                                                                                                                           Opinions of the United
2004 Decisions                                                                                                             States Court of Appeals
                                                                                                                              for the Third Circuit


6-21-2004

GTE Corp v. Allendale Mutl Ins
Precedential or Non-Precedential: Precedential

Docket No. 03-2139




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"GTE Corp v. Allendale Mutl Ins" (2004). 2004 Decisions. Paper 543.
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                      PRECEDENTIAL     ROBERT F. RUYAK (Argued)
                                       JERROLD J. GANZFRIED
   UNITED STATES COURT OF              Howrey, Simon, Arnold & White
          APPEALS                      1299 Pennsylvania Avenue, N.W.
    FOR THE THIRD CIRCUIT              Washington, DC 20004

                                             Counsel for Appellant
            No. 03-2139
                                       HENRY J. CATENACCI (Argued)
                                       Podvey, Sachs, Meanor, Catenacci,
      GTE CORPORATION,                 Hildner & Cocoziello
                                       One Riverfront Plaza
                  Appellant            The Legal Center, 8th Floor
                                       Newark, NJ 07102
                 v.
                                             Counsel for Appellees Allendale
ALLENDALE MUTUAL INSURANCE             Mutual Insurance and Afilliated FM Ins.
         COMPANY;                      Co.
  AFFILIATED FM INSURANCE
         COMPANY;                      MARY K. VYSKOCIL (Argued)
ALLIANZ INSURANCE COMPANY;             Simpson, Thatcher & Bartlett
FEDERAL INSURANCE COMPANY;             425 Lexington Ave.
  INDUSTRIAL RISK INSURERS             New York, NY 10017

                                              Counsel for Appellee Industrial
                                       Risk Insurers
  On Appeal from the United States
             District Court            WILLIAM N. ERICKSON
    for the District of New Jersey     Robins, Kaplan, Miller & Ciresi
     (Dist. Ct. No. 99-cv-02877)       111 Huntington Avenue
 District Judge: Honorable Alfred M.   Suite 1300
                Wolin                  Boston, MA 02199

                                             Counsel for Appellee Allianz Ins.
     Argued: December 9, 2003          Co.

  Before: AMBRO, FUENTES and
    CHERTOFF, Circuit Judges.          RICHARD M. MACKOWSKY
                                       Cozen & O’Connor
       (Filed: June 21, 2004)          1900 Market Street
                                       The Atrium
                                       Philadelphia, PA 19103
BERNADETTE N. GORDON                                  Provisions”) of the policies did not entitle
Cozen & O’Connor                                      GTE to coverage for costs incurred to
One Newark Center                                     prevent an excluded loss. For the reasons
Suite 1900                                            stated below, we will affirm the District
Newark, NJ 07102                                      Court’s grant of summary judgment.
                                                                           I.
      Counsel for Appellee Federal
Insurance Company                                               A. The Y2K Problem
                                                             The approach of the year 2000
                                                      evoked fears of various millenarian
                                                      catastrophes. One such fear was the “Y2K
                 OPINION
                                                      problem,” and it arose from the entirely
                                                      predictable fact that the passing of the year
                                                      1999 resulted in a change in all four digits
CHERTOFF, Circuit Judge.                              of the written representation of the
                                                      succeeding years.
       P l a i n t i f f - A p p e l l an t GTE
Corporation (“GTE”) seeks coverage for                        Historically, software was routinely
costs and expenses incurred in remediating            programmed omitting the first two digits
its computer systems to avoid Year 2000               in year dates. See, e.g., Steve Lohr,
(Y2K) related date recognition problems.              Technology and 2000—Momentous
GTE contends that it is entitled to such              Relief; Computers Prevail in First Hours
costs and expenses pursuant to insurance              of ‘00, N.Y. Times, January 1, 2000, at
policies entered into with Defendant-                 A1. There were a number of reasons for
Appellees Allendale Mutual Insurance                  this traditional use of two-digit years as an
Company (“Allendale”), Affiliated FM                  ingredient of software programing. “The
Insurance Company (“Affiliated”), Allianz             two-digit shortcut originally was taken to
Insurance Company (“Allianz”), Federal                conserve space that a four-digit entry
Insurance Company (“Federal”), and                    would have occupied in a computer’s
Industrial Risk Insurers (“IRI”)                      memory.” Bruce W. Foudree, The Year
(collectively “Insurers”). The District               2000 Problem and the Courts, 9 Kan. J.L.
Court granted summary judgment in favor               & Pub. Pol’y 515, 517 (2000).
of the Insurers. Specifically, the District           Particularly in light of the high cost of
Court concluded that: (1) GTE’s Y2K                   storing information in the early days of
remediation falls under the design defect             computers, this shortcut provided
and inherent vice exclusions of the                   numerous benefits, including “allow[ing]
policies; (2) the exceptions to these                 substantial cost savings,” enabling
exclusions were inapplicable; and (3) the             “[m]anufacturers . . . to make chips
Sue and Labor and Preservation of                     available to consumers at more affordable
Property Clauses (hereinafter referred to             prices,” and “shortening the production
collectively as the “Sue and Labor                    time for chips and software.” Id.

