State Bar of Arizona Ethics Opinions

99-08: Confidentiality; Conflict of Interest; Insurance Representation; Audits; Independent Professional Judgment
9/1999

Insurance defense lawyers ethically cannot participate in an audit review program by an insurance carrier's outside auditor where the program requires: 1) disclosure of confidential information about the client/insured (without the client's informed consent); 2) restricts the lawyer's independent professional judgment by limiting the services the lawyer may perform; and 3) grants the auditor permission to review client files. [ER 1.6(a), 1.7(b), 1.8(f), 5.4(c)]

FACTS[1]

 

The inquiring attorney is a member of an insurance defense firm.  An insurance carrier for whom the firm performs legal services employs an outside third party to conduct ongoing reviews and audits of the services rendered by the firm to the carrier's insureds.  The carrier will not employ a defense lawyer or firm unless the lawyer or firm agrees to comply with the carrier's compliance review and audit program.  The compliance review and audit program, among other things, allows the third party examiner to choose the attorney who will be representing the carrier's insured, prohibits the attorney from performing certain legal services on behalf of the insured unless the service is pre-authorized in writing by the third party examiner, restricts research and provides that routine legal research will not be compensated, provides that motions will not be compensated unless they are approved in advance and the examiner believes that the motion has a 50% or greater chance of success, limits the provision of certain services for which compensation will be allowed,  gives a right to the third party to audit the attorney's client files, and requires that certain tasks, such as conflicts checking, which normally would be performed or supervised by an attorney, be performed by staff without supervision.

 

The inquiring attorney is concerned with the ethical implications of the compliance review and audit program, especially its impact on his professional independence, its requirement that the attorney disclose to the third party auditor confidential information acquired during the representation of the insured, and the program's tendency to create conflicts of interest between the insured, the carrier, and the attorney. 

 

Question Presented

 

May a lawyer ethically enter into an agreement with an insurance carrier to provide legal services for its insureds when, as a condition for payment for the legal services, the lawyer must agree to comply with a compliance review and audit program throughout the representation, which requires the lawyer to provide the third party auditor with detailed billings, limits the attorney's ability to perform certain services, and allows the third party auditor the right to examine the attorney's client files?

 

Relevant Ethical Rules

 

ER 1.6             Confidentiality of Information

 

(a)        A lawyer shall not reveal information relating to representation of a client unless the client consents after consultation, except for disclosures that are impliedly authorized in order to carry out the representation, and except as stated in paragraphs (b), (c) and (d) or ER 3.3(a)(2).

 

ER 1.7             Conflict of Interest: General Rule

 

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(b)               A lawyer shall not represent a client if the representation of that client may be materially limited by the lawyer's responsibilities to another client or to a third person, or by the lawyer's own interests, unless:

 

(1)         the lawyer reasonably believes the representation will not be    

adversely affected; and

 

(2)         the client consents after consultation.  When representation of           

multiple clients in a single matter is undertaken, the consultation shall include explanation of the implications of the common representation and the advantages and risks involved.

  

ER 1.8             Conflict of Interest: Prohibited Transactions

 

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(f)                 A lawyer shall not accept compensation for representing a client from one other than the client unless:

 

(1)         the client consents after consultation;

 

(2)         there is no interference with the lawyer's independence of   

professional judgment or with the client-lawyer relationship; and

 

(3)         information relating to representation of a client is protected as 

required by ER 1.6.

ER 5.4             Professional Independence of a Lawyer

 

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(c)        A lawyer shall not permit a person who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer's professional judgment in rendering such legal services.

 

Opinion

 

The Committee previously stated that when an insurer engages a lawyer to defend an insured, the insured is the lawyer's client, and the lawyer does not automatically represent the insurer.  See Ariz. Op. 94-03 (1994) and the following cases cited therein, Farmer's Ins. Co. of Ariz. vs. Vagnozzi, 138 Ariz. 443, 448, 675 P.2d 703, 708 (1983) and Parsons vs. Continental Nat'l American Group, 133 Ariz. 233, 227, 550 P.2d 94, 98 (1976).  In Farmer's the court addressed the issue of whether the carrier was estopped from raising an intentional acts exclusion after having defended the insured under a reservation of rights.  The court held estoppel did not apply but emphasized that an attorney represents the insured and owes him an undeviating allegiance and cannot act as an agent of the carrier by supplying information detrimental to the insured.  The Parson's court, in a case decided prior to the adoption of the present Rules of Professional Conduct ("ERs"), also focused on the attorney's ethical duty of undeviating allegiance to the insured/client and held, under the facts of that case, estoppel did apply to prevent the carrier from denying liability because the carrier's denial was based upon confidential information obtained from the attorney hired to represent the insured.  This duty of undeviating allegiance to the client manifests itself in the Rules of Professional Responsibility in a number of the ethical rules, not the least of which is the general conflicts rule, ER 1.7.  The comment to the Rule begins, "Loyalty is an essential element in the lawyer's relationship to a client" and the Rule itself states,

 

A lawyer shall not represent a client if the representation of that client may be materially limited by the lawyer's responsibilities to another client or to a third person, or by the lawyer's own interests, unless: (1) the lawyer reasonably believes the representation will not be adversely affected; and (2) the client consents after consultation.

