The Eight Corners Rule in Texas
Over the last year, state and federal courts in Texas have faced the recurring question of whether the Eight Corners Rule in Texas should be reworked to allow the consideration of extrinsic evidence in certain, limited situations, and if so, when. The federal courts in Texas have long recognized one exception to the rule, the so-called Northfield exception, permitting review of extrinsic evidence where it is impossible to discern from the pleadings alone whether a duty to defend exists. In state court, departure from the Eight Corners Rule is still rare.
In 2020, the Texas Supreme Court twice evaluated new proposed exceptions to strict application of the rule. The court recognized an exception in one case but not the other. The overarching takeaway from these cases is that courts may in very narrow circumstances consider extrinsic evidence, but only if the extrinsic material is concrete evidence showing the insured colluded with the third-party claimant to manipulate the facts of the claim so as to make the claim covered when it otherwise would not have been. The Texas Supreme Court has yet to formally recognize the Northfield exception, but federal courts in Texas continue to apply it, as recently as this month, in Canal Insurance Company vs. Greenland Trucking, LLC.
Richards v. State Farm Lloyds, 597 S.W.3d 492 (Tex. 2020)
In Richards, the Texas Supreme Court addressed the question on certification from the Fifth Circuit on whether the Eight Corners Rule applies only if the insurance policy contains a “groundless-claims clause,” a position first adopted by the Federal District Court for the Northern District of Texas in B. Hall Contracting, Inc. v. Evanston Ins. Co. 447 F. Supp. 634 (N.D. Tex. 2006) and reiterated by the same federal court in Richards. See No. 4:17-CV-753-A, 2018 WL 2225084 (N.D. Tex. May 15, 2018).
The case involved the death of a ten-year old boy in an all-terrain vehicle (ATV) accident. At the time of the accident, the boy’s paternal grandparents were supervising him. His mother sued the grandparents for negligent failure to supervise and provide instruction to the child. The grandparents had a homeowner’s insurance policy with State Farm Lloyds, and the grandparents asked State Farm to defend them in the tort lawsuit. State Farm agreed to provide a defense subject to a reservation of rights but simultaneously filed a federal action for declaratory judgment, seeking a declaration that State Farm owed no duty to defend or indemnify the grandparents.
Through summary judgment briefing, State Farm sought to submit two pieces of evidence to support an argument that policy exclusions barred coverage: (1) the police report (to support the application of the motor-vehicle exclusion); and (2) a court order from a suit affecting the parent-child relationship (to prove the child fell under the insured exclusion). The grandparents argued that the Eight Corners Rule disallowed consideration of the evidence. The federal district court disagreed, holding that the Eight Corners Rule only applies when the insurance policy explicitly requires the insurer to defend “all actions against its insured no matter if the allegations of the suit are groundless, false, or fraudulent.” This “groundless-claims clause,” as the Texas Supreme Court called it, was not in the State Farm policy, so the district court considered the extrinsic evidence, ultimately finding in favor of State Farm. The grandparents appealed to the Fifth Circuit, and the Fifth Circuit certified the following question to the Texas Supreme Court: “Is the policy-language exception to the eight-corners rule articulated in B. Hall Contracting Inc. v. Evanston Ins. Co., 447 F. Supp. 2d 634 (N.D. Tex. 2006), a permissible exception under Texas law?”
The Texas Supreme Court began its analysis by outlining the history and policy giving rise to the Eight Corners Rule. The Richards Court rejected the position that the Rule stemmed from the inclusion of a groundless-claims cause. According to the Texas Supreme Court, the Rule is rooted in the fact that the insurer agrees in the insurance policy to defend a policyholder “if a claim is made or a suit is brought against an insured for damages because of bodily injury . . . to which this coverage applies.”
