## Facts

- Armstrong Cleaners, Inc. and its owners operated dry-cleaning businesses in Muncie, Indiana from 1989 to 1996.
- The Armstrongs were later sued in environmental-contamination litigation involving two dry-cleaning sites.
- The Armstrongs tendered the defense to their liability insurer, Erie Insurance Exchange.
- Erie agreed to defend but did so under a broad reservation of rights, disputing coverage and potentially its duty to defend, citing coverage defenses including “occurrence,” pollution exclusion, and “expected or intended” injury.
- Erie insisted on selecting and controlling defense counsel for the underlying suits.
- The Armstrongs asserted the reservation of rights created a conflict because factual and strategic choices in the liability defense (e.g., whether releases were accidental, expected, gradual, or sudden) could also determine coverage.

## Issues

1. Whether an insurer’s defense under a broad reservation of rights creates a conflict of interest under Indiana Rule of Professional Conduct 1.7(a)(2) that entitles insureds to independent counsel of their choosing, paid by the insurer, rather than insurer-selected counsel.

## Decision

- The court granted summary judgment for the Armstrongs and denied Erie’s cross-motion.
- The court held Erie’s reservation of rights created a “significant risk” under Indiana Rule of Professional Conduct 1.7(a)(2) that insurer-selected counsel’s representation would be materially limited by responsibilities to Erie.
- The court declared the Armstrongs were entitled to select independent defense counsel, subject to Erie’s reasonable approval, with reasonable fees and expenses paid by Erie.
- The court rejected Erie’s argument that conflicts exist only in narrow pleading situations (e.g., intentional vs. negligent alternatives) and found the conflict analysis must address practical risks in fact-intensive litigation.
- The court found Erie’s proposed screening (“Chinese wall”) measures inadequate to eliminate the significant risk of divided loyalty in this setting.

## Legal Principles

- Under Indiana Rule of Professional Conduct 1.7(a)(2), a conflict exists when there is a significant risk a lawyer’s representation will be materially limited by duties to a third person (including an insurer) or by the lawyer’s own interests.
- When an insurer defends under a reservation of rights and the underlying litigation is likely to resolve facts that also bear on coverage, insurer control of the defense can create a disqualifying conflict risk.
- In such circumstances, the insured may be entitled to independent counsel, selected by the insured, with the insurer responsible for reasonable defense fees and expenses, subject to reasonable insurer approval of counsel and costs.
- Internal screening procedures may be insufficient where the insurer both contests coverage on fact-dependent grounds and seeks to control defense counsel whose strategic decisions could affect coverage.

## Conclusion

The court ruled that Erie’s broad reservation of rights in fact-intensive environmental litigation created a significant risk of materially limited representation under Indiana’s conflict-of-interest rule, requiring Erie to pay for independent counsel chosen by the insureds (with reasonable insurer approval and reasonable fees).


Armstrong Cleaners, Inc. v. Erie Ins. Exch., 364 F. Supp. 2d 797 (S.D. Ind. 2005)