New Jersey Law Journal,
May 28, 2001
Copyright 2001 American Lawyer Newspapers Group, Inc.
New Jersey Law Journal
May 28, 2001
LENGTH: 2828 words
HEADLINE: The use of insurance contracts to supplement e-transaction
agreements allows e-commerce participants to rely on third parties in
the event signatories to an original agreement cannot perform. Internet
Law Using Insurance To Manage Internet Law Risks
BYLINE: JONATHAN BICK
THE AUTHOR IS AN ADJUNCT PROFESSOR OF LAW AT RUTGERS LAW SCHOOL AND
PACE LAW SCHOOL. HE IS THE AUTHOR OF 101 THINGS YOU NEED TO KNOW ABOUT
INTERNET LAW (RANDOM HOUSE 12/00).
*Due to the rapidly changing nature of the Internet, some contracts
cannot be executed in a timely manner -- or at all if there is a bankruptcy.
Consequently, means other than contracts and statutes must be relied
on to ensure that e-commerce participants get the benefit of their bargains.
The use of insurance contracts to supplement e-transaction agreements
allows e- commerce participants to rely on third parties in the event
signatories to an original agreement cannot perform.
*Typical technology company sales people will promise a customer that
he will achieve great savings and increased efficiency by adopting the
company's services. At the same time the company's sales contract contains
disclaimers and limitations of liability designed to absolve the company
of responsibility in the event of the failure of it goods or services
to perform as advertised.
*For e-commerce businesses, civil actions may be too costly and time-
consuming to rely on. Also, the fact that courts and juries are still
not completely comfortable with e-commerce raises the inherent risk
of losing such actions. Thus, alternative risk management actions should
be used. Specifically, attorneys should advise their clients that Internet-related
performance insurance would be prudent.
*The novelty of the Internet often veils existing risks. For example,
few have been advised that parents are generally not legally liable
for their children's bad acts on the Internet. Since suits against children
do not normally compensate plaintiffs, means other than contracts and
statutes should be used to manage this type of difficulty. In particular,
attorneys should instruct their clients to consider using insurance
to ameliorate harm caused by children.
*It should be noted that warranties are not insurance policies. To be
more specific, insurance covers fortuitous risks whereas warranties
cover risks reasonably associated with an underlying service agreement.
Since the Internet is so new, many legal risks are not reasonably associated
with an underlying service. Consequently, e-commerce firms are ill-advised
to rely on contractual warranties for e-service levels, for example.
Rather, such firms should identify the need to maintain specified e-service
levels and insure against adverse risks.
*In the decades since the U.S. Supreme Court's consideration of informational
privacy in Whalen v. Roe 429 U.S. 589 (1977) (holding that a New York
statute requiring the state to obtain and record in a centralized computer
system the name, address and age of persons who obtain prescriptions
for certain dangerous drugs does not invade privacy rights under the
14th Amendment), Americans have found their video rental records are
better protected by law than their medical records. Thus, it would not
be wise to depend on any form of warranty to protect an e-business from
privacy suits. Rather e-businesses should be advised to secure insurance
protection against such risks.
*In addition to an e-business buying insurance directly, many e-business
risks may be ameliorated by ensuring that an e-business require its
service providers to have contractual liability insurance. This would
also allow the service provider to transfer the risk of warranty-related
losses to a third- party insurer for a fixed cost. Usually the cost
of such insurance is between 1 percent and 3 percent of the underlying
*Among the most innovative combinations of traditional contracts and
insurance contracts that successful e-commerce firms have used is known
as insurance-backed warranties. Insurance-backed warranty programs shift
the risk from the customer to the insurer by employing two contracts.
The first is a standard contract containing appropriate warranties between
the Internet service provider and the Internet customer. The second
is a standard insurance contract between the Internet service provider
and an insurer.
*To be more specific, the Internet customer provides a fee to the Internet
service provider in exchange for services and a warranty; the Internet
service provider pays an insurer a premium in exchange for liability
insurance that covers the warranties. In this instance, the supporting
insurance program should be set up to mirror precisely the terms of
the underlying warranties. Any divergence between the terms of the insurance
policy and the terms of the warranties, and any breach of the reporting
requirements under the policy, may leave the service provider with an
*The use of insurance-backed warranties has additional benefits. First,
the use of an insurance-backed warranty program demonstrates that the
service provider has done its due diligence. Second, potential customers
will be more likely to accept the service provider's claims because
it is well-known that insurers are not willing to support a warranty
program without sufficient examination.
