The costs of Year 2000 compliance are substantial and insurers may be prime targets in litigation to recoup those costs. In claiming under their insurance policies, policyholders may attempt to rely on obscure policy provisions, implied duties, or decisions arising out of claims for environmental contamination. Regardless of the theory proffered, however, policyholders will have to demonstrate actual or imminent injury or damage caused by an insurable event. In most cases, Year 2000 remediation expenses cannot satisfy this standard.
Property Insurance
Some commentators have pointed to the "sue and labor" clause as a potential source of coverage under property insurance policies for expenses incurred to make systems or products Year 2000 compliant.1 As discussed below, neither the sue and labor clause nor other express or implied obligations to mitigate loss provide coverage for the expense to make systems or products Year 2000 compliant unless those expenses are reasonably incurred to prevent imminent loss from a covered peril. Given the substantial coverage issues which surround coverage for Year 2000 losses, including such issues as fortuity and the requirement of physical loss or damage to covered property, as well as the widespread use of policy exclusions for causes of loss such as latent defect and defective design, it is likely that in most cases policyholders will not be able to recover as "mitigation expenses" the cost of making their systems or products Year 2000 compliant.
The Sue and Labor Clause
The "sue and labor" clause generally provides that as a condition of its insurance the policyholder must take such steps as are necessary to safeguard or recover insured property in the case of imminent or actual loss. These clauses were historically present in marine insurance policies but have been used in other property insurance policies as well. A typical clause states:
In case of actual or imminent loss or damage by 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 hereunder; nor, in the event of loss or damage, shall the acts of the insured or of this company in recovering, saving and preserving the insured property be considered a waiver or an acceptance of abandonment.2
It has been said that "[t]he 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."3 The California Supreme Court described the operation of a sue and labor clause as follows:
Such a clause makes express the duty implied in law on the part of the insured to labor for the recovery and restitution of the damaged or detained property and it contemplates a correlative duty of reimbursement separate from and supplementary to the basic insurance contract. . . . There is, however, a fundamental limitation upon the insurer's duty under a "sue and labor" clause to compensate the insured for expenses incurred in the preservation and protection of insured property: the expenses in question must be incurred to preserve the insured property from a peril insured against under the basic policy.4
The sue and labor clause is generally considered to create an indemnity obligation separate from the main insuring clause of a property insurance policy.5 Courts have held that the indemnity obligation under the sue and labor clause is in addition to the limits of coverage provided under the main insuring clause and is not subject to any deductible or retention.6 Courts have held further that the clause extends to expenditures which are reasonably incurred in attempting to prevent or reduce losses suffered, even if those attempts are not successful.7
Expenses incurred by a policyholder are recoverable under the sue and labor clause only if:
(1) they were incurred to protect insured property;8 and
(2) they were incurred to protect insured property from a covered peril.9
In many cases, therefore, there will be no coverage for Year 2000 compliance expenses, either because the expenses were incurred to reduce a policyholder's liability to third parties, were incurred simply to upgrade obsolete equipment or were incurred for other reasons not covered under a property insurance policy.
Express or Implied Obligation to Prevent or Mitigate Loss
The sue and labor clause is not a common feature of the form of property insurance policies currently used for many commercial risks. Instead, the policy form may require an insured to "do everything possible to protect the property from further damage " upon the occurrence of a covered loss and provide that the insurer will reimburse the insured for expenses incurred.10 The 1997 ISO Businessowners Standard Property Coverage Form, for example, provides in the section on "Duties In The Event Of Loss Or Damage" that the policyholder must:
Take all reasonable steps to protect the Covered Property from further damage, and keep a record of your expenses necessary to protect the Covered Property, for consideration in the settlement of the claim. This will not increase the Limit of Insurance. However, we will not pay for any subsequent loss or damage resulting from a cause of loss that is not a Covered Cause of Loss.
