Drennen v. Certain Underwriters at Lloyd's of London (In re Residential Capital, LLC)
Docket: Case No. 12-12020 (MG); Adv. No. 15-01025 (SHL)
Court: United States Bankruptcy Court, S.D. New York; July 14, 2017; Us Bankruptcy; United States Bankruptcy Court
Plaintiffs have filed a motion to compel discovery from Defendant Certain Underwriters at Lloyd’s of London, alleging improper withholding of claims handling documents under attorney-client and work product privileges. Plaintiffs argue that because Underwriters utilized attorneys from Sedgwick, Detert, Moran, Arnold, LLP as claims handlers, any documents reflecting their claims handling activities should not be privileged. In contrast, Underwriters assert that these documents are protected as they were retained for legal advice concerning coverage issues under the policies.
The dispute also includes a contention regarding the timing of when litigation became likely, impacting the application of any attorney work product privilege. Since the motion's filing, Underwriters have produced some previously withheld documents, yet several discovery disputes remain unresolved, necessitating the Court's intervention.
Background information reveals that in May 2012, Residential Funding Company, LLC (RFC) and its affiliates filed for Chapter 11 bankruptcy. Prior to this, Underwriters had issued comprehensive insurance policies to RFC’s parent company, General Motors (GM), which included a liability policy designating Sedgwick's Eugene Elsbree for claims notices. From 2001 to 2013, Sedgwick reported to Underwriters on several class actions involving RFC, known as the Kessler and Mitchell class actions, among others. These reports, including Bordereaux and Direct Reports, allegedly provided updates on Sedgwick's investigation and indicated that Underwriters had delegated claims handling to Sedgwick. Underwriters contend, however, that Sedgwick's role was to provide legal advice regarding coverage implications of the claims.
A hearing on a Motion occurred in December 2016, followed by additional hearings on January 23 and February 28, 2017, during which the Court provided observations and preliminary conclusions. The parties submitted supplemental briefings after further information was released by the Underwriters. The Court is now addressing three key issues: (i) whether Underwriters acted as claims handlers instead of attorneys; (ii) the anticipated litigation date by Underwriters; and (iii) the discoverability of reserve level information established by Underwriters in relation to the Underlying Actions.
The discussion on attorney-client privilege highlights its purpose to foster open communication between attorneys and clients for the broader public interest in law and justice. The determination of applying state or federal law is crucial; in Bankruptcy Code cases, the Federal Rules of Evidence apply. The federal common law of privileges is relevant when federal law governs the substantive rights involved, while state privilege law applies if the underlying claims or defenses are state law-based. The parties concur that New York law governs the attorney-client privilege dispute. Under New York law, the privilege is defined under C.P.L.R. 4503(a) and encompasses confidential communications made for legal advice, which entails three elements: (1) an attorney-client relationship, (2) a communication made within that relationship for legal advice, and (3) intended and actual confidentiality of that communication.
To claim attorney-client privilege, the communication must be a confidential exchange made for legal advice or services. The privilege protects communications rather than underlying facts, and it applies primarily to legal matters, even if nonlegal issues are included. Communications are generally immune from discovery, but this immunity does not extend to insurance companies' claim handling activities, which are discoverable even if performed by an attorney. Reports prepared by attorneys for insurance companies as part of their regular business, including those related to claims evaluation, are not privileged. In insurance litigation, attorney-client privilege is often denied if the attorney is simply investigating a claim. A lawyer's work is not privileged when it resembles nonlegal business tasks. While the inclusion of nonprivileged information in a privileged communication may affect its protection, it does not negate the privilege entirely. The party claiming the privilege must demonstrate its applicability through competent evidence and show that it has not been waived.
Plaintiffs argue that Underwriters delegated claims handling activities to Sedgwick for the Underlying Actions, highlighting Sedgwick's involvement in tasks such as claims investigation, coverage analysis, and status reporting. They assert that Mr. Elsbree, an attorney at Sedgwick, received all claims notices without identifying himself as “coverage counsel,” and that the Direct Reports he generated are typical insurer documents shared with policyholders during discovery. In contrast, Sedgwick claims it was retained as coverage counsel to provide legal advice, asserting its role involved researching case law and analyzing coverage issues, distinct from claims handling, which typically includes processing claims and making payment decisions.
