Court Opinion

ID: 9496468
Source: CourtListenerOpinion
Date Created: 2023-08-05 16:27:33.665435+00
Date Added: 2024-06-11T17:57:36.050724
License: Public Domain

TRAXLER, Circuit Judge,
dissenting:
Whether computer software should be considered tangible or intangible property is a difficult question that has yet to be definitively answered by the state courts. In my view, however, it is unnecessary to even reach that question, because the allegations of the underlying complaint sufficiently allege damage to the computers themselves, thus bringing the claims against AOL within the scope of the policy’s coverage for claims of “physical damage to tangible property of others.” Accordingly, I respectfully dissent.
I.
States have been considering the question of whether computer software is tangible or intangible property for many years. Most of the cases have arisen in the tax context, with states considering whether computer software is subject to sales tax, ad valorem taxes, and the like. No real consensus view has emerged, although there has perhaps been a somewhat recent shift in the states’ approach to the issue. Most of the earlier cases concluded that computer software is intangible property. See, e.g., James v. TRES Computer Sys., Inc., 642 S.W.2d 847, 348-49 (Mo.1982) (en banc) (concluding that computer software contained on magnetic tapes is not tangible property for purposes of use tax imposed on out-of-state purchases of tangible property); First Nat’l Bank of Springfield v. Department of Revenue, 85 Ill.2d 84, 51 Ill.Dec. 667, 421 N.E.2d 175, 179 (1981) (same); First Nat’l Bank of Fort Worth v. Bullock, 584 S.W.2d 548, 550 (Tex.App.1979) (concluding that computer software is not tangible property for purposes of sales tax); Commerce Union Bank v. Tidwell, 538 S.W.2d 405, 407 (Tenn.1976) (concluding that computer software is not tangible personal property: “What is created and sold here is information, and the magnetic tapes which contain this information are only a method of transmitting these intellectual creations from the originator to the user. It is merely incidental that these intangibles are transmitted by way of a tangible reel of tape.... ”); District of Columbia v. Universal Computer Assocs., Inc., 465 F.2d 615, 618 (D.C.Cir.1972) (concluding that software embodied in punch cards is not tangible property: “It is the information derived by the machine from the cards which stays in the computer, and which is employed repeatedly by the machine when it is used by Universal. What rests in the machine, then, is an intangible — ‘knowledge’ — which can hardly be thought to be subject to a personal property tax.”). In the more recent cases, however, the courts have tended to treat computer software as tangible property. See, e.g., First Data Corp. v. State, 263 Neb. 344, 639 N.W.2d 898, 903-04 (2002) (concluding that computer software is tangible property for purposes of a special sales-tax exemption); Wal-Mart Stores, Inc. v. City of Mobile, 696 So.2d 290, 291 (Ala.1996) (computer *100software is tangible personal property for purposes of tax on gross receipts); South Cent. Bell Tel. Co. v. Barthelemy, 643 So.2d 1240, 1244 (La.1994) (concluding that computer software is “corporeal property” and thus tangible property subject to sales and use tax); Comptroller of the Treasury v. Equitable Trust Co., 296 Md. 459, 464 A.2d 248, 261 (1983) (concluding that computer software is tangible property subject to Maryland’s sales tax: “A meaningful sequence of magnetic impulses cannot float in space.”).*
The relatively few courts to have considered the tangible-intangible question in the context of determining coverage or a duty to defend under a commercial general liability policy have reached differing results. See State Auto Prop. & Cas. Ins. Co. v. Midwest Computers & More, 147 F.Supp.2d 1113, 1116 (W.D.Okla.2001) (“Alone, computer data cannot be touched, held, or sensed by the human mind; it has no physical substance. It is not tangible property.”); American Guarantee & Liab. Ins. Co. v. Ingram Micro, Inc., No. 99-185 TUC ACM, 2000 WL 726789, at *2-*3 (D.Ariz. April 18, 2000) (concluding that computer system that lost stored data and functionality was physically damaged within the meaning of a liability insurance policy); see also Computer Corner, Inc. v. Fireman’s Fund Ins. Co., 132 N.M. 264, 46 P.3d 1264, 1266 (Ct.App.2002) (noting district court’s unappealed ruling that computer data stored on a hard drive is tangible property); Retail Sys. Inc. v. CNA Ins. Cos., 469 N.W.2d 735, 737 (Minn.Ct.App.1991) (concluding that loss of computer tape containing valuable data fell within scope of liability policy covering claims involving physical injury or destruction of tangible property because, in part, “[t]he data on the tape was of permanent value and was integrated completely with the physical property of the tape”).