The language of the ISO provision suggests that a policyholder's obligation to mitigate, and an insurer's obligation to reimburse, arises only after a loss has occurred. At least one court, however, has declined to recognize this distinction, concluding that notwithstanding the policy language, the policyholder had a common law obligation to take steps to prevent the occurrence of a loss and the reinsurer had a corresponding duty to reimburse the policyholder for expenses incurred.11 Courts in other jurisdictions have also recognized an implied or common law duty on the part of the insured to prevent harm to the insured property and a corresponding duty on the part of the insurer to reimburse the insured for those expenses.12
To recover under this implied duty to mitigate, however, the policyholder must have incurred the expenses at issue "primarily for the benefit of the insurer by preventing an immediate covered loss to the insured property."13 An insurer does not have an obligation to reimburse its insured for costs or losses which are not incurred to prevent damage to the insured property. Thus, for example, in a case involving a claim by a contractor under an all-risk policy for "mitigation" expenses associated with ensuring that the building on which the contractor was working was not damaged by a nearby explosion, the cost of expert testing of the site was a "reimbursable mitigation expense" but the delay and inefficiency costs incurred by the contractor during the period it was unable to work on the building were not reimbursable.14
Accordingly, as with the analysis under the sue and labor clause above, to recover under this implied duty to mitigate the policyholder must have incurred the expenses at issue "primarily for the benefit of the insurer by preventing an immediate covered loss to the insured property." In the Year 2000 context, many claims for compliance expenses will not be covered because: (1) the threatened damage is not "immediate"; (2) the loss is not of a type "covered"; and (3) the threatened damage is not to "insured property." Instead, these costs are more properly recognized as nothing more than the cost of doing business and of updating outdated equipment or systems.
Liability Policies
Policyholders may also attempt to collect compliance expenses under commercial or comprehensive general liability insurance policies ("CGL policies"). Indeed, some commentators have pointed to successful attempts to recover remediation costs from insurers in the environmental context as support for claims to recoup Year 2000 compliance expenses. Upon closer examination, however, these environmental decisions do not support policyholders' claims to recover Year 2000 compliance costs.
Defining "Damages"
A CGL policy typically provides:
We will pay those sums that the insured becomes legally obligated to pay as damages because of 'bodily injury' or 'property damage' to which this insurance applies.
In environmental cases, the policyholders and insurers have litigated the question of whether the costs of cleaning up or remediating polluted property are properly considered "damages" which the insured is "legally obligated to pay." Policyholders may point to these cases in support of a claim to recover Year 2000 compliance costs. As discussed below, however, the fundamental differences between remediation costs in cases of environmental contamination and monies spent to make a policyholder's systems or products Year 2000 compliant suggest that Year 2000 compliance costs will not be covered in most instances.
In the environmental context, several courts have unequivocally determined that clean-up or remediation costs are not "damages" covered by CGL policies.15 These decisions construe the notion of damages which an insured is "legally obligated to pay" to mean only money damages which are paid to resolve a lawsuit. The costs which an insured incurs in remedying environmental harm, then, are not "damages."
Other courts have held that environmental remediation costs can be "damages" for purposes of a CGL policy.16 Even in these jurisdictions, however, emphasis is often placed on the fact that the insured is remediating its property under order of some environmental or governmental agency. In other words, there is at least an implicit recognition that this governmental involvement/coercion is what imposes the "legal obligation to pay" on the insured.17 Importantly, this type of governmental involvement is not present with respect to most Year 2000 compliance efforts.
Moreover, even courts that recognize the potential for coverage for environmental remediation costs distinguish the cost to prevent further tangible harm, which may be covered, from the general business expense of preventing future harm or injury, which are not covered under a CGL policy.18 Courts have determined that purely preventive costs are not covered by a CGL policy in non-environmental cases as well.19
Most Year 2000 compliance costs fit the mold of non-recoverable "prophylactic" costs. Just as the owner of a landfill cannot recover when it cleans up its own property to avoid possible but not-yet existent harm to third-party property, the owner of a potentially deficient computer system or product should not be able to recover the costs of making that system or product Year 2000 compliant. Rather, the cost of making a system or product functional in the Year 2000 is simply a cost of doing business.
The "Owned-Property" Exclusion
A second standard CGL provision comes into play when Year 2000 compliance costs are considered. CGL policies cover a policyholder for harm it causes to third parties or to the property of third parties. CGL policies are not intended to cover harm to the policyholder or to the policyholder's own property.20 Hence, CGL coverage forms typically exclude: "'property damage' to: (1) property [the insured] own[s], rent[s], or occup[ies]." CGL policies similarly exclude coverage for "'property damage' to '[the insured's own] product' arising out of it or any part of it."