Sedgwick emphasizes that Novae was primarily responsible for claims adjustments and explains that designating Mr. Elsbree to receive claims notices was a convenience for Underwriters, allowing him to forward claims to them for direct handling. Underwriters contend that the Direct Reports reflect Sedgwick’s legal analysis rather than claims handling. The Court recognizes that Sedgwick operated in dual capacities as both claims handler and legal counsel, noting that it engaged in claims handling tasks such as opening claims files and gathering information from brokers on behalf of Underwriters.
Direct Reports provide a factual overview of policies and claims, including updates on filed and newly initiated lawsuits against RFC, detailing litigation status, motions, appellate history, and settlement discussions. This information remains largely unredacted by Underwriters, indicating that the attorney-client privilege does not extend to underlying facts. Notably, few documents from Novae or ACE were submitted to show claims analysis or investigations outside of Sedgwick, suggesting limited claims processing activities elsewhere. The Court rejected Underwriters' depiction of Sedgwick as merely an “information conduit” and noted the lack of robust claims processing evidence beyond Sedgwick's involvement. While Sedgwick engaged in some claims handling, the record does not support the assertion that it made final coverage decisions on the Underlying Claims; instead, it indicates Sedgwick's role involved analysis and recommendations regarding coverage issues.
Direct Reports conclude with a section for "Further Handling," indicating that Sedgwick will continue to provide updates or seeking Underwriters' agreement on its proposals, as referenced in Direct Reports 12 and 18. This aligns with guidelines in the Novae claims manual's appendix, US Lawyer Terms of Engagement, which mandates preliminary reports to summarize the claim, assess liability, and detail applicable law and jurisdiction. In cases involving litigation against Underwriters, the reports must also address coverage defenses and mitigation strategies. The Direct Reports indeed reflect the required legal analyses and do not indicate that Sedgwick made ultimate coverage decisions, but demonstrate its role as legal counsel alongside claims handling. They include legal assessments of policy provisions and relevant case law, showcasing Sedgwick’s intent to provide legal advice. Additionally, there is evidence supporting Sedgwick’s counsel role, including a request for legal advice regarding lawsuits against RFC, as testified by Sedgwick attorney Mr. Elsbree. This context underscores Sedgwick’s involvement as coverage counsel, further supported by contemporaneous evidence and declarations, with established attorney-client privilege for documents requesting legal advice.
Mr. Elsbree's letter to Aon indicates that Sedgwick has been tasked with representing Underwriters' interests in class action lawsuits against RFC in multiple states. The Court finds no compelling reason to dismiss the sworn statements and supporting evidence provided. Underwriters engaged Sedgwick for legal counsel concerning coverage issues related to second-mortgage loans, and the communications between them were intended to be confidential, thus invoking attorney-client privilege for Sedgwick’s legal opinions and conclusions. The Court references the case Reliance Ins. Co. v. Am. Lintex Corp., which upheld attorney-client privilege for documents involving legal advice on claims and correspondence. Plaintiffs argue that Underwriters cannot claim this privilege if Sedgwick acted as a claims adjuster; however, the Court is not convinced by the Plaintiffs' cited cases. In Brooklyn Union Gas Co. v. Am. Home Assurance Co., the court found documents discoverable due to the lack of legal advice and the investigatory role of attorneys. In contrast, the documents in this case reflect Sedgwick’s legal advice and thought processes regarding coverage litigation, thereby maintaining the privilege.
