UK: Computer source code loss: insurance coverage

Last Updated: 10 August 2005
Article by Kate Tregidgo

On 21 July 2005, the Court of Appeal overturned a recent decision that losses claimed for the deletion of a computer source code by a virus spread by email and the theft of that same source code which was on a computer at business premises were not recoverable under the terms of an insurance policy. Whilst this may cause companies dependent on software to breathe a sigh of relief, the Court of Appeal has warned that companies should still take great care when seeking insurance for their software.

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Tektrol Limited was in the business of designing, developing and manufacturing energy saving control devices for industrial motors. Its main product, the "Powermiser", relied on certain software and the source code of the software enabled the Powermiser to be customised to the needs of a particular customer. Tektrol stored the source code in five different places: on two development computers at its premises, on a laptop belonging to the Managing Director, on a computer at a remote site operated by an independent company and on a paper printout kept at the premises.

In December 2001, the Managing Director received an email, containing a virus, which destroyed the copy of the source code on the laptop. Believing that the remote site had not been corrupted, the Managing Director repaired and reloaded the laptop from the remote site and believed that the source code had been recovered. In January 2002, Tektrol's premises were burgled and the development computers containing the source code and the paper copy of the code were stolen along with other equipment and stock. It was then realised that all copies of the source code had been lost as the virus had also destroyed the source code stored at the remote site and thus it had not been successfully restored to the laptop.

Tektrol claimed on its insurance for business interruption caused by the two incidents. The insurers resisted the claim on the basis that the policy excluded liability for damage or consequential losses resulting from erasure, loss, distortion or corruption of information on computer systems or other records, programs or software caused deliberately by rioters, strikers, locked out workers or persons taking part in labour disturbances or civil commotion or malicious persons. Other erasure, loss, distortion or corruption of information on computer systems or other records, programs or software was excluded, unless it was as a result of theft or a Defined Peril, which included malicious persons. Tektrol argued that the sending of the email virus resulting in the erasure of the source code and the loss by theft of the source code were both caused by malicious persons and that its insurers should therefore pay out under the policy.

Mr Justice Langley at first instance held that Tektrol's insurers were not liable for the losses caused by either the virus or the burglary under the terms of the policy. It was an agreed fact that the sender of the virus was a malicious person and the Judge decided that the loss had been caused deliberately even though the virus had not been specifically targeted at or intended to harm Tektrol. The Judge also found that the consequences of the burglary were excluded under the policy because burglars were not malicious persons in the sense used in the policy and the policy only covered physical, as opposed to electronic, loss.

This was reversed by the recent decision of the Court of Appeal. Lord Justice Buxton, giving the majority opinion of the Court, held that this particular clause was intended to exclude loss caused by rioters and strikers causing damage to information on the computers at Tektrol's premises. It was only concerned with interferences directed specifically at those computers and committed on or near the premises. To extend the clause to cover remote hackers by including them as "malicious persons" would mean adding a different category of persons making a very different kind of attack to those already excluded. If the insurer wanted to exclude losses caused by remote hackers indiscriminately sending out viruses, that exclusion needed to be set out in a separate clause with specific wording. Lord Justice Buxton was unsympathetic to insurers who did not use clear, unequivocal wording resulting in ambiguity as to what the policy covered.

Lord Justice Buxton also held that the insurers had to pay Tektrol for losses suffered due to the theft of the source code (which was lost when the hardware was stolen) because he thought that the draftsman of the relevant provision in the insurance policy could not have intended this sort of loss to be covered by the exclusion as drafted.

Whilst this case was decided on specific facts and on the basis of specific insurance policy exclusions, the message following this appeal remains clear: both insurers and insureds should know the detail of their insurance coverage in the area of computer software when signing or renewing policies so as to ensure certainty and so that the policy correctly reflects the parties' intentions. Insurers should draft their insurance policy exclusions carefully and precisely if they intend to exclude losses arising from the deletion or theft of software, otherwise they face the risk of a court construing exclusions narrowly and against them. It is worth noting that the Court of Appeal did show a considerable amount of sympathy for Tektrol because, as Lord Justice Carnwath said when reluctantly delivering a contrary opinion on the theft exclusion, "…it does seem harsh that the extraordinary sequence of misfortune which afflicted Tektrol in this case should be compounded by an unsuccessful legal battle to recover the loss from their so called "all risks" insurers". Whilst this may provide some comfort to policyholders, they cannot be certain of a sympathetic court on every occasion and this case therefore provides a warning that companies should take great care when seeking insurance for their software.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 09/08/2005.

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