Gte Corporation v. Allendale Mutual Insurance Company

PRECEDENTIAL
UNITED STATES COURT OF
APPEALS
FOR THE THIRD CIRCUIT
No. 03-2139
GTE CORPORATION,
Appellant
v.
ALLENDALE MUTUAL INSURANCE
COMPANY;
AFFILIATED FM INSURANCE
COMPANY;
ALLIANZ INSURANCE COMPANY;
FEDERAL INSURANCE COMPANY;
INDUSTRIAL RISK INSURERS
On Appeal from the United States
District Court
for the District of New Jersey
(Dist. Ct. No. 99-cv-02877)
District Judge: Honorable Alfred M.
Wolin
Argued: December 9, 2003
Before: AMBRO, FUENTES and
CHERTOFF, Circuit Judges.
(Filed: June 21, 2004)
ROBERT F. RUYAK (Argued)
JERROLD J. GANZFRIED
Howrey, Simon, Arnold & White
1299 Pennsylvania Avenue, N.W.
Washington, DC 20004
Counsel for Appellant
HENRY J. CATENACCI (Argued)
Podvey, Sachs, Meanor, Catenacci,
Hildner & Cocoziello
One Riverfront Plaza
The Legal Center, 8th Floor
Newark, NJ 07102
Counsel for Appellees Allendale
Mutual Insurance and Afilliated FM Ins.
Co.
MARY K. VYSKOCIL (Argued)
Simpson, Thatcher & Bartlett
425 Lexington Ave.
New York, NY 10017
Counsel for Appellee Industrial
Risk Insurers
WILLIAM N. ERICKSON
Robins, Kaplan, Miller & Ciresi
111 Huntington Avenue
Suite 1300
Boston, MA 02199
Counsel for Appellee Allianz Ins.
Co.
RICHARD M. MACKOWSKY
Cozen & O’Connor
1900 Market Street
The Atrium
Philadelphia, PA 19103

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

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

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undertaking of extensive Y2K remediation
efforts. Corporations and governments
invested more than $250 billion
worldwide in addressing the Y2K
program, with the United States
government alone spending $8.4 billion.
Lohr, supra, at A1.
In retrospect, we now know that
catastrophe did not materialize, perhaps in
part because of the success of remediation
efforts. See, e.g., Lohr, supra, at A1.
Nevertheless, the benefit of hindsight
should not cloud our appreciation of the
widespread perception, in the years
leading up to 2000, that failure to correct
the Y2K problem could result in
disastrous consequences. Moreover, even
those who did not predict “catastrophic”
consequences cautioned that the Y2K
problem was “serious enough to require
correction if contemporary business is to
continue to function in the twenty-first
century.” Stempel, supra, at 172.
B. GTE’s Y2K Efforts
Because this is an appeal from a
grant of summary judgment, we must view
the evidence in the light most favorable to
the nonmoving party GTE. See Marino v.
Indus. Crating Co., 358 F.3d 241, 247 (3d
Cir. 2004).
GTE is a worldwide leader in
telecommunications services, including
local telephone, wireless, and internet
services. GTE operated a substantial
number of computer based systems and
networks which employed the common
practice of two-digit date recognition. As
the new millennium approached, GTE
identified several Y2K-related threats.
Such harms included the prospect that
GTE’s computer programs and external
programs interacting with GTE’s systems
would crash immediately, make erroneous
calculations while continuing to process,
endlessly churn before taking a “time out”
or shutting down, or process data correctly
to no avail. GTE’s Rule 56.1 Statement of
Material Facts ¶ 38, J.A. at 3118 (citing
GTE 2000 President’s Operations Review,
p. CORP PMO 1893938 (Exhibit 35)).
In an effort to protect its expansive
network, GTE undertook an extensive
Y2K Program at a cost of about $350
million to protect data, records, and to
ensure continued business operations. In
a December 1998, corporate disclosure
document, GTE explained its activities as
follows:
GTE’s Year 2000
program is focused on both
information technology (IT)
and non-IT systems . . . .
. . . .
GTE’s Year 2000
program has been organized
into five phases as follows:
A w a r e n e s s : p r o g r a m
definition and general
education; Assessment:
analysis and prioritization of
systems supporting the core
business; Renovati on:
rectifying Year 2000 issues;
Validation: testing the Year
2 0 0 0 s o l u t i o n s ;
Implementation: placing the
t e s t e d s y s t em s i n to
production.

