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A Test of Seaworthiness.

Three major technology companies that want to recoup their Y2K-related remediation expenses from their insurers are relying on a centuries-old maritime sue-and-labor clause, but are their corporate vessels seaworthy?

Since corporate technology giants GTE, Xerox and Unisys filed their Year 2000 "sue and labor" lawsuits last summer, much has been written about this novel litigation strategy. It is ironic that these Fortune 500 high-tech companies are suing their property insurers for more than $1 billion to cover the cost of remediating Y2K problems in computer systems that they probably designed and programmed years ago. Even more surprising is their reliance on an obscure policy provision known as sue and labor, a clause traditionally associated with marine insurance risks.

Four centuries of maritime sue-and-labor litigation have created a useful framework for analyzing these Y2K-remediation complaints--a framework that incorporates important assumptions about who should bear the expense of protecting covered property against loss or damage. This Y2K litigation poses a difficult and fundamental question that the courts must address: What is the boundary between an insured's ordinary and prudent risk-management expenses to protect property against harm and reimbursable sue-and-labor expenses incurred in the face of an actual or imminent peril?

The following are among the many challenging policy issues that the courts must address in this Y2K-remediation litigation:

Is the Y2K "peril" reasonably "actual or imminent" to trigger a compensable sue-and-labor expense?

Are Y2K remediation expenses reimbursable when they are incurred to maintain corporate "seaworthiness"?

What covered property is, or would have been, imperiled by a Y2K failure that would trigger a legitimate sue-and-labor expense?

The Lawsuits

It is impossible to assess fully the merits of the Y2K sue-and-labor lawsuits involving multiple insurers and complex property insurance policies based solely on the pleadings, which offer tantalizing but undoubtedly biased snippets of facts and policy wordings. Nevertheless, the three complaints share several common elements, an analysis of which offers revealing insights into the potential validity and strength of these Y2K-remediation, sue-and-labor claims:

* The insurance policy: The GTE, Xerox and Unisys complaints all allege that the Y2K-related claims arise under "all risk" property insurance policies, covering "direct physical loss or damage to property" and any "destruction, distortion, or corruption" of computer data, coding, program or software. With minor wording variations, the policy sue-and-labor clauses generally provide that "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, safeguard, and recovery of the property or any part of the property insured...."

* Multiple insured years at risk: All of the complaints implicate policies spanning a number of years--from 1996 to 2000 for Xerox and GTE, and from 1988 to 2000 for Unisys.

* The damages and remediation: Each coverage action alleges that covered information-technology systems and facility systems have been or will be damaged by Y2K-related failures and that these systems have caused or will cause the destruction, distortion or corruption of computer data or programs causing damage to covered property. They further allege that the insureds have organized and implemented costly internal Y2K-compliance efforts to reduce or prevent actual or imminent losses to covered property.

* Recovery sought: Each plaintiff seeks indemnification for expenses incurred or to be incurred due to Y2K-related physical loss or damage to covered property, and each seeks to prevent, avoid or minimize "imminent" loss to covered property. The actions further allege that the insurers are in breach of the insurance contract, while GTE has added a "bad faith" allegation.

The controversial key to the success of these claims for Y2K-remediation expenses is an obscure property insurance provision known as the "sue and labor" clause, which, as one court more than 75 years ago put it, "is so old that its origin is obscured by antiquity." Basically, the clause stated that insurers would pay for repairs to a sinking ship or for damaged or jettisoned cargo to avoid an even greater insurable loss. The fundamental purpose of the marine sue-and-labor clause is to encourage and to bind the insured to take steps to prevent a threatened loss for which the underwriter would be liable if it occurred and, when such a loss does occur, to diminish the amount of the loss.

The sue-and-labor clause embodies an important and often overlooked legal principle--maritime law recognizes that insureds owe a fundamental duty to their underwriters to take all necessary actions after a misfortune at sea to prevent or minimize property loss or damage, hence the "lawful and necessary" language in most clauses. In effect, the sue-and-labor clause transforms what was an implied duty under maritime law into an express contractual obligation between the insured and the underwriters.

Traditionally, sue-and-labor coverage is irrevocably tied to the perils insured against. That is, the insured's sue-and-labor actions must have been taken to minimize or prevent a loss for which the underwriters would be liable under the marine policy. Courts have ruled that if the underwriters are not liable under the coverage provisions, there is no contractual obligation to repay the insured's sue-and-labor expenses. Thus, any sue-and-labor expenses paid by the insured must have been incurred with a view to averting or minimizing an "actual or imminent" loss for which the underwriters would have been liable under the policy.

Y2K Seaworthiness

Sue and labor was intended to compensate insureds for expenses incurred in protecting insured property subject to actual or imminent damage or loss from an insured peril. As a mid-l9th century Pennsylvania Supreme Court observed, the sue-and-labor clause "adds nothing to the duty of the insured and his agents, but merely expresses what would be the duty of the parties without it; that is, to use all proper exertions to save the property insured from total loss, and declares the duty of the insurer to contribute to the expense."

But this reimbursement obligation was tempered by another important marine risk-management assumption--the insured's implied warranty that the insured vessel is "seaworthy." This means that at the beginning of the voyage the ship must be suitably constructed and equipped with sufficient crew, fuel and provisions to carry the insured cargo on a particular voyage. In the Y2K sue-and-labor context, therefore, don't corporate insureds have a similar implied duty to ensure the continuing "seaworthiness" of their commercial "vessels"?