 

At least two things follow from defense counsel's duty of undeviating allegiance to the insured/client, namely, the attorney must preserve the insured/client's confidences and the attorney must not allow any interference with the exercise of his independent professional judgment on behalf of the client or with the client-lawyer relationship, regardless of who is paying for the lawyer's services.  ER 1.8(f)(3) and (2).  Furthermore, the lawyer cannot ethically allow the carrier, rather than the client, to direct or regulate the lawyer's professional judgment in rendering such legal services.  See ER 5.4(c).  Thus, whether or not the attorney may ethically participate in the audit program depends upon whether the audit program: 1) requires the attorney to impermissibly reveal the insured/client's confidences; 2) interferes with the attorney's exercise of his independent professional judgment on behalf of the client or interferes with the client-lawyer relationship; or 3) allows a third party to direct or regulate the lawyer's professional judgment in rendering legal services for his client.

 

Numerous other states have addressed various aspects of this factual situation, primarily focusing their concerns on the release of confidential information to the outside audit service without the prior consent of the client.  For instance, Utah State Bar Ethics Advisory Opinion 93-03, issued April 17, 1998, held that a lawyer may submit billing statements to an outside audit service, but prior to doing so, the lawyer must have the client's consent.  The Opinion further required a lawyer, who was relying on an insurance agreement for such consent, to review the agreement with the client and renew the client's consent before sending any billings to the outside audit service.  Florida Bar Opinion 20591, issued December 31, 1997, held that an attorney cannot allow an insurance carrier to audit and review case files of clients who were insured by the carrier without first obtaining permission from the clients.  The Florida Opinion declined to address the issue of whether the permission granted within the insurance contract was sufficient client consent.  Also expressing concern for client confidentiality, South Carolina's Ethics Advisory Opinion 97-22, determined that while an attorney could submit the insured's bills directly to the audit company, after obtaining fully informed consent by both the insurance company and the insured, the attorney could not submit other client's bills to the audit company without violating the South Carolina Rules of Professional Conduct against the disclosure of client confidences.

 

With only limited exceptions, the Arizona Rules of Professional Conduct prohibit a lawyer from revealing information relating to representation of a client unless the client consents after consultation. ER 1.6(a).  In the instant case, the only possible applicable exception is that the disclosures are impliedly authorized in order to carry out the representation.  See ER 1.6(a).  By requiring the attorney to allow the auditor to audit the attorney's client files, the audit program in question requires the lawyer to reveal information to the outside auditor, which information related to the representation of the insured.  In fact, without the release of such information, it is difficult to see how the audit examiner could perform a meaningful service for the insurance carrier.  Notwithstanding, because such information relates to the representation, it is unethical for the attorney to release the information to the outside auditor unless the client, after consultation, consents to such release or such disclosure is impliedly authorized in order to carry out the representation.  See ER 1.6(a).

 

For a consent to comply with that required by ER 1.6(a), the consent must be given after consultation.  Since no consultation occurred upon the purchase of the insurance, a consent contained as part of the agreement with the insured during the underwriting process will not suffice as the consent required by ER 1.6(a).  Only a consent obtained by the attorney after full consultation with the client as to the risks of such disclosure will suffice.  See Utah State Bar Ethics Advisory Op. 98-03 (April 17, 1998).  It is not clear from the facts stated whether the attorney and the carrier are relying on a consent given by the insured during the underwriting process.  If so, their reliance is misguided.

 

Are the required disclosures impliedly authorized in order to carry out the representation?  Neither ER 1.6 nor the comment thereto offers any definitive assistance in answering this question.  The kinds of disclosures addressed in the text are those either necessary to advance the client's position or of facts which cannot properly be disputed.  Neither of those kinds of disclosure are involved in the disclosure which would occur in the course of an audit of the attorney's client files.  Furthermore, since the audit is likely to occur after the representation has ended, it is difficult to conceive how such disclosures are necessary to carry out the representation.  Thus, the disclosures occurring during the audit are not the type impliedly authorized to carry out the representation.  It is, therefore, unethical for the defense counsel to participate in the audit program because it requires the attorney to make impermissible disclosures of information relating to the representation of the client in violation of ER 1.6(a).

 

While arguably the disclosure that occurs when a defense counsel submits bills to the carrier for services rendered for the insured, detailing the types of services rendered and the amount of time spent, is impliedly authorized, the attorney should exercise caution in making such disclosures, making every effort practicable to avoid unnecessary disclosure of information relating to the representation, erring in favor of preserving the client's confidences and disclosing nothing which could prove detrimental to the client.  See comment to ER 1.6.  While, implied authorization requires neither the actual consent of the client nor consultation, such authorization, when it exists, flows from the expectation of the client that certain matters may be necessary to be disclosed to further the purpose of the representation.  Implied authorization is independent of the insurance contract.