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

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

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

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

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

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

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

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

-- 12 of 25 --

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

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14
are true, we still conclude that GTE’s
claim is barred by the defective design
exclusion. Industry standards and the
existence of alternative feasible designs
may be relevant standards in determining
whether there is a “design defect” for the
purpose of tort liability. See, e.g.,
Restatement (Third) of Torts: Prod. Liab.
§ 16, cmt. b (1998). The fact that
something was designed in accordance
with “best practice” or industry standard
does not, however, mean that GTE’s
insurance policy provides coverage for
necessary changes and upgrades to that
system.
The policies in this case explicitly
exclude the “cost of making good
defective design or specification.”
“Defective” is defined as “[a]n
imperfection or shortcoming, esp. in a part
that is essential to the operation or safety
of a product.” Black’s Law Dictionary
429 (7th ed. 1999).10 Here there was an
“imperfection or shortcoming”—the
inability of the system to properly read
dates on or after the year 2000––in the
system’s design or specification. The
District Court pointed to extensive
testimony from GTE employees to buttress
the conclusion that the remediation
measures fall within the policies’
exclusions. See 258 F. Supp. 2d at 374-
76. Admittedly, some of this testimony is
confusing.11 Nevertheless, this testimony
supports the view that GTE’s remediation
efforts were taken to correct an
“imperfection or shortcoming” in the two-
digit system, and thus fall within the
policies’ defective design exclusions. For
example, in the context of explaining the
relationship between Y2K and “legacy
migration,”12 Michael Lawrence Brodie,
who worked as a senior staff scientist and
a senior technologist at GTE, testified:
The premise is you have a
system that has something
in it that you don’t like, and
you want to get into a state
where that thing is no
longer present. You
migrate from one state to
another state, whether it is
Y2K . . . or whether its an
old database system, or a
1 0 Black’s Law Dictionary
separately defines “defect” and the
corresponding adjective “defective” from
the term “design defect.” See Black’s
Law Dictionary 429 (7th ed. 1999).
Notably, here the language of the policies
says “defective design,” rather than using
the tort liability concept of “design
defect.”
11 At argument, the Court attempted
to clarify portions of the testimony of Joel
Cohen, Program Manager for GTE’s Y2K
Program. In the course of this
clarification, even GTE’s counsel
acknowledged that the testimony is
“confusing.” Tr. of Argument at 10:13-
20.
12 Brodie explained that the term
“legacy migration” “describe[s] the
transformation of a system . . . from one
state to an improved state.” Deposition of
Michael Lawrence Brodie at 195:11-15,
J.A. at 2364.

