TROOP

STEUBER
PASICH
REDDICK
& TOBEY, LLP

INSURANCE COVERAGE FOR THE YEAR 2000 PROBLEM

INSTITUTE FOR CORPORATE COUNSEL

Kirk A. Pasich
Troop Steuber Pasich Reddick & Tobey, LLP
24th Floor
2029 Century Park East
Los Angeles, CA 90067-3010
Telephone: (310) 728-3203
Facsimile: (310) 728-2203
kapasich@trooplaw.com

©2000. All Rights Reserved.

 TABLE OF CONTENTS

PAGE

I. INTRODUCTION 1

A. THE YEAR 2000 1

B. OTHER DATE PROBLEMS 4

1. February 29, 2000 4

2. September 8, 2001 4

3. January 19, 2038 5

II. OBTAINING INSURANCE FOR COMPUTER CODE PROBLEMS 5

A. CATEGORIES OF INSURANCE 5

B. THE INSURANCE INDUSTRY RESPONSE 6

1. Exclusions 6

2. Express Grants of Coverage 6

C. NO CHANGES 7

III. PROPERTY POLICIES 7

A. "NAMED PERIL" POLICIES 7

B. "ALL RISK" POLICIES 7

C. BUSINESS INTERRUPTION COVERAGE8

D. POTENTIAL COVERAGE ISSUES 10

1. When Does a “Loss" Take Place? 10

2. The "Known Loss" Doctrine 11

3. Contractual Limitations Periods 12

IV. CGL POLICIES 13

A. DETERMINING IF THERE IS “PROPERTY DAMAGE” 14

B. COVERAGE FOR REMEDIATION AND PREVENTIVE

STEPS 16

C. POTENTIAL COVERAGE ISSUES 17

1. When Does Damage "Occur"? 18

2. The "Known Loss" Doctrine and the "Expected or Intended"

Exclusion 20

3. "Business Risk" Exclusions 21

V. DIRECTORS AND OFFICERS POLICIES 21

 A. THE NATURE OF THE COVERAGE 21

B. "CLAIMS MADE" PROVISIONS AND REPORTING REQUIREMENTS 22

C. OBTAINING COVERAGE UNDER EXISTING POLICIES 22

VI. ERRORS AND OMISSIONS POLICIES 23

VII. CONCLUSION 23

ii
 INSURANCE COVERAGE FOR THE YEAR 2000 PROBLEM

By Kirk A. Pasich*

I.INTRODUCTION
II.
A. THE YEAR 2000

During the last several years, the “Year 2000” problem has received extensive attention, and has
resulted in American business spending billions of dollars. The Year 2000 problem involved the way in
which much computer software recognizes dates. Many software programs recognize the year in the form of
a two-digit code. This is because in the early days of computers, memory was extremely expensive, costing
around $1 per byte, as compared to today's cost of $1 per million bytes. See U.S. Senate Special Committee
on the Year 2000 Technology Problem, Investigating the Impact of the Year 2000 Problem, S. Rep. No. 106-10, at 9
(1999) [hereafter “Senate Report”].

Programs subject to the Year 2000 problem assume that the first two digits of the year are "19."
Therefore, a computer or program suffering from the Year 2000 problem could treat the years as being in
the wrong century (for example, treating "00" as 1900, not 2000). This could result in even simple date
calculations being performed incorrectly. For example, if the number of years between May 1, 1999, and
May 1, 2005, were to be calculated, the answer should be six. However, a program suffering from a Year
2000 problem could calculate the answer as being either 94 (99 minus 5) or -6 (5 minus 99)–neither being
correct.

The problem was reported to be a pervasive one, potentially affecting mainframe computers,
personal computers, and server-based networks. For example, one consulting firm predicted that
approximately 90 % of all business applications would fail–"by producing inaccurate calculations, resetting
dates to 1900, or simply freezing in something cybernetically like throwing a speeding car into 'park'–by the
end of 1999." Jeff Eckoff, State Vows to Avoid Computer Crash in Year 2000, Central Penn. Bus. J. 3, Feb. 9,
1996. The scope of the problem was described by one author as follows:

Affected computations include applications which calculate age, sort by date, and other
date-related specialized tasks. Given society's reliance on computers, the effects of a
computer system failure will range from an inconvenience to enormous problems:
military weapons systems failures; errors in the banking industry, specifically with ATMs
and direct deposits, withdrawals and account balances; personal, medical and academic
records malfunctioning; payroll and social services checks not being issued; non-issuance
of licenses and permits; inventory system failure; credit card verification failures; accounts

*Kirk Pasich is a litigation partner in the Los Angeles firm of Troop Steuber Pasich Reddick & Tobey, LLP.
He represents insureds in complex coverage matters. Mr. Pasich has been named by California Law Business
as one of the top 25 litigators in California and by the American Lawyer as one of the top 45 lawyers in the
country under the age of 45. He is the lead author of Year 2000 and Beyond: Liability and Insurance for Computer
Code Problems (CCH 1999).

1
 receivable and payable malfunctions; and many other functions ceasing to operate or
operating incorrectly.

Computers and the Year 2000, at 842-43 (note omitted). Others predicted that the combination of "[d]ate
storage and leap year logic will have a dramatic impact on computers worldwide." Id. For example, it was
predicted that "[e]very time a retailer swipes a credit card that has a 00 expiration date, the stores computers
will stop the transaction, figuring that the card expired the year the first cars came with steering wheels." Id.
Additionally, there were fears that the year 2000 problem could strike embedded computer chips. These are
microchips that have hard coded date logic and are found as components of many products, including
certain elevator systems, security systems, automobiles, communication equipment, and other devices.

However, it appears that the Year 2000 problem was overstated, or that efforts by American
business to correct the problem were successful. Now that January 1, 2000, has come and gone, it is
apparent that the massive disruption of business operations that many feared did not happen. There is
disagreement as to why, ranging from views that the problem was overstated to views that the problem was
avoided due to the significant efforts to prevent it. However, even the feared major disruptions did not
occur on January 1, 2000, the reality is that a substantial portion of American business did, in fact, experience
a Year 2000 problem. Indeed, more than 37% of U.S. companies experienced a Year 2000 related problem.
Senate Report at 10.

Furthermore, disclosures to the Securities and Exchange Commission for some Fortune 100
companies indicate that the amounts spent on the Year 2000 problem are staggering.1 However,
notwithstanding the substantial expenditures by American business, there are reports that the largest volume
of system failures because of the Year 2000 problems will occur between October 1, 1999, and March 31,
2001, with the largest number of problems occurring between October 1, 1999, and September 30, 2000.
U.S. Senate Special Committee on the Year 2000 Technology Problem, Investigating the Year 2000 Problem: The
100 Day Report 12 (Summary of Committee Findings, S. print 106-31, at 139, Sept. 22, 1999 [hereafter [100
Day Report”].

A. OTHER DATE PROBLEMS

In addition to the Year 2000 problem, there are other computer code problems.

1. February 29, 2000

The year 2000 is a leap year. However, years divisible by 100 normally are not leap years unless
they are divisible by 400. Computers and the Year 2000. Therefore, an unknown number of computers
and/or programs may treat year 2000 as a common year, rather than a leap year, creating a different, but
arguably related, set of problems.

