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October 8, 2006

Trial Graphics in Insurance-Coverage Cases: Advocacy with Data and Pictures

A picture may be worth a thousand words, but trial lawyers do not have a set of ready principles for the development of the pictures – graphics – we use at trial. A bulleted-list of points displayed in PowerPoint is hardly a substitute for a well-designed graphic that communicates to the jury. Where allowed by the budget, lawyers will work with trial-graphics firms to assist in making pretty pictures. But the case should remain that of counsel, which means that counsel must take responsibility for the development of graphics for trial.

The need to express information clearly by way of graphics is hardly new to trials, or to the modern age, or to insurance-coverage trials. In the cases I have worked up for trial over the years, we have devoted considerable effort to developing the graphics. Through this effort, and through reading of graphic-design literature, I have developed a personal working set of principles that assist in developing trial graphics.

What do I mean by trial graphics? Especially today with large-screen plasma or LCD displays, there are a number of ways to present exhibits and information to juries via a computer. In trials today, it is common to project documentary exhibits up on a screen while a witness is being examined. Through the use of trial-presentation software, which I strongly endorse and which is easy to use, the examining attorney is able to flash the document up on a screen and enlarge a key paragraph all while simultaneously asking questions of the sponsoring witness. (For some courtrooms or for technically less-savvy lawyers, a paralegal or trial-presentation specialist will operate the computer and manipulate the images on the examining lawyer’s behalf.). From the perspective of graphic design, this is a reasonably straightforward process that does not require any real artistic presentation.

Trial graphics however means something more, and typically involves either the creation via computer of simulations of reality (e.g., a computer animation showing the impact of forces when the two automobiles involved in an accident collided) or similar demonstrative exhibits or (ii) illustrative exhibits that illustrate principles or loosely (but not misleadingly) model the facts (e.g., a schematic of an intersection). For demonstrative exhibits, the exhibit is being offered to the jury itself as substantive evidence; as a result, the demonstrative exhibit needs to be independently admissible and it then can go into the jury room in deliberations.

In contrast, an illustrative exhibit is meant to assist the testimony of a witness, and it is the witness testimony that is “the” evidence, not the illustration. The illustrative exhibit is not itself moved into evidence or given to the jury, but instead is used by a witness to help him or her explain to the jury what s/he there to talk about. A proper foundation for use of the exhibit needs to be laid setting forth that use of the exhibit would be helpful to the witness in explicating the testimony and would aid the jury in understanding the testimony (and the exhibit can’t be misleading, inaccurate, etc.) While the trial judge in the judge’s discretion controls use of illustrative exhibits at trial, e.g., Fed. R. Evid. 611(b), if a modicum of care is used in preparing the illustrations most judges will allow their use.

But just because a graphic may be allowed by a judge does not mean that it is either effective or good. Lawyers are taught many subjects in law school, but even in trial-advocacy courses the work of developing effective trial graphics is not taught much, if at all (I certainly don’t remember it from my jury trial advocacy course in law school).

For me, the two most important principles in developing trial graphics are:

1. Trial graphics should be color-blind neutral.

2. The graphics should have a consistent look-and-feel and iconography.

As to the first point, in a twelve-person jury, it is extremely likely that one has difficultly discerning differences between certain pairs of colors. Given that as an advocate I want to get the vote of each juror, the last thing I want to do is risk any juror’s misunderstanding a graphic or, worse, being mad that he (and incidence of color deficiency is greater among men) cannot understand or process the chart placed before him and about which I or the witness is yammering. Moreover, trial-graphics firms seem not to have gotten this message and routinely create graphics that do not account for this. So, I am routinely required to double-check my graphics (even after explaining all this to the designer), and more often than not I have to ask the design firm to rework the graphics on this basis (at their expense since I made this a specification of their retention). There are a handful of websites that show neutral color palettes, and I recently saw a write-up about a program that aids specifically in making discernible graphics. At all events, I can’t fathom a reason not to make my graphics color-blind friendly.

I also believe that graphics should feel consistent. In part, I am trying to make sure that if the jury looks at a graphic they know it is from my side, not the other side. I think this makes the case feel coherent and consistent, and I think it helps the jurors in understanding my exhibits if they become familiar with in general how they look. But the principle applies more broadly than having a consistent look-and-feel. When similar concepts or ideas appear in more than one graphic, I think that all things being equal that concept/idea should be presented consistently. So, if we are illustrating a widget in one graphic, if a later graphic is to depict the widget presumptively the same icon should be used (i.e., the widget should be drawn the same way). All rules have exceptions (except this rule), and there may be a reason to depict the widget differently. In the absence of any reason for variation, however, the same icon should be used.

But this rule of graphic design can be applied more powerfully to help organize a lot of information in a case. I handled one fidelity insurance case where my client (the insured company) suffered a substantial loss from a rogue employee who hijacked a subsidiary and engaged in a number of criminal schemes for the purpose of embezzlement and to cover his tracks. These different schemes operated both independently and interdependently: one aspect of the overall scheme was to solicit increasing volumes of new business in order to have new cost centers against which to (falsely) account for sales and losses. We called this the “cheapest guy” scheme, as in “call the [bad guy] to bid on this job for us because he’ll do it for cheaper than will anybody else.” Thus, this scheme was for him to be the “cheapest guy.” Other schemes involved creating false and fraudulent invoices, using whiteout, photocopying, and the like, and submitting those to the parent company for reimbursement. Another scheme involved use of “ghost employees”, nonexistent workers for whom the subsidiary would also obtain payroll funds and the like from the parent company.

Our coverage-maximizing theory of the case was that all dozen or so schemes together were part of a larger effort to obtain money for the bad guys at the expense of the parent company. Certain coverage questions were presented by the “cheapest guy” scheme, for example, for maybe the loss that resulted was simply from bad business judgment in formulating bids for jobs rather than from being an integral part of the larger scheme. Putting each element together was essential for us to defeat the insurer’s effort to disaggregate and evaluate coverage and loss for each sin of the employee.

We worked for months on creating and revising our overall summary graphic to depict on one graphic the Rube Goldberg model of all the schemes together, resulting in the multi-million dollar loss (for which we were seeking insurance recovery). We worked very hard to lay out an effective graphic, but the goal was not that the graphic would be self-explanatory (it was an illustrative exhibit) but rather that it was to anchor the presentation of our side of the case.

We needed to have witnesses, documents, and experts to explain how each of the schemes worked a fraud or combined to facilitate or cover up the fraud from the parent (insured). Our graphic-design strategy involved keying each of the subsidiary issues to the main summary chart. On the summary chart we had a “ghost employees” box and an icon (no, not a ghost, we thought that was way too kitschy). Each supporting graphic then used that same icon in the upper corner of the graphic to help the jurors relate the particular graphic to the summary fraud chart as a whole. (The summary chart is available on the trial-graphics vendor’s website under its “best of” section, though the description of the case by the vendor isn’t quite right and this link should not be taken as a particular endorsement (and if it were it certainly would be an uncompensated one).)

The idea was to take each of the multitudinous schemes we depicted, and on average we probably had two or three separate illustrative graphics for each of the schemes, and then tie those all back to the main graphic that served to organize the entire case.

These two main principles by which I create graphics in my cases does not really guide the creation of particular graphics. The only way to create individual graphics is to have brainstorming sessions with the team, with the result being (one hopes) a series of stick-figure or schematic drawings that we can hand off to our firm’s in-house designer or to the trial-graphics firm to generate something pretty. We then do the same thing again – and again and again. (Our summary graphic in our fidelity case set the record at the particular graphics firm for most revisions.)

In formulating the design principles governing individual graphics, no doubt the single most important influence on my thinking is a series of books by Edward R. Tufte. Professor Tufte has published four relevant volumes (and promises a fifth), each of which is beautiful and written in an exceptionally engaging and clear way. All trial lawyers should read at least two of these, The Visual Display of Quantitative Information (1983, 2001) and his recently published Beautiful Evidence (2006). These books are themselves worth savoring even without use value, but through discussion and illustrations Tufte distills a number of principles that help guide the development of graphics for presenting information. (In his book, Visual Explanations (1997), Tufte has a now well-known discussion of the Space Shuttle Challenger disaster where he shows how the flight engineers had data that indicated the shuttle should not be launched but lacked an effective way of presenting them to make clear the unreasonableness and risk associated with launching when the shuttle did. (p. 38-54). The other book is Envisioning Information (1990).)

Perhaps the most important concept Tufte articulates is the “data:ink” ratio: that is, assess how much ink is used to depict data. This leads to the next most important principle I use and to the fourth principle, which is in some dimension an entailment of the third:

3. Maximize the amount of data relative to the ink used in its graphical analogue.

4. Everything on the graphic must point to the information/advocacy objective of creating the graphic in the first place, or don’t waste an opportunity to have each element of the graphic serve an information-conveying function.

Tufte’s data:ink metric leads to a virtually wholesale condemnation of pie-charts for example. Everyone seems to like pie-charts, and their use makes us think that we are “doing graphics.” Pie charts and bar graphs are built into MS Excel, and many lawyers believe themselves to be accomplished Excel-nauts if they use the built-in chart wizard within the program. But typically these charts fail on a data:ink analysis.

So, what’s the problem with (mom-and-apple) pie-charts? Let’s begin by analyzing what we’re trying to accomplish with a pie-chart: (i) tabulate the data and (ii) indicate their relative weight. A pie chart uses a lot of ink to accomplish those objectives, and as Tufte argues almost always a simple table will convey the same information as effectively without distracting noise and mental effort. I certainly cannot easily discern from a distance the difference between two similarly sized pie slices. And when we have many slices of a pie, the visual comparisons and discernment required are surely beyond most average folks (maybe some artists can keep it all straight). It is no answer to this observation to say that this is why the pie slices are labeled and that using a pie shows the slices total 100 percent. It is almost always going to be true that laying out the data in a table with the percentage share and totaling them to 100 at the bottom is more efficient. There is just no justification for making the viewer – here, jurors – try to use mental calipers to compare the slices, rather than making it easy by just telling the viewer the data in a straightforward manner. (And this all is at least doubly true when the slices are not directly labeled and instead a color-coded key is used along side a rainbow-segmented pie.)