Most courts hold that remediation costs borne by an insured in cleaning up its own property are covered by a CGL policy, and not barred by the owned-property exclusion, only if:
(1) the damage to the insured's property has already caused actual harm to third party property;21 and
(2) imminent additional harm will result to third party property unless the insured immediately institutes remedial measures to repair its own property.22
In short, there must be third-party harm plus the specter of additional third-party harm before a CGL policyholder may recover for the costs of remedying its own property. By contrast, "costs incurred for the sole purpose of remediating the [insured's] own property are barred by the owned-property exclusion of the policy."23 This dichotomy preserves the plain meaning of the owned-property exclusion, and assures that third-party liability policies are not suddenly converted into first-party liability policies. As theGeorgia Supreme Court explained:
Any other construction [of the owned-property exclusion] is contrary to the [CGL] policy language and would render the owned or rented exclusion meaningless because in almost every case the policyholder could simply contend that contamination on its own property presents a threat of future harm to off-site property.24
Thus, most claims for Year 2000 compliance costs will be barred under the owned-property exclusion.
Conclusion
While every claim must be evaluated on the basis of the specific facts presented and the applicable policy language, the foregoing discussion suggests that most claims to recover the cost of Year 2000 compliance expenses will not be covered under either liability or first-party property insurance policies. This Update was prepared by Paul M. Hummer and James A. Keller, attorneys in Saul Ewing's Insurance Group in its Philadelphia office. For additional information, contact Mr. Hummer at (215) 972-7788 or by e-mail at phummer@saul.com, or Mr. Keller at (215) 972-1964 or by e-mail at jkeller@saul.com
Note: Posted articles are for general information only and should not be considered legal advice.
ENDNOTES
1. See, e.g., L. Eisenstein and S. Levitt, "Year 2000 Insurance Recovery And The 'Sue And Labor' Clause", 9 Mealey's Litigation Reports - Reinsurance No. 13 (November 12, 1998).l.
2. Archer-Daniels-Midland Co. v. Phoenix Assur. Co. of New York, 975 F. Supp. 1129, 1133 (S.D. Ill. 1997).
3. Blasser Bros., Inc. v. Northern Pan-American Line, 628 F.2d 376, 386 (5th Cir. 1980); accord Commodities Reserve Co. v. St. Paul Fire & Marine Ins. Co., 879 F.2d 640, 642 (9th Cir. 1989).
4. Young's Market Co. v. American Home Assur. Co., 481 P.2d 817 (Cal. 1971) (citations omitted).
5. Witcher Constr. Co. v. St. Paul Fire & Marine Ins. Co., 550 N.W.2d 1, 7 (Minn. Ct. App. 1996).
6. Reliance Ins. Co. v. The Escapade, 280 F.2d 482 (5th Cir. 1960); Home Ins. Co. v. Ciconett, 179 F.2d 892 (6th Cir. 1950); American Home Assur. Co. v. J.F. Shea Co., 445 F. Supp. 365, 368-70 (D.D.C. 1978).
7. Insurance Co. of North America, Inc. v. U.S. Gypsum Co., Inc., 870 F.2d 148, 154 (4th Cir. 1989).
8. Trinity Industries, Inc. v. Insurance Co. of North American, 916 F.2d 267, 272 (5th Cir. 1990) (sue and labor clause does not cover legal fees spent to defend policyholder from claims of others); Archer-Daniels-Midland Co. v. Phoenix Assur. Co. of New York, 975 F. Supp. 1129, 1133-34 (S.D. Ill. 1997) (finding for insurer where property at issue was not at a scheduled location and, therefore, was not "insured property"); Hvide Marine Int'l, Inc. v. Employers Ins. of Wausau, No. 88 CIV 1523, 1989 WL 140280 (S.D.N.Y. Nov. 15, 1989) (no obligation under sue and labor clause to reimburse costs paid in defense of claim against policyholder, even if policyholder's defense would ultimately inure to benefit of insurer, since costs were not incurred to protect covered property); International Commodities Export Corp. v. American Home Assur. Co., 701 F. Supp. 448, 454 (S.D.N.Y. 1988), aff'd, 896 F.2d 543 (2nd Cir. 1990); Shell Oil Co. v. Winterthur Swiss Ins. Co., 15 Cal. Rptr. 2d 815, 848 (Cal. Dist. Ct. App. 1993) (no obligation under sue and labor clause to reimburse costs incurred in defending lawsuit against insured because "[a]n insured's attempts to avoid or reduce a liability to third parties do not constitute efforts to prevent or limit damage to the insured's covered property").