2. September 8, 2001

Another wave of computer-code problems may surface on September 8, 2001. UNIX is the
dominant system for workstations and large computers. Some UNIX programs keep track of the date and
time by counting the number of seconds since January 1, 1970. September 8, 2001, will be shown as
“999,999,999” on some UNIX software. This may be regarded as the end-of-file marker.

3. January 19, 2038

A similar UNIX problem could appear on January 19, 2038. Under UNIX timekeeping, the
system will read “999,999,999,999,” which also may be regarded as the end-of-file marker. This may cause
the counter to roll over to “0,” which may cause UNIX machines and programs to process information as if
it were January 1, 1970, all over again.

1Estimates of Y2K repair costs include AT&T’s estimate of $756,000,000, General Motors’estimate of at
least $564,000,000, McDonald’s estimate of $80,000,000, Merrill Lynch’s estimate of $520,000,000, and
Xerox’s estimate of $183,000,000. See Investigating the Year 2000 Problem: The 100 Day Report 12 (Summary of
Committee Findings, S. Print 106-31 Sept. 22, 1999).

2
I.OBTAINING INSURANCE FOR COMPUTER CODE PROBLEMS

Given the fact that American business has spent billions of dollars on the Year 2000 problem, it is
not surprising that some companies have turned to their insurance carriers, seeking to be indemnified for
their losses. Unfortunately, insurance carriers typically have responded by denying coverage. This has
resulted in several insurance coverage lawsuits, including those involving Xerox, Nike, GTE, Unisys, the Port
of Seattle, Kmart, and ITT Industries. Furthermore, several publications have published stories predicting a
wave of insurance coverage lawsuits.1

CATEGORIES OF INSURANCE

Given the potential magnitude of the year 2000 problem and other computer code problems,
insureds may look to their insurance policies to provide a source of financial security and protection. As
discussed below, there are many types of insurance policies that may provide protection. However, they
generally fall within two categories: first-party insurance policies and third-party insurance policies. First-
party insurance coverage provides an insured with protection for losses that it directly incurs. In essence, an
insurance carrier agrees to reimburse the insured for losses that the insured directly suffers, which may, or
may not, result from the wrongdoing of others. First-party insurance includes property insurance, surety
bonds, and fire insurance.

Third-party insurance protects the insured from claims asserted by others because of damage they
allege the insured caused. In essence, an insurance carrier typically agrees to defend and indemnify the
insured against such claims. Third-party insurance usually does not protect the insured against losses that it
directly incurs, but instead protects the insured against damages sought or imposed against it as a result of its
potential liability to third parties. Examples of third-party insurance include comprehensive or commercial
general liability ("CGL") policies, directors' and officers' liability policies, professional liability policies, and
errors and omissions policies.3

A. THE INSURANCE INDUSTRY RESPONSE

The insurance industry has responded to the year 2000 problem in three different ways.

1. Exclusions

Many insurance carriers added exclusions to their policies in an effort to exclude coverage for year
2000 problems. In fact, the Insurance Services Office, Inc. ("ISO"), which provides standard insurance
policy forms, pricing information, and underwriting information to insurance carriers, developed
endorsements to policies that state that the policies do not cover the year 2000 problem. In fact, ISO
introduced seven optional endorsements to address the Year 2000 problem and other computer code
problems. The basic exclusion, called the “The Exclusion -Year 2000 Computer-Related and Other

2See,e.g., Ashley Dunn, “Insurers May Become Target as Y2K Lawsuit Bonanza Fades,” Los Angeles Times,
Jan. 10, 2000 at C1 (“The relatively smooth passage of the world through the year 2000 problem has turned
the prospect of a litigation Armageddon into a bust for now, but some lawyers are predicting that new suits
may arise in the coming months–this time against insurance companies. . . . Instead of a wave of litigation
sweeping through every facet of commerce, they say that any battles in the future will likely be between huge
corporations and insurance companies–entities that have the resources to wage protracted litigation.”);
Joanne Wojcik Kochaniec, “Y2K may still be felt in court,” Business Insurance, Jan. 10, 2000 at 1 (“While only
a handful of Y2K remediation coverage cases are currently in litigation, numerous claims for coverage have
been filed with insurers and could end up being decided by the courts, policyholder and insurer attorneys
say.”).

3The fact that there are two general types of insurance coverage has no relationship to the number of policies
that an insured may have. It is not unusual for a policy to be a "package" policy that includes various types
of first-part and third-party coverage. For example, many automobile insurance policies provide third-party
coverage in the form of a duty to defend and indemnify the insured against claims brought by others, as well
as first-party coverage in the form of "collision" insurance for damage that the insured's own vehicle suffers.

3
Electronic Problems,” Form CG 21 60, purports to exclude coverage for losses arising directly or indirectly
from the failure, malfunction, or inadequacy of computer hardware, software, networks, and other items due
to the inability to recognize or accept the Year 2000 or beyond. It also purports to exclude similar losses
caused by other products or services that directly or indirectly use or rely on such equipment and software.
This endorsement appears to be extremely broad, and likely will argued to be such by insurance carriers.
Other ISO endorsements include two “limited exclusion” endorsements (Forms CG 04 31 and CG 04 32).
These contain essentially the same exclusion as the basic endorsement, but remove the exclusion as to
certain types of damages, operations, products, locations, or services listed in schedules contained in the
endorsements.

Many insurance carriers also developed their own endorsements, some removing coverage, some
providing coverage, and some excluding coverage except as expressly provided by the endorsement.

2. Express Grants of Coverage

Some insurance brokers and insurance carriers created insurance policy forms specifically designed
to address, and provide at least some coverage for, the year 2000 problem. For example, AIG expressly
provided Year 2000 coverage in one of its directors and officers liability forms, know as the “Gold” form.
The Gold Form expressly covers Year 2000 claims, which it defines, in part, as

any claim (including a securities claim) against a Director(s) or Officer(s), or . . . any Year
2000 Securities Claim against the company and/or any Employee . . .
AIG Gold Form, § 2(r). However, the AIG Gold Form does contain various limitations, including a
limitation on how much AIG may be required to pay when a claim involves both covered and uncovered
claims. See id., § 5.

A. NO CHANGES
B.
C. Some insurance carriers apparently did not do anything with their policies, perhaps because they
believe that year 2000 problems are not covered under their policies and because they have no plans to offer
policies that expressly provide such coverage. See T. Wallack, Insurers Positioning Themselves to Avoid Damage
from Year 2000 Computer Claims, The Hartford Courant, Sept. 22, 1997, at 10.
D.
E.
II. PROPERTY POLICIES

A. "NAMED PERIL" POLICIES

There generally are two types of property insurance policies. Many property policies, sometimes
called "named peril" policies, typically cover an insured against losses to property caused by the perils
named--that is, specified perils listed--in the policies. These perils typically include fire, lightning, wind
storms, and hail. It is unlikely that most "named perils" policies expressly cover the year 2000 problem.
Therefore, these policies may not provide any coverage.

A. "ALL RISK" POLICIES

Another type of property insurance policy may provide coverage. These policies are known as "all
risk" policies. The Association of British Insurers has estimated that 75% of all United Kingdom companies
have "all risk" insurance coverage against business interruption and property damage. See C. Adams, Insurers
Liable For Computer "Bomb" Payouts, Financial Times, Sept. 4, 1997, at 8. Many United States businesses also
have "all risk" coverage.