Maybe entertainment value is the only saving grace for pie charts: they have pretty colors. And I’ll confess that I’ve allowed a pie chart to sneak in, but in general pie charts simply flunk any analysis of the amount of ink needed to convey information or, more importantly, the work we are asking the viewer to do in order to understand the point we’re trying to convey by using the graphic. A variation of the pie chart I used once in a first-party bad-faith case took a dollar bill and showed what portion of the policy premium was siphoned off by the various intermediaries: brokers, managing general agents, etc. The point was to illustrate that the particular program was set up to line the intermediaries’ pockets and did not leave enough money over to accumulate reserves to pay claims; as a result, with less than fifty percent of the premium left to pay claims, policy limits equalling more than ten times the premium, and an expected short period of time between collecting premiums and paying claims, the insurer adopted the approach of denying all claims, engaging in a rope-a-dope strategy with its policyholders, and paying only those policyholders that had the gumption, wherewithal, and stick-to-it-tiveness to sue for coverage. This pie chart (the segmented dollar bill) was appropriate to use because the metric – the dollar bill – was understandable, the particular shares of the intermediaries and their relative compensation was not so important, and the key point of there not being enough money left over to pay expected claims after sales expenses was easily comprehensible. (I keep a copy of this one on the wall of my office.)

The data:ink analysis relates to the fourth point: don’t waste an opportunity to advocate (er, to convey information). Put differently, look at your proposed graphic: is each pixel or color dot being used to convey a point? Or as Tufte puts somewhat differently: “What are the content-reasoning tasks that this display is supposed to help with?”. An example: for an environmental-coverage matter we were seeking recovery of defense and indemnity costs at a very complex environmental site, where the company had spent deci-millions working on investigation and then remediation. A huge property was involved, and the remedial plan was multi-pronged, and different projects were proceeding concurrently. We had submitted a huge amount of money to the insurers for defense-cost reimbursement (holding in abeyance indemnity amounts), and the various defense and investigation costs were cumulated in a number of concurrent projects that morphed over time to remedial work (indemnity).

To try to unscramble the omelet, we held a big meeting with the insurers following our submission of a set of well-organized notebooks of information and bills. We prepared a nine-foot wide timeline graphic. The timeline bisected the chart horizontally, and defense costs were put above the horizontal line and indemnity, below. Each project then was shown as its own horizontal bar floating above the timeline (or, below, in the case of indemnity). So, project 3 was shown beginning at one point on the timeline and continuing as costs were incurred. (Eventually, a project would transform to indemnity (as it moved from investigation to implementation of a remedy), so the bar would stop above the line, and the same colored bar would then start below the line and continue so long as invoices were being incurred. By using the same color, the viewer could follow the bouncing ball as a defense project became indemnity.)

This chart was helpful in helping the viewer (in this instance the insurers’ outside counsel and claims handlers) understand what we were talking about when discussing, e.g., project 6. Along the timeline itself we marked when various EPA orders (106 and RODs) occurred. In this way, the viewer could correlate the date of an EPA and then see our responsive effort (commencing investigation and ultimately remediation). And note that we were managing many simultaneous projects at the property, and different EPA orders addressed one or more of the projects.

By taking the mass of costs we incurred over time and plotting them as concurrent streams of projects and illustrating both the relationship between the EPA orders and our responsive work we were able to put together the story for which the millions of dollars of invoices were artifacts. (We also were conveying the message that we were taking the case seriously, had an effective means of presenting the morass of information, and were gearing up for trial – all of which conduced to settlement.)

But we missed a further explanatory opportunity in how we put this chart together. The various differently colored horizontal bars on the chart differentiated the numerous projects, which was helpful. The jump from above the line to below the line showed moving from defense (the cost of investigating a problem) to indemnity (the cost of fixing it). But what we missed was a means of showing (i) how costs at a project were accumulating over time and (ii) the relative importance or costliness of one project to another. And Tufte’s data:ink principle would have helped discern this: what we could have done was to start a project as a point above the line and grow the project in a wedge shape reflecting the accumulating of costs. So, starting at the point, we could have then drawn the wedge larger and larger correlated to how much money we were spending on that project at the site.

So, instead of a timeline with horizontal colored bars above and below the timeline, we would have had in place of the bars a number of isosceles triangles beginning with a point and opening up moving left to right (following time) in proportion to the amount of money that had been spent. (And we could have illustrated that a project was closed at the time of our presentation by drawing a vertical line closing off the opening wedge of the triangle and having no vertical line closing off the triangle for projects that were still ongoing.)

Our 9-foot wide chart was effective and crucial in accomplishing our objective of presenting multi-decimillions worth of invoices, a series of EPA orders, and the classification of costs at a project between defense and indemnity. Our chart laid this all out clearly and helpfully. But it was a missed opportunity of sorts also to create a truly “data rich” presentation of information that would have also shown the viewer the relative importance of different projects, the rate of the incurrence of money at different projects, and which projects were closed or not.

This anecdote is meant to provide some concreteness to the process by which trial graphics should be created and to equip lawyers with a set of principles by which to create and more importantly to revise the graphics with which they work. Tufte’s books, The Visual Display of Quantitative Information and Beautiful Evidence summarize a number of his design principles, which I’ll put together as my point 5 (liberally quoting and paraphrasing him):

5. Follow Tufte’s lead:

a. Above all else show the data
- Do not clutter the presentation of information with “chart junk”: garish decoration, unnecessarily graphs or embroidery of graph plots.

b. Maximize the data-ink ratio

c. Erase non-data-ink.

d. Erase redundant data-ink.

e. If the nature of the data suggests the shape of the graphic, follow that suggestion.

- Otherwise, move toward horizontal graphics about 50 percent wider than tall.

f. The representation of numbers, as physically measured on the surface of the graphic itself, should be directly proportional to the numerical quantities represented.

g. Clear, detailed, and thorough labeling should be used to defeat graphical distortions and ambiguity. Write out explanations of the data on the graphic itself. Label important events in the data.

h. Show data variation, not design variation.

i. In time-series displays of money, deflated and standardized units of monetary measurement are nearly always better than nominal units.

j. The number of information-carrying (variable) dimensions depicted should not exceed the number of dimensions in the data.

k. Graphics must not quote data out of context.

l. Most explanatory and evidential images should be mapped, placed in an appropriate context for comparison, and located on the universal grid of measurement (that is, they should have a clear marked scale).

m. Focus on causality, including making transparent where the data are uncertain.

i. Credibility must be earned afresh locally by means of specific evidence demonstrating the relevance and explanatory power of the idea in its new application.

n. Indicate the sources and levels of data.

o. Annotate linking lines.

p. Nouns in diagrams should be labeled, annotated, explained, described.

q. Clunky boxes, cartoony arrows, amateur typography, and colorful chartjunk degrade diagrams.

- In an organizational chart, the boxes are unnecessary; the typographic placement of the title or name on the two-dimensional space is sufficient.

r. Completely integrate words, numbers, images, diagrams.

s. Thoroughly describe the evidence used. Provide a detailed title, indicate the authors and sponsors, document the datasources, show complete measurement scales, point out relevant issues.

No doubt, the foregoing is difficult to implement. The development of effective trial graphics takes time, effort, and creativity. Like a brilliant brief, effective trial graphics are not first drafts. And I certainly would not grade all my past efforts at trial graphics as “A’s”. But I try: it is an effort that I owe my clients, but perhaps more importantly it is an effort that I owe the viewer: judge, jury, opposing counsel, the insurer. As an advocate, I am an intermediary and medium of communication. This is no less true with graphics – which I am using as a strategy for communication – than it is with words. Tufte (again) sums up the point nicely in what he calls his Sixth Principle for the analysis and display of data:

“Analytical presentations ultimately stand or fall depending on the quality, relevance, and integrity of their content.”

Posted by Marc Mayerson at 2:16 PM | Comments (9) | TrackBack

August 31, 2006

Jury Instructions in Insurance-Coverage and Insurance Bad-Faith Cases

There is no formbook of jury instructions for complex insurance-coverage disputes, and even were there such a tome at best it would be a point of departure and not the destination. Complex insurance coverage disputes are marked by factual uncertainty, difficult legal terrain, and close parsing of issues. One mistake that lead counsel often makes in my view is not to personally take ownership of the jury instructions and instead delegates their preparation to the junior member of the team. Ultimately, it is the jury instructions that determine the case – and the appeal. Thus, it should be the responsibility of lead trial counsel to be intimately familiar with the drafting, submission, and argument over instructions to the jurors.

When we prepare instructions for jurors, we try to focus on making issues understandable to jurors by breaking down issues into understandable bites. Further, we typically will structure the instructions as a recipe: a logical step-by-step decision tree leading to a (correct) result. There is no profit in trying to trick the jury or the judge into giving the wrong or misleading instructions, for that simply invites error (and retrial – and thus further delay in the policyholder’s receiving recovery). So while there is always the temptation to structure the instructions to place the jury’s thumb on the scale, experienced counsel will demur.

This holds true for both instructions that are submitted to juries and those that are not. For cases that are tried, the instructions are “the thing.” (Hamlet, II, ii, 633) Evidentiary errors are often shielded by the court’s discretion and fights over the admission of evidence – which we surely pursue – often seem to tread over the line of trial and appellate court patience. See R&B Auto Center, Inc. v. Farmers Group, Inc. (Cal. Ct. App. June 9, 2006). Evidentiary rulings can reflect the substantive law, and thus motions in limine can be a proper vehicle for elucidating the legal issues in a case. But it is the jury instructions that form the actual basis for the trial-court judgment, and just as lead counsel focuses on his or her opening statement and closing argument, so too should the jury instructions be the subject of high-level attention.

One reason that this does not occur is that the preparation of jury instructions is tedious. One needs not only to draft the recipe for proper decision but also the supporting authority as to why the instruction is proper. Where true substantive issues are involved, we try to frame issues discretely for the court to decide and support our legal position with what I term “brieflets.” A brieflet is the supporting essay found below the instruction that supports its being offered. A brieflet can be as much as a several page essay replete with case discussions both within the jurisdiction and from across the nation. Often I find that the law in a state needs to be clarified or granulated, so we will argue for the extension or refinement of existing law in our instruction and supporting brieflet. If we don’t do this, then we may not be able to argue on appeal that the law should be one way or another. Appellate courts correct errors, and if we as the trial lawyers do not give the trial court the “opportunity” to commit error there is nothing for the appeals court to do when we complain about a misguided result.

Of course, this all can annoy the trial judge, yet as lawyers we need to take into account the needs of the trial court but also the need to preserve our record. Unfortunately, since instructions really are “the thing,” trial judges should devote their attention to the fine details of the instructions. All too often, however, I find that trial judges are not pleased by being invited to chew into a case and struggle with instructions.

