Mt. Hawley Insurance Company v. Contravest Construction

THE STATE OF SOUTH CAROLINA
In The Supreme Court
In re: Mt. Hawley Insurance Company, Petitioner,
In Which Contravest, Inc., Contravest Construction
Company and Plantation Point Horizontal Property
Regime Owners Association, Inc., as assignees, are
Respondents.
Appellate Case No. 2018-001170
CERTIFIED QUESTION
ON CERTIFICATION FROM THE UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
Opinion No. 27892
Heard April 17, 2019 – Filed June 12, 2019
CERTIFIED QUESTION ANSWERED
C. Mitchell Brown, William C. Wood Jr., and Blake T.
Williams, all of Nelson Mullins Riley & Scarborough,
LLP, of Columbia; and Andrew K. Epting Jr., of Andrew
K. Epting Jr., LLC, of Charleston, all for Petitioner.
Jesse A. Kirchner, Michael A. Timbes and Thomas J.
Rode, all of Thurmond Kirchner & Timbes, P.A., of
Charleston, for Respondents.
Gray T. Culbreath and Janice Holmes, both of Gallivan,
White, & Boyd, PA, of Columbia, for amici curiae The
American Property Casualty Insurance Association and
The South Carolina Insurance Association.
Bert G. Utsey III, of Peters, Murdaugh, Parker, Eltzroth
& Detrick, P.A., of Charleston, and J. Ashley Twombley,
of Twenge & Twombley Law Firm, of Beaufort, for
amicus curiae the South Carolina Association for Justice.
JUSTICE KITTREDGE: We are presented with a certified question from the
United States Court of Appeals for the Fourth Circuit. The underlying case is an
insurance bad faith action against an insurance company for its failure to defend its
insured in a construction defect action. The insured settled the construction defect
action and brought a bad faith tort action. When the insurer asserted it acted in
good faith in denying coverage, the insured sought to discover the reasons why the
insurer denied coverage. According to the insurer, the discovery requests included
communications protected by the attorney-client relationship. The federal district
court reviewed the parties' respective positions, determined the insured had
established a prima facie case of bad faith, and ordered the questioned documents
to be submitted to the court for an in camera inspection. The insurer then sought a
writ of mandamus from the Fourth Circuit to vacate the district court's order
regarding the discovery dispute. In turn, the Fourth Circuit certified the following
question to this Court:
Does South Carolina law support application of the "at issue"
exception to attorney-client privilege such that a party may waive the
privilege by denying liability in its answer?
The parties, especially the insured, assert the certified question does not accurately
represent the correct posture of the case. In fact, the insured concedes the narrow
question presented requires an answer in the negative. We agree, for we find little
authority for the untenable proposition that the mere denial of liability in a
pleading constitutes a waiver of the attorney-client privilege. For the reasons set
forth below, we elect to analyze the issue narrowly in the limited context of a bad
faith action against an insurer. We are constrained to answer the certified question
as follows: "No, denying liability and/or asserting good faith in the answer does
not, standing alone, place the privileged communications 'at issue' in the case."1
1
The plaintiffs (the insured and the plaintiff/condominium owners' association in
I.
In its Certification Order, the Fourth Circuit summarized the relevant facts as
follows:
Mount Hawley [Insurance Company ("Mount Hawley")] provided
ContraVest Construction Company ("Contravest") with excess
commercial liability insurance from July 21, 2003, to July 21, 2007.
During that period, Contravest constructed the Plantation Point
development in Beaufort County, South Carolina. In 2011 the
Plantation Point Horizontal Property Regime Owners Association
("the Owners Association") sued Contravest for alleged defective
construction of Plantation Point. Mount Hawley refused Contravest's
demands to defend or indemnify Contravest in the suit, as Contravest
contended was required by its insurance policies, and Contravest
ultimately settled the case.
Contravest and the Owners Association subsequently sued Mount
Hawley in South Carolina court, alleging bad faith failure to defend or
indemnify, breach of contract, and unjust enrichment. Mount Hawley
removed the case to the United States District Court for the District of
South Carolina pursuant to 28 U.S.C. § 1441 (2012), and federal
subject matter jurisdiction exists under 28 U.S.C. § 1332 (2012) based
upon complete diversity of citizenship between the parties and
damages alleged to be greater than $75,000.
During discovery, the plaintiffs sought production of, first, Mount
Hawley's file on Contravest's claim for excess coverage relating to the
Plantation Point suit, and later, Mount Hawley's files relating to all of
the construction defect action) contend the federal district court decided to conduct
an in camera review of the questioned documents based on more than a mere
denial of liability in the insurer's answer. We agree. See ContraVest Inc. v. Mt.