"All risk" policies are comprehensive in nature, covering all risks not specifically excluded. They
provide extremely broad coverage for the insured and are to be liberally interpreted to provide coverage. As
one noted authority states:

In recent years, so-called “all-risk” insurance policies have been used with
increasing frequency. An “all-risk” policy creates coverage of a type not ordinarily present
under other types of insurance, and recovery is allowed for fortuitous losses unless the
loss is excluded by a specific policy provision; the effect of such a policy is to broaden
4
 coverage and a fortuitous event is one which, to the knowledge of the parties, is
dependent upon chance.
10 Lee R. Russ & Thomas F. Segalla, Couch On Insurance 3d, § 148:50, at 148-87 to 148-88 (1998). In fact,
"the very nature of the term 'all risks' must be given a broad and comprehensive meaning as to covering any
loss other than a wilful or fraudulent act of the insured." Miller v. Boston Ins. Co., 420 Pa. 566, 572 (1966).

In determining whether there is coverage for a particular loss under an insurance policy, the first
issue is whether the loss falls within the scope of the basic coverage of the policy as defined in the insuring
clause. Royal Globe Ins. Co. v. Whitaker, 181 Cal. App. 3d 532, 536-37, 226 Cal. Rptr. 435 (1986). Once it is
determined that a loss falls within the insuring clause, the next question is whether any exclusion applies.
American Star Ins. v. Ins. Co. of the West, 232 Cal. App. 3d 1320, 1325, 284 Cal. Rptr. 45 (1991). When a policy
is an "all risk" policy, the loss is deemed to fall within the insuring clause and the insurance carrier must
prove that an exclusion applies. As a California court of appeal has explained:
[I]n an action upon an all risks policy such as the one before us (unlike a specific peril
policy), the insured does not have to prove that the peril proximately causing his loss was
covered by the policy. This is because the policy covers all risks save for those risks
specifically excluded by the policy. The insurer, though, since it is denying liability upon
the policy, must prove the policy's noncoverage of the insured's loss--that is, that the
insured's loss was proximately caused by a peril specifically excluded from the coverage of
the policy.

Strubble v. United Servs. Auto. Ass'n, 35 Cal. App. 3d 498, 504, 110 Cal. Rptr. 828 (1973).

Therefore, to defeat coverage for a year 2000 problem, insurance companies must show that the
cause of the loss was an excluded cause. See Atlantic Lines, Ltd. v. American Motorists Ins. Co., 547 F.2d 11, 12
(2d Cir. 1976). This is a showing that they cannot make unless the policy language includes an exclusion for
year 2000 problems--which most current policies do not.

A. BUSINESS INTERRUPTION COVERAGE

Property insurance policies also often provide coverage for business interruption losses. The
coverage typically compensates an insured for profits or earnings that it loses because of a covered peril. It
also usually provides an extended "indemnity period," meaning that there is additional coverage until the
insured's business returns to normal, and coverage for the "extra expense" that the insured incurs in
attempting to return its business to a state of normalcy.

Some business interruption provisions are broad enough so that the covered peril need not damage
or cause loss of insured property, but need only damage or cause loss of property of the type insured. See,
e.g., Linnton Plywood Ass’n v. Protection Mut. Ins. Co., 760 F. Supp. 170, 173 (D. Or. 1991) (business interruption
coverage provided for plywood manufacturer because of malfunction of sprinkler system, even though there
was no property damage and the manufacturer was not physically prevented from processing plywood).
Therefore, if the year 2000 problem is expressly covered by a "named perils" policy or is not expressly
excluded by an "all risk" policy, business interruption coverage may be afforded. This coverage typically will
compensate the insured for profits or earnings that are lost for the period of repair or restoration.

However, insurance carriers might try to resist coverage under business interruption provisions.
They might contend that there is no coverage unless there is a complete closure, or complete cessation, of
the insured's business. This argument should not be accepted. Most property policies require an insured to
mitigate its loss of earnings by resuming operations during the period of a business interruption. If insurance
carriers were right in their arguments that a complete cessation of operations is necessary, this would put
insureds in an impossible catch-22 situation--they would get coverage only as long as they are closed, but
they must reopen as soon as possible. Therefore, it is not surprising that courts have rejected insurance
carriers' arguments. For example, in Steel Products Co., Inc. v. Millers National Insurance Co., 209 N.W.2d 32
(Iowa 1973), the court held that the insured had a duty to mitigate its earnings losses by resuming operations
during the period of interruption pursuant to its policy. Id. at 36. Thus, the insured's partial resumption of
its business was proper mitigation. Id. The court also held that the period of business interruption was the
time it actually took to restore the insured's premises. Id. at 38. The fact that the insured resumed
operations did not terminate the business interruption coverage. Id. at 39. Coverage continued until the
premises were repaired completely. Id. The fact that the reduction in gross earnings was lessened as a result
of resumption of its operations did not shorten the period of business interruption. Id. at 38.
5
 Likewise, in American Medical Imaging Corp. v. St. Paul Fire & Marine Insurance Co., 949 F.2d 690 (3d
Cir. 1991), fire damage to the insured's headquarters forced it to relocate its office. Although the insured
relocated by the next afternoon, it had access to substantially fewer telephone lines than before the fire,
which prevented it from working at full capacity. The court held that the policy required the insurer to
indemnify the insured for the "necessary or potential suspension" of its business until the insured could
resume "normal business operations." Id. at 692. "This necessarily implies that the obligation to indemnify
can arise while business continues, albeit at a less than normal level." Id. at 693. Accordingly, complete
closure or complete cessation of operations is not required.

A. POTENTIAL SOURCES OF COVERAGE

While some of the insurance coverage lawsuits that have been filed address only certain theories of
recovery under property insurance policies, there are, in fact, at least three arguments in favor of coverage.
First, an insured may argue that the Year 2000 problem involves damage to, or a loss of use, of tangible
property covered by their property insurance policies. Second, an insured may argue that the policies’“sue
and labor” provisions provide coverage. Third, insureds may be able to rely on the common law doctrine of
mitigation of damage or loss.

