Case Briefs

Insureds Not Covered For Changing Computer's Date-Reading Capability

In GTE Corp. v. Allendale Mut. Ins. Co., No. 99-2877, slip op. (D.N.J. Mar. 26, 2003), a federal district court concluded that the “sue and labor” provisions of first-party insurance contracts do not entitle insureds to coverage for expenses allegedly incurred to identify and change the two-digit date reading capability in its computer systems prior to the date change to the year 2000. The insured undertook, beginning in 1995, to assess and then change these systems so that they could read four-digit dates. The first-party insurance contracts at issue insured certain types of property against all risks of physical loss or damage, including the business interruption resulting from insured loss or damage. Among other things, the contracts excluded the cost of “making good defective design or specifications, faulty material, or faulty workmanship” as well as “inherent vice.”

The contracts for the primary and excess layers also included either “sue and labor” or temporary “preservation and protection” provisions. Those provisions insured reasonable expenses incurred in the event of actual or imminent loss or damage of the type insured under the contract. The federal trial court cited law from New York, New Jersey, Connecticut, and other states in describing the nature, purpose, and application of the sue and labor undertaking. The opinion looked, for instance, to the recent Washington state appellate decision in Port of Seattle v. Lexington Ins. Co., 48 P.3d 334 (Wash. Ct. App. 2002), holding that the sue and labor undertaking only provides coverage when the claimed physical loss or damage that the insured seeks to avoid is one that would have been covered by the insurance contract. In GTE's case, the court ruled that the insured did not incur covered expenses because the claimed imminent difficulty in reading four-digit dates was not a peril of the type covered by the contracts.

In particular, the district court found that GTE's claim involved either systems defectively designed for operation in a four-digit environment or inherent vices in the two-digit systems that GTE had chosen to operate prior to the year 2000. The court noted that a “defect” was “the lack of something necessary or desirable for completion or perfection.” Because the software products in question lacked a method for recognizing dates beyond 1999, they had been designed without a quality necessary for proper functionality: a defect. Further, the court found that the Y2K flaw was an “inherent vice” in that the software in question contained the “seeds of its own destruction” and that any damage related to Y2K would be excluded from coverage on that basis.

Finally, the court rejected the insured's argument that physical loss or damage caused by the two-digit date reading system was nevertheless covered as an “ensuing loss” under the wording. Here, GTE's claim for ensuing loss was for projected business interruption, and this insurance only applied to interruptions caused by covered perils, none of which were shown to exist. Because any business interruption caused by the two-digit date reading system would not be covered, GTE could not be insured for its alleged efforts to avoid that result.

Insurer Must Defend Suit Alleging Violation of Consumer Protection Statute

In Auto Europe LLC v. Connecticut Indemnity Co., 321 F.3d 60 (1st Cir. 2003); a panel of the First Circuit Court of Appeals concluded that a liability insurer has an obligation to defend its insured against a suit alleging violations of Maine's consumer protection statute. The insured was sued by customers of its auto rental service who claimed in pleadings that the insured had intentionally defrauded and misled consumers regarding additional fees for auto rentals. The customers alleged that these actions had violated various state and federal laws, including Maine's consumer protection statute. The insured's insurance contract provided coverage for “any negligent act, error or omission,” but excluded “liability arising out of any act, error or omission which is willfully dishonest, fraudulent or malicious, or in willful violation of any penal or criminal statute or ordinances, and is committed (or omitted) by or with the knowledge or consent of the 'insured'.” Id. at 63. Citing this exclusion, the insurer argued that it did not have a duty to defend the insured in the underlying action.

As the insurance contract had no choice-of-law provision, the First Circuit concluded that Maine's law applied to the insurance contract because Maine was the principal location of the insured risk and because no other state had a more significant interest in the outcome of the case. Id. at 65-66. The court then applied Maine's duty to defend test, which requires the insurer to provide a defense if “there exists any legal or factual basis which could be developed at trial which would obligate the insurers to pay under the policy.” Id. at 66. Though all the complaint allegations related to intentional behavior, the court concluded that there was a theoretical possibility that the insured could be found liable for a violation of Maine's consumer protection statute even if the violation was not intentional. The court therefore concluded that the insurer was obligated to furnish a defense.

Insureds Not Covered For Changing Computer's Date-Reading Capability

In GTE Corp. v. Allendale Mut. Ins. Co., No. 99-2877, slip op. (D.N.J. Mar. 26, 2003), a federal district court concluded that the “sue and labor” provisions of first-party insurance contracts do not entitle insureds to coverage for expenses allegedly incurred to identify and change the two-digit date reading capability in its computer systems prior to the date change to the year 2000. The insured undertook, beginning in 1995, to assess and then change these systems so that they could read four-digit dates. The first-party insurance contracts at issue insured certain types of property against all risks of physical loss or damage, including the business interruption resulting from insured loss or damage. Among other things, the contracts excluded the cost of “making good defective design or specifications, faulty material, or faulty workmanship” as well as “inherent vice.”

The contracts for the primary and excess layers also included either “sue and labor” or temporary “preservation and protection” provisions. Those provisions insured reasonable expenses incurred in the event of actual or imminent loss or damage of the type insured under the contract. The federal trial court cited law from New York, New Jersey, Connecticut, and other states in describing the nature, purpose, and application of the sue and labor undertaking. The opinion looked, for instance, to the recent Washington state appellate decision in Port of Seattle v. Lexington Ins. Co., 48 P.3d 334 (Wash. Ct. App. 2002), holding that the sue and labor undertaking only provides coverage when the claimed physical loss or damage that the insured seeks to avoid is one that would have been covered by the insurance contract. In GTE's case, the court ruled that the insured did not incur covered expenses because the claimed imminent difficulty in reading four-digit dates was not a peril of the type covered by the contracts.

In particular, the district court found that GTE's claim involved either systems defectively designed for operation in a four-digit environment or inherent vices in the two-digit systems that GTE had chosen to operate prior to the year 2000. The court noted that a “defect” was “the lack of something necessary or desirable for completion or perfection.” Because the software products in question lacked a method for recognizing dates beyond 1999, they had been designed without a quality necessary for proper functionality: a defect. Further, the court found that the Y2K flaw was an “inherent vice” in that the software in question contained the “seeds of its own destruction” and that any damage related to Y2K would be excluded from coverage on that basis.

Finally, the court rejected the insured's argument that physical loss or damage caused by the two-digit date reading system was nevertheless covered as an “ensuing loss” under the wording. Here, GTE's claim for ensuing loss was for projected business interruption, and this insurance only applied to interruptions caused by covered perils, none of which were shown to exist. Because any business interruption caused by the two-digit date reading system would not be covered, GTE could not be insured for its alleged efforts to avoid that result.