Insuring tangible property: as trade secret theft becomes a greater risk, trade secret coverage becomes a bigger concern. (Loss/Risk Management Insight: Property/Casualty).

A recent decision from the United States Circuit Court of Appeals for the 9th Circuit, Avery Dennison Corp vs. Allendale Mutual Insurance Co., is the rare instance in which a decision involves significant insurance law, news and human interest. The 9th Circuit explored what "tangible property" is within the meaning of an insurance policy. Surprisingly, the appellate court did not present any facts and the lower court's decision was not reported in the standard sources. I became curious and ordered a copy of the decision.

My investigative efforts were rewarded. The lower court detailed the facts and they were increasing. The decision involved Dr. Tenhong (Victor) Lee, a man involved in a case concerning the Espionage Act (not to be confused with the controversial and widely reported espionage case against Dr. Wen Ho Lee that was eventually dropped to a much lower charge). In the Avery litigation that arose from Dr. Tenhong Lee's acts, the lower court wrote that Avery employed Dr. Lee as a research scientist. The court also wrote that Dr. Lee sold Avery's trade secrets to a Taiwanese company. Avery sought coverage from Allendale for losses allegedly caused by Dr. Lee's conduct.

Allendale had insured Avery for losses related to its employees' criminal misconduct. The insurance policy applied to "losses of 'money,' 'securities,' and 'property other than money and securities.'" The policy defined "property other than money and securities" to mean "any tangible property." The question then became: are trade secrets "tangible" property?

The policyholder argued that its loss involved tangible property in part because its trade secrets are recorded on tangible materials.

Both the trial court and the appellate court rejected the policyholder's argument and found for the insurance carrier. The 9th Circuit applied a common-sense approach. The court looked at the "plain meaning" associated with "tangible property." It cited the Black's Law Dictionary definition of tangible property. The court found that "'tangible property' refers to things that can be touched, seen and smelled." Tangible was found to be unambiguous. Thus, the court held that trade secrets are not "tangible property" and trade secrets are not covered.

The Avery decision is important on many levels.

Trade secret disputes have become more frequent. Twenty years ago, stealing a trade secret would often involve taking a compendium of documents. The act was more difficult. Now, the information that might have required volumes of books can be recorded on a disk, something easily taken and removed. With trade-secret theft becoming a bigger risk, trade-secret coverage becomes a bigger concern.

The Avery decision also affects other issues concerning computers. Courts have wrestled with the question of whether computer data is "tangible." This issue is not limited to circumstances involving nefarious activity. Computer data can be destroyed through many means besides theft or mischief. Computer failure, human error, power loss, fire and many other circumstances can cause computer data to be destroyed. The data is often valuable. But, is the data loss covered?

In the computer context, the Avery decision is a significant victory for insurance carriers. Claims for lost data will often involve insurance policies that are limited to "tangible" property. The Avery approach--a plain meaning view of tangible--strongly suggests that computer data is not tangible. Computer data cannot meet the Avery court's test in that it cannot be "touched, seen, and smelled."

Before Avery, courts had reached different conclusions on computer data. I examined this topic in my October 2000 column. At that time, the U.S. District Court for the District of Arizona was the only court to address this issue in the decision of American Guarantee and Liability Insurance Co. vs. Ingram Micro Inc. There, the court accepted a policyholder's argument that computer data is covered "property damage" because computer data is significant. In November 2002, I revisited this issue because the U.S. District Court for the Eastern District of Virginia had written the case of America Online Inc. vs. St. Paul Mercury Insurance Co., rejecting Ingram Micro, and finding for the insurance carrier through a plain meaning approach similar to the Avery court.

Importantly, while America Online and Ingram Micro were noteworthy decisions, both involved federal district courts. Avery, however, is a decision from a higher court, the federal circuit court of appeals.

Avery is a significant precedent. Although the decision involves unusual circumstances, it may apply to common circumstances as well.

Alan S. Rutkin, a Best's Review columnist, is a partner in Rivkin Radler LLP, Uniondale, N.Y. He can be reached at [e-mail].