INSURANCE COVERAGE SAVVY LITIGATION OF
INTELLECTUAL PROPERTY DISPUTES
By: David A. Gauntlett" Footnote1
I. INTRODUCTION
Although virtually any tort claim involving an intellectual property dispute could potentially give rise to coverage, identification of the range of intellectual property disputes in which potential insurance coverage may arise for the benefit of the policyholders is beyond the scope of this article. Endnote1 Nevertheless, a variety of issues arise once an insurer has agreed to defend a policyholder in an intellectual property lawsuit. This article surveys the most critical of these recurring issues emphasizing California law which is the most developed in this area.
II. TENDER EARLY, TENDER OFTEN
A. Avoiding Forfeiture of Insurance Coverage Benefits by a Prompt Tender of Claims
Depending upon what state law governs the dispute, the policyholder's rights to potential coverage will often depend on prompt notice to its insurers. The failure to give prompt notice to insurers of claims against a policyholder can have disastrous consequences. In many states, untimely tender can mean not only the denial of any right to reimbursement for attorneys' fees incurred prior to notice, but forfeiture as well as the right to any coverage under the policy. A recent article describes this rule as "draconian, archaic and anachronistic." Endnote2
Fortunately, the author's survey of applicable law in 50 states noted only 11 jurisdictions in which this forfeiture rule applied. Included among these states, however, are New York and Virginia. Even in those jurisdictions where automatic forfeiture is not the rule, some states require the policyholder to establish that the insurer was not prejudiced by the delay in tender (Connecticut, Florida and Ohio). Luckily a growing majority of states agree that the insurance company has the burden of showing that it has been prejudiced by a delay in tender. Among the jurisdictions adopting this more enlightened view are California, Massachusetts, Michigan, New Jersey, Pennsylvania, Texas, and Washington state.
B. Obtaining Reimbursement of Pre-Tender Defense Fees
Even in the majority of these jurisdictions, insurers
may be able to successfully argue that pre-tender fees
incurred prior to the date the insurer was placed on notice
of potentially covered claims (i.e., pre-tender claims) may
not be subject to reimbursement. Some jurisdictions have held
that the ability to recover pre-tender fees may ultimately
depend upon whether the insurer agrees to defend the suit.
Endnote3 If it does, it can bar them, but where it
refuses to defend and this denial is held to be improper, the
insurer cannot limit the policyholder's reimbursement to any
post-tender fees.
Endnote4
The typical factors which support finding prejudice to the insurer from a delay in tender by a policyholder do not arise in most intellectual property lawsuits. Endnote5 Few jurisdictions have directly addressed the insurer's obligation to defend when the facts underlying the defense of untimely notice is disputed prior to the final disposition of the underlying case. However, those courts that have specifically ruled on this issue have concluded that the insurer is obligated to provide a defense until the factual dispute is resolved. Endnote6
The rationale for denying the policyholder any recovery of pre-tender fees was articulated by the California Supreme Court in Gribaldo, Jacobs, Jones & Associates v. Agrippina Versicherunges A.G., 3 Cal.3d 434, 450, 91 Cal.Rptr. 6, 476 P.2d 406 (1970). Therein, the court held that when a policyholder fails to tender, it has "voluntarily incurred these costs without first demanding a defense" and therefore is not entitled to recover those defense costs. Endnote7 Some recent unpublished decisions suggest that the voluntary payments provision will not be enforceable where the insurer denied a defense on grounds other than late notice so that it cannot use that provision as a basis for barring a defense to its policyholder. Endnote8 These cases note that absent an enforceable "voluntary payments provision," California Civil Code § 2778 provides:
An indemnity against . . . liability embraces costs of defense against such . . . liability [if such defense is] incurred in good faith, and in the exercise of reasonable discretion would require payment of such fees. Endnote9
C. Intellectual Property Attorneys' Exposure to Malpractice for Failure to Advise Clients of the Opportunity for Tender of Potentially Covered Claims to Their Insurers
The penalty for failure to timely tender a claim to an insurer, or more critically to alert a policyholder to the potential for pursuit of such a claim, may be a suit for legal malpractice against intellectual property counsel. Endnote10 While an intellectual property attorney may not hold himself or herself out to the community as a specialist in insurance coverage issues, his or her retention as defense counsel puts that attorney in a unique position to refer such matters to competent insurance counsel or to advise the client of the necessity to further investigate this issue.
The legal issue is no different from that which arises where a business attorney recognizes that the expertise of tax counsel is required to fully advise clients on all options. In such circumstances, while the business attorney need not possess the expertise to render advice on tax issues, he/she has a duty to inform the client of the need to pursue counseling in this area.
In a recent decision analyzing potential coverage for an unfair competition/interference with prospective economic advantage claim, the court found that a failure to tender that claim, which potentially fell under the "advertising injury" provisions of the CGL insurance policy, supported a finding of liability against the policyholder's intellectual property counsel. In Ross v. Briggs & Morgan, 520 N.W.2d 432 (Minn.App. 1994) rev.granted, a Minnesota Court of Appeals stated:
To establish a legal malpractice claim, a plaintiff must show (1) the existence of an attorney-client relationship; (2) negligence or breach of contract by the attorney; (3) the attorney's acts proximately caused the client's damages; and (4) the client would not have been damaged but for the attorney's conduct. Wartnick v. Moss & Barnett, 490 N.W.2d 108, 112 (Minn. 1992); Briggs & Morgan argues that, as a matter of law, Ross was not damaged by his actions because none of Jaffe's claims were covered by the policy. We disagree. Id. at 435.
In clarifying the basis of its analysis, the court summarized:
Because the "passing off" portion of Jaffe's deceptive trade practices and unfair competition claims suggest that Ross took and used his advertising ideas and possibly even his entire style of doing business, they arguably were covered by the "unauthorized taking of advertising ideas or style of doing business" clause in the policy. . . . In addition, Ross' use of the name "Skin Physicians, P.A." and "Institute of Cosmetic and Laser Surgery" arguably was covered by the "infringement of copyright, title or slogan" clause. . . . The similarity of Ross' "Skin Physicians, P.A." and "Institute of Cosmetic and Laser Surgery" to Jaffe's "Skin Diseases, P.A." and "Institute of Cosmetic Surgery and Hair Transplants" arguably constituted an infringement of Jaffe's titles or slogans that was covered by the insurance policy. Id. at 435-436.
