(Article from Insurance Law Alert, October 2024)
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Holding
The Pennsylvania Supreme Court declined to accept an appeal in a cyber-related coverage dispute, leaving intact an intermediate court ruling that vacated a jury verdict in favor of the policyholder and entered judgment in the insurer’s favor. Watchword Worldwide v. Erie Ins. Exchange, 2024 Pa. LEXIS 1505 (Oct. 10, 2024).
Background
Watchword produces videos of the New Testament of the Bible and sells those videos to customers’ iPhones through servers owned and operated by GoDaddy, Inc. and Apple Inc. The process utilizes a mobile application that customers use to pay for the videos, as well as an application programming interface (“API”) that authenticates the sale and delivers the video. Watchword paid GoDaddy a fee to use its server to store the videos and API.
In 2017, a hacker deleted Watchword’s videos and API from the GoDaddy server. Thereafter, Watchword removed the mobile application from Apple’s server to “prevent adverse reactions from customers” and because the mobile application could not work without the videos and API. Watchword then filed a claim with Erie for the loss caused by the deletion of its electronic data from the GoDaddy server. Erie denied coverage, arguing that the loss was not covered because the electronic data that was destroyed was not on Watchword’s computers. The operative coverage provision in Erie’s policy stated that coverage “is limited to ‘electronic data’ which is owned by you, licensed or leased to you, [or] originates and resides in your computers.”
In jury trial, a verdict was entered in Watchword’s favor. The court also entered a non-jury verdict in favor of Watchword on its bad faith claim and issued a punitive damage award. The court denied all of Erie’s post-trial motions.
Decision
An intermediate appellate court vacated the judgements and ruled that Erie was entitled to judgment as a matter of law on both the breach of contract and bad faith claims.
Addressing this matter of first impression under Pennsylvania law, the court ruled that the phrase “your computers” was ambiguous. More specifically, the court explained that “your computers” could be construed to mean only Watchword’s own computers, or conversely, to include computers operated by third parties that Watchword used pursuant to a lease or license. Construing this ambiguity in favor of coverage, the court held that the policy provided coverage for Watchword’s electronic data that was stored on the GoDaddy server. As such, the appellate court ruled that Erie was not entitled to a judgment notwithstanding the verdict as to the coverage issue.
However, the appellate court ruled that Watchword failed to prove that Erie’s failure to pay breached the contract because the evidence at trial revealed that the loss did not exceed the policy’s deductible. The evidence indicated that the cost of replacing the deleted electronic data was less than $2,500, the deductible amount. The court held that the amounts Watchword incurred above the deductible—expenses to replace and upgrade the mobile application on the Apple server—could were not necessary expenditures since Watchword had copies of the videos and API on its own computers, and in any event, were expressly excluded by another provision in the policy.
The appellate court also ruled in Erie’s favor on the bad faith issue. The court explained that Watchword failed to establish that Erie had no reasonable basis for denying coverage, even if its coverage denial was ultimately deemed erroneous.
This month, the Supreme Court of Pennsylvania denied Watchword’s petition for appeal.
Comments
The decision highlights the importance of policy language in cyber-related coverage disputes that require interpretation of terms to novel factual scenarios. Given the frequency with which electronic data is shared among entities through various contractual arrangements in the regular course of business, the parameters of policy phrases such as “resides in your computers” are of paramount importance.