Corporation, Securities & Business Law Forum
October 1999 vol. 45, No. 1
(Notice to librarians: The following issues were published in Volume 44 of this newsletter during the fiscal year ending June 30, 1999: November, No. 1; March, No. 2; May, No. 3; June, No. 4.)
Statements or expressions of opinion or comments appearing herein are those of the editors or contributors, and not necessarily those of the association or section.
Contents
* Introduction to this special issue By Donna J. Cunningham
* Y2K lawsuits--causes of action and defenses By Todd H. Flaming
* Insurance coverage issues for the Y2K computer crisis By Roger L. Rutherford
* Directors and officers at risk for Y2K liability By Lori Iwan and James K. Horstman
* Year 2000: The business interruption & legal malpractice risks for every lawyer By Annie E. Thar
* Y2K snapshots By Donna J. Cunningham
* What you think you know could hurt you: Myths about the Year 2000 problem By Annie E. Thar
* Federal Y2K legislation signed into law By Thomas D. Lupo
* Statutes of limitations in Y2K warranty claims By William T. McGrath
* General and transactional Y2K disclaimers limiting the lawyer's liability for Year 2000-related problems By Annie E. Thar
* PULLOUT SECTION: Y2K for the small business (or law firm) By Donna J. Cunningham
Introduction to this special issue
This special Y2K issue is directed to the business lawyer, but contains articles that can be mailed to business clients. It has been written not only for the print medium, but for posting online. It contains several hypertext links. It has been months in the making. It has a special section for lawyers only, and another for small businesses (including law firms). It covers Y2K lawsuits, statutes of limitation, insurance coverage issues, federal legislation, and legal malpractice issues for the business lawyer. Want to find out whether you can sue? See Todd Flaming's "Y2K lawsuits - causes of action and defenses." Wonder whether you have insurance to cover this? See Roger Rutherford's "Insurance coverage issues." Need a Y2K triage checklist? See "Y2K for the small business (or law firm)."
Certain themes repeat themselves throughout the newsletter. You'll find, for instance, that several authors have written about the new (and old) federal legislation, and several have written about the exposure to liability of corporate directors and officers (as well as their lawyers). Each author views the topic from a different perspective, and as these several viewpoints may be helpful to you in sorting through your approach to Y2K, and so we have purposely left them in.
Need a Y2K disclaimer? We have several, and we're using all of them. For a client-friendly disclaimer to be used in engagement letters and fee agreements, see Annie Thar's "General and transactional Y2K disclaimers." For a disclaimer regarding the recommendations in this newsletter which are designed to help avoid legal malpractice claims (but not to set standards for practice), see the disclaimer at the end of the copyrighted articles by the ISBA Mutual Insurance Company. And for a disclaimer only a lawyer could love, we also adopt Todd Flaming's disclaimer below:
This presentation and outline are given only as a public service, for which I receive no compensation, and if you rely on this advice you do so entirely at your own risk. I include this disclaimer to protect myself. If you rely on any advice or information in this outline, you agree to hold me entirely harmless no matter how bad the advice is, not to sue me, and to pay all the attorney fees for my defense should you decide to sue despite not having a right to do so. I provide no warranties at all, except that the presentation and outline will include a number of bad jokes.
Regards,
Donna J. Cunningham,
Editor, Special Y2K Issue
Y2K lawsuits--causes of action and defenses
By Todd H. Flaming
No doubt you've heard predictions that the "Year 2000" bug will cause computers all around the world to crash. While some of these predictions may be exaggerated, litigation concerning the Y2K bug has already begun. Some, albeit few, helpful judicial pronouncements have been made.
The Y2K problem is neither a single problem nor a simple one. It will have direct effects on purchasers of computer software and indirect effects on people and businesses relying on those who suffer effects directly. Indeed, even fear of the problem may cause people to take actions that injure themselves and others. Consequently, predicting the number and types of lawsuits that will result from the Y2K bug is impossible.
Nonetheless, we have already seen a good number of lawsuits filed alleging damages from the Y2K bug, and these suits provide at least some idea of what we can expect in the future. This article discusses a typical Y2K lawsuit brought by a purchaser of a product that turns out not to be Y2K-compliant. It examines causes of action the plaintiff will bring and defenses the defendant will raise. This article does not address recent legislation affecting Y2K lawsuits, legislation that is covered in other articles.