9. Continental Ins. Co. v. Lone Eagle Shipping Ltd., 952 F. Supp. 1046, 1065 (S.D.N.Y. 1997) (finding for insurer where expenses were incurred to protect property from damage caused by corrosion, which was not a covered peril), aff'd in part, dismissed in part, 134 F.3d 103 (2d Cir. 1998); Destin Trading Corp. v. Royal Ins. Co. of Am., No. Civ. A. 89-5279, 1990 WL 238988 (E.D. La. Dec. 31, 1990) (no obligation to reimburse insured under hull and machinery insurance for expenses incurred to prevent the discharge of oil where policies excluded coverage for costs of any kind caused by the discharge of oil or other pollutants); Continental Ins. Co. v. Chemoil Corp., No. C 88 0085 TEH, 1988 WL 156750 (N.D. Cal. June 2, 1988) (where the damage occurred prior to policy period and loss was therefore not within coverage of policy, expenses to mitigate the loss were not made to minimize a loss covered by the policy and were not recoverable under sue and labor clause); Tillery v. Hull & Co., Inc., 717 F. Supp. 1481, 1486 (M.D. Fla. 1988) (where damage to ship was caused by barratry, an excluded cause of loss, expenses incurred to retrieve ship were not recoverable under sue and labor clause), aff'd, 876 F.2d 1517 (11th Cir. 1989); Southern Cal. Edison Co. v. Harbor Ins. Co., 148 Cal. Rptr. 106, 112 (Cal. Dist. Ct. App. 1978) (expenses incurred to prevent threatened damage to building from faulty design of foundation were not reimbursable under sue and labor clause where policy excluded coverage for the cost of correcting design defects).
10. See, e.g., Witcher Const. Co. v. St. Paul Fire & Marine Ins. Co., 550 N.W.2d 1, 7 (Minn. Ct. App. 1996).
11. Witcher Const. Co., 550 N.W.2d at 8.
12. See, e.g., Harper v. Pelican Trucking Co., 176 So.2d 767, 773 (La. Ct. App. 1965); City Coal & Supply Co. v. American Auto Ins. Co., 133 N.E.2d 415 (Ohio Ct. App. 1954).
13. Witcher Const. Co., 550 N.W.2d at 8.
14. Witcher Const. Co., 550 N.W.2d at 9. Accord Einard LeBeck, Inc. v. Underwriters at Lloyd's of London, England, 224 F. Supp. 597, 598 (D. Or. 1963) (rent for equipment used to prevent further loss was reimbursable, but rental value of idle equipment was not).
15. Wisconsin Power & Light Co. v. Century Indem. Co., 130 F.3d 787, 789-90 (7th Cir. 1997) (applying Wisconsin law); Cincinnati Ins. Co. v. Milliken & Co., 857 F.2d 979, 980-81 (4th Cir. 1988) (applying South Carolina law); City of Edgerton v. General Cas. Co. of Wisconsin, 517 N.W.2d 463, 479 (Wis. 1994), cert. denied, 514 U.S. 1017 (1995); Patrons Oxford Mutual Ins. Co. v. Marois, 573 A.2d 16, 19-20 (Me. 1990).