Let me give an example by listing the titles for the instructions we proposed in a recent case in Arizona:

Preliminary (i.e., before commencement of the trial) Instructions

Nature of the case
Outline of the Trial
Duty of Jurors
Evidence
Weighing Conflicting Testimony
Redacted Documents
Rulings of the Court
Credibility of Witnesses
Expert Witnesses
No Trial Transcript for the Jurors; Taking Notes
Admonition
Questions by Jurors
Alternate Jurors
Bench Conferences and Recesses

Final Jury Instructions

Duty of Jurors
Instructions Are to Be Considered as a Whole
What Is Evidence
What Is Not Evidence
Direct and Circumstantial Evidence
Inferences
Rulings of the Court
Credibility of Witnesses
Depositions as Substantive Evidence
Prior Inconsistent Statements
Weighing Conflicting Testimony
Evidence Admitted for Limited Purpose
Redacted Documents
Stipulations of Fact
Judicial Notice
Admissions of Party Opponent
Expert Witnesses
Charts and Summaries in Evidence
Charts and Summaries Not Received in Evidence
Corporate Party
Burden of Proof (Preponderance of the Evidence)
Breach of the Policy
Breach of [Separate Claims Handling] Agreement
Waiver
Terms of a Contract
Breach of Contract – Duty to Defend
Damages for Breach of Contract
Duty of Good Faith and Fair Dealing
Breach of Good Faith and Fair Dealing Damages
Punitive Damages
Communications Between Court and Jury During Deliberations
Chance Verdict Prohibited
Verdict Required
Excused Alternate Jurors
Conclusion and Verdict

Many of these instructions are really multiple instructions with discrete subparts and issues. Some of the accompanying brieflets are several pages long as we try to support why we are drilling down so much and articulating matters as we do.

As an example, one key can be the burden of proof on issues, and the ping-pong between what satisfies the policyholder’s prima facie case and how the carrier then has the ability to overcome that proof. If we take defense costs, for instance, then the policyholder’s offering of invoices satisfies its prima facie case as to the incurrence of damages and their presumptive reasonableness; the insurer then has the opportunity under Hadley v. Baxendale to show that the particular costs constitute unforeseeable damages or that some portion of the costs incurred are wholly attributable to an excluded head of loss (for which the insurer bears the burden of proof). Accordingly, we need to structure our introduction of evidence in a fashion that is mindful of our satisfying the elements of our prima facie case such that without more a verdict in our favor could be properly supported and defended on appeal.

It is necessary in the jury instructions, however, to set forth that we have satisfied our burden of proof by introducing the invoices, so that the jury can award us these damages; the jury then can consider whether the carrier has carried its burden of showing that the costs are not recoverable. But it is error to conflate this all to instruct the jury that the policyholder is entitled to its reasonable costs of defense. The policyholder in fact is entitled to all costs of defense it incurred, except to the extent the carrier has a legal basis not to pay under the policy or according to the standards governing recovering damages at trial for breach of contract. So a relatively straightforward bottom line – the reasonable costs of defense – ends up with a multipart decision tree that incorporates the nature of the proof and the shifting burden of proofs between the policyholder and its insurer.

On the other side of the equation, diligent counsel needs to look carefully at the instructions proposed by the other side. Accordingly, when the insurer submits its set of instructions, it is crucial that the policyholder set forth specific objections to those instructions where appropriate. And those objections can be either or both substantive (as a matter of insurance law) or based on the standards for properly articulating instructions for a jury. In terms of substance, once again we will submit a brieflet on why the carrier’s substantive articulation of the rule of law is in error. This is a crucial brieflet because if the court does submit the carrier’s proposed instruction our grounds for appeal principally will be that the court erroneously rejected the legal position we articulated (thus necessitating that we in fact articulate the grounds and arguments).

Among the general types of objections that one can make are these (again taken from our recent Arizona case), one can object to an instruction to the extent:

1. They are misleading or confusing. See Life Investors Ins. Co. of Am. v. Horizon Res. Bethany, Ltd., 182 Ariz. 529, 532, 898 P.2d 478, 481 (Ct. App. 1995) (holding a jury instruction should not mislead the jury).

2. They incorrectly charge the jury. See Valley Nat’l Bank v. Witter, 58 Ariz. 491, 121 P.2d 414 (1942) (holding that a jury should not be instructed through an instruction that only partially states the applicable law); State v. Bass, 198 Ariz. 571, 576-77, 12 P.3d 796, 801-02 (2000) (holding jury instructions must not misstate the applicable law, and must not mislead or confuse).

3. They do not inform the jury of the applicable law in understandable terms. See Barrett v. Samaritan Health Services, Inc., 153 Ariz. 138, 143, 735 P.2d 460, 465 (Ct. App. 1987).

4. We already provided a corresponding instruction that contains clearer and more understandable terms. See Noland v. Wootan, 102 Ariz. 192, 194, 427 P.2d 143, 145 (1967) (“The purpose of jury instruction[s] is to inform the jury of the applicable law in terms they can readily understand. It is therefore inappropriate to employ words in jury instructions which are susceptible to more than one definition, one of which does not properly expound the law of the case to the jury.”).

5. They misstate the law. See State v. Bass, 198 Ariz. 571, 576-77, 12 P.3d 796, 801-02 (2000) (holding jury instructions must not misstate the applicable law); State v. Hussain, 189 Ariz. 336, 337, 942 P.2d 1168, 1169 (Ct. App. 1997) (holding no err in refusing to give a jury instruction that is an incorrect statement of the law); Nichols v. Baker, 101 Ariz. 151, 416 P.2d 584 (1966).

6. They are not predicated upon the facts of the case. See State v. Hussain, 189 Ariz. 336, 337, 942 P.2d 1168, 1169 (Ct. App. 1997) (holding no err in refusing to give a jury instruction that does not fit the facts of the case); State v. Williams, 120 Ariz. 600, 601-2, 587 P.2d 1177, 1178-79 (1978) (holding that an instruction is misleading if it is not predicated on some theory of the case which may be found in the evidence).

7. They will not be supported by evidence admitted at trial. See State v. Williams, 120 Ariz. 600, 601-2, 587 P.2d 1177, 1178-79 (1978) (holding that an instruction is misleading if it is not predicated on some theory of the case which may be found in the evidence); State v. Allen, 400 P.2d 589, 529, 1 Ariz. App. 161, 164 (1965) (holding that “an instruction must be based not on a theory but upon something which is backed by some substantial evidence introduced in the case”).

8. They allow jury speculation on issues. See Brierley v. Anaconda Co., 111 Ariz. 8, 12, 522 P.2d 1085, 1088-89 (1974) (holding “it is reversible error to instruct on a theory which is not supported by the facts since the court thereby invites the jury to speculate as to possible non-existent circumstances”).

9. They do not address claims raised in the insured’s pleadings. See Porterie v. Peters, 111 Ariz. 452, 455, 532 P.2d 514, 517 (1975) (holding that the correctness of instructions given in a case must be determined in the light of the issues “raised by the pleadings”).

10. They assume facts properly determined by the jury. See State v. Patterson, 4 Ariz. App. 265, 267, 419 P.2d 395, 397 (1966) (stating that the jury should be properly instructed and be left to determine the facts).

11. They indicate any breach of duty by the insured or indicate there is a triable issue on any alleged breach by the insured, where the insured denies there is a basis for submitting such issues to the jury. See Sparks v. Republic Nat’l Life Ins. Co., 133 Ariz. 529, 539, 647 P.2d 1127, 1137 (1982) (“error to instruct the jury on a legal theory which is not supported by the evidence”).

See generally Walbolt and Alonso, Jury Instructions: A Road Map for Trial Counsel, 30 Litigation 29 (Winter 2004).

Most objections, however, are not general like the foregoing but rather go to quite detailed objections of articulation – the instruction unfairly embraces the proffering party’s theory of the case – or that they misstate the details of the law. A recent Tennessee Supreme Court decision addresses appellate review of instructions on substantive grounds. Johnson v. Tennessee Farmers Mut. Ins. Co., (Tenn. Aug. 28, 2006).

The key question there was third-party bad faith, that is, a claim that the insurer unreasonably failed to settle a liability case against the insured resulting in a judgment against the insured in excess of policy limits that could have been avoided had the earlier settlement offer been accepted. The Tennessee Supreme Court on review held that “Where a special instruction that has been requested is a correct statement of the law, is not included in the general charge, and is supported by the evidence introduced at trial, the trial court could give the instruction’ [but] [r]eversal of a judgment is appropriate . . . only when the improper denial of a request for a special jury instruction has prejudiced the rights of the requesting party.” Slip op. at 4.

In Johnson, the carrier argued that it was error for the court not to submit four instructions to the jury, all going to different ways of articulating that bad faith requires some sort of malevolence above and beyond negligent conduct. For example, the insurer argued that the trial court erred in refusing to submit the following instruction:
“Bad faith embraces more than bad judgment or negligence and it imports a dishonest purpose, moral obliquity, conscious wrongdoing, breach of a known duty through some ulterior motive or ill will partaking of the nature of fraud, and it embraces an actual intent to mislead or deceive another.”

The Tennessee Supreme Court affirmed the trial court’s correct decision not to give this instruction holding that the proposed instruction did not accurately state the law. Slip op. at 6. Cf. Rawlings v. Apodaca, 151 Ariz. 149, 160, 726 P.2d 565, 576 (1986) (For first-party bad faith, the insurer need only “form that intention without reasonable or fairly debatable grounds. [A]n ‘evil mind’ is not required.”).

Trial counsel is required to know the details of the law and what the facts will support; trial counsel must think about how the evidence will go in and how the evidence meshes with the instructions; counsel must understand what the instructions will be and develop the case and introduction of evidence to match the instructions; and counsel must be able to object on all proper bases to the other side’s proposed instructions, both as a matter of substantive law and as a matter of poor or inappropriate articulation. All this is tedious, especially when trial counsel wants to focus on the more glamorous (or stressful) tasks of examining and cross-examining witnesses and making the opening statement and closing argument. But it is not enough to plan on winning at trial; one must be able to sustain that victory on appeal. (Or unhappily, one must be able to turn around an adverse trial verdict on appeal by pointing out that the judgment was due to an error in the instructions and what the jury was erroneously asked to decide.)

Preparing jury instructions in a complex coverage case requires considerable effort in terms of legal research and fine drafting. Standard, formbook instructions do not exist or frankly are inartfully articulated, even as to the most basic instruction on what is a preponderance of evidence or a prior inconsistent statement. (But a useful exception is the new plain-English instructions from California. ) Counsel has a duty not only to the client but also to help the lay people on the jury actually understand what they are being asked to decide. The last thing one wants is an unhappy, confused jury. The instructions really are “the thing” – and as such are the responsibility of lead counsel to get right and to shape as much as the order of witnesses and the development of the evidence at trial.

Posted by Marc Mayerson at 12:17 PM | Comments (1) | TrackBack

August 22, 2006

Conflict of Laws and Insurance Disputes: Choice of Law or Choice of Outcomes?

Most insurance policies are silent as to which state’s substantive law governs their terms. As a result, insurance-coverage lawyers often find ourselves deep into the world of choice of law and conflict of laws, a subject most of us sidestepped in our law-school education. Conflicts issues are (largely) untethered from the merits yet can be outcome determinative, so it is crucial to understand and focus on choice-of-law principles in complex insurance disputes, which can yield the application of different state laws within a single case to issues of contract formation, performance, and bad faith.