The facts
In the typical Y2K lawsuit, a plaintiff will allege, sometimes on behalf of a class, that the defendant sold software or a product that uses software and that the software will not properly handle dates in the year 2000.
You probably have heard about the most obvious Y2K flaws--that in calculating years the software assumes the "19" and merely increments the last two digits. When the digits increment from "99" they become "00." The computer then adds the "00" to the "19" and comes up with "1900."
Sometimes the software will simply make mistakes in date calculations and generate a wrong number. An example of this problem is incorrectly calculating someone's age. Sometimes the software will make decisions based on the incorrect date. An example of this problem is incorrectly determining that something has expired. Sometimes the program will use the date in a way that causes the program to stop functioning altogether. An example of this problem is using only the last two digits of the year as a denominator, causing a deadly "divide-by-zero" error (meaning some part of the computer program tries to divide another number by the year -- 00 -- and dividing by zero is not possible).
There are less obvious Y2K "flaws"--ones that may give rise to litigation over whether they are actually flaws. For example, data entry programs allow employees to enter years by the last two digits, assuming the date is 19__. Some programs will "window" the date entries, assuming that, if the last two digits entered are between 00 and 50, they are in the next century and, if not, they are in this century. Some argue that failing to make those assumptions is a flaw in the program.
Similarly, other problems include database sorting errors. A database may sort according to date, but dates may be in "MM/DD/YY" format. Some programs recognize this format and, using windowing assumptions, sort such dates "correctly" as some understand it. Other programs do not. Whether or not such a failure is a Y2K bug may be a source of litigation.
Although any number of failures may give rise to litigation, they all boil down to one thing: the software does something incorrectly because of the turn of the century.
Causes of action
Now that you understand the problem, you probably have a skeletal idea what sort of lawsuit a plaintiff could bring against the seller or manufacturer of this software. To put more meat on those bones, this section outlines the theories with more detail. It also discusses some of the defenses you will see in Y2K litigation. Keep in mind that some disputes have already made it into court, although there are few judicial resolutions of the most significant issues.
Here are some of the key causes of action. Some general defenses are discussed later.
1. Breach of contract
The purchase and sale of software involves a contract, usually written, which is the first place to look for relief if the software is not Y2K-compliant. Any representation in a contract regarding the operation of the software or product can create a duty that would be breached if the software were shipped with the Y2K bug. For example, if the contract specifies that the software will serve you well into the next millennium and software fails from a Y2K bug, the seller has breached the contract.
Breach of contract may seem a relatively unattractive cause of action, because the remedies sometimes are insufficient. But keep in mind that there are many remedies for breach of contract. The most basic is the recovery of "expectation damages," which constitutes that amount of money that puts the buyer where he would have been had the seller fully performed the contract. This remedy could require a seller to do what is necessary or pay the buyer what is necessary to make the software Y2K-compliant. Also, the buyer may be able to recover for additional damages, such as consequential or incidental damages.
Problems with contract claims usually come from the contract itself. Typical contracts include warranty disclaimer and damage limitation clauses. Often, these clauses can purport to limit damages to the price of the product. Keep in mind, however, that courts can be very precise in their construction of damages limitation clauses, so a failure to mention, for example, "incidental" damages, could be fatal to the defense.
Others contract-based defenses will be more creative. For example, a seller may invoke a force majeure clause, arguing that the Y2K bug was beyond the seller's control. Although Y2K doomsayers have been predicting the problem since the 1970s, one argument that may have some merit is that Y2K bug was inherited from the computer program used to create the computer program at issue--yes, computer programmers use other computer programs to create their own software. If the force majeure clause is worded broadly enough, this defense might succeed. Some other arguments applicable to warranty cases, discussed below, may also be made in contract cases.
2. Breach of express warranty
Often software contracts fail to make an explicit statement that the product will be Y2K-compliant. Here the Uniform Commercial Code (UCC) may help. To begin with, courts generally find that the UCC applies to computers and computer software. See, e.g., Redmac, Inc. v. Computerland of Peoria, 489 N.E.2d 380, 383 (3d Dist. 1986) (statements that computer system would be free of defects sufficient to create express warranty pursuant to 2-313 of the UCC). Thus, courts will resort to the UCC to supplement a contract where it has gaps or, sometimes, to override contractual provisions.
