Handle Property Claims Properly

It is hard to imagine a modern business of any size operating without computers. Loss or damage to computer systems can effectively put a company out of business for however long it takes to replace the systems and data. Insurance coverage for property damage to computer systems and any resulting business interruption is vital for almost every business. However, a recent case addressing property insurance for damage to computer systems makes clear that even having the right coverage is not enough. The claim must be properly handled from inception.

Providence Washington Insurance Company v. Volpe & Koenig, P.C., 2005 W.L. 2860021 (E.D. Pa.), had its genesis on July 25, 2003, when Volpe & Koenig, a law firm, suffered a computer system crash. The firm's employees were not able to access data from the network servers. The firm immediately contacted a repair company and, when the technician arrived, he found the temperature in the server room to be very hot because of a cooling system failure. The increased temperature resulted in loss of data and required hardware replacement at a total cost of $135,000.

Volpe and Koenig had property insurance through Providence Washington. However, the firm waited to submit its claim until June 24, 2004, almost 11 months to the day after the loss. The policy provided coverage for computer equipment under a special computer endorsement, which excluded loss or damage to computer equipment caused by or resulting from the following.

dampness or dryness of atmosphere, or changes in or extremes of temperature, unless such conditions result from physical damage caused by a covered cause of loss to an air conditioning unit or system, including equipment and parts, which is part of, or used with the electronic data processing equipment.

Based on this exclusion, and late notice, Providence Washington denied coverage and filed a declaratory judgment action.

Although both parties agreed that the loss had been caused by a cooling system failure which allowed the computer equipment to overheat and sustain the damage which required replacement, the cause of the cooling system failure was never determined. Therefore, Volpe and Koenig could not demonstrate that the cooling failure resulted from physical damage caused by a covered cause of loss. It was, therefore, unable to show that the loss fell within the exception to the exclusion. As a result, the law firm was reduced to arguing that the exclusion was ambiguous and overly broad. The firm contended that the exclusion could be read to apply only to changes of outdoor temperature and, if applied as written, would preclude coverage any time there was merely a detectable temperature fluctuation.

The court rejected this argument, holding that the exclusion applied only where loss or damage was actually caused by the change in temperature. The exclusion would not apply merely because there had been a change in temperature if the damage or loss was caused by some other factor.

Volpe and Koenig also argued that the exclusion was ambiguous, citing cases where similar exclusions were held ambiguous because they did not specify whether they applied to fluctuations in temperature indoors, or changes in outdoor temperature or weather conditions. The court rejected this argument because of the exception to the exclusion. That exception, noted above, allows coverage when the computer equipment is damaged by a cooling system failure resulting from physical damage from a covered cause of loss to an air conditioning unit or system. Because air conditioning is used only to control indoor temperatures, the court held that the exclusion could reasonably be read as applying only to changes in indoor temperature. The court never addressed the late notice issue because the loss was excluded.

There are valuable lessons to be learned from this case. First, Volpe and Koenig acted properly and with foresight by making sure that it actually had protection for property damage to computer systems. The lack of a business interruption claim could well have been the result of the fact that Volpe and Koenig had a plan in place to address computer problems promptly and, when necessary, secure prompt replacement of damaged equipment. Such a plan undoubtedly included regular backing up of data to minimize any data loss. If so, there is a positive lesson to be learned. Companies should make sure they have proper coverage for computers, including language such as the exception to the exclusion at issue, which makes sure that there is coverage for reasonably foreseeable events such as cooling system failures. Procedures for dealing with prompt repair and replacement of key equipment, such as servers, and regular backup of data and offsite storage of backup tapes, are all crucial parts of any continuity plan. Of course, if the firm did not have business interruption coverage, the lack of any such coverage would be extremely problematic and potentially devastating under different circumstances. Businesses should make sure they have applicable business interruption coverage in appropriate amounts.

On the negative side, although it had the correct coverage, Volpe and Koenig did not handle the claim properly. First, despite having a six-figure loss, the firm did not promptly notify its insurer. It did not determine the cause of the cooling system failure and evaluate coverage to see whether that cause of loss fell within the exception to the exclusion. In fact, by waiting 11 months to notify the insurer, a time long after the cooling system had been repaired and the damaged equipment replaced, the firm left itself open to a very powerful late notice argument by the insurer. It is a rare situation where a property insurer will acknowledge coverage when it does not receive notice until all damages caused by the loss have been repaired and when the passage of time has impaired its ability to determine the cause of loss and/or whether all damages repaired were caused by the loss.

This case teaches four lessons: (1) get the proper coverage; (2) when you have a loss, review all potentially applicable policies promptly to see if coverage is available; (3) always evaluate the root cause of loss, even if it requires effort beyond simply repairing the damage; and (4) always give prompt notice to insurers, even if there is doubt about coverage. Remember, having the right coverage is not enough if you don't handle the claim properly.