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Computer Virus Ruled an "Accident" and "Physical Loss" for Insurance Purposes

    Client Alerts
  • February 10, 2005

The February 2004 Coverage Concerns reported on a court ruling that damage to computer software was not “physical damage to tangible property.”(1) A recent case in Texas reached a different conclusion, deciding that a computer virus was an “accident” that caused “physical loss.” (2)

The Texas case involved an employment service whose computers were attacked by a virus. To restore its computer system, the company had to replace its server, purchase new software, and manually reenter data. The company lost income as the result of the interruption to its business.

The company made a claim under a business insurance policy, which covered “accidental direct physical loss to business personal property,” and business income lost during a suspension of operations, if the suspension was caused by “accidental direct physical loss to property.” The insurance company denied the claim, first arguing that the damage was not an “accident,” because the hacker’s invasion into the system was intentional. The court rejected that argument, because the policyholder was not involved in any intentional conduct, and there was no evidence that the policyholder could have reasonably anticipated the virus attack or the resulting incapacitation of its system. The court concluded that the injection of the virus and resulting damage was unexpected, and therefore accidental, from the policyholder’s standpoint.

The insurer also argued that the damage was not a “physical loss,” because the data on the computers did not exist in any physical or tangible form. The court recognized that other courts have struggled with whether computer data is “physical” or “tangible.” In this particular case, however, the insurance policy specifically covered loss of business income caused by “accidental direct physical loss” to “electronic media and records.” The court concluded that the losses in this case were “physical” and that the damage to the server and loss of data were covered under the policy definition of “electronic media and records.”

The extent to which this case will impact rulings in North Carolina or South Carolina is unclear. The conclusion that the loss of data was a “physical loss” seemed to turn largely on the language of this specific insurance policy. In addition, rulings from courts in Texas are not binding on courts in North Carolina or South Carolina. Nonetheless, the ruling that a computer virus is an “accident” could be persuasive to courts in the Carolinas.

(1) Court Rules That Damage to Computer Software Is Not “Physical Damage to Tangible Property”, Coverage Concerns (Feb. 2004) (Discussing America Online, Inc. v. St. Paul Mercury Ins. Co., 347 F.3d 89 (4th Cir. 2003).
(2) Lambrecht and Assoc. v. State Farm Lloyds, 119 S.W. 3d 16 (Tex. App. 2003).