In Steel v. Philadelphia Indemnity Ins. Co., 195 Wash.App. 811, 381 P.3d 111 (Wash. App. 2016), the Washington Court of Appeals held that insurance companies do not waive attorney-client privilege or work product protection when their insured enters into a covenant judgment settlement that is subject to judicial determination as to reasonableness. In Steel, a day care center’s employee was convicted of child rape and child molestation of two children at the day care center. At the time, the defendants were insured under a Philadelphia Indemnity policy providing $1M in coverage. Plaintiffs offered to settle their claims for $4M which was rejected by Philadelphia. Shortly before trial was scheduled to begin, the insureds entered into a $25M covenant judgment settlement with the plaintiffs, receiving a covenant not to execute in return, for an assignment of the insureds’ bad faith claims against Philadelphia.
Philadelphia sought to conduct discovery regarding the reasonableness of the covenant judgment settlement. During discovery, the insureds provided Philadelphia with many documents but refused to provide documents involving attorney-client communications and attorney work-product. Philadelphia argued that the insureds had waived the attorney-client privilege and work-product protection regarding documents pertaining to the covenant judgment settlement. The trial court agreed with Philadelphia and granted Philadelphia’s motion to compel production. However, the Washington Court of Appeals reversed.
The issue before the Court was the scope of implied waiver of attorney-client privilege. In determining implied waiver of attorney-client privilege, the Washington Court followed the standard set forth in Hearn v. Rhay, 68 F.R.D. 574 (E.D. Wash. 1975) which instructed courts to consider three factors in determining privilege waiver: (1) assertion of the privilege was the result of some affirmative act; (2) through the affirmative act, the asserting party put the protected information at issue by making it relevant to the case; and (3) application of the privilege would have denied the opposing party access to information vital to his defense.
In rejecting Philadelphia’s implied waiver argument, the Court noted that under RCW 4.22.060(1), Washington law provided that when parties enter into a release, covenant not to sue, covenant not to enforce judgment, or similar agreement, Washington Courts were required to review the agreement for reasonableness. The insureds argued that they did not perform an affirmative act by entering into the settlement agreement because they were required by statute to seek a judicial determination of the settlement’s reasonableness. However, the Court of Appeals disagreed finding that the insureds had performed an affirmative act by voluntarily entering into a covenant judgment settlement that was subject to a hearing on reasonableness. However, the Court found that Philadelphia failed to show how the reasonableness of the settlement “depended on” the attorney-client communications. The privilege materials that were sought consisted of email communications among the insureds and their attorneys. Philadelphia failed to explain how those communications were integral to a determination of the reasonableness of the settlement given the fact that Philadelphia had already conducted a significant amount of discovery bearing on the merits of the underlying case. Ordinarily, reasonableness was established by expert testimony on the issues of liability, comparisons of damages in similar cases, and evidence as to the cost of defending the lawsuit. Because of this, the Court found that Philadelphia failed to show that the attorney-client communications were integral to the reasonableness determination and as such the plaintiffs had not placed them at issue. Because the attorney-client communications were not vital to Philadelphia, it was not ultimately manifestly unfair to protect the materials from discovery.