California Appellate Court Holds That "Crash" Of A Computer Database Does Not Constitute Direct Physical Loss Of Damage
January, 2004
by Dennis D. Fitzpatrick and Mindy M. Medley
A California appellate court recently held in Ward General Ins. Services, Inc. v. Employers Fire Ins. Co., 7 Cal. Rptr. 3d 844 (Cal. App.), that “under each of the potentially relevant coverage forms of the insurance policy, the losses claimed by [the insured] are not covered by the policy unless we interpret a ‘physical loss’ to include the loss of electronically stored data, without any loss or damage to the storage media or to any other property. … [W]e do not adopt this interpretation.”
Facts
In November, 1999, while the insured was updating its computer database, human error caused the computer system to crash, “resulting in the loss of [the insured’s] electronically stored data used to service its clients’ insurance policies.” The insured incurred extra expenses in restoring its data, and also incurred business interruption losses while its system was inoperative. “[The insured] quantified the loss in the amount of ‘$53,586.83 in extra expenses to restore the database,’ and ‘$209,442.80 in business income, losses of productivity, commissions, and profits.” The insurer, except for a $5000 payment, denied the insured’s claim.
Litigation ensued, with the insured arguing that its losses were covered under the policy’s “Building and Personal Property Coverage Form,” as well as other policy endorsements. The insurer claimed that the insured’s policy did not provide coverage. The trial court agreed with the insurer, holding there was no coverage for the loss.
Analysis
The appellate court affirmed on two bases. First, the court held that the cause of the insured’s claimed damage did not constitute a risk of direct physical loss or damage. Second, the court held that the actual damage itself was not a physical loss.
The appellate court stated that coverage under the insured’s policy is “triggered only” if the loss results from a risk of direct physical loss of or damage to property covered by the policy. “Unless the harm suffered, i.e., the loss of electronically stored data without loss or damage of the storage media, is determined to be a ‘physical loss,’ we cannot say that the risk encountered in this case, a negligent operator, constitutes a risk of direct physical loss. We do not understand that a computer operator, sitting at a keyboard pressing keys or moving a mouse, presents any other relevant type of risk.”
The court went on to analyze and consider the type of property that the insured alleged had been damaged. The court rejected the argument that computerized information lost by the insured constituted damage to “property”: “[h]ere, the loss suffered by [the insured] was a loss of information, i.e., the sequence of ones and zeroes stored by aligning small domains of magnetic material on the computer’s hard drive in a machine readable manner. [The insured] did not lose the tangible material of the storage medium. Rather, [it] lost the stored information.”
Learning Point:
Although the Ward General court relied on third-party coverage cases to reach its decision, it ultimately applied proper first-party concepts in defining “direct physical loss or damage.” Additionally, instead of expanding insurance policy definitions of “property” to include coverage for intangible information, the court correctly interpreted first-party property coverage to be limited to tangible property.
We will, of course, continue to update our readers on future cases that may interpret Ward General or otherwise address the concepts of direct physical loss or damage as well as the definition of property. ¨
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