There are two paradigmatic approaches to choice of law, but nuances in every state affect the analysis. What one can call the First Restatement or lex loci contractus approach looks to some formal act involved in the making of a contract and holds that the location of that act tells one which state’s law governs. Now more than 75 years old, several states still follow its teachings.

Then there is the Second Restatement approach, promulgated thirty years ago, which is plainly the dominant intellectual framework for choice of law in the US. This looks to the state with the “most significant relationship” between the issue to be resolved and the states affected. See Restatement 2d §§ 6, 188, 193. The Second Restatement analysis proceeds issue by issue, that is, one state’s law can apply to one issue in a case and another state’s law to a different one. (This is a principle called depeçage.)

In the absence of a contractual choice-of-law clause (which in any event is considered merely to be evidence of the proper choice of law and not determinative in and of itself), one can predict the governing substantive law only if one starts with a particular forum in mind. The choice of forum is not directly a selection of the forum’s law; instead, it is a selection of the forum’s rules for choice of law (there being no difference between suing in state or federal court on this issue, Klaxon Co. v. Stentor Electric Mfg. Co., 313 US 487 (1941)).

The choice-of-law question is not what law governs this contract for all purposes but rather what law should govern a particular issue for which there is a difference were one state’s or another’s law to apply. One law can govern a single contract issue or a discrete claims-handling issue, all depending on the interests of the state involved. Typically, the law of the forum applies unless and until a party demonstrates that another state’s law should apply to a particular issue. E.g., Trostel & Sons Co. v. Employers Ins. of Wausau, 576 N.W.2d 88 (Wis. Ct. App. 1998). (Note also that some states have enacted choice-of-law statutes that will supersede the common-law choice-of-law analysis, so long as their application passes muster under constitutional principles. See generally Sangamo Weston Inc. v. National Surety Corp., 414 S.E.2d 127 (S.C. 1992). )

The court’s selection of a given state’s law can be change the result, which introduces great instability in the relationship between insureds and carriers given that a race to the courthouse may lead to one result (coverage) or the other (none). To be concrete, in one matter I handled for the Michigan subsidiary of an Illinois corporate parent, we considered suing in South Carolina (where one of the carrier defendants was located), which would have resulted in the application of Georgia law (where the broker was located) and which we thought would be relatively favorable; instead, we sued in Illinois and argued successfully for the application of Illinois law to the contract (which we obviously perceived to be a bit more favorable than Georgia law). See generally Babcock & Wilcox Co. v. Arkwright-Boston Manufacturing Mutual Ins. Co., 867 F. Supp. 573 (N.D. Ohio 1992); Gabe's Construction Co. v. United Capitol Insurance Co., 539 N.W.2d 144 (Iowa 1995) (additional-insured issues); Auto Europe, LLC v. Connecticut Indemnity Co., 321 F.3d 60 (1st Cir. 2003) (location of subsidiary in forum an important contact even where parent negotiated policy). In that case, we were seeking insurance recovery for a nationwide product-liability problem, involving possible death cases and a nationwide, multi-industry product recall and replacement program involving the Consumer Products Safety Commission (CPSC). That on the same facts it was possible to apply any of Georgia, Illinois, or Michigan law underscores the malleability of the issue as well as the importance of considering carefully choice-of-law in deciding how to manage insurance recovery. See Piper Aircraft Co. v. Reyno, 454 U.S. 235, 250 (1981) (“Ordinarily, these plaintiffs will select that forum whose choice-of-law rules are most advantageous.”).

Additional complexity is introduced when one considers insurance bad-faith issues or similar remedial measures that may exist both at common law and as a matter of statute in individual states. The question in part concerns due process: does the state legislature have the power to regulate the conduct at issue? The question may also involve choice of law: does the state’s law apply to the transaction at issue? Ever since the US Supreme Court decision of Allstate Ins. Co. v. Hague, 4498 U.S. 302 (1981), which was a 4-1-3 decision (with 1 recusal), the analysis has been collapsed into the choice-of-law inquiry alone, eschewing examining the power of a state to regulate conduct. As the Third Circuit has explained:

[T]he relevant issue is the constitutionality of a choice of substantive law (not constitutional limitations on the permissible scope of a state’s substantive law). In our case we must ask whether New York’s substantive law would constitutionally apply to the facts we review, not whether New York could permissibly choose to apply its law (the choice of which substantive law to apply being an issued reserved to Pennsylvania law).

Budget Rent-a-Car System, Inc. v. Chappell, 407 F.3d 166, 176 (3d Cir. 2005).

Through the 1940s and 1950s, there was a series of US Supreme Court cases that approached these issues by looking at Due Process, Equal Protection, and Full Faith and Credit. Some of these cases have fallen into disfavor under Hague but others were cited in Hague and thus have continued vitality. E.g., Watson v. Employers Liability Corp., 348 U.S. 66 (1954). I have argued in a case that Watson dictates that the forum (Virginia) state’s statute on bad faith applies to benefit the (former) Virginia subsidiary of a D.C. company that purchased insurance from a New York company and that suffered a fidelity loss through the operation of a (sub)subsidiary in New Hampshire. On its face, the statute applied to admitted insurers doing business in the state (as was true in my case), and we posited that the legislature meant to protect Virginia citizens from the misdeeds of foreign, but admitted, insurers. While we could run that argument under choice-of-law principles, e.g., Babcock & Wilcox, 867 F. Supp. 573, to me it makes more sense to approach the matter as one of the scope of legislative authority, which is what Watson speaks to.

The Supreme Court’s decision in Watson is not a choice-of-law case but rather concerns the constitutionality of applying a state insurance statute. Watson involved Louisiana’s direct-action statute, which conflicted with a provision in the insurance policy requiring that no action could proceed against the insurer until the underlying tort claim was resolved. Given that the dominant approach to selecting which law to apply involves consideration of which state “‘would have the strongest interest in seeing its laws applied to the particular case,’” United Western Grocers, Inc. v. Twin City Fire Ins. Co., slip op. at 9550 (9th Cir. Aug. 14, 2006) (citation omitted), Watson remains relevant in assessing state interest.

At issue there was a bodily injury claim stemming from the use in Louisiana of a home hair-care product manufactured by an Illinois subsidiary of a Massachusetts company where the insurance policy was negotiated and issued in Massachusetts and delivered in Massachusetts and Illinois. “The basic issue raised . . . . is whether the Federal Constitution forbids Louisiana to apply its own law and compels it to apply the law of Massachusetts or Illinois.” 348 U.S. at 69. The plaintiff was a tort victim with no privity of contract seeking to force the insurer to provide coverage to the defendant-tortfeasor, the Illinois company.

The Supreme Court ruled that Louisiana had an interest in applying its law because the tort victims, while strangers to the contract, were Louisiana residents who obtained medical care in Louisiana and drew upon other Louisiana private and public services in connection with their injuries. “Where, as here, a contract affects the people of several states, each may have interest that leave it free to enforce its own contract policies . . . . [M]ore states than one may seize hold of local activities which are part of multistate transactions and may regulate to protect interests of its own people, even though other phases of the same transactions might justify regulatory legislation in other states.” 348 U.S. at 73, 72.

As Watson anticipates, coverage disputes can involve the application or potential application of the law of more than one state within a given case. Two recent federal district court decisions addressed choice of law in the context of both coverage questions and alleged bad-faith conduct. A comparison between them highlights the vagaries of judicial outcomes in this area. (Choice-of-law decisions are invariably fact bound, so it is always difficult to conclude that rulings are inconsistent.) In one case, an out-of-state statute was held not to be available for bad-faith conduct by claims handlers occurring in that jurisdiction; in the other, while the bad-faith acts took place in a different state – the jurisdiction whose law plainly governed the coverage questions – the court nonetheless applied the law of bad faith where the effects of that conduct were felt and thus afforded a more vigorous remedy to the policyholder who had moved to a different jurisdiction after the policy period.

In Cecilia Schwaber Trust Two v. Hartford Accident & Indem. Co., 2006 WL 1888691 (D. Md. June 26, 2006), the policyholder sought coverage as construed under Maryland law with regard to a property located in Baltimore but sought to impose bad-faith liability on the insurer based on the location of the insurer’s claims handlers (Pennsylvania). The federal district court held that Maryland had an affirmative policy against allowing first-party bad faith claims (that is, claims for unreasonable denials of coverage), which the policyholder sought to side-step by arguing that the location of the wrong at issue – bad-faith claim denial – occurred in Pennsylvania, whose law should apply under principles of lex loci delicti. The court ruled, however, that although Pennsylvania’s bad-faith scheme is implemented pursuant to a statute the question was controlled by what law properly governed the contract/coverage claim. Id. at *3.

Moreover, the court observed:

Plaintiffs are Maryland residents pursuing a claim for damage to a Maryland property under an insurance contract they admit is governed by Maryland law. Maryland has consistently refused to permit tort claims based on bad faith conduct by insurers . . . . I am confident that Maryland would not choose to import tort claims from other states in a case such as this, particularly when those tort claims are not intended to protect Maryland residents..

Id. The court sought to buttress its conclusion by arguing that the mirror-image result would likewise be absurd: that is, if a Pennsylvania policyholder with Pennsylvania property suffered bad faith at the hands of a Maryland-based claims handler, then the Pennsylvania citizen would have no bad-faith remedy. Id. at n.3.

But the problem of analytical symmetry posited by the Schwaber court does not exist: there is nothing inconsistent for choice-of-law purposes in applying Pennsylvania law on claims-handling conduct to claims handers dealing with Marylanders and applying Pennsylvania law also to claims handlers dealing with Pennsylvanians, so long as the claims handlers in each instance are located and licensed in Pennsylvania. Pennsylvania can well have an interest in ensuring that all insurance operations conducted in its state conform to its standards. (New York for example has always sought to require licensed insurers to conform to the standards of New York wherever they may operate.)

A useful contrast to the Maryland case is another federal court decision decided one week before, Love v. Blue Cross and Blue Shield of Georgia, Inc., 2006 U.S. Dist. LEXIS 42275 (D. Wis. June 20, 2006). In Love, the insured purchased a health-insurance policy in Georgia and was a permanent resident there. Later, the insured moved to Wisconsin, and the dispute concerned the handling of certain bills submitted for treatments received in Wisconsin.

The question presented was whether a Georgia statute applied, which limited bad-faith remedies, or whether Wisconsin common law did. The insured applied for coverage in Georgia, lived in Georgia, and Georgia law applied to construe the policy. The court stated that applying the law of wherever the insured roamed would lead to “confusion, not predictability, in the law.” Id. at *7. Consequently, the court concluded that “predictability of results is fostered when a state’s substantive law applies to a policy issued in that state by a state corporation to a resident of that state, especially when, as here, the policy in question explicitly states that Georgia law should apply.” Id.

