Will Your Year 2000 Liabilities Be Covered By Insurance?

Hollander and Company, LLC
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Jay Hollander, Esq. is the principal of Hollander and Company LLC, www.hollanderco.com, a New York City law firm concentrating its efforts in the protection and development of property interests relating to real property, intellectual property and commercial interests, as well as related litigation.

The content of this article is intended to provide general information relating to its subject matter. Providing it does not establish any attorney-client relationship and does not constitute legal advice. Personal advice in the context of a mutually agreed attorney-client relationship should be sought about your specific circumstances.

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Many of our clients have asked what protection they may have under their current insurance programs. While this is not easily answered, we have compiled the following from publications over the last several months. Naturally, this information, while deemed accurate, may not necessarily reflect the terms and conditions contained in all insureds policies, thus Tanenbaum-Harber requests that reliance upon this information should only be made while in conjunction with a comprehensive review of specific policies.

Most standard corporate insurance policies will probably afford little protection against Year 2000 (Y2K) losses. Even for those policies that may afford coverage (i.e. Directors' & Officers' and Fiduciary Insurance), substantial uncertainty exists.

Although the potential interruption of business and financial operations is one of a company's primary financial exposures to Y2K problems, absent special coverage enhancements, business interruption policies will likely afford very little if any coverage.

The reason is that business interruption insurance is frequently written on a "named peril" basis, affording protection for losses incurred by the insured as a result of certain business interruptions caused by specifically listed fortuitous events. Y2K problems are not likely to be included as a covered event in standard business interruption policies - even when the policy is written on an "all risk" basis, under most forms the event causing the business interruption still must arise out of a direct physical loss to covered property and be fortuitous. These conditions will likely eliminate coverage for most Y2K losses, which arise out of known, predictable conditions and are unlikely to involve physical damage to property.

Several provisions in standard general liability policies will likely greatly limit, if not eliminate, coverage for Y2K losses.

General liability insurance typically covers loss incurred by the insured company and its directors, officers and employees for liability to third parties for property damage, bodily injury and personal injury that is not "expected or intended" by the insured. Most losses incurred by third parties arising out of an insured company's Y2K problems, however, will not involve bodily injury or property damage as those terms are used in standard general liability forms, and even those that arguably do quite possibly will not be considered "unexpected and unintended" given the publicity regarding potential Y2K problems and the opportunities to engage in corrective action before those problems materialize.

Since underwriters of management liability policies never contemplated the kind of one-time-only catastrophic exposure presented by Y2K problems, underwriters have responded in one of the following manners:

- They have sought to add express exclusions to their policy to clarify the intent of the policy not to provide coverage. They have even canceled or refused to renew policies for certain risks altogether;

- Underwriters will blindly ignore the exposure now, argue no coverage for the claim when it comes in, minimize pay-out on covered losses, and then seek to recoup those losses through indiscriminate price increases for all of its insured customers;

- Underwriters will take a proactive underwriting approach by seeking to determine each company's relative exposure to Y2K liability and adjust the policy's terms, conditions and pricing to reflect that exposure. This approach is preferred since it accomplishes the following:

- It seeks to impose the cost of covered Y2K losses primarily upon those insured parties who have the greatest exposure to such losses, while rewarding those who have effectively managed their Y2K problems with perhaps only price adjustments;

- The amount of loss which must be eventually shared among all insureds is also reduced, either by placing exclusions on those companies that may not be managing the problem effectively, or, perhaps, by a prudent use of coinsurance or higher retentions on some of those risks.

In addition to the above advantages, an effective underwriting analysis at this time allows all parties to knowledgeably structure a more comprehensive and understandable insurance program with respect to the unique Y2K issues of the particular company. All parties in the insurance relationship are best served by engaging in an honest and open review and discussion of potential Y2K issues and by addressing those issues through more predictable and tailored financial protection products.

The following illustrates how each of the primary types of management liability insurance may be implicated with respect to a Y2K loss.

D&O generally covers claims against corporate directors and officers for Wrongful Acts as defined in the policy. Many policies also cover securities claims made directly against the insured corporation. It is a claims-made policy, meaning that it only covers lawsuits and other claims made during the policy period. Among a D&O policy's typical exclusions are those excluding claims arising out of litigation pending and prior to a specified date, pollution as well as an insured's personal profit, fraud or dishonesty.

Given the potential severity of Y2K claims, it is doubtful that D&O underwriters intended to provide coverage for this catastrophic exposure. Accordingly, companies should discuss Y2K coverage with their D&O insurer and encourage the insurer to underwrite the process by which companies managing the risk.

Assuming such analysis is successful, express coverage endorsements or policies might then be requested, and the insurer will probably require an additional premium for the coverage. The coverage requested might specifically include coverage for shareholder class and derivative actions as well as employment practices liability. With respect to customers or vendor claims, note that D&O policies are generally not intended to respond to corporate liabilities (outside, perhaps, the securities area) and therefore might be expected to give little, if any, protection for customer or vendor suits or other corporate contract or copyright infringement liability claims. However, due to the potential severity of such third party claims, some specific coverage might be requested.

D&O policies have also remained silent on certain issues affecting directors and officers while the corporation is in bankruptcy. These issues include coverage for claims brought by bankruptcy trustees as well as the insured status of the Debtor-in-Possession entity. These issues may become more of a concern as the costs of correcting Y2K problems soar causing some companies to file for bankruptcy protection.

In the event of a claim, both the insured and the insurer are best served by a clear, mutually understood policy, especially with respect to an exposure as significant as the Y2K issue. With respect to Y2K, silence can not and should not be regarded as "golden".

Fiduciary liability insurance generally covers claims against employee benefit plans and their fiduciaries and sponsoring organizations for breach of duties imposed under ERISA and for negligent administration of pension plans.

Given the potential for claims alleging errors in administration of covered plans and erroneous distribution to plan participants and beneficiaries as a result of Y2K problems, many of the same underwriting and risk management issues applicable to D&O insurance should also be analyzed under the Fiduciary Program.

E&O insurance generally affords coverage for claims made alleging errors or omissions by the insured parties with respect to named professional services they provide.

Many of the same underwriting and risk management issues applicable to D&O and Fiduciary insurance apply to E&O insurance. In addition, it is possible that a specific Y2K exclusion will be added to some E&O contracts, particularly where the insured's services are heavily dependent upon or otherwise involve computers. Discussions between the underwriter and the insured relating to the company's Y2K E&O exposure are important, so that all parties can understand the extent of any financial protection against such claims.

The typical fidelity or crime policy reimburses the insured for losses sustained as a result of theft, forgery or other specified wrongdoing by employees and, many times, third parties. A fidelity contract might apply in two (2) circumstances:

- If a Y2K problem allows an employee or other third party to commit a covered crime, or;

- If consultants retained by the company to become Y2K compliant commit a covered crime based on information about the company and its systems gained through their engagement.

One insurance solution to Y2K is to purchase coverage specifically written to cover this exposure. While their is both finite and risk transfer coverage available, both are costly and require a cumbersome vetting process.

Given the legal risks, it is imperative that directors and officers of companies take steps to ensure that their companies Y2K remediation programs are carefully planned and documented and executed in accordance with those plans. All applicable legal defenses should be taken advantage of, and finally, corporate indemnification provisions and insurance policies should be analyzed.

EDITOR'S NOTE: This article is contributed in the public interest. It is not intended as legal advice. Nor is any professional relationship intended or established with the reader by virtue of browsing this article. The information contained in the article is believed to be accurate but should not be relied on without independent advice of an appropriate professional.