US Court Holds that Damage to Software is not "Property Damage"

In a majority decision, the US Court of Appeals for the 4th Circuit affirmed that the damage inflicted on computers belonging to subscribers following the release of a version of America Online's (AOL) access software fell outside the company's Commercial General Liability (CGL) insurance policy. The dispute arose from the installation of AOL's Version 5.0 access software which was incompatible with the pre-existing software on computers of many of its users, rendering a machine inoperable until the Windows operating system was re-installed.   The users affected filed class actions against AOL.   In response, AOL turned to its primary insurer, St. Paul Mercury Insurance Company (St. Paul), to defend and indemnify it against any damage claims.   St. Paul refused on the basis that the damage caused was to software and data and therefore did not constitute "property damage" under the policy. AOL had then sought a declaratory judgment that St. Paul owed a duty to defend and indemnify AOL under the policy. At trial, St. Paul successfully defended its denial of the claim.   The lower court ruled that software and data are not forms of tangible property and any loss-of-use claims against AOL were excluded from a claim for "property damage". On appeal, the 4th Circuit agreed and affirmed the trial court's decision.   In doing so, the appellate court explored the question of software and data as forms of tangible or intangible property.   While the Court agreed that the magnetic material on a hard drive is tangible property, it stated that it must be distinguished from software, which is intangible property.   The Court analogized the situation to that of a combination lock where the combination is unknown.   While the lock is useless, it is not physically damaged and can be used again once the combination becomes known.   Similarly, when software becomes inoperable, it is the code that is damaged and not the hardware. The decision of the 4th Circuit represents another chapter in the ongoing question whether software is intangible or tangible property.   Until this question is definitively answered, businesses would be wise to examine their insurance policies to see whether they are clearly covered for the loss of data or software as a form of "property damage". For a copy of the decision, America Online, Incorporated v. St. Paul Mercury Insurance Company, No. 02-2084 (4th Cir. 2003), see: http://laws.findlaw.com/4th/022018p.html. Summary by:   Colin Adams