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15
code that no longer
is appropriate . . . .
You’re trying to
change an existing
system into a new
form that no longer
m a n i f e s t s t h e
p r o b l e m y o u ’ re
trying to get away
from.
Deposition of Michael Lawrence Brodie at
194:20-195:6, J.A. at 2363-64. In other
words, Y2K remediation, like other
database and code upgrades, is targeted at
changing an existing system because of a
problem or limitation within that system.
The fact that GTE may have
utilized the best available system, and
subsequently faced the need to remedy a
problem with that system, does not save
GTE from the defective design exclusion.
Taken to its logical conclusion, GTE’s
argument would render virtually every
business upgrade an insurable risk. For
example, GTE could argue that upgrades
to its software or computers undertaken in
the name of mitigating an insurable risk
would be insurable as long as it used the
best system at the time of initial
installation.
GTE also suggests that a design
cannot be faulty if it meets the
specifications at the time of its design.
That is unpersuasive. If, for example, an
airplane is built pursuant to specifications
and is unable to take-off, it is “defective”
or contains an “imperfection or
shortcoming” despite the fact that it
conformed with the specifications. More
important, GTE’s very argument is
undermined by the plain language of the
policy provisions. The defective design
provision expressly provides that the
policy does not ensure “against the cost of
making good defective design or
specifications.” (emphasis added).
2. Inherent Vice Exclusion
There is an additional ground to
reject GTE’s coverage claim: the
insurance policies explicitly do not insure
against “inherent vice.” The District
Court concluded that, in addition to the
defective design exclusion, the inherent
vice provision barred GTE from
recovering for Y2K remediation measures.
In reaching this conclusion, the District
Court relied heavily, as persuasive
authority, on the Washington Court of
Appeal’s conclusion in Port of Seattle v.
Lexington Ins. Co. that the Y2K problem
was an inherent vice. 48 P.3d 334 (Wash.
Ct. App. 2002).
As noted by the District Court, the
Port of Seattle Court began by surveying
definitions of “inherent vice”:
An inherent vice is defined
by various courts as “‘any
existing defects, diseases,
decay or the inherent nature
of the commodity which
will cause it to deteriorate
with a lapse of time.’” It is
also defined “as a cause of
loss not covered by the
policy, does not relate to an
extraneous cause but to a
loss entirely from internal
decomposition or some

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16
quality which brings
about its own injury
or destruction. The
vice must be inherent
in the property for
which recovery is
sought.”
48 P.3d at 338-39 (quoting Mo. Pac. R.R.
Co. v. Elmore & Stahl, 377 U.S. 134, 136
(1964); Employers Cas. Co. v. Holm, 393
S.W.2d 363, 367 (Tex. App. 1965))
(additional citations omitted). In other
words, the question is whether the
“insured property . . . contain[s] its own
seeds of destruction . . . [or whether it]
was threatened by an outside natural
force.” American Home Assurance Co. v.
J. F. Shea Co., Inc., 445 F. Supp. 365, 368
(D.D.C. 1978).
Port of Seattle went on to conclude
that the Y2K problem fell within the
inherent vice exclusion: “[B]ut for the
two-digit date field code programmed into
the Port’s software, the arrival of January
1, 2000, would not result in loss. Thus,
the Port’s Y2K problem is an excluded
inherent vice because the date field is an
internal quality that brought about its own
problem.” 48 P.3d at 339, quoted in 258
F. Supp. 2d at 376.
The District Court found the Port of
Seattle analysis persuasive, and concluded
that the inherent vice exclusion is
applicable. We agree. As the District
Court explained, “[h]ere . . . the insured
property, GTE’s computer systems, do
c o n t a in t h e i r o wn ‘seeds o f
destruction’—that is, the two-digit date
limitation.” 258 F. Supp. 2d at 377.
Furthermore, “GTE is not threatened by
any external force; the threat is entirely
internal.” Id.
On appeal, GTE’s principal
objection to this conclusion, as elaborated
below, is that the threats posed by Y2K
were not exclusively internal.
3. External Threats
In concluding that GTE’s claims
were barred by the defective design and
inherent vice exclusions, the District Court
rejected GTE’s argument that its claim
cannot be barred by these provisions
because it faced risk from Y2K-related
events caused by external systems. The
District Court explained that while “[t]his
argument gives the Court pause[,] . . .
[t]he record does not reflect that the
program was intended to eliminate any
external threats, as described by GTE.”
258 F. Supp. 2d at 378-79.
In support of its contention that it
faced external threats, GTE provided
numerous citations to the record in both its
brief, see Appellant Br. at 49 & n.12
(citing J.A. at 3881, 3884-96, 3871, 3877,
3840, 4789-90, 5053), and at argument,
see Tr. of Argument at 15:21-22 (citing
J.A. at 1598-1601, 1764, 1008-09, 1004,
4122-23, 1014). GTE provides minimal
explanation for how these citations
support its argument. Moreover, upon
examination, we are not satisfied that the
record supports the conclusion that GTE
faced an “external threat” such that the
defective design and inherent vice

