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Software and Data Not Covered Under Commercial Liability Policy

New policies may be needed to cover claims for “intangibles”

More than ever, businesses rely on computer systems and networks to provide services and generate revenues. A recent decision from the U.S. Court of Appeals for the Fourth Circuit indicates, however, that claims for damage to the data and software residing on computer systems may be uninsured under conventional commercial liability policies.

In America Online, Inc. v. St. Paul Mercury Insurance Company, the Fourth Circuit considered whether damage to information stored on a computer constituted “physical damage to tangible property” as described in AOL’s commercial liability policy. AOL sought indemnification for claims by software users who alleged that flaws in the software “altered [their] existing software, disrupted their network connections, caused the loss of stored data, and caused their operating systems to crash.”

Applying Virginia law, the panel’s two-member majority determined that, although the actual “physical magnetic material on the [computer's] hard drive that retains data, information, and instructions is tangible property, [the] instructions, data, and information are abstract and intangible, and damage to them is not physical damage to tangible property.” Since the policy covered solely physical damage to tangible property, the majority concluded, AOL was not covered for claims of lost or disputed computer data, which is “intangible.”

The AOL decision is significant because it confirms, as lower courts have concluded, that alleged damage to computer data from defective software does not constitute “physical damage to tangible property” under general liability insurance policies.

The decision highlights that policyholders should consider newly developed computer and Internet insurance policies to the extent they wish to insure against the loss of valuable electronic data and computer systems. These policies are written specifically to address potential exposures like software disruption and lost data. Contact your insurance agent and get any request for coverage in writing.

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