III. BROADLY CONSTRUE THE RANGE OF DISPUTES WHICH MAY TRIGGER POTENTIAL INSURANCE COVERAGE
Some states follow the rule of insurance coverage, which limits the insurer's duty to defend, to facts stated in the pleadings filed against a policyholder under the "four corners doctrine," i.e., limiting coverage to claims asserted in the four corners of the complaint. The majority of jurisdictions, however, do not so limit coverage. Endnote11 An insurer's duty to defend must be analyzed and determined on the basis of any potential liability arising from the facts available to the insurer from the complaint or other sources at the time of tender. Critically, the majority of states follow this approach. Endnote12
Even in jurisdictions purporting to follow the narrow four corners doctrine such as Texas, ambiguous facts set forth in federal court notice pleadings may be clarified by reference to facts made available to the insurer from the pleadings or discovery in the underlying action which demonstrate the availability of a defense. Endnote13 Applicable Texas coverage law reveals that the court may look beyond the face of the pleadings where there is ambiguity asserted in the pleadings as it pertains to issues triggering potential coverage. Endnote14 Thus, cases addressing this issue under the four corners doctrine have relied upon the policyholder's inability to identify "any connection" between the underlying claims and the policyholder's advertising activities. Other jurisdictions which purport to apply a four corners analysis readily recognize this exception. Endnote15
For the same reasons, the scope of claim to be tendered is not limited to complaints, but may include counterclaims, third party complaints and demands that the alleged infringer seek a license under intellectual property technology, or cease and desist the allegedly infringing conduct, as well as re-issuance, re-examination and opposition proceedings in the Patent and Trademark Office. Each of the above-referenced proceedings, at minimum, involves a potentially covered "claim" and in many instances a "suit" as those terms are used in a CGL insurance policy. Endnote16 Although the specific policy language of a particular insurance agreement must be examined to determine whether it extends its coverage to "claims" as well as "suits," standard Insurance Services Office ("ISO") policy forms include both terms.
As a consequence of the fact that litigation involves a variety of different proceedings in the intellectual property arena, it is not uncommon for a party pursuing a claim as a plaintiff in a patent infringement lawsuit to be served with a counterclaim which includes claims for violation of antitrust laws, or potentially covered claims for interference with prospective economic advantage or unfair competition. This counterclaim provides the plaintiff with a defense as broad in scope as the affirmative defenses asserted in response to that counterclaim. The costs incurred in defending against the counterclaim constitute the majority of activity in the suit from and after the date of its filing. All of these defense costs should be covered by insurance. Proof of the validity of the patent as well as the infringing character of the defendant's conduct is often essential to disprove the allegations of the counterclaim and to approve the affirmative defenses thereto.
Similarly, the cost of investigating whether a particular product infringes valid patent, copyright or trademarks claims should be chargeable to the carrier as necessary conduct essential to defend against such claims. Indeed, an AIG subsidiary, American International Specialty Lines Insurance Company, as well as the Intellectual Property Insurance Services Corporation, have recently issued insurance policies that expressly cover the defense of patent infringement lawsuits. These policies expressly provide that the costs of a declaratory relief action establishing non-infringement and/or challenging the validity of the patents sued upon is properly within the insurer's reimbursement obligations. Endnote17
IV. ACCEPT NO FOR AN ANSWER
Not every denial by an insurer of a request that it agree to defend its policyholder in an intellectual property lawsuit need precipitate an immediate declaratory relief action against that insurer. A series of factors must first be considered before electing such a path. The following seven are most pertinent:
1. Can the policyholder company afford to litigate the dispute to conclusion without insurer reimbursement of defense fees and costs?
2. Is the dispute likely to narrow issues as it proceeds to trial in such a manner that the issues remaining for resolution will still remain within the policy's potential coverage?
3. If the policyholder does not initiate coverage litigation would the insurer be able to select a forum for litigation of a coverage dispute that would prove more advantageous to it than its policyholder?
4. Is the case one where the insurer will perceive
that there is little likelihood of an eventual covered loss
falling within the heart of its policy provisions to its
policyholder?
5. Is the insurer not bound by principles of reasonableness in reimbursing independent counsel retained by the policyholder but by some artificial limit on rate such as those contained in California Civil Code § 2860, either because coverage issues are controlled by California law or its policy incorporates such limitations on reimbursement to independent counsel?
6. Does applicable coverage law not recognize the policyholder's right to retain independent counsel at the insurer's expenses where a conflict of interest is triggered by the nature of the claims asserted and the insurer's denial of the full coverage to the policyholder for such asserted claims?
7. Does the insurer's policy limit rights to resolve coverage disputes to an arbitration remedy in accord with the choice of law provision of the insurer's selection (i.e., AAA Arbitration in New York under New York law)?
If the answer to these questions is "yes," then the policyholder might well consider awaiting resolution of the underlying dispute with its chosen counsel following notice to the insurer of its claims for coverage and receipt of the insurer's denial before proceeding against its insurer for recovery of damages arising from that denial of coverage. If, however, the answer to any of these questions is "no," the consequences of delay in pursuing the insurer for claims in a declaratory relief action should be carefully evaluated.
If a policyholder does not have sufficient resources to participate actively in the litigation, without reimbursement from its insurer, a decision to await challenging the insurer's denial until later on in the case could prove to be even more disastrous. First, the policyholder may be unable to reimburse its defense counsel for fees incurred in the underlying suit. Second, the policyholder may have insufficient resources to challenge its insurer. Third, the policyholder may have insufficient evidence of payment of defense fees, to establish damages caused by the insurer sufficient to induce coverage counsel to participate in some form of shared risk fee arrangement to assist the policyholder in its claims against its insurer.
