A Phoenix dairy farmer utilizes state of the art equipment to milk his cattle. On January 1, 2000, his equipment ceases to operate because it was not Y2K compliant resulting in a partial shutdown of his operation for several weeks resulting in loss of over $100,000. Is the $100,000 loss a covered claim under his first party coverage?
First party policies do not indemnify the insured for sums the insured is obligated to pay others for damages allegedly caused by the insured nor do they ordinarily provide a defense to the insured for suits brought by third parties. First party coverages, such as business personal property, business interruption or homeowner property coverage, provide protection to the insured for losses they suffers. As a general statement, most first party policies require the following elements be met before an insured is entitled to recover: (1) a fortuitous loss; (2) direct physical loss or damage to covered property; (3) caused by a covered risk or peril; and (4) during the policy period. A brief analysis of these elements highlights the potential problems which may prevent coverage for Y2K losses.
Fortuitous Loss: Although most first party policies do not have an express fortuity provision (cf. "occurrence" definition in general liability policies), courts generally agree that coverage does not apply to losses which are substantially certain to occur. The fortuity requirement embodies the principle that insurance policies insure the risk of loss. Where the insured possesses knowledge of the risk of loss and the circumstances that will cause it, the loss is generally not fortuitous. The obvious argument that Y2K losses are not fortuitous is that the potential problems associated with it were first recognized in the 1970s. On the flip side, insureds will argue that in order for the loss to be uninsurable, both the loss and the scope of damages must be known and the latter was not known. This argument has appeal especially if the insured takes some steps prior to the millennium to become Y2K compliant and yet still sustains losses. Courts have not yet addressed the fortuity issue in the Y2K context and where they will draw the line is not known.
Direct Physical Loss or Damage to Covered Property: Generally, this element requires actual loss as opposed to mere malfunction of equipment. Claims that computer equipment ceased to function properly would not appear to be "direct physical loss of or damage to covered property." There may, however, be circumstances where this element has been met, e.g., an insured's fire sprinkler system fails to operate during a fire because it is not Y2K compliant allowing the insured's business to burn to the ground; or a city-wide power outage causes restaurants or grocery store freezers to cease working which results in the loss of perishable foods.
Covered Risk or Peril: Most commercial property insurance provides coverage for a direct physical loss to covered property caused by a "covered cause of loss," c.f. "All-risk" policies which typically insure against 'all risks of direct physical loss or damage to the insured property from an external cause...except as hereinafter excluded.' Typically, the "covered causes of loss" are fire, lightning, explosion, windstorm or hail, smoke, riot or civil commotions, vandalism, leakage from fire extinguishing equipment, sinkhole collapse, volcanic action, falling objects, weight of snow, ice or sleet or water damage. Clearly, the typical Y2K loss would not fall within the purview of "covered causes of loss."
Damage Occurred During Policy Period: Generally, the date of loss under a property policy is the date of the occurrence of physical damage. If the computer stops operating altogether on a particular date, for instance January 1, 2000, then the date of loss is easy to establish. However, if the Y2K loss took place over a period of time, fixing the date of loss, and with it the policy which must respond, may be more difficult. This latter scenario may come into play where a computer does not completely shut down, but rather produces erroneous data which is not noticed for a long period of time.
One other coverage which will certainly be potentially triggered in Y2K losses is "Business Interruption and Extra Expense" insurance. Business interruption coverage typically applies when the insured is unable to conduct its normal business operations as a result of damage to a covered risk. The purpose of the business interruption coverage is to provide insurance for the net profits and normal operating expenses, (i.e. payroll) that would have been earned or incurred by the insured during the time that its operations are interrupted as a result of a covered loss, and to preserve the continuity of the companies earnings. Extra expense coverage pays the expenses to stay in business on an emergency basis.
It is anticipated that business interruption claims will skyrocket in the wake of Y2K since businesses have become so dependent upon computers. However, to recover, usually the insured must meet the same criteria as any other first party property claim. Moreover, with respect to business interruption coverage, it is unclear if this coverage would be triggered if there was not a total suspension of the operations as a result of a Y2K glitch as compared to operating at less than full capacity. The courts have split on this particular issue.
Y2K is neither hype nor fiction. It is a real problem with unknown consequences for insurers. Absent an express exclusion, the courts will more than likely consider each case separately in light of its facts and the particular policy at issue. While it is highly questionable whether the standard commercial property and businessowners policy forms will be found to provide coverage for Y2K losses, attorneys abilities to create novel theories of coverage are boundless. Therefore, only when the courts begin addressing these particular issues will insurers know for sure in what circumstances, if any, will the Y2K property losses be covered. n