Question: Can a court consider evidence other than the petition and insurance policy to determine whether a duty to defend exists when the petition does not address a crucial issue for determining coverage?

Answer: Yes. Extrinsic evidence can be considered if the evidence (1) goes solely to the 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 facts to be proved.

It is no secret that paying to defend a lawsuit is expensive. Insurance may cover the expense, but Texas courts have been restricted in the evidence they can consider in determining whether an insurance company has a duty to pay for an insured’s expenses. Earlier this year, however, the Texas Supreme Court created an exception that allows courts to consider additional evidence in some circumstances to determine whether an insurance company has an obligation to pay attorney fees and expenses.

The Background

Insurance policies typically have both a duty to indemnify which means paying all covered claims and judgments against the insured, and a duty to defend which means defending the insured against claims or suits seeking damages covered by the policy. These are separate duties and are analyzed differently. Generally, comparing the insurance policy to the facts proven in the lawsuit controls whether a duty to indemnify is triggered. Comparing the insurance policy to the facts alleged in the petition controls whether a duty to defend is triggered.

In determining whether a duty to defend exists, courts follow a rule known as the “eight corners” rule. The rule states that the petition and insurance policy are the only relevant evidence to consider in determining whether an insurance company has a duty to defend. The duty is determined by comparing the allegations in the plaintiff’s petition to the policy provisions without regard to the truth of the allegations and without reference to facts otherwise known or ultimately proven. In an opinion issued in 2020—Loya Ins. Co. v. Osbaldo Hurtado Avalos, et al.—the Texas Supreme Court allowed an exception to the eight corners rule. The court held that evidence showing that a third-party plaintiff and the insured colluded to make false representations of fact in the petition to secure a defense and create coverage where it would not otherwise exist can be considered. In Monroe Guaranty Insurance Company v. BITCO General Insurance Corporation, however, the Texas Supreme Court was asked to determine whether an exception to the eight corners rule exists in a very different situation.

The Story

The dispute started between a property owner and a water well drilling contractor.  The property owner hired the contractor to drill a well on his property. The property owner alleged that the contractor drilled the hole incorrectly. He alleged that when the contractor drilled the well, the contractor deviated from vertical, stuck the drilling bit in the bore hole rendering the well useless and damaging the aquifer beneath his property, refused to plug the well and retrieve the bit, refused to drill a new well, and failed to properly case the hole resulting in the well filling up with clay. The petition alleges that the property owner’s land was damaged but was silent as to when the land was damaged or when the property owner learned of the damage. These were crucial issues for determining duty to defend issues.

The contractor had purchased commercial general liability insurance from two different carriers for different time periods and demanded a defense. One carrier, BITCO, defended under a reservation of rights while the other carrier—Monroe—refused to defend contending that the damage occurred before its policy period began. BITCO ultimately paid for defenses costs and to settle the case for the contractor but wanted reimbursement from Monroe.

To recover some of the defense costs, BITCO sued Monroe in federal district court seeking a declaration that Monroe owed a duty to defend the insured. The insurance companies stipulated that the drill bit became stuck in the bore hole in or around November 2014. That meant that it became stuck during BITCO’s policy period and months before Monroe’s policy period began. Monroe argued that because of this stipulation, it had no duty to defend. That would seem to be a compelling argument.

However, the eight-corners rule only allows a court to consider the insurance policy and petition in determining whether a duty to defend exists. As a result, the federal district court determined that it could not consider the stipulation. Based on the petition, the court held that the damage could have occurred anytime from formation of the drilling contract in 2014 until the filing of the lawsuit in 2016 so Monroe’s policy was triggered, and Monroe had a duty to defend the contractor. BITCO won, but Monroe would not go quietly.

Monroe appealed to the United States Court of Appeals for the Fifth Circuit. The Fifth Circuit recognized that whether it could consider the stipulation was key to deciding the case. Since this was an unsettled issue of Texas law, the Fifth Circuit sent certified questions to the Texas Supreme Court asking them to decide whether the Fifth Circuit could consider the stipulation.

And the Answer is . . .

The Texas Supreme Court held that a court can consider evidence outside of the narrow evidence allowed under the eight corners rule in determining whether a duty to defend exists in certain circumstances. Specifically, the extrinsic evidence can be considered when 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.” It sounded like Monroe had won, but the Court still had to apply the rule to the facts of the case.

The Court held that although extrinsic evidence can be considered if it meets the test, the facts of this case did not fall within the exception. Namely, the court reiterated that the evidence can only be considered if the evidence “goes solely to an issue of coverage and does not overlap the merits of the liability.” Remember, the stipulated fact was the date when the drill bit became stuck. The Court reasoned that to trigger coverage, the contractor would likely have tried to prove that the drill bit becoming stuck did not cause any damage. Likewise, the contractor would also likely have tried to prove that some of Plaintiff’s damages occurred after the bit became stuck to trigger Monroe’s policy. These arguments, however, would undermine the contractor’s best liability defenses for the underlying lawsuit. Specifically, these would undermine the insured’s ability to argue that there was no damage in November 2014 or at any time after that. As a result, the stipulation did not fall within the exception and could not be considered. BITCO won again meaning Monroe was obligated to assist with payment of the legal expenses.

The Lesson

This case and the Avalos case opened the possibility of using extrinsic evidence to determine duty to defend issues in Texas. In another case decided the same day as the Monroe case—Pharr-San Juan Alamo ISD v. Texas Political Subdivisions Prop./Cas. Joint Self Ins. Fund—the Texas Supreme Court cited Monroe for the existence of an exception, but again decided that the facts of that case did not warrant going outside of the “eight corners rule.” This month, however, the Fifth Circuit in Drawbridge Energy US Ventures v. Fed. Ins. Co. cited the exception set out in Monroe and allowed extrinsic evidence to be considered for determining a duty to defend under a claims-made policy. The coming months and years will tell us just how broad this exception really is.

Scot Pierce, Esq. is a trial lawyer and transactional attorney.  Click on his picture for his profile page.

Disclaimer: This post contains general opinions and analysis, is solely for educational purposes, and should not be treated as advice for any specific case.