Sedgwick acted as coverage counsel rather than merely a claims investigator, differentiating its role from that in Brooklyn Union. Plaintiffs incorrectly reference AIU Ins. Co. v. TIG Ins. Co., where the court ruled that the attorney-client privilege did not apply due to the investigatory role of the insurer’s counsel, as the insurer failed to show that the documents were primarily legal rather than business-related. The court concluded that many documents involved communications that did not seek legal advice and reflected business matters instead. Similar cases cited by the plaintiffs found that attorneys acting as claims handlers did not have protected communications under attorney-client privilege. However, there is no case law supporting the notion that the privilege is waived when an attorney serves as both legal counsel and claims handler, which aligns with the principle that legal communications retain their protection even if they also pertain to non-legal matters. The court noted the importance of distinguishing between non-privileged communications and those where Sedgwick provided legal advice. While attorney-client communications in insurance litigation can lose protection if deemed purely investigatory, those related to legal advice remain protected, regardless of the context of an insurance claim. Plaintiffs' argument that Sedgwick was only a claims handler due to the hiring of other counsel by Underwriters is undermined by Sedgwick's comprehensive legal analysis provided in its reports. The presence of multiple attorneys for different tasks in complex commercial disputes does not negate the attorney-client privilege established with Sedgwick.
The Court has determined that the examined documents contain both privileged and non-privileged information and provides guidance on categorizing the texts. Four categories are identified for distinguishing between privileged and releasable content.
1. **Privileged Material**: This includes the Policy's clauses and definitions followed by Sedgwick’s legal analysis, which is protected under attorney-client privilege. Examples span various Direct Reports (e.g., Direct Report 1 at 8-11, Direct Report 7 at 11-25). The Court emphasizes that factual statements intertwined with legal analysis may also retain privileged status.
2. **Factual Information**: Certain factual or historical information related to claims processing, such as correspondence, settlements, and court filing summaries, should be released. Specific Direct Reports (e.g., Direct Report 2 at 11, Direct Report 10 at 11) illustrate this type of content.
3. **Legal Discussions**: Portions that involve framing legal issues, case law, and statutes are also protected under attorney-client privilege. Examples include commentary on legal issues and analysis found in several Direct Reports (e.g., Direct Report 1 at 2, Direct Report 19 at 13-14).
4. **Inconsistencies in Redactions**: The Court notes discrepancies in how information is redacted across the Direct Reports. It mandates that similar material should be consistently released. For instance, information redacted in Direct Report 10 should also be released in Direct Report 6, as well as others, particularly regarding historical content such as the Mitchell reservation of rights letter (found in Direct Reports 19 and 20).
The guidance is intended to assist the parties in determining the treatment of the affected documents while ensuring that privileged information remains protected.
The work product doctrine, governed by federal law in federal court, is a qualified privilege under Federal Rule of Civil Procedure 26(b)(3). Its primary purpose is to permit attorneys to gather and analyze information, develop legal theories, and strategize without interference. The doctrine protects an attorney's thought processes, including litigation strategies and trial tactics, thereby preserving the integrity of the adversary process by preventing opposing parties from benefiting from an attorney's preparatory work.
There are two categories of work product: non-opinion work product, which contains non-privileged relevant facts, and opinion work product, which includes an attorney's opinions and mental processes. For the doctrine to apply, documents must be prepared "in anticipation of litigation." Courts in the Second Circuit determine this based on whether the documents were created due to the prospect of litigation, as opposed to being produced in the ordinary course of business, which does not qualify for protection.
While a document serving a business purpose does not lose work product protection if it was created in anticipation of litigation, the mere possibility of litigation is insufficient for protection. In the insurance context, challenges arise regarding documents prepared by insurers, as their role involves claim investigation and adjustment. Reports generated in the regular course of an insurer's business are generally not protected from discovery.
In the insurance context, courts often assume that investigative reports created by insurers before making a coverage decision are part of normal business operations and do not receive work-product protection. This presumption can be challenged if the insurer provides competent evidence showing it had a "resolve to litigate" at the time the documents were created. The hiring of a law firm is a significant but not decisive factor in determining whether litigation was anticipated. Courts may not grant work-product protection to documents created after hiring counsel if the insurer continues investigating the claim without denying coverage. Some courts adopt a flexible, case-by-case approach, assessing when an insurer had reasonable grounds to deny a claim, rather than relying on blanket presumptions. For example, a reservation of rights letter can indicate anticipated litigation, making it reasonable for parties to foresee a coverage dispute. The burden of establishing work-product privilege lies with the party claiming it, which must provide specific evidence of the documents being created in anticipation of litigation. If that burden is met, the opposing party must then show grounds to pierce the privilege, such as exceptions or waivers. The Underwriters claim that they anticipated litigation on October 17, 2008, coinciding with the issuance of a reservation of rights letter.