*A variation of the insurance-backed warranty is for a service provider
to purchase insurance on behalf of registered users on a blanket basis.
Under such a program, the insurer will be directly liable to the customer
in the event of a claim.
Errors and Omissions
*E-commerce both creates and exploits intellectual property that cannot
be patented. Improper use of intellectual property by e-businesses has
caused many such businesses to be forced out of business. Therefore,
e-businesses should purchase insurance policies specifically designed
to cover the types of risks they face in this area. These insurance
policies are typically called "errors and omissions" policies.
*Errors and omissions policies generally ensure against liability for
the dissemination of any portion of an insured's creative works, as
well as the dissemination of advertising for those works. Also, they
generally cover only the works specified on the insured's application,
not the insured's business as a whole.
*Normally, E & O policies cover liability arising out of copyright
infringement; trademark infringement; misappropriation of ideas, titles
or other items not covered by copyright; breach of an implied contract
stemming from the alleged use of the submission of an idea or other
material; defamation of a person or organization, including libel, slander,
product disparagement, trade libel and infliction of emotional distress;
and violation of rights of privacy and publicity. Errors and omissions
insurance usually pays for litigation defense expenses, damages awarded,
settlement payments and pre-judgment interest.
*Errors and omissions policies do not cover patent infringement, false
advertising and liability arising out of an express breach of contract
(such as a failure to pay license fees). The polices do not extend to
willful infringement or antitrust claims. The cost of defending against
a claim for an injunction, however, usually is covered. Should an injunction
issue, wasted advertising and promotional expenses may also be covered,
but the insured's economic loss resulting from an injunction, including
production costs and lost opportunity costs, are not typically covered.
It should be noted that policies vary, and since wasted advertising
and promotional expenses are first-party losses, many E & O policies
do not cover them.
*The amount of the deductible is directly related to the cost of the
E & O policy. Normally such coverage for $1 million to $5 million
can be purchased for less than $10,000.
*Patents have also played a large part in e-commerce. Patent insurance
policies have regularly saved dot-com firms from being forced out of
business. Coinciding with the explosion of business process patents,
the past several years has seen a significant increase in patent litigation.
Most major insurance companies have recognized this business risk and
have offered their clients separate insurance policies covering losses
due to patent infringement. These policies typically cover patent infringement
resulting from the use, distribution, sale and advertising of the insured's
*Similar to E & O policies, patent insurance policies cover liability
for defense, damage awards, settlement payments and prejudgment interest.
As in the case of E & O policies, payments in each of these areas
are counted against the total amount of the coverage. Thus, the amount
of the indemnity remaining to pay damages will be reduced by the cost
of an unsuccessful defense. This fact is very important in the case
of patent litigation cases because patent infringement suits normally
are more expensive than copyright and trademark suits, thereby leaving
less coverage to satisfy a judgment.
*Patent insurance usually costs about $3,000 annually for each patent
insured. Insurance providers who specialize in this field usually will
reduce the premium cost for each patent if the insured buys patent insurance
for more than 10 patents simultaneously.
Commercial General Liability
*Like most businesses, many e-commerce firms have a Commercial General
Liability policy. A CGL insures against a wide variety of risks, primarily
bodily injury and damage to physical property.
*The industrywide standard CGL policy is written by an insurance industry
organization called the Insurance Services Office. Though patent infringement
is not covered, the federal District Courts located in the state of
New York have found that copyright infringement, trademark infringement
and actions related to trademark infringement -- such as trade dress
or trade name infringement -- are covered by a provision in the CGL
policy providing coverage for "advertising injury."
*Advertising injury is defined as "arising out of an offense committed
during the policy period in the course of the named insured's advertising
activities, if such injury arises out of libel, slander, defamation,
violation of right of privacy, piracy, unfair competition, or infringement
of copyright, title or slogan."
*To receive coverage under the advertising injury provisions of the
CGL, the insured must show (1) that the injury complained of was committed
in the course of the insured's advertising activities during the policy
period and (2) that the offense is one of those enumerated, and not
excluded, in the policy. The extension of coverage seen in recent decisions
hinges largely on an expanded construction of what constitutes injury
committed "in the course of advertising."
*Typical insurance law requires that the scope of a policy be determined
by the insured's reasonable expectations. As the Internet became more
and more mainstream, it is easy to believe that when insureds purchased
their CGL policies, they thought they were getting protection for intellectual
property and, hence, Internet-related harms. On a cautionary note, however,
insurance law varies from state to state. The reasonable expectations
doctrine is not universally accepted, although it is the law in New
Jersey and some other states.
