Federal Court In North Carolina Holds Damage To Software Is Not Covered Property Damage

A federal court in North Carolina held that claims in an underlying lawsuit stemming from alleged unauthorized access to and copying of proprietary software were not covered by the underlying insured defendant’s commercial general liability policy because, among other deficiencies in the insured’s position, damage to software was not property damage under the terms of the policy. Nautilus Ins. Co. v. Philips Med. Sys. Nederland B.V., No. 3:20-CV-00571-GCM, 2021 U.S. Dist. LEXIS 129778 (W.D.N.C. July 13, 2021).

The underlying plaintiff alleged that the insured misappropriated trade secrets to gain unauthorized access to and make unauthorized copies of the plaintiff’s proprietary, copyrighted medical-imaging software, and that the insured further decrypted and made unauthorized copies of copyrighted software service documentation on its systems. The plaintiff further asserted that the compromised and copied software and documentation was used by the insured to unfairly compete against the plaintiff. Based on these and other related allegations, the plaintiff asserted various claims against the insured and other defendants in the underlying litigation, including violation of the Computer Fraud and Abuse Act, misappropriation of trade secrets and copyright infringement. During the pendency of the underlying action, the insurer filed a declaratory judgment action and moved for summary judgment on whether it had a duty to defend the insured.

The court noted that in addition to defining “property damage” as “physical damage to tangible property,” the policy further provided that “electronic data is not tangible property.” The court reasoned that damage exclusively to software could not therefore constitute property damage. Despite arguments by the insured pointing to allegations in the underlying complaint alleging damage to “proprietary software on the systems,” the court observed that there were, in fact, no allegations of damage to the hardware of any computer system—what it deemed to be the tangible elements of a computer. Thus, the court concluded that there was no allegation of property damage in the complaint. Based on this, and analysis of several other relevant provisions and exclusions in the policy, the court concluded that the insurer had no duty to defend and granted summary judgment for the insurer.

Phelps represented the insurer. For more information on the holding, please contact Kevin O’Brien in the firm’s Raleigh office at: kevin.o’brien@phelps.com.