The United States District Court for the Northern District of California has held that defective computer chips that were incorporated into computer disk drives did not cause “property damage” within the meaning of a commercial general liability policy. ( Atmel Corporation v. St. Paul Fire & Marine Insurance Co. (N.D. Cal. 2006) 430 F.Supp.2d 989)
Facts
Atmel Corporation manufactured and sold allegedly defective computer chips to Seagate Corporation. Seagate incorporated the allegedly defective chips into computer disk drives, and then sold the disk drives to its customers. The defective chips later short circuited, causing the disk drives to fail. The defective chips did not cause any physical damage to the disk drives, but did cause the drives to become inoperable.
As a result of customer complaints, Seagate voluntarily repaired the disk drives which contained the defective computer chips. Customers who returned disk drives to Seagate received either a new drive or a refurbished drive with the Atmel chip replaced.
Seagate sued Atmel, alleging that Atmel’s computer chips were defective and had caused Seagate’s disk drives to fail. Atmel tendered defense of the action to St. Paul Fire & Marine Insurance Company under various commercial general liability policies. However, St. Paul failed to defend Atmel against Seagate’s claims. As a result, Atmel defended the action on its own and ultimately settled the action by agreeing to pay Seagate $5.9 million.
Atmel then sued St. Paul for breach of contract and bad faith arising from St. Paul’s failure to defend and indemnify Atmel in the underlying action. St. Paul moved for partial summary judgment that it had no duty to indemnify Atmel for the $5.9 million Atmel paid in settlement of the underlying action.
Holding
The federal district court, applying California law, granted St. Paul’s motion, holding that St. Paul had no duty to indemnify Atmel for its settlement with Seagate.
The court first held that St. Paul’s failure to defend Atmel in the underlying action did not preclude St. Paul from challenging whether it had a duty to indemnify Atmel. Rather, the court concluded that even if an insurer breaches its duty to defend, the insured still has the burden of proving a right to indemnification under the policy.
Turning to the issue of indemnification, the court noted that the St. Paul policies covered Atmel’s liability for “property damage,” defined as either “physical damage to tangible property of others” or “loss of use of tangible property of others that isn’t physically damaged.” Here, it was undisputed that Atmel had not paid any sums to Seagate for “physical damage” to Seagate’s disk drives. Moreover, according to the court, Atmel had not paid any sums to Seagate for “loss of use” of the disk drives. Rather, Atmel had only paid sums to Seagate for the cost of repairing and replacing drives containing the defective chips. Because there was no “property damage,” St. Paul had no duty to indemnify Atmel for its $5.9 million settlement with Seagate.
Comment
Note that the only issue before the district court was whether the insurer had a duty to indemnify the insured (which depended on whether the underlying settlement was actually covered under the policy). The court specifically did not consider whether the insurer had a duty to defend the insured (which would depend on whether the underlying claims were merely potentially covered). The district court distinguished Anthem Electronics, Inc. v. Pacific Employers Insurance Co. (9th Cir. 2002) 302 F.3d 1049 – an earlier case involving somewhat similar facts – on the ground that Anthem involved an insurer’s duty to defend and on the ground that Anthem involved a claimant who had specifically alleged “loss of use” damages.