(Article from Insurance Law Alert, June 2023)
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Holding
The Third Circuit declined to determine whether, under Pennsylvania law, an insurer in a dispute over a duty to defend can introduce extrinsic evidence relevant to a dispositive coverage issue when that issue is unrelated to the merits of the underlying liability case. The court observed that Pennsylvania follows the “four corners” rule and has not yet recognized any exceptions to that approach. Republic Franklin Ins. Co. v. Ebensburg Ins. Agency, 2023 U.S. App. LEXIS 14528 (3d Cir. June 9, 2023).
Background
An insurance agency sought coverage from Republic Franklin Insurance Company (“Republic”), its professional liability insurer, for a suit alleging professional negligence and fraudulent misrepresentation, among other claims. Republic defended under a reservation of rights, but later sought a declaration that it had no duty to defend. Republic argued that its policy did not provide coverage for the underlying claims because the insurance agency had knowledge of a wrongful act that was likely to give rise to a claim prior to the policy’s inception. In support of this contention, Republic relied on certain deposition testimony and a reservation of rights letter related to separate litigation, both of which purportedly established the insurance agency’s knowledge of wrongful acts likely to give rise to a claim prior to the policy’s effective date. A Pennsylvania district court dismissed Republic’s suit, ruling that consideration of extrinsic evidence was impermissible under Pennsylvania law. The Third Circuit affirmed.
Decision
The Third Circuit explained that, under Pennsylvania’s “four corners” approach, an insurer’s duty to defend is determined by comparing the allegations in the underlying complaint to the insurance contract. In seeking to rely on certain extrinsic evidence in its declaratory judgment action, Republic noted that the Pennsylvania Supreme Court has acknowledged that, “to the extent there are undetermined facts that might impact on coverage, the insurer has a duty to defend until the ‘claim is narrowed to one patently outside the policy coverage.’” Republic argued that this statement means that, once an insurer’s duty to defend is triggered, an insurer may offer evidence outside the complaint to negate its duty to defend, so long as the coverage issue is independent of the underlying claims. The Third Circuit viewed this contention with some skepticism, but declined to decide the question. The Third Circuit noted that the Pennsylvania Supreme Court’s holding could mean that a narrowing of the duty to defend could occur if the underlying plaintiff drops or the court dismisses the claims that had triggered policy coverage.
The Third Circuit ruled in favor of the policyholder on the ground that Republic could not prove, while the underlying merits action was pending, that an exclusion concerning known wrongful acts applied. That exclusion precluded coverage for claims arising out of known wrongful acts. The Third Circuit found that whether such a wrongful act occurred was the subject of the underlying merits litigation and adjudication of the issue would “overlap with the issues” in that case. Extrinsic evidence related to the underlying merits question would not be considered under Pennsylvania law.
Comments
The Third Circuit seemed to acknowledge that consideration of extrinsic evidence might be appropriate in some duty to defend disputes, including disputes over a policyholder’s failure to establish a “condition precedent” to coverage (such as the requirement of when a claim was “first made”). The Third Circuit noted that a Pennsylvania trial court considered extrinsic evidence relating to a condition precedent to coverage in determining an insurer’s duty to defend, but distinguished that decision from the present case, in which the insurer sought to rely on extrinsic evidence for purposes of enforcing a policy exclusion. Additionally, as the Third Circuit noted, other jurisdictions, such as Florida and Texas, expressly recognize limited exceptions to the “four corners” rule.