1. Damage or Loss of Tangible Property

Courts have not yet addressed the question of whether the year 2000 problem is damage to
property. However, courts have addressed questions about whether computer data constitutes property.
They have done so primarily in the context of tax law, and have reached mixed conclusions. Many of these
courts have found that computer tapes are intangible property for tax purposes. See, e.g., District of Columbia v.
Universal Computer Associates, Inc., 465 F.2d 615, 617 (D.C. Cir. 1972) (computer tapes are intangible property
for tax purposes); First Nat’lBank v. Department of Revenue, 85 Ill. 2d 84, 88, 421 N.E.2d 175, 178 (1981).
However, other courts have reached the contrary conclusion. See, e.g., South Central Bell Tele. v. Barthelemy, 643
So.2d 1240 (La. 1994) (holding computer software to constitute taxable tangible personal property);
Chittenden Trust Co. v. King, 143 Vt. 271, 274, 465 A.2d 1100, 1102 (1983). There is a persuasive argument that
the latter courts are correct. As the South Central court explained:

Most commentators agree that computer software is tangible for sales, use, and property
tax purposes, and thus taxable, at least to some degree.
....
In addition, computer software has generally been held to constitute “goods”
under the Uniform Commercial Code.
....
When stored on magnetic tape, disk, or computer chip, this software, or set of
instructions, is physically manifested in machine readable form by arranging electrons, by
use of an electric current, to create either a magnetized or unmagnetized space. . . . The
computer reads the pattern of magnetized and unmagnetized spaces with a read/write
head as “on” and “off”, or to put it another way, “0" and “1". This machine readable
language or code is the physical manifestation of the information in binary form.
...
. . . The software at issue is not merely knowledge, but rather is knowledge
recorded in a physical form which has physical existence, takes up space on the tape, disk,
or hard drive, makes physical things happen, and can be perceived by the senses. . . . “In
defining tangible, ‘seen’is not limited to the unaided eye, ‘weighed’is not limited to the
butcher or bathroom scale, and ‘measured’is not limited to a yard stick.” . . . That we use
a read/write head to read the magnetic or unmagnetic spaces is no different than any
other machine that humans use to perceive those corporeal things which our naked senses
cannot perceive. . . .
The software itself, i.e., the physical copy, is not merely a right or an idea to be
comprehended by the understanding. The purchaser of computer software neither desires
nor receives mere knowledge, but rather receives a certain arrangement of matter that will
make his or her computer perform a desired function. This arrangement of matter,
physically recorded on some tangible medium, constitutes a corporeal body.

6
643 So. 2d at 1245-46.

Additionally, some courts have concluded, in discussing CGL coverage, the mere incorporation of a
defective product to another product constitutes damage to the overall product. See, e.g., Armstrong World
Indus. v. Aetna Cas. & Sur. Co., 45 Cal. App. 4th 1, 91-93, 52 Cal. Rptr. 2d 690 (1996). Thus, the mere
presence of the defective code might be deemed to constitute appreciable damage, even if it has not caused
other damage.

2. “Sue and Labor” Provisions

Insureds also may seek coverage under the “sue and labor” provisions of their property policies. A
typical sue and labor clause states:

In the event of any loss or damage insured against, it shall be lawful and necessary for the
Insured . . . to sue, labor, and travel for, in and about the defense, safeguard and recovery
of the property insured hereunder . . . without prejudice to this insurance . . . .

Form CPMIS, Miller’s Standard Insurance Policies Annotated I (1999). These clauses provide, in essence,
coverage in addition to the limits otherwise applicable. See 12 Couch on Insurance 3d § 183:163 (1998)
(“[L]iability to the insured for sue and labor expenses is in addition to the amount payable under the dollar
limits of the . . . coverage . . . .”). In spite of its relatively arcane language, the clause is designed to encourage
insureds to take reasonable steps to prevent a threatened loss for which an insurer would be liable and to
reimburse the insured for its costs in seeking to reduce covered loss. See American Home Assurance Co. v. J.F.
Shea Co., 445 F. Supp. 365, 369 (D.D.C. 1978). While sue and labor clauses more commonly are invoked in
the face of natural disaster such as hurricanes (where businesses may board up their windows to prevent
them from being damaged), insureds can argue that they apply here, where insureds took reasonable steps
(given the projected magnitude of the Y2K problem) to minimize their Y2K losses, thereby saving their
insurers millions of dollars over what they might have had to pay had major Y2K losses actually occurred.
This clause is at the heart of most of the pending coverage lawsuits.

3. The Common Law

Insureds also may be able to rely on the common law of mitigation of damages or loss. The
doctrine is well-established in California, where courts long have recognized that an injured party has a duty
to mitigate its damages. See, e.g., Locklin v. City of Lafayette, 7 Cal. 4th 327, 352 (1994) (a person threatened
with injury to his property must “take reasonable precautions to avoid or reduce any actual or potential
injury”); Geddes & Smith, Inc. v. St. Paul Mercury Indem. Co., 63 Cal. 2d 602, 605 (1965) (“The policy of the
courts has been to promote mitigation of damages . . . .”). Courts have recognized that this doctrine can
apply in a property insurance context. For example, in Witcher Construction Co. v. St. Paul Fire & Marine Ins.
Co., 550 N.W.2d 1 (Minn. Ct. App. 1996), the court concluded that coverage would be afforded under the
common law doctrine of mitigation for certain mitigation expenses. See also Slay Warehousing Co. v. Reliance
Ins. Co., 471 F.2d 1364, 1367-68 (8th Cir. 1973) (“[T]he obligation to pay the expenses of protecting the
exposed property may arise from either the insurance agreement itself . . . or an implied duty under the policy
contract based upon general principles of law and equity . . . .”); Winkler v. Great Am. Ins. Co., 447 F. Supp.
135, 142 (E.D.N.Y. 1978) (recognizing that if insured had raised house to avoid flood damage, insurer would
have had to pay expenses because “the duty to protect the property from further damage implies a
responsibility on the insurer’s part to pay for the costs of reasonable protective measures . . . .”). In fact, if a
party mitigates its damages or loss, it should be entitled to recover all reasonable expenses incurred in that
effort. See Brandon & Tibbs v. George Kevorkian Accountancy Corp., 226 Cal. App. 3d 442, 460-61 (1990) (“justice
requires that the risks incident to [mitigation] should be carried by the party whose wrongful conduct makes
them necessary”); Hartong v. Partake, Inc., 266 Cal. App. 2d 942, 968 (1968) (party attempting to mitigate
entitled to recover “reasonable cost” of mitigation effort).

7
A. POTENTIAL COVERAGE ISSUES

1. When Does a “Loss" Take Place?

Property policies typically obligate an insurance carrier to pay an insured for any “loss” covered by
the policy. The question presented is: When does an insured suffer a “loss”? If an insured believes that its
computer system may suffer from the year 2000 problem, but that problem has not actually interfered with
the insured’s operations, coverage may be problematic.

In the context of first-party policies, such as property policies, many courts have concluded that an
insured suffers a “loss” when there has been some appreciable damage. As the California Supreme Court
has explained, an insured suffers a “loss” at

that point in time when appreciable damage occurs and is or should be known to the
insured, such that a reasonable insured would be aware that his . . . duty under the policy
[to notify his insurer] has been triggered. . . .
Determining when appreciable damage occurs such that a reasonable insured
would be on notice of a potentially insured loss is a factual matter for the trier of fact.

Prudential-LMI Ins. Co. v. Superior Court, 51 Cal. 3d 674, 687, 798 P.2d 1230, 274 Cal. Rptr. 387 (1990). See
Nationwide Mut. Fire Ins. Co. v. Tomlin, 181 Ga. App. 413, 352 S.E.2d 612 (1986).

