For companies which distribute software or hardware containing date sensitive firmware ("Vendors"), Year 2000 poses a two-sided problem since they not only use software licensed from others, but also offer their software or firmware to other entities. As a result, companies must assess the business impact and potential liability associated with the use of third party software which is not Year 2000-compliant while they review and correct these problems in their own software products. This Cooley Alert briefly describes these issues and offers possible solutions from the standpoint of users of computer software as well as Vendors.
User Issues
To assess the scope of the Year 2000 problem on your business, you should create an inventory of all hardware and software which you are using. You should then determine which items on the list could impact your business if there is a Year 2000 problem and review the corresponding license agreements or hardware purchase agreements to determine the scope of the Vendor.s obligations with respect to Year 2000 compliance. Since many users and Vendors have only begun to confront the Year 2000 problem recently, it is unlikely that these agreements will specifically address Year 2000 compliance. You should not be discouraged if this is the case since it may be possible to require Vendors to ensure Year 2000 compliance based on warranty and maintenance provisions in the agreements.
For example, a provision in an agreement where the licensor agrees to fix "bugs" or "defects" or a warranty that "the software will conform to the specifications" could serve as an avenue for a user to impose responsibility on the Vendor if the Year 2000 problem will cause the software not to work or fail to conform to the specifications. Although agreements generally specify a date when the warranty obligations will terminate, Vendors could still be obligated to make their software Year 2000 compliant at their expense under maintenance agreements which include similar obligations regarding the software.s functionality. In addition, you may be able to claim that a Year 2000 problem renders the software unmerchantable or unfit for the user.s particular purpose if the Vendor failed to disclaim the implied warranties of merchantability and fitness for a particular purpose.
Early assessment of Year 2000 problems will not only allow you to resolve any Year 2000 problems in a timely manner, it will also permit you to adopt a strategy with your Vendors to attempt to make such Vendors responsible for correcting, preferably at no charge, Year 2000 problems. As soon as practical, you should contact your Vendors to request information regarding the availability of Year 2000 upgrades. In addition, early implementation of a plan to correct Year 2000 problems may be useful in demonstrating that you tried to mitigate your damages, something that you may be required to demonstrate if you are forced to sue a Vendor of non-compliant software on a theory of liability, e.g., breach of contract, breach of express warranty or breach of an implied warranty.
As a preventative measure, in future agreements with Vendors you should specifically address Year 2000 compliance, identify the remedies available to you and limit to the greatest extent possible the Vendor.s limits of liability for Year 2000 compliance problems.
Vendor Issues
The flip side of the user issues are those associated with Vendors which have distributed or are continuing to distribute non-compliant software to their customers. If your company is a Vendor, you should quickly conduct a technical review of your products to determine whether Year 2000 issues could prevent them from functioning properly. Failure to remedy Year 2000 problems could expose you to lawsuits for breach of contract, breach of express warranty, breach of implied warranty, negligence, or fraud. The specific requirements of these theories of liability are beyond the scope of this Cooley Alert but the extent of your potential exposure will depend heavily on the language contained in your existing agreements. It is therefore critical that you also review the obligations you have assumed in your existing agreements.
Key provisions in the agreements which you should focus on are warranty and maintenance provisions, disclaimers of implied warranties, limitation of liabilities and remedies for breach of warranty or maintenance and support. To the extent you determine that there are Year 2000 problems, you should move quickly to address ways to cost-effectively and quickly fix the problems to avoid customer complaints. In addition, it is imperative that management inform your sales personnel regarding the company.s policy with respect to Year 2000 compliance. By doing this you may be able to avoid situations where the sales personnel overestimate and possibly overstate your ability to fix or remedy Year 2000 problems. You should also implement a strategic approach to internal communications regarding your company.s Year 2000 vulnerabilities to minimize the chance that those communications could be used against your company in potential litigation.
Even if you have fixed any Year 2000 problems or plan to do so prior to December 31,1999, you should include language in any future agreements which limit your liability for Year 2000 problems. Possible ways to achieve this result include: (i) confine your obligation with respect to Year 2000 compliance to a specific repair or replace remedy; (ii) make such remedy the sole and exclusive remedy of the licensee; (iii) disclaim the implied warranties of merchantability and fitness for a particular purpose and (iv) disclaim consequential damages arising out of or relating to any action under the agreement.
Other Potential Liabilities
A company with Year 2000 problems may be required to make disclosures under various accounting standards and securities laws. For example, one of the guiding principles of Generally Accepted Accounting Principles ("GAAP") is that loss contingencies which are reasonably possible must be disclosed in a note to the financial statements, whether or not the amount of such loss can be calculated or estimated. If it is reasonably possible that your company (if you are a software user) and your products (if you are a Vendor) may not be able to become Year 2000 compliant in time resulting in loss or damage to the company, you may be required to disclose this fact in a note to your financial statements. In addition, if such results are probable, this liability may need to be reported in the body of the financial statements.
In addition, the standards of care imposed on the directors may require them to pay very close attention to Year 2000 problems and seek to resolve such problems to minimize potential personal liability. Directors seeking to establish that they were due diligent in the exercise of their duties and exercised reasonable business judgment, should be able to produce a record demonstrating that they focused on Year 2000 problems in a timely fashion and implemented a corrective plan to deal with them. Due to the potential personal liability of officers and directors to shareholder suits, you should review your indemnification provisions as well as any directors and officers insurance to determine the scope of coverage. The scope of the Company.s coverage under its insurance policy should also be analyzed in the process of determining how to deal with potential liability issues arising from Year 2000 compliance problems.
Finally, federal and state securities laws require that all material facts be disclosed in connection with the purchase or sale of securities of a public company. If your company is publicly held, or if you are in the process of going public and you know it is not reasonably likely that you will be able to become Year 2000 compliant in time, and that noncompliance may have a material adverse effect on your business, you may be required to disclose this fact in your annual and quarterly reports. As a final matter, in the context of mergers and acquisitions, the acquirer should understand the target.s potential exposure arising from Year 2000 problems.
Conclusion
Because of the magnitude of the Year 2000 problem in terms of time and costs, you may wish to seek the services of an outside consultant. Prior to retaining the services of an outside consultant, you should review your Vendor agreements to ensure that providing a consultant with a copy of, or access to the third party software which you use will not violate any provisions of the accompanying software license.
Due to the potential issues associated with Year 2000 compliance, companies should quickly put in place a strategic approach to identify Year 2000 potential liabilities, seek time and cost-effective solutions to address potential problems, and move forward with a business model designed to prevent Year 2000 compliance issues from being a problem for the company.
We would like to thank Joseph R. Giammona, Corporate Counsel for the Millennium Strategies Group, LLC for his assistance with this Cooley Alert. The Millennium Group, LLC works with companies to develop strategies, including Year 2000 strategies, necessary for companies to successfully transition to the next century.