Hawley Ins. Co., 273 F. Supp. 3d 607, 617–23 (D.S.C. 2017) (including the district
court's discussion of the need for the insured to make a prima facie showing of bad
faith—in addition to the insurer's denial of liability in its answer—under the test set
forth in City of Myrtle Beach v. United National Insurance Co., C/A No. 4:08-
1183-TLW-SVH, 2010 WL 3420044 (D.S.C. Aug. 27, 2010), and finding the
plaintiffs had made such a showing there).
Contravest's claims under its excess liability policies. See Fed. R. Civ.
P. 26(b)(1), 34(a)(1)(A). Mount Hawley contended that these files
contained material protected by the attorney-client privilege, and
produced files in redacted form with accompanying privilege logs.
See Fed. R. Civ. P. 26(b)(5)(A). The plaintiffs filed multiple motions
to compel, arguing that Mount Hawley waived the attorney-client
privilege as to these files. See Fed. R. Civ. P. 37(a)(3)(B)(iv). The
district court adopted the recommendation of the magistrate judge,
granted the motions to compel, and ordered Mount Hawley to produce
the files for in camera inspection. ContraVest Inc. v. Mt. Hawley Ins.
Co., 273 F. Supp. 3d 607, 622–23 (D.S.C. 2017). The district court
subsequently denied Mount Hawley's motion for reconsideration [in
which it asked the district court to certify four questions of law to the
Supreme Court of South Carolina]. Mount Hawley then sought a writ
of mandamus from [the Fourth Circuit] to vacate the district court's
order granting the motions to compel.
[]
In its petition for a writ of mandamus, Mount Hawley challenges the
district court's holding that the relevant files were not protected by the
attorney-client privilege because Mount Hawley put them "at issue" in
the case by denying liability for bad faith failure to defend or
indemnify. Because this is a diversity action involving claims for
which South Carolina law provides the rule of decision, South
Carolina's law of attorney-client privilege applies. See Ashcraft v.
Conoco, Inc., 218 F.3d 282, 285 n.5 (4th Cir. 2000); Fed. R. Evid.
501. In South Carolina the attorney-client privilege is defined as
follows:
(1) Where legal advice of any kind is sought (2) from a
professional legal adviser in his capacity as such, (3) the
communications relating to that purpose (4) made in
confidence (5) by the client, (6) are at his instance
permanently protected (7) from disclosure by himself or
by the legal adviser, (8) except the protection be waived.
Tobaccoville USA, Inc. v. McMaster, 387 S.C. 287, 293, 692 S.E.2d
526, 530 (2010). "In general, the burden of establishing the privilege
rests upon the party asserting it." Wilson v. Preston, 378 S.C. 348,
359, 662 S.E.2d 580, 585 (2008).
In finding that the relevant files were not protected by South
Carolina's attorney-client privilege, the district court relied on City of
Myrtle Beach v. United Nat[ional] Ins[urance] Co., No. 4:08-1183-
TLW-SVH, 2010 WL 3420044 (D.S.C. Aug. 27, 2010) (unpublished).
City of Myrtle Beach also involved a bad faith insurance suit under
South Carolina law in which the insured sought to compel the insurer
to produce the relevant claim files, and the insurer argued that the files
contained material protected by the attorney-client privilege. Id. at
*1–2. The district court adopted the approach articulated in Hearn v.
Rhay, 68 F.R.D. 574 (E.D. Wash. 1975), as "consistent with
established South Carolina law." Id. at *5. Applying Hearn, the
district court found that
there is no per se waiver of the attorney client privilege
simply by a plaintiff making allegations of bad faith.
However, if a defendant voluntarily injects an issue in the
case, whether legal or factual, the insurer voluntarily
waives, explicitly or impliedly, the attorney-client
privilege. Thus, "voluntarily injecting" the issue is not
limited to asserting the advice of counsel as an
affirmative defense. A party's assertion of a new position
of law or fact may be the basis of waiver.
Id. (citation omitted).
