Appellate court rules insurer had duty to defend

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Key website source code and proprietary computer systems that took years to create are at the heart of an insurance coverage decision recently handed down by the 2nd District Court of Appeals in Air Engineering Inc. v. Industrial Air Power LLC et al., 2012 AP 103.

At the core of this high-tech appellate conundrum is whether the trial court properly allowed the defendants’ insurer, Acuity Insurance, to deny policy coverage to defendants charged with “willfully and wantonly” causing advertising injury, misappropriating trade secrets, conspiracy , and other allegations.

In reversing the trial court decision, the appellate court found that it was the intervenor insurance company’s duty to defend and indemnify Industrial Air Power and two other defendants covered under its commercial general liability policy.

“An insurance company has a duty to defend,” said the court, “when allegations, if proven, give rise to the possibility of recovery under terms of the policy.”

In its almost 50 years buying and selling compressor replacement parts and related products, Air Engineering allegedly took great pains to keep its proprietary systems and source codes confidential.

Part of this information included a product purchasing system, which enabled customers to see AEI’s array of available compressor parts and prices, and an internet advertising system.

The multifaceted Internet advertising tool allowed AEI to:

1) identify Internet search terms used by potential customers looking for compressor replacement parts;
2) recognize and buy those Internet domain names that might be listed first in searches;
3) design and position ads on Google that appear when certain Internet search terms are used; and
4) build websites based on those domain names.

Such an Internet mechanism was “essential to Air Engineering’s success and profitability,” according to court documents, and gave AEI a competitive advantage over its competitors.

Defendants Industrial Air and its employees Christopher Klemz and Matthew Kraus allegedly took sensitive website source code and proprietary systems from AEI in 2008 and 2009, while Klemz and Kraus were still employed by AEI.

It was undisputed that, as employees, Klemz and Kraus had access to extensive AEI proprietary information. AEI’s six-count complaint also accused the two of registering a website name for and incorporating Industrial Air while still employed at AEI, just before starting work for the company in late 2008 and 2009.

AEI contended that much of the content and website source codes for Industrial Air were “identical” to AEI’s website. The Industrial Air offered product lines also were similar, but reduced by five percent.

According to court documents, AEI started to feel the results of the issue financially. Two longstanding customers of AEI stopped buying parts and instead purchased those same parts cheaper from Industrial Air.

The only way for Industrial Air to offer a similar line of products at lower prices, according to AEI, was to use information wrongly obtained from the proprietary systems, and know the website source codes.

Acuity had asked the trial court for a declaratory judgment on its insurance coverage based on a variety of reasons. Among them was Acuity’s exclusionary clause for acts where an insured knew he or she was committing wrongful acts.

The trial court granted Acuity’s declaratory judgment, and Industrial Air, Klemz and Kraus appealed. Industrial Air was represented by Schott, Bublitz & Engel SC, Brookfield. Acuity was represented by Simpson & Deardorff SC, Milwaukee.

According to the court, for cases where a duty to defend is involved, the court must first look to and compare the “allegations in the complaint with the terms of the [insurance] policy” and need not look outside the four corners of the complaint.

IAP, Klemz and Kraus do not have to conclusively show that insurer coverage is appropriate, the appellate court said. Those allegations only need rise to the level of a “possibility” of recovery in order to trigger coverage. Additionally, policy coverage for just one claim need only be shown to compel Acuity coverage for the entire defense.

The court agreed that, for Acuity coverage to apply, three questions needed to be asked. First, did the complaint allege a covered offense, under the insurance company’s advertising injury section? Second, did the complaint allege that the defendant engaged in advertising activity? And third, does the complaint allege a causal connection between AEI’s alleged injury and Industrial Air’s advertising activity?

After reviewing these factors, the appellate court stated that coverage was appropriate, noting that the Acuity policy-covered offense of “use of another’s advertising idea in your advertisement” applied.

The Acuity policy did not specifically define “advertising idea.” Therefore, the appellate court looked to Wisconsin and federal caselaw to better clarify how this language should be interpreted, in the context of the facts of this case.

In Atlantic Mutual Ins. Co. v. Badger Medical Supply Co., 19 Wis. 2d (Ct. App. 1995), an ex-employee allegedly breached a restrictive covenant by funneling customer information to his new employer. The appellate court there examined several dictionary definitions of “advertising idea,” including Black’s Law Dictionary, which states: “an idea for calling public attention to a product or business especially by proclaiming desirable qualities so as to increase sales or patronage.”

The court found that defendants’ alleged transfer of information was not an “advertising idea,” and coverage did not apply.

However, the appellate court did find that an “advertising idea” had been misappropriated in Hyundai Motor America v. National Union Fire Insurance of Pittsburgh, 600 F.3d 1092 (9th Cir. 2010), when Hyundai allegedly used Orion’s “build-your-own-vehicle” component on its own corporate website.

As creator of the build-your-own-vehicle concept, Orion described its product as a “marketing system,” which generated a customized product proposal for possible customers based on “their stated preferences.”

This was different than just lists of customers given over to a new employer, and the appellate court there found that an “advertising idea” had been appropriated.

With guidance provided by Atlantic and Hyundai, the appellate court here found that AEI’s complaint had alleged advertising activities by Industrial Air, which was causally connected to an allegation of advertising injury.

However, Acuity further asserted that because each count in AEI’s complaint alleged “willful and wanton” behavior, coverage should be denied because of its noted policy exclusions for insureds who “knowingly violate the rights of another.”

Additionally, the Acuity policy further excluded coverage in the event trade secrets were allegedly misappropriated. Between these two exclusions, Acuity believed that the appellate had ample reason to uphold the lower court’s decision.

The appellate court was not persuaded. In reversing the trial court’s decision, the court noted that even if the underlying complaint alleges that policyholder knew that it was committing a wrongful act, the insurance company still has a duty to defend if the policyholder could still be liable without a showing of intent.