The Texas Supreme Court Recognizes an Exception to the "Eight Corners Rule" in Insurance Coverage
Background. The eight-corners rule refers to a rule of practice used in Texas to determine if an insurer has a duty to defend an insured under a liability insurance policy for claims asserted against the insured in a third-party lawsuit. GuideOne Elite Ins. Co. v. Fielder Road Baptist Church, 197 S.W.3d 305, 307 (Tex. 2006). Generally, an insurer has two separate and distinct duties under a liability insurance policy, the duty to defend and the duty to indemnify. An insurer may have a duty to defend even when it has no duty to indemnify, and vice versa, an insurer may have a duty to indemnify even when it had no duty to defend. D.R. Horton-Texas, Ltd. v. Markel Int’l Ins. Co., Ltd., 300 S.W3d 740, 743-744(Tex. 2009). Allegations raised against the insured in a lawsuit may fit within the policy coverage and trigger a duty to defend even if the facts actually established in the underlying suit negate the insurer's duty to indemnify. However, if the factual allegations in an underlying complaint fall outside the policy coverage, neither duty is triggered. Farmers Tex. County Mut. Ins. Co. v. Griffin, 955 S.W.2d 81, 82 (Tex. 1997). For many years, Texas has used the eight-corners rule to determine the insurer's duty to defend. The rule prescribes the comparison of the four corners of the third-party plaintiff's petition against the four corners of the insured's insurance policy. GuideOne at 307. Even if the allegations in the petition were groundless, false, or fraudulent the insurer is still obligated to defend if an allegation falls within the coverage provided by the policy. Zurich Amer. Ins. Co. v. Nokia, Inc., 268 S.W.3d 487, 491 (Tex 2008). When applying the eight -corners rule, courts are to give the allegations in the petition a liberal interpretation, focus on the factual allegations that show the origin of the damages rather than on the legal theories alleged, and resolve all doubts concerning the duty to defend in favor of the insured. "It is not the cause of action alleged that determines coverage, but the facts giving rise to the alleged actionable conduct." Adamo v. State Farm Lloyds Co., 853 S.W.2d 673, 676 (Tex.App.- Houston [14th Dist.] 1993, writ denied). Up until recently, evidence outside of the eight corners that contradicts the allegations in the petition, i.e. extrinsic evidence, could not be considered to determine coverage. Pine Oak Builders, Inc. v. Great Am. Lloyds Ins. Co., 292 S.W.3d 48, 52 (Tex. App.—Houston [14th Dist.] 2006), aff’d in part, rev’d in part on other grounds, Pine Oak Builders, 279 S.W.3d at 655. The duty to defend depends on the language of the policy setting out the contractual agreement between insurer and insured.” An insurer has a duty to defend if the facts as alleged by the plaintiff against the insured, when fairly and reasonably construed, whether true or not, state a cause of action potentially covered by the policy. Folsum Investment, Inc. v. American Motorists Ins. Co., 26 S.W.3d 556, 558-9 (Tex. App. – Dallas 2000, n.w.h.) Where the petition does not state facts sufficient to clearly bring the case within or without the coverage, the general rule is that the insurer is obligated to defend if potentially, there is a case under the petition within the coverage of the policy. Zurich, 268 S.W.3d at 491. Stated differently, in case of doubt as to whether or not the allegations of a petition or complaint against the insured state a cause of action within the coverage of a liability policy sufficient to compel the insurer to defend the action, such doubt is to be resolved in the insured's favor. Id. If an insurer has a duty to defend its insured against any one claim plead in the petition of the underlying suit, then the insurer is required to defend its insured against all claims in that petition. Id. The eight-corners rule is a well established insurance doctrine used for many decades in Texas to determine the duty to defend. Richards v. State Farm Lloyds, 63 Tex. Sup Ct. J. 614, 2020 WL 1313782, *6 (March 20, 2020). For years, courts other than the Texas Supreme Court, have speculated as to whether the Texas Supreme Court would ultimately recognize any exception to the eight-corners rule. It now has.
