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Abstract

Most Americans and American businesses purchase liability insurance to protect against financial loss should they ever be sued. In furnishing this protection, liability insurers contractually promise policyholders that they will defend them against lawsuits seeking covered damages and indemnify them for such damages up to the policy limits. As important as the insurer’s promise of indemnification is to an insured, the insurer’s agreement to defend the insured in litigation is an equally essential aspect of the liability insurance bargain. An insurer must decide whether it has a duty to defend its insured at the outset of a case. There are two approaches to determining an insurer’s duty to defend. First, there is the eight corners rule, under which the factual allegations in the plaintiff’s complaint or petition are compared with the policy, and the insurer owes a defense only if those allegations potentially implicate the insurer’s duty to indemnify the insured. Second, there is the extrinsic evidence approach. Courts employing an extrinsic evidence approach hold that an insurer must look beyond the pleadings and consider any facts brought to its attention or any facts that it reasonably could discover at the time suit was filed in deciding whether it has a duty to defend. Liability insurance policies typically provide that the insurer will pay the cost of the insured’s defense in addition to the policy’s liability limits. This is a potentially significant expense for the insurer because defense costs may, and often do, exceed any settlement or judgment ultimately paid. Given the expense associated with providing a defense, it is not surprising that an insurer may want to disclaim its duty to defend based on extrinsic evidence that establishes that it will have no duty to indemnify the insured. Of course, an insurer generally cannot decline to defend its insured if, in making that determination, it is limited to the facts alleged in the plaintiff’s petition or complaint; after all, even in extrinsic evidence states, it usually is the allegations in that pleading that triggered the insurer’s duty to defend in the first place. Thus, insurers frequently test their ability to rely on extrinsic evidence to disclaim their duty to defend when the plaintiff’s complaint or petition alleges facts that trigger the duty. In other words, if an insurer must, in many states, consider extrinsic evidence in accepting its duty to defend, can it also rely on extrinsic evidence to deny or exit a defense? The answer, generally, is no; the use of extrinsic evidence is rarely a two-way street. As a result, even an insurance company with a solid factual defense to coverage generally must defend the insured under a reservation of rights and file a separate declaratory judgment action to establish that it will have no duty to indemnify the insured and can therefore terminate its duty to defend. From an insurer’s perspective, however, that approach is of limited value unless the declaratory judgment action can be decided before the tort action against the insured concludes. In fact, such an outcome is rare. Consequently, an insurer may be forced to bear the cost of defending a lawsuit alleging uncovered claims or causes of action well after it has discovered that it will never have to indemnify the insured. Those costs get passed on to insureds through premiums. Although the general rule holds that an insurer may not rely on extrinsic evidence to refuse to defend an insured, some courts that adhere to the general rule occasionally recognize exceptions. Plus, there is a contrary minority rule. It is therefore fair to ask whether an insurer should be allowed to rely on extrinsic evidence to disclaim or extinguish its duty to defend when the plaintiff’s complaint or petition alleges facts that implicate coverage, and, if so, under what circumstances? This question is timely first because of two 2020 Texas Supreme Court decisions addressing it and offering different answers based on the facts presented: Richards v. State Farm Lloyds and Loya Insurance Co. v. Avalos. Second, as Richards and Loya demonstrate, insurers’ use of extrinsic evidence to excuse their defense obligations is an ongoing litigation strategy. That is not to say that the strategy is good or bad, but it is to say that the extrinsic evidence issue will continue to surface in key cases in various jurisdictions. Third, while insurers’ use of extrinsic evidence to defeat the duty to defend is hotly contested by policyholders, courts that have considered the issue over the years have rarely discussed it in meaningful fashion in their opinions. The resulting lack of guidance hampers courts either confronting the issue for the first time or entertaining reconsideration of prior holdings. This Article provides that guidance.

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