Federal Appeals Court To Retailers: In A Breach, Pay For The Damn Replacement Card. And Buy Some Insurance, Too

A federal appellate panel, reviewing some of the data-breach lawsuits against Hannaford, has dealt a very narrow setback to retailers, ruling that consumers can be entitled to identify-theft insurance and replacement payment cards. The fact that such an extremely limited support for consumer rights can even be seen as a setback for retailers puts into context how incredibly retail-friendly federal courts have consistently been in various data-breach rulings.

There are two likely near-term impacts from the ruling. First, Hannaford itself will now have this case return to an active trial status, where it will likely reside for an absurdly short of time before it's settled for the very small number of dollars that such an insurance policy and card replacements (for just a few customers) will cost. For retailers throughout the country, though, the impact will be more muted.

To begin with, the ruling narrowly looks at Maine law and will, therefore, not necessarily impact other regions. On the flip side, though, it is a federal appellate ruling and the logic the panel used will influence federal judges nationally. Given the relatively small dollars involved in these policies and card replacements, many chains are likely to just amend their breach reactions to pay for those items.

(Related story: During A Data Breach, Customers Will Stay—Unless You Alienate Them One At A Time)

What the panel said on October 20 was that the rulings from U.S. District Court Judge D. Brock Hornby involving the Hannaford breach—from December 2007 and impacting "4.2 million credit- and debit-card numbers, expiration dates and security codes"—were almost all correct. The panel deviated from just two decisions.

The rationale comes down to a practical definition of "reasonableness." In this instance, the consumers were told that their specific account information had been accessed. In that situation—as opposed to one where, for example, the consumer merely heard of a major breach—the panel ruled that it's legitimate for a consumer to expect to be issued new payment cards.

"The question then becomes whether plaintiffs' mitigation steps were reasonable. This case involves a large-scale criminal operation conducted over three months and the deliberate taking of credit- and debit-card information by sophisticated thieves intending to use the information to their financial advantage," the panel wrote. "Unlike the cases cited by Hannaford, this case does not involve inadvertently misplaced or lost data, which has not been accessed or misused by third parties. Here, there was actual misuse, and it was apparently global in reach. The thieves appeared to have expertise in accomplishing their theft and to be sophisticated in how to take advantage of the stolen numbers. The data was used to run up thousands of improper charges across the globe to the customers' accounts. The card owners were not merely exposed to a hypothetical risk but to a real risk of misuse."

The panel added: "Further, there is no suggestion there was any way to sort through to predict whose accounts would be used to ring up improper charges. By the time Hannaford acknowledged the breach, more than 1,800 fraudulent charges had been identified and the plaintiffs could reasonably expect that many more fraudulent charges would follow. Hannaford did not notify its customers of exactly what data, or whose data, was stolen."Continuing: "It reasonably appeared that all Hannaford customers to have used credit or debit cards during the class period were at risk of unauthorized charges. That many banks or issuers immediately issued new cards is evidence of the reasonableness of replacement of cards as mitigation. Those banks thought the cards would be subject to unauthorized use, and cancelled those cards to mitigate their own losses in what was a commercially reasonable judgment. That other financial institutions did not replace cards immediately does not make it unreasonable for cardholders to take steps to protect themselves. It was foreseeable, on these facts, that a customer, knowing that her credit- or debit-card data had been compromised and that thousands of fraudulent charges had resulted from the same security breach, would replace the card to mitigate against misuse of the card data."

The panel also addressed the argument that the consumers who sought the compensation for their replacement-card fees had never seen any bogus charges on their cards. "It is true that the only plaintiffs to allege having to pay a replacement-card fee do not allege that they experienced any unauthorized charges to their account, but the test for mitigation is not hindsight. Similarly, it was foreseeable that a customer who had experienced unauthorized charges to her account would reasonably purchase insurance to protect against the consequences of data misuse," the panel said.

Another Hannaford claim the appellate panel rejected was that paying for insurance for consumer breach victims would cause tons of unnecessary insurance to be purchased. "Hannaford also argues that allowing recovery for prophylactic measures such as identity-theft insurance would provide incentives for the unnecessary purchase of such products. As we have discussed, however, such recovery is bounded by the principle of reasonableness. Recovery is allowable only if the decision to purchase such a product was a reasonable effort to mitigate under the circumstances."

The panel seemed to be suggesting that the overwhelming majority of consumer breach victims would not likely be able to make such an argument successfully.

Our take: The panel's decision is quite sound. As a practical matter, when a chain is admitting a huge data breach by global criminals who are still at large (the Albert Gonzalez gang was eventually charged with the attacks), the act of denying customers a replacement payment card seems miserly at best and foolish at worst. At that particular moment, you really want to treat your customers really well. Seems an odd time to get all anal about a several-dollar replacement charge.

As for the insurance, that's the sort of thing chains should now buy in bulk and hand out like candy during a breach, not dissimilar to the way credit monitoring services are now doled out.