The Texas Supreme Court reserved comment on whether the Northfield exception exists in Texas for situations where coverage cannot be determined from the facts as pled. The Texas Supreme Court twice mentioning the exception in the opinion may indicate the Court leans toward acknowledging it. But the certified question did not involve the Northfield inquiry. Addressing the specific question posed by the Fifth Circuit, the Texas Supreme Court concluded that the “policy-language exception,” created by the federal district court in B. Hall and reiterated in Richards, “is not a permissible exception [to the Eight Corners Rule] under Texas law.”
Loya Insurance Company v. Avalos, 610 S.W.3d 878 (Tex. 2020)
Avalos arose from an automobile accident. Loya Insurance Company issued an automobile policy to Karla Flores Guevara. The Loya Insurance policy explicitly excluded Guevara’s husband, Rodolfo Flores, from coverage. At the time of the accident, however, Flores was driving. He struck another car driven by Osbalda Hurtado Avalos and Antonio Hurtado (collectively referred to by the Texas Supreme Court as the “Hurtados”). The Hurtados, Guevara, and Flores agreed to tell both the responding police officer and Loya Insurance that Guevara was driving, not Flores. The Hurtados thereafter sued Guevara and sought coverage from Loya Insurance, claiming damages resulting from Guevara’s negligent operation of her vehicle. Loya Insurance hired an attorney to defend Guevara, but early in the discovery process, Guevara disclosed to the attorney that Flores was the person driving when the accident occurred. On learning this information, Loya Insurance withdrew its defense and disclaimed a duty to defend or indemnify Guevara. Meanwhile, the trial court granted summary judgment in favor of the Hurtados, awarding them over $450,000.
Armed with a judgment in their favor and an assignment of Guevara’s rights against Loya Insurance, the Hurtados filed suit against Loya Insurance, asserting claims of negligence, breach of contract, bad faith, and various violations of the Texas consumer statute. Loya Insurance counterclaimed for breach of contract, fraud, and declaratory judgment. In the course of litigation, Loya Insurance deposed Guevara, who acknowledged on the record that Flores rather than she was driving the car. Loya Insurance moved for summary judgment on the ground that Loya Insurance owed no duty to defend or indemnify under the Loya Insurance Policy. The trial court took the evidence into consideration and ruled in favor of Loya Insurance.
The Hurtados appealed, seeking to use the Eight Corners Rule to suppress evidence of the fraud and bind Loya Insurance solely to the contents of the policy and the pleadings. The appellate court, constrained by the strict articulation of the Eight Corners Rule, reversed in favor of the Hurtados, with one concurring opinion inviting the Texas Supreme Court to create an exception to the Eight Corners Rule “for instances of undisputed fraud and collusion designed solely to create a duty to defend.”
The Texas Supreme Court granted certiorari to address the unique question raised by the case. The court summarized the prevalence and precedence underpinning the Eight Corners Rule, including the reservation in past cases for future circumstances that might warrant creating an exception. The Avalos Court then determined, “This case presents just such a circumstance.” As elaborated by the Texas Supreme Court:
Given the contractual foundations of the eight-corners rule, we conclude it does not bar courts from considering such extrinsic evidence regarding collusive fraud by the insured in determining the insurer's duty to defend . . . . The insurer has not agreed to undertake, and the insured has not paid for, a duty to defend the insured against fraudulent allegations brought about by the insured itself. Thus, an insurer owes no duty to defend when there is conclusive evidence that groundless, false, or fraudulent claims against the insured have been manipulated by the insured's own hands in order to secure a defense and coverage where they would not otherwise exist.
Avalos is a common sense but very limited holding, confined to the specific set of facts presented in that case. The collusive-fraud exception to the Eight Corners Rule created by Avalos is the first and only exception recognized by the Texas Supreme Court, which otherwise has acted consistently to uphold a strict application of the Eight Corners Rule in determining an insurer’s duty to defend. And although the Avalos Court concluded that an insurer, encountered with “undisputed evidence of collusive fraud,” need not first pursue declaratory relief before withdrawing its defense, the Court cautioned that statutory remedies, including treble damages, penalty interest, and attorneys’ fees, could be imposed if an insurer is wrong.
