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Fifth Circuit Finds Insurer Not Required to Reimburse Insured for Independent Counsel

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The United States Court of Appeals for the Fifth Circuit recently affirmed a lower court’s denial of reimbursement for defense costs where the insured rejected representation following its insurer’s issuance of a reservation of rights letter. In Downhole Navigator, L.L.C. v. Nautilus Insurance Company,decided on June 29, 2012, the insured, Downhole Navigator, L.L.C. (Downhole), appeals from an order granting partial summary judgment in favor of the insurer, Nautilus Insurance Company (Nautilus), and ruling that Nautilus was not required to reimburse Downhole for the cost of its independent counsel.

This matter arose when Downhole, a company providing services to the oil drilling industry, was sued by a client based on allegations that it negligently redirected an oil well. Downhole submitted a notice of claim and indemnification to its general commercial liability insurer, Nautilus. In response, Nautilus tendered a qualified defense, reserving its rights to decline indemnity coverage if, after further investigation, the underlying suit fell under one of several listed policy exclusions. Thereafter, Downhole notified Nautilus that, due to the “material conflict” created by the reservation of rights, Downhole had “no choice but to select its own representation.” Downhole further informed Nautilus that it expected Nautilus to cover defense costs for its independent counsel. Nautilus insistend that “[u]ntil or unless a coverage issue develops, Downhole is not entitled to separate counsel.”

Donwhole filed suit seeking a declaration that, among other things, Nautilus has a contractual duty under the policy to cover the cost of Downhole’s independent counsel. On cross-motions for summary judgment, the magistrate judge granted that part of Nautilus’s motion relating to its duty to defend, ruling that Nautilus was not required to reimburse Downhole for the cost of hiring independent counsel to defend Downhole in the underlying litigation suit.

On appeal, Downhole’s argument hinges on a narrow exception to the general rule that an insurer’s right to conduct the defense includes the authority to select the attorney who will defend the claim. Under Texas law, “when the facts to be adjudicated in the liability lawsuit are the same facts upon which coverage depends, the conflict of interest will prevent the insurer from conducting the defense.” Id.citing N. Cnty. Mut. Ins. Co. v. Davalos, 140 S.W.3d 685, 688 (Tex. 2004). The Fifth Circuit finds the exception not applicable here, as the facts to be adjudicated in the underlying negligence suit are not the same facts upon which coverage depends. The court reasons that if the insurance policy between Downhole and Nautilus excluded coverage for Downhole’s negligent conduct, and Nautilus accordingly reserved its right to disclaim coverage based on whether Downhole had negligently performed its work, then the “facts to be adjudicated” in the underlying litigation would be equivalent to the “facts upon which coverage depends.” However, the court finds no such equivalency exists here, as Downhole’s negligence is not a coverage issue between Downhole and Nautilus. 

Downhole also urges the court to relax the standard enunciated in Davalos based on the Texas Supreme Court’s 2008 decision in Unauthorized Practice of Law Committee v. American Home , 261 S.W. 3d 24, 39 (Tex. 2008). Based on Downhole’s reading of Unauthorized Practice, a conflict of interest arises if facts that could be developedin the underlying litigation are the same facts upon which coverage depends. Downhole warns that if Nautilus were permitted to select Downhole’s attorney, that attorney could steer the defense to develop facts – by formulating questions and written responses during discovery – supporting the theory that goes against coverage. Nonetheless, the court declines to follow Downhole’s “strained reading of Unauthorized Practice,” noting that “one inconsequential line of dicta . . . surely did not usher doctrinal change.”