                                                  2
        With the approach of the year 2000,         economic failures and public panic.”
however, experts voiced dire predictions            Foudree, supra, at 517-18.      A likely
that the four-digit changeover could                scenario of the consequences of the Y2K
utterly upset computer programs. This               problem was described as follows:
problem, commonly referred to as the
                                                                  The most common
“Y2K problem,” is essentially summarized
                                                          scenario for a Y2K problem
as follows:
                                                          involves a computer reading
       [C]omputers have trouble                           two-digit dates of “00” or
       distinguishing between                             “01” and either being
       years in the 1900s and years                       stymied (if an inanimate
       in the 2000s.          Until                       object can be stymied) or
       comparatively recently,                            reading the dates
       date-sensitive computer                            erroneously as “1900” or
       programs identified years by                       “1901,” a misreading that in
       their last two digits. For                         the estimation of many has
       example, using the standard                        “potentially devastating
       format of mm/dd/yy, 1988                           results.”
       was entered as “88” by
                                                                     For   example,
       programers.      Thus, on
                                                          information systems may
       January 1, 2000, many
                                                          lock or freeze, causing
       computers and equipment
                                                          interruptions and emergency
       which contain computer
                                                          repairs or perhaps even
       chips (“embedded chips”)
                                                          requiring the discarding of
       may not be able to
                                                          old equipment and its
       recognize the difference
                                                          replacement with new.
       between 1900 and 2000
                                                          Misread dates could lead to
       since both are abbreviated
                                                          lost funds, improperly
       as “00.”
                                                          administered medicine, or
Foudree, supra, at 516-17; see also Jeffrey               f a i l u re t o r e p l e n i s h
W. Stempel, A Mixed Bag for Chicken                       inventory. For example, an
Little: Analyzing Year 2000 Claims and                    insurance policy could be
Insurance Coverage, 48 Emory L.J. 169,                    canceled, a lease terminated,
177 (1999).                                               or astounding late fees
                                                          assessed when a computer
       Commentators acknowledged that
                                                          mistakenly reads the date
while “[n]o one can accurately predict the
                                                          “2000” as “1900.”
scope, severity, or duration of Y2K
disruptions . . . , Y2K-related failures have       Stempel, supra, at 177 (internal citations
the potential to touch every sector of              omitted).
society and cause widespread and systemic
                                                          These      fears      prompted       the

                                                3
undertaking of extensive Y2K remediation          Such harms included the prospect that
efforts. Corporations and governments             GTE’s computer programs and external
invested more than $250 billion                   programs interacting with GTE’s systems
worldwide in addressing the Y2K                   would crash immediately, make erroneous
program, with the United States                   calculations while continuing to process,
government alone spending $8.4 billion.           endlessly churn before taking a “time out”
Lohr, supra, at A1.                               or shutting down, or process data correctly
                                                  to no avail. GTE’s Rule 56.1 Statement of
        In retrospect, we now know that
                                                  Material Facts ¶ 38, J.A. at 3118 (citing
catastrophe did not materialize, perhaps in
                                                  GTE 2000 President’s Operations Review,
part because of the success of remediation
                                                  p. CORP PMO 1893938 (Exhibit 35)).
efforts. See, e.g., Lohr, supra, at A1.
Nevertheless, the benefit of hindsight                   In an effort to protect its expansive
should not cloud our appreciation of the          network, GTE undertook an extensive
widespread perception, in the years               Y2K Program at a cost of about $350
leading up to 2000, that failure to correct       million to protect data, records, and to
the Y2K problem could result in                   ensure continued business operations. In
disastrous consequences. Moreover, even           a December 1998, corporate disclosure
those who did not predict “catastrophic”          document, GTE explained its activities as
consequences cautioned that the Y2K               follows:
problem was “serious enough to require
                                                               GTE’s Year 2000
correction if contemporary business is to
                                                         program is focused on both
continue to function in the twenty-first
                                                         information technology (IT)
century.” Stempel, supra, at 172.
                                                         and non-IT systems . . . .
        B. GTE’s Y2K Efforts
                                                         ....
       Because this is an appeal from a
                                                                    GTE’s Year 2000
grant of summary judgment, we must view
                                                         program has been organized
the evidence in the light most favorable to
                                                         into five phases as follows:
the nonmoving party GTE. See Marino v.
                                                         Awareness : program
Indus. Crating Co., 358 F.3d 241, 247 (3d
                                                         definition and general
Cir. 2004).
                                                         education; Assessment:
       GTE is a worldwide leader in                      analysis and prioritization of
telecommunications services, including                   systems supporting the core
local telephone, wireless, and internet                  business; Renovati on:
services. GTE operated a substantial                     rectifying Year 2000 issues;
number of computer based systems and                     Validation: testing the Year
networks which employed the common                       2000          solutions;
practice of two-digit date recognition. As               Implementation: placing the
the new millennium approached, GTE                       t e s t e d s y s t em s i n to
identified several Y2K-related threats.                  production.

                                              4
GTE Corp. 10-K for 12/31/98, J.A. at                   C. Insurance Policy Provisions
3979-80.
                                                          GTE contends that in an effort “[t]o
        Notably, GTE appears to have been          protect its expansive network from
aware of the potential threat posed by the         damage and destruction, [it] . . . contracted
Y2K problem as early as 1994. In                   for extensive insurance protection.”
December of that year, GTE Service                 Appellant Br. at 11.       The insurance
Corporation published a report entitled            policies to which GTE refers were sold in
Algorithmic Anarchy: Chaos in the Year             1996 and 1997. As the District Court
2000, identifying the potential impact of          explained, GTE was actually insured by a
the Y2K problem on GTE, and outlining              “panel of insurers” who provided different
preliminary strategies for addressing the          percentages of coverage on the primary
problem. See J.A. at 1395-1428. In 1995,           layer and excess layer of coverage.2
GTE established a Program Management
Office (PMO) “to oversee the planning
and execution of a corporate-wide Year             impacts to our networks, switches, and
2000 initiative,” as well as a “Master             network management systems; changes
Schedule for GTE’s Year 2000 Program.”             necessary to continue electronic operations
GTE Millennium 2000 Program–Year                   with our major business and financial
2000 Year End Report–1996 (December                partners; upgrades to customer premise
10, 1996), J.A. at 1598, 1602 (“1996 Year          equipment for which GTE is responsible;
End Report”). Moreover, in 1996 GTE                changes required to systems which have
completed the Proposed Criteria for                been developed by GTE for commercial
“Century Compliance”, “provid[ing]                 resale; and the costs to incorporate
information regarding the scope of the . .         changes made to other third-party software
. (Y2K) challenge and . . . identif[ying]          systems providing basic functionality to
and discuss[ing] four suggested criteria for       GTE’s business operations.” J.A. at 1598.
consideration in assessing century                        Interestingly, the Report also
compliance.” J.A. at 1477. From the                outlines potential sources of funding for
inception of its Y2K program, GTE                  the program. The Report does not suggest
exhibited an awareness of the tremendous           that the costs might be reimbursable
resources required to address the date-            through insurance, but instead suggests the
recognition problem. For example, the              f o l l o w i n g          f u n d i n g
1996 Year End Report reported that the             mechanisms—“Business as Usual,”
“cost of the Year 2000 Program is                  “Opportunity Cost,” “Incremental Cost,”
currently estimated to be $361 [million].”         “Replacement Funds,” and “Customer
J.A. at 1598.1                                     Funds.” Id.
                                                          2
                                                            The primary layer provides $50
       1
        The Report explains, “These costs          million in coverage, and the excess layer
include not only the conversion of our             provides $400 million in coverage for
legacy systems, but also: the anticipated          losses in excess of $50 million. Because