1. The "Known Loss" Doctrine

One question that insurance carriers might raise is whether coverage is precluded pursuant to the
“known loss” doctrine because an insured knows that it may have a potential problem. See Cal. Ins. Code
§ 22 (“Insurance is a contract whereby one undertakes to indemnify another against loss, damage, or liability
arising from a contingent or unknown event”); id., § 250 (“[A]ny contingent or unknown event, whether past
or future, which may damnify a person having an insurable interest, or create a liability against him, may be
insured against . . . .”). As the California Supreme Court has explained:

Critically, the requirement that the “event” be “unknown” or “contingent” is

stated in the disjunctive in the rules embodied in sections 22 and 250. We long ago
recognized that all that is required to establish an insurable risk is that there be some
contingency. Even where subsequent damage might be deemed inevitable, “‘such
inevitability does not alter the fact that at the time the contract of insurance was entered
into, the event was only a contingency or risk that might or might not occur within the term
of the policy.’”

Montrose Chem. Corp. v. Admiral Ins. Co., 10 Cal. 4th 645, 690, 913 P.2d 878, 42 Cal. Rptr. 2d 324 (1995). The
court favorably cited its earlier decision in Sabella v. Wisler, 59 Cal. 2d 21, 377 P.2d 889, 27 Cal. Rptr. 689
(1963). In Sabella, an insurance carrier argued that damage to the insured’s residence was not fortuitous and
therefore was not covered because “the damage occurred as a result of the operation of forces inherent” in
the inherent soil conditions. The court rejected this argument, holding that even if it were inevitable that the
damage would have occurred at some time during ownership of the house, the loss was covered because it
was a contingency or risk at the time the parties entered into the policy. Id. at 34. Thus, knowledge that
there might be a year 2000 problem alone should not suffice to eliminate coverage.4

4Itis important, however, that an insured review the notice provisions in an insurance policy. An insured
may find it has a duty to give notice of events that might give rise to a potential loss. A delay in giving notice
could jeopardize coverage.

8
1. Contractual Limitations Periods

Many property insurance policies contain "contractual limitations" provisions--contractual versions

of statutes of limitations that may limit when an insured may bring suit. It is not unusual for contractual
limitations periods to specify that any suit must be filed within one or two years after the loss, even though
that period may be tolled from the time when the insured notifies its carrier until the carrier responds. See
Prudential-LMI Ins. Co. v. Superior Court, 51 Cal. 3d 674, 693, 798 P.2d 1230, 274 Cal. Rptr. 387 (1990).
Therefore, an insured should be careful to determine when a “loss” has taken place and when its time to sue
expires.

I. CGL POLICIES

Comprehensive or commercial general liability (“CGL”) policies typically provide coverage for four
types of injury or damage–“bodily injury,” “property damage,” “advertising injury,” and “personal injury.”
Of these types of coverage, the most common to be triggered will be “property damage” provisions. 5

A CGL policy obligates an insurance carrier to defend an insured against claims and suits that
potentially are covered by the policy and indemnify the insured for any settlements of, or judgments in, such
suits. One standard form of a CGL policy states:

We will pay those sums that the insured becomes legally obligated to pay as damages because of . . .
‘property damage’to which this insurance applies. . . . This insurance applies to . . . “property
damage” which occurs during the policy period. . . . The . . . “property damage”must be caused by
an “occurrence.” . . . We will have the right and duty to defend any “suit” seeking those damages.6

Commercial General Liability Insurance Policy Form (Occurrence), § 1, Coverage A, ¶1.a. (Insurance
Services Office, Inc. 1982). The insurance carrier’s duty to defend extends even to suits that are “groundless,
false, or fraudulent.”

A. DETERMINING IF THERE IS “PROPERTY DAMAGE”

Property damage often is defined in CGL policies as meaning:

a. Physical injury to tangible property, including all resulting loss of use of that
property; or

5”Bodily injury” typically is defined as “bodily injury, sickness or disease sustained by a person, including
death . . . .” Commercial General Liability Insurance Policy Form § V.3. (Insurance Services Office, Inc.
1982). This coverage may be applicable to claims involving imbedded chips or devices affected by the Year
2000 problem. Coverage likely would be triggered under at least policies in effect when the device is installed
and when injury or malfunction results. See Section IV.B.1 infra. “Advertising injury” typically is defined to
include offenses that relate to the publication of material that slanders, libels, or disparages a person or
organization, violates a person’s right of privacy, misappropriates advertising ideas or style of doing business,
or infringes copyright, title, or slogan. Id., § V.1. “Personal injury” typically is defined as including false
arrest, malicious prosecution, wrongful entry into, or eviction of a person from a room, dwelling, or premises
(or, in some versions, a “wrongful invasion of the private right of occupancy” or publication of slanderous,
libelous, or disparaging material). See id., § 5.10. If there are claims involving alleged contamination or
recontamination by the Year 2000 code, personal injury coverage may apply. See, e.g., Titan Holdings Syndicate,
Inc. v. City of Keene, 898 F.2d 265, 272 (1st Cir. 1990) (pollution and odor claim covered as “invasion of the
right of private occupancy”); Martin-Marietta Corp. v. Insurance Co. of N. Am., 40 Cal. App. 4th 1113, 47 Cal.
Rptr. 2d 670 (1995) (migration of pollutants from one property to another may constitute a trespass covered
by personal injury provisions). However, a number of courts have held that the personal injury coverage
applies only to claims involving some interest in real property. See Nichols v. Great Am. Inc. Cos., 169 Cal. App.
3d 766, 215 Cal. Rptr. 416 (1985) (claim of airwave piracy not covered because “personal injury” relates to
some interest in real property).

6Some forms of CGL policies provide coverage on a “claims made,” rather than “occurrence” basis. These
policies are subject to many of the concerns discussed below for D&O and E&O policies, which typically are
written on a “claims made” basis.

9
 b. Loss of use of tangible property, including all resulting loss of use of that
property . . .

Commercial General Liability Insurance Policy Form, § V.12 (Insurance Services Office, Inc. 1982).

Insurance carriers may argue that the defective code does not involve damage to “tangible”
property. While there are, as yet, no cases addressing this question in the context of the year 2000 problem,
the question of whether computer data or software constitutes tangible property has been addressed in
various contexts. As noted above, one context involves the question of whether computer data constitutes
“tangible property” for tax purposes. As noted above, courts have reached different conclusions.

Two courts have considered whether computer data or software constitutes tangible property can
be damaged in the context of CGL policies. In Retail Systems, Inc. v. CNA Insurance Cos., 469 N.W.2d 735
(Minn. Ct. App. 1991), a Minnesota court of appeal addressed the question of whether a data processing
consultant was entitled to a defense in a lawsuit alleging that the consultant has lost the claimant’s computer
tape. The court concluded that the computer tape and data were tangible property. As it explained:
We find no precedent in Minnesota or elsewhere to direct us in deciding whether
computer tapes and data are tangible property under an insurance policy. . . .
At best, the policy’s requirement that only tangible property is covered is
ambiguous. Thus, this term must be construed in favor of the insured. Other
considerations also support the conclusion that the computer tape and data are tangible
property under this policy. The data on the tape was of permanent value and was
integrated completely with the physical property of the tape. Like a motion picture, where
the information and celluloid medium are integrated, so too were the tape and data
integrated at the moment the tape was lost.”

Id. at 737. Therefore, the court concluded that the computer tape and data “were tangible property under
the insurance policy.” Id. at 738.

