Introduction
Fairy Tale or Search For A Fit?
The "Sue and Labor" Clause
Endnotes
Introduction
On June 18, 1999, GTE Corporation filed an action in federal court seeking as much as $400 million in insurance coverage for costs incurred to eradicate the millennium bug. 1 Two weeks later, a property insurer for Xerox filed a New York state court action in which the insurer disputes Xerox's claim for Y2K remediation cost coverage. 2 The next day, Xerox retaliated with a $183 million lawsuit of its own in Connecticut. 3 These developments demonstrate that the long anticipated fight over insurance coverage for massive Y2K remediation expenditures has officially begun.
When companies like GTE and Xerox declare through suit that their insurers should share the burden of Y2K remediation, is it a declaration that the Boards of other major corporation will ignore? Or can it be expected that leaders of companies that have incurred significant Y2K remediation expenses will ask their risk managers, in-house counsel and other professional advisors to seriously consider pursuing insurance claims? Given the stakes, it is a safe bet that corporate insureds will at least want to review the bidding currently before they effectively foreclose themselves through non-action from later pursuing insurance benefits.
Fairy Tale or Search For A Fit?
Insurers have maintained all along that Y2K remediation costs do not fit the definition of insurable loss or damage under most forms of commercial property insurance. Indeed, insurers insist that, come 2000, neither property insurance nor commercial general liability insurance will respond to loss, damage or liability that arises from actual Y2K failures. In other words, from the insurance industry's perspective, the notion that remediation costs may trigger coverage under commercial property policies is as make believe as Alice's adventures in Wonderland.
By contrast, the recent GTE and Xerox actions demonstrate that policyholder thought regarding insurance and Y2K remediation costs has evolved well beyond the dream stage. Instead, an examination of the coverage theories being advanced by insureds like GTE and Xerox reveals that the exercise involved may be more akin to the search for a fit to Cinderella's slipper than the fantastic adventures of Alice through insurance Wonderland.
The "Sue and Labor" Clause
In their respective lawsuits, GTE and Xerox assert that a clause in their property policies, known as the "sue and labor" clause, entitles them to reimbursement because their Y2K remediation efforts will prevent future losses that would otherwise be covered by the policies. The sue and labor clauses at issue in GTE and Xerox actions allegedly provide the following:
In case of actual or imminent loss or damage by a peril insured against, it shall, without prejudice to this insurance, be lawful and necessary for the Insured . . . to sue, labor, and travel for, in and about the defense, the safeguard and the recovery of the property or any part of the property insured hereunderÂ…
The sue and labor clauses at issue in the GTE and Xerox actions appear to be representative of at least one form of sue and labor clause currently in widespread use. 4
The "sue and labor" clause originated in the London marine market and is of ancient lineage that extends back at least into the seventeenth century, appearing as early as 1613. 5 Its use in the U.S. has a long history as well. 6 Marine insurance policies included the clause primarily due to the emergency nature of most maritime accidents and the difficulty in communicating with the insurer regarding how best to mitigate or reduce actual or impending damage. 7
In essence, the clause states that the insurer will reimburse the insured for costs incurred in an effort to mitigate or prevent a "covered loss" that has already occurred or is "imminent." The theory behind the clause is that expenses incurred to mitigate or prevent actual or imminent covered loss are primarily for the benefit of the insurer. 8 For example, if a ship that is "frozen in" on a river prior to reaching its destination might be destroyed by the build up and sudden release of thawing ice in spring, would it not be reasonable for the insurer to pay the cost of transporting the insured cargo overland before warmer weather permitted the ship to complete its voyage? The answer to that question was "yes" to at least one United States Court of Appeals. 9
Will Y2K Expenditures "Fit" the Sue and Labor Clause?
The search for a coverage "fit" begins with an evaluation of whether the policyholder's property insurance coverage includes the right form of sue and labor clause. While sue and labor clauses of the type allegedly included in GTE's and Xerox's property programs are common, they are by no means a universal. Many modern policies include a so-called "preservation of property" clause that award reimbursement only for costs incurred to mitigate "covered" losses once they have already occurred, not when they are merely "imminent." 10
Second, the loss or damage -- in this case, impaired system functionality and its direct and indirect effects - must be "imminent." In one court's view, "imminent" means "likely to happen without delay; impending, threatening." 11 Can an event whose arrival has been anticipated for several years be "imminent"? Is there a universal time standard that can be applied or is "imminent" a relative concept dependent for meaning on the type of peril threatened (e.g., flash flood v. global warming)? Courts addressing insurance coverage disputes over Y2K remediation expenses will have to answer the question without the benefit of much guiding authority.
