Law and Insurance

Federal District Judge Says Texas' "Eight-Corner" Rule Is No Longer Law. Really?

David Lewis Builders v. Mid-Continent Cas. Co., No. 4:09-CV- 218-A (N.D. Tex. April 1, 2010), see Lewis Decision

This otherwise unremarkable decision denies defense and indemnity liability coverage to a homebuilder who had to repair or replace its own work, something excluded under exclusions j.(5) and (6) in standard CGL policies.  What is remarable, however, is an observation made in footnote 3 of the decision that the so-called "eight-corners" or "complaint-allegation " rule no longer applies under Texas law.  Say what?

I have frequently commented on "eight-corner" cases.  In fact, my very first post on this blog in April 2007 highlighted the strickness with which Texas courts apply the rule (see Good for the Gander- Strict "Complaint-Allegation Rule Not Always Beneficial for Policyholders) Under this rule, upheld by the Texas Supreme Court in GuideOne Elite Ins. Co. v. Fielder Road Baptist Church, 197 S.W.3d 305, 308 (Tex. 2006), a liability insurer's duty to defend its insured must be determined only with reference to the insurance policy and the pleading or complaint in the lawsuit.  A court is instructed not to consider any "extrinsic evidence" that might impact coverage, and so far, the high court has not recognized any exceptions to this strict rule.

For example, the Texas Supreme Court a few months ago upheld a lower court decision that a general contractor was not entitled to a defense of a claim that alleged liability for property damage only against the general, who, however, was covered only for work performed by a subcontractor.  Well, guess what, the subcontractor in fact caused the damage, and the general offered evidence to establish the fact.  (See my post, Policyholder Wins Big In Texas High Court Duty-To-Indemnify Decision).  The court reaffirmed that the insurer owed no duty to defend (because the pleading was silent on the crucial fact that established coverage), but the court accepted the evidence to require the insurer to indemnify.  The point is, the "eight-corner" rule in Texas is tighter than a tick.

So why does a federal district court judge say that it is no longer Texas law?  The court cites to an 2006 case, B. Hall Contracting Inc. v. Evanston Ins. Co., 447 F.Supp.2d 634, 644-46 (N.D. 2006) rev'd on other grounds, 273 F. App'x 310 (5th Cir. 2008), which was authored by the same judge (see B. Hall Decision).  In the B. Hall case, the court held that alleged property damage fell within exclusion j(5) and (6), just as in the Lewis case, so no duty to defend.  But the court went on to explain another reason for denying the duty to defend that depended on consideration of extrinsic evidence. 

The policy before the court required the insurer to "pay those sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies."  The court noted that this wording "is different from the wording found in most liability policies, in that it does not say that [the insurer] 'will defend any suit brought against [the insured] seeking damages, even if the allegations of the suit are groundless, false or fraudulent.'"  The court then considered that the "eight-corner" rule somehow depended on the groundless-false-or-fraudulent language in the policies the judge was accustomed to seeing, citing the GuideOne case that affirmed the "eight-corner" rule based on the broader duty owed under the duty to defend.  The B. Hall court then concluded that the language of the policy before it "makes the duty to pay and the duty to defend co-extensive."  In other words, the "eight-corner" rule is dead in Texas.

However, respectfully, this conclusion over-reads GuideOne and does not comport with the insurance industry's own understanding of the current duty-to-defend language.  Standard ISO (i.e., Insurance Services Office, which promulgates standard forms for the industry) CGL policies dropped the groundless-false-fraudulent formula after 1985 and has used the language in the B. Hall policy for 20 years before that case was decided.  ISO's own annotated treatise on the CGL policy addressed the very point raised in B. Hall:

Before the introduction of the 1986 commercial general liability form, the insurer's obligation to defend claims against the insured extended explicitly to allegations that were "groundless, false or fraudulent."  That language does not appear in the 1986 and subesequent CGL editions and its removal has occasionally raised questions as to whether the duty to defend is narrower than under older versions of CGL coverage.  Under the current language, the insurer's duty to defend does not in any way depend on whether the allegations made against the insured are true:

We will have the right an duty to defend the insured against "suit" seeking those damages [i.e., damages becasue of "bodily injury" or "property damage" to which this insurance applies].

In other words, as long as it is alleged that insured has caused injury or damage of a kind insured against by the poloicy--even if the insured did not in fact cause such injury or damage--the insurer is entitled to a defense against those charges.

[Annotated Commercial General Liability Insurance, IRMI, 15th printing 2008, at p. v.c.12].  I fail to see anything in the post-1985 formula that would offer greater inducement to consider extrinsic evidence than the older language.  Whether Texas courts should entertain some reasonable exceptions to their strict interpretation of the rule is another question.

Thus, B. Hall's report of the demise of the "eight-corners" rule appears to be greatly exaggerated.

David S. White, Thompson & Knight LLP

www.tklaw.com

Texas High Court Applies "Assumption of Liability" Exclusion to Insured's Own Conduct

Gilbert Tex. Construction, L.P. v. Underwriters at Lloyd's London, No. 08-0246 (Tex. June 4, 2010), see Decision

This Texas Supreme Court decision opens a whole can of worms insurance-wise, particularly in the construction industry, when a plaintiff sues a contractor for faulty workmanship, alleging only breach of contract, not negligence.  The case may have little effect beyond the peculiar facts presented, but insurers will argue that the decision limits the supreme court's 2007 Lamar Homes decision, which allowed CGL coverage of some faulty construction lawsuits brought under a breach-of-contract cause of action.