The United States Court of Appeal for the Seventh Circuit addressed an analogous question. In
Centennial Insurance Co. v. Applied Health Care Systems, Inc., 710 F.2d 1288 (7th Cir. 1983), the court addressed
whether an insurance carrier had a duty to defend its insured in a lawsuit seeking damages because the
insured allegedly introduced a faulty controller into the claimant’s data processing system. The underlying
claimant alleged that

“the controllers were defective in that each of them had a wiring-connection defect that
caused them to consistently malfunction through the random loss of customer billing and
patient care information that had been stored in the system” [and] that the defective
controllers prevented the company from adequately serving its clients and that the
ultimate result was the termination of [the company’s] business.

Id. at 1290. The court did not address the question of whether there was, in fact, tangible property damage,
holding that that question depended upon facts to be adjudicated in the claimant’s lawsuit against the
insured. It also noted that it did not have to resolve “whether information stored in a data processing system
may be fairly characterized as tangible property.” However, the court did conclude, under California law,
that the insurance carrier had a duty to defend its insured. As the court held:

A fair reading of the complaint in the [underlying] action clearly raises the specter
that liability for property damage may ensue. Whether [the claimant] will prove such
property damage at trial remains to be seen; in any event, that issue is of no moment here.
Accordingly, [the carrier’s] argument that [the claimant] has suffered no property damage
is inapt and cannot exonerate [the carrier] of the duty to defend.

Id. at 1291. Thus, in many situations, it will not matter whether the year 2000 problem actually involves
damage to tangible property. As long as such damage is alleged, or could be alleged, in a lawsuit, an
insurance carrier should be obligated to defend its insured against that lawsuit. See, e.g., Gray v. Zurich Ins. Co.,
65 Cal. 2d 263, 276-77, 419 P.2d 168, 54 Cal. Rptr. 104 (1966) (all that is required to trigger an insurance
carrier's duty to defend is a bare 'potential' or 'possibility' of coverage . . .).

10
 Even if the defective code were not deemed to constitute damage to tangible property, coverage
still may be afforded by CGL policies. Because many standard form insurance policies expressly cover loss
of use of tangible property, it should not matter whether there is actual damage to tangible property. As long
as a claim is made against an insured based on the notion that the claimant suffered a loss of use of tangible
property because of the year 2000 problem, a CGL carrier should have a duty to defend its insured.

Notwithstanding these facts, carriers still might attempt to argue that because the Code is
performing exactly as it was intended to perform, there should not be deemed to be any injury or loss of use
of tangible property. This is similar to the argument that insurance carriers made in attempting to resist
defending and indemnifying their insureds against claims that buildings contained "asbestos." At least some
insurance carriers argued that the asbestos insulation was supposed to be in the buildings and that it
performed its intended function--to insulate. However, many courts rejected this argument, finding that
even if the insulation performed its intended function, it was defective and its presence caused property
damage. See, e.g., Armstrong World Indus. v. Aetna Cas. & Sur. Co., 45 Cal. App. 4th 1, 114, 52 Cal. Rptr. 2d 690
(1996).

A. COVERAGE FOR REMEDIATION AND PREVENTIVE STEPS

One issue likely to be encountered is whether there is coverage under liability policies before a Year
2000 problem actually has interfered with the functioning of a computer or other item. While there are no
decisions involving the Year 2000 problem, there are decisions that suggest that coverage could be afforded
for remediation efforts or other efforts to mitigate, or reduce, the effects of a Year 2000 problem. Thus,
courts have recognized that if an insured, in reaction to damage that has taken place, takes steps to prevent
damage to other people’s property (thereby “mitigating” what otherwise would be covered by liability
policies), coverage is afforded. As the California Supreme Court has explained:

[E]ven if . . . costs are incurred largely to prevent damage previously confined to the
insured’s property from spreading to . . . third party property (i.e., the costs are
“mitigative” in character), reimbursement of such costs constitutes “damages” in ordinary
terms. A contrary result would fail to fulfill the reasonable expectations of the parties.

AIU Ins. Co. v. Superior Court.7 In AIU, the court addressed the question of the insurability of “damages”that
included expenses incurred to mitigate against future damage. However, the court also addressed whether
injunctive relief could constitute “damages”–for example, an injunction requiring remediation. The court
concluded that injunctive relief could qualify as “damages” insured by a liability policy.8
A number of other courts have reached similar conclusions, at least where there already has been
damage suffered, even if that damage is only to the insured’s own property. For example, in Globe Indemnity
Co. v. State,9 a California court of appeal ruled that the liability policy was obligated to pay the “damages” an
insured incurred in the form of fire suppression costs for preventing a fire from spreading from its own
property to a neighbor’s property. As the court explained:

We cannot conceive as reasonable a rule of law which would encourage an

insured property owner not to report that neighboring property was being destroyed by

751 Cal. 3d 807, 833, 799 P.2d 1253, 274 Cal. Rptr. 820 (1990).

8The court explained:

The mere fact that the agencies seek an injunction in an environmental
protection action does not indicate an absence of cognizable property damage or personal
injury. The prima facie case for injunctive relief is identical to that for reimbursement of
response costs, with the single added element of “imminent and substantial
endangerment” of public health or welfare or the environment.
...
For these reasons, it would exalt form over substance to interpret CGL policies
to cover one remedy but not the other.
Id. at 840, 799 P.2d at 1277.

943 Cal. App. 3d 745, 118 Cal. Rptr. 75 (1974).

11
 reason of its negligence in permitting a fire to escape from his property because his
insurance would cover him for the property damage but not for the fire suppression costs.
We do not believe that the facts of this case direct us to reach such an unreasonable and
potentially stultifying conclusion.10 Many other courts have reached similar conclusions.11
A. POTENTIAL COVERAGE ISSUES

As with property insurance policies, insurance carriers may raise a number of arguments against
coverage.

1. When Does Damage "Occur"?

Insurance carriers may contend that there is no coverage until damage or loss of use "manifests"
itself. However, this theory has been rejected by many courts, including the California Supreme Court. See
Montrose Chem. Corp. v. Admiral Ins. Co., 10 Cal. 4th 645, 913 P.2d 878, 42 Cal. Rptr. 2d 324 (1995). As the
Montrose court stated, applying a "manifestation" trigger of coverage

would be to effectively rewrite [the contracts of insurance], . . . transforming the broader

and more expensive occurrence-based CGL policy into a claims made policy.

Id. at 689. Instead, damage may be deemed to occur even if it has not yet manifested. See id. at 675
("Neither is the date of discovery of the damage or injury controlling . . . .").

While courts have not yet addressed the question of when damage occurs for the year 2000
problem, there are decisions in an analogous context that provide guidance. For example, in Armstrong World
Industries, Inc. v. Aetna Casualty & Surety Co., 45 Cal. App. 4th 1, 114, 52 Cal. Rptr. 2d 690 (1996), a California
court of appeal addressed the question of when damage occurred in the context of buildings that contained
asbestos. The court rejected the insurance carrier’s arguments that the buildings were not damaged simply
because they contained asbestos. The court concluded that the incorporation of asbestos products into the
building was itself physical damage covered by a CGL policy. As the court explained:

We conclude that even in such cases, when there have been no releases of asbestos fibers, if [the
insured] is held liable for the mere presence of ACBM [asbestos-containing building material], the
injury to the buildings is a physical one. Once installed, the ACBM . . . is physically linked with or
physically incorporated into the building and therefore physically affects tangible property. . . .
....
. . . . In our view, however, the damages allegedly suffered by the building owners from the
presence of ACBM cannot be considered solely economic losses.