Underwriters assert that by October 2008, it was clear they would not cover damages related to certain claims, as indicated in their supplemental brief. In contrast, Plaintiffs argue that this date is premature, highlighting that Underwriters continued to seek information from RFC and made partial defense payments even after October 2008. Plaintiffs propose February 29, 2012, as the relevant date because it was when Underwriters formally denied RFC's request for payment for the Mitchell compensatory damages judgment. The Court ultimately determines October 17, 2008, the date of the Mitchell Reservation of Rights (ROR) letter, as the anticipated litigation date. The Court references case law indicating that the issuance of a reservation of rights letter suggests a reasonable expectation of future litigation. The Mitchell ROR characterizes the claims as a "mortgage fee claim" and states coverage is only potentially available for defense costs, effectively signaling Underwriters’ refusal to cover damages. Additional correspondence from RFC disputes Underwriters’ characterization and asserts their responsibility for all losses. Contextually, the issuance of the Mitchell ROR followed a significant judgment against RFC. Communications from RFC around this time indicate an expectation for Underwriters to fulfill their obligations and reflect an adversarial relationship, with RFC seeking Underwriters’ consent to settle claims up to $57 million.
In Lloyd's Acceptance Corp. v. Affiliated FM Ins. Co., the court determined that emails were produced in anticipation of litigation due to the adversarial nature of the communications, even prior to an official claim denial. The case highlights the need for a detailed, fact-specific inquiry to ascertain whether documents were created with litigation in mind. Direct Report 18 indicated a comprehensive review of invoices was undertaken in anticipation of a dispute with the Assureds, noting potential for arbitration or litigation. Furthermore, an email from Novae to Aon mentioned that Underwriters outlined their coverage position, contradicting the Plaintiffs' assertion about the timeline. The Underwriters’ ongoing requests for information from RFC, post-Mitchell ROR, were justified as necessary for claim development, indicating a shift from ordinary business operations to litigation anticipation around October 2008. The court found that Underwriters provided sufficient proof that litigation was anticipated by that date.
Additionally, in insurance disputes, insureds often seek access to the insurer's reserve amounts for claims. The discoverability of reserve information hinges on its relevance, with references made to legal precedents and discussions in insurance law literature regarding the subject.
The party seeking discovery must demonstrate the relevance of the information requested, as per the Federal Rules of Civil Procedure. Discovery is allowed for any nonprivileged matter relevant to claims or defenses, provided it is proportional to the case's needs. Factors for proportionality include the importance of issues, amount in controversy, access to information, party resources, and the burden versus benefits of the discovery. Relevant information is defined as having a tendency to affect the probability of a fact that is significant to the case's outcome. Courts in the Second Circuit have addressed the discoverability of reserve information, with a mix of rulings. In Champion Int’l Corp. v. Liberty Mut. Ins. Co., the court ordered the production of reserve information, recognizing its relevance in coverage cases unless hindered by attorney-client privilege or excessive burden. Conversely, in Sundance Cruises Corp. v. Am. Bureau of Shipping, the court ruled reserve information was not discoverable, asserting it did not pertain to liability determinations. Other cases, such as U.S. Fire Ins. Co. v. City of Warren, have similarly concluded that reserves reflect a business judgment rather than a legal assessment of claim validity.
Reserve information is deemed tenuously relevant and qualifies as work product, relating to the legal expertise involved in assessing the value of claims and associated legal fees. In cases involving bad faith claims against insurers—where plaintiffs allege the insurer failed to act in good faith, such as by not settling within policy limits—discovery requests for reserve information become pertinent. Notable cases highlight this relevance, including Scottsdale Ins. Co. v. Indian Harbor Ins. Co., which addresses the insurer's duty of good faith under New York law, and Groben v. Travelers Indem. Co., involving allegations of bad faith and negligence in claims handling. Courts have recognized that reserve information can be probative in bad faith cases, as seen in Nat’l Union Fire Ins. Co. of Pittsburgh v. H&R Block, Inc., and Fireman’s Fund Ins. Co. v. Great Am. Ins. Co. of N.Y. However, there is a split of authority regarding the relevance of reserve information, with some courts permitting its discovery in bad faith contexts while others exclude it, particularly in non-bad faith cases. Even when considered relevant, reserve information may be protected under attorney-client and work product privileges, as indicated in cases like Lava Trading, Inc. v. Hartford Fire Ins. Co., where courts have ruled that such figures are created in anticipation of litigation.
