Insurance Law Blog

March 27, 2020
Dear Colleague,
Twice in one week! How lucky are you?!

Again, we remain OPEN during the COVID-19 pandemic and look forward to assisting you in any insurance coverage needs—from a safe 6-foot distance of course. 
BREAKING NEWS . . . well, it’s all relative these days.
We wanted to follow up on our blog from earlier this week to point out another case recently argued in the Supreme Court of Texas that may (but if history is any indicator likely not) provide clarity as to whether and what extent extrinsic evidence is admissible in evaluating the duty to defend. Before getting back in those weeds again, we also wanted to highlight a recent Fifth Circuit opinion where the court essentially adopted in full the analysis of the district court in a broad application of a manuscript breach of contract exclusion. This holding effectively kills coverage for construction defect claims and could incentivize insurers to endorse their policies with similar manuscript language, so be on the lookout.

A.        The Fifth Circuit Upholds Broad Application of a Manuscript “Breach of Contract" Exclusion

In Mt. Hawley Insurance Co. v. Huser Construction Company, Inc.,[1] the Fifth Circuit evaluated a manuscript “Breach of Contract” Exclusion in a policy issued by Mt. Hawley Insurance Company. The court essentially adopted in full the opinion[2] issued by Judge Sim Lake when the matter was pending in the district court. In its very brief per curiam opinion, the Fifth Circuit explained that it agreed that Mt. Hawley owed no coverage under its policy “for essentially the same reasons expressed by [the district] court.”[3] Thus, to get a flavor for the issues, we look back to the opinion issued just last year by Judge Lake.

Huser involved damages arising out of the construction of an apartment complex owned by Eagle Heights Pleasanton, LLC (“EHP”).[4] Huser hired several subcontractors for the construction, including Schaffer, who was responsible for designing and installing the HVAC system.[5] After Huser completed work on the project in 2016 and EHP took possession, EHP discovered multiple deficiencies in the workmanship and materials used in the project. EHP claimed that work performed by Schaffer was deficient in multiple respects, including: (1) breaching a fire wall; (2) using the wrong type of ducts; (3) misplacing air vents; (4) leaving trash in the air ducts; (5) improperly installing electrical connections to the HVAC; and (6) using poorer quality units than those specified by the job architect.[6] EHP filed suit against Huser and Schaffer, asserting claims for breach of contract and negligence.

In its opinion, the Southern District explained that the “Breach of Contract” manuscript exclusion added to the Mt. Hawley policies by endorsement barred coverage for “any claim or ‘suit’ for ‘property damage’ ‘arising directly or indirectly out of’ breaches of contract and/or warranty are not covered by the Mt. Hawley Policies.”[7] According to the court, the parties’ dispute focused on the following:

(1) whether the property damage that is the subject of the Underlying Action “ar[ose] directly or indirectly” out of a breach of the contract between Huser and EHP and (2) whether the Mt. Hawley Policies’ separate “Your Work” Exclusion, and its subcontractor exception, preserve coverage because the property damage in the Underlying Action was caused by a subcontractor.[8]

The court began its analysis by recognizing that, when an exclusion bars coverage for damage “arising out of” specified conduct, the claim need only bear an incidental relationship to the described conduct for the exclusion to apply.[9] The court also recognized that the Supreme Court of Texas has interpreted the “arising out of” language “to mean that there is but for causation, though not necessarily direct or proximate causation.”[10] Moreover, the court explained that exclusions containing the “arising out of” language are “given a broad, general, and comprehensive interpretation.”[11] The court also acknowledged that the “arising out of” language has a “much broader significance than ‘caused by,’” with the former requiring only that the damage originate from, grow out of, or have connection with the conduct, as opposed to the latter, which generally requires proximate causation.[12]

The court determined that the “Breach of Contract” exclusion unambiguously applied to bar coverage for all the damages alleged against Huser, as those damages “‘ar[ose] directly or indirectly’ from Huser’s alleged breach of its contract with EHP.”[13] Specifically, Huser’s contract with EHP imposed upon Huser to supervise and staff the project with adequate subcontractors, and its failure to do so allegedly resulted in the damages sought by EHP.

Moreover, the court rejected Huser’s arguments that the subcontractor exception in the “Damage to Your Work” exclusion negated the scope of the “Breach of Contract” exclusion. Relying upon the opinion from the Supreme Court of Texas in Lamar Homes, Inc. v. Mid-Continent Casualty Co.,[14] Huser argued that the exception restored coverage for any damage caused by subcontractors, notwithstanding the “Breach of Contract” exclusion.[15] Disagreeing with this position, the court explained: “Nothing in Lamar Homes prevents an insurer from adding an additional exclusion eliminating coverage for property damage arising out of a breach of contract. Lamar Homes held the opposite—the court discussed the many types of exclusions insurers can utilize, including those that exclude the insured’s ‘contractually-assumed liabilities.”’[16] Thus, according to the district court, because the subcontractor exception contained within the “Damage to Your Work” Exclusion expressly modifies only the “Damage to Your Work” Exclusion, not the other exclusions contained in the Mt. Hawley Policies, it was inapplicable as to the scope of the “Breach of Contract” exclusion.[17] The court also explained that, in the event of any conflict between the terms of an endorsement and other policy language, the language of the endorsement will control.[18]

