Mending the Gap (in Pleadings): Texas Supreme Court allows for consideration of extrinsic evidence in evaluating an insurer’s duty to defend

The Texas Supreme Court answered certified questions from the Fifth Circuit last week in Monroe Guaranty Insurance Company v. BITCO General Insurance Corporation, -- S.W.3d --, 2022 WL --, at * -- (Tex. Feb. 11, 2022), carving out an exception to the long-standing “eight corners rule” defining when a liability insurer is obligated to defend its insured in an underlying lawsuit. In particular, the Court held that an insurer may consider evidence extrinsic to the complaint in the underlying lawsuit if that evidence (1) goes solely to an issue of coverage and does not overlap with the merits of liability; (2) does not contradict facts alleged in the underlying pleading, and (3) conclusively establishes the coverage fact to be proved. Importantly, this test differs from the test for the use of extrinsic evidence that the Fifth Circuit had previously prescribed in Northfield Ins. Co. v. Loving Home Care, Inc., 363 F.3d 523 (5th Cir. 2004) in several ways.

In Texas, the application of the eight-corners rule is considered well-settled law.  E.g., Monroe v. BITCO, -- S.W.3d --, 2022 WL --, at * -- (Tex. Feb. 11, 2022); Heyden Newport Chem. Corp. v. S. Gen. Ins. Co., 387 S.W.2d 22, 24 (Tex. 1965). Under this rule, a liability insurer may consider only only the four corners of the policy and the four corners of the live pleading in the underlying lawsuit when determining whether it must defend an insured in that lawsuit.  Northfield Ins. Co. v. Loving Home Care, Inc., 363 F.3d 523, 528 (5th Cir. 2004).  Extrinsic evidence or facts outside of the pleadings are generally not considered under this rule.  

Insurers and policyholders alike have challenged the contours of the rule, and over the last fifty years there has been considerable litigation questioning whether exceptions to the general rule may apply. See, e.g., id. at 529–30 n.3, 5 (citing Cook v. Ohio Cas. Ins. Co., 418 S.W.2d 712 (Tex. App. 1967), Int’l Serv. Ins. Co. v. Boll, 392 S.W.2d 158 (Tex. App. 1965), and John Deere Ins. Co. v. Truckin’ USA, 122 F.3d 270 (5th Cir. 1997)).); Monroe, S.W.3d at __.  Despite these efforts, Texas has been generally regarded as a strict “eight corners” jurisdiction.  Indeed, prior to handing down Monroe, the Texas Supreme Court had recently carved out only a limited exception to the “eight corners” rule, in which it permitted an insurer to introduce extrinsic evidence of collusion between the insured and a third party claimant to make false representations of fact to secure a defense under the insurer’s policy and create coverage where it would otherwise not exist. Loya Ins. Co. v. Avalos, 610 S.W.3d 878, 879 (Tex. 2020).

Last week’s decision in Monroe clarifies more broadly when an insurer may consider extrinsic evidence in determining whether it has a duty to defend. In Monroe, the underlying plaintiff asserted breach-of-contract and negligence causes of action against the insured drilling company alleging that it had negligently drilled an irrigation well, damaging the plaintiff’s land. The plaintiff’s petition did not specify when the insured’s purportedly negligent acts occurred or when any damage occurred. The drilling company had obtained two different commercial general liability insurance policies from two different insurers, each insuring the drilling company in different but consecutive policy years, and sought coverage for the underlying lawsuit from both insurers. One insurer defended under a reservation of rights. The other declined to defend, asserting that any property damage occurred before its subsequent policy period began. The defending insurer ultimately settled the underlying lawsuit and sued the declining insurer for contribution to defense costs it incurred in the underlying lawsuit. In that coverage action, both insurers stipulated that the alleged incident causing damage to the underlying plaintiff’s land occurred in November 2014, which was approximately ten (10) months before the declining insurer’s policy period began. Upon cross-motions for summary judgment in that coverage action, the district court concluded that it could not consider the insurers’ stipulated, extrinsic evidence that the alleged incident occurred in November 2014 for purposes of evaluating whether the declining insurer actually had a duty to defend in the underlying lawsuit because of the “eight corners” rule and granted summary judgment to the defending insurer. 

On the declining insurer’s appeal to the Fifth Circuit, the Fifth Circuit certified the following two questions to the Texas Supreme Court:

1 Is the exception to the eight-corners rule articulated in Northfield Ins. Co. v. Loving Home Care, Inc., 363 F.3d 523 (5th Cir. 2004), permissible under Texas law?

2 When applying such an exception, may a court consider extrinsic evidence of the date of an occurrence when (1) it is initially impossible to discern whether a duty to defend potentially exists from the eight-corners of the policy and pleadings alone; (2) the date goes solely to the issue of coverage and does not overlap with the merits of liability; and (3) the date does not engage the truth or falsity of any facts alleged in the third party pleadings?

