Downhole Navigator: The Right to Independent Counsel
by Amy Elizabeth Stewart
In June 2012, the Fifth Circuit issued its opinion in Downhole Navigator, L.L.C. v. Nautilus Insurance Company, 686 F.2d 325 (5th Cir. 2012), affirming the district court’s ruling that the insured was not entitled to select its own defense counsel at the insurer’s expense. Analyzing Texas law, the Fifth Circuit concluded that the facts to be adjudicated in the underlying lawsuit against the insured were not the same facts on which coverage turned, as required to preempt the insurer’s right to control the defense.
Downhole, an oil drilling servicer, was hired by an oil well operator 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. The well operator sued Downhole for negligence in Texas state court.
Downhole notified its commercial general liability insurer of the lawsuit. The insurer tendered a qualified defense, reserving its 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.
Based on the reservation of rights, Downhole rejected the qualified defense and engaged its own defense counsel. When the insurer insisted that Downhole had no right to independent counsel “unless or until” a coverage issue developed, Downhole filed suit seeking a declaration that the insurer was required 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. And whether Downhole acted negligently, which would be decided in the underlying case, did not impact the coverage issues.
[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 test applied by the Fifth Circuit comes from Northern County Mutual Insurance Company v. Davalos, 140 S.W.3d 685 (Tex. 2004), in which the Texas Supreme Court recognized that circumstances exist in which “an insurer may not insist upon its contractual right to control the defense.”
In the typical coverage dispute, an insurer will issue a reservation of rights letter, which creates a potential conflict of interest. And 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.
In reaching its conclusion, the Fifth Circuit rejected Downhole’s argument that facts could be developed in the underlying litigation that might be used to disclaim coverage. The court noted, moreover, 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.
Amy Elizabeth Stewart is managing shareholder of Amy Stewart PC. She can be reached at email@example.com.