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Recently, insurers have expanded their product lines to cover traditional risks in new advertising mediums, such as the Internet, as well as to cover new insureds such as computer software companies and the “dot-coms” in new areas of risk. These insurance policies eliminate the gap in many commercial general liability policies which offer very limited coverage for advertising injury and infringement of intellectual property such as trademarks, copyrights, titles, or slogans. For example, some new policies offer third-party liability coverage that provides protection for a computer security company’s negligence. Despite all the evolving insurance claims related to new e-commerce risk, subrogation has been little addressed and rarely pursued. As both statutory and common law develop, however, creative counsel can help an insurer obtain a recovery of previously unsubrograted losses.

Insurers paying first party benefits for computer, c-commerce, or intellectual property losses often encounter contractual hurdles to successful subrogation. Computer contracts and licensing agreements may contain exclusions or limitations on warranties and damages (such as limiting recovery to the cost of the product or services, rather than consequential damages and lost profits). Enforceability of these provisions requires careful legal analysis on a case-by-case basis. Issues which may allow subrogation to succeed, despite restrictions and obstacles, include whether such contractual limitations are unconscionable and whether there was adequate disclosure to the parties suffering a loss. For example, if a software developer installs a computer “time bomb” or virus which would be activated upon the customer’s first late payment, that software developer is not likely to be treated kindly by the judicial system, especially if the injury-inflicting feature was never disclosed to the customer. Contracts eliminating responsibility for the software containing a time bomb which halts a manufacturing plant, or worse yet, incapacitates a hospital or medical facility’s operation, may violate both federal and state laws and be unenforceable.

The “chicken and egg” relationship of insurance coverage and the subsequent subrogation are intertwined in the policy language and definitions. Recovery on a policy which provides coverage for “All Risks of direct physical loss or damage from any cause, howsoever or wheresoever occurring...” will depend upon the definition of “physical loss” in computer cases. Take the case of a power outage (from whatever source) that causes software and data to vanish from an insured’s computer memory. In the first-party context, the original insurer might contend that the power outage did not cause a “physical loss” because the power outage did not adversely affect the computer equipment’s ability to perform intended functions nor its inherent ability to accept and process data. In a subrogation context, however, the same underlying carrier upon an adverse ruling finding coverage must reverse its position and contend that there was “physical damage” consequent to the power loss. While jurisdictions are split on the interpretation of “physical damage” in computers, more modem jurisdictions are examining loss of use and loss of functionality of the data as determinative of “physical damage.”

Although state and federal statutes do not address loss of a computer’s functional ability in terms of insurance coverage, criminal statutes focus on damage from intentional interference with the operation of a computer’s services. Under the federal Computer Fraud and Abuse Act, it is illegal to cause damage to a protected computer. The Act defines damage as “any impairment to the integrity or availability of data, a program, a system or information.” Likewise, in Connecticut, a person is guilty of computer crime when he “disrupts or degrades or causes the disruption or degradation of computer services.” In Minnesota, computer damages include the alteration of any computer, computer system, computer network or computer software. In Missouri, damage to a computer is defined as “any alteration, deletion or destruction of any part of a computer system or network.” In New York, a person is guilty of computer tampering in the fourth degree when he “intentionally alters in any manner or destroys computer data or a computer program of another person.”

While intentional wrongdoing is not covered by insurance, the originating intentional act may redistribute the wrongdoing, innocently, to unanticipated defendants. Computer viruses (created for entertainment or for more nefarious reasons) replicate themselves in the distribution copies of commercial software, concealed in the product. The losses from these redistributions can be substantial and could have been prevented by the distributor through the use of appropriate, updated, anti-virus software. That accidental redistribution is not intentional and is a candidate for subrogation recovery.

Protection of evidence on a computer system loss is not a simple nor obvious task, and experts can make all the difference. To illustrate, in an FBI sting operation, the federal agents, armed with an appropriate search warrant, entered the home of a suspect in a credit card theft ring. The FBI’s goal was to capture the computer and computer diskettes containing anticipated proof of many Internet credit card thefts. When the federal agents entered the suspect’s poorly lit computer room, they flipped on the switch to the large overhead light. Thinking nothing was amiss, they collected the entire computer system and all electronic data, exiting by the front door. Back at the FBI laboratory, the agents discovered that the computer was blank, as were all of the diskettes. A return to the original site revealed that the light switch operated a large electromagnet surrounding the front door, a magnet which deleted all electronic information on the computer and diskettes. This situation makes a good story, but also makes an important lesson: get an expert on the site before moving any electronic medium. Because of the low price of computers today, it is sometimes worthwhile to retain the damaged equipment and data as evidence and replace the insured’s computers with new ones. In any event, good subrogation techniques require someone who can protect the evidence.

Potential subrogees sometimes assume that the “bad actor” will be judgment-proof, but there may be coverage for a creative insurance carrier to pursue. For example, an unsupervised 10-year-old at the home computer may be the hacker whose family has homeowner’s insurance that would respond to a “negligent supervision” claim. Also, if a disgruntled former employee relocates to a new place of business and then uses the new employer’s computer to hack into the former employer’s computer, that new employer’s coverage might be triggered under vicarious liability theories. In some cases, even foreign governments can be responsible for intention ally inflicted injuries.

Expert witnesses make subrogation recovery possible in many cases. Without them, e-commerce losses are difficult to assess, often resulting in claims which include other relatively intangible damages such as lost personnel time in finding the virus or finding the negligent programming in a product. The Economic Loss Doctrine precludes recovery under tort law for damages to a product that malfunctions and damages itself.

The “negligent misrepresentation” exception to the Economic Loss Doctrine may, in some cases, save the subrogation potential of a claim. If the plaintiff can demonstrate that (1) the defendant is in the business of supplying information for the guidance of others in their business dealings, (2) the defendant provided information that constitutes a misrepresentation, and (3) the defendant supplied the information for guidance in the plaintiffs business dealings, the Economic Loss Doctrine may not apply in some jurisdictions. A computer consultant advising his customers of firewall and other security measures in computer data might qualify under the exception. Purely economic losses on a contract resulting from defeated expectations of a commercial bargain are not likely to survive the limitations of this doctrine. However, where the consult -ant merely advises on (but does not sell) the computer product, or where the consultant both advises on and sells computer products, the critical question will be whether the consultant’s information is an important part of the product. If so, that might qualify under the exception to the Economic Loss Doctrine.

There are many other first-party losses which can trigger valid subrogation claims. For example, an Internet address (a “domain name”) is frequently the subject of infringement claims, as is the taking of copyrighted material from a web site. Privacy of customer information on the web, as well as defamation, redistributed nationwide in the form of “chat rooms” create new liabilities where none existed until recently.

In an effort to expand the use of the Internet and computer facilities in general, Congress has passed a number of new statutes allowing for new causes of action against those who have violated the rights of others in the new media. The Digital Millennium Copyright Act, The Computer Fraud and Abuse Act, and The Federal Trademark Dilution Act, all allow new avenues of recovery for the subrogation professional. In all these instances, careful analysis of both facts of the loss and the policy language can help an insurer pick the right cases in which to pursue valuable subrogation.