Id. at 91-93.

Similar conclusions have been reached by courts addressing insurance coverage for construction
defect claims. One of the leading decisions is Hauenstein v. St. Paul-Mercury Indemnity Co., 242 Minn. 354, 65
N.W.2d 122 (1954). In Hauenstein, the insured supplied plaster for use on walls. After it was applied, the
plaster shrank and cracked, forcing its removal. The Hauenstein court concluded that the mere presence of
the defective plaster constituted damage that was insured. As the court stated:

No one can reasonably contend that the application of a useless plaster, which has to be removed
before the walls can be properly replastered, does not lower the market value of a building.
10Id. at 751-52. Indeed, this rule is recognized in California’s Insurance Code. See Cal. Ins. Code § 531(b)
(stating that an insurer is liable “[i]f a loss is caused by efforts to rescue the thing insured from a peril insured
against”).

11See,e.g., Goodyear Rubber & Supply, Inc. v. Great Am. Ins. Co., 545 F.2d 95, 96 (9th Cir. 1976) (liability policy
provided coverage for insured’s potential liability for salvage claim undertaken when there was explosion and
fire on barge); Gowans v. Northwestern Pacific Indem. Co., 260 Or. 618, 621, 491 P.2d 1178 (1971) (insured
entitled to reimbursement for award paid for recovery of stolen jewelry because it followed as a natural
consequence of the theft); American Economy Ins. Co. v. Commons, 26 Or. App. 153, 552 P.2d 612 (1976) (costs
insured by fire marshal and chargeable to insured in putting out fire covered by insurance policy).

12
 Although the injury to the walls and ceilings can be rectified by removal of the defective plaster,
nevertheless, the presence of the defective plaster . . . constituted property damage. The measure
of damages is the diminution in the market value of the building, or the cost of removing the
defective plaster and restoring the building to its former condition plus any loss from deprival of
use, whichever is the lesser.

65 N.W.2d at 125. This reasoning has been adopted and followed by other courts. See, e.g., Geddes & Smith,
Inc. v. St. Paul-Mercury Indem. Co., 51 Cal.2d 558, 565, 334 P.2d 881 (1959).

While insurance carriers probably will disagree, the reasoning of these courts should apply to the
year 2000 problem. Incorporation of the code into computer systems may interfere with the operations of
those systems, lower their value, and force removal or repair of the code. The presence of the defective code
should be deemed to constitute property damage. If a software or hardware provider, or consultant, is sued
because of a year 2000 problem, it should ask its carriers to defend them. Insurance carriers should be hard-
pressed to resist, particularly if the suit against their insured alleges that there is damage to, or loss of use, of
tangible property. And, if the insured faces a settlement or judgment, the carrier may be obligated to pay the
full amount of that judgment or settlement.

The Armstrong court also recognized that damage occurred when asbestos fibers were released. The
court concluded, as had many other courts, that contamination constituted property damage. Armstrong, 45
Cal. App. 4th at 21. By analogy, if a claimant alleges that the year 2000 problem has begun interfering with
its operations or ability to conduct business, the insured may be covered by the policies in effect at the time
of the interference.

In short, an insured may be entitled to coverage under policies in effect from the date that the
defective code was incorporated through the time that the code allegedly causes interruption or interference
with the claimant’s systems, business, or operations. The question that will need to be resolved is: when did
that damage actually occur? While it might seem surprising that a policy issued years, or even decades, ago
could provide coverage, courts nationally have recognized this possibility. Under “occurrence”-based CGL
policies, the key for coverage is not when a claim is made or a suit is filed, but when the damage or injury
took place. Under Armstrong, Hauenstein, Geddes, and similar cases, damage arguably first took place at the
time the code was installed, meaning that the policy in effect at that time would provide coverage.
However, because damage also may occur when the code actually causes a disruption, the policies in effect
during the period of disruption also may apply. Thus, an insured may be covered under multiple policies
issued at different times.

1. The "Known Loss" Doctrine and the "Expected or

Intended" Exclusion

Insurance carriers also may argue, as they might with property insurance policies, that there is no
coverage for year 2000 claims against their insureds because they are "known risk" or "known loss." As with
property insurance policies, this argument should be rejected. As the Montrose court explained:

Where, as here, there is uncertainty about the imposition of liability and no "legal obligation to
pay" yet established, there is an insurable risk for which coverage may be sought under a third party
policy.

Montrose Chem Corp. v. Admiral Ins. Co., 10 Cal. 4th 645, 692, 913 P.2d 878, 42 Cal. Rptr. 2d 324 (1995).
Therefore, the court held:

[T]he loss-in-progress rule will not defeat coverage for a claimed loss where it had yet to
be established, at the time the insurer entered into the contract of insurance with the
policyholder, that the insured had a legal obligation to pay damages to a third party in
connection with a loss.

Id. at 693.

For the same reason, exclusions in policies for damages "expected or intended" by the insured also
should not eliminate coverage:

13
 In general, what makes injuries or damages expected or intended rather than accidental are
the knowledge and intent of the insured. It is not enough that an insured was warned that
damages might ensue from its actions, or that, once warned, an insured decided to take a
calculated risk and proceed as before. . . .
....
[P]roof of warnings of possible physical damages is not enough to show that as a
matter of law the damages ultimately incurred were expected or intended.

City of Johnstown v. Bankers Standard Ins. Co., 877 F.2d 1146, 1150-52 (2d Cir. 1989). As the Armstrong court
explained:

An insurance policy exclusion from . . . activities which carry a risk of causing . . . harm,
although not known or intended to cause harm in the insured’s business conduct, would
create an exclusion swallowing the entire purpose of insurance protection for unintended
consequences. Insurance is purchased and premiums are paid to indemnify the insured
for damages caused by accidents, that is, for conduct not meant to cause harm but which
goes awry. The insured may be negligent indeed in failing to take precautions or to
foresee the possibility of harm, yet insurance coverage protects the insured from his own
lack of due care. If coverage is lost for damage which a prudent person should have
foreseen, there would be no point to purchasing a policy of liability insurance.

Armstrong World Indus., Inc. v. Aetna Cas. & Sur. Co., 45 Cal. App. 4th 1, 72-73, 52 Cal. Rptr. 2d 690 (1996).
As another California court concluded, damage would be excluded only when an insurance carrier can
demonstrate that that damage was “intended”–that is, “desired, purposefully sought, or brought about by
design,” or “expected”–that is, when “the insured knew or believed its conduct was substantially certain or
highly likely to result in that kind of damage.” Shell Oil Co. v. Winterthur Swiss Ins. Co., 12 Cal. App. 4th 715,
745 & 748, 15 Cal. Rptr. 2d 815 (1993).

1. "Business Risk" Exclusions

An insurance carrier also might attempt to assert that CGL policies contain so-called "business risk"
exclusions--that is, exclusions that apply to liabilities that arise from risks that an insured might take in
conducting its business, such as the risks that flow from breaching a contract or warranty, or from causing
another party to suffer economic losses. However, these exclusions should not eliminate coverage in many,
if not most, situations involving year 2000 claims. See, e.g., Armstrong World Indus., Inc. v. Aetna Cas. & Sur.
Co., 45 Cal. App. 4th 1, 110-15, 52 Cal. Rptr. 2d 690 (1996) (rejecting application of "business risk"
exclusions to claims of damage arising from presence of asbestos-containing material in buildings).