Applying this definition of waiver, the court in City of Myrtle Beach
found that "for the purposes of the motion to compel, the insured has
presented a prima facie case of bad faith," and the insurer failed to
meet its burden of establishing the absence of waiver of the attorney
client privilege on account of the defenses asserted in its answer,
including that the insurer acted reasonably and in good faith. Id. at
*7. The court noted that "while this ruling amounts to a virtual per se
waiver of the privilege in this case, this result is based on the facts and
issues presented by the insurer in its Answer and its failure to meet its
burden as to the applicability of the privilege with this in mind." Id.In the present case, the district court rejected Mount Hawley's
argument that City of Myrtle Beach was inconsistent with South
Carolina law in light of the fact that one member of the Supreme
Court of South Carolina criticized the Hearn decision in a separate
opinion concurring in part and dissenting in part. See Davis v.
Parkview Apartments, 409 S.C. 266, 291–96, 762 S.E.2d 535, 549–51
(2014) (Pleicones, J., concurring in part and dissenting in part). The
district court found "that the numerous decisions that have applied
City of Myrtle Beach in this district provide stronger evidence than the
separate opinion in Davis that the Supreme Court of South Carolina
would adopt such an approach." ContraVest, 273 F. Supp. 3d at 616.
The district court also concluded that this approach strikes the best
balance between "the important policy goals of the attorney-client
privilege against the substantive interests underlying an insured bad
faith claim." Id. (citation omitted).
Following the approach articulated in City of Myrtle Beach, the
district court concluded that because the plaintiffs had established a
prima facie case of bad faith failure to insure, and Mount Hawley in
its answer denied bad faith liability, Mount Hawley waived the
attorney-client privilege with respect to the attorney-client
communications in the claim files, to the extent such communications
are relevant under [Rule 26 of the Federal Rules of Civil Procedure].
Id. at 611–23.[2] The court thus ordered Mount Hawley to produce the
files for an in camera review. Id. at 623.
Order of Certification at 2–6 (footnotes omitted) (internal alteration marks
omitted).
II.
There are three broad approaches that jurisdictions use to determine the presence
or absence of a waiver of the attorney-client privilege. See Bertelsen v. Allstate
Ins. Co., 796 N.W.2d 685, 702 n.6 (S.D. 2011) (describing the three approaches
and collecting cases); Restatement (Third) of the Law Governing Lawyers § 80
Reporter's Note cmt. b (2000) (same); infra Part II.B (discussing the three
approaches in more detail). However, regardless of what test is employed by the
2
The district court also noted the in camera review would focus on whether the
documents in the claim files were protected by the work-product doctrine.
ContraVest, 273 F. Supp. 3d at 623 n.13.
Court, the answer to the certified question must be "no," as stated above. Because
the certified question necessarily involves a determination of the circumstances
under which a communication otherwise protected by the attorney-client privilege
is discoverable under South Carolina law, we will examine the law generally and
set forth the proper framework to be applied in South Carolina in a tort action by
an insured against the insurer for bad faith refusal to provide coverage.
A. Existing South Carolina Law
i. Discovery and Privilege
The scope of discovery in South Carolina is generally broad. Oncology &
Hematology Assocs. of S.C., L.L.C. v. S.C. Dep't of Health & Envtl. Control, 387
S.C. 380, 385, 692 S.E.2d 920, 923 (2010); S.C. State Highway Dep't v. Booker,
260 S.C. 245, 252–53, 195 S.E.2d 615, 619 (1973) ("Since dockets must be kept
current largely by settlements, litigants and attorneys should be allowed liberal
discovery. Such would, of course, increase the likelihood of fair trial." (alteration
in original) (quoting Hodge v. Myers, 255 S.C. 542, 548, 180 S.E.2d 203, 206
(1971))). As a result, parties may obtain discovery regarding any matter that is not
privileged so long as it is relevant to the subject matter involved in the pending
claim. Rule 26(b)(1), SCRCP.
South Carolina's sole evidentiary rule regarding privileges is found in Rule 501,
SCRE, which states:
Except as required by the Constitution of South Carolina, by the
Constitution of the United States or by South Carolina statute, the
privilege of a witness, person or government shall be governed by the
principles of the common law as they may be interpreted by the courts
in light of reason and experience.
Rule 501, SCRE.