                                               5
Although the policies at issue in this                        The primary layer policies outline
litigation are actually five distinct policies,       the scope of the coverage. In pertinent
because the terms of the relevant policy              part, the provisions read:
provisions are identical, the District Court
                                                             COVERAGE
and the parties did not analyze the
provisions separately. Therefore, we do                      Except as hereinafter
not differentiate among the policies.3                       excluded, this policy covers:
                                                             a.     Real and Personal
                                                                    Property
the claim in this case does not exceed
                                                                    (1) The interest of
$400 million, we are not concerned with
                                                                    the Insured in all real
the blanket layer of coverage that provides
                                                                    and personal
insurance for claims in excess of $400
                                                                    property (including
million.
                                                                    improvements and
       Primary layer coverage was divided
                                                                    betterments) owned,
among the Insurers as follows—Affiliated
                                                                    used, or under
(40%), see J.A. at 237, IRI (20%), see J.A.
                                                                    contract to be
at 416, Allianz (10%), see J.A. at 630,
                                                                    purchased or leased
Federal (10%), see J.A. at 703. Excess
                                                                    by the Insured, or
layer coverage was divided among the
                                                                    h e r e a f t e r
Insurers as follows—Allendale (40%), see
                                                                    constructed, erected,
J.A. at 278, IRI (20%), see J.A. at 416,
                                                                    installed, or acquired
and Allianz (10%), see J.A. at 630. These
                                                                    including while in
percentages do not add up to 100%
                                                                    c o u r s e         o f
because coverage was also provided by
                                                                    construction,
insurance companies who are not a party
                                                                    erection, installation,
to this suit (because these other policies
                                                                    and assembly.
contained mandatory arbitration clauses).
See GTE Corp. v. Allendale Mut. Ins. Co.,                    ....
258 F. Supp. 2d 364, 369 & n.4 (D.N.J.
                                                             b.     B u s i n e s s
2003).
                                                                    Interruption–Gross
       3
          The only relevant distinction                             Earning
pertains to Federal and IRI’s supplemental                          Coverage shall apply
motions for summary judgment. Federal                               under this section
and IRI argue that GTE’s Y2K costs were                             unless there is a loss
not incurred to prevent loss that would                             of profits policy in
have occurred during their policy periods,
which ended on July 1, 1999. Because, as
discussed below, we do not reach the                  need not analyze this distinction in policy
supplemental grounds for affirmance, we               terms.

                                                  6
                      f o r c e                           hereunder, except         as
                      covering the                        hereinafter excluded.
                      location
                                                          Physical loss or damage
                      where loss is
                                                          shall include any
                      incurred.
                                                          destruction, distortion or
              (1) Loss resulting                          corruption of any computer
              f r o m n e c e s s a ry                    data, coding, program or
              i n t e r r u p ti o n o f                  software except as
              business conducted                          hereinafter excluded.
              by the Insured and
                                                   Affiliated Policy, J.A. at 252; IRI Policy,
              caused by loss,
                                                   J.A. at 437; Allianz Policy, J.A. at 655;
              damage,                or
                                                   Federal Policy, J.A. at 724 (emphasis
              destruction by any of
                                                   added).
              the perils covered
              herein during the                           Certain perils,     however,    are
              term of this policy to               explicitly excluded:
              real and personal
                                                          PERILS EXCLUDED
              property . . . not
              otherwise excluded.                         This policy does not insure:
Affiliated FM Insurance Policy No.                        ....
AE016 [hereinafter “Affiliated Policy”],
                                                          c.     against the cost of
J.A. at 241; IRI Policy No. 31-3-64676
                                                                 making good
[hereinafter “IRI Policy”], J.A. at 425;
                                                                 defective design or
Allianz Policy No. CLP 1025660
                                                                 specifications, faulty
[hereinafter “Allianz Policy”], J.A. at 643;
                                                                 material, or faulty
Federal Policy No. 648-22-99 [hereinafter
                                                                 workmanship. This
“Federal Policy”], J.A. at 712.
                                                                 exclusion shall not
       The policies also specifically                            apply to loss or
outline included perils:                                         damage resulting
                                                                 from such defective
       PERILS          INSURED
                                                                 d e s i g n       o r
       AGAINST
                                                                 specifications, faulty
       This policy insures against                               material, or faulty
       all risks of physical loss of                             workmanship;
       or damage to property                                     however any such
       described herein including                                resulting damage
       general average, salvage,                                 will be subject to all
       and all other charges on                                  other exclusions in
       shipments covered                                         this Policy.


                                               7
       ....                                               or latent defect; all unless
                                                          physical damage not
       k.     against unexplained
                                                          excluded by this Policy
              loss, mysterious
                                                          results, in which event, this
              disappearance, loss
                                                          Policy shall cover only such
              or shortage disclosed
                                                          resulting damage . . . .
              on taking inventory,
              inherent vice or                     Allendale Policy, J.A. at 297-99; IRI
              latent defect unless                 Policy, J.A. at 454-56; Allianz Policy, J.A.
              loss or damage from                  at 676-78.
              a peril insured herein
                                                          Moreover, the excess layer policies
              ensues and then this
                                                   contain a “Business Interruption
              policy shall cover for
                                                   Endorsement” which provides, in
              such ensuing loss or
                                                   pertinent part:
              damage.
                                                          In consideration of
Affiliated Policy, J.A. at 252-55; IRI
                                                          additional premium, this
Policy, J.A. 438-40; Allianz Policy, J.A. at
                                                          Policy is extended to cover
656-58; Federal Policy, J.A. at 725-27.
                                                          the Actual Loss Sustained
      The excess layer policies similarly                 by the Insured during a
provide, in pertinent part:                               Period of Interruption
                                                          directly resulting from
       EXCLUSIONS
                                                          physical loss or damage of
       ....                                               the type insured against by
                                                          this Policy, to property not
       This Policy does not insure
                                                          otherwise excluded by this
       against:
                                                          Policy, utilized by the
       ....                                               insured and located as
                                                          described elsewhere in this
       3. faulty workmanship,
                                                          Policy.
       material, construction or
       design from any cause; all                  Allendale Policy, J.A. at 306; IRI Policy,
       unless physical damage not                  J.A. at 463; Allianz Policy, J.A. at 685.
       excluded by this Policy
                                                         In addition to the above coverage
       results, in which event, this
                                                   and exclusion provisions, both the primary
       Policy will cover only such
                                                   and excess policies contain clauses that
       resulting damage;
                                                   permit GTE to recover for certain
       ....                                        preventative measures.
       5. deterioration, depletion,                      The primary policies contain Sue
       rust, corrosion, erosion,                   and Labor Clauses providing, in pertinent
       wear and tear, inherent vice                part:

