Expensive Recalls Can be the Least of the problems created by flawed hardware and software. Protection is available, but elusive, in comprehensive general liability insurance.
As society's reliance on computer technology to perform complex tasks has increased, so has the risk of liability arising from flaws in computer hardware and software products. The recent controversy over Intel's flawed Pentium microprocessor is but one example of such defects; problems may be far more serious than the inconvenience and expense of a product recall. Technology companies should not overlook the protection that liability insurance is intended to afford, and that their insurance carriers promised to provide, nor should they automatically accept their insurer's coverage decisions without making an independent and educated determination of whether a claim is, in fact, covered by their policy.
Further, policyholders should not necessarily expect their insurers to honestly evaluate claims. Instead, insurers often attempt to find ways to deny coverage by taking advantage of the fact that many of their policyholders are unschooled in the complexities of insurance policy interpretation.
Hidden Flaws, Hidden Dangers
The risk of manufacturing a defective product is a common one faced by product manufacturers. Most corporations have prepared for unforeseen liabilities by purchasing comprehensive general liability D CGL D insurance policies. CGL policies are intended to provide broad coverage for liabilities, including those that could not have been anticipated when a particular policy went into effect.The incorporation of a flawed component part into a line of computers may cause millions of dollars in damages if the component part cannot be replaced without damaging other parts of the computer. Design defects in an aircraft engine linked to a deadly crash may be traced to a flaw in a system used to design the engine years before. Discovery of such a flaw may even ground an entire airline's fleet, with resulting severe financial losses. The collapse of an office building or a bridge in an earthquake may be traced to a flaw in a design program used by structural engineers. Discovery of the same flaw may also lead to the closure of other structures.
As plaintiffs' attorneys search for deep pockets in which to impose liability, these types of events may lead to claims against computer hardware or software manufacturers based upon theories of negligence or strict products liability. Claims arising out of products manufactured today may not be raised for years, while claims based on products manufactured in the past may be brought today for the first time, even though the manufacturer had no knowledge of anything wrong with its products.
For example, in the environmental liability context, courts in California and throughout the country have held that costs incurred by policyholders in complying with state and federal environmental laws constitute covered damages under CGL policies, even though these environmental laws may not have been in existence when the policies were written. Similarly, damages imposed upon products manufacturers based upon theories of strict liability are covered under CGL policies issued before the courts adopted strict liability.
Common Business Risks
Most CGL policies contain standard language adopted and approved by insurance industry organizations. Standard form policy language has changed over the years, and coverage may depend upon which version of the standard policy applies to a particular claim. Subtle differences in policy language may mean the difference between coverage or no coverage for a given claim.The standard CGL policy contains several exclusions that attempt to address common business risks. For example, no coverage exists if the only property damage claimed is damage to the product manufactured by the insured. Carriers claim that this type of damage is like a warranty claim and not within the coverage of the policy. Thus, the cost of Intel's flawed Pentium chips would not be covered, but when the damaged product caused damage to a third party's property, there would be coverage.
Recent versions of the standard CGL policy also contain the concept of "impaired property." Impaired property means tangible property other than the insured's product "that cannot be used or is less useful because" it incorporates a product manufactured by the insured "that is known or thought to be defective, deficient, inadequate, or dangerous . . . if such property can be restored to use by the repair, replacement, adjustment, or removal of" the insured's product. The impaired-property exclusion precludes coverage for damage to impaired property or tangible property that has not been "physically injured," if such damage arises out of a defect in the insured's product.
If a flawed chip could not be removed from a particular computer without causing other damage, coverage would not be excluded.
Under the impaired-property exclusion, although an IBM PC may be less useful because it contains a flawed Pentium chip, Intel would not be covered for claims brought by IBM, or purchasers of IBM computers, because the computers could be restored simply by replacing the flawed chip. Damages claimed for the costs of recalling the insured's product or for recalling impaired property also are not covered. Thus, if IBM had recalled PCs containing flawed Pentium chips and then had sought to hold Intel liable for its recall expenses, Intel's liability would not be covered under a standard CGL policy.Damage to Other Property
The presence of so-called business-risk exclusions, however, does not mean that all defective-product claims are excluded. For example, there is at least one gray area associated with the impaired-property exclusion, which can be illustrated by the following hypothetical.Assume a computer manufacturer had a special order for a certain number of Pentium-equipped computers that had to be shipped within two weeks or the manufacturer would lose the sale; the computers could not be sold to other customers. The flawed Pentium chips could not be replaced in time for the order to go out. In this situation, the computers would not be impaired property because replacement of the Pentium chips would not restore the computers to their intended use. Also, the computers would not be considered property that has not been "physically injured," because many courts have recognized the presence of a defective component as a form of physical injury. In this case, Intel would have had a strong argument for coverage in a claim brought by the computer manufacturer.
Also, where the completed product cannot be restored to use simply by replacing the defective component part manufactured by the insured, the impaired-property exclusion does not apply. This occurs in situations where replacing a defective component part requires damaging other parts of a finished product. For example, in Elco Industries Inc. v. Liberty Mutual Insurance Co., 361 N.E.2d 589 (Ill. 1977), coverage was found where the process of repairing defective pins in an engine caused the destruction and replacement of other components in the engine.
In Travelers Insurance Companies v. Penda Corp., 974 F.2d 823 (7th Cir. 1992), the insured manufactured styrene sheets for a printing contractor who intended to use them as display pages in sample books the contractor was to provide for a customer. After the sheets were incorporated into the books, the pages of the sample books containing the sheets yellowed, rendering the books unusable. Claims were brought against the manufacturer of the styrene sheets. Coverage was found for these claims because the books could not be returned to use simply by removing and replacing the styrene sheets.