-- 16 of 25 --

17
exclusions do not apply.13 At best, these
citations appear to support the claim that
the Y2K problem is particularly complex
because of the manner in which GTE’s
systems interface with third party
systems.14
We disagree with the suggestion
that the Y2K threat is “external” merely
because GTE’s systems interacted with
other systems or read data from outside
sources. Such a conception of external
would essentially allow all defective
designs and inherent vices to be
characterized as external problems. For
example, if a car is defectively designed so
that the tires come off when the car is
driven at 10 miles per hour, the threat is
not external merely because the “external”
event of the road contacting the tire
caused the tires to fly off. The road
contacting the tire is an entirely
predictable event that is inherent to the
very function and purpose of the
automobile—there is no problem
independent of the automotive design.
To take another example, if a dam whose
very purpose is to hold water falls apart
when the water rises to an entirely
predictable level, the rising of the water is
not an “external” problem—the problem is
that the dam was not properly designed to
allow it to perform precisely the function
it was intended to perform, the holding of
water.
By contrast, if as a consequence of
a defective Y2K design the fire retardation
system in a building does not function and
the building goes up in flames, the fire
would be an external event. The fire
represents an independent problem
external to the design of the computer
system.
13 In fact, some of GTE’s citations
actually seem to support a contrary
conclusion. For example, GTE cites to a
letter responding to a “request for
information concerning the steps that GTE
has taken to avoid or minimize imminent
loss or damage to its insured property.”
Letter from Raymond J. Alletto, GTE
Director of Risk Management, to Ronald
H. Davis et. al., Executive General
Adjuster McLarens Toplis N.A., Inc. (Oct.
12, 1999), J.A. at 971. In response to one
question, GTE explains, “Some of the
costs and expenses associated with the
conversion of third party hardware and
software have been borne by GTE’s
suppliers. We do not believe that the
insurers need this information to carry out
their analysis because the figures that GTE
submitted in its proof of loss do not
include any of the costs and expenses that
were borne by GTE’s suppliers.” J.A. at
1014.
14 For example, the 1996 Year End
Report explains that “the interdependence
of systems required to support today’s
telecommunications business compounds
the complexity of the Year 2000 problem
[because] [p]lann ing of system
conversions requires coordination of all
underlying hardware, operating systems,
third party software layered products and
an understanding of all software and data
interfaces between systems.” J.A. at 1599.

-- 17 of 25 --

18
In this case, there was no
unpredictable external threat posing a risk
to GTE’s system.15 The problem is that
the systems were programmed only to
recognize the last two digits of the
date—the preface remaining a constant
“19.” The fact, however, that at the turn
of the millennium, the preface would now
be “20’” rather than “19,” thereby
requiring four-digit date recognition, was
entirely predictable. The annual change in
date, like the road impacting the tire and
the water level rising, is within the scope
of occurrences for which the system was
purposely designed. The flaw—that the
systems were limited to two-digit date
recognition—is entirely endemic to the
system. That is, the insured
property—GTE’s systems—“contain[s] its
own seeds of destruction” and is not
“threatened by an outside natural force.”
American Home Assurance Co., 445 F.
Supp. at 368.16
B. Exceptions to Exclusions
GTE argues that the District Court
failed to consider all relevant policy
provisions in finding that GTE’s claim
fell within the defective design and
inherent vice exclusions. In particular,
15 GTE has not attempted to
characterize the Y2K problem as a
“computer virus.” In Port of Seattle, the
court rejected a characterization of the
Y2K problem as a virus, noting that “[t]he
Port’s Y2K problem was the result of a
deliberate decision by programmers to use
a two-digit rather than four-digit year field
. . . [and] [t]his feature does not cause the
software to be infectious.” 48 P.3d at 338.
We note in passing that the issue of
whether a computer virus constitutes an
“external threat” may pose a different
question than the one presented in this
case.
16 On appeal, GTE argues that its
risk assessment “included risks . . . that
systems might fail as a result of corrupt or
destroyed data stemming from interactions
with computer systems and networks
outside of GTE.” Appellant Br. at 48.
But the record reflects no carefully
tailored remediation effort that was limited
just to corrupted data entering from
outside sources. Nor, as the District Court
found, does GTE identify what portion, if
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
programs merely because some elements
of the program might also serve to
mitigate the effect of corrupted data
entering from outside sources. GTE was
obligated to specifically identify and
quantify remediating steps aimed directly
at damage from external threats, and
therefore potentially covered by the
Insurers’ policies. GTE did not proceed
under such a theory in District Court.
Instead it sought reimbursement for its
entire program, and attempted to support
this claim by alleging that some portion of
its program could mitigate unspecified
“external” threats.

