TEXAS SUPREME COURT HOLDS THAT INSURERS MAY USE STAFF ATTORNEYS TO DEFEND CLAIMS AGAINST ITS INSUREDS IF INTERESTS OF PARTIES ARE CONGRUENT

The Texas Supreme Court’s recent decision in Unauthorized Practice of Law Committee v. Am. Home Assurance Co., Inc., No. 04-0138 (Tex. March 20, 2008) addressed the issue of “whether a liability insurer that uses staff attorneys to defend claims against its insureds is representing its own interests, which is permitted, or engaging in the unauthorized practice of law, which is not.” In a 7-2 decision, the Court held that an insurer who has the right to “full and absolute” control of its insured’s defense is not engaged in the unauthorized practice of law when it utilizes in-house staff attorneys to defend its insured from claims in which the parties’ interests are aligned and no conflict of interest exists.

The case arose from an investigation by the Dallas subcommittee of the Unauthorized Practice of Law Committee (“Committee”) into legal work performed by a staff attorney for American Home Assurance Co., Katherine D. Woodruff, and her firm, Woodruff & Associates. All attorneys working at Woodruff & Associates were staff attorneys employed by American Home. As a result of the Committee’s investigation, American Home, Travelers Indemnity Co., Ms. Woodruff and the firm brought a declaratory judgment action seeking a determination that “neither the insurance companies’ employment of staff counsel nor the attorneys’ practice as staff counsel constitutes the unauthorized practice of law.”

The Court began its analysis from a point of agreement among the parties – that a corporation is not authorized to engage in the practice of law. The Court acknowledged, however, that insurance companies do not engage in the practice of law by employing in-house attorneys to represent their own interests or by hiring outside counsel to defend their insureds against claims as required by the policy language. Citing to its prior precedent in Employers Cas. Co. v. Tilley, 496 S.W.2d 552, 558 (Tex. 1973) and State Farm Mut. Auto. Ins. Co. v. Traver, 980 S.W.2d 625, 627 (Tex. 1998), the Court noted that in any such instance, “the insured’s lawyer ‘owes the insured the same type of unqualified loyalty as if he had been originally employed by the insured’ and ‘must at all time protect the interests of the insured if those interests would be compromised by the insurer’s instructions.’” Accordingly, the Court had to determine whether an insurance company that uses staff counsel to defend claims against its insured is practicing law or simply defending its own interests in discharging its contractual duty to the insured and defeating claims it otherwise would be required to indemnify.

The Court relied heavily on its prior analysis and decision in Hexter Title & Abstract Co. v. Grievance Committee, 179 S.W.2d 946 (Tex. 1944) to distill three factors to be considered when determining whether an insurer is practicing law by using staff counsel to defend claims against its insured. The first factor is whether the company’s interest being served by the rendition of legal services is existing or only prospective. In this instance, the Court determined that an insurer’s interest already exists because it has a contractual obligation under the policy to provide its insured with a defense. Second, the Court must determine whether an insurer has a direct, substantial financial interest in the matter for which it provides legal services. Unlike in Hexter, in which the title company’s interest was in trying to attract new business, the Court ruled in this case that a liability insurer has a “direct, financial, and substantial interest” in defending claims against its insured due to its interest in avoiding its indemnity obligation. Most importantly, however, is the third factor: whether the insurance company’s interest is aligned with that of the insured for whom the company is providing legal services. The Court observed that in the vast majority of cases, an insurer and its insured have similar interests in defeating a liability claim, and differences arise only when there are coverage questions or when the consequences of the manner in which the defense is rendered affect them differently. Applying these three factors, the Court in this case held that “a liability insurer does not engage in the practice of law by providing staff attorneys to defend claims against its insureds, provided that the insurer’s interests and the insured’s interests in the defense in the particular case are congruent.” The Court ruled, however, that staff attorneys must disclose their relationship with the insurer to the insured.

The Court went on to describe several instances in which a staff attorney may face a conflict of interest arising from the defense of an insured, such as when there is a tripartite relationship or when counsel obtains confidential information about its insured, but the Court ultimately concluded that similar conflicts arise when insurers hire outside counsel, and there was nothing in the record to indicate that staff attorneys would resolve these conflicts any differently than private attorneys would. However, when such conflicts exist or arise, the Court held that the insurer cannot use a staff attorney to defend the claim without engaging in the practice of law.

A full copy of the opinion and dissent can be found on the Texas Supreme Court’s website at http://www.supreme.courts.state.tx.us/historical/2008/mar/040138.pdf