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Court Rules that Damage to Computer Software is "Not Physical Damage to Tangible Property"

  • February 26, 2004

In October 2000, Coverage Concerns focused on a number of computer-related insurance coverage issues. One of the arguments anticipated in both the liability insurance and property insurance context was the insurance company’s argument that loss of computer programs and data are not covered because they do not constitute "physical damage to tangible property." A federal court in Virginia recently agreed with an insurance company on that issue.(1) America Online sought insurance coverage from its liability insurance carrier when consumers filed suit alleging that AOL software had substantial "bugs" in it. The consumers claimed that the AOL software damaged their existing software, caused them to lose stored data, and caused their computers to "crash." The insurance company denied coverage, arguing that the damages claimed were not "property damage" as defined in the insurance policy because they did not constitute "physical damage to tangible property."

The court drew a distinction between damage to "hardware" and damage to "software." The court observed that if a hard drive had been physically scarred or scratched so that it could no longer properly record data, then the damage would be "physical." The court reasoned that damage to "software" is damage to intangible property – ideas and logic – not tangible property. In short, the court concluded: "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."

This case was decided by a federal court in Virginia. It will not be binding on any court in North Carolina and South Carolina. This decision’s reasoning, however, can be cited by insurance companies with disputes in the Carolinas. Policyholders should continue to anticipate an uphill battle when arguing that damage to computer software or data constitutes "property damage" in the context of a liability insurance policy.

(1) America Online, Inc. v. St. Paul Mercury Ins. Co., 2003 U.S. App. LEXIS 20928 (4th Cir. 2003).