-- 18 of 25 --

19
GTE points out that the defective design
and inherent vice provisions except from
the exclusions “resulting damage” and
“ensuing loss or damage.”
Specifically, the primary layer
policies state that the defective design or
specifications exclusion “shall not apply to
loss or damage resulting from such
defective design or specifications . . . ;
however any such resulting damage will
be subject to all other exclusions in this
Policy.” Additionally, inherent vices are
not covered “unless loss or damage from
a peril insured herein ensues and then this
policy shall cover for such ensuing loss or
damage.” Similarly, the excess layer
policies do not insure against faulty design
or inherent vice “all unless physical
damage not excluded by this Policy
results, in which event, this Policy will
cover only such resulting damage.”
We are not persuaded that the
ensuing and resulting loss provisions
allow GTE to recover in this case. Several
courts considering similar policy
provisions have concluded that the cost of
correcting design defects cannot be
covered under an ensuing loss provision
where it was incurred to correct an
excluded peril. See Swire Pac. Holdings
Inc. v. Zurich Ins. Co., 284 F.3d 1228,
1231 (11th Cir. 2002) (hereinafter Swire
II) (citing cases)17; see also Montefiore
Med. Center v. Am. Protect. Ins., 226 F.
Supp. 2d 470, 479 (S.D.N.Y. 2002) (“An
ensuing loss provision does not cover loss
caused by the excluded peril, but rather
covers loss caused to other property
wholly separate from the defective
property itself.”); Prudential Property &
Cas. Ins. Co., 2002 WL 31495830, at *19-
20 (D. Or. 2002). That is, “an ensuing
loss provision does not cover loss caused
by the excluded peril, but rather covers
loss caused to other property wholly
separate from the defective property
itself.” Swire Pac. Holdings, Inc. v.
Zurich Ins. Co., 139 F. Supp. 2d 1374,
1380 (S.D. Fla. 2001) (hereinafter Swire
I), certified on appeal 284 F.3d 1228 (11th
Cir. 2002) (emphasis in original).
Moreover, in the factually analogous Port
of Seattle case, the Washington Court of
Appeals rejected the contention that even
if the Port’s Y2K problem was an
excluded inherent vice, the Port could
recover under the ensuing loss provision.
48 P.3d at 339-40.
An alternative reading of the
ensuing and resulting loss provisions
would render the policy exclusions
virtually meaningless. That is, the
“exception to [the] . . . exclusion cannot
be construed so broadly that the rule (the
exclusion) is swallowed by the exception.”
Swire I, 139 F. Supp. 2d at 1381. Rather,
17 In Swire II, the Eleventh Circuit
ultimately certified the question of the
design defect exclusion’s scope to the
Florida Supreme Court. See 284 F.3d at
1231, 1234. We do not, however, believe
that certification is necessary in this case.
This is not a case in which there is a
particular area of the law that we need the
state courts to clarify; rather, we find
support for our interpretation in the plain
meaning of the contract.

