FYI: Ohio Sup Ct Upholds Denial of Coverage for Ransomware Attack Losses

The Ohio Supreme Court recently reversed the decision of an appellate court and reinstated the trial court's grant of summary judgment in favor of an insurer and against an insured company on the company's claim for breach of contract and bad faith denial of insurance coverage relating to damages arising from a ransomware attack.

 

In so ruling, the Ohio Supreme Court held that because a ransomware attack caused no "direct physical loss of or damage to" the company's software —- a requirement for coverage under the policy at issue -— the insurer was not responsible for covering the resulting loss.

 

A copy of the opinion is available at:  Link to Opinion

 

As background, the insured company became the target of a ransomware attack when a hacker illegally gained access to the company's computer systems and encrypted files needed for using its software and database systems.  After looking into the timing and financial feasibility of recovering the files through the assistance of a third-party company, the insured company decided to pay the ransom.

 

At the time of the ransomware attack, the company was insured under a businessowners insurance policy issued by the defendant insurer. Thus, the insured company's general manager contacted the insurer to file an insurance claim within a day of the attack. However, the insurer denied coverage because, among other reasons, there was no "direct physical loss of or damage to 'media'," as defined in the electronic-equipment endorsement in the policy.

 

The policy's electronic-equipment endorsement provided:

 

When a limit of insurance is shown in the Declarations under ELECTRONIC EQUIPMENT, MEDIA, we will pay for direct physical loss of or damage to "media" which you own, which is leased or rented to you or which is in your care, custody or control while located at the premises described in the Declarations. We will pay for your costs to research, replace or restore information on "media" which has incurred direct physical loss or damage by a Covered Cause of Loss. Direct physical loss of or damage to Covered Property must be caused by a Covered Cause of Loss.

 

Furthermore, the electronic-equipment endorsement defined "media" as "materials on which information is recorded such as film, magnetic tape, paper tape, disks, drums, and cards." The definition section further stated that "media" included "computer software and reproduction of data contained on covered media."

 

The insured company filed a lawsuit against the insurer, alleging that the insurer breached the insurance policy by denying coverage under the electronic-equipment endorsement and that the insurer denied coverage in bad faith.

 

The insurer answered the complaint by denying the insured company's legal claims and counterclaimed for a declaratory judgment that "no coverage, payment or indemnity is owed" to the company under the policy. Thereafter, the insurer filed a motion for summary judgment on the insured company's claims and its counterclaim for declaratory judgment.

 

The trial court granted summary judgment to the insurer and explained that the evidence showed that the software and database systems were not damaged by the encryption but that the insured company was prevented from accessing or using those systems because of the ransomware encryption.

 

The insured company appealed the trial court's grant of summary judgment, and the appellate court reversed the trial court's decision. The appellate court determined that the language of the electronic-equipment endorsement potentially applied to the insured company's claim if the company could prove that its media, i.e., its software, was in fact damaged by the encryption. The insurer timely appealed.

 

This appeal turned on the legal interpretation of the electronic-equipment endorsement in the businessowners insurance policy issued by the insurer. The Ohio Supreme Court found the language in the electronic-equipment endorsement to be clear and unambiguous in its requirement that there be direct physical loss of, or direct physical damage to, electronic equipment or media before the endorsement is applicable. Because software is an intangible item that cannot experience direct physical loss or direct physical damage, the Court determined that the endorsement did not apply in this case.

 

The Ohio Supreme Court concluded that the most natural reading of the phrase "direct physical loss of or damage to" was that the company was insured for direct physical loss of its media and insured for direct physical damage to its media. See Ward Gen. Ins. Servs., Inc. v. Emps. Fire Ins. Co., 114 Cal.App.4th 548, 554, 7 Cal.Rptr.3d 844 (2003); see also Santo's Italian Café, L.L.C. v. Acuity Ins. Co., 15 F.4th 398, 402 (6th Cir.2021). Similarly, although the term "computer software" was included within the definition of "media," the Court held that it was included only insofar as the software was "contained on covered media" and that "covered media" means media that has a physical existence.

 

Accordingly, because the insurance policy at issue did not cover the type of loss the insured company experienced, the Ohio Supreme Court held that the insurer did not breach its contract with the company. Therefore, the Court reversed the judgment of the appellate court and reinstated the trial court's grant of summary judgment in favor of the insurer.

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 6^th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

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FYI: 7th Cir Reverses Denial of Bankruptcy Trustee's Action to Recover Money Paid to Debt Collector

In a bankruptcy trustee's adversary action to recover money paid to a collection agency within 90 days prior to the filing of the debtor's bankruptcy petition, and pursuant to a previous garnishment order, the U.S. Court of Appeals for the Seventh Circuit recently reversed the ruling of a trial court denying the trustee's application.