The attorney-client privilege has long been recognized in this State and protects
against disclosure of confidential communications by a client to his attorney
regarding a legal matter. Tobaccoville USA, 387 S.C. at 293, 692 S.E.2d at 529;
State v. Doster, 276 S.C. 647, 650, 284 S.E.2d 218, 219 (1981). The privilege is
based upon a "wise public policy" that determines the best interest of society is
served by "inviting the utmost confidence on the part of the client in disclosing his
secrets to his professional advisor, under the pledge of the law that such confidence
shall not be abused by permitting disclosure of such communications." Booker,
260 S.C. at 254, 195 S.E.2d at 619–20; see also Mohawk Indus., Inc. v. Carpenter,
558 U.S. 100, 108 (2009) ("By assuring confidentiality, the privilege encourages
clients to make 'full and frank' disclosures to their attorneys, who are then better
able to provide candid advice and effective representation." (citation omitted));
Hartsock v. Goodyear Dunlop Tires N. Am. Ltd., 422 S.C. 643, 647 n.1, 813 S.E.2d
696, 699 n.1 (2018) (describing the privilege as "rooted in the imperative need for
confidence and trust" (quoting Jaffee v. Redmond, 518 U.S. 1, 10 (1996))). South
Carolina courts strictly construe the attorney-client privilege. Doster, 276 S.C. at
651, 284 S.E.2d at 219.
Despite the importance of confidential communications between an attorney and
his client, we, like other jurisdictions, must understand and examine the tension
that is created by competing policy goals. See Doster, 276 S.C. at 651, 284 S.E.2d
at 220 ("The public policy protecting confidential communications must be
balanced against the public interest in the proper administration of justice."). Thus,
while South Carolina bestows significant weight to the attorney-client privilege,
the privilege is not absolute. See Ross v. Med. Univ. of S.C., 317 S.C. 377, 384,
453 S.E.2d 880, 884 (1994). For example, the attorney-client privilege does not
extend to communications made in furtherance of criminal, tortious, or fraudulent
conduct. Doster, 276 S.C. at 651, 284 S.E.2d at 220. Likewise, information—in
and of itself—does not become privileged merely because it was communicated to
an attorney. Booker, 260 S.C. at 256, 195 S.E.2d at 621.
Similarly, the client, as the sole owner of the attorney-client privilege, can waive
the privilege. State v. Thompson, 329 S.C. 72, 76–77, 495 S.E.2d 437, 439 (1998).
Such waiver must be "distinct and unequivocal." Id. As a result, when a party
asserts an implied waiver of privilege, "caution must be exercised, for waiver will
not be implied from doubtful acts." Id. at 77, 495 S.E.2d at 439.
Generally, the party claiming the privilege has the burden of establishing the
confidential nature of the communication, including the absence of waiver. State
v. Love, 275 S.C. 55, 59, 271 S.E.2d 110, 112 (1980). There is, however,
considerable authority for a burden-shifting analysis.3 We hold that the party
3
Compare, e.g., James v. Harris Cty., 237 F.R.D. 606, 609 (S.D. Tex. 2006) ("The
party asserting a privilege has the burden to demonstrate that the privilege exists
under the circumstances presented. Courts typically hold that waiver is a negative
burden that the privilege proponent must satisfy." (citations omitted)), and Jordan
v. Ct. of App. for Fourth Sup. Jud. Dist., 701 S.W.2d 644, 648–49 (Tex. 1985)
("The burden of proof to establish the existence of a privilege rests on the one
asserting the privilege has the initial burden to make a prima facie showing that the
communications in question are privileged; if the initial burden is met, the party
challenging the privilege must establish the communications are otherwise
discoverable under an exception or waiver.
ii. Insurance and Bad Faith Claims
"In this jurisdiction it has long been recognized that insurance is a business
affected with a public interest." Hinds v. United Ins. Co. of Am., 248 S.C. 285,
291, 149 S.E.2d 771, 774–75 (1966). In furtherance of this policy, this Court has
recognized, in addition to a breach of contract action, a separate tort action for an
insurer's bad-faith refusal to pay benefits under an insurance policy, whether for a
first-party claim or a third-party claim. Tadlock Painting Co. v. Md. Cas. Co., 322
S.C. 498, 500–01, 473 S.E.2d 52, 53–54 (1996) (rejecting an insurer's argument
that bad faith must be premised on breach of an express contractual provision);
Nichols v. State Farm Mut. Auto. Ins. Co., 279 S.C. 336, 340, 306 S.E.2d 616, 619
(1983). As the Nichols Court explained:
Absent the threat of tort action, the insurance company can, with
complete impunity, deny any claim they wish, whether valid or not.
