Pennsylvania Superior Court Vacates Judgment for Watchword Worldwide in Breach of Contract and Bad Faith Action Against Erie Insurance

Pennsylvania Superior Court Vacates Judgment for Watchword Worldwide in Breach of Contract and Bad Faith Action Against Erie Insurance

Pennsylvania Superior Court Vacates Judgment for Watchword Worldwide in Breach of Contract and Bad Faith Action Against Erie Insurance

This case of Watchword Worldwide v. Erie Ins. Exchange, 2024 PA Super 2 arises out of a breach of contract and insurance bad faith claim flowing from a loss of videos and other electronic data as a result of a computer hacking incident. Watchword produced, sold, and transmitted videos of the New Testament to its customers’ iPhones through a server owned and operated by GoDaddy, Inc. (GoDaddy), and a server owned and operated by Apple Inc. (Apple). This process required both a mobile application that customers used to order and pay for the videos, and an application programing interface (API) that authenticated the sale and delivered the video. Watchword’s videos and API were stored on the GoDaddy server. The mobile application was on the Apple server. Watchword paid GoDaddy a license fee to use the GoDaddy server.

An unknown hacker had deleted Watchword’s videos and API from the GoDaddy server. Watchword had copies of the videos, and Truefit Solutions (Truefit), Watchword’s consultant had a copy of the API. Watchworld did not determine if the videos and API could have been reinstalled to the GoDaddy server from the copies that Watchworld and Truefit maintained. Instead, Watchword removed the mobile application from Apple’s server to prevent adverse reactions from customers because the mobile application could not work without the videos and API on the GoDaddy server.

At the time that the videos and API were deleted from the GoDaddy server, Watchword was insured by Erie under a property damage and liability insurance policy (the Policy) that included coverage for the reproduction or replacement of electronic data. The Policy provided the following in pertinent part with respect to electronic data coverage:

We will cover the expenses incurred to reproduce or replace your “electronic data” when destruction or corruption is caused by a peril insured against including loss by theft….Coverage is limited to “electronic data” which is owned by you, licensed or leased to you, originates and resides in your computers, and is used in the e-commerce activity of your business.

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…. We will pay for the expenses incurred in the reproduction or replacement of your “electronic data” which is in excess of the deductible amount shown in the “Declarations”.

The Policy had a $2,500 deductible, and excluded from coverage electronic data “which cannot be replaced with the same kind or quality.” Although the Policy contained a coverage limit of $25,000, the Policy contained an endorsement that provided up to a total of $250,000 in coverage for expenses of reproduction or replacement of electronic data, damage to electronic data processing equipment, and a number of other types of business losses.

Watchword filed a claim with Erie for the loss caused by the deletion of its electronic data from the GoDaddy server, however, Erie denied the claim because: (1) the Policy did not cover the loss of the electronic data on the GoDaddy server, and (2) because the cost of replacing the videos on the GoDaddy server from the copies that Watchword was less than the $2,500 deductible.

Therefore, Watchword filed an action for breach of contract against Erie arising out of Erie’s failure to pay its claim for the cost of replacing electronic data, and an insurance bad faith claim against Erie, asserting that Erie had no reasonably basis to deny coverage. At the jury trial on the breach of contract claim, Watchword claimed damages of $168,000, which were based on the cost of creating a new mobile application, upgraded to the standards required by Apple to put it on Apple’s server after the original mobile application had been deleted, and upgrading the videos. Importantly, Watchword admitted at trial that the mobile application on Apple’s server would have worked properly, and would not have had to be removed if Watchword had put the videos and API back on the GoDaddy server from the copies that it had of those items. Watchword also admitted that it did not attempt to have the videos and API put back on the GoDaddy server. Moreover, Truefit’s CEO testified that the cost of having the videos and API put back on the GoDaddy server would have been $1,500 to $2,500, and that the cost of restoring Watchword’s system with the upgrades required by Apple at the time of trial was $10,000 to $20,000. The jury returned a verdict in favor of Watchword, awarding Watchword $18,750 in damages.

The trial court issued its nonjury verdict on the bad faith claim, finding that Erie acted in bad faith because it denied coverage on the ground that the GoDaddy server was not on Watchword’s property, and because Erie relied on Truefit, rather than Watchword, in evaluating what had been deleted from the GoDaddy server. The trial court awarded Watchword $20,000 in punitive damages and $50,000 in attorney fees and costs. The trial court denied both parties’ post-trial motions, and judgment was entered against Erie on the verdicts in the amount of $88,750. Both parties filed timely appeals from this judgment.

The Superior Court determined that the Policy term “your computers,” was ambiguous. Therefore, it was proper for the court to find coverage for Watchworld’s loss. However, the Court determined that Watchworld failed to prove that Erie’s failure to pay Watchword’s claim breached the insurance contract because the evidence at trial showed that the loss did not exceed the Policy’s deductible. More specifically, Watchworld could have reinstalled the videos and API from its existing copies to the mobile application on the Apple server. Furthermore, the Court concluded that the Policy did not cover the cost of upgrading lost or damaged electronic data, as it specifically excluded from coverage electronic data “which cannot be replaced with the same kind or quality.” Finally, the Court determined that Watchworld failed to demonstrate that Erie had no reasonable basis for denying benefits under the Policy.

The case of Watchword Worldwide v. Erie Ins. Exchange, 2024 PA Super 2 can be accessed here.