You have asked for an opinion on the following fact situation: You have been hired to represent an insured and are being paid by the insurance company. You are defending a liability claim for an insured and have discovered that a defense to the action would be to plead that the plaintiff was acting in the scope of his employment and should pursue a Worker's Compensation as opposed to a general liability claim. However, if you notify the insurance company of these facts it could be to the detriment of your client, in that the insurance company will be able to deny coverage to the insured who will then be left liable for damages (and possible statutory penalties) without any coverage.
Rule of Professional Conduct 1.4 provides that:
(a) A lawyer shall keep a client informed about the status of a matter and promptly comply with reasonable requests for information.
(b) A lawyer shall explain a matter to the extent necessary to permit the client to make informed decision regarding the representation.
Rule of Professional Conduct 1.8 (f) provides that:
A lawyer shall not accept compensation for representing a client from one other than the client unless:
(1) the client consents after full disclosure of the circumstances and consultation;
(2) there is no interference with the lawyer' a independence of professional judgment or with the client-lawyer relationship; and
(3) information relating to representation of a client is protected as required by Rule 1.6.
The Committee is of the opinion that Rule 1.4 requires that you disclose the information you have to your client and explaining that disclosure of the information would be detrimental to the client and advising the client against such disclosure. Moving on to Rule 1.8f as above, the Committee feels that although it is to the insurance carrier's benefit to have the information, that to provide it would constitute a violation of Rule 1.8f(2) & (3).
The issue of divided loyalties when representing insureds and being paid by insurance carriers has been addressed in the context of in-house counsel providing representation in prior Committee Opinion 86-108. While there are considerable conflict of interest problems present for in-house counsel that are not present for an outside firm hired to represent a client, some of the considerations are the same and you are urged to also read Opinion 86-108 as it does have some applicability to your situation.