Most of the legal discussion on insurance for Y2K problems has been about compensation for damages that will be incurred when the year change takes place, i.e., January 1, 2000. Recently, however, companies have made claims against their insurers pursuant to "sue and labor" clauses for expenses incurred now in fixing the Y2K problem. A typical sue and labor clause reads: "In case of actual or imminent loss or damage, it shall be lawful and necessary for the Insured, their factors, servants, or assigns to sue, labor and travel for, in and about the defense, safeguard, and recovery of the property insured hereunder, or any part thereof, without prejudice to this insurance; . . . underwriters shall pay for charges and expenses incurred as a result of the Insured's compliance with this Clause. (Unisys Corp. v. Royal Indemnity Co., No. 99C-08-055 (Superior Court of Delaware, New Castle County, filed August 6, 1999))."
Some insurers have already paid for Y2K repair claims based on sue and labor clauses. The amounts and circumstances surrounding those payments are not public. (Barnaby J. Feder, GTE Sues 5 Insurers in a Bid To Spread Year 2000 Costs, New York Times, July 2, 1999). In addition to these settlements, GTE, Xerox and Unisys each have filed complaints for recovery based upon the sue and labor clauses in their insurance agreements. The Port of Seattle has also filed a notice of claim for up to $39 million in Y2K expenses based on a sue and labor clause. On the insurer's side, American Guarantee and Liability Insurance Co. filed a complaint for declaratory judgment against Xerox Corporation to preclude Xerox from claiming Y2K costs under a sue and labor clause.
The Insured's Duty To Mitigate And Its Concomitant Right To Recompense For The Costs Of Mitigating Y2K Damage
The common law duty of an insured to mitigate damages to covered property generally provides that the insured will recover expenses which minimized, or likely minimized, a loss for which the insurer would have been liable. (12 Couch on Insurance 3d §178:10, West Group Pub. 1998). This common law principle is supported by public policy considerations that it is more economically and socially efficient to compensate for measures undertaken at the prevention stage, where the loss and damage could be mitigated or eliminated.
The common law duty to act and the corresponding right to recompense has been written into insurance policies in sue and labor clauses. Though sue and labor clauses trace their origins to maritime law, they now have a secure place in questions of general property loss as well. (12 Couch on Insurance 3d §178:9 - §178:15, West Group Pub. 1998). Thus, sue and labor clauses impose a duty on the insured to mitigate imminent damage to insured property and provide for a corresponding right to recompense for the costs of mitigation from the insurer. When an insured has a duty to mitigate which will trigger its right to recompense from its insurer is not easily determined: "The issue of recovery under a property insurance policy for the insured's own expenses in preventing, minimizing, or investigating a loss is generally determined in part by the terms of the policy, in part by application of historical common law principles of mitigation, and, potentially, by the terms of statutes of various types." (12 Couch on Insurance 3d §178:10, West Group Pub. 1998). Sue and labor clauses may also specify procedures for taking mitigation measures, such as notice or proof of damage requirements, as well as the manner and amount of compensation if appropriate mitigation measures are taken.
In order to trigger a sue and labor clause, the property must be covered by the policy, the mitigation must benefit the insurer, and the mitigation measures taken must be reasonable and necessary. (12 Couch on Insurance 3d §178:12, West Group Pub. 1998). Whether the property is covered depends upon the language of the insurance policy; thus, the starting point is always the language of the policy. Whether the action is to the insurer's benefit is determined in part on whether the mitigation expenses are less than the estimated repair replacement cost if no action were taken. Whether the mitigation is reasonable and necessary is a highly fact-sensitive determination to be proved generally by the insured.
Insureds have argued that reimbursement for action taken to mitigate damage caused by Y2K difficulties is a logical application of the duty to mitigate and the corresponding right to recompense under a sue and labor clause. In the Y2K context, the insured takes a series of actions designed to mitigate or prevent a potentially severe damage to or loss of property covered by an insurance policy. This mitigation of damage provides the economic advantage to the insurer by reducing the amount of the ultimate claim. This type of action is consistent with the efficiency-based policy objectives underlying the duty to act and right to recompense.
Defenses Offered Against The Use Of Sue And Labor Clauses In The Y2K Context
There are four principal arguments used against the application of sue and labor clauses in the Y2K context. The insurers' first argument is that Y2K problems are not covered by the policy. Some policies are more favorably worded than others. For example, GTE, Xerox and Unisys each have property coverage provisions with language specific to computer data. GTE's primary policy with Allendale Mutual "insures against all risks of physical loss of or damage to property," including "any destruction, distortion or corruption of any computer data, coding, program or software..." (GTE Corporation v. Allendale Mutual Insurance Co., Complaint for Declaratory Relief and Damages, (United States District Court of New Jersey, filed June 18, 1999)).
