Texas Supreme Court Recognizes Exception to Eight Corners Rule

The Texas Supreme Court issued an opinion today recognizing an exception to the eight corners rule in a case involving collusive fraud on the part of the insured.  At issue was a dispute over coverage for damages arising from an automobile accident in which an excluded driver was operating the insured vehicle.  Following the accident, the insured, the excluded driver, and the claimants agreed to falsely represent to the responding officer that the insured had been driving the vehicle.  The claimants brought suit against the insured for damages arising from the collision, and the insurer furnished a defense.  When the discovery process revealed that an excluded driver had been driving the vehicle, the insurer withdrew the defense and denied coverage.  The claimants moved for summary judgment against the insured, and the court ultimately entered a judgment of approximately $450,000.

The insured assigned her rights to the claimants, who then sued the insurer alleging that the denial of a defense and coverage was improper.  The insurer brought a counterclaim seeking a declaratory judgment that it owed no defense or coverage because an excluded driver was operating the vehicle at the time of the accident.  In support of its motion for summary judgment, the insurer relied on excerpts from the insured’s deposition in which she recanted her initial statement that she had been driving the vehicle.  The trial court granted summary judgment, and the claimants appealed.  The court of appeals reversed the trial court’s judgment, holding that the insurer had a duty to defend under the eight-corners rule.

The supreme court unanimously held that the eight-corners rule does not bar the consideration of extrinsic evidence in determining an insurer’s duty to defend in situations in which  the insured fraudulently colludes with the claimant to invoke the policy’s coverage.  The Court reasoned that the duty to defend applies to fraudulent allegations against the insured by third parties, and not those brought about by the insured itself.  Therefore, if there is conclusive evidence that fraudulent claims against the insured have been manipulated by the insured’s “own hands”  to bring about coverage where it would not otherwise exist, the insurer owes no duty to defend.

The Court also rejected the argument that the insurer should have been required to obtain a declaratory judgment before withdrawing defense, concluding that a declaratory judgment is not necessary when proof of fraud is undisputed.  In doing so, the Court noted that an insurer that breaches its duty to defend by improperly withdrawing a defense can be liable for statutory damages and attorney fees.   The court encouraged insurers to seek a favorable declaratory judgment before withdrawing a defense in most cases in which  there is a “real controversy” regarding the duty to defend.