Arizona Court of Appeals Finds No Implied Waiver of Insurer’s Attorney Client Privilege by Defending a Bad Faith Case Based on Subjective Good Faith Defense

A recent Arizona Court of Appeals decision, Everest Indemnity Insurance Company v. the Hon. John Rea, Judge of Sup. Ct of State of Az., 2015 WL 195450, addresses the attorney-client privilege in a bad faith case.  Everest examines a highly fact sensitive and jurisdictionally specific issue of when an “implied waiver” of the attorney-client privilege occurs, even though the insurer has not asserted advice of counsel as a defense to a bad faith claim.  The Court held that as long as the insurer had not put the legal advice that it received at issue in the pending litigation, an insurer defending against a bad faith case based on its subjective good faith, did not waive the attorney client privilege.  It further held that waiver did not occur even though Everest’s personnel had consulted with counsel during the claim settlement process and even though counsel was involved in the settlement negotiations.

At issue in the underlying case was plaintiff sub-contractor’s allegation that Everest acted in bad faith by entering into a settlement agreement that exhausted the liability coverage of an Owner Controlled Insurance Program (OCIP) to the detriment of the subcontractor.  Plaintiff argued that Everest waived the attorney-client privilege by asserting “subjective good faith” as a defense to the bad faith claim and asserted that Everest is required to produce documents containing otherwise privileged communications between Everest and its counsel.  Everest acknowledged that it did communicate with counsel during the process of deciding to settle, however, it contended that its decision to settle was made in good faith based on Everest’s own subjective beliefs concerning the relative merits of the available courses of action.   The trial court ordered production of the documents, but the Arizona Court of Appeals, Division 1, accepted review of the order via special action and vacated the portion of the trial court’s order pertaining to the implied waiver of the attorney-client privilege by Everest.

The attorney client privilege will typically be waived when an insurer in defending a bad faith case alleges that it acted reasonably in relying on the advice of counsel.  In doing so, the insurer puts at issue the advice which it received from counsel.  In this case, the Arizona Court of Appeals noted that the assertion of a subjective good faith defense and the consultation with counsel, without more, did not waive the attorney-client privilege.  Under the facts in Everest, the question was decided in favor of the insurer – upholding the privilege.

Everest tested the limits of the earlier Arizona Supreme Court decision in State Farm Mut. Auto, Ins. Co v. Lee, 199 Ariz. 52 (2000) and followed the reasoning, but distinguished the facts of State Farm.    Other Arizona intermediate court decisions on the same subject, but with different facts than Everest, have found an implied waiver of the attorney client privilege. See Mendoza v. McDonalds Corp., 222 Ariz. 139 (2009).

Under Arizona law, an insurer may defend a bad faith claim based on objective reasonableness of its position and/or subjective reasonableness of its position.   It is only with respect to a defense based on subjective reasonableness that the question of implied waiver of the attorney client privilege may arise. Additionally, Arizona utilizes a “fairness” test adopted from the case of Hearn v. Rhay, 69 F.R.D. 574, 581(E.D.Wash 1975) (a prisoner’s rights case) in assessing implied waiver.  State Farm, supra at 1173.    The Hearn test sets forth three criteria that must be met to find an implied waiver of the attorney-client privilege:

(1) assertion of the privilege was a result of some affirmative act, such as filing suit [or raising an affirmative defense], by the asserting party; (2) through this affirmative act, the asserting party put the protected information at issue by making it relevant to the case; and (3) application of the privilege would have denied the opposing party access to information vital to his defense.

The issue of implied waiver may not arise in other jurisdictions where only an “express waiver” of the attorney client privilege will put communications with counsel at issue.  Id. at 1176.

In the State Farm decision, the Arizona Supreme Court explained that to waive a privilege, a party must do more than simply confer with counsel and take a position incorporating counsel’s advice.  While such information may always be relevant to the claim process, waiver does not occur simply based on such consultation.   On the other hand, waiver is implied when, after receiving advice from an attorney, a party makes an affirmative assertion that it was acting in good faith because it relied on counsel’s advice to inform its own evaluation and interpretation of the law.  Id. at 66.   Relying on a “fairness” analysis, in State Farm,  the Arizona Supreme Court held that the attorney-client privilege may be deemed waived when application of  the privilege would deny an opposing party access to necessary information to counter a claim or defense asserted by the other party.  Id. at 1179.  Under State Farm, the privilege is impliedly waived only when the litigant asserts a claim or defense that is dependent upon the advice or consultation of counsel.

The coverage issue in State Farm turned on State Farm’s interpretation of recently decided case law.  The court concluded that State Farm waived the attorney-client privilege because its defense was based on its “investigation and evaluation “of the law which was inextricably intertwined with the advice that it received from counsel.  Importantly, in State Farm, the witnesses for the insurer could not point to any independent work or analysis they received other than what they received from their in-house attorney.

Applying the State Farm criteria, and distinguishing the facts of the Everest case, the Court of Appeals held that Everest’s defense fell short of the State Farm’s requirements.  In contrast to the facts in State Farm, there was nothing to suggest that Everest’s subjective belief in the legality of its actions necessarily included or depended on the advice it received from counsel.   Furthermore, the fact that Everest’s counsel participated in settlement negotiations was not determinative.

Courts in other cases which have recently declined to uphold the attorney-client privilege in connection with claim files have done so for several different reasons, including those based on public policy grounds.   The Everest decision rejected the argument that merely because communications with counsel would be relevant to the bad faith case that the privilege had been waived.  Nevertheless, as noted in Everest, under Arizona law, when an insurer puts at issue the advice which it received from its counsel, either expressly or impliedly, then the privilege could cease to exist.

Care should be taken by the insurer and its counsel during the claim process to assess whether or not the attorney’s role is likely to become “at issue” in the event of a later bad faith case, either by the company’s choice or based on the lack of  well-defined decision making by the adjusters, independent of the legal advice they received.