A few years ago, as companies rushed to plug into the World Wide Web, some
business policyholders scrambled to find answers to two fundamental questions
relating to e-commerce and commercial insurance. The first question was whether
electronically recorded or stored information—for example, data, programs, software
and other media (hereinafter, "computer data")—is "tangible property." A second
but related question was whether such computer data could be subject to "physical
loss or damage."
Some insurance buyers focused on these two questions because the insuring
agreements in standard-form commercial general liability and commercial property
insurance policies rest on the concepts of "tangible property" and "physical
loss or damage." The standard commercial general liability (CGL) insurance policy
protects against liability for "property damage," defined as "physical injury
to tangible property . . . or loss of use of tangible property that is not physically
injured." The standard commercial property insurance form insures against "all
risks of physical loss or damage" to covered property.
In the early 1990s, a handful of court decisions touched on these questions
but did not squarely answer them. Thus, with the approach of Y2K, some commercial
buyers of insurance were understandably confused as to the application of the
standard policies to e-commerce activities.
Now, in 2001, we report that case law relating to questions of coverage for
loss of computer data under standard commercial insurance policies appears to
remain unresolved. We find this development ironic, given the fact that (a)
several insurers, on both CGL and property policies, have paid claims involving
computer data during the last several years; (b) some off-the-shelf insurance
forms expressly recognize that computer data is "tangible property" or subject
to "physical loss or damage"; and (c) several insurers, when structuring insurance
programs in today's market, take the position that computer data is "tangible
property" or subject to "physical loss or damage."
The problem is that there are still a few insurers that might challenge this
issue in court if presented with a claim where the policy does not expressly
address the issue. Thus, the lack of clear and unequivocal case law on the subject
can leave some commercial insurance buyers in the dark as to the scope of coverage
for computer data losses provided by their insurance programs.
What does this mean for companies whose existing policies do not expressly
state that computer data is "tangible property" or subject to "physical loss
or damage"? Can they be confident of coverage? And what of companies now looking
ahead to renewal? In the still uncertain legal climate, will companies face
an unpleasant surprise if they do not act now to put these questions on the
table while negotiating their policies?
In this article, we will trace the evolution of court decisions dealing with
the questions of whether computer data is "tangible property" or subject to
"physical loss or damage" for purposes of insurance coverage. In a subsequent
article we will (a) explain the arguments that policyholders should make when
faced with claims involving computer data under policies that do not expressly
address these issues; and (b) suggest a strategy for insurance buyers to consider
to avoid the uncertainty that still exists with respect to these issues.
Is Computer Data Subject to "Physical Loss or Damage"?
A federal court in Kansas appears to be the first court to have issued a
published decision addressing the question of whether a standard-form first-party
property policy would protect the insured against loss of computer data. In Home Indemnity Co. v Hyplains Beef, L.C., 893
F Supp 987 (D Kan 1995), aff'd without opinion, 89 F3d 859 (10th Cir 1996),
a meat packing plant purchased a computer system to help control cutting and
track inventory. When placed online, the computer system failed to retain the
electronic data fed into it. Without the data, the packing plant suffered a
decrease in orders and lower than normal carcass yields. The court observed
that the claim raised:
several interesting questions. Among these are whether there could in
fact be a "direct physical loss" to the electronic data which was allegedly
collected but never existed in a tangible form. Also, because the electronic
data never existed in a usable form, was it in fact lost or rather did it
never come into existence?
However, the court did not answer this question, holding instead that there
was no coverage for the packing plant's business interruption claim because
the decrease in plant efficiency was not a complete "suspension" of plant operations.
Is Computer Data "Tangible Property" for Insurance Coverage Purposes?
A string of cases involving both standard-form CGL insurance policies and
a first-party employee theft policy next raised the question of whether computer
data was "tangible property" for purposes of applying the policies' "property
damage" definition. In Centennial Insurance Co. v Applied
Health Care Systems, Inc., 710 F2d 1288 (7th Cir 1983), the insured installed
a faulty controller in its customer's data processing system, causing random
loss of the customer's billing and patient care information. Taking the position
that the customer would not be able to prove any "physical injury to tangible
property," the insurer refused to defend. The court held that the insurer was
obligated to defend the claim because there was at least a potential that the
customer might prove there had been damage to tangible property. But because
only the duty to defend was at issue, the court stopped short of deciding that
the computer data was in fact tangible property.
In Magnetic Data, Inc. v St. Paul Fire & Marine Insurance
Co., 442 NW2d 153 (Minn 1989), the policyholder had erased data from
its customer's disks while checking the disks for defects. The Minnesota Supreme
Court concluded that because the disks and data had been in the insured's possession
when the loss occurred, coverage was barred under a "control of property" exclusion.
But, because the lower court had reasoned that an injury to tangible property
was not a requirement of coverage, the state supreme court dealt with the "tangible
property" question by stating that it would not extend the policy to provide
coverage for damage to intangible property. The court's statement does not actually
resolve the "tangible property" question, but some courts and commentators have
assumed that it did so—in favor of insurers.
Soon after Magnetic Data, an intermediate
appellate court in Minnesota held that loss of computer data was covered under
a CGL insurance policy. In Retail Systems, Inc. v CNA
Insurance Cos., 469 NW2d 735 (Minn App 1991), a customer's computer tape
mysteriously disappeared while in the insured's custody. After finding the phrase
"tangible property" to be ambiguous in the case of computer data, the court
observed that the data recorded on the tape was merged with the tape itself.