Nevertheless, the court concluded that Wisconsin had a strong interest in protecting Wisconsin residents regarding services provided in Wisconsin, even from an out-of-state insurer that issued a policy under out-of-state law to someone who then lived outside the state. Id. at *11-12. This was true even though “a policy issued in Georgia to Georgia residents might well cost less because of the damage caps the [Georgia] state legislature has put in place” and “the processing of the claims occurred in Georgia.” Id. at *9, *12. As the court concluded, “Wisconsin has indicated its belief that bad faith is a tort for which a wide array of damages [should be] available, and it has a strong interest in ensuring that its residents receive full compensation for such torts.” Id. at *19.

That an insurance contract was issued and delivered in Massachusetts did not preclude the application of Louisiana law in Watson, where Louisiana had a more direct and concrete interest in the particular dispute before the court. A Maryland policyholder suffering bad faith at the hands of Pennsylvania claims handlers perhaps should have the same remedies that a resident of Pennsylvania would have in the same circumstances, Schwaber notwithstanding. The former Georgia policyholder in Love was found to have the same remedies available as Wisconsin residents because the impact of the insurer’s alleged post-policy bad-faith conduct occurred there, even though performance otherwise would be gauged under Georgia law.

The choice-of-law issue, albeit seemingly divorced from the merits, can determine who wins or loses a coverage case. See Fluke Corp. v. Hartford Acc. & Indem. Co., 7 P.3d 825 (Wash. App. 2000), aff’d, 34 P.3d 809 (Wash. 2001) (finding insurance coverage for punitive damages following choice-of-law analysis). Given the current regime of state-by-state regulation of the insurance industry and the absence of choice-of-law provisions in policies, fighting over which law to apply (and to which issues) is one more crucial battle in complex insurance disputes.

Posted by Marc Mayerson at 5:39 PM | Comments (3) | TrackBack

March 19, 2006

Witness for the Prosecution: Me!

Insurance lawyers face a dilemma in that we sometimes can be called as witnesses in bad-faith trials. As a result, policyholder counsel like me need to consider whether we should be the person who interacts with the insurance company’s representatives, for we risk being disqualified from serving as trial counsel for our clients.

The potential for disqualification of the policyholder's lawyer stems in part from the fact that settlement discussions with the insurance company are admissible in bad-faith cases. Many lawyers and claims handlers seem surprised that settlement discussions to resolve an insurance claim constitute evidence in bad-faith cases and point to the settlement “privilege” as a shield.

But like the heffalump and the griffin, the settlement privilege is the stuff of myth: in the absence of an actual confidentiality contract between the parties that specifies that all communications for settlement are inadmissible for any purpose and in any proceeding, e.g., Tower Action Holdings, LLC v. LA County Waterworks Dist., 129 Cal. Rptr. 2d 640, 647 (Cal. App. 2002), communications during the course of settlement discussions are admissible for any purpose other than proving liability on the claim itself. See Federal Rule of Evidence 408. Indeed, Rule 408 states expressly that settlement-related discussions are admissible for “another purpose.”

Evidence of the insurer’s conduct during negotiation of a settlement of the insured’s (or a third-party’s) claim may be admitted at trial for purposes other than proving the insurer’s liability to pay under the contract. E.g., Crackel v. Allstate Ins. Co., 92 P.3d 882, 893 (Ariz. App. 2004); see also ESPN Inc. v. Office of Comm’r of Baseball, 76 F. Supp. 2d 383, 412-13 (S.D.N.Y. 1999); American Re-Insurance Co v. United States Fid. & Cas. Co., (N.Y. App. Div. June 2, 2005).

Insurers’ settlement communications and conduct are relevant evidence. Insurers must negotiate with their insureds in good faith, neither providing "lowball" offers nor "hoping the insured will settle for less," Zilisch v. State Farm Mut. Auto. Ins. Co., 995 P.2d 276, 280 (Ariz. 2000), nor failing “in good faith to effectuate prompt, fair and equitable settlements of claims” nor failing to provide “reasonable explanation of the basis . . . for the offer of a compromise settlement” nor compelling insureds to “institute litigation” where they recover substantially more than what the insurer has offered. E.g., Unfair Claims Settlement Practices Act, A.R.S. sec. 20-461(A)(6), (A)(7), (A)(14). A policyholder’s means of proof that its insurer violated these various obligations during the process of adjusting the claim is to offer evidence of how the insurer sought to negotiate the claim. Evidence during settlement or during the claim-adjustment process, therefore, is admissible to prove undue delay or bad intent or for impeachment of the insurer’s witnesses. E.g., Southwest Nurseries LLC v. Florists Mut. Ins. Inc., 266 F. Supp. 2d 1263 (D. Colo. 2003); Bower v. Stein Eriksen Lodge Owners Ass’n Inc., 201 F. Supp. 2d 1134, 1139 (D. Utah 2002) (while denying admission of the particular evidence, ruling that “[e]vidence of a party’s bad faith may fall under ‘another purpose’ [under Rule 408].”). All this evidence goes to the insurer’s independent obligations to conduct itself in good faith, rather than its liability for the claim itself (which is the purpose for which Rule 408 limits the admission of evidence). (Fed. R. Evid. 105 allows for a party to ask the court to provide a limiting instruction to the jury making this clear.)

While policyholders may welcome that this type of evidence can be admitted in the litigation against the insurance company, the next question is what is that evidence and who are the witnesses? The reality is that the policyholder’s lawyer may be the person who on behalf of the policyholder witnessed the insurer’s course of conduct during settlement negotiations. If this is so, then there is risk that the lawyer will be disqualified from representing the policyholder in the insurance litigation for he or she may be a percipient witness at trial of the insurance bad-faith claim.

This is the question that was presented in a recent case, Carta v. Lumbermen’s Mut. Cas. Co., __ F. Supp. 2d __, 2006 WL 595496 (D. Mass. March 13, 2006). In general, a lawyer representing a party at trial is not allowed to be a witness because it can prejudice the other side and confuse the jury.

Nevertheless, motions to disqualify policyholder counsel in such circumstances are highly disfavored for the obvious reason that they can be offered not for reasons of fairness and the appearance of neutrality of court proceedings but rather for tactical advantage and harassment. “Thus, it is clear that disqualification should be allowed only when ‘absolutely necessary.’” Carta, 2006 WL 595496 at *4.

In Carta, the court described the anticipated scope of testimony of the plaintiff’s lawyers:

The proposed testimony of the plaintiff’s lawyers is certainly relevant and material – indeed, her two attorneys are the only people who will be able to testify on the plaintiff’s behalf about the settlement negotiations with the defendants, the correspondence that went back and forth between the parties, the meetings that were had between the plaintiff’s counsel and defense counsel and the strategic decisions made during the settlement process. Even the plaintiff herself likely would not be able to testify about such matters since they were undertaken by the attorneys themselves, not by the plaintiff, and they involve technical legal nuances that the plaintiff herself probably would not understand.

Id. at *5. The Carta court furthermore rejected (in my view, too quickly) the lawyers’ argument that proof of the bad-faith case would come solely from the mouths and pens of the insurer’s witnesses – so the policyholder’s representatives’ testimony would be unnecessary.

Where as in Carta the policyholder is willing to hamstring its own case by limiting the scope of proof that may be offered, the court should be more chary in disqualifying counsel and should defer pulling the trigger until absolutely necessary (that is, defer until it is certain there is actual prejudice to the insurance company rather than merely a prospect of prejudice). Courts should also be leery of permitting the insurance company’s witnesses to prevaricate necessitating rebuttal through the testimony of the policyholder’s attorney.

An adequate remedy in most circumstances is simply to prevent the policyholder’s counsel from testifying at the trial, even if that limits the scope of proof of the bad-faith claim. What Carta also teaches – along with the admissibility of settlement discussions – is that the policyholder (or its counsel) should be mindful in structuring the interactions with its insurer to make sure that it has the witnesses it wants at trial. (The policyholder should be mindful also that all its dealings with the insurance company – including its settlement correspondence – are trial exhibits.)

Dealing with insurance companies in the resolution of complex and contentious claims requires, as in chess, that one see the whole board, which includes understanding the risk that the policyholder’s selected counsel might later be the target of a motion to disqualify as a key witness to the insurance company’s bad-faith tactics.

Posted by Marc Mayerson at 3:41 PM | Comments (3) | TrackBack

February 4, 2006

Fettering the Insurer’s Privilege to Control the Defense It Is Duty Bound to Provide

For more than fifty years, policyholders and their insurers have been struggling over the insurer’s promise to defend and the insurer’s control the defense. Policyholders properly have been concerned that an insurance company that controls the defense of an action potentially covered by the carrier’s duty to indemnify will use that control to avoid that very same indemnity obligation. While in egregious cases where a lawyer hired by the carrier has abused his or her relationship with the insured, the client, so as to favor the lawyer’s source of income – the insurance company – the courts have responded to protect the insured’s interests. But most courts have ruled that such after-the-fact remedies are insufficient: they do not adequately compensate for the injury; meritorious claims are not pursued (in part because insureds may not discover the abuse); and the potential for this abuse alone undermines the dominant purpose of the insurance relationship to afford protection and peace of mind for the insured.

As a result, most jurisdictions have fashioned a number of rules affording remedies in cases of actual abuse – by allowing bad-faith actions to proceed against insurers, by barring insurers from using the fruits of the poisonous tree, by allowing malpractice claims against the lawyer, and other measures. But most furthermore have held that where there is a situation of potential abuse a prophylactic approach is appropriate; thus the insured is permitted to select the lawyer to defend it and the carrier continues to have the obligation to pay for that defense. This is usually referred to as the "independent counsel" rule (or in California, the Cumis or 2860 rule).

Rarely do I see as a policyholder lawyer a insurance provision that expressly addresses this problem – something that is incomprehensible given that for more than two generations this struggle has been waged. Since at least the 1950s, the courts have made clear to insurers that, because their policies do not set out how these circumstances should be handled, the courts themselves will fashion rules designed to balance the interests of policyholders and their insurers. In general, the courts have looked to the dominant promise of the insurance contract to defend (and to indemnify) the insured and held that the correlative responsibility of the insurer to defend can yield to safeguarding that dominant purpose of the insurance contract. In part this stems from the contract drafting in which two words – “right and” -- in the insurance policy are what carriers rely on: they have the “right and duty to defend” (plus the insured’s duty to cooperate set out in the boilerplate portion of the policy).

