Insurance May Cover Y2K Compliance Costs

Have you spent money making your computers and software programs Y2K compliant?

If so, let your insurer know about your expenses right away--because you may recover them under obscure language found in your business property insurance policy.

The key lies in what insurers call the “sue and labor” or “preservation of property” provisions common in property insurance. Often couched in dense language, these provisions illustrate a simple idea--namely that you must take reasonable steps to keep small losses from becoming big ones.

The classic example comes from the days when insurers began covering ships at sea: The owner of a ship caught on rocks near shore could not stand by while the ship went down if by reasonable effort the owner might save it.

As this implies, the courts understand the language of the sue and labor or preservation of property provisions to create a kind of partnership between policyholder and insurer, each required to look out for the interests of the other with a reasonable diligence.

The courts take this to mean that insurers must pay certain costs incurred by policyholders in limiting losses--for example, the cost of hiring boats and sailors to save that ship on the rocks. Sometimes the courts want insurers to pay a policyholder’s costs in preventing losses, too, and some property policies make this obligation explicit, though couched in language so opaque as to make the eyes glaze over.

In any case, few business owners understand their rights under these provisions and insurers may resist paying the costs of fixing the Y2K problem, lest they lose untold treasure. And given the complexity of the case law on the question, not to mention the opacity of the language of most insurance policies, your own insurer may fight and win if you make a claim.

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But if you face big costs in making your computers and software Y2K compliant, prudence dictates that you put your insurer on notice that you expect it to foot the bill, according to David P. Schack, who heads the insurance practice group for the Los Angeles law firm Mitchell Silberberg & Knupp.

Why? Because doing so protects your right to fight the matter out in court, and you may need to exercise that right.

“Some policies say the insurance company will reimburse you for such costs,” Schack says. “Others don’t have the language; they impose the obligation on you to protect your property without promising to reimburse you for the cost of doing so.

“But where you do take steps to protect property and that benefits your insurer, you can make the argument that you should be reimbursed even if your policy’s language doesn’t specifically provide for it.”

Schack cites two lawsuits now pending that involve Y2K costs, one filed by GTE Corp. against five property insurers in U.S. District Court in New Jersey, and the other filed by Unisys Corp. against four insurers in Delaware Superior Court.

The insurers in these cases, Schack notes, argue that insurance covers you against unforeseen accidents, and that since business has known of the Y2K problem for years, their coverage doesn’t apply. They also argue that businesses often fix the Y2K problem by buying new computers and software--that is, by improving, not repairing, their systems--and that insurance doesn’t cover such things.

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A number of other complexities cloud the picture as well, Schack says. One is the question of whether damage to computer data or software is damage to tangible property as commonly understood in insurance law.

In addition, some property policies sold to small and mid-size businesses don’t cover computer software and data, Schack adds, and some cover only specific perils named in the policy--for example, fire damage to your plant.

“A policy covering you against only specific, named perils probably doesn’t cover you against Y2K compliance costs,” Schack says. “An all-risk policy covers you against any hazard not specifically excluded, and you probably have a better chance with this kind of coverage.”

The GTE and Unisys cases may dictate the fates of similar litigation, Schack says, but no business owner who has spent substantial sums on Y2K remediation should await a resolution to those cases before acting.

Fix your Y2K problems first, he says, and then check your insurance, and if you see any possibility that the coverage does apply, he says, notify your insurers within one year of incurring any Y2K remediation costs or risk losing the right to take the issue to court.

“Each situation will turn on its own facts,” Schack says. “The important thing is to do whatever makes sense for Y2K remediation--and not let the possibility that your insurer may reimburse you for your expenses drive your action.

“First you protect your business interests. Then you look to your insurance to see if you have any coverage.”

Juan Hovey can be reached at (805) 492-7909 or at jhovey@gte.net.