                                               8
       Sue and Labor                                      against by this Policy, the
                                                          expenses incurred by the
       In the case of actual or
                                                          Insured in taking reasonable
       imminent loss or damage by
                                                          and necessary actions for
       a peril insured against, it
                                                          the temporary protection
       shall, without prejudice to
                                                          and preservation of property
       this insurance, be lawful
                                                          insured hereunder shall be
       and necessary for the
                                                          added to the total physical
       Insured, their factors,
                                                          loss or damage otherwise
       servants, or assigns to sue,
                                                          recoverable under this
       labor, and travel for, in, and
                                                          Policy . . . .
       about the defense, the
       safeguard, and the recovery                 Allendale Policy, J.A. at 301; IRI Policy,
       of the property or any part                 J.A. at 458; Allianz Policy, J.A. at 680.
       of the property insured
                                                   D. Procedural History and Standard
       hereunder; nor, in the event
                                                               of Review
       of loss or damage, shall the
       acts of the Insured or of this                      On June 18, 1999, GTE filed a
       Company in recovering,                      declaratory judgment action seeking
       saving, and preserving the                  coverage for costs and expenses incurred
       i n s u r e d p r operty b e                remediating its computer systems to avoid
       considered a waiver or an                   Y2K problems: Count One sought a
       acceptance of abandonment.                  declaratory judgment that the costs were
       This C o m p any shall                      covered by the policies’ Sue and Labor
       contribute to the expenses                  Provisions; Count Two alleged breach of
       so incurred according to the                contract; and Count Three sought damages
       rate and quantity of the sum                from Allendale for bad faith. The
       herein insured.          This               Appellees each answered the complaint,
       provision does not increase                 and Appellee Federal counterclaimed
       any amounts or limits of                    seeking a declaration denying coverage.
       insurance . . . .                           To facilitate the ease of the litigation, on
                                                   August 31, 2000, the U.S. Magistrate
Affilliated Policy, J.A. at 265; IRI Policy,
                                                   Judge entered an order dividing the
J.A. at 450; Federal Policy, J.A. at 737.
                                                   litigation into phases. In Phase I, the
       Similarly, the excess layer policies        parties were instructed to address whether
contain Preservation and Protection of             insurance coverage existed under the
Property Clauses providing, in pertinent           insurance policies. Following discovery
part:                                              on Phase I issues, the parties filed motions
                                                   for summary judgment on October 16,
       In case of actual or
                                                   2002.
       imminent physical loss or
       damage of the type insured                         The    District   Court    properly

                                               9
exercised jurisdiction under 28 U.S.C. §           District Court also granted IRI and
1332.4 On March 26, 2003, the District             Federal’s supplementary summary
Court granted the Insurers’ joint motion           judgment motions, alleging that GTE’s
for summary judgment in its entirety. As           Y2K costs were not incurred to avoid loss
an initial matter, the District Court noted        or damage that occurred during those
that the Sue and Labor Provisions only             Insurers’ policy periods.5
permit GTE to recover for costs incurred
                                                          Notice of appeal was timely filed
to prevent a loss that is covered under the
                                                   on April 17, 2003. This Court has
policies. The District Court went on to
                                                   jurisdiction pursuant to 28 U.S.C. § 1291.
conclude that the Y2K problem was not
                                                   We conduct plenary review over a district
covered because it fell within the design
                                                   court’s order granting summary judgment.
defect and inherent vice exclusions.
                                                   Morton Int’l, Inc. v. A.E. Staley Mfg. Co.,
Moreover, the exceptions to these
                                                   343 F.3d 669, 679 (3d Cir. 2003).
exclusions—the ensuing and resulting loss
                                                   Summary judgment will be granted if the
provisions—did not permit GTE to
                                                   record establishes “there is no genuine
recover. In light of this finding of non-
                                                   issue as to any material fact and that the
coverage, the District Court also granted
                                                   moving party is entitled to a judgment as a
Allendale’s motion for summary judgment
                                                   matter of law.” Fed. R. Civ. P. 56(c); see
on the third count claim of bad faith (that
                                                   also Celotex Corp. v. Catrett, 477 U.S. 317
is, there being no coverage, GTE cannot
                                                   (1986); Anderson v. Liberty Lobby, Inc.,
claim bad faith denial of coverage). The
                                                   477 U.S. 242 (1986); Matsushita Elec.
                                                   Indus. v. Zenith Radio Corp., 475 U.S. 574
                                                   (1986). 6 For the reasons elaborated below,
       4
         At the time of suit, GTE was a
corporation organized under the laws of
New York with its principal place of                      5
                                                             In granting IRI and Federal’s
business in Texas.       Allendale and             supplementary motions, however, the
Affiliated were corporations organized             District Court did not specifically reach
under the laws of Rhode Island with their          the merits of the claim. Instead, the
principal places of business in Rhode              District Court concluded that it could
Island; Allianz was a corporation                  grant the motions without reaching these
organized under the laws of California             issues because the relief requested had
with its principal place of business in            already been provided by virtue of its
California; Federal was a corporation              grant of Insurers’ joint motion for
organized under the laws of Indiana with           summary judgment. See 258 F. Supp. 2d
its principal place of business in New             at 381-82.
Jersey; and IRI was a corporation
                                                          6
organized under the laws of Connecticut                    In concluding that the District
with its principal place of business in New        Court properly granted summary
Jersey.     The amount in controversy              judgment, there are several issues that we
exceeded $75,000.                                  do not reach. First, we need not decide