In order to truly appreciate all the considerations which make one forum a preferred choice over another, careful examination of the nature of the policy language at issue, the claims asserted, how applicable principles of law vary from jurisdiction to jurisdiction, and the jurisdiction where the claim may be brought should be considered. Endnote18 Where the choice of forum may be predictive of the result of a coverage dispute, a delay in pursuing a declaratory relief claim can allow the insurer to select its forum and by so doing, in effect, choose the applicable law to be applied to a dispute -- both to the serious disadvantage of the policyholder. Thus, some jurisdictions, such as California, find that the policyholder's failure to articulate specific grounds for denial of a defense constitutes a waiver of all such unarticulated bases for denial. An insurer which relies on an insurer's denial letter which notes that there is no "advertising injury" coverage because one of the enumerated offenses is not asserted in the complaint, waives the right to subsequently deny a defense based on the policy exclusions or other grounds supporting a finding of no coverage. Endnote19
In a recent case, a California company was sued for patent infringement in the Eastern District of Virginia where the underlying case was moving forward rapidly ahead on the Rocket Docket. The policyholder received a denial in its quest for coverage from its insurer. After its receipt of the initial denial, the policyholder insisted that further written negotiations proceed any filing. A comprehensive analysis of the policyholder's coverage position with pertinent factual support was provided to the insurer. The insurer sent to the policyholder two documents. The first was a more comprehensive denial letter, the second was a coverage action filed in the Eastern District of Virginia where the underlying suit was pending. Virginia law follows the four corners rule and other narrow principles of policy construction. Although coverage counsel for the policyholder successfully argued that California law should apply to this dispute, nevertheless, the Virginia court's interpretation of California coverage law in the whole resembled more of the law of Virginia than that of California. The ultimate result was an unfavorable resolution of the coverage dispute. While it cannot be guaranteed that a different result would have attended had the coverage issue been litigated in California, choice of a California forum would have entailed less expense in educating the district court about the nature of pertinent California coverage law. Endnote20
V. EXPEDITIOUSLY COMPEL INSURERS TO DEFEND INTELLECTUAL PROPERTY DISPUTES
Before electing a particular litigation strategy to pursue recovery of defense fees, coverage counsel should address the following issues:
1. Can a defense be readily established for the
asserted claims that are likely to cover the policyholder's
principal exposure for damages in the underlying case?
2. Is the client's primary desire to obtain a cost effective and expeditious determination of its right to a duty of defense in the underlying action?
3. Is the forum one where once a duty of defense is
established, from one claim in a lawsuit, the right to
reimbursement of defense costs for the entirety of the
lawsuit flows?
4. Is the forum one where the costs of suit in a declaratory relief action to establish coverage are not recoverable by the policyholder even without a threshold showing of bad faith?
5. Is the forum one where punitive damages are
recovered by the policyholder upon a showing of egregious
conduct by the insurer in denial of a defense?
If the answer to each of the above questions is "yes," then adjudication of the coverage issue should proceed, preferably without discovery on cross-motions for summary judgment of the duty of defense issue. In most coverage cases involving "advertising injury" issues, there is little need for discovery as the character of the dispute has been framed by the parties submission in letters both tendering and denying coverage. If the insurer seeks to conduct a fact investigation on coverage issues that it should have performed prior to its denial of a defense to its policyholder, its very quest for discovery on these issues evidences its bad faith for failure to properly investigate the policyholder's claims before precipitously denying it a defense. Additional criteria to bear in mind is whether the trial judge in the underlying action might not be the best choice to adjudicate coverage issues based on his/her overall knowledge of the facts in the underlying suit. Another key consideration is whether there are other pending coverage actions in that jurisdiction applying its law which might impact the availability of potential coverage in that suit. Finally, choice of forum must take into account the myriad factors based on the nature of intellectual property claims asserted. Endnote21
VI. INTELLECTUAL PROPERTY AND/OR FEE DISPUTE RESOLUTION COUNSEL MAY SERVE AS THE POLICYHOLDER'S COVERAGE COUNSEL
The first issue to consider is whether there are inherent dangers in handling both the coverage and the intellectual property dispute given the nature of those disputes. Where the ultimate goal is to vindicate the insurer's right to recover payments, independent counsel defending an intellectual property suit may become a witness in any subsequent fee dispute regarding the reasonableness of the work performed as part of the defense effort. Segregating conduct that is coverage related from defense related activity requires not only segregated billing, but the capacity to make fine distinctions between what conduct was defense related and what was coverage related in the day-to-day handling of a case.
The issue is more difficult where not only coverage but the reasonableness of fees are at issue. Only the defense related activities will be properly subject to reimbursement, battles over this line drawing process could lead to both parties incurring additional fees. Counsel who must defend their own fees and represent their own interests as counsel in a fee dispute have an inherent disadvantage.
There is also one further practical consideration, if intellectual property counsel initiates a declaratory relief action against the insurer while it is also serving as defense counsel, its ability to focus on both lawsuits at the same moment may be impacted. Some jurisdictions recognize that facts may have to be developed in the underlying suit before a duty of defense can arise. These jurisdictions have permitted a stay of a declaratory relief action after the insurer's recognition of a duty of defense to permit the policyholder to properly defend a case. Endnote22 If subsequent facts discovered therein establish that no duty to defend properly arose after these facts have been conclusively established, the insurer may bring a suit for declaratory relief and cease providing a defense to its policyholder. Endnote23
If, however, counsel is accustomed to making these distinctions and carefully segregates billing, there is no reason that the same counsel could not represent both the defendant as defense and coverage counsel. By contrast, coverage counsel for the insurer is precluded by law from also defending the policyholder's suit. This follows, because the policyholder's appointed coverage counsel would have a conflict of interest with the policyholder since it would be on the one hand seeking to investigate a basis for freeing the insurer from any defense obligation while at the same purporting to defend the suit against the policyholder. Indeed, it is this practical conflict which causes the recognition of the policyholder's right to independent counsel to be paid for at the policyholder's expense. Endnote24
VII. WHAT TO DO WHEN AN INSURER AGREES TO DEFEND BUT ITS PERFORMANCE IS "A DAY LATE AND A DOLLAR SHORT"?
A. Specific Questions to Address
The approach to this problem depends upon the nature of the dispute between the insurer and the policyholder. The following questions should be addressed:
1. Is there a dispute over the rate of reimbursement for independent counsel?
2. Is there a dispute over the staffing of the case by independent counsel?
3. Is there a dispute over reimbursement of identifiable categories of work performed by intellectual property defense counsel?
4. Is there a dispute over the allocation of
litigation expenses where some portion of the conduct relates
to the policyholder's pursuit of affirmative claims not
covered by insurance?
5. Is there a dispute over the allocation of
litigation expenses where a policyholder is also represented
by defense counsel?
