Extrinsic Evidence, or Eight Corners? Texas Court Sheds Light on Determining the Duty to Defend

Last year, the Texas Supreme Court adopted a narrow exception to the state’s eight-corners rule, and allowed the consideration of extrinsic evidence to determine the duty to defend. The exception arguably raised more questions than it resolved. Last month, a Texas federal court answered some of these questions by rejecting an insurer’s attempt to introduce extrinsic evidence under the newly minted exception.

Texas permits few, if any, deviations from its eight-corners rule, which determines an insurer’s duty to defend by only considering the operative pleading and the terms of the policy, without any regard to extrinsic evidence or facts. This protects policyholders by erring on the side of defending claims, even if coverage is questionable. In Monroe Guar. Ins. Co. v. Bitco Gen. Ins. Corp., 640 S.W.3d 195, 199 (Tex. 2022) (“Monroe”), the Texas Supreme Court adopted an exception to the eight-corners rule, holding that extrinsic evidence may be considered when an “information gap” between the pleading and the policy makes it impossible to determine coverage, but only in limited scenarios where the extrinsic 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.

Monroe was troublesome to policyholders. Not only was this the first proverbial crack in the eight-corners rule dam, but Monroe raised several questions about when insurers can rely on extrinsic evidence to determine coverage. For example, what qualifies as a “gap” in pleadings, what kind of evidence is relevant to coverage but does not overlap with underlying liability, and what evidence “conclusively” establishes a fact relevant to coverage?

Last month, a Texas federal court shed light on these questions when it rejected Underwriters at Lloyd’s (“Underwriters”) attempt to introduce extrinsic evidence under the Monroe exception. In Certain Underwriters at Lloyd’s, London v. Keystone Dev., LLC, No. 3:21-CV-336-L, 2022 WL 6202129 (N.D. Tex. Oct. 7, 2022) (“Keystone”), Keystone was sued for construction defects and resulting physical damage at a residential development known as Cityscape Plaza. The operative petition alleged that the plaza consists of two separate projects: one comprised of four buildings with 24 three-story condominiums, and another comprised of two buildings with 15 three-story condominiums. Underwriters denied coverage, relying on policy language that excludes coverage for “projects that exceed 25 units.” Underwriters offered extrinsic evidence (a master deed, that was referenced in an earlier petition) to show that Cityscape was, in fact, a single project, consisting of 39 units, and therefore excluded from coverage. 

The court rejected Underwriters’ bid. Applying the eight-corners rule, the court held that the operative pleading alleges facts that implicate coverage under the policy, thereby triggering Underwriters’ duty to defend. The petition directly alleged that the development was two projects, each with less than 25 units, so the court would not consider the master deed to determine whether Underwriters’ exclusion applied. The court rejected Underwriters’ attempt to conflate ambiguous policy language (undefined terms like “project” and “units”) with an “information gap” between the pleading and policy provision as contemplated by Monroe. Because ambiguities must be resolved in favor of coverage, the Keystone court did not accept the extrinsic evidence and ordered Underwriters to defend the case. 

The Keystone court further held that, even if an information gap didexist between the policy and the pleading, it could not consider the master deed because its relevant language describes the project in a way that would cause the court to engage in the truth or falsity in the underlying petition, which is forbidden under Monroe. 

Underwriters also sought to introduce extrinsic evidence about the actual heightof the buildings, since the pleadings allege that they were three-story buildings, but the policy excludes coverage for projects “exceeding three stories or 36 feet in height.” Underwriters’ argument was again rejected. There was no information gap in the pleadings; they alleged three-story buildings, which fall within coverage. 

Takeaways 

Time will tell how much of an impact the Monroe exception will have on Texas’ eight-corner rule. Keystone was a good test; the Keystone court held that the extrinsic evidence, which (arguably) demonstrated that a claim fell within coverage exclusions was impermissible under Monroe’s factors, and the insurer was ordered to defend. Keystone is especially helpful because it implies that ambiguous policy language does not create an “information gap” warranting the use of extrinsic evidence, and the ruling sheds light on how narrowly Texas courts still view extrinsic evidence, even in construction defect cases where the pleadings are often vague (and sometimes contradictory).