Shipshape Computers

Inevitably, four centuries of maritime sue-and-labor jurisprudence will play a decisive role in shaping the boundaries of the sue-and-labor clause at issue in the Y2K litigation. Consider the three questions central to the debate regarding the insurability of Y2K-remediation expenses:

* Imminence: How "actual or imminent" must the anticipated Y2K failure be to transform remediation costs incurred by the insured as part of its implied "seaworthiness" warranty into a reimbursable sue-and-labor expense? If an insured recognized in 1988 that a Y2K failure might occur in 2000, is this sufficiently "imminent" to trigger sue-and-labor coverage? In most maritime sue-and-labor cases, the covered loss or damage was apparent immediately before the insured incurred reimbursable sue-and-labor expenses--the vessel ran aground during a storm, hit a submerged object or simply sank.

Cases involving the recovery of sue-and-labor reimbursements for anticipated loss or damage are exceedingly rare and highly dependent on the facts of the case. Consider the Washington appellate court decision earlier this year in Wolstein vs. Yorkshire Insurance Co. In that case, the insured sought sue-and-labor expenses under a marine builder's risk insurance policy for the cost of protecting a multimillion-dollar yacht under construction against anticipated vandalism and freezing damage after the Wisconsin ship-building company closed its doors and abandoned the boat yard. Although not a true maritime sue-and-labor case because the vessel had not yet been launched, the court relied on maritime cases m reaching its holding that "just as the [sue and labor] expenses will be reviewed for reasonableness, an assured's actions will also be reviewed for reasonableness."

Y2K remediation expenses dating back more than a decade raise serious questions about how far in advance an insured can initiate reimbursable sue-and-labor activities before the concept of "actual and imminent" is rendered meaningless.

How elastic is this standard when anticipated losses are at issue? For example, is the cost of reinforcing a ship's hull to withstand some future storm damage or submerged object a reimbursable sue-and-labor claim? The underwriters would undoubtedly view such outfitting expenses as an integral part of the insured's implied warranty of seaworthiness or, put another way, a prudent risk-management activity that insureds are obligated to undertake.

* Seaworthiness: What is "lawful and necessary" for the insured to do when confronted with Y2K problems that, if left unresolved, could lead to "actual or imminent" loss or damage? In the context of the Y2K sue-and-labor litigation, the parties will inevitably clash over whether the implied warranty-of-seaworthiness concept applies to these Fortune 500 insureds. Were the property underwriters entitled to assume that the insureds did and would continue to do all things necessary to carry on their businesses "safely"? Is the Y2K threat averted or remediated by these corporations more akin to outfitting a vessel against storms typically encountered during North Atlantic voyages--part of the insured's seaworthiness warranty--or protecting the ship and its cargo against the ravages of a specific storm encountered during a specific North Sea voyage, which is more likely to be a reimbursable sue-and-labor expense?

If the courts adopt the analytical framework derived from the maritime sue-and-labor cases, they may be inclined to view a corporation as the business equivalent of a "vessel" and hold the captain and crew--the directors, officers and employees--dutybound to ensure the corporation's "seaworthiness." If so, claims for past and anticipatory Y2K-remediation expenses should be rejected because an insurer is not liable on its policy for die safety of the ship unless it is suitably constructed and equipped, "has a captain of competent skill" and a "crew competent for the voyage." Are not the directors, officers and employees obligated to exert themselves to the utmost to protect the corporate "vessel" against potential Y2K failures, especially given the significant lead time they have had to address this problem?

* Covered property: Insurers have no sue-and-labor reimbursement obligation unless the insured's expenses were incurred in protecting covered property. Thus, another hotly contested issue in the Y2K sue-and-labor lawsuits will be whether any "covered property" was subject to "direct physical loss or damage" due to a Y2K problem. Based on the complaints, the "all risk" property insurance policies in question apparently did not include a Y2K exclusion. To the extent that the plaintiffs can point to covered property that has sustained damage due to a Y2K failure, they may have the factual rudiments of a cognizable claim. But the main economic thrust of their lawsuits is that their remediation expenses--past, present and future--are recoverable as sue-and-labor claims because the potential damage was averted by their early intervention.

From the complaints, not much is known about these companies' imperiled information-technology and facility systems. But one envisions endless depositions about precisely what the direct physical loss or damage would have been in the absence of remediation and what covered property would have been physically destroyed, distorted or corrupted. If a Y2K software problem was remediated before any computer data was destroyed, distorted or corrupted, what is the direct physical loss or damage to covered property? Does "physical" loss or damage encompass errant, but intangible, Y2K-induced alterations in the polarity of magnetic media? if data is "lost" on a computer due to a Y2K problem, how is that loss made "physical"?

The controversial GTE, Xerox and Unisys Y2K sue-and-labor litigation and the anticipated flood of similar lawsuits undoubtedly will carry us well into the next millennium. But what distinguishes these claims from, say, environmental or asbestos claims, is that the interpretative principles associated with the sue-and-labor clause have been forged over four centuries of maritime litigation and commercial custom and practice, making it difficult to ignore the mutual duties and obligations inherent in marine sue-and-labor coverage and the risk-allocation implications of the implied seaworthiness warranty. The maritime sue-and-labor cases provide a useful framework for analyzing these questions and highlight essential risk-management assumptions that may prove influential when courts ultimately decide how to allocate the costs of Y2K remediation between insurers and their insureds.

Ronald S. Gass is associate general counsel and vice president with Nac Reinsurance Corp., Greenwich, Conn., an XL Capital Ltd. company
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Title Annotation:Y2K-related remediation expenses
Comment:A Test of Seaworthiness.(Y2K-related remediation expenses)
Author:Gass, Ronald S.
Publication:Best's Review
Geographic Code:1USA
Date:Jan 1, 2000
Words:2059
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