B. Reasonableness as the Universal Standard
If there is a dispute over the hourly rate of reimbursement of attorneys' fees, in most jurisdictions the standard is "reasonableness." If the mechanism for dispute resolution is not addressed in the insurance policy, the remedy for resolution of this dispute is by a declaratory relief action. As a practical matter, however, many policyholders and insurers are able to more economically resolve these disputes through arbitration before an agreed arbitrator. Indeed, that specific mechanism is part of the statutory remedy of California Civil Code § 2860, however, the procedure for selecting an arbitrator is set forth therein. Other aspects of insurer/independent counsel
disputes may not lend themselves as readily to arbitration (i.e. the host of legal issues regarding the standard of care owed by independent counsel to an insurer and incurring "reasonable" fees).
The essence of the insurer-policyholder dispute over independent counsel is the insurer's desire that counsel, whose bills they pay, conduct their activities as would defense counsel they appointed. This extends to the manner in which they bill, the kinds of report formats they utilize, the frequency with which they submit billing information, the procedures for requesting authorization to conduct particular travel and discovery activities, the desire to receive routine reports and the progress of the litigation. Indeed, many insurers memorialize these requests in the form of guidelines. The tension arises because the insurer's practices are not the standard to gauge "reasonableness." Endnote25 Indeed, they may be so restrictive in character that their adoption especially in intellectual property cases are antithetical to the quest for "reasonableness." As a practical matter to the extent that the insurer's guidelines are not unreasonable, it is best to review them, agree to those that can be complied with and dispute the others. If an insurer insists, however, that such guidelines must be adhered to, that insistence would itself be evidence of the insurer's bad faith.
C. Cal. Civil Code § 2860's Impact on the
Analysis of Reasonableness
An actual written contract should be entered into between independent counsel and the insurer, governing the mechanism and criteria to be employed by the insurer in reviewing outside attorneys' fees. If the insurer will not agree to enter into a contract, then its failure for agreeing to a reasonable contract provision should be memorialized in writing. Such issues as the period of time from receipt of invoice to payment, format of billing, format of reporting to the insurer, policyholder's right for specific identification of items disputed by the insurer, and like items should be identified where the insurer retains "audit counsel." Policyholder counsel should request that the basis for "audit counsel's" investigation and review should be set forth, including the assumptions upon which "audit counsel" relies in conducting its review. Similarly, the rate offered by insurer is based on what it purports to pay other independent counsel for similar actions.
Pursuant to Civil Code § 2860, the "insurer's obligations to pay independent counsel selected by the policyholder, is limited to the rates that are actually paid by the insurer to attorneys retained by it in the ordinary course of business in defense of similar actions in the community where the claim arose or is being defended." In view of this provision, specific information regarding the insurer's retention of such appointed defense counsel should be provided to independent counsel. An insurer's failure to provide specific information to justify the rates it offers to pay to independent counsel may evidence its failure to hold its policyholder's interests equal to those of its own (i.e., breach of the covenant of good faith and fair dealing).
D. Criteria to Bear in Mind in Retaining Coverage Counsel to Resolve Disputes Over Rate or Reasonableness
In the absence of proof by the insurer that it can meet the applicable standard under Civil Code § 2860, in a manner that comports with its duty of good faith and fair dealing to its policyholder, the standard reverts to reasonableness. Endnote26 This standard applies as a matter of course in virtually every other jurisdiction in the country. In deciding whether to refer a dispute regarding any of the identified problems to distinct coverage counsel, the following factors should be kept in mind:
1. What relationship is most consistent with promotion of the client's interests in preserving coverage while also assuring full reimbursement of defense costs incurred by intellectual property counsel?
2. Does intellectual property counsel possess the expertise required to litigate the coverage disputes which may underlie the disagreement on rate or other aspects of the insurer's payment of fees?
3. If the insurer does not purport to reserve its rights in such a manner as to trigger a conflict of interest requiring it to pay the insurer's selected independent counsel, is intellectual property counsel willing to function as defense counsel and thereby save the insurer the cost of educating new panel counsel which might otherwise be selected by the policyholder?
4. Where the policyholder client does not desire to incur the expense of challenging the insurer's denial of a right to independent counsel, can intellectual property counsel functioning in the role of defense counsel properly represent the policyholder's interest at an acceptable rate of reimbursement leaving coverage counsel's ultimate pursuit of any damages arising from the insurer's inappropriate failure to recognize a right to independent counsel?
If the insurer refuses to accede to intellectual property counsel's continuation in the defense as appointed defense counsel, and the policyholder is unwilling to contest the insurer's failure to recognize its right to independent counsel, then the client's goal of controlling litigation may be accomplished by having intellectual
property counsel function as the policyholder's "monitoring counsel." It may thereby assure that the appointed defense counsel lives up to its professional obligations.
Note that counsel acting as monitoring counsel should not become counsel of record. Otherwise, the insurer will force the policyholder to discharge its defense obligations though the policyholder's chosen counsel and direct its defense counsel to minimize their involvement. Indeed, it would be monitoring counsel's goal is to assure high quality of work product and appropriate attention paid to litigation matters by appropriate defense counsel, not to control as do the insurer's monitoring counsel, the amount of time and ultimately the expenses incurred by independent counsel. The role of monitoring counsel is to act more as a coach than a player. The intellectual property attorney can use his/her knowledge of the case and expertise to communicate concerns that the client has over the way in which litigation is being handled.
Failure to accede to a request by "monitoring counsel" directed to appointed "defense counsel" may subject defense counsel to professional liability exposure. It would be in the insurer's interest to have defense counsel request independent counsel to perform the lion's share of the defense work, well knowing that it would be at the policyholder's, not the insurer's expense.
VIII. WHEN DOES THE INSURER'S RESERVATION OF RIGHTS ON COVERAGE ISSUES TRIGGER THE POLICYHOLDER'S RIGHT TO INDEPENDENT COUNSEL AT THE INSURER'S EXPENSE?
What if the insurer contends that even though its agreement to defend is subject to a reservation of rights, that particular reservation does not trigger the policyholder's right to independent counsel. As always, gauging the forum in which these issues will be litigated is critical. Several factors, however, should be evaluated by counsel for the policyholder before recommending pursuit of claims against the insurer in such an instance. They include the following:
1. In light of the scope of the reservation of rights could defense counsel appointed by the insurer direct liability in such a fashion that it could fall outside of coverage, thereby insulating the insurer but not necessarily the policyholder from further liability.
