In disputes concerning an insurer’s duty to defend, Texas courts may now consider extrinsic evidence of fraud and collusion designed to secure a defense.
On May 1, 2020, the Texas Supreme Court delivered its opinion in Loya Insurance Company v. Avalos, adopting a new exception to the “Eight Corners Rule.” The opinion addresses an open question from the Court’s recent opinion in Richards v. State Farm Lloyds in which the Court answered a certified question from the Fifth Circuit asking whether the absence of a groundless-claims clause in an insurance policy impacts the applicability of the Eight-Corners Rule. The Court held that it did not, but noted in its analysis that, “some courts often allow extrinsic evidence on coverage issues that do not overlap with the merits [of the plaintiff’s claim] in order to determine whether the claim is for losses covered by the policy.” As the Fifth Circuit did not ask the Court’s opinion on that practice, the Court left the issue unaddressed. But Avalos presented the Court with an opportunity to consider the practice.
In Avalos, there was undisputed evidence that the defendant-insured and the plaintiff colluded to make false statements for the purpose of invoking the insurer’s duty to defend. The trial court granted summary judgment for the insurer, stating that the parties were essentially asking the court to perpetuate a fraud. However, the court of appeals reversed, ignoring the extrinsic evidence of fraud and holding that the insurer had a duty to defend as a matter of law based on the face of the pleadings and the terms of the insurance policy—even though the court found its own conclusion “logically contrary.” One justice concurred in the judgment and requested the Court create a narrow exception to the Eight-Corners Rule “for instances of undisputed fraud and collusion designed solely to create a duty to defend.”
The Court did just that, holding that the Rule “does not bar courts from considering . . . extrinsic evidence regarding collusive fraud by the insured in determining the insurer’s duty to defend.” The Court explained that “the duty to defend in liability insurance policies applies to fraudulent allegations against the insured by third parties,” not “against fraudulent allegations brought about by the insured itself.” Consequently, “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.” The Court further held that in such cases, an insurer is not “required to pursue a declaratory judgment action before withdrawing its defense.” But in light of the potential legal consequences of wrongfully withdrawing a defense, the Court encouraged insurers to seek a declaratory judgment if there is any potential for “a real controversy regarding the duty to defend.”