The question in this case, of course, is how computer software should be characterized under Virginia law. See, e.g., Liberty Mut. Ins. Co. v. Triangle Indus., Inc., 957 F.2d 1153, 1156 (4th Cir.1992) (explaining that “a federal court sitting in diversity has a duty to apply the operative state law as would the highest court of the state in which the suit was brought”). Unfortunately, there is no Virginia law on point, nor have I found any analogous cases that suggest how the Virginia courts would resolve the issue. Given the absence of controlling Virginia law, the lack of consensus among the courts that have considered the issue, and the increasing importance of computers and computer software to every aspect of our daily lives, I would be inclined to certify the issue to the Supreme Court of Virginia if resolution of the question was necessary in this case. See Grattan v. Board of Sch. Comm’rs, 805 F.2d 1160, 1164 (4th Cir.1986) (“A federal court’s certification of a question of state law to that state’s highest court is appropriate when the federal tribunal is required to address a novel issue of local law which is determinative in the case before it.”). As I explain below, however, I do not believe that this case turns on the *101question of whether computer software and data is tangible or intangible property.
II.
Because the issue in this case is whether St. Paul was obligated to provide a defense to AOL, our focus must be on the allegations of the underlying complaint. See Lerner v. General Ins. Co. of America, 219 Va. 101, 245 S.E.2d 249, 251 (1978) (“[A]n insurer’s obligation to defend is broader than its obligation to pay, and arises whenever the complaint alleges facts and circumstances, some of which would, if proved, fall within the risk covered by the policy.”) (emphasis added). An insurer can avoid its duty to defend “[o]nly when it appears clearly the insurer would not be liable under its contract for any judgment based on the allegations.” Parker v. Hartford Fire Ins. Co., 222 Va. 33, 278 S.E.2d 803, 804 (1981) (per curiam) (internal quotation marks and alteration omitted).
The district court believed that the claims against AOL really involved damage not to computer hardware, but to computer software, the “ ‘brains’ of the computer.” America Online, Inc. v. St. Paul Mercury Ins. Co., 207 F.Supp.2d 459, 469 (E.D.Va.2002). Thus, the district court concluded that “[t]he allegations of injury to the computer itself are more properly characterized as a loss of use of the computer.” Id. AOL contends that the district court’s interpretation of the MDL complaint is impermissibly narrow. According to AOL, the complaint, properly read, alleged damage to the computer itself, not just to computer software. Because a computer is tangible property, AOL contends that the allegations of the MDL complaint were sufficient to trigger St. Paul’s duty to defend. I agree with AOL that the allegations of the MDL complaint are sufficient to bring the claims within the scope of the St. Paul policy.
The underlying MDL complaint alleged that when AOL Version 5.0 was installed, it
cause[d] serious injury to [the plaintiffs’] computer system and preexisting software. The default options provided by AOL 5.0 ... modified], add[ed] or altered] over 200 files on the user’s computer system, primarily Windows systems files, many of which are essential components of Windows’ operating and networking systems. The installation of version 5.0 results in a user unknowingly creating multiple versions of the same essential system files, which results in system instability and/or non-operability.
J.A. 145 (emphasis omitted). Throughout the complaint there are allegations - that version 5.0 caused things like “corrupt[ion of] the computer systems,” J.A. 130, “complete operating system failure,” J.A. 161; “system crashes and computer freezes,” J.A. 165; alteration and reconfiguration of the computers, J.A. 165; and “complete system failure.” J.A. 169. Given that the computer itself is, of course, tangible property, I believe that these allegations are sufficient to trigger St. Paul’s duty to defend against claims involving “physical damage to tangible property of others.”
These allegations clearly indicate the MDL plaintiffs’ belief that the installation of version 5.0 caused actual damage to their computer hardware. While the plaintiffs might not have been able to prove that version 5.0 caused physical damage to their computers, the ultimate inability to prove a claim is not relevant to the duty-to-defend inquiry. See Virginia Elec. & Power Co. v. Northbrook Prop. & Cas. Ins. Co., 252 Va. 265, 475 S.E.2d 264, 266 (1996) (“The insurer has the obligation to defend the insured in such circumstances even though the obligation to. pay is not ultimately invoked.... Stated dif*102ferently, the insurer has a duty to defend against risks covered by the policy even though the defense successfully litigates the issue of its lack of obligation to pay the claim.”); cf. Centennial Ins. Co. v. Applied Health Care Sys., Inc., 710 F.2d 1288, 1290 (7th Cir.1983) (concluding that complaint alleging loss of computer data because of malfunctioning “controllers” potentially sought damages within scope of liability policy covering claims for “physical injury to or destruction of tangible property”).