The Fifth Circuit explained that after it “conducted a de novo review of the record on appeal, including the exhaustive order and reasons of the district court, the briefs of the parties, and the arguments raised at oral argument,” it was “convinced that Mt. Hawley does not owe Huser defense or indemnity with respect to the underlying action.”[19]

We point out that such a broad exclusion is not within the standard ISO coverage form that is attached to a majority of the general liability policies issued to insureds. Emboldened by this opinion from the Fifth Circuit, however, we foresee underwriters—particularly on the surplus lines market—potentially starting to include similar manuscript exclusions in future policies. Be vigilant as renewals for your (or your client’s) policies come up to ensure that you are getting the coverage that you thought you purchased….

B.        Will the Supreme Court of Texas Find that a “Fraud” Exception to the Eight-Corners Rule Exists?

Moving back into the eight-corners weeds… in Avalos v. Loya Insurance Co., the Court of Appeals of San Antonio utilized a strict eight-corners analysis in evaluating whether a duty to defend existed under an automobile policy.[20] The underlying suit arose out of a car accident between a vehicle operated by the Hurtados and a vehicle being operated by Rodolfo Flores (“Flores”). Flores’ wife, Karla Flores Guevara (“Guevara”) was insured by a policy issued by Loya Insurance Company (“Loya”).[21] Although Guevara was insured, there was a named driver exclusion for Flores. Nevertheless, according to the court, “[t]he record reflects that Guevara, Flores, and the Hurtados reported to the police and insurance company that Guevara—not Flores—was driving the vehicle at the time of the accident.”[22]

The Hurtados sued Guevara, alleging that she negligently operated her vehicle and caused the injuries at issue.[23] Loya appointed counsel to defend Guevara. During the early course of the discovery process, Guevara identified herself as the driver of the vehicle at the time of the accident. However, Loya apparently later learned Guevara was not the driver at the time of the accident; rather, that Flores was the driver.[24] Guevara’s counsel cancelled Guevara’s deposition and, on that same day, Loya denied coverage. Loya ultimately withdrew the defense, and a judgment was ultimately rendered against Guevara for $450,343.34.[25]

The Hurtados, as assignees of Guevara, filed suit against Loya, asserting that Loya breached its duty to defend Guevara. In response, Loya counterclaimed, asserting claims for breach of contract and fraud. Loya also sought declaratory relief that it had no duty to defend Guevara based on the named driver exclusion.[26] Loya moved for summary judgment, attaching portions of deposition testimony where Guevara admitted that Flores was driving her car at the time of the accident. In a competing motion, the Hurtados argued that Loya’s motion was moot and attached numerous documents and evidence in support of their position. The trial court ultimately struck the written discovery provided by Guevara and Mr. Hurtado, and granted summary judgment in favor of Loya.[27]

On appeal, the Hurtados argued that because they had alleged in their pleading that Guevara was operating the vehicle—as opposed to Flores—Loya could not avoid its duty to defend Guevera under the eight-corners rule.[28] Loya countered that its duty to defend did not arise because Guevara breached the insurance policy by falsely representing to the police and insurance company that she was driving the car in the accident.[29] In reversing the trial court, the court of appeals noted that “[n]owhere in the petition did the Hurtados allege that Flores negligently operated the vehicle involved in the underlying car accident.”[30] The court rejected Loya’s request that the court consider portions of Guevara’s deposition that established she was not driving the vehicle at the time of the accident, but rather her husband, Flores, was driving the vehicle.[31] The court explained that “under the eight-corners rule, we may not consider such extrinsic evidence as it directly contradicts the Hurtados’ allegations that Guevara was driving.”[32]

The court also stated—in dicta—that even if it were to “consider the potential narrow exception to the eight-corners rule” as alluded to by the Supreme Court of Texas, it would not do so in this case because the “deposition testimony upon which Loya . . . relies does not strictly go to the question of coverage.”[33] According to the court of appeals, the deposition testimony directly contradicted the allegations by the Hurtados, which was material to the merits of the underlying negligence claim.[34] The court concluded: “as logically contrary as it may seem, we hold that under the eight-corners rule, it was the duty of Loya . . . to defend Guevara against allegations that she negligently operated the vehicle even if the allegations were false or fraudulent.”[35]

Loya had also argued that the deposition testimony that Flores was the driver should have been considered because it established that Guevara materially breached the policy by falsely reporting she was the driver.[36] Rejecting this argument, the court concluded that the “defense of third-party claims provided by the insurer is a valuable benefit granted to the insured by the policy,” and that if Loya “knew the allegations asserted by the Hurtados to be untrue, then it had a duty to establish such facts in defense of Guevara in the underlying negligence suit filed against her by the Hurtados.”[37]

The Supreme Court of Texas granted review on January 17, 2020. At the recent oral argument, Loya urged the Court to recognize an exception to the eight-corners rule to allow consideration of evidence that a policyholder committed fraud. Counsel for Loya argued that the Court should look beyond the eight-corners of the pleading and policy to consider Guevara's admission during her deposition in evaluating whether the duty to defend was triggered.

