December 31 is an unyielding date which will arrive whether everyone is "Y2K ready" or not. Continuing with TLIE’s risk management efforts, your trusty reporter recently attended another conference on Year 2000 issues, a two-day event sponsored by the Practising Law Institute. Last year, the national focus was on awareness. Now, the focus has shifted to status reports. This article condenses many of the ideas offered to help attorneys avoid legal malpractice claims when reviewing, modifying, and creating contracts.
I. What is "Y2K Compliant?"
There is no uniform definition of "Y2K compliant." The Information Technology Association of America has adopted the following definition of a product able to meet the Year 2000 challenge:
"The IT Product(s), when used in accordance with its associated documentation, will be capable upon installation of accurately processing, providing and/or receiving date data from, into, and between the twentieth and twenty-first centuries, including the years 1999 and 2000, and leap year calculations, provided that all other products (e.g., hardware, software and firmware) used in combination with the IT Product(s) properly exchange date data with it." See ITAA website www.itaa.org/year2000/legalgrp.htm.
The General Services Administration has established a contractual warranty by regulation, which may be found at www.itpolicy.gsa.gov/mks/yr2000/contlang.htm. The Institute of Electrical and Electronics Engineers has published another definition at http://grouper.ieee.org/groups/2000. The British Standards Institute adopted a definition of Year 2000 conformity which may be found at www.bsi.org.uk/disc/year2000.html.
II. Statutory Developments
In the United States, Congress and the State legislatures are creating governmental immunity legislation and safe harbor laws restricting liability for Y2K "readiness disclosures." The Y2K Readiness & Responsibility Act (H. R. 775, the "RRA") passed the U. S. House on May 15, 1999, and is on the Senate calendar, CR S.5262, Cal. Order No. 113. It would confer original federal court jurisdiction but require 90 days pre-suit notice. Texas has enacted Y2K legislation requiring 60-day notice before suit and eliminating certain damages, Senate Bill 598.
Since each country can develop its own Year 2000 legislation, international contracts present additional concerns. Look for differences in substantive contract and tort law, definitions of terms of art, legal remedies allowed, and choice of jurisdiction issues. Privity of contract issues may prevent certain causes of action. Liability exposure of officers, directors, and managers also may differ in foreign jurisdictions.
III. Some Pointers on Careful Contracting
A. Review of Existing Contracts
Contract claims against vendors may arise mainly out of two problem areas: product supply problems and information supply problems. Either way, enforcement of an older contract that is silent on Y2K issues may turn on warranty clauses if they are broad enough to provide protection. However, some products may now be out of date or the warranties have expired, so enforcement would be difficult unless the customer has a current maintenance agreement. In existing contracts, look for any waivers or caps of consequential damages, or limits on damages with "sole and exclusive remedy" clauses. Be aware that many older contracts were prepared by non-lawyers, raising questions of enforceability.
B. Remedies for Performance Problems
Whether enforcing an old contract or drafting a new one, consider remedies other than litigation. Conversion to a new system or a product replacement may be suitable; however, determine whether consulting or installation costs are included. New warranties extending past the Y2K "fix" time period are a complementary remedy. Letters intended to modify original contracts could be rendered useless because of merger and integration clauses in the original contract, so it is best to incorporate them as an official contract amendment governing remediation terms.
C. Contract Drafting
Conference attendees were given several suggestions for drafting Y2K contracts. What constitutes "the contract" varies: disclaimers need to be clear and obvious, and manuals and other written materials that might be part of the contract terms need to be integrated or incorporated by reference. Among the clauses recommended were apportionment of future liability and mediation clauses. On issues of due diligence, consultation with local counsel was recommended, as was consultation with technical personnel when drafting definitions. In defining compliance or readiness, relevant time periods should also cover the leap year and warranty periods ending after December 31, 1999. Specify the length of a warranty, and when it actually begins to run (date of sale, acceptance, or other points). The Uniform Commercial Code may apply, to the extent the problem is with the software as a good. However, non-UCC service problems raise issues about consultation or the integration or customization of the software.
D. Testing 1, 2, 3
In an acquisition, a testing agreement is a practical element of due diligence. Be careful of using the target company’s own testing procedures, or require independent testing by a disinterested party. Blanket assurances or compliance statements could sound like unconditional warranties. Representations or assurances made in order to close a deal work better on a product by product basis, and also when tied to date-related issues. Specific disclaimers may be appropriate in response to compliance or readiness questions, to avoid creating any warranty.
Also, note the SEC emphasis on full testing to be done by this summer, and certain disclosures required in financial statements of publicly-held companies as regards state of compliance. SEC Interpretative Release August 4, 1998; see also www.sec.gov/rules/concept/33-7558.htm. Be alert to potential Section 10b-5 class actions or derivative actions for breach of fiduciary duty, for failing to implement effective Y2K procedures or to disclose the status of readiness. The Mortgage Banking Association and the Big 5 accounting firms have also announced testing requirements.
Each company will have a different answer to the question, "When will the testing be finished?" The contract should determine who bears responsibility for evaluating the results, and for continuing to test if initial results are unsatisfactory. Clients may need to consider restricting public disclosure of test results, or making disclaimers of reliance on results. They may also need to label Y2K statements as "readiness disclosures" in order to invoke applicable protection under the Information Readiness & Disclosure Act ("IRDA"), P.L. 105-271 (10/19/98, S.2392).
E. Financial Concerns: Business Advice v. "Due Diligence"
Because of the financial impact of Y2K preparations, clients are likely to ask attorneys to comment on the viability of a deal or reasonableness of remediation costs. Mergers and acquisitions raise special due diligence issues regarding legal assessments as to whether the parties have addressed Y2K issues adequately.
Attorneys should distinguish carefully between giving business investment advice and legal advice, because clients may complain that the attorney’s advice was faulty. A professional liability policy may not cover the erroneous business advice. Exposure of law firms to Y2K claims may arise from establishing legal protocols or contracts regarding their clients’ Y2K plans, according to Liz Horn, CPCU with Marsh, Inc.(San Francisco). Such legal services could include drafting or reviewing contracts containing (or omitting) Y2K disclaimers; reviewing vendor documents to assure inclusion of appropriate indemnity; reviewing public disclosure documents concerning materiality of a company’s Y2K vulnerability; or reviewing a firm’s remediation efforts. Also, buyers and sellers may target attorneys with allegations of false or misleading representations of their clients’ Y2K exposures. Remediation efforts should be documented to create an audit or evidentiary trail which would establish the care taken in preparing for Y2K contingencies.
F. Risk of Loss & Insurance
First party all-risk insurance, including general liability, property, and errors/omissions policies will be important for most businesses. Whether or not remediation costs fall within the contractual definition of damages sought by a client, the client’s failure to remediate could create insurance coverage issues for failure to mitigate "anticipated losses." Additional protection might be had through coverage under the contracting party’s insurance or an indemnity agreement.
Expect directors and officers of public companies to be key targets of Y2K claims. Directors’ and Officers’ insurance needs to be in place before Y2K problems become manifest. Most policies will not protect the entity for loss and defense of non-security claims, whether or not the directors and officers are named in the complaint. Because of the soft insurance market, some companies will negotiate and eliminate Y2K exclusion clauses on D&O and E&O policies, but not property and casualty policies. A special word of caution is due to attorneys serving as directors or officers of corporations, who may not be covered under E&O policies if serving in those capacities. Claims under auditors’ and lawyers’ policies will be likely if the parties have problems with recovery (or defense) under the D&O policies.
For additional resources and current Y2K information, please note the list of website addresses contained in this and prior issues of the Advisory. Onward to December 31!
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