2. Is the forum one, where the particular risk that conduct will not be found to trigger a right to independent counsel, established by statute (i.e., Civil Code § 2860 -- claims for punitive damages or excess policy limits liability)?
3. Is the appointed defense counsel perceived by the policyholder, or objectively evident, to be less qualified or experienced in the nature and kind of litigation pursued against the policyholder than selected independent counsel would require?
4. While the policyholder challenged the insurer's denial of a right to independent counsel in a declaratory relief action, will the insurer be able to claim that its appointment of "passive" defense counsel discharged its duty to contribute to payment of fees?
5. Will the policyholder be entitled to recover the attorneys' fees of its independent counsel while its entitlement to establish the insurer's obligation to reimburse such counsel is adjudicated?
If the answer to all of the above questions is "yes," then prompt pursuit of a declaratory relief action is in order. If the policyholder has serious reservations about the caliber of the defense counsel to be appointed to defend the suit it has three options:
First, continue with its chosen counsel as lead counsel and run the risk that fees incurred by such counsel will not be subject to reimbursement.
Second, have its intellectual defense property counsel serve as "monitoring counsel" in the interim while allowing appointed counsel to assume their duties in the case. This would allow the policyholder to accede to the insurer's request that new counsel of its own selection be appointed, thereby eliminating any danger of a request for reimbursement from and after the date of defense counsel becoming of record.
Third, initiate a declaratory relief action to establish the insurer's entitlement to independent counsel seeking recovery of any damages caused by the insurer's appointment of counsel who failed to properly represent the policyholder's interests.
Intellectual property counsel who are uncomfortable with leaving the case to less qualified counsel can remain associated in the suit and demand to run the case as lead counsel. Their ultimate entitlement to full reimbursement, however, must depend upon a favorable result in a declaratory relief action to establish entitlement to independent counsel. As long as this situation persists, the insurer can discharge its obligation by paying "shadow defense counsel" who can effectively rely on lead counsel's activities. A refusal to participate with or acknowledge the existence of shadow defense counsel, where the insurer was entitled to appoint them could arguably breach the covenant of good faith and fair dealing owed by the policyholder to the insurer as well as the contractual duty of cooperation in defense of the lawsuit.
IX. WHAT REMEDY SHOULD BE PURSUED WHERE THE INSURER AGREES TO INDEPENDENT COUNSEL BUT CHALLENGES RATES AND/OR REASONABLENESS
Most jurisdictions limit the policyholder's right to reimbursement to reasonable fees. California Civil Code § 2860 only provides that the panel counsel rate need serve as a bench mark for rates, not other aspects of the insurer-independent counsel relationship. Although California compels arbitration of rate disputes, declaratory relief is the vehicle for settling reasonableness issues (i.e. regarding the selection of tasks by counsel as well as the appropriateness of the time increments incurred for each selected task.) As a practical matter, counsel often agrees that all issues in dispute can be arbitrated to save time and resources of both parties.
X. HOW CAN RATE DISPUTES BE RESOLVED UNDER CAL. CIVIL CODE § 2860?
Although the case law is not crystal clear, it appears that Civil Code § 2860 shifts the burden to the policyholder in establishing the reasonableness of its rates once the insurer shows that its rates meet the statutory criteria. It is a rare insurer, however, which can show that it has retained competent defense counsel to handle intellectual property matters for a sufficient period of time for such counsel to have served as independent counsel. Policyholders can and should argue under Civil Code § 2860 that "what's good for the goose is good for the gander."
If the defense counsel whose rate is offered as a bench mark by which the policyholder's independent counsel must be judged, could not itself qualify as independent counsel, that rate should not be applicable. Were the results to the contrary, the insurer could select the latest law school graduates, appoint them as "panel counsel" and retain them to defend intellectual property cases where the insurer had minimal exposure for covered damages. Having secured "panel counsel," the insurer could then contend that such new "panel counsel" set the bench mark for the rates to be charged by even the most experienced intellectual property practitioners. Such a perversion of the statutory intent behind Civil Code § 2860 should not be and has not been countenanced by arbitrators who have addressed this issue.
In Verteq v. Northbrook Ins. Co., Case No. SA CV 93-334 AHS, the court found Northbrook Insurance Company liable for bad faith arising from its failure to identify "panel counsel" in response to the specific written requests from the policyholder's coverage counsel. The arbitrator also found that Northbrook failed to demonstrate at the arbitration that competent "panel counsel" received this rate or had ever tried a case equivalent to that before the court. Northbrook could not meet the criteria to show any applicable "panel counsel" rate to use as a benchmark as against the policyholder's retained independent counsel. Endnote27 Thus, the court awarded all attorneys' fees at the full rates charged by Knobbe, Martens, Olsen & Bear in defense of the counterclaim plus interest accruing on such attorneys' fees, as well as fees and costs incurred by coverage counsel in the arbitration.
XI. BAD FAITH CLAIMS AGAINST INSURERS FOR THEIR FAILURE TO PROMPTLY REIMBURSE DEFENSE FEES OWED
Typically, the focus of most bad faith litigation is the insurer's failure to contribute to a settlement which ultimately subjects the policyholder to an excess policy limits judgment, where had the insurer accepted the proposed offer within policy limits, no excess policy limits exposure was possible. In such cases, courts have routinely found that the insurer's conduct directly caused injury to the policyholder subjecting it to liability for which the policyholder would have otherwise not been responsible. Under such circumstances, the courts have routinely awarded excess policy limits liability to the insurer in a majority of jurisdictions.
A more difficult case, however, and a scenario more of interest to intellectual property practitioners is what pressure can be brought to bear on insurers to compel them to promptly pay defense fees. In most jurisdictions, an insurer's failure to hold the policyholder's interest equal to those of its own in fulfilling contractual obligations will meet such a standard. The remedy for such "bad faith" conduct may, however, be limited to fees incurred by coverage counsel to establish such bad faith. In a particularly egregious situation where there is evidence of malice, fraud or oppression, many forums permit an award of punitive damages." Endnote28
Ultimately, independent counsel who have agreed to defend a policyholder under a reservation of rights, even absent a written contract between the insurer and policyholder, can establish either an oral contract supporting recovery, an account stated, or the entitlement to recovery on a quantum meruit basis. The attorneys' fees expended in a declaratory relief claim to establish a duty of defense will only be recoverable upon a showing of bad faith in most jurisdictions. Endnote29
Where the underlying action has been concluded and it is not envisioned that further fees will be incurred, a duty of defense can be established. If the insurer has agreed to defend, but it is difficult to tell because no monies have yet been forwarded, a bad faith claim against the insurer may be appropriate. Endnote30
In order to set the ground work for recovery of claims in a bad faith action, the following elements should be in place.
