Opinion ID: 3014059
Heading Depth: 2
Heading Rank: 2

Heading: Exceptions to Exclusions

Text: to GTE’s system. 15 The problem is that the systems were programmed only to GTE argues that the District Court recognize the last two digits of the failed to consider all relevant policy date—the preface remaining a constant provisions in finding that GTE’s claim “19.” The fact, however, that at the turn fell within the defective design and of the millennium, the preface would now inherent vice exclusions. In particular, be “20’” rather than “19,” thereby requiring four-digit date recognition, was entirely predictable. The annual change in 16 On appeal, GTE argues that its date, like the road impacting the tire and risk assessment “included risks . . . that the water level rising, is within the scope systems might fail as a result of corrupt or of occurrences for which the system was destroyed data stemming from interactions purposely designed. The flaw—that the with computer systems and networks systems were limited to two-digit date outside of GTE.” Appellant Br. at 48. recognition—is entirely endemic to the But the record reflects no carefully system. That is, the insu red tailored remediation effort that was limited property—GTE’s systems—“contain[s] its just to corrupted data entering from own seeds of destruction” and is not outside sources. Nor, as the District Court “threatened by an outside natural force.” found, does GTE identify what portion, if American Home Assurance Co., 445 F. any, of its extensive $350 million Y2K program targeted that type of external threat. 258 F. Supp. 2d at 378-79. GTE cannot seek reimbursement for the entire cost of remediating its own defective 15 GTE has not attempted to programs merely because some elements characterize the Y2K problem as a of the program might also serve to “computer virus.” In Port of Seattle, the mitigate the effect of corrupted data court rejected a characterization of the entering from outside sources. GTE was Y2K problem as a virus, noting that “[t]he obligated to specifically identify and Port’s Y2K problem was the result of a quantify remediating steps aimed directly deliberate decision by programmers to use at damage from external threats, and a two-digit rather than four-digit year field therefore potentially covered by the . . . [and] [t]his feature does not cause the Insurers’ policies. GTE did not proceed software to be infectious.” 48 P.3d at 338. under such a theory in District Court. We note in passing that the issue of Instead it sought reimbursement for its whether a computer virus constitutes an entire program, and attempted to support “external threat” may pose a different this claim by alleging that some portion of question than the one presented in this its program could mitigate unspecified case. “external” threats. 18 GTE points out that the defective design Med. Center v. Am. Protect. Ins., 226 F. and inherent vice provisions except from Supp. 2d 470, 479 (S.D.N.Y. 2002) (“An the exclusions “resulting damage” and ensuing loss provision does not cover loss “ensuing loss or damage.” caused by the excluded peril, but rather covers loss caused to other property Specifically, the primary layer wholly separate from the defective policies state that the defective design or property itself.”); Prudential Property & specifications exclusion “shall not apply to Cas. Ins. Co., 2002 WL 31495830, at - loss or damage resulting from such 20 (D. Or. 2002). That is, “an ensuing defective design or specifications . . . ; loss provision does not cover loss caused however any such resulting damage will by the excluded peril, but rather covers be subject to all other exclusions in this loss caused to other property wholly Policy.” Additionally, inherent vices are separate from the defective property not covered “unless loss or damage from itself.” Swire Pac. Holdings, Inc. v. a peril insured herein ensues and then this Zurich Ins. Co., 139 F. Supp. 2d 1374, policy shall cover for such ensuing loss or 1380 (S.D. Fla. 2001) (hereinafter Swire damage.” Similarly, the excess layer I), certified on appeal 284 F.3d 1228 (11th policies do not insure against faulty design Cir. 2002) (emphasis in original). or inherent vice “all unless physical Moreover, in the factually analogous Port damage not excluded by this Policy of Seattle case, the Washington Court of results, in which event, this Policy will Appeals rejected the contention that even cover only such resulting damage.” if the Port’s Y2K problem was an We are not persuaded that the excluded inherent vice, the Port could ensuing and resulting loss provisions recover under the ensuing loss provision. allow GTE to recover in this case. Several 48 P.3d at 339-40. courts considering similar policy An alternative reading of the provisions have concluded that the cost of ensuing and resulting loss provisions correcting design defects cannot be would render the policy exclusions covered under an ensuing loss provision virtually meaningless. That is, the where it was incurred to correct an “exception to [the] . . . exclusion cannot excluded peril. See Swire Pac. Holdings be construed so broadly that the rule (the Inc. v. Zurich Ins. Co., 284 F.3d 1228, exclusion) is swallowed by the exception.” 1231 (11th Cir. 2002) (hereinafter Swire Swire I, 139 F. Supp. 2d at 1381. Rather, II) (citing cases)17 ; see also Montefiore that certification is necessary in this case. 17 In Swire II, the Eleventh Circuit This is not a case in which there is a ultimately certified the question of the particular area of the law that we need the design defect exclusion’s scope to the state courts to clarify; rather, we find Florida Supreme Court. See 284 F.3d at support for our interpretation in the plain 1231, 1234. We do not, however, believe meaning of the contract. 19 the ensuing loss provisions are best read as GTE is entitled to coverage because (1) permitting recovery where a covered peril data destruction and (2) business or damage results from the design defect interruption are specifically covered perils. or inherent vice.18 Thus we disagree that