Third, the insured must be prepared to prove that its expenditures served to mitigate "covered" loss or damage. 12 To date, insurers have been steadfast in their views that Y2K related loss or damage would not trigger coverage even under the broadest formulations of commercial property coverage. In support of their views, insurers can point to authorities that suggest that impaired computer functionality and/or loss or corruption of data does not represent the sort of "physical" loss or damage that might trigger commercial property coverage. 13
The types of loss or damage to insured "property" that can result from Y2K failures, however, are so varied that broad generalizations regarding the potential for covered loss or damage are not entirely reliable. The quest for predictability is made all the more difficult by the fact that commercial property policy forms run the gamut from "all risk" protection to coverage only for specifically defined "perils." For these reasons, insureds will be able to point to authorities that interpret the a property policy's "physical loss or damage" requirement broadly enough to include impaired computer functionality and/or loss or corruption of data. 14 In addition, insureds will argue that some courts have already found that damage to computer data is "physical injury" to "tangible property" within in meaning of a comprehensive general liability policy. 15
In conclusion, there are a variety of factors and issues that are raised by a sue and labor claim for reimbursement of Y2K remediation expenses. Like the perfect fit for Cinderella's slipper, the question of coverage under a particular insured's property policy can only be addressed by careful analysis of the particular terms, conditions and circumstances underlying the insured's claim.
Time, however, may have already run out for many insureds. Property policies often include provisions governing when notice of a loss must be given, proofs of loss must be submitted and suit (if necessary) must be commenced. These requirements may already pose insurmountable obstacles for insureds interested in finding the elusive coverage "fit" for their Y2K remediation expenses.
1 GTE Corp. v. Allendale Mutual Ins. Co., et al., Civ. No. 99-2877 (D.N.J.).
2 American Guarantee and Liability Ins. Co. v. Xerox Corp., Index No. 603/69/99 (N.Y. Sup. Ct., N.Y. County).
3 Xerox Corp. v. American Guarantee and Liability Ins. Co., Case No. __ (Conn. Sup. Ct, Stamford/Norwalk Dist.)
4 See 15 Couch on Ins. $ 55:124 (1983)
5 Reliance Ins. Co. v. The Escapade, 280 F.2d 482, 488-89, fn.11 (5th Cir. 1960)
6 Biays v. Chesapeake Ins. Co., 11 U.S. 415, 418 (1813)
7 McNeilab, Inc. v. North River Ins. Co., 645 F.Supp. 525, 557, fn. 34 (D.N.J. 1986)
8 See Blasser Bros., Inc. v. Northern Pan-American Line (5th Cir. 1980) 628 F.2d 376, 386 ("The purpose of the sue and labor clause is to reimburse the insured for those expenditures which are made primarily for the benefit of the insurer to reduce or eliminate a covered loss."); Southern Cal. Edison Co. v. Harbor Ins. Co. (1978) 83 Cal.App.3d 747, 757 ("It is the benefit conferred which creates the duty on the part of the insurer to reimburse the insured for prevention and mitigation expenses.").
9 St. Paul Fire & Marine Ins. Co. v. Pacific Cold Storage Co., 157 F. 625 (9th Cir. 1907)
10 Bates and Bower, Year 2000 Insurance Recovery, The "Sue and Labor" Clause and Similar Preservation Provisions, Mealey's Year 2000 Report, 39 (December 1998).
11 Doheny West Homeowners' Assoc. v. American Guarantee & Liability Ins. Co., 60 Cal.App.4th 400, 406 (1997)
12 Biays v. Chesapeake Ins. Co., 11 U.S. 415, 418 (1813) ("The parties certainly meant to apply it [the sue and labor clause] only to the case of those losses or injuries for which the insurers, if they had happened, would have been responsible."); accord Reliance Ins. Co. v. Escapade, 280 F.2d 482, 489 (5th Cir. 1960); Young's Market Co. v. American Home Assurance Co., 4 Cal.3d 309, 314 (1971).
13 See Peoples Telephone Company v. Hartford Fire Insurance Co., 36 F.Supp.2d 1335 (S.D.Fla. 1997) (holding that information is intangible property whereas the paper it is printed on is tangible property); accord St. Paul Fire & Marine Ins. Co. v. National Computer Systems, Inc., 490 N.W.2d 626, 631 (Minn. App. 1992) (because dictionary definition of "tangible" is "[d]iscernible by the touch; capable of being touched; palpable . . . [c]apable of being treated as fact; real; concrete: tangible evidence," misappropriation of proprietary information was not loss or damage to tangible property); see e.g., Great Northern Ins. Co. v. Benjamin Franklin Federal Savings and Loan Ass'n, 793 F.Supp. 259 (D. Or. 1990) (no physical loss or damage to building made uninhabitable by prior installation of asbestos); Rockport Pharmacy, Inc. v. Digital Simplistics, Inc., 53 F.3d 195 (8th Cir. 1995) (under state law precluding tort recovery for mere economic loss, damage to or loss of data because of computer hardware or software malfunction held insufficient to support recovery); Transport Corp. v. IBM, 30 F.3d 953 (8th Cir. 1994) (same).
14 E.g., Farmers Ins. Co. of Oregon v. Trutanich, 858 P.2d 1332 (Or. App. 1993) (odors from abandoned drug lab constituted "physical damage" to rental property); Western Fire Ins. Co. v. First Presbyterian Church 437 P.2d 52 (Colo. 1968) (held "direct physical loss" occurred from gasoline vapor contamination of church building).
15 Retail Systems, Inc. v. C.N.A. Insurance, 469 N.W.2d 735 (Minn. 1991) (loss of computer information and tape was physical injury to tangible property under CGL policy); see Centennial Ins. Co. v. Applied Health Care Systems, Inc., 710 F.2d 1288 (7th Cir. 1983) (holding that CGL insurer had duty to defend complaint alleging that insured's faulty computer components caused loss of valuable customer data).