Does Your Insurance Policy Cover You? The Question of Computer Data as "Tangible" or "Intangible" Property Under Insurance Law

"Other considerations also support the conclusion that the computer tape and data are tangible property under this policy. The data on the tape was of permanent value and was integrated completely with the physical property of the tape. Like a motion picture, where the information and celluloid medium are integrated, so too were the tape and data integrated at the moment the tape was lost." ²

Two other cases appear to support the contention that computer data can be tangible property. In American Guaranty and Liability Insurance Co. v. Ingram Micro, Inc., the Arizona District Court was faced with the question of whether a power outage, which resulted in lost computer data necessary for network functions, qualified as "physical damage" under an all-risk policy. ³ The policy covered computers and all risks of direct physical loss or damage from any cause. The court ruled that physical damage was not restricted to the physical destruction or harm of computer circuitry but included loss of access, loss of use, and loss of functionality. Accordingly, the court found that the loss of the custom network configurations which ran the network constituted physical damage under the policy.

Outside the U.S., the Australian case of Switzerland Insurance Australia Ltd. v. Dundean Distributors Pty. Ltd. considered the question of whether a power fluctuation that led to the corruption and loss of computer data constituted "damage" to the insured's electronic accounting equipment under the policy. ⁴ Under the insurance policy, "damage" was not qualified by the terms "physical property" or "tangible property". Rather, physicality seemed to be implied as the policy covered damage to "electronic equipment". Although the court rejected coverage for the lost accounting data stored on the hard drive, it did rule that the operating system and accounting software were covered by the policy. In the opinion of the court, the policy was meant to cover more than simply hardware. The hardware and software shared a symbiotic relationship. Together, the hardware and software were inseparable pieces comprising the accounting system and coverage was granted.

However, the decisions in Retail Systems, American Guaranty, and Switzerland Insurance, should all be viewed with a measure of caution. A year after Retail Systems was decided, the Minnesota Court of Appeals appeared to limit the reach of the case by distinguishing it in St. Paul Fire & Marine Insurance Company v. National Computer Systems. ⁵ This latter case considered whether the misappropriation of confidential proprietary information located in binders belonging to Boeing, and in the possession of a former employee, was property damage under a CGL policy. The court ruled that there was no property damage as the confidential information was not damaged or destroyed, it had merely become unavailable. In contrast, the data and the computer tape in Retail Systems were permanently lost and damage resulted. This distinction has proved to be important and resurfaced in the recent Court of Appeals for the 4^th Circuit decision of America Online, Incorporated v. St. Paul Mercury Insurance discussed below. ⁶ More importantly, by distinguishing Retail Systems in this manner, it suggests that physical damage will only occur to computer data if the data and the physical mechanism which reads the data are simultaneously and independently destroyed.

In American Guaranty and Switzerland Insurance, the positive outcomes for the insured in both cases were aided by the specific wording of the policies. In American Guaranty, the policy did not limit damage or loss to hardware specifically. In Switzerland Insurance, the policy did not limit the definition of "damage" to electronic equipment with the use of terms such as "physical" or "tangible". While there is no way of knowing whether the use of such limiting words in the policies would have led to different decisions in American Guaranty and Switzerland Insurance, these cases do illustrate the importance of precise drafting and carefully reviewing the policy wording.

The district court for the Western District of Oklahoma in State Auto Property and Casualty Insurance Co. v. Midwest Computers and More came to a virtually identical conclusion. ⁷ In this case, the insurer moved for summary judgment on the issue that it had no duty to defend or indemnify the insured for negligent computer service work as it did not fall within the definition of "property damage" under the policy. The court briefly considered the issue of whether computer data is tangible property. In a terse paragraph, the court stated that computer data cannot be tangible property as it does not accord with the common dictionary definition of the term. Although the storage medium for computer data is tangible, the data is not. Computer data cannot be touched, held, sensed by the human mind, and has no physical substance. As such, the damage caused by the insured did not fall under the policy.

St. Paul Mercury and State Auto offer important counterpoints to the argument supporting the tangibility of computer data found in Retail Systems. First, both cases make the conceptual leap of separating the data from the medium which holds it. In conceiving of computer data in this manner, each court is able to conclude that the data residing on a physical computer readable medium does not constitute a single item of property. Second, building on the separation of data and substrate, St. Paul Mercury, like St. Paul Fire before it, distinguishes between damage and loss of use. In the court's opinion hardware is not necessarily "damaged" when the software becomes inoperable. Rather, the user simply experiences a loss of use. Whether these arguments will be adopted or rejected in future cases remains to be seen. However, the arguments in St. Paul Mercury and State Auto, in combination with limitations on a finding of tangibility in Retail Systems, appear to have more persuasive value in determining that computer data is not tangible property.