The policies in this case ensure 18 Some courts have more narrowly against “all risks of physical loss of or interpreted ensuing loss clauses to apply damage to property described herein.” only “in those rare cases where the “Physical loss or damage” is defined to reasonable damage expected to be caused include “any destruction, distortion or by [for example] faulty workmanship corruption of any computer data, coding, leads to another peril that causes damage program except as hereinafter excluded” beyond that normally expected.” (emphasis added). Prudential, 2002 WL 31495830, at  GTE conceded at argument that (emphasis added). The following “[t]here has to be a physical damage illustration is helpful: resulting from design defect or inherent vice.” Tr. of Argument at 21:22-23. GTE [I]f defectively installed agrees with the Court, for example, that if, roof flashing allows water as a consequence of a defective Y2K to leak into the wall cavity, design, the fire retardation system in a then subsequent damage building does not function and the caused by water, such as dry building goes up in flames, “[t]his rot or mold, to the interior provision means that the building gets of the house is caused by covered, because it is a physical damage to the faulty workmanship and the building, but it doesn’t mean that the not covered. If, however, redesign of the software gets covered.” the water migrates into an Id. at 5:15-18. This concession seriously electrical box and causes an undermines GTE’s argument. In this case, electrical short which in GTE is essentially seeking recovery for turn causes a fire, then the measures taken to correct its systems, and fire damage is a covered not for some eventuating physical damage “ensuing loss.” [That is,] . . mold, unlike fire, is not an “ensuing loss” due to the an “intervening cause” or be “beyond that lack of any intervening normally expected.” Rather, we conclude cause other than time that GTE has failed to establish any beyond the initial water physical damage (whether normally damage. expected or not) “wholly separate from the defective property itself.” Swire I, 139 F. Id. We do not reach the issue of whether Supp. at 1380. the “ensuing loss” needs to be the result of 20 sustained to its property. other databases.” Letter from Raymond J. Alletto, GTE Director of Risk GTE argues that because the Y2K Management, to Ronald H. Davis et. al., problem would inflict physical damage to Executive General Adjuster McLarens the system and/or data, it can recover, Toplis N.A., Inc. (Oct. 12, 1999), J.A. at under the Sue and Labor Provisions 992-93. The record, however, does not discussed more extensively below, for appear to provide support for this preventive measures taken to mitigate this allegation of data corruption. Moreover, “ensuing loss.” The problem, however, is at best this establishes that incorrect data that GTE has failed to adequately may have been generated as a result of demonstrate that it was threatened by problems within GTE’s own systems—it “physical loss” in the form of does not establish that data destruction or “destruction, distortion or corruption of corruption would have ensued “to other any computer data, coding, program,” as property wholly separate from the distinct from the otherwise excluded defective property itself.” Swire I, 139 F. defective design and inherent vice. That Supp. 2d at 1380. Here, the plain is, GTE has not illustrated that the language of the policies provides coverage consequences of failing to correct the two- for data destruction or corruption “except digit date designation system, causing data as hereinafter excluded.” As discussed to enter the system in an unrecognizable above, the defective design and inherent format, are a covered loss. vice exclusions bar recovery, and a In response to this Court’s inquiry reading of the ensuing loss provisions to at oral argument, GTE provided record provide coverage would essentially read citations on the issue of the “data these exclusions out of the policy. destruction, distortion and corruption that
GTE potentially faced as distinct from the impact on GTE’s computers and/or GTE also points to the fact that software.”19 GTE’s strongest claim “business interruption” is a specifically appears to be its allegation that absent covered peril. The primary layer policies remediation, “some of [its] . . . systems provide for coverage for “[l]oss resulting might have generated incorrect data, from necessary interruption of business thereby corrupting financial records and conducted by the Insured and caused by loss, damage, or destruction by any of the perils covered herein . . . .” (emphasis 19 Letter from Robert F. Ruyak, added). The “Business Interruption Counsel for GTE Corporation, to Marcia Endorsement” in the excess policies M. Waldron, Clerk for the United States provides coverage for business Court of Appeals for the Third Circuit interruption “resulting from physical loss (December 15, 2003) (citing J.A. at 992- or damage of the type insured against by 94, 995-99, 1209-10, 1220-27, 3839-40, this Policy, to property not otherwise 