During the ensuing period of litigation following such a denial, the
asserting it. If the matter for which a privilege is sought has been disclosed to a
third party, thus raising the question of waiver of the privilege, the party asserting
the privilege has the burden of proving that no waiver has occurred." (citations
omitted)), with Shumaker, Loop & Kendrick, L.L.P. v. Zaremba, 403 B.R. 480, 483
(N.D. Ohio 2009) ("The general rule is that the burden of establishing the existence
of the privilege rests with the party claiming it. Case law is clear that it is the
burden of the proponent of the privilege to establish that the privilege has not been
waived, for example, by disclosure to a third party. . . . There is also general
agreement among many courts and circuits that once a prima facie case of privilege
is established by a proponent, the party challenging the privilege then has the
burden to establish that the communications in question are otherwise discoverable
under an exception or waiver." (internal citations omitted)), and Bagwell v. Pa.
Dep't of Educ., 103 A.3d 409, 420 (Pa. Commw. Ct. 2014) ("The confusion
regarding who bears the burden of proving waiver of a privilege is understandable.
Absence of waiver is one of the elements required to establish the privilege.
However, when waiver is the focus of a dispute, the burden is shifted to the party
asserting waiver." (footnote omitted) (citations omitted)).
insurance company has the benefit of profiting on the use of the
insured's money. Heretofore, the only compensation a successful
insured could expect through litigation was the belated payment of his
claim and the possibility of recovering attorney fees up to [$2,500, as
set by statute].
We hold today that if an insured can demonstrate bad faith or
unreasonable action by the insurer in processing a claim under their
mutually binding insurance contract, he can recover consequential
damages in a tort action. Actual damages are not limited by the
contract. Further, if he can demonstrate the insurer's actions were
willful or in reckless disregard of the insured's rights, he can recover
punitive damages.
Nichols, 279 S.C. at 340, 306 S.E.2d at 619 (internal citations omitted) (internal
quotation and alteration marks omitted).
The Court has oft expressed similar concerns regarding an insurer denying
coverage with impunity. See, e.g., Varnadore v. Nationwide Mut. Ins. Co., 289
S.C. 155, 158, 345 S.E.2d 711, 713 (1986) (rejecting an insurer's argument that it
was entitled to a directed verdict because, based on its own investigation, it
believed there was a reasonable basis to deny the claim, and stating, "This position
is not tenable. First, it binds the insured to the findings and conclusions of the
insurer's own independent investigation; next, it effectually insulates the insurer
from liability; and finally, it forecloses a jury consideration of the insured's
evidence of bad faith." (emphasis added)).
These decisions promoted "this State's long held philosophy that those in the
insurance industry who fail to deal in good faith should be penalized." Duncan v.
Provident Mut. Life Ins. Co. of Phila., 310 S.C. 465, 468, 427 S.E.2d 657, 659
(1993). Of course, however, "[i]f there is a reasonable ground for contesting a
claim, there is no bad faith." Crossley v. State Farm Mut. Auto. Ins. Co., 307 S.C.
354, 360, 415 S.E.2d 393, 397 (1992). The bad faith determination must be judged
by the evidence before the insurance company at the time it denied the claim.
Howard v. State Farm Mut. Auto. Ins. Co., 316 S.C. 445, 448, 450 S.E.2d 582, 584
(1994) (per curiam). Thus, evidence arising after the denial of the claim is not
relevant to the propriety of the insurer's conduct at the time of its refusal. Id.The Court has often observed that the relationship between an insurer and its
insured is "special," more so than parties in a mere contractual relationship. See,
e.g., Tadlock Painting, 322 S.C. at 503 n.5, 473 S.E.2d at 55 n.5; Williams v.
Riedman, 339 S.C. 251, 268–74, 529 S.E.2d 28, 36–40 (Ct. App. 2000) (discussing
the "special relationship" between an insurance company and its insured, and
distinguishing other types of relationships from that "special" one). The basis of
this special relationship between the insurer and the insured derives from an
extension of the implied covenant of good faith and fair dealing that exists in all
contracts. Tadlock, 322 S.C. at 501–03 & nn.4–5, 473 S.E.2d at 54–55 & nn.4–5
(quoting Deese v. State Farm Mut. Auto. Ins. Co., 838 P.2d 1265, 1269 (Ariz.
1992) (en banc); Carolina Bank & Trust Co. v. St. Paul Fire & Marine Co., 279
S.C. 576, 580, 310 S.E.2d 163, 165 (Ct. App. 1983)).
With this general background, we turn to the three approaches to the waiver of the
attorney-client privilege.
