The insured tendered the complaint to both insurers and each took a different position with respect to the duty to defend, with BITCO agreeing to provide the insured a defense under a reservation of rights, and Monroe refusing to defend on the grounds that the alleged damage fell outside of its policy period.  BITCO filed suit against Monroe seeking a declaration that Monroe owed the insured a duty to defend, and in that dispute, the insurers stipulated that the allegedly negligent acts and resulting damage occurred "in or around November 2014" – about ten months before BITCO's CGL coverage ended and Monroe's began.  Based on this stipulation, Monroe maintained it had no duty to defend because the damage occurred during BITCO's policy period.  The district court rejected Monroe's argument, holding it could not consider the stipulated extrinsic evidence.  Monroe appealed to the Fifth Circuit, and the Fifth Circuit certified the issue to the Supreme Court of Texas.

The Supreme Court of Texas began its analysis by noting that although the eight-corners rule "is a settled feature Texas law" adopted "more than fifty years ago," it "is not absolute."  Indeed, less than two years ago, the Court adopted an exception to the eight-corners rule in Loya Ins. Co. v. Avalos, 610 S.W.3d 878, 879 (Tex. 2020), pursuant to which "courts may consider extrinsic evidence that the insured and a third party suing the insured colluded to make false representations of fact to secure a defense and create coverage where it would not otherwise exist."  Before Avalos, some Texas appellate courts considered extrinsic evidence where a petition stated a claim that could trigger the duty to defend but was silent on facts necessary to determine coverage – a practice that eventually trickled into federal courts in the Fifth Circuit.[1]

Given that the principles governing consideration of extrinsic evidence in duty-to-defend cases were not uniform, the Court undertook to standardize Texas law on the issue.  The Court held:

[I]f the underlying petition states a claim that could trigger the duty to defend, and the application of the eight-corners rule, due to a gap in the plaintiff's pleading, is not determinative of whether coverage exists, Texas law permits consideration of extrinsic evidence provided the evidence (1) goes solely to an issue of coverage and does not overlap with the merits of liability, (2) does not contradict facts alleged in the pleading, and (3) conclusively establishes the coverage fact to be proved.

The Court proceeded to consider whether the exception applied in the dispute between Monroe and BITCO, noting that under the right circumstances courts may consider extrinsic evidence of the date of an occurrence.  Under the facts of Monroe, however, the parties' stipulation that the allegedly negligent acts occurred "in or around November 2014" failed to satisfy the first prong of the Court's newly articulated test because the stipulation overlapped with the merits of the underlying lawsuit.  According to the Court, "[a] dispute as to when property damage occurs also implicates whether property damage occurred on that date, forcing the insured to confess damages at a particular date to invoke coverage, when its position may very well be that no damage was sustained at all."  The Court, therefore, held that consideration of the stipulation in determining Monroe's duty to defend was impermissible.  Because the allegations in the underlying complaint were silent as to when the property damage occurred, there was a potential for coverage under Monroe's policy, triggering Monroe's duty to defend.

II. The Pharr-San Juan-Alamo Decision

That same day, the Court took an opportunity to further illustrate the application of the Monroe exception in Pharr-San Juan-Alamo.  In the underlying lawsuit, the plaintiff sued a school district for injuries she suffered after being thrown from a golf cart driven by an employee.  The school district had automobile-liability insurance that obligated the insured to provide coverage for damages "caused by an accident and result[ing] from the ownership, maintenance or use of a covered auto."  The policy defined "auto" as "a land motor vehicle . . . designed for travel on public roads," but it did "not include mobile equipment," i.e., certain types of "land vehicles," including "[b]ulldozers, farm machinery, forklifts and other vehicles designed for use principally off public roads."  The dispute thus turned on whether, as the school district argued, the golf cart was a covered auto designed for travel on public roads, or whether, as the insurer argued, the golf cart was a non-covered vehicle designed for use principally off public roads.  The parties disagreed on whether extrinsic evidence was admissible to resolve this dispute.

