By: Donald L Swanson
When an individual files Chapter 7 bankruptcy, with a bad-faith claim against Debtor’s insurer as an asset, who controls Debtor’s attorney client privilege?
That’s the question in this new opinion:
- Chambers v. State Farm Mutual Automobile Insurance Co., Case No. 24-cv-00557 in the Colorado U.S. District Court, decided September 4, 2024.
The new opinion addresses and resolves discovery disputes in a bad faith lawsuit in which the Plaintiff had purchased a Chapter 7 Debtor’s bad faith claim against the Debtor’s insurer.
- The U.S. District Court rules against the insurer.
Facts
Here’s a simplified version of what happened.
In 2018, Plaintiff was a passenger in a BMW driven by Debtor. The BMW, allegedly going 80 miles per hour, collided with a vehicle turning left at an intersection. Plaintiff and two others were injured.
State Farm, Debtor’s insurer, determined that Debtor, the driver, was 10% at fault.
Plaintiff and two other injured individuals filed suit against Debtor. No pre- or post-suit settlement was reached, and State Farm paid for Debtor’s defense.
Trial resulted in a verdict and judgment against Debtor in excess of the $100,000 policy limit. State Farm paid the policy’s remaining limits on the judgment but refused to pay the excess. Debtor asserted a bad faith claim against State Farm.
Debtor filed Chapter 7 bankruptcy because of the excess verdict, and Debtor’s bad faith claim against State Farm became part of the bankruptcy estate.
Then, the Chapter 7 Trustee assigned Debtor’s bad faith claim against State Farm to Plaintiff, who brought suit as assignee.
The Bad Faith Claim
Plaintiff claims:
- State Farm’s 10% fault allocation in the underlying case is unreasonable on its face, so that State Farm breached its duty to pay the policy limit pre-suit; and
- State Farm moved to settle, soon after the lawsuit was filed, indicating that it had undervalued the risk to Debtor during its pre-suit assessment.
Waiving a Privilege in Bankruptcy
In the bankruptcy, Debtor expressly refused to waive any available privilege relating to the underlying tort case, saying to the Chapter 7 Trustee:
- “Per attorney client privileges, you are not authorized to give up personal information to anyone.”
Nonetheless, the Chapter 7 Trustee, on behalf of the bankruptcy estate, expressly waived any privilege the Debtor may have had with respect to the underlying tort case.
The Waiver Question—And its Context
The waiver question to be decided is this:
- whether Debtor’s attorney/client privilege is the Chapter 7 Trustee’s to waive?
Plaintiff now seeks to obtain, through discovery, information on State Farm’s reserves and settlement authority, along with State Farm’s entire claim file for each of the claimants.
And Plaintiff seeks rulings on:
- whether Debtor can claim attorney-client and/or work product privilege for documents from the underlying case; and
- whether State Farm can raise a work product privilege for the same documents.
State Farm’s position is:
- information on reserves and settlement authority are not relevant to the claims and not admissible;
- claim files for other claimants are protected by privacy concerns; and
- the wishes of State Farm’s insured, who refused to waive any privilege, must be respected.
State Farm’s Arguments
State Farm argues that the Chapter 7 Trustee cannot waive a privilege held by State Farm’s insured, under Colorado case law, because:
- the attorney-client privilege inures to the benefit and protection of the client (the Debtor in this case); and
- an attorney retained by an insurance carrier to defend the insured owes duties to the insured—not the insurance carrier.
Further, under case law outside Colorado, when a debtor’s claim is assigned to a third party in a bankruptcy proceeding, no waiver of the attorney-client privilege occurs absent an express or implicit waiver of that privilege in the bankruptcy court’s assignment order.
Individual Bankruptcy v. Corporate Bankruptcy
The U.S. Supreme Court has held that a bankruptcy trustee may waive a corporation’s attorney-client privilege with respect to pre-bankruptcy communications. See Commodity Futures Trading Comm’n v.Weintraub, 471 U.S. 343, 356 (1985).
However, the Supreme Court in that case expressly limited its holding to the privilege held by a corporation:
- “our holding today has no bearing on the problem of individual bankruptcy, which we have no reason to address in this case” (471 U.S. at 356).
So, in Chapter 7 bankruptcies filed by individual debtors, the questions are:
- does the attorney-client privilege pass to the trustee to be waived at the trustee’s whim? or
- does the debtor retain the right to waive or not waive the privilege?
The answer is this. It depends on:
- whether the bankruptcy trustee and the individual debtor are in an adversarial posture—or not; and
- whether the balancing of the parties’ interests favors the trustee’s control of the attorney-client privilege and its waiver.
Put another way:
- if the individual debtor and the bankruptcy trustee are in an adversarial position and if the debtor would be harmed by the trustee’s control of the attorney-client privilege, then the debtor should remain in control of that privilege; but
- if the trustee is not adverse to the individual debtor as to claims in the underlying lawsuit and the claims in question could benefit the bankruptcy estate, then the bankruptcy trustee should control the privilege.
Application to This Case
In this case, there is no evidence, or even a suggestion, of a tension between the Debtor and the Trustee:
- the Trustee seeks to maximize recoveries to the estate by assigning the bad faith claim to Plaintiff; and
- part of the Trustee’s assignment agreement with Plaintiff is that some portion of any recovery from the lawsuit against State Farm will be shared with the bankruptcy estate.
So, based on a balancing of the parties’ interests:
- the Trustee has the right to waive Debtor’s attorney-client privilege as to the underlying tort case; and
- State Farm cannot invoke the work product privilege to withhold documents.
“Therefore, the Court concludes that State Farm is not entitled to withhold, and is ordered to produce, those portions of its claim file from the underlying case that it believes to contain attorney-client or attorney-work product material.”
Related Issues
–Reserves & Settlement Authority
As to State Farm’s effort to withhold reserves and settlement authority information on grounds of relevance and inadmissibility at trial:
- even if such information is ultimately not admissible at trial, it is still discoverable in a bad faith case because of it’s potential relevance to the insurer’s good faith (or bad faith) conduct.
–Claim Files of Other Claimants
Protecting the “privacy interests” of other claimants is not a basis for State Farm to withhold their claim files. Here’s why:
- the material can and should be considered as “confidential” under the Protective Order issued in this case;
- it is important, for Plaintiff’s bad faith claim against State Farm, to know all the variables that State Farm was considering in deciding whether or not to offer policy limits pre-suit; and
- given the limited overall policy limits and the presence of multiple injured parties, what was going on in the claim files of the other claimants is relevant to an understanding of whether State Farm took a reasonable approach to defending the Debtor.
Conclusion
Fascinating stuff!
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