Conflict-Of-Interest – Independent Counsel:  Minnesota Federal Court Rejects Insurer’s Claim That Reservation-of-Rights Did Not Require Insurer To Pay Policyholder’s Counsel.

A Minnesota federal court, applying Minnesota law, held that Arrowood Indemnity Company’s (“Arrowood”) reservation of rights, while accepting defense of an class action on behalf of Select Comfort Corporation (“Select Comfort”), created a conflict of interest that converted its duty to defend into a duty to reimburse Select Comfort for reasonable defense costs.

A putative class-action lawsuit was filed against Select Comfort, alleging that beds Select Comfort had sold had a propensity to develop and incubate mold, leading to adverse health consequences for users, and Select Comfort failed to take remedial measures.

Select Comfort tendered the defense of the case to one of its insurers, Arrowood.   Arrowood agreed to defend Select Comfort, subject to both specific and general reservation of rights.  In relevant part, Arrowood reserved the right to deny coverage for “occurrences” not covered by the Arrowood policy.  Select Comfort objected, claiming that Arrowood’s reservation of rights created a conflict of interest that required Arrowood to reimburse Select Comfort for independent counsel (i.e. Cumis counsel), because the class-action contained allegations of intentional conduct that would not constitute an “occurrence” under the Arrowood policy.  Arrowood maintained its position on the conflict of interest dispute, but agreed to reimburse Select Comfort.

Ultimately, however, Arrowood refused to pay for approximately half of the costs incurred by Select Comfort, resulting in Select Comfort suing Arrowood.  The parties filed cross-motions for summary judgment on the issue of whether Arrowood’s reservation of rights letters created a conflict of interest.  The court found that they did:  “Arrowood reserved its right to challenge coverage on the issue of intentionality of Select Comfort’s conduct…[and] such a reservation creates a qualifying conflict of interest.”

Arrowood argued the potential for abuse of allowing separate counsel when a conflict of interest arises from a reservation of rights, such as policyholder’s chosen counsel charging more than panel counsel regularly retained by the insurer.  The court rejected this argument, finding insurers can protect themselves from this outcome through contract.  Select Comfort Corp. v. Arrowood Indemn. Co., No. 13-2975 (D. Minn. August 26, 2014).