A good example of this sits in the express warranty section of the UCC. Section 2-313 provides that affirmations of fact, descriptions of the goods, and samples that become part of the basis of the bargain and relate to the goods create express warranties that the goods will conform. 810 ILCS 5/2-313. So, if the sales material shows someone entering dates into the software and one of those dates is in the year 2000, the sales material may have created an express warranty that the goods can handle dates in the year 2000.
The Uniform Commercial Code (UCC) offers some help with respect to contract warranty limitations as well. An exclusion of an express warranty brings into action UCC 2-316, which provides:
Words or conduct relevant to the creation of an express warranty and words or conduct tending to negate or limit warranty shall be construed wherever reasonable as consistent with each other; but subject to the provisions of this Article on parol or extrinsic evidence (section 2-202) negation or limitation is inoperative to the extent that such construction is unreasonable.
810 ILCS 5/2-316. Thus, if the contract provides that the software will work well into the next millennium and also provides that there are no express warranties, the buyer has a reasonable argument that the warranty limitation is ineffective.
The UCC also places some restrictions on a contracting party's ability to limit damages. See 810 ILCS 5/2-719.
3. Breach of implied warranty of merchantability
Often no express warranty provides that the software will function through the year 2000. One argument a plaintiff can make is that the implied warranty of merchantability requires the software to, among other things, pass without objection in the trade and be fit for the ordinary purposes for which it is used. The implied warranty of merchantability is that the goods:
(a) pass without objection in the trade under the contract description; and (b) in the case of fungible goods, are of fair average quality within the description; and (c) are fit for the ordinary purposes for which such goods are used; and (d) run, within the variations permitted by the agreement, of even kind, quality and quantity within each unit and among all units involved; and (e) are adequately contained, packaged, and labeled as the agreement may require; and (f) conform to the promises or affirmations of fact made on the container or label if any.
810 ILCS 5/2-314. Plaintiffs will argue that software unable to work past the end of this year neither passes without objection in the trade nor is fit for the ordinary purposes for which it is used. Whether computer software should be required to recognize Y2K dates is a question of fact.
Typical defenses to such a claim will include that the contract contains a disclaimer and that lots of software will stop working--software is meant to have a short lifespan. Although the second is a tough argument to make for new software, it may have some merit for much older software. The first argument would require that the warranty limitation clause uses the proper language. Generally speaking, exclusions must be conspicuous and either mention "merchantability" or use traditional full disclaimer words, such as "as is."
4. Breach of the implied warranty of fitness for a particular purpose
Often companies retain consultants to identify appropriate software and install it on the company's computers. These consultants frequently have arrangements with the manufacturer, under which the consultant receives a percentage of the sale price of the software. In effect, the consultant is a value-added reseller of the software.
Because of the consulting role, the reseller has knowledge of the needs of the company. Commonly the company will explain to the consultant how long the company expects the software to work. Thus, the software consultant will know of a particular need of the company and a particular purpose for the software. Should the software stop working prematurely because of the Y2K bug, the company may have a claim for breach of the implied warranty of fitness for a particular purpose against the consultant-reseller. The UCC provides:
Where the seller at the time of contracting has reason to know any particular purpose for which the goods are required and that the buyer is relying on the seller's skill or judgment to select or furnish suitable goods, there is unless excluded or modified under the next section an implied warranty that the goods shall be fit for such purpose.
810 ILCS 5/2-315. As with the implied warranty of merchantability, this section relies on a factual determination.
Apart from denying the elements of the plaintiff's claim, the most common defense to such a claim likely will be that the implied warranty of fitness for a particular purpose has been disclaimed. Under the UCC, disclaimers of such warranties are permissible. However, they must meet certain conditions, such as being conspicuous. See 810 ILCS 5/2-316.
5. Breach of the Magnuson Moss Warranty Act.
The ability to limit warranty claims means that most software contracts offer little protection. Few software sellers leave warranty disclaimers out of their contracts. Also, a breach of warranty claim has a significant limitation, in that the plaintiff's real injury consists of both the reduced value of the product purchased and the plaintiff's attorney fees.