I. DIRECTORS AND OFFICERS POLICIES

A. THE NATURE OF THE COVERAGE

Directors and officers of corporations may be sued by shareholders (or others) if they fail to take
appropriate steps to address a year 2000 problem. If such claims or suits are filed, directors and officers
("D&O") liability insurance policies may afford coverage. D&O insurance policies typically provide two
types of coverage--one for the individual directors and officers and one for the company itself, should it
indemnify the directors and officers against claims. The "directors and officers liability" provision typically
obligates the carrier to pay on behalf of each director or officer all "loss" for which the director or officer is
not indemnified by the corporation that the director or officer must pay because of a claim first made during
the policy period for a "wrongful act." The "company reimbursement" provision of a D&O policy
(sometimes called the "directors and officers indemnity" provision) legally obligates the carrier to pay on
behalf of the corporation all "loss" for which it indemnifies any director or officer who has become legally
obligated to pay because of a claim first made during the policy period for a "wrongful act."

A "wrongful act" often is defined as an "error, misstatement, misleading statement, act, omission,
neglect, or breach of duty," committed or attempted to be committed by a director or officer acting in his or
her capacity as such. See, e.g., Federal Insurance Company Executive Liability and Indemnification Policy,
Form 14-02-0386, ¶ 9.1 (ed. 2-84). Other policies define "wrongful act" as "any breach of duty, neglect,
error, misstatement, misleading statement or omission" by an officer or director. Harbor Directors and
Officers Liability Insurance Policy, Form HU 8128-1, ¶ 2(D) (ed. 9-85). Given the breadth of these
14
definitions, an insured may have a strong argument for coverage if a claim or suit is brought against a
director or officer because the director or officer erred, failed to act, acted, or acted negligently, in
responding (or not responding) to a year 2000 problem.

A. "CLAIMS MADE" PROVISIONS AND REPORTING

REQUIREMENTS

One potentially important limitation on D&O coverage is the fact that most D&O policies are
"claims made" or "claims made and reported" policies. Under these policies, coverage purportedly is limited,
at least by policy language, to claims that are "first made" against the insured during the policy period, and, in
the case of "claims made and reported" policies, to claims that are both first made and reported during the
policy period. Therefore, carriers may argue that these policies do not cover a claim made before or after the
policy period, or a claim made during the policy period that is not reported when the policy is in effect.
Therefore, it is essential that an insured review its policy and determine what its notice obligations are.

A. OBTAINING COVERAGE UNDER EXISTING POLICIES

Because some insurance carriers have added Year 2000 exclusions to their policies, one question
presented is whether coverage can be obtained under an earlier policy (or an existing policy that does not
have such an exclusion). It may be possible. D&O policies typically contain provisions specifying that if an
insured gives notice during the policy period of an act, omission, occurrence, or some other defined event
that may give rise to a claim, then any claim subsequently made would be deemed to have been made during
the policy period. This means that a policy in effect now may provide coverage for a future claim as long as
the insured gives notice now of the potential claim. Therefore, an insured may wish to consider giving
notice under an existing D&O policy of the possibility of a year 2000 claim based upon news reports and any
analysis or review that it has conducted of its potential exposure. Indeed, such notice might be given as part
of a "laundry list" near the end of a policy period–that is, a summary listing of potential claims (particularly if
an exclusion for year 2000 problems is being added to a policy on renewal). While courts have not reached a
uniform conclusion as to the effectiveness of such a laundry list, many courts have held that such a notice is
sufficient to satisfy a policy's requirements. See, e.g., Concord Hospital v. New Hampshire Medical Malpractice Joint
Underwriting Ass'n, 137 N.H. 680, 684, 633 A.2d 1384 (1993) (notice provision satisfied by letter sent two days
before the policy expired and which the insured merely notified the carrier of 36 "patient events" that could
lead to claims); American Cas. Co. v. Resolution Trust Corp., 845 F. Supp. 318, 323 (D. Md. 1993) (insured's
notice of listing of potential claims, without substantial detail as to any claims, held sufficient); Federal Deposit
Ins. Corp. v. Heidrick, 812 F. Supp. 586, 591 (D. Md. 1991), aff’d, 995 F.2d 471 (1993) (broad sweep of notice
of "potential claims" provision "precludes the need for undue specificity").12 Therefore, according to these
courts, subsequent claims would be deemed to have been made within the policy period in which the laundry
list was provided. Of course, an insured should carefully review its policy language before making a decision
on whether or not notice should be given to a carrier of an act that may give rise to a potential claim and, if
so, the content of such a notice.

I. ERRORS AND OMISSIONS POLICIES

Many insureds who provide professional services have errors and omissions ("E&O") policies.
These policies typically are designed to insure professionals against claims based upon their acts or omissions
in rendering professional services. USM Corp. v. First State Ins. Co., 37 Mass. App. Ct. 471, 475, 641 N.E.2d
115 (1994), aff'd, 420 Mass. 865, 652 N.E.2d 613 (1995). E&O policies have many of the same features as
D&O policies, typically including substantially similar language, terms, conditions, and exclusions. Like
D&O policies, E&O policies often provide coverage on a "claims made" or "claims made and reported"
basis and, therefore, are subject to the same concerns as D&O policies. However, E&O policies may be
particularly valuable to companies that have provided computer, network, and/or software services or

12It is possible that insurance carriers will inquire in the renewal process about potential year 2000 problems.
If they do so, the provision of such information in a renewal application might constitute notice to the carrier
satisfying a "potential claims" provision. See, e.g., United Ass'n Local 38 v. Aetna Cas. & Sur. Co., 790 F.2d
1428, 1429 (9th Cir. 1986). However, an insured should not count on this fact and should give separate
notice before the policy expires. It also is important that the insured answer accurately any questions posed
in the renewal process and application. Otherwise, the insurance carrier might argue that the insured
misrepresented or concealed facts, entitling the carrier to rescind the policy.

15
advice. See id. (rejecting carrier arguments that errors in providing services in connection with "turnkey"
computer system not covered under consultant's E&O policy). Therefore, these policies should be reviewed
carefully to determine their potential for coverage.

I. CONCLUSION

It is too early to say with certainty that there will be no major disruptions from the Year 2000
problem and other problems affecting software and computer codes. However, whether such problems
arise in the future does not change the fact that American business has spent a substantial amount of money
in an effort to prevent, or mitigate, Year 2000 problems. For the reasons noted above, insureds may be able
to obtain insurance coverage for such costs. They also may be entitled to insurance coverage if they receive
claims or suits in the future regarding computer code problems. Because insurance may be valuable, those
who have incurred costs in attempting to mitigate or prevent the Year 2000 problem, or may face claims in
the future relating to the Year 2000 problem, should carefully review their insurance policies. They should
determine whether those policies provide coverage. By doing so, insureds may discovery that whatever the
nature and extent of their Year 2000 costs and claims, they are fully insured.

16