Intellectual Property Law

Do Business Insurance Cover Electronic Data Loss Caused by Defective Software?

By IBLS Editor

The software industry is booming worldwide.  China's software industry, one of the fastest growing markets, generated US$80.8 billion (580 billion Yuan) in revenue in 2007.  Security software is the most profitable among software categories.  Experts predict that the security software industry in China will grow at a compound average growth rate of 10.5 from 2007 to 2012. The panorama is similar for the United States (US) software industry; Microsoft, IBM, Maximizer Software, and other US software companies reported record profits for the year 2007.  Hence, as the software industry expands so does consumer complaints. If software products are defective and damage consumers' computers or software, who does pay for these damages? 

Answers to this question depend on the type of relation between consumers and software company.  For example, whether the software was specifically made for the consumer; in this particular case, the relationship is controlled by the parties' contractual agreement.  A more complex case arises when an internet service provider (ISP) provides its customers with software products, specifically made for the ISP to facilitate ISP services.  There is an interesting case that illustrates how consumers have sought readdress for defective software provided by ISPs.

In AOL v. St. Paul Mercury Ins., 347 F.3d 89 (2003) customers of AOL filed a class action against AOL alleging that AOL Version 5.0 access software had bugs and incompatibility with other software and operating systems which caused costumers' computers to be damaged.  Costumers alleged that their computer operating systems and software were damaged after they installed AOL Version 5.0 software; damages included loss of data; inability to connect to other ISPs; inability to connect to other local networks or use other e-mail services; inability to remove AOL 5.0 software completely; etc.  

AOL tendered defense of this action to its insurance company.  The insurance company refused coverage alleging that plaintiffs' claims "do not allege damages to 'tangible' property and are not property damages as defined by [their] commercial general liability policy."  The District Court ruled for the insurance company.  AOL appealed.

On appeal, AOL argued that the damages caused by software 5.0 amounted to "physical damage to tangible property" and the complaint alleged "loss of use of tangible property."  The commercial liability policy between AOL and the insurance company allowed coverage when software damaged "tangible property" or caused "loss of tangible property."  The insurance company argued loss of data, damages to other software, disruption of internet connections did not constitute damage to "tangible property" within the meaning of the contract between the parties; thus, they were not to indemnify AOL's customers. 

The ultimate decision laid on "comparison of the policy language with the underlying complaint to determine whether any claims alleged [in the complaint] are covered by the policy."  After analyzing whether damage to data and software constituted damages to "tangible property" under the contract, the Court of Appeals concluded that data lost by AOL customers is not "tangible property." "The hard drive itself is a medium in which the data, information, and instructions are stored, but the data itself must be considered apart from the medium," the court said.  "The insurance policy in this case covers liability for "physical damage to tangible property," not damage to data and software, i.e., the abstract ideas, logic, instructions, and information. Thus, while it covers any damage that may have been caused to circuits, switches, drives, and any other physical components of the computer, it does not cover the loss of instructions to configure the switches or the loss of data stored magnetically. These instructions, data, and information are abstract and intangible, and damage to them is not physical damage to tangible property." AOL did not show that actual component of the computer were damaged; they just argued that damage to its customers' software and computer applications constituted "loss of use of tangible property of others," for which the contract provided coverage.  The court, however, concluded that AOL had not provided evidence that physical or tangible components of the computers were damaged.  Thus, no coverage was available under this wording of the contract. 

AOL was ordered to pay its customers for damages caused by its software Version 5.0 and its insurance company was relieved of any coverage under these circumstances.  

In contractual agreements "Less is better", some people say.  But, is this true for insurance agreements involving software?  Maybe not.  Business insurance policies for software products should carefully describe any possible contingency; after all, many are looking for these big- packet defendants and any gap may be used against software producers.     

Full post as published by IBLS Internet Law Blog on June 29, 2008 (boomark / email).