Gilbert was hired by a municipal transit authority to construct a light rail system.  After very heavy rains, a  business adjacent to the project was flooded and sued Gilbert for negligent construction and for breach of contract.  Although the plaintiff was not a party to the municipal contract, it asserted rights as a third-party beneficiary based on the following language in the contract:

The Contractor shall protect from damage all exisiting improvements and utilities (1) at or near the work site and (2) on adjacent property of a third party . . . [and] repair any damage to those facilities, including those that are property of a third party, resulting from failure to exercise reasonable care in performing the work.

Gilbert's general liability insurers (Lloyd's provided excess coverage) agreed to defend under a reservations of rights.  Gilbert moved for summary judgment, and the trial court dismissed the negligence claims because Gilbert was entitled to claim the same governmental immunity enjoyed by the transit authority.  Gilbert later settled the contract claim for $6.175 million.  Lloyd's refused to contribute to the settlement, arguing no duty to indemnify Gilbert under the following standard exclusion, called a "contract" or "assumption of liability" exclusion:

[This insurance does not apply to] "Bodily injury" or "property damage" for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement.  This exclusion does not apply to liability for damages:  (1) assumed in a contract or agreement that is an "insured contract"; or (2) that the insured would have in the absence of the contract or agreement.

An "insured contract" is defined to include indemnity agreements under which the named insured assumes the tort liability of another to pay damages for bodily injury or property damage.

Lloyd's argument is simple on its face: (1) Gilbert expressly agreed to assume liability for damage to adjacent property; (2) the agreement does not meet the policy definition of an "insured contract"; and (3) absent the contract, Gilbert would have no liability because all other claims had been dismissed.  Nevertheless Gilbert sued Lloyd's.  The trial court granted summary judgment in favor of Gilbert, but the appellate court reversed, basically accepting Lloyd's argument that the "contract exclusion" applied. 

At the time, I thought the appellate court was off base and said so in this blog ("Assumption of Liability" Exclusion Misapplied in Coverage Lawsuit).  Like Gilbert, I understood that the "contract exclusion" and the "insured contract" exception applied only to indemnity agreements in contracts.  I thought the appellate court failed to distinguish between an "assumption of duties" and an "assumption of liabilities," which, I argued, means the insured's assumption of another's liability, not its own.

Surprise!  The Texas Supreme Court affirmed the appellate court decision, holding that Gilbert had expressly assumed the liability for the damage in question.  The court noted that several other states, as well as the federal 5th Circuit Court of Appeals, had construed the "contract exclusion" narrowly, as I had.  Still, some other jurisdictions had interpreted the exclusion broadly, as in this case. 

So, where are we?  Earlier I mentioned the Lamar Homes decision, which held that an allegation of accidental misconduct may constitute a covered "occurrence" under a liability policy, even though the plaintiff sues only under a breach-of-contract cause of action.  The Gilbert court says that its decision does not disturb the Lamar Homes ruling, but certain questions remain.  The two most important are: how broadly should courts interpret (1) "assumption of liability," and (2) liability the insured "would have in the absence of the contract or agreement."

Assumption of Liability. 

The insurance industry will probably try to expand the Gilbert ruling to include any alleged breach of contract, putting us back in the pre-Lamar Homes days when insurers argued that only tort claims could trigger CGL coverage.  In Lamar Homes, a homeowner sued his own builder for faulty construction, which the insurer argued was a breach-of-contract claim and so not covered by the policy.  The insurer lost.  However, may insurers now use Gilbert to argue that any breach-of-contract claim falls within the "contract exclusion"? 

Let's assume that the builder's contract contains no express assumption of liability.  The builder simply agrees to build such and such a structure using such and such specifications.  Homeowner sues in contract for damage due to accidental yet faulty construction.  Insurer refuses to defend builder under the "contract exclusion," arguing that every contract carries an implied duty to perform in a reasonable, workmanlike manner.  May the "assumption of liability" be implied, or must it be stated expressly, as in Gilbert?  If implied assumptions trigger the exclusion, then, insurers will argue, no breach-of-contract action can be covered.  Also, from now on, insurers will flyspeck every contract for any term that might arguably constitute an assumption of liability. 

Insureds might consider adding a provision to their business contracts that they assume no liabilities except those expressly assumed in the contract.

Liability in the absence of contract.

The "contract exclusion" does not apply if the insured would be liable absent the contract.  Gilbert was left facing only a contract claim for arguably accidental misconduct because it was protected by governmental immunity against tort claims.  Outside of government contracts, contractors don't have this defense and may be sued for negligence.  But what if the plaintiff chooses to sue only in contract, even though the insured could be subject to tort liability?  Is that liability the insured "would have" in the absence of the contract?  Insurers will no doubt argue that an insured would have no liability for something not alleged in the complaint.

Also, are insureds compelled to raise defenses that could eliminate all tort claims and insurance coverage to boot?  Defenses such as governmental immiunity and statute of limitations are affirmative defenses that the defendant may choose to waive.  This potentially creates a dilemma for defense counsel who must choose between the insured's instruction to forgo a tort-killing defense and insurer's insistence to raise it.

These and many other thorny issues will no doubt be disputed hotly in months to come.

David S. White, Thompson & Knight LLP

www.tklaw.com