                                              10
we agree with the District Court.                         The motions for summary judgment
                                                   were brought following discovery in
                    II.
                                                   Phase I of the litigation, pertaining to
        As a preliminary matter, GTE               whether insurance coverage existed for
argues that consideration of the                   GTE’s claims. As the District Court
exclusionary provisions was premature              noted, any factual issues pertaining to
because “factual issues regarding design           whether the Y2K problem constitutes a
defect are reserved for later stages of the        design defect are “inextricably tied to the
litigation.” See GTE Corp. v. Allendale            Phase I issue of coverage.” Id. In fact,
Mut. Ins. Co., 258 F. Supp. 2d 364, 377            perhaps the most quintessential coverage
(D.N.J. 2003). GTE argues that there is a          issue is the applicability of policy
disputed factual issue, which cannot be            exclusions.     Moreover, there is no
resolved on summary judgment, about                indication that GTE was prohibited by
whether two-digit software programming             order or otherwise from taking any
is a design defect or inherent vice.               discovery relevant to the coverage issue.7
Furthermore, GTE argues that these issues          If GTE felt that additional evidence,
of fact fall within the province of a jury.        including expert testimony, was required,
We are unpersuaded.                                GTE was free to conduct such discovery
                                                   and present such evidence to the District
                                                   Court. To the extent GTE’s argument
the merits of Federal and IRI’s                    constitutes a challenge to the District
supplemental motions for summary                   Court’s discovery orders, this Court will
judgment because we conclude that,                 not disturb those discovery decisions
irrespective of the time frame issue, the          because there has been no showing of an
policies did not provide coverage.                 abuse of discretion. See Arnold Pontiac-
Second, we do not examine whether                  GMC, Inc. v. General Motors Corp., 786
affirmation of the District Court’s opinion        F.2d 564, 568 (3d Cir. 1986). Thus, the
is warranted on the basis of independent           exclusionary provisions were properly
legal arguments raised by the Insurers,
including the arguments that (a) GTE’s
                                                          7
Y2K costs were not fortuitous at inception                  In support of the contention that it
of the policies; and (b) GTE failed to             was denied discovery, GTE references
comply with the Policies’ notice and suit          J.A. at 4734-35 and J.A. at 4794. See
limitations provisions. While this Court           Appellant Br. at 45-46. These references
“may affirm a district court’s grant of            are to GTE’s Memorandum in Response
summary judgment on any ground that                to Defendants’ Joint Motion for Summary
appears in the record,” Hedges v. Musco,           Judgment and GTE’s Supplemental Rule
204 F.3d 109, 116 (3d Cir. 2000), we see           56.1 Statement of Material Facts,
no reason to do so in light of our                 respectively.     Neither provides any
conclusion that the policies did not cover         specific indication of what discovery GTE
Y2K compliance costs.                              was prohibited from taking.

                                              11
within the consideration of the District            questions of contract interpretation
Court in considering the motions for                properly within the province of the
summary judgment in Phase I of the                  District Court at the summary judgment
litigation.                                         stage of the litigation.
        In addition, the design defect issue                            III.
did not need to be resolved by a jury. We
                                                            Generally, under New Jersey law,8
agree with the District Court that in
                                                    “the interpretation of insurance contracts
arguing that the issue falls within the
                                                    requires generous readings of coverage
province of the jury, GTE erroneously
                                                    provisions, narrow read ings o f
looks to products liability cases for the
                                                    exclusionary provisions, resolution of
standards applicable to this insurance
                                                    ambiguities in favor of the insured, and
contract dispute. See Motter v. Everest &
                                                    construction consistent with the insured’s
Jennings, Inc., 883 F.2d 1223 (3d Cir.
                                                    reasonable expectations.” Cobra Prods.,
1989) (cited before the District Court)
(holding issues of whether product was
defectively designed and whether
                                                           8
defective design was proximate cause of                       While there is some dispute over
injury were jury questions); Rooney v.              whether New Jersey law governs, both
Federal Press Co., 751 F.2d 140, 144 (3d            parties concede that the choice of law is
Cir. 1985) (Hunter, III, J., dissenting in          not dispositive in this case, as the standard
part and concurring in part) (internal              governing contract interpretation is the
quotations and citations omitted) (cited in         same under each of the potentially
Appellant Br.) (“The question whether a             applicable bodies of law. Insurers explain
design defect exists, that is, whether the          in their brief:
product left the supplier’s control lacking                 Throughout its brief, GTE
an element necessary to make it safe for its                relies on New Jersey law.
intended use, remains within the province                   The facts in this case also
of the jury.”). This case does not involve                  support an argument that the
a question of whether a product was                         law of New York or
defectively designed for purposes of a tort                 C o n n e c t i cu t a p p l i e s .
action. GTE cites no case concluding that                   Because the laws of any
(and offers no explanation as to why)                       relevant jurisdiction are the
product liability cases and concepts, which                 same with respect to the
concern the balance between “the risk of a                  issues raised on this appeal
product versus its social utility,” Motter,                 and lead to the same result,
883 F.2d at 1227, are relevant to insurance                 choice of law should not be
contract disputes that involve agreements                   an issue. The Insurers do
between specific parties. The issue of                      not concede, however, that
whether the defective design and inherent                   this dispute is governed by
vice exclusions bar recovery were                           New Jersey law.
                                                    Appellee Br. at 26 n.6.