16. See, e.g., Bituminous Cas. Corp. v. Vacuum Tanks, Inc., 75 F.3d 1048, 1053-54 (5th Cir. 1996) (applying Texas law); Gerrish Corp. v. Universal Underwriters Ins. Co., 947 F.2d 1023, 1030 (2d Cir. 1991), cert. denied, 504 U.S. 973 (1992) (applying Vermont law); Avondale Indus., Inc. v. Travelers Indemn. Co., 887 F.2d 1200, 1207 (2d Cir. 1989), cert. denied, 496 U.S. 906 (1990) (applying New York law); Farmland Indus., Inc. v. Republic Ins. Co., 941 S.W.2d 505, 509-12 (Mo. 1997); Hartford Accident & Indemn. Co. v. Dana Corp., 690 N.E.2d 285, 298 (Ind. App. 1997); Aetna Ins. Co. v. Aaron, 685 A.2d 858, 864-65 (Md. Ct. Spec. App. 1996); SCSC Corp. v. Allied Mut. Ins. Co., 536 N.W.2d 305, 315 (Minn. 1995); Weyerhaeuser Co. v. Aetna Cas. & Surety Co., 874 P.2d 142, 146 (Wash. 1994); Coakley v. Maine Bonding & Cas. Co., 618 A.2d 777, 785 (N.H. 1992); Morton Int'l, Inc. v. General Accident Ins. Co. of America, 629 A.2d 831, 845 (N.J. 1993), cert. denied, 512 U.S. 1245 (1994); Sanborn Plastics Corp. v. St. Paul Fire & Marine Ins. Co., 616 N.E.2d 988, 998 (Ohio Ct. App. 1993); Outboard Marine Corp. v. Liberty Mutual Ins. Co., 607 N.E.2d 1204, 1215 (Ill. 1992), appeal denied, 675 N.E.2d 634 (1996).
17. See, e.g., Anderson Development Co. v. Travelers Indemn. Co., 49 F.3d 1128, 1133 (6th Cir. 1995) ("environmental costs mandated by the EPA constitute damages ) (emphasis added); E.I. DuPont De Nemours & Co. v. Allstate Ins. Co., 686 A.2d 152, 154 (Del. 1996) ("with respect to third party sites, [coverage for remediation] is available only if the cleanup was pursuant to court or governmental order extended to actual damage at the third party sites"); North American Philips Corp. v. Aetna Cas. & Surety Co., No. Civ. 88C-JA-155, 1995 WL 626059 at *5 - *6 (Del. Super. 1995) (costs incurred "as a result of regulatory orders" are insured damages); but see Aetna Cas. & Surety Co. v. Dow Chemical Co., 28 F. Supp. 2d 448, 456 (E.D. Mich. 1998) (governmental demand to perform remediation irrelevant, and voluntary remediation covered, if damage or imminent damage to third-party property exists). Some courts find similar governmental coercion in state statutes which impose strict liability on the owner of polluted property. See, e.g., Metex Corp. v. Federal Ins. Co., 675 A.2d 220, 225 (N.J. Super. Ct. App. Div. 1996) (insured compelled to remediate pollution by the "statutory mandate" of New Jersey's Spill Compensation and Control Act); Weyerhaeuser Co. v. Aetna Cas. & Sur. Co., 874 P.2d 142, 145 (Wash. 1994) (remediation costs covered by CGL policy where insured cleans up pursuant to strict liability provisions of Washington environmental law).
18. See E.I. DuPont De Nemours & Co. v. Allstate Ins. Co., 686 A.2d 152, 156 (Del. 1996) ("since DuPont's actions are not remediating any property damage, but instead are sums spent to prevent further damage, its actions are not insured under the policies"); AIU Ins. Co. v. The Superior Court of Santa Clara County, 799 P.2d 1253, 1279-80 (Cal. 1990) (en banc) (prophylactic costs not recoverable, as there is no coverage under CGL policy "until [actual] damage has occurred, whether on the waste site itself or elsewhere"); Gelman Sciences, Inc. v. Fireman's Fund Ins. Cos., 455 N.W.2d 328, 330 (Mich. Ct. App. 1990), appeal denied, 478 N.W.2d 447 (1991), ("[p]reventative measures are cost effective and commendable," but not covered); Minnesota Mining & Mfg. Co. v. Travelers Indemn. Co., 457 N.W.2d 175, 184 (Min. Sup. Ct. 1990) ("[p]urely preventative measures" taken in clean-up cases "are not covered in the absence of property damage"); Hazen Paper Co. v. United States Fidelity & Guar. Co., 555 N.E.2d 576, 582 (Mass. 1990) (remediation costs are not "damages" covered by CGL policy, even when undertaken in response to government order, where there has been no property damage); Boeing Co. v. Aetna Cas. & Surety Co., 784 P.2d 507, 516 (Wash. 1990) (en banc) ("preventive measures taken before pollution has occurred are not costs incurred because of property damage").