Because insurers are well aware of the rule that uncertainties in the contract will be construed against them and the rule in the overwhelming majority of jurisdictions that their right to defend and its entailed privilege of selection and control of counsel has to yield to protect the benefit of the bargain the insured struck to obtain both defense and indemnity, the courts generally have held that insurers forfeit their privilege of control.

The paradigmatic circumstance where the insurer’s privilege of control yields to its duty to defend, to protecting the insured’s expectations of coverage, and to subordination to the insured’s interest is where a complaint alleges more than one claim arising out of a single event and the case can be lost on either a covered basis or an uncovered one. Take as an example where an during a pickup basketball game an elbow is thrown: if that occurred because of gross negligence, there will be coverage, but if it occurred because the player sought to intentionally injure the recipient, there won’t be. Trial of the case involves the same facts and testimony either way, and ultimately it’s up to the jury to weigh the testimony and the facts. The insurer if it is to lose the case would prefer to lose it on intentional-injury grounds, for then it won’t have to pay the judgment.

Another example: assume there is a technical defense available to the covered claim; should the lawyer file a motion for summary judgment on the covered claim, which will effectively pretermit the carrier’s ongoing obligation to defend (since the case no longer can eventuate in a judgment covered by the duty to indemnify)? Does the lawyer have an obligation to leave the weak claim hanging around just to preserve the defense or does the lawyer – whose bills are being paid by the insurer – have the obligation to clean out the dross and thus allow the carrier off the hook?

Insurers have pooh-poohed such concerns by contending that lawyers act ethically so the courts’ concerns are unfounded. And the United States Court of Appeals for the Fourth Circuit – a court that has a penchant for mispredicting state insurance law by siding with insurance companies – recently agreed with the insurers in what should become carrier-side lawyers’ favorite case to cite on these issues. In a well-written, well-analyzed, but erroneous ruling, Twin City Fire Ins. Co. v. Ben Arnold-Sunbelt Beverage Co. (4th Cir. Dec. 27, 2005), the Fourth Circuit rejected the argument that an insurer’s reservation of the right to deny coverage called for prophylactic protection of the interest of the insured by allowing it to select counsel of it choice to defend at the insurer’s expense.

Of course, Ben Arnold involves reasonably favorable set of facts for carriers and overbroad argument by the policyholder, but the court’s ruling is not so confined. The court sets up the question presented as follows:

When a party with insurance coverage is sued, the insured notifies the insurance company of the suit. The insurance company, in turn,typically chooses, retains, and pays private counsel to represent the insured as to all claims. If the suit involves some claims that are covered under the insurance policy and some claims that are not covered, the insurance company typically will send a reservation of rights letter to the insured stating what claims the insurance company believes are covered and what claims it believes are not covered. In this case, we examine whether, under South Carolina law, such a reservation of rights letter automatically triggers a conflict of interest entitling the insured to reject counsel tendered by the insurance company and instead to choose and retain its own counsel and to have the insurance company pay for that counsel.

Slip op. at 1. The proposition offered by the insured was that any time an insurer issues a reservation-of-rights letter it is still required to provide a defense but the policyholder gets to select counsel to defend it and control the course of the defense.

The Fourth Circuit rejected the policyholder’s argument, noting correctly that courts tend to require that the insured show there to be a conflict of interest between it and the insurance company before wresting the defense from the carrier. This is sensible, of course, given that in the insurance policy the policyholder delegated to the insurance company the right to defend the case. Insurance companies issue reservation-of-rights letters in response to case law in the 1950s and 1960s that a carrier that defends a suit cannot turn around at the end of the case and tell the insured that it won’t pay for the judgment – at least without alerting the insured of this possibility earlier; as a result, insurance companies issue reservations of rights to prevent the insured from having detrimental reliance (or claiming waiver). National Mut. Ins. Co. v. McMahon & Sons, 356 S.E. 2d 488, 493 (W. Va. 1987); Safeco Ins. Co. v. Elllingshouse, 725 P.2d 217, 221 (Mont. 1986); Richmond v. Georgia Farm Bureau Mut. Ins. Co., 231 S.E.2d 245 (Ga. 1976); Royal Ins. Co. v. Process Design Associates, 582 N.E.2d 1234, 1239 (1st Dist. 1991).

But it is not the insurance company’s fault that a suit may involve both covered and uncovered amounts, and coverage is not to be expanded beyond the terms of the policy through application of principles of waiver. As a result, it is entirely appropriate for an insurance company that is contractually obligated to provide a defense to a policyholder to alert it to the possibility that the judgment in the case might not be covered. D.E.M. v. Allickson (North Star Mut. Ins. Co.), 555 N.W.2d 596 (N.D. 1996). In this way, the policyholder can act to protect its own interest, including in some states choosing to settle the lawsuit against it in a fashion that camouflages whether the payment is also on account of uncovered amounts or claims. See generally Miller v. Shugart, 316 N.W.2d 729 (Minn. 1982).

So, unless some other interest or question is involved, the mere fact that an insurer sends a reservation-of-rights letter should not alter the parties’ preexisting rights and powers (since all the insurer is trying to do is to avoid waiver/estoppel from its assuming the defense).

Against this background, the Fourth Circuit rejected the notion that a reservation-of-rights letter per se creates some sort of conflict between the interests of the insured and its insurer such that the insurer is divested of its contractually bargained-for right to defend. But the court went on to recognize that there are circumstances where the interest of the insured and the insurer in the development of the defense can diverge, which has led most courts to express concern about insurer-appointed and insurer-directed counsel.

The Ben Arnold court reviews the law in a number of jurisdictions (having found that South Carolina law applies and was without governing precedent) and concludes that some courts allow the insured to select counsel paid contemporaneously by the insurer whereas other courts permit the insurer to select “independent” counsel who in turn may have heightened professional duties to safeguard the insured’s interest. Because a strong undercurrent in those cases vesting the choice of counsel in the hands of the insured questions the ethical integrity of the insurance-defense bar, e.g., Howard v. Russell Stover Candies, Inc., 649 F.2d 620, 625 (8th Cir. 1981) (requiring independent counsel for fear that counsel for insurer “would be inclined, albeit acting in good faith, to bend his efforts, however unconsciously” in insurer’s favor), the Fourth Circuit was highly reluctant to impugn with such a broad brush the integrity of an entire swath of the bar. Slip op. at 11 (“We are equally unable to conclude that the Supreme Court of South Carolina would profess so little confidence in the integrity of the members of the South Carolina Bar. Rigorous ethical standards govern South Carolina attorneys.”).

The Fourth Circuit concluded that the ethical rules and discipline, “coupled with the threat of bad faith actions or malpractice actions if a lawyer violates these rules, provide strong external incentives for attorneys to comply with their ethical obligations.” Slip op. at 12. Accordingly, the Ben Arnold court refused to find that, where there was a conflict of interest between the insured and the insurer in the development of the facts at issue in the liability case, the insured had a right to counsel of its choice, paid for contemporaneously by the insurer.

The court furthermore adopted a strict forfeiture rule in this regard, finding that if an insured rejected counsel tendered by an insurance company it forfeits the right to defense coverage. In other words, the policyholder is precluded from seeking coverage even if the insurance company cannot show that it was in any way was harmed by the policyholder’s selection of counsel (e.g., competent counsel at the same rate, for example, who obtains an outstanding result). The court rejected the policyholder’s contention that the insurers must show substantial injury or prejudice or at least some detriment in order to be excused from providing the policyholder any of the benefit of the bargain. Slip op. at 13-15.

Ben Arnold is sure to be relied on by insurance companies as a cogent statement of their position in favor of rejecting the policyholder’s selection of counsel of its choice. Nevertheless, the court need not have reached out to proclaim its own, pro-insurer prophylactic rule because the facts of the case and the conduct of the insurers at issue merit no such prolegomenon.

In Ben Arnold, the insurers retained qualified counsel to defend the covered counts and in addition offered to pay for separate counsel to represent the insured’s interests with respect to uncovered counts. Moreover, with respect to a different insured in the case where there was a conflict of interest in the development of the facts, both the trial court and the Fourth Circuit found that independent counsel was required to be appointed at the carriers’ expense. And even with respect to the principal insured for which there was no conflict at issue in the development of the underlying facts, the trial court recognized that at the time of settlement independent counsel might be required due to the conflict that then would be manifest. 2004 WL 2165971 (D.S.C. July 26, 2004), at n. 14.

What is lamentable about the Fourth Circuit’s opinion is that the court could easily and more properly have held that, given the absence of a conflict of interest between the insured and insurer in the development of the underlying facts, independent counsel was not required and in any event the insurers satisfied their obligations by offering to pay for two sets of counsel. This is the rule in “independent counsel” states where most courts recognize that merely sending a reservation-of-rights letter – without more – is insufficient to oust the insurer of the control of the defense. National Union Fire Ins. Co. v. Hilton Hotels Corp., 1991 WL 405182 (N.D. Cal. 1991). In fact, wresting control whenever a reservation of rights is sent ironically defeats the purpose for why such reservations were sent in the first place.

But Ben Arnold should not be rejected just because it is overly broad, for even were the facts to match the very broad rule adopted that rule still would be ill advised and erroneous under principles both of insurance law and of contract law. Perhaps because the issue has been in dispute for so long (half-a-century), the footings of the independent-counsel rule seem to have become beclouded.

Let’s look first at the consequences of the Ben Arnold court position. The court makes clear that, while there might a perception of discomfort by the policyholder in the carrier’s selected lawyer being in charge (and thus having the ability to steer the defense toward uncovered grounds), the insured’s interest is adequately protected because of legal-ethics rules, attorney-malpractice liability, and insurance bad-faith principles. This rejoinder to the policyholder position really does not withstand scrutiny.

The Fourth Circuit’s remedies render nugatory the peace of mind and security the insured is supposed to receive by paying a premium to the insurance company for the broad protection afforded by insurance policies. See Rawlings v. Apodaca, 151 Ariz. 149, 154-55 (1986) (“Although the insured is not without remedies if he disagrees with the insurer, the very invocation of those remedies detracts significantly from the protection or security which was the objection of the transaction.”). The court envisions requiring policyholders to endure bad faith or ethical breaches, and then seeking recovery only at the end of the underlying litigation by suing for legal malpractice or bad faith. Ben Arnold thus replaces the security that insurance is supposed to provide with a chose in action against the insurer-appointed lawyer, requiring the policyholder to (a) sue for legal malpractice, requiring a showing both of breach of the standard of care and a showing that the outcome would have been different (the “trial within the trial” of such malpractice actions), (b) undertake that action at its own expense (since the insurer is not paying, and there’s no attorneys’ fees recovery in malpractice cases), (c) in the meantime front the money for the adverse judgment in excess of policy limits or even the entire judgment if it is based on an uncovered claim (and subsequently, if successful, refund to the carrier in subrogation any amounts recovered after the policyholder was made whole), and (d) expose itself to an uncollectible judgment because the lawyer may not have assets sufficient to cover the judgment that resulted from his malpractice.