1. A forum should be selected that best facilitates recovery of bad faith damages.
2. Records of requests for reasonable reimbursement developed over a significant period of time with full access to information sufficient for the insurer to evaluate the request for reimbursement should be submitted.
3. The insurer's practices outside the context of formal discovery should be evaluated to evidence the manner in which it has treated other policyholder's counsel.
4. Other proceedings should be examined to show how the insurer's pattern and practice of wrongful conduct has come to light.
5. When suit is initiated discovery should be propounded. That discovery should require the insurer to identify:
a. Any and all basis for delay of the payment of claims to audit proceedings initiated by the insurer which may have delayed the processing of payment;
b. Why audit procedures were initiated by the insurer;
c. What delay should proceedings cause in the processing of payment;
d. How those audit procedures compare to others employed with respect to appointed defense counsel or other independent defense counsel;
e. Specific claims manuals and procedural manuals that evidence instructions from home office to insurance adjusters regarding handling of claims and the payment of defense fees for such claims;
f. The insurer's history of handling similar claims;
g. The insurer's experience with damage awards for punitive damage arising from failure to promptly pay defense fees;
Bad faith actions require a healthy supply of the three "Ps." Patience, perseverance and proof. Unlike coverage disputes over the duty of defense and even indemnity, in the case where a settlement has arose, bad faith claims require an adjudication of disputed fact issues. Sometimes, however, the insurers are so reluctant to provide pertinent information in discovery that they prefer entry of a default on their obligations to the policyholder to pay reasonable defense fees, over providing pertinent information regarding their claims practices.
In Surgin Surgical Instrumentation Co. v. Truck Insurance Exchange, O.C.S.C. Case No. 662216, a coverage case involving patent infringement claims the insurer was found to be in default for failing to comply with discovery when it refused to provide aspects of its claims files to detail the manner in which its adjusters were informed as to how to handle "advertising injury" claims of the kind at issue in the suit. An inflamed state court judge found that the conduct of Truck Insurance Exchange, all things considered, was an 11 on a scale of 1-10. The court accordingly awarded punitive damages of one hundred times the amount of the outstanding attorneys' fees for a judgment in excess of $57,000,000. Although the matter is presently on appeal, negative publicity generated by this case was instrumental in forestalling tort legislation supported by the insurer's lobbyist. Endnote31
XII. CONCLUSION
Knowing more about applicable law that compels insurers to reimburse defense costs will support policyholders intellectual property counsel in asserting rights to reimbursement of defense fees such counsel may have incurred. Endnote32
Although beyond the scope of this article, the availability of insurance coverage causes a host of challenges for intellectual property litigants which range from the need to involve insurers in settlement negotiations in the underlying suit, to taking advantage of counterclaims filed against plaintiffs to secure defense benefits. A myriad of considerations surface in litigating intellectual property matters mindful of the coverage implications of such suits. Coverage issues are important but coverage attorneys who assist intellectual property attorneys must not lose sight of the fact that the underlying action is the policyholder's primary vehicle for recovery or avoidance of exposure. Insurance coverage is a tail that should not wag the dog, however, without that tail properly in place, the dog will have difficulty navigating its way down the road.
ENDNOTES:
"©1995 David A. Gauntlett is the principal of Gauntlett & Associates in Irvine, California. He is Chair of the Intellectual Property Committee of the Tort Trial & Insurance Practice Section, as well as Chair-Elect of the Special Committee on Insurance of the Intellectual Property Section and Vice-Chair of the Insurance Coverage Committee of the Litigation Section of the American Bar Association. Mr. Gauntlett is also the author of numerous articles as well as Matthew Bender's "Intellectual Property Counseling and Litigation," Chapter 29, Vol. 2 ©1994. Business Insurance Law, Chapter 18 "Insurance Coverage For Intellectual Property Lawsuits," ©1994. Mr. Gauntlett represents policyholders in insurance coverage disputes regarding complex business litigation and intellectual property matters presently pending in 30-states and was counsel for the policyholders in the Arbek, Bradleys', Comsat, Omnitel, Kurisu, Land & Sky, Sentex, and Surgin Surgical actions.
. See Changing Winds -- Late 1994-1995 Court Rulings Favor Policyholders in a Broad Range of Intellectual Property Insurance Coverage Cases," by David A. Gauntlett of Gauntlett & Associates, Intellectual Property Committee of the Tort Trial & Insurance Practice Section of the American Bar Association, August 1995.
. The authors noted that:
Forfeiture of insurance coverage is a massive and disproportionate penalty for what may be a relatively harmless breach by the policy. Our culture and our laws frown on forfeitures. Late notice forfeiture rules are out of date and out of touch. See The Draconian Late Notice Forfeiture Rule: "Off With The Policyholder's Heads" by Bart Pesoriero, CPCU, Finley T. Harckman and David Garfield Rollin of Anderson, Kill, Olick & Oshinsky, P.C., Shepard's Insurance Litigator Reporter, 812 (1993) p. 113.
. Liability insurance contracts typically provide that "no policyholder will, except at their own cost, voluntarily make a payment, assume any obligations, or incur any expense, other than for first aid, without our consent."
. In order to escape liability, or its duty to defend because of a policyholder's unexcused delay in giving notice, a liability insurer is required to show that it was prejudiced by the policyholder's delay. Ouellette v. Maine Bonding & Casualty Co., 495 A.2d 1232, 1235 (Me. 1985).
. See Great American Ins. Co. v. Tate Constr. Co., 303 N.C. 387, 398, 279 S.E.2d 769, 776 (1981); Hamilton Mutual Ins. Co. v. Perry, 1993 WL 49798 (Ohio App. 6 Dist., 2/26/93). In contrast to an accident which gives rise to bodily injury or a tort action involving tangible property damage, there will not generally be one physical incident which needs to be reconstructed to understand the nature of the injury for which coverage arises. By contrast, intellectual property claims involve continuing torts where the character of the covered "advertising injury" offense may be a series of advertising activities that trigger a right to recovery damages against the policyholder defendant under the policy.