Under the principles of Elco and Travelers, if a flawed Pentium chip could not be removed from a particular computer without causing other damage, coverage would not be excluded.
Because the business-risk exclusions were intended to preclude coverage for damage to the insured's products or items incorporating the insured's products, coverage exists for claims alleging damage to other property allegedly caused by the use of the insured's defective products. Thus, claims alleging damages arising out of an aircraft engine designed with the use of a flawed computer-software program would be covered, as would claims alleging damages to a bridge designed with a computer containing a flawed microprocessor.
Further, claims alleging bodily injuries linked to a defective product are not excluded by any business-risk exclusion. Thus, claims made by a patient misdiagnosed because of a defective software program would be covered, as would claims brought by individuals injured in a plane crash linked to a defective on-board computer.
Learning from History
Many products liability claims involve damage that occurred years ago, but has only recently been discovered. Accordingly, insurance policies purchased decades ago may provide coverage for claims brought against a policyholder today. It is critical, therefore, for policyholders to locate and archive all insurance policies before any claims are received. Under no circumstances should insurance policies be destroyed pursuant to document-retention procedures. They should be retained forever and kept separately from other documents.Often, extensive searches are required to locate old insurance policies. A wide variety of documents should be reviewed for evidence of old insurance policies. Documents relating to premium payments, insurance department logs or registers, documents from insurance brokers, insurance applications, correspondence files, certificates of insurance and other insurance policies, among other things, should be reviewed to locate old insurance policies. Current or former employees with insurance responsibilities should also be consulted. If the policies themselves cannot be found, the above information can be used as evidence to prove the existence of missing insurance policies and their contents. Thus, insurance coverage can be obtained even if the actual insurance policy cannot be located.
Intel's Pentium microprocessor is but one example of manufacturing defects; problems may be far more serious than the inconvenience and expense of a product recall.
To maximize the potential for coverage under CGL policies, policyholders should give prompt notice of any claims to their insurance carriers. Most CGL policies require timely notice of claims; however, in many jurisdictions, including California, the insurer can enforce a notice provision only if it has suffered actual prejudice from the policyholder's delay in providing notice. And insurers cannot rely on a late-notice defense if they would have denied coverage anyway had they received timely notice.
Despite the difficulties of carriers prevailing on a late-notice defense, policyholders should follow the safest course of action by giving notice to their insurers as soon as possible. Policyholders should also consider contacting experienced coverage counsel to analyze the claim to determine which insurers to put on notice and to deal with the insurers if coverage is denied, as it most often is. In fact, most of the time insurers will automatically deny coverage for products liability claims without having done any investigation into the claim whatsoever. Policyholders cannot rely on their insurers to fairly evaluate their claims, and certainly should not accept any denial of coverage without carefully reviewing their policies in light of the specific claims they are facing.
In addition to paying for judgments and settlements, CGL policies provide security and peace of mind to policyholders by promising to defend claims even if they are "groundless, false or fraudulent." See Horace Mann Insurance Co. v. Barbara B., 4 Cal.4th 1076 (1993). The insurer's duty to defend is separate and much broader than the duty to indemnify. As long as there is the potential for coverage under the policy at the time the defense is tendered to the insurer, the insurer must provide a defense.
Manufacturers are often faced with meritless claims that may not warrant any damages at all. If the claims take the form of class actions or multi-plaintiff suits, the claims may require hundreds of thousands of dollars to defend. Nevertheless, manufacturers must defend themselves against these claims. CGL insurers have agreed for a price to accept the risk that groundless claims will be made against their policyholders and are obligated to provide a defense for such claims. For the policyholders, they have bought peace of mind -- the security of knowing that the defense will be funded if a claim is made.
If a carrier agrees to provide a defense while reserving the right to deny coverage if it later determines that no coverage exists, the policyholder often is entitled to independent counsel, selected by the policyholder and paid for by the insurer. See Cal. Insurance Code 2860. Independent counsel is invaluable because the allegiances of defense counsel regularly selected by insurers often lie with the insurers, rather than with the policyholders whom they are charged with representing.
Analyzing the Policy
When analyzing coverage for a particular claim under the CGL policy, one starts by examining the basic coverage provisions of the policy. Standard CGL policies provide coverage for liabilities arising out of "bodily injury" and "property damage." How these terms are defined in the policy are important in determining coverage. The 1986 standard form policy defines "property damage" as: physical injury to tangible property, including all resulting loss of use of that property; or loss of use of tangible property that is not physically injured.Simply because a claim alleges damages that fall within the definition of property damage does not necessarily mean that the claim is covered by the policy. CGL policies contain a variety of coverage exclusions that may or may not apply to preclude coverage for a given claim. These exclusions tend to be complex in contrast with the policy's broad and seemingly clear grant of coverage.
In addition to the business-risk exclusions discussed above, insurers invariably argue that claims are precluded by the exclusion for bodily injury or property damage expected or intended from the standpoint of the insured. To prove that damage was "expected or intended" in a situation such as that encountered by Intel with the Pentium product, carriers will attempt to contact and interview former employees and disgruntled workers in an attempt to dig up any dirt that they can about their policyholder's operations.
After making a coverage claim, policyholders need to take prompt action by notifying their employees, as well as former employees if feasible, that they may be contacted by the insurance company, that they can refuse to talk to insurance company representatives, and that the company would appreciate immediate notice if they are contacted.
Insurers may even contact the plaintiff's counsel in the underlying litigation in their attempt to obtain information to deny coverage. Indeed, it is not unusual for the carrier to attempt to ferret out information to defeat coverage for their own insured.