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For the first time in Texas, a court has ruled that the insurance company practice of using so-called “captive firms” to defend policyholders against suits constitutes the unauthorized practice of law. The May 20 ruling by 68th District Court Judge Gary Hall of Dallas is a win for the state Unauthorized Practice of Law Committee, which first attacked the use of captive firms by insurance companies three years ago. But lawyers on both sides of the case say the district court ruling is merely the first step toward a final resolution of the controversial issue in Texas’ appellate courts. Captive firms essentially are law offices staffed by attorneys who are employees of insurance companies but who represent policyholders. The UPLC began investigating numerous insurance companies that employed captive firms in 1998, maintaining that corporations cannot practice law in Texas except to defend themselves. UPLC lawyers argue that the staff counsel of captive firms can’t serve two masters: insurance companies that pay their salary and policyholders who are their clients. Hall’s ruling in American Home Assurance Co., The Travelers Indemnity Co, et al. v. UPLC, a 2-year-old declaratory judgment action filed by two insurance companies seeking to have their captive firms blessed by the courts, provides no injunctive relief. Rather, the order requires American Home and Travelers to adopt a policy of referring questions regarding conflicts of interest and ethics in policyholders’ cases to outside counsel. “The net effect is to provide a buffer between the staff counsel and the employer [the insurance company],” says Leland De La Garza of Dallas’ De La Garza & Wallace and chairman of the Dallas UPL Subcommittee. “If a question of any kind of coverage or conflict arises, then the staff counsel can’t go up their normal chain of command on that issue,” says Jim Cowles of Dallas’ Cowles & Thompson who represents American Home. “They have to go to outside.” Tom Rogers, a partner in the Austin office of Jackson Walker who represents Travelers, says he is not pleased with Hall’s ruling but is grateful the order allows the insurance companies to continue using staff counsel. “We’re pleased he didn’t enter an injunction,” Rogers says. “But we still believe he is incorrect in his finding that use of staff counsel by an insurer to defend its insureds in a liability policy is the unauthorized practice of law by the insurer.” Rogers says there is no difference between staff counsel and outside counsel employed by insurance companies, except that staff counsel are usually salaried employees of the company. NOT OVER YET Attorneys on both sides believe the Texas Supreme Court will have to settle American Home once and for all. The first case to address the issue, UPLC v. Allstate, was filed in state district court in Dallas in October 1998, and is more complicated than the American Home case. Allstate is bogged down in discovery. Another declaratory judgment action, Nationwide v. UPLC, was filed two years ago in U.S. District Court in Dallas. The district court dismissed the case, advising that the company could join other state court suits where the same issue is being litigated. A February 2002 decision by the 5th U.S. Circuit Court of Appeals found nothing wrong with Nationwide Mutual Insurance Co.’s use of staff counsel, but ruled that the issue should ultimately be decided by state courts. The case is pending in state court. The posture by lawyers for the insurance companies and the UPLC in American Home always has been to get the issue before the state appellate courts, Cowles says. “There was no acrimony at all. The issue was to get this decision in Texas. It’s been decided in 10 other states,” Cowles says. “Now it’s time for Texas to decide it.” Mark Ticer, a former Dallas UPL Subcommittee chairman who represents the committee in Allstate and American Home, agrees with Cowles. “In simple terms, round one to the UPLC, round two will take place at the Dallas Court of Appeals, and the winner there will go to the supreme court” unless the Texas Legislature intervenes and changes the law, Ticer says. Ticer says he is not sure how American Home might affect the Allstate and Nationwide litigation other than “it certainly doesn’t hurt us in other courts.” Rod Phelan, a partner in Dallas’ Baker Botts who represents Allstate, says a ruling favorable to the insurance companies in American Home would be dispositive in Allstate, but an unfavorable ruling wouldn’t necessarily stop the Allstate litigation. In pleadings, Allstate’s lawyers maintain that the UPLC cannot prove any policyholders were harmed or complained about the company’s use of captive firms. James W. Walker, managing partner of Dallas’ Walker Sewell who represents Nationwide, was out of town last week and could not be reached for comment. Rogers says 10 state courts and one federal court have issued opinions finding that the use of captive firms is not the unauthorized practice of law. Ethics opinions in 10 other states also have blessed the practice. Two states, North Carolina and Kentucky, have issued state court opinions that prohibit the practice. Captive firms have been used in the United States for more than 100 years and for more than 50 years in Texas, Rogers says, as a way for insurance companies to minimize litigation costs. Notes Rogers, “That’s one important factor is the insurers are able to control costs which, in turn, saves the rate payers money.”

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