Is software failure considered material damage under machinery breakdown coverage?

Modern methods of construction (MMC) increasingly requires integration of new technologies in construction processes and management, providing more efficiency, less contamination, more manageable data, and a wider scope of control on construction systems solutions and products.

New solutions provide improvements to design and construction stages, but also assume the acceptance of new risks arising from the implementation of new technologies, diversifying tasks and procedures. IA, software solutions, digital tools, new materials and alternative supply chains, are definitively defining a new framework for the construction sector.

Consequently, coverage disputes relating to new risks and commercial disputes on contractual issues are expected to grow, as implementation of MMC is challenging traditional risk assessment methods and requires new approaches for understanding how they fit in traditional legal solutions.

The recent Court decision nº 208/2020 dated 26 May 2020 analysed below from the Valencia Court of Appeal (Section 11) provides an example of such coverage issues and legal implications that arise while the dispute itself refers to new technology issues.

Court decision

The factual background of the case was the following. A company had in place two policies covering business and industrial risks. An industrial folding machine of its facilities stopped working due to an internal failure. The insured company claimed against the insurer requesting coverage under machinery breakdown provisions.

The machinery breakdown was caused by a software failure; and there was no possibility for reloading the program or resetting the software. Expert evidence stated that replacement of the software was the only way forward, and that the loss was due to internal failure or the handling of the machine's automaton that had produced the deletion.

The insured had a maintenance contract for the machine, but it did not include specific maintenance for the software. The company insured had in place two policies providing coverage for industrial activity (Wording One) and business activity (Wording Two). The main requirements under both policies were:

Coverage was provided for machinery breakdown (damages and material losses suffered by the machine), and the “material damage” definition was provided as “deterioration, destruction or disappearance of the insured assets”.
Policy (particular conditions) required a maintenance contract in place with the manufacturer, the supplier or a qualified expert. There was no other specification under the policy on maintenance requirements for fulfilling the coverage provisions.

The two main questions were (i) if the software loss should be considered “material damage”, and therefore whether it was covered under machinery breakdown provisions, and (ii) whether the possible lack of maintenance suggested that the loss was not “sudden and unforeseen”.

The first instance court dismissed the claim concluding that the loss of software was not covered because a loss of software cannot be considered as material damage. The court ruled that, although it implies a loss of utility, it cannot be considered as a material damage to the machine that is the consequence of a sudden, unforeseen and foreign event (definition of loss)”.

The Appeal Court (Audiencia Provincial) overruled this decision, stating that:

Software failure should be considered material damage under the wording provisions, as part of the machine and therefore “regardless of the cause by which it does not work, its impossibility of repair forced its replacement, just as it would have happened if there was another damaged component”
The maintenance contract in place is considered sufficient as there was no specific provision in the policy about the extent required for this maintenance
Considerations are made on the validity of insurance wording clauses under Spanish law. Valid clauses limiting the rights of the insured are those that are (i) clearly drafted; (ii) highlighted in bold text; and (iii) expressly accepted by the insured
Punitive interest, following the Spanish Insurance Contract Act, are imposed upon the insurer (rate of legal interest plus 50% for the first two years since the loss, and flat rate of 20% for the following year).

Comment

Implementation of new technology solutions to construction processes (as IA solutions, software applications and BIM) may give rise to new risks that require new approaches when assessing risks or providing evidence on coverage disputes.

The terms under policy wordings should be carefully considered and eventually reviewed or redrafted as traditional wordings or provisions may be insufficiently updated for MMC and new technologies.

When facing court or arbitration disputes in Spain, expert reports clarifying technical issues linked to wording provisions are required for providing assistance to the court as non-specialised Spanish courts are unfamiliar with these technical issues.

Related items: