Y2K Liability

One of the emerging trends in the law is the concern over Year 2000 (Y2K) liability. Speculation is widespread that our society will be dramatically impacted when the calendar turns over to the Year 2000.

Whether or not the predicted events will occur, the perceived difficulties presented by the Year 2000 software problem have prompted action by companies, individuals and their insurers to protect against the various predicted dire consequences. Already, lawsuits have been filed seeking to clarify the legal responsibilities of various parties.

This article summarizes some of the possible types of claims and coverage issues that we anticipate will arise from the Y2K problem. Next, we summarize the current Y2K litigation which has already been filed.

Product Developer Litigation. Claims against manufacturers, developers, licensors and maintenance/ service providers or consultants of non-compliant software and hardware are included in this category. The only known Year 2000 (Y2K) lawsuits to have been filed fall within this category.

Product Developer Litigation can be separated into the following categories:

Breach of express or implied warranties. Express warranties most often arise from language in the purchase/license contract and they also arise through other communications such as advertising, trade usage and course of dealing. Courts will probably have to make an initial determination as to whether the Uniform Commercial Code applies to the transaction between purchaser and seller of the computer goods in question. This determination will weigh heavily on whether the product is determined to be a good or a service, because services are not governed by the UCC.

Implied warranties such as the warranty of merchantability and fitness for a particular purpose may also give rise to causes of action.

Fraudulent Inducement. Claims may arise on the basis of whether a software developer's knowledge or constructive knowledge that the six digit date fields (i.e. 12/31/97 as opposed to 12/31/1997) would fail at the millennium constitutes knowledge that the software was defective at the time it was sold. There may be potential causes of action under Unfair Trade Practices statutes on this basis.

Negligence, Professional Malpractice and Products Liability. In situations where a person claims physical injury as a result of the Y2K problem, actions under negligence, professional malpractice and/or products liability may arise. An example of this type of scenario is micro processor chips embedded in certain products, such as heart defibrilators and elevators, which automatically shut down when not serviced within a certain time. Even if these products are seasonably serviced, they could cease to function at the year 2000.

Business Interruption Litigation. These claims would arise from the users of non-compliant software, when alleged malfunctions may cause the users or purchasers to breach their own obligations to their customers, vendors, distributors and other parties. Claimants may seek to recover damages under the same theories of liability outlined under product developer litigation. The most likely situation involves a company that manufacturers, distributes or provides some product or service whose software is not Y2K compliant. Even if the actual company suffers no internal Y2K problems, any vendors, customers, independent contractors downstream on whom the company relies may claim Y2K disruptions. Other issues may include defective or untimely delivery of products, billing, maintenance, etc.

One of the most prevalent potential defenses to these claims is likely to be the argument that the Y2K problem should be viewed as an act of God. The viability of this defense is currently uncertain.

Licensing Agreement Litigation. Software licensors may sue their own customers for copying or modifying the software to make it Year 2000 compliant. Licensors may seek to recover under copyright infringement or violation of trade secrets causes of action.

Other Litigation. Other possible litigation includes ERISA violations (employers, improperly handling ERISA protected accounts), insurance coverage, shareholder litigation, tax code violations (accountant malpractice), financial institution litigation and failure of the Year 2000 consulting companies to adequately remedy a non-compliant system.

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The following provides a preliminary summary of insurance coverage issues which we anticipate may arise as a result of the Year 2000 problem.

First Party Coverage. First party coverage may be sought for repair to the damaged or non-compliant computer/software under first party property damage/repair coverage. Additionally, first party coverage may be sought under first party business interruption coverage for losses suffered as a result of the non-compliant software. Obviously, the insureds would first have to establish that the damaged property falls within the definition of insured property which in turn has suffered a physical loss or damage as defined by the terms of the respective policy. The potential defenses to these claims include the argument that there is no actual physical destruction of the property but rather there has been only a loss of use of the property and economic impairment of the property. There is also the question that because Y2K problems are well known at this time, whether any such damage will be considered fortuitous under the terms of the policy. Other potential defenses include whether the Y2K defect is aninherent/latent defect which would be excluded from many policies. Also there is the question of whether such a loss is a known loss or loss in progress.