Exception Recognized for an Insured's Collusive Fraud. In Loya Ins. Co. v Avalos, ____ Tex. Sup Ct.J. ___ , 2020 WL 2089752 (May 1, 2020), the Texas Supreme Court considered a situation where the insured conspired with the plaintiff to lie about how the accident happened so there could be coverage for the accident. Rodolfo Flores caused an accident while driving his wife's car injuring the Hurtados. Flores was excluded from coverage under his wife's insurance policy. Flores and his wife and the Hurtados conspired to report that Flores' wife was operating her car at the time of the accident so there would be coverage. After the wife was sued for negligently causing the accident, she confided in her attorney that she was not operating her vehicle at the time of the accident and that they all conspired to lie about who was driving. Upon learning this, her insurance carrier terminated its defense of her and denied any coverage to her under the policy. The Hurtados ultimately took a judgment against Flores' wife for over $450,000. Flores' wife assigned her rights against her insurer to the Hurtados, who then filed suit against the insurer, alleging its denial of a defense and coverage was negligent, breached the insurance contract, breached the duty of good faith and fair dealing, and violated the Texas Deceptive Trade Practices–Consumer Protection Act (DTPA). The insurer brought counterclaims for breach of contract, fraud, and a declaratory judgment that it owed no coverage and had no duty to defend because Flores, an excluded driver, was driving at the time of the accident. The insurer then brought a motion for summary judgment which the trial court granted providing that the plaintiffs take nothing. The Court of Appeals reversed holding that despite the apparent fraud by the insured, the eight-corners rule dictated that the insurer had a duty to defend and wrongfully withdrew its defense of Flores' wife. Id. at *2. On further appeal, the Texas Supreme Court adopted for the first time an exception to the eight-corners rule based on the facts of this case. The Court held: 1) that the eight-corners rule does not bar a court from considering extrinsic evidence of collusive fraud by the insured in determining a liability insurer’s duty to defend; a liability 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; and when confronted with undisputed evidence of collusive fraud, a liability insurer need not pursue a declaratory judgment action to determine its duty to defend before terminating representation. Id. What set the Avalos case apart, and created the right facts for the recognition of this exception to the eight-corners rule, was the evidence of collusive fraud by the insured herself. Id. at *3. In such cases, when an insurer is presented with undisputed evidence of an insured's collusive fraud the insurer is permitted to terminate its defense of the insured, although getting a declaratory judgment that it is not required to defend is typically recommended and a safer avenue to pursue for the insurer.
Second Possible Exception Noted. In another recent case, the Texas Supreme Court answered a certified question from the federal Fifth Circuit Court of Appeals on whether certain policy language can contract away from the application of the eight-corners rule. Richards v. State Farm Lloyds, 63 Tex. Sup Ct. J. 614, 2020 WL 1313782, *6 (March 20, 2020). While the Court did not say it was not possible to contract out of the application of the eight-corners rule, it did hold by omitting the words "groundless, false or fraudulent" from its defense provision in the policy, the insurer did not contract out of the application of the eight-corners rule. Id. at *6. The Court noted that the eight-corners rule is a well established precedent in Texas used to determine the duty to defend. Id. The Court also indicated in Richards, that other exceptions to the eight-corners rule might be justified. One such exception mentioned in the Richards case, but not determined, is an exception to the use of extrinsic evidence. Typically extrinsic evidence, i.e. evidence outside the eight corners, is not permitted in an analysis of an insurer's duty to defend. An exception was recognized by the Fifth Circuit Court of Appeals in Northfield Ins. Co. v. Loving Home Care, Inc., 363 F.3d 523, 531 (5th Cir. 2004). That exception allows the use of extrinsic evidence which bears on the duty to defend and is applicable only when (1) “it is initially impossible to discern whether coverage is potentially implicated” and (2) “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.” Northfield Ins. Co., 363 F.3d at 531. As noted in Richards, courts applying Texas law are split on whether this exception should be recognized or not. And while discussed in passing by the Texas Supreme Court in Richards, that Court has has not yet had the right case to determine whether this exception will be recognized in Texas or not. Until the Texas Supreme Court has a case with this issue, the federal courts, and some state courts, will likely continue to utilize this exception.
Conclusion. The eight-corners rule is still alive and well in Texas, and provides the framework for an insurer to determine its duty to defend an insured in third-party claims against the insured. If there is undisputed evidence of collusive fraud by the insured, the insurer may terminate its defense or seek a declaratory judgment against its insured on the duty to defend. Federal courts, applying Texas law, recognize a second exception, which has not yet been ruled on by the Texas Supreme Court. This leads to the conclusion, that with most insurance issues in Texas, it is generally better to be in federal court if you represent an insurer and state court if you represent an insured.