Tuesday, July 03, 2012

On Friday, the Fifth Circuit handed down its opinion in Downhole Navigator, L.L.C. v. Nautilus Insurance Company, affirming the district court’s ruling that the insured did not have a right to independent counsel.  Analyzing the conflict issue under Davalos, the court concluded that the facts to be adjudicated in the underlying case were not the same facts on which coverage turned as required to preempt the insurer’s right to control the defense.

The insured, Downhole Navigator, provides services to the oil drilling industry.  In 2008, an oil well operator hired Downhole to redirect a well toward a better location within a particular reservoir.  Downhole developed a plan to conduct the deviation and participated in the deviation process, during which the well was damaged.  In 2009, the oil well operator sued Downhole for negligence in Texas state court.

Downhole provided notice of the claim to Nautilus Insurance Company, its commercial general liability (CGL) insurer.  The insurer tendered a qualified defense subject to a reservation of the right to deny coverage based on several policy exclusions, including:  (1) the “expected or intended injury” exclusion; (2) the “property damage” exclusion, which excluded certain “physical injury to tangible property;” and (3) the “testing or consulting” exclusion, which excluded damages arising from an error, omission, defect, or deficiency in any test performed or in any evaluation, consultation or advice given.  The policy also contained a “professional liability” exclusion, excluding damages arising from “the rendering of or failure to render any professional services,” including the preparation or approval of opinions, reports, surveys, drawings, specifications and the like.  Finally, the policy’s “data processing” exclusion excluded damages arising from the rendition of or failure to render electronic data processing services.

Downhole declared a conflict of interest based on the reservation of rights, rejected the qualified defense, and engaged its own independent counsel.  When Nautilus insisted that Downhole had no right to independent counsel “unless or until” a coverage issue developed, Downhole filed suit seeking a declaration that Nautilus had a duty to defend, cover the cost of independent counsel, and indemnify it in the underlying lawsuit.

The issue in the underlying case was whether Downhole negligently performed its work for the oil well operator.  The coverage dispute, on the other hand, turned on the exclusion for testing or consulting services, the expected or intended injury exclusion, the property damage exclusion, and the professional liability exclusion.  The Fifth Circuit concluded that these exclusions raised issues that would never be addressed in the underlying case.

[T]he underlying fact-finder will not decide whether Downhole’s work constituted “testing” or “consulting.” Likewise, while several other issues—whether Downhole provided “professional” or “data processing” services to Sedona, whether Downhole should have expected the damage to the well resulting from its work, or whether Downhole was occupying the property while providing its deviation-correction services—could be critical coverage issues, they are irrelevant to whether Downhole acted negligently.

Because the issues in the coverage dispute were not the issues to be determined in the underlying case, the court ruled that the insured did not have a right to independent counsel.  The court rejected the insured’s argument that facts could be developed in the underlying litigation—in violation of defense counsel’s duty of loyalty to the insured—that could be used to exclude coverage.  The court noted, however, that the insurer would breach its duty to defend if it directed defense counsel to advance the insurer’s interest at the expense of the insured:

Although the prospect that the attorney provided by Nautilus could develop facts harmful to Downhole’s pursuit of coverage does not itself raise an actual conflict, if the attorney (at Nautilus’s direction) improperly advanced Nautilus’s interests at the expense of Downhole’s interests, Nautilus would breach its duty to defend Downhole; such breach would free Downhole to reject the counsel provided by Nautilus and entitle Downhole to reimbursement for the cost of its own independent counsel. See 1 Allan D. Windt, Insurance Claims and Disputes § 4.25 (5th ed. 2007).

For more information regarding the insured’s right to select its own independent counsel or the Downhole Navigator decision, contact Amy Elizabeth Stewart at amy@amystewartlaw.com.