Recently, in Coats, Rose, Yale, Ryman & Lee, P.C. v. Navigators Specialty Ins. Co., C.A. No. 3:11–CV–0642–D, 2011 WL 5870066 (N.D. Tex. Nov. 21, 2011) (Fitzwater, J.), U.S. District Court Judge Sid Fitzwater was presented the question of whether there was a conflict of interest between an insurance company and its insured that superseded the insurance company’s contractual right to select counsel to defend the insured in a state-court legal malpractice suit.  Coats, Rose, Yale, Ryman & Lee, a law firm insured under a professional liability insurance policy issued by defendant Navigators Specialty Insurance Company, sued Navigators seeking a declaratory judgment that Navigators was required to pay for attorney’s fees and expenses incurred in the defense of a state-court legal malpractice action.

The law firm tendered the suit to Navigators, who agreed to provide a defense under a reservation of rights. The relevant policy provided that Navigators had the right to defend the firm, which included the right to select defense counsel.  The law firm asserted that any attorney whom Navigators selected would have a conflict of interest, and the firm hired counsel of its choice to defend it in the underlying lawsuit. Navigators maintained that there was no conflict of interest, and it refused the firm’s requests to pay attorney’s fees incurred by its independently-retained attorney.

The parties filed cross-motions for summary judgment.  The firm argued: (1) although Navigators has yet to reserve its rights for claims arising from any dishonest, intentionally wrongful, fraudulent, criminal, or malicious actions, Navigators’ ability to do so in the future creates a conflict of interest; (2) a conflict of interest existed because the policy covers compensatory damages but not the return of fees, and an attorney chosen by Navigators would be able to steer any damage award toward the return of fees so that the award is not covered by the policy; and (3) the declaratory judgment claim in the underlying lawsuit created a conflict of interest because the policy does not cover, and Navigators reserved its rights with regard to, “costs arising from declaratory relief.”

Navigators responded to these arguments as follows: (1) Navigators represented that it has not and will not ever reserve its right to deny coverage for any claim in the underlying lawsuit based on the policy’s dishonesty exclusion; (2) any concession of facts that would tend to establish liability for either a claim for compensatory damages or a return of fees would increase the likelihood of compensatory damages that Navigators would be obligated as insurer to pay on Coats’s behalf; and (3) there is no incentive for an attorney whom it selects to do anything but vigorously defend the declaratory judgment claim because any declaratory relief granted would lead to liability under the malpractice or breach of fiduciary duty claim, both of which are at least partially covered under the policy.

The  court  agreed  with  Navigators  and  concluded  there  was  no  conflict  of  interest  that  superseded Navigators’ right to select defense counsel for the law firm.

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