Violation of an Insured’s Right to Independent Counsel May Preclude Collateral Estoppel

Many states recognize an insured’s right to independent counsel when an insurer’s reservation of rights creates a conflict of interest. The usual situation is where there are claims that an insured acted both negligently and intentionally. The typical dispute between the insured and insurer is whether there is a right to independent counsel and what rates the insurer must pay.

However, in a worst-case scenario, what happens when the insurer, despite the conflict, defends the case through appointed counsel and there is a finding or judgement that triggers the very exclusion that created the conflict? Can the insured relitigate the issues decided in the underlying liability action to establish coverage for the liability created or does collateral estoppel apply? There is authority that says collateral estoppel is not a bar to relitigating those types of issues. 

In Manzanita Park, Inc. v. Insurance Company of North America, 857 F.2d 549 (9th Cir. 1988), the insured, a racetrack operator, was sued by an injured flagman. There was coverage for the flagman’s claim if he was an independent contractor but not if he was an employee, which created a conflict of interest between the insured and insurer. Defense counsel appointed by the insurer stipulated to a dismissal of the flagman’s independent contractor claim, leaving only the flagman’s claim that he was an employee. The insurer was “relieved of potential indemnification obligations once that claim was dismissed.” Id. at 553. Judgment was entered in favor of the flagman, who was held to be Manzanita Park’s employee. Manzanita Park sought to relitigate the independent contractor/employee issue in its coverage action against the insurer for bad faith refusal to pay the judgment. The insurer argued that Manzanita Park was collaterally estopped from relitigating the issues.

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"Violation of an Insured’s Right to Independent Counsel May Preclude Collateral Estoppel," by Daniel H. Rylaarsdam was published in the American Bar Association Litigation Section on September 30, 2026.