Extrinsic Evidence Not Allowed to Prove Exclusions to Duty to Defend

The United States Court of Appeals for the Fifth Circuit, applying Texas law, reversed and remanded the decision of the district court because, in contravention of the eight-corners rule, the district court improperly allowed extrinsic evidence into its review of whether State Farm Lloyds (“State Farm”) had a duty to defend.

This case stems from an ATV accident where a ten-year old child died after his grandparents, Janet and Melvin Richards, allowed him to drive an ATV while he was at their house. The boy’s mother sued the Richards alleging that they were negligent in allowing the child to operate the ATV at his young age, without instruction, supervision, a helmet, or other protective gear.  The Richards tendered their defense and indemnity of the case to their homeowner’s insurer, State Farm. State Farm sued the Richards seeking a declaration that it did not have a duty to defend or indemnify the Richards.

State Farm moved for summary judgment arguing that two policy exclusions barred coverage: (1) the “motor-vehicle exclusion” and (2) the “insured exclusion.”  In support of its motion, State Farm attached extrinsic evidence supporting each exclusion. The Richards argued that under Texas’s eight-corners rule, State Farm could not rely on extrinsic evidence to prove a policy exclusion.  The district court disagreed with the Richards and found the purported “policy-language exception”  to the “eight-corners” rule applied, stating that “[T]he eight-corners rule does not apply if a policy does not include language requiring the insurer to defend ‘all actions against its insured no matter if the allegations of the suit are groundless, false or fraudulent.’” As a result, the district court held that State Farm did not have a duty to defend or indemnify.  The Richards appealed.

The Fifth Circuit certified the following question to the Supreme Court of Texas: “Is the policy-language exception to the eight-corners rule … a permissible exception under Texas law?” The Supreme Court of Texas answered in the negative; the “policy-language exception” to the eight-corners rule is not permissible under Texas law.  According to the Texas Supreme Court, a showing of collusive fraud by the insured is the only exception to the eight-corners rule.

Thus, finding no allegations of collusive fraud, the Fifth Circuit applied the eight-corners rule without exception on appeal.  Under the eight-corners rule, the allegations in the complaint and the terms of the policy determine whether an insurer has a duty to defend. If the insured establishes the claim could fall within the scope of coverage, then the burden shifts to the insurer to show that the plain language of a policy exclusion applies to avoid coverage. If there are any doubts regarding whether there is a duty to defend, the courts should find in favor of coverage.

The Fifth Circuit found that the underlying complaint alleged facts that possibly implicated coverage under the policy.  State Farm urged the Fifth Circuit to apply an alternative exception to the eight-corners rule. Under the very narrow exception, “where 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.” According to the Fifth Circuit, the narrow exception did not apply because the extrinsic evidence offered to support the exclusions directly overlapped and contradicted the facts alleged in the underlying complaint.

Under the eight-corners rule, the insurer failed to meet its burden to establish that either proposed exclusion applied to bar coverage. Therefore, State Farm has a duty to defend.  The Fifth Circuit reversed and remanded the case back to the district court. State Farm Lloyds v. Richards, 966 F.3d 389, No. 18-10721 (5th Cir. July 20, 2020).