 

In so ruling, Seventh Circuit held that federal rather than state law defines the meaning of a "transfer" under 11 U.S.C. 547(b)(4)(A). The "transfer" occurs when money changes hands.  Here, the Seventh Circuit held, the money at issue changed hands within the 90 days prior to the filing of the debtor's bankruptcy petition, and not previously when the garnishment order was entered.

 

A copy of the opinion is available at:  Link to Opinion

 

As you may recall, bankruptcy trustees can recover some transfers made to outside parties during the 90 days before the debtor files a petition. 11 U.S.C. 547(b)(4)(A). The trustee in a bankruptcy discovered that about $3,700 had been paid to a collection agency during those 90 days under a garnishment order, which was issued by an Indiana state court more than 90 days before the debtor filed his bankruptcy petition. The trustee began an adversary proceeding to recover the $3,700.

 

Relying on In re Coppie, 728 F.2d 951 (7th Cir. 1984), the collection agency argued that the definition of a "transfer" under section 547 depends on state law and that, under Indiana law, a "transfer" occurs when a garnishment order is entered, not when money is paid.

 

The trial court found Coppie controlling and denied the trustee's application. The trial court added that Coppie appeared to be wrongly decided, but wrote that only the Seventh Circuit can overrule its own decisions. The trustee timely appealed.

 

On appeal, the Seventh Circuit did in fact find that Coppie was wrongly decided. The reason was that Barnhill v. Johnson, 503 U.S. 393 (1992) held that federal rather than state law defines the meaning of a "transfer" in §547. A ruling by the Seventh Circuit in 1984 must give way to a decision by the Supreme Court of the United States in 1992.

 

Barnhill arose from a check that was signed and delivered outside the 90-day preference window but negotiated inside that window. The SCOTUS held that the date of the check was irrelevant and that only payment of the check marks a "transfer."

 

Here, the Seventh Circuit reasoned that the rule that the "transfer" occurs when money changes hands is as applicable to garnishment as it is to checks. The check is an instruction to a bank, while the garnishment order is an instruction to an employer. The date of transfer is the time at which the money passes to the creditor's control.

 

As the Seventh Circuit pointed out, this was not the first time that it recognized the effect of Barnhill on the definition of a transfer. Freedom Group, Inc. v. Lapham-Hickey Steel Corp., 50 F.3d 408, 412 (7th Cir. 1995) collected several decisions that did not comport with Barnhill. The Seventh Circuit overruled or disapproved each of them after a circulation to the full court under Circuit Rule 40. Nevertheless, Freedom Group did not include Coppie in its list of defunct rulings, possibly because it was a rarely cited opinion.

 

The collection agency tried to distinguish Barnhill and Freedom Group on the ground that they dealt with dates on which people learned of a transfer order (for example, the date on which a check arrived in the mail) rather than the date the order was made or took effect.

 

However, the Seventh Circuit determined that the rationale of Barnhill did not depend on a payment order's entry versus the date any given person learned of it. Under Barnhill, both dates are irrelevant to the "transfer." Deferred knowledge of a transfer order may affect priority among creditors, if something happened between entry of an order and notice to a person trying to make a secured loan, but only the date of payment matters when defining a transfer under §547.

 

Moreover, the Seventh Circuit decided that Freedom Group did not purport to provide a comprehensive list of all decisions undermined by Barnhill and that it was enough to hold now that Coppie must be treated just as Freedom Group treated similar decisions.

 

Accordingly, the Seventh Circuit concluded that federal law defines a "transfer" and only actual payment counts as a "transfer." Coppie, which held otherwise in both respects, accordingly was overruled, and this case was remanded with instructions to resolve the trustee's claim on the merits.

 

 

 

Ralph T. Wutscher
Maurice Wutscher LLP
The Loop Center Building
105 W. Madison Street, 6^th Floor
Chicago, Illinois 60602
Direct:  (312) 551-9320
Fax: (312) 284-4751

Mobile:  (312) 493-0874
Email: rwutscher@MauriceWutscher.com

 

Admitted to practice law in Illinois

 

 

 

Alabama   |   California   |   Florida   |   Illinois   |   Massachusetts   |   New Jersey   |   New York   |   Ohio   |   Pennsylvania   |   Tennessee   |   Texas   |   Washington, DC

 

 

NOTICE: We do not send unsolicited emails. If you received this email in error, or if you wish to be removed from our update distribution list, please simply reply to this email and state your intention. Thank you.

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