. Vermont Gas Systems, Inc. v. U.S.F.G., 805 F.Supp. 227, 231 (D.Vt. 1992); (Timeliness of notice was question of fact to be resolved by the fact finder, but in interim, insurer obligated to provide a defense); Upjohn Co. v. Aetna, 768 F.Supp. 1186, 1203 (W.D.Mich. 1990) (Because allegations of complaint brought claim within policy, insurer bound to defend policyholder despite late notice defense); Avondale Industries, Inc. v. Travelers Indemn. Co., 774 F.Supp. 1416, 1429 (S.D.N.Y. 1991) (Policyholder's diligence in ascertaining coverage in order to promptly notify insurer is matter to be explored at trial, therefore, insurer must pay defense costs).
. See Northern Ins.. Co. v. Allied Met. Ins.. Co., 955 F.2d 1353, 1360 (9th Cir. 1992); Scottsdale Ins. Co. v. Homestead Land Development Corp., 145 F.R.D. 523, 536, n.13 (N.D.Cal. 1992); but see Fiorito v. Superior Court, 226 Cal.App.3d 433, 277 Cal.Rptr. 27, (Cal.App. 4 Dist., 1990) (court specifically declined to "consider at this time whether the [voluntary payments] provision applies to pre-tender defense expenses.") Id. at 440, n. 4; Shell Oil Co. v. Winterthur Swiss Ins. Co., 12 Cal.App.4th 715, 716, 15 Cal.Rptr. 2d 815 (Cal.App. 1 Dist., 1993); Moe v. Transamerica Title Ins. Co., 21 Cal.App.3d 289, 302, 98 Cal.Rptr. 547 (Cal.App. 1 Dist., 1971).
. See Kawasaki Motors Co. USA v. Travelers Indemnity Co., No. BC 069594, Ordered p. 4 (L.A.Sup.Ct. Apr. 7, 1994); American Motorists Ins. Co. v. First National Ins. Co., No. BC 016453 (L.A.Sup.Ct. July 26, 1992).
. See also Stein v. Int'l Ins., 217 Cal.App.3d 609, 266 Cal.Rptr. 72 (Cal.App. 4 Dist., 1990); Paulfrey v. Blue Chip Stamps, 150 Cal.App.3d 187, 197 Cal.Rptr. 501 (Cal.App. 2 Dist., 1985)..
. See Matthew Bender, Intellectual Property Counseling and Litigation, Vol. 2, "Insurance Coverage for Intellectual Property Lawsuits," Ch. § 29.03[1] Failure to Make Insurance Claims for Defense Costs as Legal Malpractice, p. 29-22.
"Many attorneys who practice in the intellectual property arena have little experience in tendering claims to insurance carriers. Their clients will often learn of the availability of potential insurance coverage through media exposure or from their own investigation after the entry of judgment against them in the course of their pursuit of appellate remedies, often with new counsel. Such clients have brought malpractice actions against their former attorneys arising solely from the lawyer's failure to tender claims to the insurance company. Intellectual property attorneys are, therefore, well advised to refer their clients to independent counsel for investigation of the coverage issue, or to advise them to investigate potential coverage through their own resources. These recommendations should be memorialized in writing to avoid any contention that the intellectual property attorneys failed to investigate this critical issue."
. These jurisdictions include Alaska, Arizona, California, Illinois, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, Nevada, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, South Dakota, Utah, Vermont, West Virginia, and Wyoming, as well as Alaska.
. Matthew Bender, Intellectual Property Counseling Litigation, Ch. 29, Appendix "A."
. Sentry Ins. v. R. J. Weber Co. Inc., 2 F.3d 554 (5th Cir. 1993) ("Other courts that have examined this issue [whether the obligations of copyright infringement (and covered offenses) potentially state an offense committed in the course of the policyholder's advertising activities] have required the insured to demonstrate that there is some connection between its advertising activity and the plaintiff's claim [citations omitted]. In the case before us, Weber does not identify any connection between Caterpillar's claims and Weber's advertising activity.")
. Gonzales v. American States Ins. Co. of Texas, 628 S.W.2d 184, 187 (Tex.App., Corpus Christi 1982) no writ; Western Heritage Ins. Co. v. River Entertainment, 998 F.2d 311, 313 (5th Cir. 1993) (based on Texas law, the court held that "when the petition does not contain sufficient facts to enable the court to determine if coverage exists, it is proper to look to extrinsic evidence in order to adequately address the issue"); State Farm Fire & Casualty Co. v. Wade, 827 S.W.2d 448, 452 (Tex.App., Corpus Christi 1992) error denied ("When the petition in the underlying lawsuit does not allege facts sufficient for determination of whether those facts, even true, are covered by the policy, the evidence adduced at the trial in a declaratory judgment action may be considered along with the allegations in the underlying petition.")
. Federal Ins. Co. v. Microsoft Corp., 1993 U.S.Dist. LEXIS 4567 (W.D.Wash. [Seattle Div. 1/15/93]) reconsideration denied 1993 U.S.Dist. LEXIS 4568 (4/15/93) (the allegations regarding "distribution and sale of windows" was inadequate for determination as to whether the copyright infringement alleged constituted an "advertising injury"); Fitzpatrick v. American Honda Motor Co. Inc., 78 N.Y.2d 61, 68, 575 N.E.2d 90, 94, 571 N.Y.S.2d 672, 676 (1991) (although New York applies a four corners doctrine, a duty to defend was found "where the complaint on its face did not state a covered claim but the underlying facts made known to the insurer by its insured unquestionably involve a covered event.")
. The term "suit" in an insurance contract triggering a duty to defend, is susceptible to more than one meaning and should be liberally construed in favor of the policyholder. Professional Rental, Inc. v. Shelby Insurance Co., 75 Ohio App. 3d 365, 372, 599 N.E.2d 423, 427 (Ohio App., 11 Dist., 1991). C.D. Spangler Constr. Co. v. Indus. Crankshaft & Eng. Co., 326 N.C. 133, 153-154, 388 S.E.2d 557, 570 (1990) (Issuance of state compliance order directed remedial action constituted "suit" within meaning of policies.) Higgins Indus., Inc. v. Fireman's Fund Ins. Co., 730 F.Supp. 774, 776 (E.D.Mich. 1989) (Insurance company must defend all governmental claims and demands in environmental context irrespective of the form the demand takes.)