*It should be noted that as a result of American Guarantee & Liability
Insurance Company v. Ingram Micro, Inc. No. Civ 99-185 TUC ACM, United
States District Court for the District of Arizona, 2000 U.S. Dist. Lexis
7298, Feb. 18, 2000, the insurance ISO forms for commercial general
liability are going to change effective Oct. 1, 2001. In American Guarantee,
the court found that the defendant's loss was covered by an insurance
policy because it suffered physical damage when a power outage caused
an interruption of its business and required the reprogramming of computers.
*Many traditional businesses correctly conclude that their traditional
insurance covers them completely; however, this is not generally true
for e- commerce businesses. For example: Errors and Omissions insurance
usually excludes coverage for computer breaches of security; some CGL
policies will exclude liability for advertising injury unless you are
in the business of advertising; and property insurance policies are
triggered by "physical damage" but not unauthorized use of
*Due to this coverage gap, specialized insurance coverage exists for
internet service providers, such as America Online and various other
companies -- a portion of whose business is to provide connection to
the Internet. These businesses face a host of specialized liability
and vicarious liability issues, such as liability for the dissemination
of computer viruses.
*Generally speaking, it doesn't matter to if the content is print, broadcast
or Internet, it is still just another means of expression. Errors and
omissions insurance policies that are marketed for the Internet resemble
those previously in use. It should be noted that some Internet E&O
policies are somewhat broader. For example, an Internet policy will
likely expand its definition of covered "matter" to include
"printed, verbal, numerical, audio or visual expression or any
other form of expression."
*There are, however, several potential risk management pitfalls unique
to the Internet. The Internet by its very nature is global. Thus, an
insurance policy covering an e-commerce business in the United States
alone is inadequate.
*Traditional businesses, which have not been intellectual property users,
use intellectual property when they participate in e-commerce. Since
such businesses must obtain licenses for the use of software, music
and visual materials on other Web sites, they need to obtain E &
*When a traditional business offers Internet service, it will also increase
its Internet-related risks. For example, when "chat room"
services are offered, traditional companies will face unique problems
that cannot be easily resolved by contracts or existing statutes. By
maintaining a chat room, a business suddenly may be considered to function
as a publisher, depending on the amount of control the business exercises
over its room. In this way, a business could become liable for violations
of the right to privacy and for defamation committed in its chat rooms.
*Intellectual property rights make up most of an e-commerce firm's assets.
The protection of such rights is tantamount to the protection of an
e-entity. One of the consequences of this reality is the need to be
able to afford to litigate. The cost of litigation is so high that many
businesses simply cannot afford the expense of bringing an infringement
suit, even if attorneys' fees may be recovered in the end.
*This problem is exacerbated by the fact that many significant Internet
innovations are developed by smaller e-businesses lacking the financial
resources to sue larger companies that are likely to defend vigorously.
In response to this problem, some insurance policies provide funding
for plaintiffs' litigation against intellectual property infringers.
*Such a policy normally will cover 80 percent of the insured's cost
of prosecuting an infringement action and any costs incurred in defending
against a counterclaim based on the invalidity of the insured's patent,
trademark or copyright.
*The cost of $1 million to $3 million in the aggregate coverage of 10
patents is about $15,000 per year. Also, such "offensive"
insurance is not available in the state of New York because such policies
were not authorized under New York State Insurance Law '1113(a).
*Some companies offer "Patent Infringement Defense Cost Reimbursement
Insurance." This insurance is designed to cover only the cost of
defending a patent infringement lawsuit in the United States. Normally,
such policies do not cover judgment or settlement liability. The size
of the premiums is usually about 4 percent of the policy. So a $20,000
a year premium will pay for a $500,000 policy.
*Insurance also exists to cover risks other than disputes. Intellectual
property net loss insurance is one example. To be specific, a content
provider can negotiate a multimillion dollar insurance policy to protect
a portion of its investment in a set of content to be made available
by certain Web sites. This policy is designed to ensure a certain amount
of the content provider's risk, thus reducing the volatility of its
*It is understandable why content providers would want to moderate their
earnings swings by offsetting some risk in exchange for a fixed stream
of payments. It is particularly desirable to Internet content providers
because only one in seven of the sites that use the content is likely
to earn a profit. More insurance policies of this type are written for
a substantial amount of content. It is more feasible to insure all of
a content providers' content, rather than individual content, because
the insurer's risk is more broadly distributed among numerous sets of