Id. at __.

In response to the first certified question, the Supreme Court of Texas explained that the “eight corners” rule is still the initial inquiry to be used when determining whether a duty to defend exists, but [I]f 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 provided the evidence (1) goes solely to an issue of coverage and does not overlap with the merits of liability, (2) does not contradict facts alleged in the pleading, and (3) conclusively establishes the coverage fact to be proved.

Id. at __ (emphasis added).

This test differs from that in Northfield in three important ways. First, the exception is not limited only to situations where it is impossible to discern from the pleadings and policy “whether coverage is potentially implicated,” as articulated in Northfield. Id. at __ (quoting Northfield, 363 F.33d at 531). Instead, the Texas Supreme Court stated that the threshold inquiry should be: “does the pleading contain the facts necessary to resolve the question of whether the claim is covered?” Id. at __.

Second, the Northfield exception limited the types of extrinsic evidence that may be considered to those that go to a “fundamental” coverage issue, specified as: “(1) whether the person sued has been excluded by name or description from any coverage; (2) whether the property in the suit is included in or has been expressly excluded from any coverage; and (3) whether the policy exists.” Northfield, 363 F.3d at 530 (citing Westport Ins. Corp. v. Atchley, 267 F. Supp. 2d 601, 621 (E.D. Tex. 2003)). In Monroe, the Supreme Court eliminated this requirement to prevent tasking courts with determining whether the coverage issue in the dispute is “fundamental.” Id. at __.

Finally, under Monroe, the extrinsic evidence must conclusively establish the coverage fact at issue. Id. at __ (“But extrinsic evidence may not be considered if there would remain a genuine issue of material fact as to the coverage fact to be proved.”). The Northfield test did not require this additional element. Accordingly, as long as each prong of the Monroe test is satisfied, extrinsic evidence may be considered to mend a gap in a plaintiff’s live pleading to conclusively establish whether the duty to defend exists.

In response to the Fifth Circuit’s second certified question, the Supreme Court held that it would not categorically limit the types of extrinsic evidence to be considered, as in Northfield, and that evidence of the date of an occurrence may be considered if it meets the other requirements of the Monroe test.  Monroe, ---S.W.3d --- at ___.  Nevertheless, the Supreme Court concluded that the insurers’ stipulation that the alleged incident in the underlying lawsuit occurred in November 2014 did not pass this test because that evidence was relevant both to whether coverage applied and to the merits of the underlying dispute.  Id.   In particular, the Supreme Court determined that the question of when the insured’s allegedly negligent drilling occurred was relevant to the underlying liability issue of whether any property damage occurred, because the insured may contend that its acts or omissions did not cause any property damage to the plaintiff at all. The Supreme Court reasoned that the insured would have to assert that some of plaintiff’s alleged damages occurred after November 2014 to trigger coverage under the declining insurer’s policy, which would undermine its liability defense.  Id.  Therefore, the Supreme Court concluded that the declining insurer could not consider the stipulation of the date of the allegedly negligent incident in determining its duty to defend because that fact overlapped with the merits of the underlying case.

On the same day, the Texas Supreme Court applied the newly-defined Monroe test to another set of facts in Pharr-San Juan-Alamo Indep. Sch. Dist. v. Tex. Political Subdivisions Prop./Cas. Joint Self Ins. Fund, -- S.W.3d --, 2022 WL --, at * -- (Tex. Feb. 11, 2022). The question in Pharr-San was whether an automobile liability insurer could consider extrinsic evidence of the description of a golf-cart, by way of evidence gathered during discovery, to determine whether the golf-cart at issue was “a vehicle designed for travel on public roads” that may trigger its duty to defend the insured in a lawsuit arising out of a golf-cart accident. In that case, the Supreme Court first concluded that, under the “eight corners” rule, the insurer did not have a duty to defend the insured in an underlying lawsuit because the allegation in the pleadings that the plaintiff was “thrown from a golf cart” did not include any allegation that the plaintiff was thrown from “a vehicle designed for travel on public roads.”  Id. at ____.  The Supreme Court further concluded that the Monroe test for potentially considering evidence extrinsic to the pleadings was inapplicable because a “golf cart” is designed for travel on a golf course, not on public roads, such that an allegation that the plaintiff was thrown from a golf cart left no “gap” that would prevent the determination of whether a duty to defend exists. Id. Therefore, the circumstances in Pharr-San required only application of the standard “eight-corners” rule, without resort to any extrinsic evidence, to determine the duty to defend, such that the Monroe test for potential consideration of extrinsic evidence was inapplicable.

Though many welcome the Supreme Court’s answer to the question of the application of the Northfield exception, it is likely that the Court has simply shifted the focus of the litigation from “does the exception exist” to a myriad of questions as to whether the exception applies to a specified set of facts and, when applied, whether it was applied correctly. As a result, the impact of these decisions is likely to be experienced in litigation for numerous years to come.