Canal Ins. Co. v. Greenland Trucking, LLC, Civil Action No. 3:20-CV-2970-G, 2021 WL 462051 (N.D. Tex. Feb. 9, 2021)
Federal courts in Texas recognize an additional exception to the Eight Corners Rule when it is unclear from the face of the pleadings whether a duty to defend exists. Courts and legal commentators often credit the Fifth Circuit’s opinion in Northfield for this exception.
Pursuant to the Northfield exception, a court can consider extrinsic evidence when two elements are met: (1) when it is impossible to discern from the pleadings whether coverage is potentially implicated; and (2) when the extrinsic evidence goes solely to a fundamental issue of coverage and does not “overlap with the merits of or engage the truth or falsity of any facts alleged in the underlying case.” In application, courts have used the exception as a basis to consider whether extrinsic evidence indicates a policy exclusion will apply to bar coverage.
In Greenland Trucking, the federal district court determined that the insurer, under the Northfield exception, could introduce evidence showing a tort plaintiff was an employee, triggering two policy exclusions. The case arose from an accident involving a tractor-trailer. The tractor-trailer had been leased to Greenland Trucking, LLC by Maekel Habtemariam. A party injured in the accident, Simon Yitbarek, was a passenger in the tractor-trailer at the time of the accident. Yitbarek brought suit in Texas state court against the driver, Yohannes Meharena, and against the driver’s employer, Greenland Trucking “and/or” Habtemariam.
Canal Insurance Company’s commercial automobile policy was issued to Greenland Trucking. With the tort lawsuit pending in state court, Canal Insurance filed a federal action for declaratory judgment in the Northern District of Texas, seeking a declaration that the Canal Insurance did not owe Greenland Trucking a defense againsat Yitbarek’s bodily injury claims. Specifically, Canal Insurance argued that the Employee Indemnification and Employer's Liability Exclusion and the Fellow Employee Exclusion barred coverage. Yitbarek filed a motion to dismiss, attempting to use the Eight Corners Rule as a sword to disallow any evidence indicating Yitbarek was an employee of Greenland Trucking.
Relying on the Northfield exception, the federal district court denied Yitbarek’s motion to dismiss. In evaluating Yitbarek’s state court pleading, the federal court concluded that the petition omitted “a necessary fundamental fact to determine coverage: whether Yitbarek was or was not an employee of Greenland.” Because the question of whether Canal Insurance owed a defense hinged on whether Yitbarek was an employee of Greenland Trucking, the court, adopting language from prior Fifth Circuit precedent, reasoned that “such an explanation is critical to the question of coverage.” This, the court held, satisfied the first Northfield element.
Looking to the second Northfield element, the court explained that the question of Yitbarek’s employment status did not necessarily impact the merits of Yitbarek’s underlying tort claims. Moreover, as previously held by the Fifth Circuit, extrinsic evidence is more likely to be considered “when an explicit policy coverage exclusion clause is at issue.” See Star-Tex Res., L.L.C. v. Granite State Ins. Co., 553 Fed. App’x 366, 371-72 (5th Cir. 2014).
Based on the federal courts’ continued endorsement of the Northfield exception, the federal district court denied Yitbarek’s dismissal motion, finding that based on the facts and pleadings in that case, the Eight Corners Rule could not be used foreclose relevant evidence that might establish the absence of coverage.
The Canal Insurance ruling, and the line of cases applying the Northfield exception that precede it, stand for the principle that a party seeking coverage cannot omit facts easily established in an effort to plead into coverage. In that respect, the public policy accomplished by the Northfield exception is consistent with the concerns underlying the Texas Supreme Court’s Avalos holding. But whether the Texas Supreme Court will also ultimately fully adopt the Northfield exception is yet to be determined.