by Peter Kelman, Esquire
This article appeared in substantially the same form in Mass HighTech, November 21, 1999.
Just when it seemed like we had done all there was to do for Y2K preparation, just when it seemed like it was time to kick back, wait if the lights go out and the lawsuits ensue, a new “hot topic” has emerged in Y2K insurance coverage. Several companies are testing the limits of insurance coverage by demanding that their insurers pay for their Y2K remediation costs. Relying on an obscure provision, called the “sue and labor clause,” found in certain types of property insurance, these companies make the case that their Y2K remediation efforts will ultimately save insurers money and that they should be reimbursed for their preventative measurers. As you might expect, insurance companies do not agree with this theory, and the courts may ultimately decide the outcome of these disputes. Right now the leading case on which all eyes are focused is GTE Corp. v. Allendale Mutual Insurance Co., filed in the Federal District Court of New Jersey. Unisys and Xerox have filed similar suits against their insurance companies.
The Company’s Position
The “sue and labor” is an optional provision usually found in a property policy. It states, in essence, that the insurance company will reimburse the policyholder for the cost of activities, which prevent covered property from suffering harm. It has its historical roots in property coverage for maritime vessels where it was intended to cover emergency situations in foreign ports. It encouraged the insured to take corrective action to alleviate the peril, before full-blown damage occurred. By doing so, the theory was that it saved the insurance company money by averting or lessening the consequences of imminent disaster. For example, if a vessel suffered hull damage as a result of a storm, if that damage could be repaired and thereby prevent the vessel from sinking, under a sue and labor clause, the insurance company would reimburse the ship’s owners for the cost of the repairs.
Over time, several precedents have developed which make sue and labor coverage attractive to insureds. First, this coverage usually is not subject to either deductibles or to limits of a policy. Second, the clause has been construed to cover the cost of activities and repairs designed to prevent likely harm. A policyholder does not have to wait for harm to strike before taking corrective action. Thus if a ship’s owner spent $1,000 to caulk the hull on a boat damaged by a storm and which was insured for only $500, under a sue and labor clause, the insurance company would be liable for the full amount of $1,000. Present day companies maintain that their fixes to keep their mainframes from sinking in a sea of Y2K problems are the 20th century version of repairs to a ship’s hull.
The Insurer’s Position
As you might expect, insurance companies take a different view of Y2K remediation costs. They cite the following reasons to support their position that Y2K activities are not covered by sue and labor:
- Y2K problems have been created by insureds themselves, they are not the result of accidental occurrences;
- Y2K problems would not harm property covered by property insurance; and
- The Y2K problem is not a sudden disaster; on the contrary companies have had years of warnings.
If you attempt to prove to your insurer that Y2K remediation and failure are the Scylla and Charibdis of computer systems, anticipate resistance. In addition to the obstacles above, many commercial insurance policies have been modified to exclude coverage for Y2K caused harm. In Massachusetts, the Commissioner of Insurance has allowed such Y2K exclusions since the fall of 1998. A Y2K exclusion may absolve an insurance company of liability for Y2K-related harm, thereby rendering your remediation inconsequential to your insurance policy. Further, if you try to collect for past Y2K remediation activities expect your insurer to raise issues of proper notice.
What You Should Do
At this time nothing is settled in the controversy around applicability of the sue and labor clause to Y2K remediation costs. The battle is being fought in the courts among high-powered companies with hundreds of millions of dollars at stake. For now a company’s prudent course of action appears to be:
- Review your insurance policies to determine if your policy contains either a sue and labor provision or a Y2K exclusion endorsement;
- Document the costs, both internal and external, of your Y2K remediation efforts;
- Discuss your insurance coverage with your broker and/or your attorney; and
- Discuss with your attorney whether your obligation to your shareholders requires you to file a claim with your insurance company.
Depending on the outcome of this analysis you may decide to put your insurance company on notice of your intentions. If so, you would be well advised to stay on top of this story in the hope that your insurer bails you out and prevents yourY2K remediation costs from sinking your bottom line.
Copyright 1999, Peter Kelman. All rights reserved.