The Supreme Court of Texas declined to apply the Monroe exception, and instead applied the eight-corners rule without consideration of extrinsic evidence.  Because the underlying complaint alleged injuries resulting from the negligent use of a "golf cart," a term that did not appear in the insurance policy, the Court turned to dictionary definitions, statutes, court decisions, and other authorities to determine its common, ordinary meaning.  Based on a review of these sources, the Court concluded the term "golf cart" refers to a vehicle designed "primarily for use on a golf course," meaning it does not refer to a vehicle "designed for travel on public roads" and thus was not a covered auto.  Accordingly, pursuant to the eight-corners rule, the Court held the insurer did not have a duty to defend.

The Court proceeded to explain why the Monroe exception was irrelevant.  Although the fact at issue – i.e., whether the vehicle from which the plaintiff was thrown was "designed for travel on public roads" – related solely to coverage and did not overlap with the merits of the underlying lawsuit, extrinsic evidence regarding that fact nevertheless could not be considered because there was no "gap" in the pleadings that prevented the Court from determining whether a duty to defend existed.  Indeed, the Court had already concluded that the common, ordinary meaning of the term "golf cart" is a vehicle "designed for travel on a golf course and not on public roads."  According to the court, "[m]ere disagreements about the common, ordinary meaning of an undefined term do not create the type of 'gap'" necessary to permit the application of the Monroe exception.  Moreover, in the absence of such a gap, any extrinsic evidence that the plaintiff was thrown from something other than a "golf cart" would have contradicted facts alleged in the underlying complaint, meaning the second prong of the Monroe exception could not be satisfied.

III. The Monroe Exception in Future Duty to Defend Litigation

The Court's formalization of this extrinsic evidence exception to the eight-corners rule creates an important factor for both policyholders and insurers to consider in duty-to-defend disputes moving forward, and the exact scope of the exception is something that is sure to be extensively litigated in lower courts for years to come.  Both Monroe and Pharr-San Juan-Alamo provide some initial guideposts for those disputes.

Before even getting into the details of the exception, parties must demonstrate that there is a "gap" in the pleadings.  As detailed in the Pharr-San Juan-Alamo opinion, a gap does not exist solely because the parties disagree on the meaning of a term.  Thus, where the common, ordinary meaning of a term is discernible and determinative of the insurer's duty to defend, resort to extrinsic evidence will be impermissible.  The Monroe exception may therefore turn out to be rather narrow, especially given that the test's three additional prongs will have to be satisfied to justify its application even if a gap exists.  Insurers who view Monroe as a boon that will allow use of extrinsic evidence to avoid defense obligations may ultimately be disappointed.

The clarity provided by the Court's ruling will nevertheless aid in focusing disputes regarding extrinsic evidence, and Monroe provides the first example of a factual scenario in which such evidence will not be permissible.  Where extrinsic evidence touches on disputed matters relating to liability in the underlying litigation, such as a stipulation regarding when certain damage occurred, it is unlikely to pass muster under the Monroe exception.  Under another set of facts, such as extrinsic evidence that the insured had merely performed work on the allegedly damaged property during one policy period, courts are more likely to reach a different outcome.

Meanwhile, there are certain factual circumstances in which Monroe may assist policyholders in establishing a duty to defend.  Policyholder contractual arrangements, which are often extrinsic to underlying complaints, may impact whether coverage exists.  For instance, a general contractor sued for personal injury may be entitled to liability coverage as an additional insured if it had a written contract with the subcontractor that employed the injured plaintiff.  The same may be true for a general contractor sued for property damage to its "work" but which engaged subcontractors, not identified in the plaintiff's lawsuit, to perform that work.[2]  Similarly, an employer sued by an employee for wrongful acts may be entitled to Employment Practices Liability coverage if the allegedly wrongful acts constitute a breach of an employment contract.  In these situations, the Monroe exception may prove to be a helpful tool for policyholders.

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If you have any questions about the content of this article, please contact Douglas C. Rawles, Jim Cooper or Andrew Barrios, or any other member of Reed Smith's Insurance Recovery Group.

[1] See, e.g., Northfield Ins. Co. v. Loving Home Care, Inc., 363 F.3d 523, 531 (5th Cir. 2004) (explaining extrinsic evidence is admissible "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").

[2] See, e.g., Pine Oak Builders, Inc. v. Great Am. Lloyds Ins. Co., 279 S.W.3d 650, 655 (Tex. 2009) (the insured argued that the complained-of work was performed by subcontractors, but the court held that there was no duty to defend under a strict reading of the eight-corners doctrine because the pleading alleged that the insured alone was liable for its conduct).