The Ben Arnold solution to the conundrum of insurer-appointed counsel further would do substantial injury to the attorney-client relationship; not only would the insured find it difficult to confide in counsel assigned to it, but counsel’s effectiveness would be undermined by its knowledge that the carrier has set it up for an impending malpractice action. And the same problems apply regarding suing the carrier for bad faith for some misconduct of the insurer-appointed lawyer or suing for negligent performance of the duty to defend by providing inadequate counsel.

The proposed remedy that the Ben Arnold court contemplates is a feeble substitution for the security and protection that the policyholder thought it was paying for. And if one looks at the cases decided forty or fifty years ago, these courts found it salient that the insurers’ policies did not spell out how this conflict situation would be handled. Standard insurance policies then (as now) were not written to state plainly and unambiguously that (i) interference with the right to defend forfeits coverage or (ii) the right to defend constitutes a material part of the consideration of the overall insurance transaction (which would be an overreach anyway given the aleatory nature of insurance contracts, that is, that the policyholder has fully performed its principal obligation of paying the premium).

Thus, the courts have applied the ordinary rules that where the policy language was uncertain and the insurer was in a position to clarify by drafting a provision clearly, the policy is construed in favor of coverage to achieve its purpose of indemnifying the insured, especially bearing in mind the reasonable expectations of insureds and avoiding the appearance of unseemliness from insurer-appointed counsel’s being in the position to steer the case to favor his or her source of future business. E.g., Employers' Fire Ins. Co. v. Beals, 240 A.2d 397, 402 (R.I. 1968); Magoun v. Liberty Mut. Ins. Co., 195 N.E.2d 514 (Mass. 1964); Prashker v. United States Guarantee Co., 136 N.E.2d 871 (N.Y. 1956); see also CHI of Alaska, Inc. v. Employers Reinsurance Corp., 844 P.2d 1113, 1116 (Alaska 1993). As a result, most courts ruled that the carriers’ right to control the defense – an ancillary part of the insurance contract – must yield to the predominate purpose of the contract to provide the policyholder a defense and to safeguard the policyholder’s peace of mind. See Jacobs & Youngs, Inc., 129 N.E. 889, 891 (N.Y. 1921) (Cardozo, J.) (“There will be no assumption of a purpose to visit venial faults with oppressive retribution.”). That carriers have not fixed their policy language after 50 years of litigation and instead require that the law be developed in each state and locality smacks of ineptitude or bad faith or some synergistic combination of the two.

Nevertheless, one dissembling rejoinder to this would be to contemplate a situation where the policyholder does erroneously reject the carrier’s offered defense (which approximates the actual facts in Ben Arnold). In that circumstance, so the argument goes, if the carrier remains responsible for funding the defense, the carrier that offers to perform properly is no better off than is the carrier that breaches its contract by refusing to provide a defense at all. In other words, a carrier that breaches its duty to defend by erroneously denying coverage is liable to pay the reasonable costs of defense; and according to this argument a carrier that offers counsel that is rejected by the policyholder is still obligated to pay the reasonable costs of defense.

This is a false counter, because it misstates the damages that are to be paid by a breaching carrier (that is, the contract-law damages it owes for breach of the duty to defend). It is not precise to say that a breaching insurer owes the reasonable costs of defense; rather, under Hadley v. Baxendale, the insurer owes all foreseeable damages. In the circumstances, the policyholder proffers in its prima facie case all defense costs it incurred (that were caused in fact by the carrier’s failure to perform), and the carrier may argue by way of affirmative defense (and for which it has the burden of proof) that the costs were so unreasonable as to constitute unforeseeable damages ( which when framed correctly is a difficult standard for the carrier to meet, especially in the light of the fact that the insured had every economic incentive to incur only reasonable costs since, at the time, it was paying them out of its own pocket with no certainty of recovery from the carrier). Moreover, a breaching carrier is not just liable for defense costs, it is liable for all damages incurred by the insured from the breach. Beck v. Farmers Insurance Exchange, 701 P.2d 795, 801 (Utah 1985).

Contrast this situation to that of the carrier that does offer a defense but which is rejected by the policyholder on the ground that independent counsel is required – though in this illustration the policyholder is wrong to do that. In that circumstance, the concepts of material versus immaterial breach are key (as are dependent versus independent covenants). Here, the carrier has not breached, but the policyholder has. But the policyholder’s breach – by interfering with the carrier’s right of control – exposes the policyholder to the carrier’s set-off claim because it is an immaterial breach of the overall contract. In other words, the carrier is still required to perform its contract – for the policyholder’s breach is not a material breach of the contract excusing the carrier’s obligation (especially when the policyholder has probably already paid the full premium). See generally Steakhouse, Inc. v. Barnett, 65 So.2d 736, 738 (Fla.1953)(defining dependent covenants). But because the policyholder did breach the contract, the carrier is entitled to show its damages from the policyholder’s breach. In this context, what that means is the additional cost of the defense that would not have been incurred had the policyholder not breached (i.e., not been in charged). So, if the defense counsel the insurer would have appointed charged only $300 an hour (because of say a bulk deal with the carrier) and the policyholder’s selected lawyer charges $400 an hour, the carrier is not obligated to pay the $100 an hour difference. (Unlike Ben Arnold where the carriers' to their mirth owe nothing.) Importantly, this is in contrast to the breaching carrier which is unlikely to be able to show that the $100 an hour delta is such an unreasonable cost differential as to constitute unforeseeable damages under Hadley v. Baxendale. Moreover, the carrier that properly offered counsel is not exposed to paying the insured’s full damages (sometimes pejoratively characterized as “consequential damages” (Machan v. Unum Provident Ins. Co., 2005 UT 37 (Utah June 17, 2005)), because it did not breach.

Thus, a carrier that properly tenders performance that is incorrectly rejected is not in the same (disadvantaged) position as is a carrier that breaches its contract. Accordingly, under this analysis, everyone is put in the position they would be in had the contract been properly performed – the benefit of the bargain is preserved.

Until such time, therefore, that insurers revise their contracts to specify that even in a conflict of interest situation the insurer still gets to appoint counsel (or whatever method it would propose, such as allowing the insured to pick from a list of five counsel suggested by the insurer), the uncertainty of the contract, and the disproportionality of the proposed remedy contemplated by the Ben Arnold court, confirms the rightness of the independent-counsel rule. See generally Restatement (2d) Contracts Sections 197, 229 (2004). If insurers do revise their contacts, then (i) insurance regulators would be in the position to weigh in, (ii) policyholders would know expressly what the process is for dealing with a conflict situation if it purchases the particular insurance policy, and (iii) policyholders could choose to purchase policies from other insurers that offer more generous terms. But it is folly to believe that policyholders contemplate the remedial scheme adopted by the Ben Arnold court. See Restatement (2d) Contracts Section 211(3).

Note: A version of this commentary was published in 5 Insurance Coverage Law Bulletin (May 2006) at 1

Posted by Marc Mayerson at 11:39 PM | Comments (0) | TrackBack

September 15, 2005

Defending Defense Costs: Parrying the Attack of the Legal-Fee Auditors

A common play by insurers that have failed to perform their duty to defend is to challenge the defense costs their policyholders incur on the grounds that they were unreasonable. The suggestion is that had the carrier defended the costs would have been less because the carrier would have hired cheaper defense counsel, or it would have ridden tighter herd on the costs incurred, or it would have required that only a limited number of lawyers be involved, or any of several other grounds for second-guessing the costs incurred by the policyholder. In addition to advancing these arguments, insurers have fabricated a specialized mouthpiece for making these points: "legal fee auditors." But both the legal premise and the "expert" testimony offered in support increasingly are being looked upon with the skepticism properly applied to the excuses of a breaching party that is seeking to reduce its obligation to pay damages - especially when that breaching party is an insurance company that was supposed to defend its insured in the first place.

The legal premise of a carrier's argument is that it needs to reimburse the insured only for "reasonable" defense costs, even if the policyholder already has spent the money. But this misconceives the legal context and the nature of the carrier's obligation. In these after-the-fact circumstances, the carrier's obligation is measured by ordinary principles of contract damages - and the hoary rule of Hadley v. Baxendale. E.g., Hajoca Corp. v. Security Trust Co., 25 A.2d 378, 381 (Del. 1942). The key to properly understanding the issues is to hold fast to first principles: when a party breaches a contract, the non-breaching party proves its recoverable damages by showing what was factually caused by the breach. In the context of the duty to defend, the natural and probable consequences of a breach of a duty to defend is that the policyholder will hire lawyers and experts to defend the suit against it. These costs, therefore, are the presumptive amount of damages for breach of the duty to defend.

Because the policyholder had no certainty that it would obtain recovery from someone else (i.e., the insurer), the amounts it incurred are presumed in the first instance to have been "reasonable" and "foreseeable." E.g., Aerojet-General Corp. v. Transport Indem. Co., 948 P.2d 990, 924-25 (Cal. 1997); Lanier v. Lovett, 213 P.2d 391, 394 (Ariz. 1923) ("The price agreed upon for labor or materials . . . is, prima facie, the reasonable value"); Smith v. Champaign Urbana City Lines, Inc., 252 N.E.2d 381, 382 (Ill. App. 1969) (paid invoice prima facie evidence). Once the policyholder establishes the amounts it paid (which therefore would be sufficient to support a jury verdict in its favor on damages), the burden shifts to the carrier to prove by competent evidence that some or all of the insured's incurred costs are so unreasonable as to constitute "unforeseeable" damages. See Marc Mayerson, Insurance Recovery of Litigation Costs, 30 Tort & Ins. L. J. 997 (1995). The presumption that costs incurred are reasonable or recoverable, though not conclusive, is a strong one: as the Seventh Circuit held:

When [the insured] hired its lawyers, and indeed at all times since, [the insurer] was vigorously denying that it had any duty to defend - any duty, therefore, to reimburse [the insured]. Because of the resulting uncertainty about reimbursement, [the insured] had an incentive to minimize its legal expenses (for it might not be able to shift them); and where there are market incentives to economize, there is no occasion for a painstaking judicial review.

Taco Bell Corp. v. Continental Cas. Co. (7th Cir. Nov. 5, 2004). Cf. National American Ins. Co. v. Certain Underwriters at Lloyd's, London, 93 F.3d 529, 539-40 (9th Cir. 1996); Laffey v. Northwest Airlines Inc., 746 F.2d 4, 17 & n.88, 24-25 (D.C. Cir. 1984). (It is also worth mentioning that lawyers have an independent professional obligation only to charge a reasonable fee. DR 1.5; Florida Bar v Herzog, 521 So.2d 1118 (Fla. 1988).)

