ELECTRONIC DATA AND THE CGL

Rough Notes, May 2005 by Malecki, Donald S

Explosion of the use of electronic data triggers coverage gaps

Two very experienced movers of property were carrying a heavy object down some stairs in a commercial building. Neither noticed that a sprinkler head was protruding from the ceiling above them. The object struck the sprinkler head breaking it off causing extensive water damage to the building before the water main could be shut off. As a consequence, the entity whose property was being moved also sustained a disruption of its computer facility and the loss of data.

The movers' employer breathed a sigh of relief upon learning that it had a commercial general liability in place-and for higher limits than would be necessary to make good the damages that would likely be sought because of its employees' negligence.

Unfortunately, what the moving company did not know at the time was that, while a commercial liability policy at one time would have paid all of the damages, the latest policy would not. Unlike earlier policies, what this liability policy contained was a definition of "property damage" that included an "oh-by-the-way" provision. "For purposes of this insurance," it stated, "electronic data is not tangible property." To make sure this was understood, the term "electronic data" was defined to include precisely what the employer thought would be covered.

Although it is difficult to identify the different types of scenarios that could possibly trigger a liability coverage gap involving loss to electronic data, some are obvious. One example is landscapers and other contractors who perform underground work where there may be wires, fiber optic cables or kindred property that could adversely affect a business's electronic data if damaged or severed.

Property damage coverage for the explosion, underground or collapse hazards has been automatically included in CGL policies since 1986; however, that coverage is not good enough today, if there is any chance of electronic data damage. Coverage for these three hazards was the answer until the latest CGL provisions were amended in 2001. Since then, extra coverage has been required.

Common questions from businesses are why they were not informed about this coverage gap, and what would have been necessary to have avoided such as predicament. The answer is not easy.

Good and bad news

With the introduction of this new definition of property damage precluding electronic data as property damage, ISO introduced an Electronic Data Liability endorsement. When attached to a CGL policy, this endorsement modifies the definition of property damage so as to include loss or damage having to do with electronic data, so long as this loss or damage follows physical injury to or damage to tangible property.

Most cases involving loss of electronic data do occur following physical injury to tangible property, but there are cases where electronic data is lost even when tangible property does not suffer any physical injury. Therefore, the fact that this endorsement does not apply when there is an absence of physical injury or damage to property can be worrisome.

Fortunately, with its 2004 CGL changes, ISO introduced Electronic Data Coverage Form CG OO 65 that applies to loss of electronic data, whether there is damage to tangible property or not. For purposes of this form, "loss of electronic data" is defined to mean "damage to, loss of, loss of use of, corruption of, inability to access, or inability to properly manipulate, 'electronic data.' "

Note, however, that this coverage form should not be viewed as a panacea for all possible loss exposures confronting all businesses. It is not. In fact, this coverage form is not intended for any business providing computer product services. Briefly, the form does not cover firms involved in manufacturing, developing, designing, creating, selling, etc., of computer or electronic goods. This includes computer software, programming, equipment, peripherals, communication or broadcasting equipment, and industrial or robotic equipment.

The coverage form definitely is better than the endorsement, but it is still necessary to tread carefully with it. Of course, it is on a claims-made basis. The insuring agreement also looks like the insuring agreements of ISO's standard CGL policy, but the coverage form is significantly different.

Reference in the insuring agreement to "sums the insured becomes legally obligated to pay" might lead agents and brokers to think that coverage applies for liability arising out of any acts or omissions. Not until one reviews the entire form will he or she discover coverage falling short of that mark.

It takes a while to figure this out. The insuring agreement states that this insurance applies to loss to electronic data only if such loss is caused by an "electronic data incident, which is defined in part to mean 'an accident or a negligent act, error or omission'." It is important to note that a negligent act cannot be intentional. This may never become an issue, but if it does, rest assured the insured will have a fight on its hands, because there is case law with which to contend.