Claims of bad faith present unique challenges for insurers (and their counsel) with respect to attorney-client privilege: if the insurer’s state of mind is at issue, is the legal advice on which the insurer relied also at issue, thereby waiving the privilege? And if so, under what circumstances? The following addresses this issue in the context of a common practice for insurance counsel—authoring denial letters—and two recent holdings that should serve as warnings in this practice.

I.  Waiving Attorney-Client Privilege: Legal Advice vs. Insurer’s Coverage Decision

In cases involving claims of bad faith, courts are relatively clear that an insurer waives its attorney-client privilege when it expressly invokes the “advice of counsel” defense, which generally provides that “when an insurer’s actions are in conformity with advice given to it by counsel, the insurer’s actions are taken in good faith, and thus the essential element that an aggrieved insured must demonstrate in establishing insurer bad faith is nullified.”^[1] However, courts are less united on whether a waiver occurs when the insurer receives advice from its attorney when making its coverage decision, but does not expressly assert the “advice of counsel” defense.

Most courts reject claims of waiver under these circumstances, recognizing the difference between (a) the attorney’s advice on the law and (b) the insurer’s ultimate decision to provide coverage or not. The latter is relevant to a claim of bad faith, but the former is not.^[2] By contrast, some courts have held that under certain circumstances, the insurer waives its attorney-client privilege by relying on legal advice—even without actually invoking the “advice of counsel” defense. The Supreme Court of Arizona summarized the underlying rationale as follows:  

When a litigant seeks to establish its mental state by asserting that it acted after investigating the law and reaching a well-founded belief that the law permitted the action it took, then the extent of its investigation and the basis for its subjective evaluation are called into question. Thus, the advice received from counsel as part of its investigation and evaluation is not only relevant but, on an issue such as this, inextricably intertwined with the court’s truth-seeking functions.^[3]

II.  Insurance Counsel Authoring Denial Letters

This attorney-client privilege issue has recently spread to a new battleground, and one which is common practice for insurance counsel: authoring denial letters. To address waiver under these circumstances, some courts have continued the majority rationale by reinforcing the distinction between the attorney’s legal advice and the insurer’s ultimate decision whether to grant coverage.^[4] However, two recent decisions should serve as warnings to insurers and their attorneys moving forward.

The first is Canyon Estates Condo. Ass’n v. Atain Specialty Ins. Co., in which the Western District of Washington held that the insurer’s outside counsel did not perform “a privileged task” when it authored and sent denial letters directly to the insured.^[5] The court explained that Washington law enforces a presumption that “there is no attorney-client privilege relevant between the insured and the insurer in the claims adjusting process,” which the insurer may overcome “by showing its attorney was not engaged in the quasi-fiduciary tasks of investigating and evaluating or processing the claim, but instead in providing the insurer with counsel as to its own potential liability,” such as “whether or not coverage exists under the law.”^[6]

Concluding that the insurer had not overcome this presumption with respect to the denial letters, the court explained that the attorney “clearly—and arguably, knowingly—engaged in at least some quasi-fiduciary activities, including the authoring of draft letters signed by [the insurer] and sent to [the insured] related to coverage and claims processing.”^[7] Although drafting the denial letter surely involved legal questions regarding coverage, the court reasoned that “where the insurer’s attorney is involved in both quasi-fiduciary and coverage or liability capacities,” waiving privilege is likely to occur because “counsel’s legal analysis and recommendations to the insurer regarding liability generally or coverage in particular will very likely implicate the work performed and information obtained in his or her quasi-fiduciary capacity.”^[8] Importantly, although Canyon Estates did involve claims of bad faith, the court’s reasoning offers no indication that the presence of such claims was essential to its decision. Indeed, the district court did not mention “bad faith” at all, which suggests that insurers and their attorneys could face privilege challenges even when the insured does not assert claims of bad faith.      

The second warning is Travelers Prop. Cas. Co. of Am. v. 100 Renaissance, LLC, in which the Supreme Court of Mississippi held that an insurer waived its attorney-client privilege when its in-house counsel ghostwrote denial letters, which were then sent from the adjuster to the insured.^[9] Initially, the insurer had denied the insured’s claim because it did not involve a covered “auto” under the policy.^[10] The insured’s attorney then sent a lengthy legal analysis to the insurer’s adjuster, arguing that a particular Mississippi statute mandated coverage.^[11] The adjuster was not an attorney, and therefore sought advice from the insurer’s in-house counsel, who then penned a letter (in the adjuster’s name) that reaffirmed why—under the policy and Mississippi statutes—coverage was not required.^[12] Ultimately, the insured asserted claims against the insurer for bad faith, and sought a deposition of the insurer’s in-house counsel, along with emails between counsel and the adjuster.^[13]

The Supreme Court of Mississippi concluded that the insurer waived its attorney-client privilege, explaining that “if the claims handler relied substantially, if not wholly, on in-house counsel to prepare her denial letter, the reasoning of in-house counsel should be discoverable.”^[14] The court reasoned that although the insurer sent the letter “in an effort to explain its arguable and legitimate basis to deny the claim,” the adjuster’s testimony made clear that she did not actually understand the legal basis for the denial, and therefore the letter merely represented the attorney’s reasons for denying the claim—not the insurer’s.^[15] According to the court, this meant that the attorney did more than just “act as legal counsel and give advice to [the adjuster] to include in the denial letter.”^[16] Citing with approval the Supreme Court of Arizona’s decision in Lee, the court explained: 

[A] litigant cannot with one hand wield the sword—asserting as a defense that, as the law requires, it made a reasonable investigation into the state of the law and in good faith drew conclusions from that investigation—and with the other hand raise the shield—using the privilege to keep the jury from finding out what its employees actually did, learned in, and gained from that investigation.^[17]

Like in Lee, the heart of this decision is the rejection of any distinction between (a) the attorney’s advice on the law and (b) the insurer’s ultimate decision to provide coverage or not. Yet, whether the insurer can articulate that advice as well as its attorney should be immaterial to whether the coverage decision itself had sound legal basis—an issue which the dissent in 100 Renaissance underscored.^[18] Without this distinction, privilege would seemingly be at risk in every case involving claims of bad faith (and perhaps even those without such claims) where legal analysis is at least a partial basis for the denial. And given the vast array of statutory, common law, and interpretive issues that inform each decision, this will be a frequent occurrence.

