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Insurance companies that use so-called captive firms to represent their policyholders are not violating rules regulating the practice of law. So ruled California’s 4th District Court of Appeal on Wednesday in a case that could have had wide-ranging implications for the insurance industry and certain segments of the legal industry. “An insurance company does not engage in the practice of law due to the mere employment relationship between the insurer and the attorneys defending its insured against third-party claims,” wrote Justice Terry O’Rourke in a 50-page unanimous opinion. The plaintiffs in the case challenged the widespread practice in which insurers employ lawyers to defend policyholders in litigation. While these firms appear to be autonomous entities, often sporting distinct names and their own letterhead, they are actually divisions of the insurance company. In the case decided Wednesday, Gafcon v. Ponsor, Travelers Property Casualty Corp. assigned its captive firm, Ponsor & Associates, to represent policyholder Gafcon Inc. in a construction dispute. According to Gafcon’s lawyers, Travelers’ use of Ponsor constituted an unauthorized practice of law and amounts to a corporation offering legal services to third parties, in violation of the Business & Professions Code. But the court agreed with Travelers that the practice was permissible since Travelers had its own financial interest in the outcome of the case. The court also held that Ponsor’s reliance on salaried lawyers does not inherently create a temptation to violate ethical rules on client loyalty. “We reject the argument that such a relationship supports the presumption that in-house counsel will always favor the insurer’s interests,” O’Rourke wrote. Solana Beach, Calif.-based Stuart Eppsteiner, who represented Gafcon, said he was disappointed with the court’s decision, calling it “erroneous.” He said he plans to file a motion for reconsideration, as well as a petition for supreme court review. A representative for Travelers was unavailable for comment.

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