The MDL complaint alleged that AOL version 5.0 caused serious injury to the plaintiffs’ computer systems and hardware by re-writing the code or “instructions” that allowed the computers to operate. As AOL points out, these instructions leave a physical imprint on the computer hard drive. See Brief of Appellant at 11-12 (“Once data is stored in a cell of a hard drive, that cell is physically different from a cell without data, and the physical differences between the two cells can be detected through the use of certain tools. Data stored on a hard drive is visible with the use of a microscope.”): While it may be that version 5.0 merely re-arranged, rather than destroyed, the instructions on the user’s hard drive, that re-arrangement of the instructions changed the physical structure of the computer hardware. And in my opinion, a change in the physical structure of the computer that renders the computer inoperable must be viewed as physical damage to the computer itself.
In one sense, most of what we think of as typical physical damage' to tangible property is merely the re-configuration of parts of that property. Few would dispute that a car with a dented door is physically damaged, but all that has happened is that the metal making up the door has been reconfigured in a way not intended by the manufacturer. The car is still able to function exactly as it did before the unfortunate dent, and another re-configuration of the metal will put the car back into its original condition. But during the time the car door was configured to include a dent, the car was physically damaged. This analogy, of course, is a rough one, and I do not mean to suggest that questions about whether a computer has been physically damaged can necessarily be resolved as easily as the same questions about a car. Nonetheless, this example does help bring home the point that property can be physically damaged even though no part of the property is destroyed and even though it can be fixed by simply putting its parts back in the intended order.
If the MDL complaint is read as potentially stating a claim for physical damage to the computer hardware, as I believe it should be, then the question of whether computer software in the abstract is tangible or intangible simply is not relevant. The policy provides coverage for claims of physical damage to tangible property, not tangible physical damage to tangible property. Therefore, even if, as the district court concluded, computer software is not tangible because it is not “capable of being touched or perceptible to the senses,” America Online, Inc., 207 F.Supp.2d at 467, St. Paul still has a duty to defend because the allegations of the MDL complaint could support the conclusion that the intangible software worked physical damage on the tangible computer hardware. See Parker, 278 S.E.2d at 804 (“We cannot say that Turpin’s pleadings clearly show that any recovery against the Parkers would not have been covered by the insurance policy. While some of the language of the pleadings is couched in terms of intentional trespass[, which would not be covered by the policy], the pleadings, without amendment, could have supported *103a judgment of unintentional trespass[, which would be covered by the policy].”).
In sum, I believe that the MDL complaint includes allegations of physical damage to computers themselves, not just computer software, thus triggering St. Paul’s duty to defend against claims of “physical damage to tangible property.” By construing the MDL complaint to allege damage to computer software and data only, I believe that the district court read the complaint too narrowly. See Fuisz v. Selective Ins. Co. of America, 61 F.3d 238, 242 (4th Cir.1995) (“If a complaint, however ambiguous, may be read as premising liability on alternative grounds, and either ground states liability potentially or arguably covered by the policy, the insured is entitled to a defense.”) (quoting Donnelly v. Transportation Ins. Co., 589 F.2d 761, 767 (4th Cir.1978)). Because I believe that St. Paul had a duty to defend AOL against the allegations asserted in the MDL complaint, I respectfully dissent from the majority’s affirmance of the district court’s order.

 The applicability of the tax cases to the insurance question before this court is less than clear. In the tax arena, courts are typically considering the tax consequences of a particular transaction involving computer software. Such an inquiry involves very specific statutory language and often requires the courts to determine things like the "ultimate object” of the transaction or the "essence of the transaction,” TRES Computer Sys., 642 S.W.2d at 349, issues that do not arise in the contract-based insurance arena. Thus, the fact that computer software has (or has not) been treated as tangible property for taxation purposes does not necessarily mean that software should (or should not) be treated as tangible property for purposes of this insurance dispute.