The Texas Supreme Court has, for the first time, explicitly adopted a narrow exception to the venerable "eight-corners rule" for determining an insurer's duty to defend in Loya Ins. Co. v. Avalos, No. 18-0837 (May 1, 2020).
Specifically, the court held that "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."
As I discussed in a previous commentary, "Eight-Corners Rule under Siege," the eight-corners role as applied in Texas has been under siege in recent years. The rule was reinforced in Richards v. State Farm Lloyds, 2020 WL 1313782 (Mar. 20, 2020), where the court, answering a question certified by the Fifth Circuit, rejected the "policy-language exception" that would allow a resort to extrinsic evidence under most current policies, which no longer explicitly promise a defense "even if the allegations of the suit are groundless, false or fraudulent."
The court in Richards declined to weigh in on the so-called Northfield exception favored by the Fifth Circuit Court of Appeals, which would allow extrinsic evidence "when it is initially impossible to discern whether coverage is potentially implicated and when 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. v. Loving Home Care, Inc., 363 F.3d 523, 531 (5th Cir. 2004). [Emphasis in original.]
Loya Ins. Co. v. Avalos: Facts and Ruling
Confronting a more stark set of facts in Loya, the court held the eight-corners rule is nullified by deliberate fraudulent collusion between an insured and a third-party plaintiff. Kara Flores Guevara was the sole insured under an auto liability policy issued by Loya Insurance. Her husband, Rodolfo Flores, who was explicitly excluded from coverage, was driving Guevara's car when it collided with a car owned by Osbaldo Hurtado Avalos and Antonio Hurtado (the "Hurtados"). But Guevara, Flores, and the Hurtados agreed to tell the responding officer and the insurer that Guevara was driving her car at the time of the accident.
The Hurtados then sued Guevara, and Loya hired an attorney to defend her. When Guevara told the attorney her husband had been driving the car, the insurer immediately withdrew its defense and denied coverage. The Hurtados obtained a judgment against Guevara, who assigned them any rights she had against the insurer.
The Hurtados sued Loya for breach of the insurance policy and the usual tort and statutory claims. Loya counterclaimed and deposed Guevara, who admitted the truth about her husband's role in the accident. The trial court concluded the Hurtados were asking the court "to ignore every rule of justice and help [them] perpetuate a fraud" and granted summary judgment for Loya.
The Hurtados appealed, and the San Antonio Court of Appeals reversed, holding that the eight-corners rule barred reliance on extrinsic evidence of collusion. One justice concurred in the judgment, urging the Texas Supreme Court to create a narrow exception to the rule that would encompass "undisputed fraud and collusion."
The Texas Supreme Court reviewed the history of the eight-corners rule and its reluctance to create exceptions but noted it had previously indicated "that collusive fraud by the insured might provide the basis for an exception." The court concluded the facts of this case presented "such a circumstance," emphasizing that the evidence conclusively established Guevara was not driving her car at the time of the accident and the "parties to the underlying case conspired to lie about who was driving to trigger insurance coverage."
The court also rejected the argument that the insurer was required to obtain a judicial declaration that it had no duty to defend before withdrawing its defense. While the court encourages declaratory judgment actions to resolve such issues, it does not mandate them. This does not, however, give insurers carte blanche to abandon their insureds "where there is a real controversy regarding the duty to defend." The court emphasized the substantial risks of common law or statutory bad-faith liability facing an insurer who refuses to defend without seeking judicial confirmation of its position. Therefore, the Texas Supreme Court reversed the court of appeals and reinstated the trial court's judgment.
In addition to the continued controversy over the putative Northfield exception, insurers and policyholders can now be expected to disagree over the scope and effect of the Loya collusion exception to the eight-corners rule.
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