                                               12
Inc. v. Fed. Ins. Co., 722 A.2d 545, 549           We agree.
(N.J. Super. Ct. App. Div. 1998); see also
                                                          The Y2K problem squarely falls
Elizabethtown Water Co. v. Hartford Cas.
                                                   within the defective design or
Ins. Co., 998 F. Supp. 447, 452 (D.N.J.
                                                   specification exclusion. The essence of
1998).     Insurers contend this rule is
                                                   the Y2K problem is that the two-digit date
inapplicable where the insured is a large
                                                   design precludes the system from
sophisticated corporation, such as GTE.
                                                   functioning properly on or after January 1,
See Pittson Co. v. Allianz Ins. Co., 905 F.
                                                   2000. The problem in this case was not
Supp. 1279, 1320 (D.N.J. 1995), rev’d in
                                                   that a program or system malfunctioned,
part 124 F.3d 508, 521 (3d Cir. 1997).
                                                   or some external threat caused damage to
However, we need not address this issue
                                                   GTE’s systems. Rather, the system
because we conclude that the contract is
                                                   performed in exactly the manner it was
not ambiguous; rather, the exclusions
                                                   designed to operate—the problem is that
clearly bar coverage.        Because the
                                                   the system as designed and specified did
contract in this case is “clear and
                                                   not permit recognition of dates in the 21st
unambiguous . . . [,][it] must be enforced
                                                   century.9
as written.” Cobra, 722 A.2d at 549.
                                                          GTE argues that the two-date
         A. Policy Exclusions
                                                   designation system cannot be a
       We agree with the District Court            “defective” design because, at the time of
that coverage for GTE’s remediation                its implementation, such a design
measures is barred by the plain language           conformed with industry standard (either
of both the defective design and inherent          as a widespread practice or “best
vice exclusions, and disagree with GTE’s           practice”), complied with government
contention that its claim is not subject to        regulation, and was required for GTE’s
these exclusions because the threats were          systems to be able to interface with other
external.                                          systems. Even assuming all these factors
     1. Defective Design Exclusion
       The policy provisions outlining                    9
                                                            Even GTE’s characterization of
excluded perils specifically preclude              the Y2K problem supports the conclusion
coverage for “the cost of making good              that it falls within the defective design
defective design or specifications.” The           exclusion. At argument, GTE’s counsel
District Court concluded that “any efforts         explained the problem as follows: “It is
taken to correct a date recognition                the data coming in is in a different format
problem within the computer systems, in            than was anticipated when the system was
order to ensure that the computer systems          designed.” Tr. of Argument at 7:13-15
continue to process dates as expected and          (emphasis added). In other words, it is the
required, are efforts undertaken to correct        system’s inability, as designed, to
a problem with the design or specification         recognize and process the data, and not a
of the system.” 258 F. Supp. 2d at 375.            problem with the data itself.

                                              13
are true, we still conclude that GTE’s              measures fall within the policies’
claim is barred by the defective design             exclusions. See 258 F. Supp. 2d at 374-
exclusion. Industry standards and the               76. Admittedly, some of this testimony is
existence of alternative feasible designs           confusing.11 Nevertheless, this testimony
may be relevant standards in determining            supports the view that GTE’s remediation
whether there is a “design defect” for the          efforts were taken to correct an
purpose of tort liability. See, e.g.,               “imperfection or shortcoming” in the two-
Restatement (Third) of Torts: Prod. Liab.           digit system, and thus fall within the
§ 16, cmt. b (1998). The fact that                  policies’ defective design exclusions. For
something was designed in accordance                example, in the context of explaining the
with “best practice” or industry standard           relationship between Y2K and “legacy
does not, however, mean that GTE’s                  migration,”12 Michael Lawrence Brodie,
insurance policy provides coverage for              who worked as a senior staff scientist and
necessary changes and upgrades to that              a senior technologist at GTE, testified:
system.
                                                           The premise is you have a
        The policies in this case explicitly               system that has something
exclude the “cost of making good                           in it that you don’t like, and
defective design or specification.”                        you want to get into a state
“Defective” is defined as “[a]n                            where that thing is no
imperfection or shortcoming, esp. in a part                longer present.           You
that is essential to the operation or safety               migrate from one state to
of a product.” Black’s Law Dictionary                      another state, whether it is
429 (7th ed. 1999).10 Here there was an                    Y2K . . . or whether its an
“imperfection or shortcoming”—the                          old database system, or a
inability of the system to properly read
dates on or after the year 2000––in the
                                                           11
system’s design or specification. The                         At argument, the Court attempted
District Court pointed to extensive                 to clarify portions of the testimony of Joel
testimony from GTE employees to buttress            Cohen, Program Manager for GTE’s Y2K
the conclusion that the remediation                 Program.        In the course of this
                                                    clarification, even GTE’s counsel
                                                    acknowledged that the testimony is
       10
           Black’s Law Dictionary                   “confusing.” Tr. of Argument at 10:13-
separately defines “defect” and the                 20.
corresponding adjective “defective” from
                                                           12
the term “design defect.” See Black’s                          Brodie explained that the term
Law Dictionary 429 (7th ed. 1999).                  “legacy migration” “describe[s] the
Notably, here the language of the policies          transformation of a system . . . from one
says “defective design,” rather than using          state to an improved state.” Deposition of
the tort liability concept of “design               Michael Lawrence Brodie at 195:11-15,
defect.”                                            J.A. at 2364.