3885). excluded by this Policy.” (emphasis 21 added). is a covered peril. However, GTE cannot claim business interruption losses ensuing As the District Court explained, in or resulting from the specifically excluded this case, in contrast to the factually intrinsic design defect and inherent vice analogous Port of Seattle case, “GTE has perils. Any other reading of the done more than claim testing losses; GTE exclusionary provisions would render the clearly claims that had it not remediated its provisions a virtual nullity. GTE could computer system in preparation for Y2K, argue, for example, that any upgrade to or it would have faced separate business correction of a defective system is interruption losses of a great magnitude.” reimbursable because the ensuing loss 258 F. Supp. 2d at 380. Viewing the from failing to correct the system would evidence in the light most favorable to result in “business interruption.” GTE, the District Court concluded that GTE faced potential business interruption In sum, we conclude that even losses and its remediation efforts were when read in conjunction with the other taken to prevent su ch losses. terms of the policies—the ensuing loss, Nevertheless, the District Court concluded data destruction, and business interruption that, pursuant to the terms of the policies, provisions—GTE’s claim is still barred by the alleged business interruption losses the defective design and inherent vice were not insurable. We agree. exclusions. The District Court explained that C. Consideration of After-The-Fact “[t]he ensuing loss provisions clearly only Correspondence provide coverage for a covered loss Finally, GTE argues that the ensuing from one of the excluded perils.” District Court, in interpreting the 258 F. Supp. 2d at 381. Moreover, foregoing contract provisions, erred by “[u]nder the plain language of the policies, failing to consider the Insurers’ alleged the business interruption loss must be after-the-fact efforts to amend the policies caused by a covered peril.” Id. As a to exclude coverage for Y2K costs. To result, because design defects and inherent begin, GTE points out that the Insurers vices are not perils covered, “the business chose to extend GTE’s insurance policies interruption loss ensuing from a design through the millennium without including defect or inherent vice would not be a a Y2K exclusion. Moreover, GTE alleges covered loss.” Id. In other words, GTE that, in 1998 and the spring of 1999, each cannot recover for just any ensuing or Insurer asked GTE to accept a Y2K resulting business loss—the underlying exclusion.20 GTE contends that Insurers peril resulting in business interruption must be covered. Returning to the fire example above, business interruption 20 GTE suggests that its decision to losses ensuing or resulting from any reject such policies resulted in subsequent physical damage sustained by a fire would cancellation of its IRI and Federal be covered because such physical damage policies, as well as Allendale’s 22 should not now be permitted to obtain In fact, the correspondence in this from the Court contract terms they were case does not even appear to support unsuccessful in negotiating, and suggests GTE’s contention that the Insurers sought that the efforts to negotiate Y2K to amend the policies to exclude Y2K exclusions illustrate an awareness on the coverage. In a fax dated June 3, 1998, part of Insurers that under the existing GTE’s Counsel requested that Allendale language they were liable for GTE’s Y2K include clarifying language that it would remediation measures. We conclude that not add such a Y2K exclusion. The fax such alleged after-the-fact correspondence provides: is not properly considered in interpreting The letter received was this contract, and, moreover, that the incomplete in GTE and our correspondence in this case does not estimation based on our appear to support GTE’s claim. meeting and Allendale’s New Jersey courts consider the positive response. We insurer’s conduct in determining whether would like the letter to read a policy’s terms are ambiguous. See as follows: Fortunato v. Highlands Ins. Group, 785 Allendale will not A.2d 963, 967 (N.J. Super. Ct. Law Div. add any additional 2001) (“The ambiguity of the umbrella exclusions, policy here is also shown by the conduct amendments or of the insurer.”). Moreover, courts do not endorsements “permi[t] insurance companies to seek regarding Year 2000 refuge in the literal language of their issues (inability to policies when the company’s conduct and recognize the correct actions . . . causes [sic] the insured to act data including Year or to fail to act based on that conduct.” 2000) to the Doto v. Russo, 659 A.2d 1371, 1377 (N.J. currently in force 1995). We have already concluded, G T E/ Allendale however, that the terms of the policy policies prior to the unambiguously exclude GTE’s claim. expiration of such Therefore, we find no reason to look to the policies (July 1, Insurers’ alleged conduct. In addition, 2000). GTE has failed to point to conduct by the Insurers that caused GTE to act or fail to J.A. at 4156 (emphasis added). act—this is not a case where GTE took On June 15, 1998, Allendale some action, to its detriment, in reliance appears to have transmitted to GTE’s on the Insurers’ statements or conduct. insurance broker proposed agreements between Allendale, Affiliated, and GTE. cancellation of selective policies. One of the stated objectives of the See Appellant Br. at 21. agreement was to “[e]liminat[e] 23 uncertainty and achiev[e] mutual policy.21 agreement as to how the policy responds