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).

BODY:
*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 service cost.
Insurance-Backed Warranties
*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 uninsured loss.
*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.
Patent Insurance
*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 products.
*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.
Coverage Gap
*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 information.
*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 & O insurance.
*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 earnings.
*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 content.