Documents detailing the methodology for calculating case reserves for individual claimants are deemed privileged as work product and potentially as attorney-client communications. Reserve information may indicate potential liability and could be based on counsel's opinions, thus protected from disclosure. Plaintiffs argue that such information is pertinent to the Underwriters’ knowledge of claims, their coverage position, the reasonableness of settlements, and allegations of bad faith and delays in claims adjustment. They assert that reserve amounts are relevant to the Underwriters’ refusal to pay defense costs, issues of consent to settle, and notice defenses.
Conversely, Underwriters contend that reserve information is irrelevant and protected by attorney-client and work product privileges, pointing out that Plaintiffs have not formally alleged a bad faith claim. They argue that there is no ambiguity in the policy that would necessitate the review of reserve information to interpret the contract. The Court finds that Plaintiffs have not demonstrated the relevance of the reserve information, noting that while Plaintiffs suggest that documents produced might indicate potential bad faith, no actual claim for bad faith exists in the Complaint, which primarily seeks declaratory judgment and breach of contract.
The Court concludes that the existence or amount of a reserve fund does not influence the legal question of coverage, which is solely determined by the insurance contract’s language. Furthermore, the Court rejects Plaintiffs’ argument that reserve information is relevant to coverage claims, particularly regarding fee-related exclusions. Plaintiffs’ reliance on the doctrine of contra proferentum to argue that reserve information is crucial for resolving ambiguities in policy language is unsubstantiated, as they fail to identify specific ambiguous policy language or provide evidence of ambiguity.
The Court emphasizes that discovery requests must remain relevant and not allow parties to explore unrelated matters based on speculative future relevance. Consequently, the Court denies the Plaintiffs' request for reserve information. It partially grants the Plaintiffs' Motion, ordering Underwriters to produce unredacted documents withheld under work product privilege that are dated before October 17, 2008, and to review other documents for potential additional disclosures.
Underwriters submitted documents for in camera review and redacted pleadings to protect claimed privileged or confidential information. The Court concludes that the decision does not contain privileged information. Underwriters issued an insurance policy to GM and noted that other defendant insurers provided excess policies. A letter from Swiss Re International dated March 6, 2017, urged the Court to consider October 13, 2008, as the litigation anticipation date.
Underwriters argue that the applicable law for an insurance policy covering multiple states is determined by the insured's principal place of business, which is Michigan for GM and Minnesota for RFC. Despite this, Underwriters do not object to applying New York law for this discovery dispute but reserve the right to argue for another state’s law on substantive issues later.
The Court acknowledges that privilege may be overridden in cases of strong public policy demands, but no party has raised this argument. The Court reviewed Direct Reports and a sample binder of documents in camera. After reviewing the sample, Underwriters produced additional documents, although some remained redacted based solely on attorney-client privilege. The Court finds Underwriters' claims regarding the uniqueness of the claims handling situation unpersuasive.
Underwriters provided a rationale for employing two sets of legal counsel, asserting that Smith Haughey, located in Michigan, serves as local counsel while Sedgwick continues to offer legal guidance. The excerpt delineates a historical overview of the case, indicating that both parties had initially held extreme positions regarding the anticipated litigation dates, which were ultimately deemed unsupported. Plaintiffs claimed entitlement to documents held by Sedgwick under the work product doctrine due to substantial need for Underwriters' defenses regarding late notice. However, the Court determined that the plaintiffs failed to demonstrate such need, as equivalent information was obtainable from other sources. The document also references a prior bad faith claim that plaintiffs withdrew, confirming that no such claim exists in the current complaint. Additionally, there is contention over whether reserve information is protected by attorney-client and work product privileges. The Court's in camera review suggested that this reserve information likely reflects Sedgwick's legal analysis and mental impressions, thus warranting protection from disclosure.
