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.
Conclusion
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.