Insurers Prepare for Change as Texas Supreme Court Considers Eight-Corners Exception

Will the Texas Supreme Court finally confirm whether it is adopting or rejecting the “Northfield Exception” to the eight-corners rule? The Bitco case may have the answer. The 5th Circuit Court of Appeals in Bitco recently presented this in the form of a certified question to the Texas Supreme Court. If the Court adopts the exception, it could bring big changes for Texas insurers.

What is the Northfield Exception?

The exception is now recognized in the federal 5th Circuit and some Texas state appellate courts. It allows a court to consider evidence extrinsic to the petition on the duty to defend when both of these factors are present:

• It is initially impossible to tell whether coverage may be implicated
• The extrinsic evidence goes solely to a fundamental issue of coverage that does not overlap with the merits of, or engage the truth or falsity of, any facts alleged in the underlying case

The exception is significant because it is a departure from Texas’ eight-corners rule, under which an insurer is limited to review of the petition and the policy when it evaluates the duty to defend. The Texas Supreme Court has acknowledged the exception’s existence in the past but declined to apply it. In prior cases, the Court has held that the extrinsic evidence before it did not meet one or both of the exception’s requirements.

What will change if the Court adopts the exception?

Possible shifts in duty to defend

If the Court adopts the Northfield Exception, there is still some question on how far-reaching that holding would be in construction defect cases. The time when property damage occurred is a key coverage concern in construction defect cases because policies generally only respond to damage during their policy periods, but this information is often left out of the underlying petition. In the Bitco case, the petition was silent on the date of damage, but the parties stipulated on the exact date of damage. This stipulation was the extrinsic evidence the district court used to determine whether there was a duty to defend under the Northfield Exception framework. If an insured will not stipulate on when damage occurred, however, it may be an uphill battle for a carrier to introduce unassailable evidence showing a date certain that damage occurred. Also, many construction defect suits concern issues like water intrusion in which the damage occurs gradually over time, and it may be impossible (at least initially) to discern when that damage began. In those instances, simply providing evidence on when work on a building was completed would not necessarily lead to a conclusion that the damage began on that date, as sometimes water intrusion can begin while work is ongoing or does not begin for several years after work is completed. 

But in the other cases, the adoption of the Northfield Exception would lead to major shifts in the duty to defend. For instance, if a policy included a Townhome Exclusion and the underlying petition was silent on whether the damaged building was a townhome, it would be fairly straightforward to present evidence that the building was a townhome. While there are some courts that are already using extrinsic evidence on these types of issues, others have declined to do so because the Texas Supreme Court has not expressly adopted the exception. The Court’s adoption of the exception would take the guesswork out of whether a court can consider such evidence.

Impacts on the duty to indemnify

Not only would the Texas Supreme Court’s decision to adopt the Northfield Exception affect the duty to defend, but it could also impact the duty to indemnify, which is a separate duty under Texas law. Right now, the duty to indemnify is not deemed “ripe” until the underlying case resolves through settlement or judgment. The Court does allow one exception “when the insurer has no duty to defend and the same reasons that negate the duty to defend likewise negate any possibility the insurer will ever have a duty to indemnify.” Thus, if a court rules that there is no duty to defend based on extrinsic evidence due to the Northfield Exception, it stands to reason that this same evidence could be considered, at the same time, on the duty to indemnify issue. In fact, that is exactly what the Southern District of Texas did recently. After concluding there was no duty to defend because extrinsic evidence showed that the underlying accident occurred outside of the policy’s coverage territory, the court then ruled that this same evidence also defeated the duty to indemnify.

We are watching this case closely and will provide updates as needed. Please contact Sara Nau or any member of Phelps’ Insurance team if you have questions or need compliance advice and guidance.