                                               14
              code that no longer                   important, GTE’s very argument is
              is appropriate . . . .                undermined by the plain language of the
              You’re trying to                      policy provisions. The defective design
              change an existing                    provision expressly provides that the
              system into a new                     policy does not ensure “against the cost of
              form that no longer                   making good defective design or
              manifests the                         specifications.” (emphasis added).
              p r o b l e m y o u ’ re
                                                          2. Inherent Vice Exclusion
              trying to get away
              from.                                        There is an additional ground to
                                                    reject GTE’s coverage claim: the
Deposition of Michael Lawrence Brodie at
                                                    insurance policies explicitly do not insure
194:20-195:6, J.A. at 2363-64. In other
                                                    against “inherent vice.”      The District
words, Y2K remediation, like other
                                                    Court concluded that, in addition to the
database and code upgrades, is targeted at
                                                    defective design exclusion, the inherent
changing an existing system because of a
                                                    vice provision barred GTE from
problem or limitation within that system.
                                                    recovering for Y2K remediation measures.
         The fact that GTE may have                 In reaching this conclusion, the District
utilized the best available system, and             Court relied heavily, as persuasive
subsequently faced the need to remedy a             authority, on the Washington Court of
problem with that system, does not save             Appeal’s conclusion in Port of Seattle v.
GTE from the defective design exclusion.            Lexington Ins. Co. that the Y2K problem
Taken to its logical conclusion, GTE’s              was an inherent vice. 48 P.3d 334 (Wash.
argument would render virtually every               Ct. App. 2002).
business upgrade an insurable risk. For
                                                           As noted by the District Court, the
example, GTE could argue that upgrades
                                                    Port of Seattle Court began by surveying
to its software or computers undertaken in
                                                    definitions of “inherent vice”:
the name of mitigating an insurable risk
would be insurable as long as it used the                  An inherent vice is defined
best system at the time of initial                         by various courts as “‘any
installation.                                              existing defects, diseases,
                                                           decay or the inherent nature
       GTE also suggests that a design
                                                           of the commodity which
cannot be faulty if it meets the
                                                           will cause it to deteriorate
specifications at the time of its design.
                                                           with a lapse of time.’” It is
That is unpersuasive. If, for example, an
                                                           also defined “as a cause of
airplane is built pursuant to specifications
                                                           loss not covered by the
and is unable to take-off, it is “defective”
                                                           policy, does not relate to an
or contains an “imperfection or
                                                           extraneous cause but to a
shortcoming” despite the fact that it
                                                           loss entirely from internal
conformed with the specifications. More
                                                           decomposition or some

                                               15
               quality which brings                   Furthermore, “GTE is not threatened by
               about its own injury                   any external force; the threat is entirely
               or destruction. The                    internal.” Id.
               vice must be inherent
                                                             On appeal, GTE’s principal
               in the property for
                                                      objection to this conclusion, as elaborated
               which recovery is
                                                      below, is that the threats posed by Y2K
               sought.”
                                                      were not exclusively internal.
48 P.3d at 338-39 (quoting Mo. Pac. R.R.
                                                                3. External Threats
Co. v. Elmore & Stahl, 377 U.S. 134, 136
(1964); Employers Cas. Co. v. Holm, 393                      In concluding that GTE’s claims
S.W.2d 363, 367 (Tex. App. 1965))                     were barred by the defective design and
(additional citations omitted). In other              inherent vice exclusions, the District Court
words, the question is whether the                    rejected GTE’s argument that its claim
“insured property . . . contain[s] its own            cannot be barred by these provisions
seeds of destruction . . . [or whether it]            because it faced risk from Y2K-related
was threatened by an outside natural                  events caused by external systems. The
force.” American Home Assurance Co. v.                District Court explained that while “[t]his
J. F. Shea Co., Inc., 445 F. Supp. 365, 368           argument gives the Court pause[,] . . .
(D.D.C. 1978).                                        [t]he record does not reflect that the
                                                      program was intended to eliminate any
       Port of Seattle went on to conclude
                                                      external threats, as described by GTE.”
that the Y2K problem fell within the
                                                      258 F. Supp. 2d at 378-79.
inherent vice exclusion: “[B]ut for the
two-digit date field code programmed into                     In support of its contention that it
the Port’s software, the arrival of January           faced external threats, GTE provided
1, 2000, would not result in loss. Thus,              numerous citations to the record in both its
the Port’s Y2K problem is an excluded                 brief, see Appellant Br. at 49 & n.12
inherent vice because the date field is an            (citing J.A. at 3881, 3884-96, 3871, 3877,
internal quality that brought about its own           3840, 4789-90, 5053), and at argument,
problem.” 48 P.3d at 339, quoted in 258               see Tr. of Argument at 15:21-22 (citing
F. Supp. 2d at 376.                                   J.A. at 1598-1601, 1764, 1008-09, 1004,
                                                      4122-23, 1014). GTE provides minimal
          The District Court found the Port of
                                                      explanation for how these citations
Seattle analysis persuasive, and concluded
                                                      support its argument. Moreover, upon
that the inherent vice exclusion is
                                                      examination, we are not satisfied that the
applicable. We agree. As the District
                                                      record supports the conclusion that GTE
Court explained, “[h]ere . . . the insured
                                                      faced an “external threat” such that the
property, GTE’s computer systems, do
                                                      defective design and inherent vice
c o n t a in t h e i r o wn ‘ s e e d s o f
destruction’—that is, the two-digit date
limitation.” 258 F. Supp. 2d at 377.


                                                 16
exclusions do not apply.13 At best, these                  We disagree with the suggestion
citations appear to support the claim that         that the Y2K threat is “external” merely
the Y2K problem is particularly complex            because GTE’s systems interacted with
because of the manner in which GTE’s               other systems or read data from outside
systems interface with third party                 sources. Such a conception of external
systems.14                                         would essentially allow all defective
                                                   designs and inherent vices to be
                                                   characterized as external problems. For
       13                                          example, if a car is defectively designed so
          In fact, some of GTE’s citations
                                                   that the tires come off when the car is
actually seem to support a contrary
                                                   driven at 10 miles per hour, the threat is
conclusion. For example, GTE cites to a
                                                   not external merely because the “external”
letter responding to a “request for
                                                   event of the road contacting the tire
information concerning the steps that GTE
                                                   caused the tires to fly off. The road
has taken to avoid or minimize imminent
                                                   contacting the tire is an entirely
loss or damage to its insured property.”
                                                   predictable event that is inherent to the
Letter from Raymond J. Alletto, GTE
                                                   very function and purpose of the
Director of Risk Management, to Ronald
                                                   automobile—there is no problem
H. Davis et. al., Executive General
                                                   independent of the automotive design.
Adjuster McLarens Toplis N.A., Inc. (Oct.
                                                   To take another example, if a dam whose
12, 1999), J.A. at 971. In response to one
                                                   very purpose is to hold water falls apart
question, GTE explains, “Some of the
                                                   when the water rises to an entirely
costs and expenses associated with the
                                                   predictable level, the rising of the water is
conversion of third party hardware and
                                                   not an “external” problem—the problem is
software have been borne by GTE’s
                                                   that the dam was not properly designed to
suppliers. We do not believe that the
                                                   allow it to perform precisely the function
insurers need this information to carry out
                                                   it was intended to perform, the holding of
their analysis because the figures that GTE
                                                   water.
submitted in its proof of loss do not
include any of the costs and expenses that                By contrast, if as a consequence of
were borne by GTE’s suppliers.” J.A. at            a defective Y2K design the fire retardation
1014.                                              system in a building does not function and
                                                   the building goes up in flames, the fire
       14
          For example, the 1996 Year End           would be an external event. The fire
Report explains that “the interdependence          represents an independent problem
of systems required to support today’s             external to the design of the computer
telecommunications business compounds              system.
the complexity of the Year 2000 problem
[because] [p]lann ing of system
conversions requires coordination of all           an understanding of all software and data
underlying hardware, operating systems,            interfaces between systems.” J.A. at 1599.
third party software layered products and

