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October 17, 2001

This is one of a series of articles under the by line “Butler on Bad Faith” originally published in Mealey’s Litigation Report: Insurance Bad Faith, Vol. 15, #12, p. 24 (October 17, 2001). © Copyright Butler 2001.

Two recent state court decisions jeopardize the right of insurers to consult legal counsel when considering whether to pay or deny the claim of a policyholder. The Arizona and Ohio state supreme courts have issued opinions eroding, even abro6

), the insurer has petitioned the United States Supreme Court to issue the writ of certiorari, hear the case and reverse the Ohio Supreme Court. The undersigned urges the United States Supreme Court to take the Vanliner case for the reasons stated below.

I.  State Farm v. Lee, 13 P.3d 1169 (Ariz. 2000)

State Farm v. Lee involved a bad faith class action suit brought by policyholders after State Farm denied stacked UM claims. The denial was made pursuant to an anti-stacking provision in the policy. In bad faith suits, Arizona law requires plaintiffs to allege both objective and subjective unreasonableness on the part of the insurer, and the Lee plaintiffs did so. Id. at 1185. State Farm denied Plaintiffs’ allegations of subjective unreasonableness and maintained that its reliance on the anti-stacking provision was a good faith, subjectively reasonable position. State Farm did not assert advice of counsel as an affirmative defense to the class action. State Farm acknowledged, however, that its personnel considered advice of counsel, in addition to their own review of the policy provisions, statutes, and cases.

In discovery, Plaintiffs sought, among other things, correspondence between State Farm and 15 of its law firms. State Farm resisted and Plaintiffs filed a motion to compel. The trial court granted the motion based on implied waiver. State Farm filed a special action in the Arizona Court of Appeals contesting the decision. The appellate court reversed.

On review, the Arizona Supreme Court reinstated the trial court’s ruling. The Supreme Court found that State Farm had relied on “advice of counsel” as an implicit defense to the class action. It found State Farm had waived the attorney-client privilege by asserting advice of counsel as a defense implicitly.

The Arizona Supreme Court recognized that Arizona follows the Hearn test in evaluating whether a court can compel disclosure of attorney-client communications. Id. at 1173—74, citing Hearn v. Ray, 68 F.R.D. 574 (E.D. Wash. 1975). Under the Hearn test, three criteria must be met to establish implied waiver of the attorney-client privilege: 1) assertion of the privilege through some affirmative act; 2) that makes the privileged information relevant to the case such that 3) continued use of the privilege must deny the opposing party access to information vital to his case. Id. at 1173.

The Arizona Supreme Court determined that Hearn supported disclosure of the privileged communications in the class action. Id. at 1174. The Court found that an insurer can implicitly waive the attorney client privilege if it satisfies a “Hearn-like requirement” by doing an affirmative act that puts the privileged materials at issue. State Farm satisfied this “Hearn-like requirement” when it advanced its own interpretation of the law as a defense, thus rendering the advice of counsel discoverable because the information known to State Farm personnel included advice of counsel. Id. at 1175. As mentioned, even though State Farm did not assert it rejected the stacking claims because of its lawyer’s advice, it conceded the knowledge of its personnel included information from lawyers. Id.

State Farm contended it had raised the subject of the belief of its personnel merely to deny allegations that it knew it was misinterpreting the law. The Arizona Supreme Court rejected that position. State Farm, said the Court, could have defended by simply denying it knew it was acting unlawfully, and relying on a defense of objective reasonableness. Id. at 1182. State Farm need not allege that it investigated and evaluated the law, arriving at a subjective belief that its denial was reasonable. Id. A general denial by State Farm still would have required Plaintiffs to prove that State Farm knew it was acting unlawfully. Id.

II.  Boone v. Vanliner, 744 N.E.2d 154 (Ohio 2001)

In Boone v. Vanliner, truck driver Boone had an on-the-job motor vehicle accident. He brought suit for declaratory judgment and bad faith against Vanliner Insurance Company claiming entitlement to UM benefits under both his personal policy and his employer’s policy. In the answer to complaint, Vanliner first denied, but later admitted, both policies provided coverage. Id. at 155.

During discovery, Boone tried to get Vanliner’s claim file. Vanliner sought a protective order pursuant to the attorney client and/or work product privilege. Id. Following an in camera inspection, the trial court protected numerous documents, but found that 30 were not shielded by either privilege. Id.

Vanliner appealed the trial court’s ruling and obtained a reversal as to all but one of the 30 documents. Boone then took a discretionary appeal to the Supreme Court of Ohio. Id. In an action alleging bad faith denial of insurance coverage, is the insured entitled to claim file documents, containing attorney-client communications and work product, that may cast light on whether the denial was in bad faith? Id.

In support of the affirmative position, Boone argued by analogy to an earlier Ohio case, Moscovitz v. Mt. Sinai Med. Ctr., 635 N.E.2d 331 (Ohio 1994). That case involved whether the prevailing party is entitled to prejudgment interest based upon the losing party’s lack of a good faith effort to settle. It held the privilege protects the insurer’s claim file from disclosure only as to matters that go directly to the theory of the underlying case. Vanliner, 744 N.E.2d at 156-57. Boone argued that the claim file showing an insurer’s bad faith evaluation of coverage is unworthy of protection. Id. at 157. The Supreme Court of Ohio agreed. Id.