Thus, when the entire tape was lost along with its embedded data, there had
been a loss of tangible property. However, the Retail Systems case did not actually
answer the question of whether data itself, apart from the medium in which it
is stored, is "tangible property."
Another Minnesota court then added further confusion, attempting to apply
the reasoning of Magnetic Data and Retail Systems in a case that did not even involve
electronic data, but rather information recorded on paper in three-ring binders.
In St. Paul Fire & Marine Insurance Co. v National Computer
Systems, Inc., 490 NW2d 626 (Minn App 1992), the insured used photocopies
of its competitor's confidential pricing information that it had obtained when
it hired its competitor's former employee. The insured argued that under the Magnetic Data and Retail
Systems decisions, the loss of its data in the binders was a loss of
tangible property. The court disagreed, reasoning that the binders themselves
had not been lost or damaged, nor was the information in the binders rendered
unusable. The court viewed the claim as involving a loss of the exclusive use
of the information rather than a loss of the information itself. Viewed in this
way, there was no coverage because there was no damage or loss of use of tangible
property, but only an injury to the competitor's right to use the property.
A federal court in Florida subsequently relied on National Computer Systems to hold that a first-party employee theft policy
did not provide coverage for losses sustained when the employee of a cellular
telephone service provider disclosed access codes that enabled non-customers
to use the telephone service. In Peoples Telephone Co.
v Hartford Fire Insurance Co., 36 F Supp 2d 1335 (SD Fla 1997), the court
reasoned that the policy term "tangible property" was unambiguous, and that
the only real loss suffered was the loss of the economic value of the access
codes, an intangible. As in National Computer Systems,
the loss arose not from the loss of data, but from an inability to restrict
its use by others.
As a careful reading of the cases discussed above reveals, there still is
no clear answer -- in the case law -- to the "tangible property" conundrum.
Maybe the "perfect" fact pattern has not yet occurred that would place squarely
before a court the question of whether computer data is "tangible property"
or subject to "physical loss or damage." Maybe the courts are not publishing
decisions on the issue, or maybe insurers are settling out of court and thereby
preventing the development of a clearer body of law.
The Bellwether Ingram Micro Case
In 2000 a court was faced with the question originally posed in Hyplains Beef—whether a loss of computer data
could be "physical loss or damage" to property. In American
Guarantee & Liability Insurance Co. v Ingram Micro, Inc., 200 U.S. Dist
LEXIS 7299 (D Ariz Apr. 18, 2000), a federal court in Arizona held that the
loss of computer data was physical damage to the insured's computer equipment
under a business interruption policy. Ingram Micro's loss was caused by a brief
electrical power outage, during which custom programming information stored
in the computers' random access memory was lost. Ingram Micro lost data processing
capability at its data center hub location for several days while the system's
default programming was replaced with its custom programming configurations.
The insurer argued that there had been no "physical damage" to the computer
system because the computers retained their default programming and their inherent
ability to accept and process data. The court disagreed, finding that "physical
damage" is not restricted to the physical destruction or harm of computer circuitry
but includes the "loss of access, loss of use, and loss of functionality."
Ingram Micro does not precisely answer the
question whether damage to computer data is "physical loss or damage." Instead, Ingram Micro appears to stand for the proposition
that when the computer data stored in a computer is altered, the computer itself has suffered "physical
loss or damage."
Also, the federal district court's decision in Ingram
Micro may not be the last word on this subject. The case settled after
the Ninth Circuit Court of Appeals refused to hear an early appeal before trial.
The federal district court's decision may be highly persuasive, but it is not
binding on other courts. So, at least technically speaking, the matter is open
to further debate if an insurer wants to test the issue in a different court
against a different policyholder.
So Where Does This Leave Insurance Buyers?
Despite the fact that several courts have been faced, in the insurance context,
with the question of whether computer data is "tangible property" or subject
to "physical loss or damage," there appears to be no definitive case law on
the subject. Still, there are many good arguments to explain why, for insurance
coverage purposes, computer data can be deemed "tangible property" and subject
to "physical loss or damage." Some lawyers are even looking at tax law as one
source of arguments in favor of coverage for computer data under traditional
policy language. We'll take a look at these and other pro-coverage arguments
in our next article.
Only time will tell if the courts will fully—and consistently—find that computer
data is "tangible property" and subject to "physical loss or damage." As long
as these questions remain unanswered in the courts, insurance buyers should
consider dealing with these issues during renewals. Our next article will explain
the arguments that policyholders can make at claim time, and will also discuss
several different ways to address these issues with insurers during renewals.
Click on Part 2 to go to the second part of this
article.
This article was written by Catherine Rivard and
edited by Michael Rossi.
Catherine Rivard is Senior
Risk Management Counsel at Insurance Law Group, Inc., a law firm providing legal
services to middle-market and multinational corporate risk managers. She advises
on initial placements and renewals (including e-commerce issues), manuscripts
insurance policies, and handles disputed claims outside of litigation. She previously
was a partner of Troop Steuber Pasich Reddick & Tobey, LLP. Ms. Rivard has represented
policyholders in insurance matters since the mid-1980s. She developed the first
arguments for "personal injury" coverage in asbestos-in-building and environmental
claims. More recently, she wrote briefs in Alpha
Therapeutic Corp. v. Home Insurance Co., 90 Cal. App. 4th 1330 (2001) (single-occurrence
multi-injury claim not limited to single policy year's limits).
Ms. Rivard is a member of the State Bar of California and
the American and International Bar Associations. She earned her JD degree in
1986 from Northwestern University and her AB degree in political science, cum
laude, in 1982 from Occidental College. Ms. Rivard can be reached by e-mail
at