So, an insurer bears a heavy burden in showing that costs are so unreasonable as to constitute unrecoverable contract damages (recognizing the costs actually were already incurred). The means for the insurers to make these arguments in recent years has been via "legal fee auditors." These chaps - typically former lawyers for insurance companies and almost certainly not "auditors" - really are disguised advocates who lack professional training and opine with no professional standards guiding their work. The audit profession is a real one, of course, and audits require compliance with written standards, such as Generally Accepted Auditing Standards promulgated by the AICPA. See generally Cumis Ins. Society Inc. v. Tooke, 293 A.D. 2d 794, 797-98 (N.Y. App. Div. 2002). The "legal audit" firms are not part of such disinterested, professional organizations - instead, they are mouthpieces with a mission to flyspeck legal fees on an after-the-fact basis. Several courts have not welcomed the testimony offered by these auditors/advocates:

[The insurance company] submitted an affidavit by a firm that hires itself out to review lawyers' bills and that opined that [the insured] had overpaid the lawyers who represented it [in the underlying] litigation. We are unimpressed, as was the district court. . . The affidavit of the firm that picked through [the insured's] legal bills is excruciatingly detailed. The amount of time and money that went into its preparation and would be incurred in adjudicating its accuracy probably would exceed the potential excesses that it identifies.

Taco Bell, slip op. at 9. The District of Massachusetts recognized that the testimony of a legal auditor is not likely to pass muster under Fed. R. Evid. 702 and the Daubert rule. E.g., Liberty Mut. Ins. Co. v. Black & Decker Corp., 2004 WL 1941351 (D. Mass. Aug. 25, 2004), at *8 & n.8. In Black & Decker, the court indicated that a fee auditor from one of the national fee-auditing outfits lacked the “specialized knowledge” and methodology as to testify properly as an expert witness. Id. While the court sought to be generous in saying that the effort was still helpful to the court, helpfulness alone is not a sufficient basis for its admission into evidence.

But there is an insurance spin that is worth returning to in evaluating the admissibility of the testimony of legal auditors and consideration of their project: As the Seventh Circuit concluded, "the duty to defend would be significantly undermined if an insurance company could, by the facile expedient of hiring an audit firm to pick apart law firm's billings, obtain an evidentiary hearing on how much of the insured's defense costs it had to reimburse." Taco Bell, slip op. at 10-11. To similar effect was the thinking of the District of Massachusetts:

Having declined to involve itself in the insured’s conduct of the litigation once notified, [the insurer] is in no position ex post to complain that the insured’s billing and litigation management policies do not meet its private criteria. The insurer that declines defense after notice cannot claim prejudice in the form of billing format or litigation practices that do not meet its standards, since it could have assumed the defense and imposed those standards.

Black & Decker, 2004 WL 1941351 at *8.

The context of breach of contract is different from the situations where an application for reimbursement of fees is submitted under a federal statute or in a bankruptcy proceeding. Just because the insured’s damages for breach of contract are in the form of attorneys’ fees does not mean that the standard of proof of damages is any different – a distinction insurers often seek to efface. Insurers thus often object to “block billing” or “inadequate descriptions” and argue that they are excused entirely from reimbursing such amounts, but this is simply wrong. The issue is whether a jury is provided with a non-speculative basis to determine the insured’s damages – and in the circumstance of block billing or the like so long as one can be reasonably certain that the business methods of the law firm yields an accurate statement of the time spent on the matter, the insured has established its right to those damages. E.g., Jowdy v. Guerin, 457 P.2d 745, 749 (Ct. App. 1969) (“Under Arizona law there is a distinction between the degree of proof necessary to establish the fact of damages and that necessary to fix the amount. Once the plaintiff has clearly established that he has suffered damages, his burden is relaxed and he need only show the amount with reasonable certainty, free from mere speculation or conjecture.”). Lawyers bill for their time, not for their time descriptions (as the old “for services rendered” billing format confirms).

Similarly, some carriers have objected to including as an element of damages the costs of computerized legal research and other expenses, arguing that these are more properly overhead expenses; while such costs could be wrapped into the hourly rate at particular law firms, there is no impediment to billing for them separately. E.g., ABA Comm. On Ethics and Prof’l Respo., Formal Op. 93-379 (Dec. 6, 1993). These are not per se unforeseeable costs and their being billed separately is not outside market practices.

None of this is to deny that clients should control the costs incurred by their counsel, and sophisticated corporate clients monitor the costs incurred and the manner of their billing – because they are paying for it! There are innumerable ways to structure the fees and expenses of lawyers, including increasing the lawyers’ billing rates so that expenses are no longer broken out (i.e., setting the rate so that the firm absorbs expenses rather than setting rates contemplating that expenses are separately billed); clients may impose standards for how law firms use outside vendors for copying and the like. Some clients want task-based billing and are willing to pay for it; others are satisfied with daily billing or what carriers like to call “block” billing. All of these may be appropriate business deals to work out with defense counsel. The point here, however, is in determining a carrier’s obligation to reimburse defense costs all of these quibbles are too late – in a breach of contract the insured shows what it spent and the breaching party bears a heavy burden of showing that costs that were spent and were caused by its breach should nonetheless not be awarded as an element of damages. Holding fast to these straightforward principles of contract law and damages jurisprudence simplifies coverage cases and streamlines the presentation of damages evidence at trial (to the considerable relief of jurors).

In one of my cases, the legal auditor purported to question 73 percent of all the defense costs incurred for a sophisticated client by a leading employment-liability defense firm, preparing a report of some 748 pages. This should be Exhibit A in showing that this entire project quite properly is a dead-end, as the Seventh Circuit and District of Massachusetts both found.

Posted by Marc Mayerson at 12:14 PM | Comments (15) | TrackBack

April 22, 2005

Expecting the Run-Around: Juries and Insurance-Coverage Cases

Over the past few years, we have participated in mock jury exercises in some of our coverage cases for policyholders. These exercises are extremely helpful in preparing for trial. They allow us to road test trial themes and to see what points gain transaction with our mock jury. Mock jury exercises sometimes will provide us with great handles for the real trial, such as a phrase or analogy that we had not thought of ourselves. We watch via closed-circuit television or through a one-way mirror while the jurors discuss the case and deliberate (they also fill out a raft of questionnaires that help us understand attitudes, demographics, and the like). But it is the deliberations that are most helpful to the trial lawyer. As an example, a mock juror in one exercise said, “A half truth is a whole lie,” which nicely characterized what we were trying to say about how the insurance company had misrepresented the policy language to the policyholder by omitting the key sentence that undercut its position entirely.

Typically, we compress the case into two 90-minute presentations, one for the insurer and one for the policyholder. (We – that is, lawyers for the policyholder – play both roles, but I haven’t found this to skew the exercise in the policyholder’s favor; we don’t tell the jurors that the lawyer playing the insurance-company’s lawyer really is a lawyer for the policyholder.) The presentations will use key documents and graphics. One of the consultants with whom I’ve worked calls what we do a “clopening”, that is, a combination of opening statement and closing argument. Essentially, we summarize and present the evidence and then argue our case. We’ll have a group of 30 to 40 people who are the audience; sometimes we make the presentation to all the jurors, and sometimes we present the case twice or three times to different juror panels (this allows us to tinker with our presentations based on the feedback from the prior mock jury).

Reflecting on the exercises I’ve participated in over the years has led me to the surprising realization that one consequence of (what I believe to be) the downward moral spiral of the insurance industry over the last couple of decades has been the lowering of expectations of jurors as to appropriate insurance company conduct. Jurors may have experienced the runaround themselves in the adjustment of their own claims, seen major price hikes in personal-lines coverage, and been flooded the stream of news of corruption in the industry (such as the broker-compensation imbroglio, the AIG mess, insurer bankruptcies, or in some states insurance commissioners being in the pocket – or trying to be – of insurance companies). I think the conventional wisdom is that juries are therefore primed to sock it to an insurance company and to cast the policyholder as a hero that in a surrogate capacity is vindicating the rights of the jurors.

No doubt that some jurors have this reaction. But I am increasingly feeling that the accumulation of years and years of insurer misconduct has browbeaten juries into submission. It is not that jurors feel that insurers are right or correct; rather, there is more of a sense that this is what you get when you buy insurance, whether you are a big guy or a little one. (One can think of this as a variant on a blame-the-victim theme.) In some ways, it may even be a relief to jurors to see companies encounter the same runarounds and hurdles that individuals deal with. None of this is to say that the insurance company is doing the right thing or is properly construing the policy or forthrightly dealing with its policyholder. Rather, misconduct now may be increasingly seen as par for the course. (The recent movie The Incredibles portrays well some of the inappropriate attitudes and approaches by insurers, where one needs an ex-superhero on your side in order to have your claim fully paid.)

The startling cynicism of some jurors – and perhaps an increasing percentage of them – has some important consequences:

1. At trial, it is crucial to establish the standards by which insurers are to be judged. The jurors must understand that both the aspirations of the insurance industry and its (best) customs and practices embrace fidelity to the interests of the insured and providing help and support in the policyholder’s time of need. The jury cannot be permitted to take the reality of current (mis) conduct and raise that to a normative standard by which to judge the insurer’s actions.

2. Long before we get to trial or litigation, the policyholder needs to be mindful that it has to set up its claim well. This means not putting things on the table simply in order to take them away and thus have something to negotiate with; that only serves to legitimize insurer nit-picking. The policyholder also must consistently provide full and detailed responses to the insurance company, demonstrating patience but also showing that the insurer is abandoning the insured and failing to discharge its obligations. (I’m not saying that policyholders should threaten bad faith at every turn but rather explain how they need the insurer’s support and are looking to the insurer for help.) Policyholders need to cross their T’s, dot their I’s, and turn square corners, or one provides the insurer with a cover for misconduct. (For some guidelines on doing this see, Mayerson, Pursuing and Perfecting Liability Insurance Coverage: A Primer for Policyholders on Complying with Notice Obligations, 32 Tort & Ins. L. J. 1003 (1997), available http://www.spriggs.com/news/pdfs/MSM-6.pdf.)

3. Insurance companies should not be heartened by all of this. In the short term, this may help insurers win trials (or the bad-faith claim) by moving the line for bad faith further out, such that bad faith is considered less to be a breach of acting in good faith and instead to require evil and malicious conduct (collapsing bad-faith liability into punitive damages). In the long run, however, a recognition by consumers and businesses that insurance really isn’t there for you when you need it most will doom the industry. What value would there be in buying insurance? On this point, see the extraordinarily thoughtful article (that also discusses past episodes of insurer shenanigans), Richard Stewart and Barbara Stewart, The Loss of the Certainty Effect, 4 Risk Management & Ins. Rev. 29 (2002), available at http://www.stewarteconomics.com/Certainty%20Effect.pdf.

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