In so doing, the Supreme Court summarily rejected Vanliner’s argument that allowing access to attorney-client communications will discourage insurers from seeking legal advice whether a claim is covered. Id. The Supreme Court of Ohio was not moved. That argument assumes insurers will violate their duty to conduct a thorough investigation (including getting legal counsel) to avoid giving up that information in discovery. Id. The Supreme Court of Ohio also rejected the argument that disclosure of communications would undermine the insurer’s ability to defend the UM claim. The insurer can move to stay the bad faith suit if it had such concern. Id.

The Supreme Court of Ohio limited the required disclosure to documents created before denial of the claim; a lack of good faith in determining coverage occurs only when the assessment of coverage is made. Id. at 158. The Court reasoned that the claim file will not contain work product, i.e., things prepared in anticipation of litigation, because, at that point, the insurer would not yet have determined coverage. Presumably, an insurer cannot anticipate litigation over coverage until it denies coverage.

III.  Discussion

These two sketchily reasoned decisions depart from well-established principles of existing law. The attorney-client privilege is the oldest of the privileges for confidential communications known to the common law. Upjohn Co. v. United States, 449 U.S. 383, 389, 101 S. Ct. 677, 682, 66 L. Ed. 2d 584 (1981). The purpose of the privilege is to encourage full and frank communications between attorneys and their clients and thereby promote broader public interest in the observance of law and administration of justice. Id., 101 S. Ct. at 682.

Interpretation of the scope of the attorney-client privilege should be guided by principles of the common law. Swindler and Berlin v. United States, 524 U.S. 399, 403; 118 S. Ct. 2081, 2084 114 L. Ed. 2d 379 (1998). The test is whether the court, in light of the court’s reason and experience, preservation of the privilege in a particular case promotes interests sufficiently important to outweigh the need for probative evidence. See Jaffee v. Redmond, 518 U.S. 1, 9—10; 116 S. Ct. 1923, 1928 (1996). Federal courts following these principles have declined to abrogate the privilege based merely upon an allegation of bad faith in a policyholder’s complaint. See Ferrara & DiMercurio v. St. Paul Mercury Ins. Co., 173 F.R.D. 7, 11 (bad faith and unfair claim settlements do not constitute crime or fraud and crime or fraud exception to attorney-client privilege therefore inapplicable).

As a practical matter, the Lee decision allows plaintiffs to trigger an exception to the attorney client privilege by pleading that an insurer knew its actions were in bad faith. That puts the insurer on a tightrope between denying it knew its actions were in bad faith and asserting it believed its actions were in good faith. It is difficult to envision a deposition of an adjuster that would not open that door. The adjuster can testify she denied the claim. But if she says she did so because she believed the claim was not covered, then the Lee rationale says the insurer has placed the subjective beliefs of its personnel at issue. The privilege thus will be waived and any material the adjuster considered, including advice of counsel (whether followed or not), will become discoverable.

The Vanliner decision, for its part, explicitly allows plaintiffs to abrogate an insurer’s attorney-client privilege merely by alleging bad faith. Vanliner’s sweeping holding eviscerates the attorney client privilege for an entire class of communications by declaring summarily, without analysis, that claim file materials showing a lack of good faith are unworthy of protection.

Vanliner ignores precedent requiring procedural and substantive safeguards before deeming that a class of communications is unprotected by the attorney-client privilege. For example, in United States v. Zolin, 491 U.S. 554; 109 S. Ct. 2619, 2632; 105 L. Ed. 2d 469 (1989), the United States Supreme Court held that a party challenging application of the privilege based upon the crime or fraud exception must first make a prima facie showing that there is a reasonable belief that the communications relate to a future crime or fraud. Second, the trial court must independently corroborate that there is evidence of crime or fraud by conducting an in camera review of the disputed documents. Id.

In Vanliner, the Court did not require plaintiff to make a prima facie showing that the insurer had engaged in bad faith. Nor did the Court conduct an in camera review to ensure that there was a factual basis for the bad faith allegation. The decision in Vanliner denied the insurer the basic protections afforded even to defendants who would use the legal system to perpetrate crime and fraud.

Lee and Vanliner, if followed, will have a chilling effect for insurers seeking legal advice to resolve coverage questions. Presumably, this will result in erroneous decisions. This will result also in more litigation, driving up the cost of insurance for everyone.

Vanliner also annulled in part the work product privilege. The Supreme Court of Ohio found that “prior to the denial of coverage . . . the claims file materials will not contain work product, i.e., things prepared in anticipation of litigation, because at that point it has not yet been determined whether coverage exists.” Vanliner, 744 N.E.2d at 158. Under this rule, the free and honest flow of information between attorney and client is impeded. And that will change the nature of the attorney-client relationship (even assuming insurers will risk seeking legal advice). Insurers may withhold information from counsel that is critical to the formation of an accurate legal opinion.

Similarly, when the insurance attorney provides an opinion letter recommending denial, the attorney will hesitate to discuss factors supporting coverage. The attorney will fear that a jury, when confronted with an out-of-context caveat, will lose sight of the fine distinctions in the coverage analysis. Moreover, the insurer’s very choice of counsel will be impacted. An attorney cannot act as advocate at a trial in which the attorney is likely to be a necessary witness. Rule 3.7 of the ABA Model Rules of Professional Conduct (2001 edition).

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In conclusion, Lee and Vanliner are bad law and make bad public policy. We hope that the United States Supreme Court will accept, review and reverse Vanliner.