B. Various Approaches
This Court has not previously been tasked with harmonizing attorney-client
privilege and insurance bad faith law. As the Supreme Court of Washington noted,
insurance bad faith claims place in tension three valued principles: on the one side,
the attorney-client privilege; and on the other side, the importance of broad
discovery and holding insurance companies accountable for their bad acts. See
Cedell v. Farmers Ins. Co. of Wash., 295 P.3d 239, 245–46 (Wash. 2013) (en
banc). As mentioned previously, there are three broad approaches jurisdictions
take to resolve this tension. Bertelsen, 796 N.W.2d at 702 n.6; Restatement
(Third) of the Law Governing Lawyers § 80 Reporter's Note cmt. b. We
acknowledge that none of the various approaches is without legitimate criticisms.
First, a "substantial minority" of jurisdictions have broadened the crime-fraud
exception to the attorney-client privilege and found the privilege does not extend to
any communications in furtherance of any crime or tort, including bad faith
insurance claims.4 These jurisdictions have typically found the entire pre-denial
claim file discoverable.5 While this approach would certainly promote South
Carolina's policies in favor of promoting broad discovery and holding insurers
4
Cedell, 295 P.3d at 251 (Alexander, J., dissenting) (citing 2 Edward J.
Imwinkelried, The New Wigmore: A Treatise on Evidence: Evidentiary Privileges
§ 6.13.2(d)(1), at 1174 (2d ed. 2010)).
5
See, e.g., Silva v. Fire Ins. Exch., 112 F.R.D. 699, 699 (D. Mont. 1986); Boone v.
Vanliner Ins. Co., 744 N.E.2d 154, 157 (Ohio 2001).
accountable when they act in bad faith, we reject it, as the approach places only
nominal value on the importance of the attorney-client privilege.
Second, and on the other extreme, other jurisdictions have upheld the attorney-
client privilege absent direct, express reliance on a privileged communication by a
client in making out his claim or defense. Such jurisdictions reject the suggestion
of an implied waiver of the attorney-client privilege.6 We reject this approach as
well, as it fails to balance the attorney-client privilege with any competing policy
considerations. See Doster, 276 S.C. at 651, 284 S.E.2d at 220 ("The public policy
protecting confidential communications must be balanced against the public
interest in the proper administration of justice." (emphasis added)).
Third, some jurisdictions take a middle-ground approach and find the answer
depends on a case-by-case analysis of the facts.7 This is the general approach we
adopt when determining if the attorney-client privilege has been waived in a tort
action against an insurer for bad faith refusal to deny coverage.
We find the case of State Farm Mutual Automobile Insurance Co. v. Lee from the
Supreme Court of Arizona instructive. See 13 P.3d 1169 (Ariz. 2000) (en banc).
In Lee, a class of insureds brought claims for insurance fraud and bad faith and
sought discovery of their insurer's files and documents related to the insurer's
pattern of rejecting their underinsured and uninsured claims. Id. at 1170. The
insurer resisted discovery, arguing the documents were protected by the attorney-
client privilege because it had sought and received advice of counsel about whether
to pay or reject the insureds' claims. Id. at 1170, 1172. However, the insurer
"denied it intended to show good faith by advancing a defense of reliance on
advice of counsel." Id. at 1172. The trial court granted the insureds' motion to
compel, finding the insurer had waived the privilege:
[The insurer has] claimed that its managers held a good faith belief in
their interpretation that stacking was not permitted under its insurance
policies. While not expressly setting forth the advice of counsel
6
See, e.g., Rhone-Poulenc Rorer Inc. v. Home Indem. Co., 32 F.3d 851, 863–64
(3d Cir. 1994); Palmer ex rel. Diacon v. Farmers Ins. Exch., 861 P.2d 895, 907
(Mont. 1993).
7
See, e.g., Hearn, 68 F.R.D. at 581; State Farm Mut. Auto. Ins. Co. v. Lee, 13 P.3d
1169, 1183–84 (Ariz. 2000) (en banc); Tackett v. State Farm Fire & Cas. Ins. Co.,
653 A.2d 254, 262–63 (Del. 1995).
defense, the facts in this case demonstrate that the [insurer's] position
on stacking was made after having its counsel review the applicable
statutes and developing cases and advise the corporate decision
makers. Thus, the advice of counsel was a part of the basis for [the
insurer's] position that was taken. The advice of counsel defense is
impliedly one of the bases for the defense [the insurer] maintain[s] in
this action. [The insurer has], therefore, impliedly waived the
attorney-client privilege.
Id. at 1172–73 (internal alteration marks omitted).