-- 19 of 25 --

20
the ensuing loss provisions are best read as
permitting recovery where a covered peril
or damage results from the design defect
or inherent vice.18 Thus we disagree that
GTE is entitled to coverage because (1)
data destruction and (2) business
interruption are specifically covered perils.
1. Data Destruction
The policies in this case ensure
against “all risks of physical loss of or
damage to property described herein.”
“Physical loss or damage” is defined to
include “any destruction, distortion or
corruption of any computer data, coding,
program except as hereinafter excluded”
(emphasis added).
GTE conceded at argument that
“[t]here has to be a physical damage
resulting from design defect or inherent
vice.” Tr. of Argument at 21:22-23. GTE
agrees with the Court, for example, that if,
as a consequence of a defective Y2K
design, the fire retardation system in a
building does not function and the
building goes up in flames, “[t]his
provision means that the building gets
covered, because it is a physical damage to
the building, but it doesn’t mean that the
redesign of the software gets covered.”
Id. at 5:15-18. This concession seriously
undermines GTE’s argument. In this case,
GTE is essentially seeking recovery for
measures taken to correct its systems, and
not for some eventuating physical damage
18 Some courts have more narrowly
interpreted ensuing loss clauses to apply
only “in those rare cases where the
reasonable damage expected to be caused
by [for example] faulty workmanship
leads to another peril that causes damage
beyond that normally expected.”
Prudential, 2002 WL 31495830, at *19
(emphasis added). The following
illustration is helpful:
[I]f defectively installed
roof flashing allows water
to leak into the wall cavity,
then subsequent damage
caused by water, such as dry
rot or mold, to the interior
of the house is caused by
the faulty workmanship and
not covered. If, however,
the water migrates into an
electrical box and causes an
electrical short which in
turn causes a fire, then the
fire damage is a covered
“ensuing loss.” [That is,] . .
mold, unlike fire, is not an
“ensuing loss” due to the
lack of any intervening
cause other than time
beyond the initial water
damage.
Id. We do not reach the issue of whether
the “ensuing loss” needs to be the result of
an “intervening cause” or be “beyond that
normally expected.” Rather, we conclude
that GTE has failed to establish any
physical damage (whether normally
expected or not) “wholly separate from the
defective property itself.” Swire I, 139 F.
Supp. at 1380.

-- 20 of 25 --

21
sustained to its property.
GTE argues that because the Y2K
problem would inflict physical damage to
the system and/or data, it can recover,
under the Sue and Labor Provisions
discussed more extensively below, for
preventive measures taken to mitigate this
“ensuing loss.” The problem, however, is
that GTE has failed to adequately
demonstrate that it was threatened by
“physical loss” in the form of
“destruction, distortion or corruption of
any computer data, coding, program,” as
distinct from the otherwise excluded
defective design and inherent vice. That
is, GTE has not illustrated that the
consequences of failing to correct the two-
digit date designation system, causing data
to enter the system in an unrecognizable
format, are a covered loss.
In response to this Court’s inquiry
at oral argument, GTE provided record
citations on the issue of the “data
destruction, distortion and corruption that
GTE potentially faced as distinct from the
impact on GTE’s computers and/or
software.”19 GTE’s strongest claim
appears to be its allegation that absent
remediation, “some of [its] . . . systems
might have generated incorrect data,
thereby corrupting financial records and
other databases.” Letter from Raymond J.
Alletto, GTE Director of Risk
Management, to Ronald H. Davis et. al.,
Executive General Adjuster McLarens
Toplis N.A., Inc. (Oct. 12, 1999), J.A. at
992-93. The record, however, does not
appear to provide support for this
allegation of data corruption. Moreover,
at best this establishes that incorrect data
may have been generated as a result of
problems within GTE’s own systems—it
does not establish that data destruction or
corruption would have ensued “to other
property wholly separate from the
defective property itself.” Swire I, 139 F.
Supp. 2d at 1380. Here, the plain
language of the policies provides coverage
for data destruction or corruption “except
as hereinafter excluded.” As discussed
above, the defective design and inherent
vice exclusions bar recovery, and a
reading of the ensuing loss provisions to
provide coverage would essentially read
these exclusions out of the policy.
2. Business Interruption
GTE also points to the fact that
“business interruption” is a specifically
covered peril. The primary layer policies
provide for coverage for “[l]oss resulting
from necessary interruption of business
conducted by the Insured and caused by
loss, damage, or destruction by any of the
perils covered herein . . . .” (emphasis
added). The “Business Interruption
Endorsement” in the excess policies
provides coverage for business
interruption “resulting from physical loss
or damage of the type insured against by
this Policy, to property not otherwise
excluded by this Policy.” (emphasis
19 Letter from Robert F. Ruyak,
Counsel for GTE Corporation, to Marcia
M. Waldron, Clerk for the United States
Court of Appeals for the Third Circuit
(December 15, 2003) (citing J.A. at 992-
94, 995-99, 1209-10, 1220-27, 3839-40,
3885).

