Mansell, Engel & Cole

Is computer damage from ransomware a direct physical loss?

If your policy requires a "direct physical loss" before a claim will be paid, you will be interested in a recent decision by a federal court in another state. Although the ruling would only be used as persuasive authority, not precedent, in Oklahoma, federal judges here would be likely to see the argument as quite persuasive.

The situation involved a company called National Ink & Stitch, which does screen printing and embroidery. The company suffered a ransomware attack in December 2016 and made a claim against its insurance policy through State Auto Property and Casualty Insurance Co. The claim sought replacement of a computer server that had been damaged, and perhaps permanently compromised in the attack.

In the ransomware attack, hackers had demanded a certain amount of ransom in Bitcoin in order to remove malware that had been installed on the server. National Ink paid the ransom, but the system was still compromised.

Some files could still not be accessed, and new protective measures had to be installed that slowed everything down. Computer experts said that the problem was likely dormant remnants of the malware.

This left National Ink with a choice. They could either wipe their entire system and reinstall all their software and re-upload all their data, or they could purchase a new server setup.

State Auto denied the claim. Although the policy did cover "electronic media and records (including software), the insurer argued that National Ink had not suffered a "direct physical loss of or damage to" the computer server, as was required before the policy would pay out. Instead, State Auto said that National Ink had only lost data, which is intangible.

National Ink asked the federal judge to rule in its favor on summary judgment, or before trial. In order to do so, the judge would have to find that State Auto had no legitimate defense to the claim, even considering everything from its point of view.

The judge did rule for National Ink on summary judgment after finding that other courts had already addressed the question of whether loss of data constituted a "physical loss." He cited rulings from the Texas Court of Appeal and the U.S. Court of Appeals for the Fourth Circuit.

"Indeed, a computer stores information by the rearrangement of the atoms or molecules of a disc or tape to effect the formation of a particular order of magnetic impulses, and a meaningful sequence of magnetic impulses cannot float in space," the judge wrote, citing the Fourth Circuit.

In other words, data is, in fact, physical.

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