For decades, an insurer’s duty to defend under Texas law was determined exclusively by reviewing the insurance contract and the allegations of the complaint under the “eight-corners rule.” All of this changed last week when, in a long-awaited decision, the Texas Supreme Court ruled that courts may consider extrinsic evidence to determine the existence of coverage in certain limited situations. Monroe Guar. Ins. Co. v. BITCO Gen. Ins. Corp., No. 21-0232, 2022 WL 413940 (Tex. Feb. 11, 2022).
In Monroe, a drilling contractor was sued for damages arising out of the allegedly botched drilling of an irrigation well. The underlying lawsuit alleged that negligent drilling caused damage to surrounding farmland. However, the complaint did not allege when the damage occurred. The contractor’s insurers, BITCO General Insurance Corporation (“Bitco”) and Monroe Guarantee Insurance Company (“Monroe”) disputed whether Monroe owed a duty to defend. Although Bitco agreed to provide a defense, Monroe refused, arguing that the property damage happened before its policy period. Bitco sued Monroe for contribution. In the trial court, the insurers stipulated that a drill bit became stuck before Monroe’s policy incepted, a fact that would have supported Monroe’s “prior damage” defense. On summary judgment, though, the trial court ruled this stipulated fact could not be considered under Texas’s eight-corners rule. Monroe appealed, and the Fifth Circuit, which had previously endorsed an exception to the eight-corners rule under Northfield Insurance Co. v. Loving Home Care, Inc., 363 F.3d 523, 531 (5th Cir. 2004), certified the question to the Texas Supreme Court.
The Texas Supreme Court responded by recognizing an exception to the eight-corners rule and explaining there are certain instances where courts can use extrinsic evidence when evaluating coverage. The Court held that extrinsic evidence can be used when it is not possible to determine coverage due to “gaps” in the plaintiff’s pleading, and where the proffered extrinsic 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 fact to be proved.”
Applying this exception to the facts in Monroe, the Texas Supreme Court refused to consider the stipulated extrinsic fact that a drill bit became stuck on a certain date. The Court reasoned that this extrinsic evidence goes to the question of when property damage occurred, which overlaps with the question of whether property damage occurred; because this question was critical to liability, the Texas Supreme Court refused to consider the date on which the drill bit became stuck when analyzing Monroe’s duty to defend.
Monroe is a game-changing opinion that will have broad consequences for Texas insurers and policyholders. Monroe leaves unresolved several important questions, including what qualifies as a “gap” in pleadings, what kind of evidence relevant to coverage would not overlap with underlying liability, and what it takes for evidence to “conclusively” establish a fact relevant to coverage.
We expect to see significant litigation on each of these issues in the future. Although it is too early to tell whether the Monroe exception will favor insurers or policyholders, based on the Texas Supreme Court’s single application, Monroe suggests that an insurer hoping to avoid a defense based on extrinsic evidence will have an uphill battle.
Finally, it appears that the Monroe exception will have a big impact on construction-defect litigation. Establishing a duty to defend in these cases often turns on undisputed extrinsic evidence such as subcontracts that satisfy the terms of additional-insured endorsements, or generally-accepted presumptions about when property damage occurred (like close of escrow dates or certificates of occupancy). There are often extrinsic facts that might be relevant to coverage but which plaintiffs’ attorneys do not include in pleadings and that are often vague. It remains to be seen how courts will treat this scenario.