This leaves an insurer (and the adjuster in particular) with two choices: (a) try to interpret the law itself without help from legal counsel, or (b) ask the insurer’s attorney for legal advice, in which case their communications will be subject to discovery unless the insurer can sufficiently re-articulate the legal analysis. Thus, in either case, the insurer must be able to explain often-complex legal issues. The dissent in 100 Renaissance described this exact dilemma: “The majority thus appears to impose a requirement that in order to preserve the privilege, a claims handler must be able to explain legal arguments at her deposition—the same legal issues for which she sought advice in the first place.”^[19] Not only that, these are also the same legal issues that the insured had to have its attorney explain, with which the insurer’s counsel then disagreed. As a result, not only must the insurer be able to articulate legal analyses, it must do so for issues on which legal professionals diverge. Indeed, both the majority and dissent in 100 Renaissance actually appear to acknowledge this, yet arrive at starkly different conclusions.^[20]

^[1] James M. Fischer, Should Advice of Counsel Constitute a Defense for Insurer Bad Faith, 72 Tex. L. Rev. 1447, 1461–62 (1994)

^[2] See Aetna Casualty & Sur. Co. v. Superior Court, 153 Cal. App. 3d 467, 475 (Cal. Ct. App. 1984) (insurer did not waive privilege because it did not invoke “advice of counsel” defense, but instead “claim[ed] it acted as it did not because it was advised to do so, but because the advice was, in its view, correct; and it is prepared to defend itself on the basis of that asserted correctness rather than the mere fact of the advice. Such a defense does not waive the attorney-client privilege”); Botkin v. Donegal Mut. Ins. Co., 2011 U.S. Dist. LEXIS 63871, *19 (W.D. Va. 2011) (“There would be little point in retaining coverage counsel to issue an opinion if a party did not intend to rely on it. Likewise, if reliance always gave rise to waiver in this circumstance, no one would seek coverage counsel’s advice.”); Palmer by Diacon v. Farmers Ins. Exch., 261 Mont. 91, 110 (Mont. 1993) (“The attorney-client privilege applies unless the insurer directly relies on advice of counsel as a defense to the bad faith charge.”) (emphasis in original) (citations omitted)

^[3] State Farm Mut. Auto. Ins. Co. v. Lee, 199 Ariz. 52, 60 (Ariz. 2000); see Tackett v. State Farm Fire & Casualty Ins. Co., 653 A.2d 254, 260 (Del. 1995) (when “an insurer makes factual representations which implicitly rely upon legal advice as justification for non-payment of claims, the insurer cannot shield itself from disclosure of the complete advice of counsel relevant to the handling of the claim”); but see Bertelsen v. Allstate Ins. Co., 796 N.W.2d 685, 703 (S.D. 2011) (finding that the Supreme Court of Arizona’s decision in Lee went “too far.”).

^[4] See Liberty Corp. Capital Ltd. v. Palmetto Bluff Shooting Club, LLC, 2020 U.S. Dist. LEXIS 220654, *11 (D. S.C. 2020) (drafting denial letter does not waive privilege because “[b]ased on counsel’s advice, the client will always have subjective evaluations of its claims and defenses,” and therefore “insurer must take one step further and assert that its denial of the claim is objectively reasonable because it relied on the advice of counsel”) (citations omitted); Barnard Pipeline, Inc. v. Travelers Prop. Cas. Co. of Am., 2014 U.S. Dist. LEXIS 53778, *9 (D. Mont. 2014) (insurer’s attorney drafted denial letter, but “insurer has not asserted the defense of advice of counsel, and therefore has not waived the attorney-client privilege, simply because the insurer’s representative admits in response to a question on cross-examination that he/she listened to advice of counsel in deciding to deny an insured’s claim.”).

^[5] 2020 U.S. Dist. LEXIS 10915, *4 (W.D. Wash. 2020).

^[6] Id. at *2–3 (citations omitted).

^[7] Id. at *4.

^[8] Id. at *3–4 (citations omitted).

^[9] 2020 Miss. LEXIS 409, *16–17 (Miss. 2020).

^[10] Id. at *2

^[11] Id

^[12] Id. at *4–5

^[13] Id. at *13–14.

^[14] Id. at *22 (emphasis in original).

^[15] See id. at *12 (“I don’t know. I’m not an attorney. I don’t know anything about statutes. That’s what we have General Counsel for. I deal with policy language, what’s in the policy.”).

^[16] Id. at *18.

^[17] Id. at *21.

^[18] Id. at *27 (regardless of whether it can articulate legal analysis, “Travelers has already given its reasons for denying the claim. And the relevant question is whether Travelers had an ‘arguable or legitimate basis for denying the claim.’”) (citations omitted).

^[19] Id. at *25.

^[20] See id. at *16–17 (Majority explaining that adjuster’s “testimony also demonstrated a lack of knowledge of Mississippi UM law. She could not explain the origin or intended purpose of her citation of a nonexistent Mississippi statute in the denial letter.”).