-- 21 of 25 --

22
added).
As the District Court explained, in
this case, in contrast to the factually
analogous Port of Seattle case, “GTE has
done more than claim testing losses; GTE
clearly claims that had it not remediated its
computer system in preparation for Y2K,
it would have faced separate business
interruption losses of a great magnitude.”
258 F. Supp. 2d at 380. Viewing the
evidence in the light most favorable to
GTE, the District Court concluded that
GTE faced potential business interruption
losses and its remediation efforts were
taken to prevent su ch losses.
Nevertheless, the District Court concluded
that, pursuant to the terms of the policies,
the alleged business interruption losses
were not insurable. We agree.
The District Court explained that
“[t]he ensuing loss provisions clearly only
provide coverage for a covered loss
ensuing from one of the excluded perils.”
258 F. Supp. 2d at 381. Moreover,
“[u]nder the plain language of the policies,
the business interruption loss must be
caused by a covered peril.” Id. As a
result, because design defects and inherent
vices are not perils covered, “the business
interruption loss ensuing from a design
defect or inherent vice would not be a
covered loss.” Id. In other words, GTE
cannot recover for just any ensuing or
resulting business loss—the underlying
peril resulting in business interruption
must be covered. Returning to the fire
example above, business interruption
losses ensuing or resulting from any
physical damage sustained by a fire would
be covered because such physical damage
is a covered peril. However, GTE cannot
claim business interruption losses ensuing
or resulting from the specifically excluded
intrinsic design defect and inherent vice
perils. Any other reading of the
exclusionary provisions would render the
provisions a virtual nullity. GTE could
argue, for example, that any upgrade to or
correction of a defective system is
reimbursable because the ensuing loss
from failing to correct the system would
result in “business interruption.”
In sum, we conclude that even
when read in conjunction with the other
terms of the policies—the ensuing loss,
data destruction, and business interruption
provisions—GTE’s claim is still barred by
the defective design and inherent vice
exclusions.
C. Consideration of After-The-Fact
Correspondence
Finally, GTE argues that the
District Court, in interpreting the
foregoing contract provisions, erred by
failing to consider the Insurers’ alleged
after-the-fact efforts to amend the policies
to exclude coverage for Y2K costs. To
begin, GTE points out that the Insurers
chose to extend GTE’s insurance policies
through the millennium without including
a Y2K exclusion. Moreover, GTE alleges
that, in 1998 and the spring of 1999, each
Insurer asked GTE to accept a Y2K
exclusion.20 GTE contends that Insurers
20 GTE suggests that its decision to
reject such policies resulted in subsequent
cancellation of its IRI and Federal
policies, as well as Allendale’s