CGL Policy. It is expected that coverage for the potential causes of action arising out of non-compliant software will result in requests for a defense to be provided under CGL policies. Establishing coverage under CGL policies generally requires (1) the assertion or a claim for liability and (2) third party personal injury or property damage. However, many policies typically define property damage as physical injury to tangible property, including all resulting loss of use of that property. The issues will then become whether the non-compliant software is tangible property; whether there is actual physical damage to property or only loss of use; whether there is bodily injury and whether the damages were expected or intended from the standpoint of the insured.

Errors and Omissions Coverage. Insureds may seek a defense under E&O policies for liability claims against computer consultants and perhaps other professionals such as accountants. An example of situations in which insureds may seek a defense are a computer consultant mistakenly recommending Year 2000 non-compliant software, and an accountant's failure to advise a client on financial reporting obligations with respect to the Year 2000 issues.

Directors and Officers Coverage. Year 2000 issues may result in potential claims against officers and directors of corporations for their failure to take action to comply. As such, D&O coverage will be triggered from any resulting suits.

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The following summarizes pending Y2K litigation:

• Produce Palace International v. TEC-America Corporation. (Circuit Court of Macomb County, Michigan).

  This case, the first Year 2000 lawsuit, based its cause of action on the failure of grocery store credit card scanner to read dates after 12/31/99. The complaint alleged breach of warranty, fraud and deceit, and unfair business practices in violation of state business laws. The complaint also alleged five counts which were dismissed by the court: breach of the duty of good faith, breach of contract, revocation, violation of the Magnusson-Moss Warranty Act, and violation of the Michigan Consumer Protection Act.

• Atlaz International, Inc. v. Software Business Technologies (Superior Court of California, Marin County); Capellan v. Symantic Corporation (Superior Court of California, Santa Clara County); Cameron v. Symantec (Superior Court of California, Santa Clara County); Paragon Networks International v. Macola, Inc. (Court of Common Pleas of Marion County, Ohio).

  These cases are class actions brought by owners of software that is not Year 2000 compliant, after the vendor refused to upgrade the software for free.

• Issokson v. Intuit, Inc. (Superior Court of California, Santa Clara County); Chilelli v. Intuit, Inc. (Supreme Court of New York, Nassau County); Faegenburg v. Intuit, Inc. (Supreme Court of New York, New York County); Stein v. Intuit, Inc. (Supreme Court of New York, New York County); Rubin v. Intuit, Inc. (Superior Court of California, Santa Clara County); Colburn v. Intuit, Inc. (Superior Court of California, San Mateo County).

  These lawsuits involve claims against the manufacturer of the popular financial software Quicken. Plaintiffs in these cases allege violations of the Magnusson-Moss Warranty Act, implied warranty of merchantability, fraudulent business practices and violations of various state codes and acts. The Faegenburg case also alleges that the computer industry was aware of the Year 2000 problem since the early 1970's and did nothing because of the costs involved. The plaintiffs seek free software upgrades.

• Peerless Wall and Window Coverings, Inc. v. Synchronics, Inc. (Western District of Pennsylvania).

  The theories of liability in this case are breach of contract, breach of express warranty, breach of implied warranty of merchantability, fraud and negligence. The complaint alleges that the software manufactured and sold by defendant, for use in retail businesses, was not Year 2000 compliant and that the defendant knew or should have known this defect and concealed this information from 1984 until the spring of 1987. The plaintiffs seek compensatory damages and punitive damages.

• Courtney v. Medical Manager Corporation (District Court of New Jersey).

  This case was brought by a doctor on behalf of all other doctors similarly situated against the maker of The Medical Manager bookkeeping software. The doctor complains he purchased this software only a year before the newer version was offered as Year 2000 compliant.

• Against Gravity Apparel, Inc. v. Quarterdeck Corporation (Supreme Court of New York, New York County). The complaint alleges that the defendant marketed and sold its software which was Year 2000 compliant despite knowing that it would be obsolete after December 31, 1999.