Customers R Us has developed a new customer-service software package. WidgetCo is an important early adopter of the software. Unfortunately, the package has bugs, causing the computers of WidgetCo's customer service representatives to lock-up. Customers cannot get through. When they do, the representatives cannot access customer data and thus cannot answer customer questions. WidgetCo's IT department has to spend several days reinstalling software and setting up the customer service computers; some customer data has been irretrievably lost.
WidgetCo has lost several thousand dollars and an untold amount of goodwill. It sues Customers R Us Software to recover its costs. The executives of Customers R Us are not worried: their insurer will handle the case. They notify their commercial general liability ("CGL") insurer of the suit. To their surprise, the insurer denies their claim and refuses to indemnify them. Most courts would say the insurer is fully in the right and that Customers R Us is out of luck.
CGL Policies: Damage to Tangible Property
Historically, the mainstay insurance policy of commercial actors has been the CGL policy. It provides coverage for numerous types of liability a company can expect to incur. Among the most important standard provisions is the coverage for property damage suffered by third parties. These provisions could cover everything from automobile accidents caused by the insured's employees to product liability claims.
Standard policy language of such provisions is that the policy covers "physical damage to tangible property of others." What happens when software or data is damaged or destroyed? Has there been "physical damage" to "tangible property?" Most courts have answered "no."
America Online v. St. Paul Mercury Ins. Co.
America Online, Inc. v. St. Paul Mercury Ins. Co., 347 F.3d 89 (4th Cir. 2003), involved a dispute between America Online and its insurers. Following the 1999 release of Version 5.0 of its access software, AOL customers encountered a variety of difficulties including (1) interference with their non-AOL communications software, (2) inability to run non-AOL email programs, and (3) alteration of many operating systems files on the customers' computers. For some of the customers, the only remedy was to reinstall the operating system after reformatting the hard drive on their computers, thus losing many files and data.
AOL was sued by 43 customers and later established a fund of $15.5 million to compensate them and others. AOL's insurer denied coverage of the settlement and refused to pay defense costs. AOL, in turn, sued its insurer contending that the damage to its customers' files and software was "physical damage to tangible property" and thus covered under its CGL policy.
The U.S. Court of Appeals for the Fourth Circuit disagreed, reasoning that "tangible" meant "capable of being touched." The court went on to conclude that while the hard drives of AOL customers were "tangible property," the software and data were not. Instead, software and data are merely "instructions to the computer" that are "abstract ideas in the minds of the programmer and the user." Likening a computer to a combination lock, the court concluded that losing a combination to a lock would render the lock useless. Nevertheless, the lock would not by physically damaged. Similarly, losing software and data would render the computer useless, but the computer would remain physically intact. Because only users' software and data had been damaged, the claims against AOL were not covered by its CGL policy.
Other Cases
The AOL case is by no means unique. Other courts have held that damage to software or data is not damage to tangible property. Thus, a federal court in Oklahoma concluded that where a computer technician inadvertently caused business data to be lost, the technician's insurer correctly denied coverage. See State Auto Prop. & Cas. Ins. Co. v. Midwest Computers & More, 147 F. Supp. 2d 1113, 1115-16 (W.D. Okla. 2001); see also Lucker Mfg., Inc. v. Home Ins. Co., 23 F.3d 808, 818 (3d Cir. 1994) (summarizing cases as establishing "a sharp distinction between recovery for the value of a tangible medium storing ideas, and recovery for the ideas themselves"). In other contexts, courts have concluded that loss of data is not "property damage" but mere economic loss. See Rockport Pharmacy, Inc. v. Digital Simplistics, Inc., 53 F.3d 195, 198-99 (8th Cir. 1995).
There are cases concluding that the loss of data or damage to software may be damage to tangible property. See, e.g., Centennial Ins. Co. v. Applied Health Care Sys, Inc., 710 F.2d 1288 (7th Cir. 1983); Am. Guar. & Liab. Ins. Co. v. Ingram Micro, Inc., 2000 WL 726789 (D. Ariz. Apr. 18, 2000) (concluding physical damage includes alteration to a computer's "software or network"). These cases are, however, a small minority.
What Should You Do?
Software developers and companies whose products interact with computer software and data should be aware that their CGL policies might not cover them for damage to software and data. Instead, they should evaluate the risks associated with their products, educate their insurance brokers, and discuss with their brokers the potential for obtaining a specialty policy tailored to those needs, like emerging "system risks" policies for electronic commerce companies. In turn, these policies should be evaluated closely by company counsel to determine whether the policy language reaches the risks associated with the business. Without that extra coverage, a company may be taking on more risk than it expected.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.
|
