Liability of Insurers for Defense Counsel Malpractice

Proposed section 12 of the American Law Institute’s (“ALI”) Restatement of the Law of Liability Insurance sets forth two alternative conditions under which a liability “insurer exercising the right to defend a claim is subject to liability for a breach of professional obligation by defense counsel and related service providers in relation to the claim.” The first condition is that the “[d]efense counsel is an employee of the [liability] insurer acting within the scope of employment.” The second condition is that “[t]he insurer negligently selects or supervises defense counsel, including by retaining a lawyer who carries inadequate liability insurance.” In a previous draft of the Restatement, the Reporters endorsed vicarious liability of liability insurers for all defense counsel malpractice. In part based on an earlier draft of this Article, the current Restatement draft opts instead for vicarious liability only for “inside” defense counsel, and a direct liability standard with respect to “outside” defense counsel. The question of the appropriate standard of liability for liability insurers with respect to defense counsel malpractice is an important one, which has split the courts in different jurisdictions, but which has not received sufficient academic attention. I support the current Restatement approach, and in this Article I will discuss the reasons I think the Reporters were correct to switch from a vicarious liability rule in all cases to a direct liability rule for non-employee defense counsel. By endorsing a negligence standard for outside defense counsel that expressly incorporates an assessment of the adequacy of defense counsel’s malpractice insurance, the Restatement preserves the primary benefit of a vicarious liability rule while avoiding its costs. Nevertheless, the Restatement approach raises a number of interpretive and practical issues that will need to be resolved by the courts.

I begin this Article with a discussion of the law of vicarious liability and its application to lawyers. I then examine Restatement section 12 and the cases on vicarious liability of insurers for defense counsel misconduct in light of this background law. Next, I turn to the law of direct liability and the discussion of this law in cases on insurer liability for lawyer misconduct. I then consider modern economic rationales for vicarious liability and apply these rationales to the context of insurer liability. Finally, I raise some questions about the limits of the scope of liability under section 12 if it is adopted by the ALI and subsequently by courts.