 

Next, due to the fact that the carrier is paying for the representation, the question must be asked, Does the audit review program interfere with the attorney's exercise of his independent professional judgment on behalf of the client or interfere with the client-lawyer relationship? At least one other jurisdiction considered this point when analyzing the ethical propriety of attorneys participating in similar programs, and concluded that they do so interfere.  See Washington State Bar Association Professional Liability Counsel Inquiry 1758, proposed formal opinion (September 16, 1998).  However, each program's provisions must be analyzed separately.

 

In the instant case, the audit program interferes with the lawyer's independent professional judgment by: 1) allowing the audit examiner and not the attorney the right to choose which motions will be filed based upon the audit examiner's belief as to the motion's chance of success;

2) allowing the audit examiner the right to withhold authorization of those services for which the attorney must seek pre-authorization before he performs them if he is going to be paid; 3) restricting the amount of research that will be compensated; and 4) directing that certain tasks be undertaken without the supervision of an attorney.  Furthermore, the audit review program interferes with the client-lawyer relationship by allowing the audit examiner to choose which attorney will be assigned to represent the client.  Thus, it would be a violation of ER 1.8(f) and ethically improper for an attorney to participate in an audit program having the above-referenced provisions because each provision impermissibly interferes either with the attorney's exercise of independent professional judgment or with the attorney-client relationship.

 

One of the greatest difficulties with the audit program is its inherent tendency to create conflicts of interest between the third party auditor, the attorney's self-interest, and that of the client.  When presented with the program by an insurance carrier, most attorneys will understand that unless they participate in the program they will not be representing the carrier's insureds.  Yet, a lawyer shall not represent a client if the representation of that client may be materially limited by the lawyer's responsibilities to a third person, or by the lawyer's own interests, unless the lawyer reasonably believes the representation will not be adversely affected and the client consents after consultation. See ER 1.7(b) and ER 1.8(f).  Since the lawyer is entering into the agreement in order to further his own economic interest and, as previously discussed, the agreement materially limits the lawyer's representation of his client, entering into the agreement would be a violation of ER 1.7(b) unless the lawyer reasonably believes the representation will not be adversely affected and the client consents after consultation.  As previously stated, the consent required by the Rules must occur after consultation with the attorney.  Notwithstanding such consultation and consent, the attorney would still have to form a reasonable belief that the representation would not be adversely affected either by his self-interest, or by the interest of the third party auditor and its principal, the carrier.  Since this audit program allows the third party auditor to limit the services for which the attorney will be paid, it is hard to conceive of how an attorney could reasonably believe such limitations would not adversely affect his representation of the client.

 

Is the attorney's involvement in the audit review program ethically improper in light of ER 5.4(c), which prohibits a lawyer from allowing the third party paying for his services for another to direct or regulate the lawyer's professional judgment in rendering such legal services?  While this may appear to be duplicative of the discussion of the applicability of ER 1.8(f), it would appear that the lawyer's independent professional judgment and the attorney-client relationship could be interfered with by the third party directing or regulating the lawyer's services.  Thus, a violation of ER 1.8(f) could occur without also being a violation of ER 5.4(c), but a violation of ER 5.4(c) will always be a violation of ER 1.8(f).  In the instant case, any of the provisions of the audit review program that allow the third party examiner to direct the lawyer's professional judgment, such as those provisions addressed in the discussion of the application of ER 1.8(f), also give rise to ethical problems under ER 5.4(c) for attorney's participating in the audit program.  But more importantly, there can be no doubt that the aggregate effect and purpose of this particular program is to regulate the lawyer in the provision of legal services for the insured in an effort to reduce the defense costs sustained by the carrier.  While there is nothing wrong with the carrier attempting to reduce defense costs, the attorney cannot ethically participate in such an effort if it involves the use of procedures that allow a third party to regulate or direct the lawyer's independent professional judgment on behalf of his client, as is the case with this audit review program. 

 

Conclusion

 

Although the factual situation raises additional concerns under a number of ethical rules, this Opinion can only discuss the major areas of concern with the insurance defense audit review program proposed.  Therefore, in summary, while an attorney may ethically enter into an agreement with an insurance carrier to provide legal services for the carrier's insureds and be paid for those services by the carrier in accordance with requirements set forth in ER 1.8(f), the lawyer cannot ethically allow the carrier, or the lawyer's self-interest, to adversely affect his representation of his client.  Participation in an audit program having limitations similar to those set forth in the Facts section of this Opinion, would be a violation of the Ethical Rules discussed herein.



[1] Formal Opinions of the Committee on the Rules of Professional Conduct are advisory in nature only and are not binding in any disciplinary or other legal proceedings.  © State Bar of Arizona 1999