The Arizona Supreme Court ultimately upheld the trial court's decision granting
the insureds' motion to compel. Id. at 1173, 1184. The court rested its decision on
the fact that the insurer defended its denial of coverage based on its agents'
subjective understanding of the law—as informed by counsel—rather than
defending exclusively on an objective reading of the disputed policy exclusions.
See, e.g., id. at 1173, 1174 ("What [the insurer] knew about the law obviously
included what it learned from its lawyers."). In reaching its holding, the court
concluded that in cases "in which the litigant claiming the privilege relies on and
advances as a claim or defense a subjective and allegedly reasonable evaluation of
the law—but an evaluation that necessarily incorporates what the litigant learned
from its lawyer—the communication is discoverable and admissible." Id. at 1175.
As the court explained:
"A waiver is to be predicated not only when the conduct indicates a
plain intention to abandon the privilege, but also when the conduct
(though not evincing that intention) places the claimant in such a
position, with reference to the evidence, that it would be unfair and
inconsistent to permit the retention of the privilege. It is not to be
both a sword and a shield." [8 Wigmore, § 2388, at 855].
....
[Thus], a litigant's affirmative disavowal of express reliance on the
privileged communication is not enough to prevent a finding of
waiver. When a litigant seeks to establish its mental state by asserting
that it acted after investigating the law and reaching a well-founded
belief that the law permitted the action it took, then the extent of its
investigation and the basis for its subjective evaluation are called into
question. Thus, the advice received from counsel as part of its
investigation and evaluation is not only relevant but, on an issue such
as this, inextricably intertwined with the court's truth-seeking
functions. A litigant cannot assert a defense based on the contention
that it acted reasonably because of what it did to educate itself about
the law, when the investigation and knowledge about the law included
information it obtained from its lawyer, and then use the privilege to
preclude the other party from ascertaining what it actually learned and
knew. . . .
Id. at 1176–78 & n.4 (emphasis added) (citations omitted) (internal quotation and
alteration marks omitted) (discussing with approval the holding in Tackett, 653
A.2d at 259–60).
The Lee court addressed the question certified by the Fourth Circuit here,
recognizing its approach would prohibit a finding of waiver based solely on "the
mere filing of a bad faith action, the denial of bad faith [in the answer to the
complaint], or the affirmative claim of good faith." Id. at 1179 (applying the
approach set forth in Restatement (Third) of the Law Governing Lawyers §
80(1)(a)).8 Under the Arizona Supreme Court's interpretation of the Restatement,
The party that would assert the privilege has not waived unless it has
asserted some claim or defense, such as the reasonableness of its
evaluation of the law, which necessarily includes the information
received from counsel. In that situation, the party claiming the
privilege has interjected the issue of advice of counsel into the
litigation to the extent that recognition of the privilege would deny the
opposing party access to proof without which it would be impossible
for the factfinder to fairly determine the very issue raised by that
party. We believe such a point is reached when, as in the present case,
8
Section 80(1)(a) of the Restatement (Third) of the Law Governing Lawyers
provides:
The attorney-client privilege is waived for any relevant
communication if the client asserts as to a material issue in a
proceeding that: (a) the client acted upon the advice of a lawyer or
that the advice was otherwise relevant to the legal significance of the
client's conduct . . . .
(Emphasis added.)
the party asserting the privilege claims its conduct was proper and
permitted by law and based in whole or in part on its evaluation of the
state of the law. In that situation, the party's knowledge about the law
is vital, and the advice of counsel is highly relevant to the legal
significance of the client's conduct. Add to that the fact that the truth
cannot be found absent exploration of that issue, and the conditions of
RESTATEMENT § 80 are met.
Id. (emphasis added).
Lee was not unanimous. The Lee majority noted the dissent and the insurer (like
Mount Hawley) argued the insureds, and not the insurer, raised the subjective good
faith of the insurer's claims people; however, the majority rejected the argument
because it was not the insurer's mere denial of that allegation that waived the
privilege, but instead was the insurer's "affirmative assertion that its actions were
reasonable because of its [subjective] evaluation of the law, based on its
interpretations of the policies, statutes, and case law, and because of what its
personnel actually knew or did." Id. at 1180–81 & n.7, 1182 ("It is not enough that
plaintiff brings the privilege holder's mental state in issue. The waiver exists only
when the privilege holder raises and defends on the theory that its mental state was
based on its evaluation of the law and the facts show that evaluation included and
was informed by advice from legal counsel."). The court noted it would be
"difficult" for the insurer to respond to the insureds' allegations of subjective bad
faith "without affirmatively alleging that it investigated and evaluated the law." Id.
at 1182. However, the court stated it was not impossible, and that the insurer
"could do so simply by denying that it knew it was acting unlawfully and relying
[solely] on a defense of objective reasonableness." Id. at 1182–83 (acknowledging
that whichever strategy the insurer chose, it was "faced with serious problems
about the advice of counsel" to the extent it was, in some ways, "between Scylla
and Charybdis").