. The patent infringement liability insurance from American Specialty Lines Insurance Company provides:
Insuring Agreement:
(a) Insurance Coverage for Damages:
This policy shall reimburse the Policyholder for all sums which the policyholder shall become legally obligated to pay and shall have paid as damages resulting from any claim or claims first made against the Policyholder and reported in writing to the company during the policy period or the extended reporting period (if applicable) for any covered infringement caused by the manufacture, use, distribution, advertising, or sale of a covered product committed by the policyholder .
. . Defense expenses include:
Expenses incurred by the company in any declaratory action initiated by the company."
. See "Survey of Coverage Law of the 50 States as it Pertains to Key Coverage Issues that Typically Arise in Intellectual Property Coverage Disputes," ("50 State Survey") to be published.
. See "50 State Survey"; Canadian Ins. Co. of California v. Rusty's Island Chip Co., ____ Cal.App. 4th ___, ____ Cal.Rptr. 2d _____, 1995 WL 389844 (Cal.App. 2d Dist., 6/30/95) (". . .Canadian's failure to reserve its right to contest coverage under the policy's exclusions of coverage for willful acts or trademark infringement waive its right to assert those exclusions as a basis for denying coverage in the Federal action.")
. Compare St. Paul Fire & Marine v. Advanced Interventional Systems, Inc., 824 F.Supp. 583 (E.D.Va. 1993) aff'd on distinct grounds 30 U.S.P.Q.2d 1494 (4th Cir. 1994) (unpublished decision), with Clary Corp. v. Union Standard Ins. Co., 27 Cal.App. 4th 1410, 33 Cal.Rptr. 2d 486 (Cal.App. 4 Dist., 1994) (depublished) 94 Daily Journal D.A.R. 15060 (Dec. 22, 1994) and Owens-Brockway Glass v. International Ins. Co., 884 F.Supp. 363 (E.D.Cal. 1995).
. See "50 State Survey."
. Haskel, Inc. v. Superior Court (Aetna Cas. & Sur. Co.), 33 Cal.App. 4th 963, 39 Cal.Rptr.2d 520, 526 (Cal.App. 2 Dist., 1995)("Thus where the facts adduced in the declaratory relief action do not permit the Court to eliminate the possibility that the insurer's conduct falls within coverage of the policy, the duty to defend is then established absent additional insureds.")
. Montrose Chemical Co. v. Superior Court, 6 Cal. 4th 287, 24 Cal.Rptr. 2d 467, 475, 861 P.2d 1153,1161 (1993) (Only undisputed extrinsic facts may relieve insurer of its duty to defend.)
. Golden Eagle Insurance Co. v. Foremost Insurance Co., 20 Cal.App. 4th 1372, 25 Cal.Rptr. 2d 242 (Cal.App. 2 Dist., 1993) (When the insurer disputes liability for indemnification but continues to provide a defense for the policyholder against the claim, a potential conflict of interest arises. Assertions made to defeat the liability of the insurer under the policy may promote the claim of the third party against the policyholder.)
. Assurance Co. of America v. Haven, 32 Cal.App. 4th 78, 87-88, 38 Cal.Rptr.2d 25, 31-32 (Cal.App. 3 Dist. 1995) (Cumis counsel owed no duty to insurer to investigate, prepare, assert, establish or perform similar functions regarding defense or position in insurer's favor with respect to policyholder, who Cumis counsel was representing because of conflict of interest between the parties over issue of coverage.)
. Corrected JAMS Verteq Arbitration Award (11/1/93) ("It is the finding of the Arbitrator that the evidence fails to establish that Northbrook paid an actual rate of $125.00 to any retained counsel to defend a case similar to the Semitool case. Therefore, the fee issue presented here is governed by the rule of reasonable value in the community of services of counsel competent to handle the particular type of lawsuit at issue.") Absent a preponderance of evidence by the insurer that its proposed rate meets applicable criteria under Civil Code § 2860, the statute's provisions are inapplicable and the standard of reasonableness applies; Bogard v. Employer's Casualty Co., 164 Cal.App.3d 602, 611, 210 Cal.Rptr. 578, 586 (Cal.App. 2 Dist., 1985) (Insurer required to pay reasonable value of legal services and costs incurred by the policyholder's independent counsel); Assurance Co. of America v. Haven, 38 Cal.Rptr.2d 25, 31, 32 Cal.App. 4th 78, 87 (Cal.App. 3d Dist., 1995) ("An important corollary of the Cumis doctrine is that if the insured is entitled to Cumis counsel, the insured is entitled to control the defense of the case." (citations omitted)).
. David A. Gauntlett represented the policyholders in the Verteq dispute.
. See "50 States Survey."
. See "50 States Survey."
. Delay in payment is a particular problem in defending intellectual property actions because of the rapid pace of the litigation as well as the enormous impact the motions for preliminary injunction can have on the ultimate adjudication of the suit.
. David A. Gauntlett, presently the principal of Gauntlett & Associates, was a partner with Callahan & Gauntlett which represented Surgin Surgical and participated in key aspects of this coverage case.
. It is important to clarify with your client that insurance coverage may be available and that if it is, that coverage will serve to reimburse some portion, but perhaps not all, of the attorneys' fees incurred in defense of the intellectual property claims asserted against the policyholder. A sample provision to be included in intellectual property counsel's retainer agreement clarifies one way of structuring the policyholder/defendant - intellectual property counsel relationship:
"Part or all of our services to you may be covered under one or more of your insurance policies. If [Intellectual Property Counsel] is directed to bill any insurance company for services provided to you, this agreement shall constitute an assignment of such insurance benefits. [Intellectual Property Counsel] is authorized and empowered to endorse and negotiate any check or draft issued by any insurer in payment for defense benefits, even though it may be made jointly payable to [Intellectual Property Counsel] and Client. All amounts paid or to be paid by your insurer(s) as defense benefits shall be first applied to any outstanding [Intellectual Property Counsel's] invoices and the balance, if any, to be refunded to you at the point that all invoices and required retainer balances are current. Notwithstanding the foregoing assignment of insurance benefits, the client remains primarily responsible for payment of all sums and expenses including, without limitation any shortfall in insurance payments for any reason."