19. See Stonewall Ins. Co. v. Asbestos Claims Mngmt. Corp., 73 F.3d 1178, 1208 (2d Cir. 1995), Opinion modified and on remand to S.D.N.Y.-1998 (analyzing distinction between prophylactic costs and property damage in asbestos-removal context); W.M. Schlosser Co., Inc. v. Insurance Co. of North America, 600 A.2d 836, 838-39 (Md. 1992) (preventive costs incurred by subcontractor to avoid "imminent catastrophic damage" to excavated property not covered); City of Laguna Beach v. Mead Reinsurance Corp., 276 Cal. Rptr. 438, 444-45 (Cal. Ct. App. 1990) (insured city not entitled to recover costs expended to prevent possible landslide where no existing property damage, as they were "voluntarily incurred 'prophylactic costs'").
20. McNeilab, Inc. v. North River Ins. Co., 645 F. Supp. 525, 537-38 (D.N.J. 1986).
21. Baumann v. North Pacific Ins. Co., 952 P.2d 1052, 1055-56 (Or. App.), rev. denied, 327 Or. 621, --- P.2d --- (Or. 1998) (costs incurred by insured in cleaning up petroleum contamination on its own property excluded by owned-property exclusion when there is no actual damage to third-party property, rejecting insured's argument that the potential for third-party property damage is enough); Hakim v. Massachusetts Insurers' Insolvency Fund, 675 N.E. 2d 1161, 1164 (Mass. 1997) (costs of cleaning up policyholder's own property are covered under CGL policy where "environmental contaminants have [already] migrated from [the] policyholder's property to an adjacent property . . . coverage is not barred if the cleanup is designed to remediate, to prevent or to abate further migration of contaminants to the off-site property"); E.I. DuPont De Nemours & Co. v. Allstate Ins. Co., 686 A.2d 152, 157 (Del. 1996) (owned property exclusion means that coverage is not provided "unless it is in response to damage to third party property"); Aetna Ins. Co. v. Aaron, 685 A.2d 858, 862-65 (Md. Ct. Spec. App. 1996) (in a non-environmental case, court holds that insured, a condominium owner, entitled to coverage for cost of fixing glass enclosure around his balcony where faulty enclosure has already caused water damage to third-party property); State v. Signo Trading Int'l, Inc., 612 A.2d 932, 937-39 (N.J. 1992) (owned property exclusion applies even where there is a threat of harm to third party property when there is no existing harm to such property).
22. Figgie Int'l, Inc. v. Bailey, 25 F.3d 1267, 1274 (5th Cir. 1994) (no coverage absent evidence of "real threat" to third-party property); Boardman Petroleum, Inc. v. Federated Mutual Ins. Co., 498 S.E.2d 492, 495-96 (Ga. 1998) (owned-property exclusion bars coverage for contamination clean-up costs where "evidence failed to establish an imminent threat of harm to third-party property"); Aaron, 685 A.2d at 865; Signo, 612 A.2d at 939 (recovery for remedial measures requires existing injury plus "imminent or immediate future damage" to third-party).
23. Hakim, 675 N.E.2d at 1166; Aaron, 685 A.2d at 862 (remediation costs only recoverable "to the extent that the repairs were not merely to benefit the insured's property"); Assumption Parish Sch. Bd. v. Mt. Airy Ins. Co., No. Civ. A. 95-646, 1995 WL 626151, at *4, (E.D. La. October 23, 1995) (costs incurred by insured school in replacing school property tainted with pesticide not recoverable because only insured's property involved).
24. Boardman, 498 S.E.2d at 495; accord Western World Ins. Co. v. Dana, 765 F. Supp. 1011, 1015 (E.D. Cal. 1991); Cedar Lane Invs. v. St. Paul Fire & Marine Ins. Co., 883 P.2d 600, 603 (Colo. Ct. App. 1994); State v. Signo Trading Int'l, 612 A.2d 932 (N.J. 1992); but see Patz v. St. Paul Fire & Marine Ins., 15 F.3d 699 (7th Cir. 1994) (clean-up costs to first-party property are covered by CGL policy, even where no actual or imminent threat to third-party property).