When is an audit demand not an audit demand?

The Court of Appeals of Ohio, Third Appellate District has had its say in a recent consideration.

Published on 19th October 2016

In its recent decision in Eighth Floor Promotions v. The Cincinnati Ins. Cos., 2016 Ohio App. LEXIS 4119 (Oct. 11, 2016), the Court of Appeals of Ohio, Third Appellate District, had occasion to consider whether an audit demand made by a computer company investigating software licensing violations constituted a “claim” under a directors and officers policy.

Eighth Floor concerned the insured’s right to coverage for a letter issued by the Business Software Alliance – an software industry protection group – concerning Eighth Floor’s alleged illegal duplication of software. The letter warned that Eighth Floor’s actions could be considered copyright infringement for which actual and statutory damages could be awarded. The letter referenced the potential for litigation, but stated as follows:

… [the] BSA member companies have determined that litigation may not be necessary in this case, especially as senior management may not have had an opportunity to investigate or consider the ramifications of using unlicensed software. The BSA member companies instead wish to resolve this matter amicably by providing Eighth Floor with an opportunity to conduct its own company-wide investigation. To take advantage of this opportunity, Eighth Floor’s investigation must include an audit of all of the software published by [the] BSA members … on all of its computers and a review of the software licenses and proofs of purchase for those licenses.

Please understand that while we are contacting you in an effort to avoid litigation, the BSA member companies are not waiving their right to litigate to protect their copyrights if this effort is not successful. …

Eighth Floor gave notice of the letter to its insurer, Cincinnati Insurance, which denied Eighth Floor’s request to retain an attorney to oversee the audit. Cincinnati took the position that the letter did not qualify as a “claim,” defined by the policy as a “written demand for monetary damages or non-monetary relief” or a “civil proceeding commenced by filing a complaint or similar pleading.” Cincinnati nevertheless agreed to treat Eighth Floor’s notice as notice of circumstances in the event a claim of a later claim.

Eighth Floor performed the audit, which revealed several instances of unauthorized duplications. As a result, BSA later wrote again to warn of its statutory rights under copyright law, but offered to settle its claim for certain remedial efforts and a cash payment. This demand was sent to Cincinnati, which denied coverage on the basis of the following policy exclusion applicable to any claim:

Based upon, arising out of, or in consequence of, or in any way involving actual or alleged infringement of copyright, patent, trademark, trade secret, service mark, trade name, or misappropriation of ideas or trade secrets or other intellectual property rights. . .

The Court of Appeals considered Cincinnati’s argument, initially successful on summary judgment at the trial court level, that its policy was not triggered by the initial audit demand letter since the letter was not a written demand for non-monetary relief. Cincinnati argued instead that the letter merely advised of an investigation of potential copyright violations, which if proven, could result in a demand for monetary or non-monetary relief.

The court rejected this reasoning, noting that BSA’s letter made plain that it considered Eighth Floor to have committed copyright infringement already and that the requested investigation was to determine the extent rather than the existence of violations. As such, explained the court, the letter had to be read as a demand for relief:

… although the audit request gave Eighth Floor the “opportunity” to conduct a company-wide software audit, it implied that if Eighth Floor did not take up this “opportunity,” then the matter would proceed to litigation, where the BSA could have achieved the same result. … These measures were the BSA’s “means of enforcing a right” and “preventing a wrong” within the plain and ordinary meaning of “remedy.”

While the court agreed that the letter qualified as a claim, as defined by the Cincinnati policy, it also agreed that the copyright exclusion applied, at least with respect to the settlement demand made by BSA, which was predicated on copyright infringements. Since the trial court did not address whether the exclusion also applied to the initial audit letter, the matter was remanded solely with respect to that question.

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