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23
should not now be permitted to obtain
from the Court contract terms they were
unsuccessful in negotiating, and suggests
that the efforts to negotiate Y2K
exclusions illustrate an awareness on the
part of Insurers that under the existing
language they were liable for GTE’s Y2K
remediation measures. We conclude that
such alleged after-the-fact correspondence
is not properly considered in interpreting
this contract, and, moreover, that the
correspondence in this case does not
appear to support GTE’s claim.
New Jersey courts consider the
insurer’s conduct in determining whether
a policy’s terms are ambiguous. See
Fortunato v. Highlands Ins. Group, 785
A.2d 963, 967 (N.J. Super. Ct. Law Div.
2001) (“The ambiguity of the umbrella
policy here is also shown by the conduct
of the insurer.”). Moreover, courts do not
“permi[t] insurance companies to seek
refuge in the literal language of their
policies when the company’s conduct and
actions . . . causes [sic] the insured to act
or to fail to act based on that conduct.”
Doto v. Russo, 659 A.2d 1371, 1377 (N.J.
1995). We have already concluded,
however, that the terms of the policy
unambiguously exclude GTE’s claim.
Therefore, we find no reason to look to the
Insurers’ alleged conduct. In addition,
GTE has failed to point to conduct by the
Insurers that caused GTE to act or fail to
act—this is not a case where GTE took
some action, to its detriment, in reliance
on the Insurers’ statements or conduct.
In fact, the correspondence in this
case does not even appear to support
GTE’s contention that the Insurers sought
to amend the policies to exclude Y2K
coverage. In a fax dated June 3, 1998,
GTE’s Counsel requested that Allendale
include clarifying language that it would
not add such a Y2K exclusion. The fax
provides:
The letter received was
incomplete in GTE and our
estimation based on our
meeting and Allendale’s
positive response. We
would like the letter to read
as follows:
Allendale will not
add any additional
e x c l u s i o n s ,
a m e n d m e n t s o r
e n d o r s e m e n t s
regarding Year 2000
issues (inability to
recognize the correct
data including Year
2 0 0 0 ) t o t h e
currently in force
G T E/ Allendale
policies prior to the
expiration of such
policies (July 1,
2000).
J.A. at 4156 (emphasis added).
On June 15, 1998, Allendale
appears to have transmitted to GTE’s
insurance broker proposed agreements
between Allendale, Affiliated, and GTE.
One of the stated objectives of the
agreement was to “[e]liminat[e]
cancellation of selective policies.
See Appellant Br. at 21.

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24
uncertainty and achiev[e] mutual
agreement as to how the policy responds
to Y2K or other similar date or time
recognition claims.” Letter from Brian J.
Krais, Vice President and Operations
Manager of Allendale Insurance, to Adam
Kagan, J & H Marsh & McLennan (June
15, 1998), J.A. at 4129. The proposed
agreement provided that “Afilliated and
GTE agree that Affilliated will not
endorse onto the existing policy any
restriction or clarification to the policy
language specifically relating to Y2K.”
Id. The agreement went on to explain,
however, that the parties would “agree that
a proper construction and interpretation of
the policy is as follows: 1) the policy does
not pay for remediation, repair or
assessment of any Y2K or similar date or
time recognition problem in any electronic
data processing equipment and media,
whether preventative or remedial . . . .”
Id. at 4129-30. However, there is no
indication in the record that the parties
ever assented to the agreement.
The fact that agreements clarifying
the scope of Y2K coverage were
discussed, and that GTE may have sought
to have Insurers clarify that no “additional
exclusions” would be added in no way
suggests that GTE believed, much less that
Allendale represented, that the policies
provided for Y2K coverage. In fact,
GTE’s attempts to ensure that no
“additional exclusions” pertaining to Y2K
would be added suggest that GTE
anticipated that at least some Y2K
measures were not covered under the
policy.21
IV. Sue and Labor Provisions
GTE contends that it is entitled to
reimbursement under the Sue and Labor
Provisions. GTE argues that these
provisions require the company to avert
certain losses22 and then obligate the
Insurers to reimburse GTE for those
21 At oral argument, GTE’s counsel
contended that there is a “disputed fact” as
to whether GTE or the Insurers sought
clarification on whether the policy covered
Y2K measures, indicating “we haven’t
had discovery on that issue yet.” Tr. of
Argument at 18:7-10. Even assuming that
the Insurers sought the clarification,
GTE’s argument still fails. The fact that
Insurers may have sought clarification and
after negotiations agreed not to add
additional Y2K exclusions does not
support GTE’s claim that the Insurers
represented that Y2K measures were
covered.
22 The language of the Preservation
and Protection of Property Clause, in the
excess layer policies, does not appear to
explicitly obligate GTE to take action.
Rather, it merely provides that “the
expenses incurred by the Insured in taking
reasonable and necessary actions for the
temporary protection and preservation of
property . . . shall be added to the total
physical loss or damage otherwise
recoverable . . . .” Whether or not GTE
was obligated to take such measures,
however, is ultimately immaterial to our
holding.

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

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