The court also noted the criticisms of its approach from decisions such as Rhone-
Poulenc, and in return pointed out the problems inherent in the Rhone-Poulenc
approach advanced by Mount Hawley here:
It simply makes a mockery of the law to allow a litigant to claim on
the one hand that it acted reasonably because it made a legal
evaluation from which it concluded that the law permitted it to act in a
certain manner, while at the same time allowing that litigant to
withhold from its adversary and the factfinder information it received
from counsel on that very subject and that therefore was included in
its evaluation. The sword and shield metaphor would truly apply were
we to allow a party to raise the privilege in that situation.
Id. at 1182.9
Lee made plain the importance of the attorney-client privilege and reiterated that a
waiver would not be lightly found:
We assume client and counsel will confer in every case, trading
information for advice. This does not waive the privilege. We
assume most if not all actions taken will be based on counsel's advice.
This does not waive the privilege. Based on counsel's advice, the
client will always have subjective evaluations of its claims and
defenses. This does not waive the privilege. All of this occurred in
the present case, and none of it, separately or together, created an
implied waiver. But the present case has one more factor—[the
insurer] claims its actions were the result of its reasonable and good-
faith belief that its conduct was permitted by law and its subjective
belief based on its claims agents' investigation into and evaluation of
the law. It turns out that the investigation and evaluation included
information and advice received from a number of lawyers. It is the
last element, combined with the others, that impliedly waives the
privilege. State Farm claims that its actions were prompted by what
its employees knew and believed, not by what its lawyers told them.
But a litigant cannot with one hand wield the sword—asserting as a
9
Mount Hawley additionally contends that anything less than adopting the Rhone-
Poulenc approach would chill attorney-client communications due to the
destabilization of the privilege. We agree with the Supreme Court of Ohio's
dismissal of this argument:
This argument is not well taken because it assumes that insurers will
violate their duty to conduct a thorough investigation by failing, when
necessary, to seek legal counsel regarding whether an insured's claim
is covered under the policy of insurance, in order to avoid the [mere
possibility of the] insured later having access to such communications,
through discovery.
Boone, 744 N.E.2d at 157. Such an assumption would be speculative, at best.
defense that, as the law requires, it made a reasonable investigation
into the state of the law and in good faith drew conclusions from that
investigation—and with the other hand raise the shield—using the
privilege to keep the jury from finding out what its employees actually
did, learned in, and gained from that investigation.
....
[A party] is not permitted to thrust his knowledge into the litigation as
a foundation to sustain his claim while simultaneously retaining the
lawyer-client privilege to frustrate proof negating the claim asserted.
Such a tactic would repudiate the sword-shield maxim.
Id. at 1183–84 (second emphasis added) (citation omitted) (internal quotation and
alteration marks omitted).
In finding the Lee framework instructive, we emphasize the sanctity of the
attorney-client privilege. In this regard, a client does not waive the privilege
simply by bringing or defending a lawsuit. We adopt the Lee framework in a tort
action against an insurer for bad faith refusal to provide coverage, and we impose
the additional requirement that the party seeking waiver of the attorney-client
privilege make a prima facie showing of bad faith.
III.
Insurance bad faith actions necessarily bring into conflict the competing policy
considerations of protecting the attorney-client privilege and promoting broad
discovery to facilitate the truth-seeking function of our justice system. In
balancing these considerations, we find the Lee framework is the most consistent
with South Carolina's policy of strictly construing the attorney-client privilege and
requiring waiver to be "distinct and unequivocal." See Thompson, 329 S.C. at 76–
77, 495 S.E.2d at 439; Doster, 276 S.C. at 651, 284 S.E.2d at 219. This case-by-
case approach accounts for and fairly distributes the risks and benefits of the
various competing public policies. We therefore answer the certified question
from the United States Court of Appeals for the Fourth Circuit by holding that a
denial of bad faith and/or the assertion of good faith in the answer does not,
standing alone, place a privileged communication "at issue" in a case such that the
attorney-client privilege is waived.
CERTIFIED QUESTION ANSWERED.
BEATTY, C.J., HEARN, FEW and JAMES, JJ., concur.