of abuses or complaints by insured are seldom, if ever, relied on in objecting to the practice. However, until a month ago there has not been much guidance in one of the key battleground states, Texas.

In Texas, the use of staff counsel has been vigorously opposed by the Unauthorized Practice of Law Committee (UPLC), an entity created by the Texas Legislature whose members are appointed by the Texas Supreme Court. The UPLC has vigorously opposed insurance companies using staff counsel to defend suits against insureds arguing, among other things, that: a) no attorney can serve two masters; b) the insurance companies’ right to control and direct staff counsel violates the lawyer’s ethical obligations to exercise independent judgment; and c) that an insurance company cannot act as a law firm.

The UPLC originally sought to address these concerns in a suit against Allstate Insurance Company. The UPLC alleged that Allstate was engaged in the unauthorized practice of law because of its use of staff counsel rather than obtaining independent outside counsel. That suit led to a ruling by the Fifth Federal Circuit Court of Appeals last year styled Nationwide Mutual Ins. Co. vs. Unauthorized Practice of Law Committee, 283 F.3d 650 (2002). The Fifth Circuit abstained from ruling on the merits of the case concluding that the potential federal issue—whether the UPLC’s interpretation of the use of staff counsel violated the U.S. Constitution—would likely not be reached since the ruling on the “unclear” state law issue would resolve the matter. The court noted, however, that Texas law “is fairly susceptible to a reading that would permit Nationwide to employ staff counsel on behalf of its insureds.” However, by applying an abstention doctrine the Fifth Circuit did not ultimately resolve the issue.

Indeed, the Texas Legislature has also failed to resolve the issue. In the 2001 legislative session two separate bills were introduced in the Texas House of Representatives to prevent staff counsel from representing insureds. However, both of those bills failed to be enacted into law. Nor did the Legislature enact any related measures in the 2003 sessions.

But now we do have a published opinion on point, and it seems destined for Texas Supreme Court review next year. In a well-written opinion by Justice Terry McCall, the Eastland Court of Appeals in American Home Insurance Co. Inc., et. al. vs. Unauthorized Practice of Law Committee, 2003 WL 22532817 (Tex. App.-Eastland Nov. 6, 2003) carefully evaluated the arguments raised by the UPLC and found them to be unconvincing. The suit was originally brought by American Home Assurance Company and Travelers Indemnity Company seeking a declaration that using lawyers who are employees of the insurance companies to defend insureds under liability policies is not the unauthorized practice of law. The trial court disagreed, bought the UPLC arguments, and entered a judgment finding that the insurance companies were engaged in the unauthorized practice of law. The carriers appealed.

The Court of Appeals began its analysis by recognizing that the purpose of laws to prevent the unauthorized practice of law were meant to prevent the mistakes of the untrained and unscrupulous who are not governed by attorneys’ judicially imposed disciplinary standards of competence, responsibility and accountability. However, even the UPLC conceded that the staff attorneys were licensed and competent. Indeed, there was no evidence in the case of any complaint by insureds regarding the use or competence of staff counsel. Rather, the Court reduced the UPLC’s argument to a simple syllogism: 1) a corporation cannot practice law; 2) staff attorneys, whose sole client is the insured, are agents of the insurance corporation; therefore, 3) the insurance company is practicing law.

The Court of Appeals considered and rejected each premise, as well as the ultimate conclusion. For instance, while an employer (the insurance company) does have a right to direct and control an employee (the staff attorney) to some extent, even the cases relied upon by the UPLC recognize that there are limitations to that right. In this case, the insurance company does not have the right to direct the attorney to ignore or violate their professional judgment. Nor would an attorney’s ethical duty to the client be outweighed by the employer’s interest in demanding loyalty from the attorney. The court noted that the use of staff attorneys, just like outside counsel, may face conflicts, “however, … status as an employee is not an irreconcilable conflict. There is no evidence in the record that staff attorneys face conflicts not faced by outside attorneys. Potential conflicts are inherent in the tri-partite relationship, and those ethical concerns are properly addressed by the Texas grievance system.” Id. at 3.

In addition, the court noted that the American Bar Association had recently reaffirmed its earlier rulings that nothing in the ethics rulings prohibits insurance staff counsel from defending insureds. Indeed, as early as 1950 the ABA issued a formal opinion concluding: “There is nothing basically unethical in a lawyer, who is employed and compensated by a collision insurance company, defending a person in an action based upon damage to person and property brought by a third party.” (ABA Formal Opinion 282.)

The Appellate Court noted that there is nothing in the Texas Rules of Professional Responsibility that conflicts with the ABA model rules. Consequently, it found no irreconcilable conflict that would prevent the use of staff counsel.

The UPLC also focused heavily on Texas being a “one-client” state, meaning simply that the insured is the only client. However, the Appellate Court noted that the Texas Supreme Court has not expressly held that Texas is a one-client state. Though the Texas Supreme Court in State Farm Mutual Automobile Insurance Company vs. Travers, 180 S.W.2d 625 (Tex. 1998) stated that “the lawyer owes unqualified loyalty to the insured” and that “the lawyer must at all times protect the interests of the insured if those interests would be compromised by the insured’s instructions,” those principles do not preclude the insurer also being a client, at least when there is no conflict. The Court of Appeals recognized that common sense requires that an insurance company is also a client, at least for some purposes.

The ruling also addresses the more esoteric arguments of the UPLC, but the key is that staff attorneys are governed by the same ethical standards as outside counsel. The decision raises the pertinent issues and briefly explores the scope of tri-partite duties. Consequently, the issues have been well framed for review by the Texas Supreme Court.

So, it appears likely that we will see this hot button issue before the high court next year. The issues raised may go beyond simply the use of staff counsel, extending to the contours of the tri-partite relationship and whether Texas is a “one” or “two” client state. The only certainty is that next year will not be boring.

Brian Martin is a partner in the Houston office of Thompson, Coe, Cousins & Irons LLC.

Topics Carriers Texas