Fifth Circuit Reverses and Remands Denial of Cyber Claim
The Fifth Circuit Court of Appeals reversed the district court's finding that Southwest had no coverage for a cyber claim. Southwest Airlines Co. v. Liberty Ins, Underwriters, Inc., 2024 U.S. App. LEXIS 996 (5th Cir. Jan. 16, 2024).
On July 20, 2016, Southwest suffered a massive computer failure, which resulted in a three-day disruption of its flight schedule. Approximately 475,839 Southwest customers experienced either a flight cancelation or a delay of two hours or more. Southwest held a cyber risk policy from AIG which included a provision for "System Failure Coverage." This section provided that the insurer "shall pay all Loss . . . that an Insured incurs . . . solely as a result of a System Failure . . ." Liberty issued a follow form excess policy to Southwest. Liberty's coverage was only implicated if Southwest's system-failure -related loss exceeded $50 million.
Southwest suffered more that $77 million in losses due to the system failure, reaching Liberty's level. Liberty denied the claim, challenging five categories of Southwest's claims losses, without which its covered losses would total less than $50 million and therefore not trigger Liberty's policy. The five categories were FareSaver Promo codes, Travel vouchers, Cover Refunds, Rapid Rewards Points, and Advertising costs.
Southwest sued Liberty for breach of contract, bad faith, and declaratory judgment on the issue of coverage. Liberty moved for summary judgment. Southwest filed a cross-motion for partial summary judgment. The district court granted Liberty's motion after concluding that Southwest's costs were not caused by the system failure but rather were the "result of various and purely discretionary customer-related rewards programs, practices and market promotions."
On appeal, Liberty argued that the system failure could not be the sole cause of Southwest's claimed costs because the "independent" and "more direct" cause of the losses was Southwest's decisions to incur them. But the decisions could only be independent, sole causes of the costs if they were the precipitating causes of the costs. The Fifth Circuit determined that the district court erred in concluding that Southwest's five categories of costs were all precluded as a matter of law because they were discretionary. The court, however, noted it was not determining whether the system failure was in fact the sole cause of each of the costs that Southwest claimed. The question of the exact costs to which Southwest was entitled to was not before the court because the district court did not reach it.
The court also found that the two exclusions promoted by Liberty did not preclude coverage. The first exclusion provided that Liberty was not liable for "any Loss . . . alleging, arising out of, based upon or attributable to contractual penalties or consequential damages.'" The parties disagreed on the interpretation of "consequential damages." Liberty argued this included any costs that "do not flow directly and immediately from the act." The court found this definition would seem to preclude costs incurred as a result of a decision to mitigate damages from the system failure, even though the System Failure Coverage provision permitted such costs in principle. Liberty's definition of consequently damages would also render much of the coverage completely illusory. The district court therefore erred in determining that the five categories of costs were consequential damages excluded from coverage,
The second exclusion provided that Liberty would not pay for "any Loss . . . arising out of, based upon or attributable to . . . any liability to third persons for whatever reason . . ." Liberty interpreted the term "third-parties" to include Southwest's customers and therefore argued that the exclusion applied to any payments to customers, such as refunds; payments for lost, damaged, or delayed luggage; and refunds for alternative travel arrangements. Again, the court disagreed. Liberty's broad definition of "third party" would effectively wipe out provisions in the policy that explicitly covered other "pecuniary obligations" to "a person other than the principals," including provisions covering Southwest's payroll obligations to its employees and fines owed to regulators. The term "third parties" therefore did not apply to Southwest's customers and, in turn, did not preclude costs related to Southwest's payments to its customers. Consequently, the district court errored in granting summary judgment on this basis as well.
Finally, the district court also erred in granted summary judgment to Liberty on the bad faith claim. Southwest satisfied its burden of showing that a genuine dispute of material fact existed as to whether Liberty had a reasonable basis to deny Southwest's claims.