As we noted earlier this week, the Supreme Court of Texas in Richards v. State Farm Lloyds again recognized but refused to apply or even endorse that any exception to the eight-corners rule exists.[38] In that case, however, the Court ruled that the carrier had not contracted around the eight-corners rule by declining to expressly agree that the insurer had to defend claims “even if groundless, false or fraudulent.”[39] What the Supreme Court of Texas did not address in Richards—but now has the opportunity to consider—is whether the insurer still must defend if there is actual evidence that the claims are, in fact, groundless, false, and fraudulent. As each opinion from the Supreme Court of Texas that potentially addresses whether an exception to the eight-corners rule exists gets considerable attention by both sides of the insurance bar, the ruling in Avalos is sure to garner much attention.

Stay tuned for updates… We will keep you posted in future blogs.
Shidlofsky Law Firm PLLC continues to monitor all coverage arguments and implications raised by COVID-19 and is available to audit your policies to determine if any coverage may exist for business interruption or other losses. There is a lot of information circulating around the blogosphere about potential coverage for COVID-19. Quite frankly, and to be perfectly honest, we think that a lot of the information paints too rosy a picture of potential coverage for business income losses related to COVID-19. Simply put, the “off the shelf” type commercial property and builders risk policies are going to contain a requirement for “direct physical loss” or “direct physical damage” and that likely will be a difficult obstacle to overcome. In addition, a lot of current property policies contain explicit exclusions for “Loss Due to Virus or Bacteria” (i.e., a reaction to SARS). That being said, if you have suffered a loss related to COVID-19, it is critical to document the loss and put the relevant insurers on notice. Contact us if you need help.  


Lee Shidlofsky

Douglas P. Skelley

Rebecca DiMasi

Blake Crawford
Senior Counsel

[1] No. 19-20368, 2020 WL 1188329 (5th Cir. Mar. 11, 2020) (per curiam).
[2] Mt. Hawley Ins. Co. v. Huser Constr. Co., Inc., No. H-18-0787, 2019 WL 1255756 (S.D. Tex. Mar. 19, 2019).
[3] 2020 WL 1188329, at *1.
[4] Huser, 2019 WL 1255756, at *2.
[5] Id. at *3.
[6] Id.
[7] Id. at *6.
[8] Id.
[9] Id. (citing Sport Supply Group, Inc. v. Columbia Cas. Co., 335 F.3d 453, 458 (5th Cir. 2003)).
[10] Id. (quoting Utica Nat’l Ins. Co. of Tex. v. Am. Indem. Co., 141 S.W.3d 198, 203 (Tex. 2004)).
[11] Id.
[12] See id. (citing EMCASCO Ins. Co. v. Am. Int’l Spec. Lines Ins. Co., 438 F.3d 519, 524–25 (5th Cir. 2006)).
[13] Id. at *7–8 (alteration in original).
[14] 242 S.W.3d 1 (Tex. 2007).
[15] Huser, 2019 WL 1255756, at *7.
[16] Id. (citing Lamar Homes, Inc., 242 S.W.3d at 10).
[17] Id.
[18] Id. at *8.
[19] Mt. Hawley Ins. Co. v. Huser Constr. Co., Inc., No. 19-20368, 2020 WL 1188329, at *1 (5th Cir. Mar. 11, 2020) (per curiam).
[20] 592 S.W.3d 138 (Tex. App.—San Antonio 2018, pet. granted Jan. 17, 2020).
[21] Id. at 140.
[22] Id.
[23] Id. at 140–41.
[24] Id. at 141.
[25] Id.
[26] Id. at 141.
[27] Id. at 142.
[28] Id. at 143.
[29] Id. at 144.
[30] Id. at 145.
[31] Id.
[32] Id. (citing Pine Oak Builders, Inc. v. Great Am. Lloyds Ins. Co., 279 S.W.3d 650, 655 (Tex. 2009) and GuideOne Elite Ins. Co. v. Fielder Rd. Baptist Church, 197 S.W.3d 305, 310 (Tex. 2006)).
[33] Id. at 144 (citing Pine Oak Builders, Inc., 279 S.W.3d at 655 (describing narrow exception as one that would permit use of extrinsic evidence only when relevant to independent and discrete coverage issue); GuideOne Elite Ins., 197 S.W.3d at 310 (recognizing exception would be limited to circumstances involving “pure coverage questions”).
[34] Id.
[35] Id. at 145–46.
[36] Id. at 146.
[37] Id. (citing GuideOne Elite Ins. Co., 197 S.W.3d at 311).
[38] No. 19-0802, 2020 WL 1313782 (Tex. Mar. 20, 2020).
[39] Id. at *6.
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