A lawyer representing GTE in its action to recover for Y2K expenses using a sue and labor analysis stated that GTE's basis for recovery is "very specific to the language in GTE's policies" and that many companies would not have such clear language relating specifically to software, data, and computers. (Barnaby J. Feder, GTE Sues 5 Insurers in a Bid To Spread Year 2000 Costs, New York Times, July 2, 1999). Not surprisingly, John J. Pomeroy, Allendale's general counsel, said that the GTE policy language was not unusual. (Barnaby J. Feder, GTE Sues 5 Insurers in a Bid To Spread Year 2000 Costs, New York Times, July 2, 1999). Regardless of whether the wording of GTE's policies is common or unusual, any coverage language which specifically addresses computer data and the reimbursement of expenses incurred to protect it is favorable to an insured's claim.
Insurers also argue that mitigation costs are "ordinary business expenses" and, therefore, are not covered. For example, in American Guarantee and Liability Insurance Co.'s declaratory judgment complaint against Xerox Corporation, American Guarantee alleged that Y2K-related costs reported in Xerox's SEC filings constitute ordinary business expenses, which are not covered by their insurance policy. American Guarantee cites some of Xerox's own statements as support for the argument that Y2K-related costs are ordinary business expenses. While the insured's public statements, are something to consider in determining whether Y2K-related preventive costs are ordinary business expenses, when one considers the magnitude and complexity of the Y2K problem, arguing that the Y2K complications are ordinary business expenses may be a difficult position to advocate. The ultimate determination of who will pay for Y2K remediation and mitigation costs will likely be made in view of the impact of Y2K on commerce as a whole.
A second argument of the insurers is based on the insured's alleged notice and proof of damage violations. In the pending lawsuits, when notice should have been given and when notice was given are being hotly contested. Indeed, it is often difficult to clearly identify the damage caused by Y2K-related problems and when such damage occurs in the context of a sue and labor clause such that one would be obligated to give notice of it. To the extent that companies have undergone years of Y2K preparation and have not given notice of such reparation to their insurers, it could work to their disadvantage. Determinations of what an insured must do to fulfill these notice requirements will vary based on state law as well as on the language of the insurance policy.
Insurance companies also argue that, because Y2K problems have been widely publicized and known for a number of years, Y2K problems are not fortuities and, therefore, are not insured events. Fortuity is a highly fact-sensitive inquiry. Because Y2K problems may have similar effects on a wide range of businesses, and because many companies have taken similar steps to mitigate or prevent Y2K-related damage or loss, the fortuity of Y2K problems, in the context of sue and labor clauses, again will likely be determined in the context of the overall impact of Y2K problems on business.
The final argument that the insurers have advanced is that where sue and labor clauses require partial or imminent damage or loss to be shown, such a showing is not present. It is with this question that the Y2K problem most distinguishes itself from traditional sue and labor analysis. Unlike a crack in a building or in the hull of a ship, where a showing of partial loss is evident, the Y2K problem does not easily lend itself to such a showing. The affected systems function normally without tangible evidence of loss or damage right up until the moment their internal clocks switch to the year 2000, at which point the entire system can shut down or malfunction, creating huge losses for the affected company and its consumers.
Much like the showing of partial loss or damage, the concept of imminence takes on a different shade when placed in the Y2K context. Under a more traditional sue and labor analysis, an "imminent" event could be interpreted as being within a week or even several months. Under normal circumstances, this would be enough time to make the needed reparation. But because the Year 2000 issue is so vast and complex, the amount of time required to mitigate or prevent effectively damage or loss is substantially drawn out, often requiring years of effort. If the time frame required for reparation is extended, the time frame of when a potential loss or damage is considered to be imminent could arguably be extended as well. Showing partial loss or imminence in the Y2K context, therefore, requires a different interpretation of those concepts.
Conclusion
A sue and labor clause may be a strong basis for insureds to recover Y2K costs. Clearly, more and more insureds will be submitting claims based on them. Indeed, in addition to the several complaints filed and settlements purportedly reached, other companies have notified their insurers that they intend to file Y2K preventive expenses claims. Thus, sue and labor clauses could play a critical role in the success or failure of any attempt to recover the costs expended to make computer systems ready for the Year 2000.
*article courtesy of John Callagy, Robert Crotty, and Mitchell Purcell of Kelley Drye & Warren.