                                              17
        In this case, there was no                   Supp. at 368.16
unpredictable external threat posing a risk
                                                           B. Exceptions to Exclusions
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 *19-
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
                                                               1. Data Destruction
                                                           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 *19                        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
                                                           2. Business Interruption
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
                                                        IV. Sue and Labor Provisions
to Y2K or other similar date or time
recognition claims.” Letter from Brian J.                  GTE contends that it is entitled to
Krais, Vice President and Operations                reimbursement under the Sue and Labor
Manager of Allendale Insurance, to Adam             Provisions.    GTE argues that these
Kagan, J & H Marsh & McLennan (June                 provisions require the company to avert
15, 1998), J.A. at 4129. The proposed               certain losses22 and then obligate the
agreement provided that “Afilliated and             Insurers to reimburse GTE for those
GTE agree that Affilliated will not
endorse onto the existing policy any
restriction or clarification to the policy                 21
                                                              At oral argument, GTE’s counsel
language specifically relating to Y2K.”
                                                    contended that there is a “disputed fact” as
Id. The agreement went on to explain,
                                                    to whether GTE or the Insurers sought
however, that the parties would “agree that
                                                    clarification on whether the policy covered
a proper construction and interpretation of
                                                    Y2K measures, indicating “we haven’t
the policy is as follows: 1) the policy does
                                                    had discovery on that issue yet.” Tr. of
not pay for remediation, repair or
                                                    Argument at 18:7-10. Even assuming that
assessment of any Y2K or similar date or
                                                    the Insurers sought the clarification,
time recognition problem in any electronic
                                                    GTE’s argument still fails. The fact that
data processing equipment and media,
                                                    Insurers may have sought clarification and
whether preventative or remedial . . . .”
                                                    after negotiations agreed not to add
Id. at 4129-30. However, there is no
                                                    additional Y2K exclusions does not
indication in the record that the parties
                                                    support GTE’s claim that the Insurers
ever assented to the agreement.
                                                    represented that Y2K measures were
       The fact that agreements clarifying          covered.
the scope of Y2K coverage were
                                                           22
discussed, and that GTE may have sought                       The language of the Preservation
to have Insurers clarify that no “additional        and Protection of Property Clause, in the
exclusions” would be added in no way                excess layer policies, does not appear to
suggests that GTE believed, much less that          explicitly obligate GTE to take action.
Allendale represented, that the policies            Rather, it merely provides that “the
provided for Y2K coverage. In fact,                 expenses incurred by the Insured in taking
GTE’s attempts to ensure that no                    reasonable and necessary actions for the
“additional exclusions” pertaining to Y2K           temporary protection and preservation of
would be added suggest that GTE                     property . . . shall be added to the total
anticipated that at least some Y2K                  physical loss or damage otherwise
measures were not covered under the                 recoverable . . . .” Whether or not GTE
                                                    was obligated to take such measures,
                                                    however, is ultimately immaterial to our
                                                    holding.

                                               24
expenses. We decided in Part III that,               of loss that is the subject of the policy; that
because of the policies’ exclusions, GTE’s           is, the clause is designed to allow
actions were not aimed at averting a                 reimbursement for measures taken by the
covered loss.       Therefore, the only              insured to mitigate damages in order to
remaining question is whether the Sue and            reduce the insurer’s obligation under the
Labor Provisions provide an independent              policy. See Swire I, 139 F. Supp. 2d at
basis for recovery. They do not.                     1383. While there is some dispute as to
                                                     whether the covered loss has to occur to
       The Sue and Labor Provisions do
                                                     invoke coverage, see Swire II, 284 F.3d at
not save GTE’s claims from the policy
                                                     1232 (citing cases), it seems undisputed
exclusions. Rather, as the District Court
                                                     that the actions must at least be aimed at a
explained,
                                                     covered loss.         An alternative view,
       [T]he purpose of the sue                      construing the Sue and Labor Provisions
       and labor clause is to                        as separate insuring agreements, would
       reimburse the insured for                     read the defective design and inherent vice
       costs incurred to satisfy the                 exclusions out of the policy.
       insured’s duty to the insurer.
                                                            Thus, the Sue and Labor Provisions
       If the insured acts to prevent
                                                     do not provide an independent basis for
       a loss that is not covered by
                                                     GTE’s recovery. Such an interpretation of
       the policy, there is no duty
                                                     the Sue and Labor Provisions is necessary
       or benefit to insurer; “[t]he
                                                     to avoid rendering the exclusionary
       obligation only exists when
                                                     provisions meaningless; an alternative
       the action taken is to
                                                     interpretation would permit GTE to
       prevent a loss for which the
                                                     recover for improvements and measures
       underwriter would be
                                                     taken to address a host of uninsured risks.
       liable.”
                                                                        *****
258 F. Supp. 2d at 373 (quoting Port of
Seattle, 48 P.3d at 340). In Port of Seattle,              For the foregoing reasons, we will
the Washington Court of Appeals held                 affirm the District Court’s grant of
that expenses incurred to prevent Y2K                summary judgment.
losses were not covered under the sue and
labor clause because the Port sought to
prevent a loss that would occur after the
policies expired. 48 P.3d at 340. While
Port of Seattle is arguably distinguishable
on some grounds and is certainly not
binding precedent, the underlying
rationale of the court’s decision is
persuasive. The purpose of a sue and
labor clause is to encourage the prevention


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