WHAT'S HAPPENING

The 8 corners and beyond, a Texas Supreme Court ruling and implications for designers’ and contractors’ insurance

By Andrew Le, Esq., Atheria Law

This article originally appeared in Westlaw Today on April 21, 2022

(April 21, 2022) – Andrew Le of Atheria Law discusses a recent Texas Supreme Court decision that confirmed an exception to the state’s “eight corners rule” and how the ruling might apply to coverage issues surrounding design and construction defect litigation.

The Texas Supreme Court recently issued a decision in Monroe Guaranty Insurance Co. v. BITCO General Insurance Corp., providing long-awaited guidance on the state’s eight-corners rule, which, under usual circumstances, strictly requires that an insurer’s duty to defend be based on (1) the pleadings against the insured and (2) the terms of the insurance policy.

The Monroe ruling confirms an exception to the rule, providing insurers the option to use extrinsic evidence beyond the “eight-corners” of the policy and pleadings to determine whether insurers have a duty to defend if the pleadings and policy are insufficient in themselves to assess whether the duty exists.

In the context of design and construction defect litigation, the decision provides a useful framework for insurers when evaluating whether to pursue declaratory relief regarding duty to defend issues. However, given the standard imposed by Monroe, the scope of this decision’s influence remains to be seen until the lower courts have had an opportunity to interpret and apply its guidance.

Background

In Texas, an insurer’s duty to defend historically has been understood to be broad and the pleadings are meant to be taken literally, as “[t]he duty to defend does not turn on the truth or falsity of the plaintiff’s allegations.”1

Prior to the Monroe decision, the U.S. Court of Appeals for the Fifth Circuit in Northfield v. Loving Home Care, Inc. read into Texas law an exception to the state’s otherwise strict eight-corners rule, permitting the use of extrinsic evidence to resolve duty to defend issues “when it is initially impossible to discern whether coverage is potentially implicated and when the extrinsic evidence goes solely to a fundamental issue of coverage which does not overlap with the merits of or engage the truth or falsity of any facts alleged in the underlying case.”2

In the years following the Fifth Circuit’s Northfield decision, the Texas Supreme Court generally declined to clarify or refine its position on whether the eight-corners rule remained effective in all cases. In 2020, the Texas Supreme Court in Loya Insurance Co. v. Avalos took one modest step away from the eight-corners rule, determining that a court may “consider extrinsic evidence that the insured and a third party suing the insured colluded to make false representations of fact to secure a defense and create coverage where it would not otherwise exist.”3

The Texas Supreme Court took a further step in Monroe, which considered the Fifth Circuit’s presentation of two certified questions (i.e. a formal request by one court to another to provide guidance on a question of law): (1) Is the Northfield exception to the eight-corners rule permissible under Texas law; and (2) In applying the exception, may a court consider extrinsic evidence regarding the date of an occurrence to determine if a duty to defend exists?

Monroe Guaranty Insurance Co. v. BITCO General Insurance Corp.

The Court’s decision in Monroe modifies the Northfield standard, stating that the 8-corners rule “remains the initial inquiry to be used to determine whether a duty to defend exists.”4 However, the court went on to hold that “if the underlying petition states a claim that could trigger the duty to defend, and the application of the eight-corners rule, due to a gap in the plaintiff’s pleading, is not determinative of whether coverage exists, Texas law permits consideration of extrinsic evidence,” where the evidence:

  • goes solely to an issue of coverage and does not overlap with the merits of liability;
  • does not contradict facts alleged in the pleading; and
  • conclusively establishes the coverage fact to be proved.5

The Court went on to rule that the proffered extrinsic evidence failed to meet the new Texas standard because extrinsic evidence regarding the date that property damage occurred overlapped with the merits of the case, which concerned damages resulting from a company’s drilling operations on the plaintiff’s property. Specifically, the date on which property damage occurred was essential to the merits of a case because continuous damages were at issue and could not be used to determine whether a duty to defend existed.6

While the Court ultimately declined to consider the extrinsic evidence at issue because part one of the test was not satisfied under the specific facts presented, the ruling sets out a new standard for insurers evaluating potential coverage duties under Texas law, particularly on those claims involving pleadings with significant factual gaps that make it difficult to reach a coverage determination.

Consideration of extrinsic evidence in other states

While a detailed overview of how courts across the United States handle the use of extrinsic evidence is beyond the scope here, it is apparent that jurisdictions remain largely divided on how to utilize extrinsic evidence, if at all, to establish (or relieve) an insurer’s duty to defend. How Texas now compares with California and New York’s respective approaches is illustrative.

The Monroe decision brings Texas into greater alignment with California’s more flexible approach in evaluating extrinsic evidence to assess whether a duty to defend exists. Under California law, the “duty to defend is determined by reference to the policy, the complaint, and all facts known to the insurer from any source,” and extrinsic evidence may be used to relieve an insurer’s duty to defend where the evidence “presents undisputed facts which conclusively eliminate a potential for liability.”7

By comparison, the new Texas exception adds flexibility to the previously strict rule against extrinsic evidence, although it technically remains the more stringent of the two approaches. As noted, Texas still requires, as an initial matter, the application of the “eight-corners” rule, with extrinsic evidence on the duty to defend issue admitted only if the three-part test above (i.e., goes solely to the issue of coverage and does not overlap with the merits, does not contradict alleged facts in the pleading, and conclusively establishes the coverage fact to be proved) is met.

On the other hand, under New York law, the rule is more one-sided in its impact, requiring an insurer to consider extrinsic evidence beyond the pleadings to determine whether a duty to defend exists if that duty is not supported by the pleadings. The insurer may not look beyond the face of the complaint to relieve itself of the duty to defend if the wording of the complaint is sufficient to trigger the duty.8 Washington also follows this approach.9

In the context of professional liability insurance, particularly in the space occupied by designers and contractors, lawsuits alleging design and/or construction defects are commonly filed with significant factual gaps in the pleadings as plaintiffs (typically distressed project owners, investors, or managers) are usually unaware of the cause and source of the defects at issue.

As such, it is possible (and even likely) for pleadings to omit facts that could determine whether a duty to defend exists, including, for example, information regarding an insured’s actual or constructive notice of a defect, the contract at issue, and scope of services at issue.

In these examples, insurers regularly use various pieces of evidence to assess, for example, whether the insured received and provided notice of the matter in accordance with a policy’s notification provisions and whether the allegations are related to another claim previously reported to another policy, which could negate coverage under the current policy.

Under the new Texas standard stated in Monroe, insurers are now allowed in specified situations to consider facts beyond the pleading to determine whether a duty to defend exists. The standard may be a challenging hurdle to overcome for insurers considering pursuit of declaratory relief on its duty to defend, primarily because the decision continues to prohibit the use of extrinsic evidence to the extent the evidence goes towards the merits of a case and contradicts facts in the pleadings. Further, the evidence must conclusively establish the coverage-related fact that it is introduced to prove.

In cases in which continuous damage is at issue (which was the case in Monroe), extrinsic evidence of an insured’s notice of a defect may be precluded from consideration because it goes to the merits of the underlying case. In construction and design defect lawsuits, continuous damage is often a concern, particularly on projects expected to generate revenues following substantial completion.

Further, evidence that allegations from a lawsuit are “related” to another claim for insurance coverage purposes is a notoriously fact-intensive inquiry, and usually requires multiple sources of evidence to establish. Texas, like California, has held that claims are related where they have “a logical or casual connection.”10

Given this relatively amorphous standard, insurers may, in attempting to establish relatedness, offer up multiple sources of extrinsic evidence, but will need to remain vigilant in light of the limitations presented by Monroe (e.g., evidence must not go to the merits of the case or otherwise contradict facts alleged in the underlying pleadings).

Summary

For insurers weighing the potential duty to defend under Texas law, the Monroe decision opens the door to consider new information outside of the “eight-corners” of the policy and pleading in some situations. This brings Texas closer to California, which generally allows the use of extrinsic evidence. The Monroe decision also appears to promote a fairer application of an insurance policy’s terms, enabling the parties to more appropriately evaluate coverage based on all available evidence, and perhaps reduce insurers’ exposure in some scenarios.

This approach, in promoting fairness as between insurer and insured, may inure to the benefit of insureds as well. Ultimately, by avoiding the expense of defending claims which are not actually covered, insurers can manage their claims portfolios more efficiently and may be in position to hold down premium increases for their insureds.

Insurers and their monitoring counsel applying Texas law must take care in evaluating available extrinsic evidence where the duty to defend is in question and ensure that the evidence adheres to the standards set out by the Texas Supreme Court in Monroe, although only time will tell how lower courts interpret and apply the standard. Further, insurers must carefully weigh the time and expense required to maintain an insured’s defense and determine whether there is value (from a time and cost perspective) in pursuing declaratory relief on a duty to defend issue.

 

Notes

GuideOne Elite Ins. Co. v. Fielder Rd. Baptist Church, 197 S.W.3d 305, 311 (Tex. 2006).

363 F.3d 523, 531 (5th Cir. 2004).

610 S.W.3d 878, 879 (Tex. 2020).

No. 21-0232, at 6 (Tex. Feb. 11, 2022).

Id.

Id. at 8.

Montrose Chem. Corp. v. Superior Ct., 6 Cal. 4th 287, 298-300 (1993).

8 See Fitzpatrick v. Am. Honda Motor Co., 78 N.Y.2d 61, 66-68 (1991).

9 See Expedia, Inc. v. Steadfast Ins. Co., 180 Wash. 2d 793, 804 (2014).

10 Columbia Cas. Co. v. CP Nat., Inc., 175 S.W.3d 339, 348 (Tex. App. 2004); see also Bay Cities Paving & Grading, Inc. v. Lawyers’ Mut. Ins. Co., 5 Cal. 4th 854, 873 (1993).

 

Andrew Le is an associate at Atheria Law in San Francisco, advising insurers on errors and omissions policies issued to professionals such as architects, engineers, attorneys, real estate agents and mortgage professionals. His practice includes representation, coverage advice and analysis of high-profile, multimillion-dollar claims. He also represents insurers in connection with general liability and property insurance policies. He can be reached at [email protected].