The federal Magnuson Moss Warranty Act, 15 U.S.C. § 2301 et seq., offers a way around these problems in certain cases. By way of cautionary warning, the Warranty Act uses precise definitions and enables the Federal Trade Commission to issue certain types of interpretive rulings, so both should be reviewed prior to filing a claim pursuant to the act. Generally, it applies only to a "consumer product," which is defined as "any tangible personal property which is distributed in commerce and which is normally used for personal, family, or household purposes...." 15 U.S.C. § 2301(1). Particularly in cases in which the item sold involves both hardware and software, this section may apply.
The Warranty Act provides several kinds of protection. First, it sets forth requirements for warrantors for certain written warranties (defined in the statute), such as what language they must use (e.g., "full" versus "limited") and whether and how they can be limited. See 15 U.S.C. §§ 2302-2304. Second, it places restrictions on the ability of "suppliers" to limit implied warranties arising under state law, even rendering certain disclaimers ineffective. 15 U.S.C. § 2308. The Act provides that a "supplier" who makes a "written warranty" to a "consumer" with respect to a "consumer product" may not disclaim or modify an implied warranty, except by limiting it to the duration of a written warranty of "reasonable duration" if certain requirements are met. See 15 U.S.C. § 2308. Note that the act applies differently to "warrantors" and "suppliers."
Third, it allows a "consumer" damaged by the failure of a "supplier, warrantor, or service contractor" to comply with an obligation under the Act or "under a written warranty, implied warranty, or service contract," to sue for damages and other relief, including costs and attorney fees. See 15 U.S.C. § 2310(d). Its attorney fees provision makes consumer suits for smaller-dollar claims worth considering. Magnuson Moss claims are typical in Y2K lawsuits.
Such a claim has several prerequisites. For example, the Act allows a warrantor to establish an informal dispute resolution procedure, to which the consumer must first resort before filing suit. 15 U.S.C. § 2310(a)(3). The Act has similar special requirements for a class of consumers. Id. Also, the act requires notice and an opportunity to cure a defect. 15 U.S.C.§ 2130(e).
A Magnuson Moss claim is no panacea. It suffers from the same no-injury problem as other claims. See Faegenburg v. Intuit, Inc., No. 602587/98, http://www. thefederation.org/Public/Y2K/intuit.pdf at 6-7 (N.Y. Sup. Ct. N.Y. County, Dec. 1, 1998) (dismissing Magnuson-Moss claim because Y2K failure was not yet manifest).
6. Fraud and violation of the Consumer Fraud Act
Any form of misrepresentation regarding a product may give rise to a claim for fraud. Actions for fraud take many forms, several of which should be common in Y2K claims.
First, there is fraudulent misrepresentation. The elements of a cause of action for fraudulent misrepresentation, a form of common law fraud, are: (1) a false statement of material fact; (2) known or believed to be false by the party stating it; (3) intent to induce the other party to act; (4) action in reliance by the other party; and (5) damage as a result of that reliance. Hirsch v. Feuer, 702 N.E.2d 265, 272 (1st Dist. 1998). A false statement that a product is Y2K-compliant, made knowingly to get a consumer to buy a product, can give rise to such a claim.
Second, if there is no affirmative misrepresentation, a plaintiff may be able to show fraudulent concealment. To state a cause of action for fraudulent concealment, also a form of common law fraud, a plaintiff must show that the defendant concealed a material fact when under a duty to disclose that fact to the plaintiff. Id. at 273. Although mere silence in a transaction does not amount to fraud, silence accompanied by deceptive conduct or suppression of material facts can give rise to concealment. Id. If a plaintiff can establish a duty to inform the plaintiff of Y2K problems, a court may hold a seller liable for failing to do so.
Third, there is consumer fraud. The Illinois Consumer Fraud and Deceptive Businesses Practices Act, 815 ILCS 505/2, allows a consumer to recover for a business's deceptive practices. It requires showing of a deceptive act or practice, the defendant's intent that the plaintiff rely on the deception, and that the deception occur in the course of conduct involving trade or commerce. Lionel Trains, Inc. v. Albano, 831 F. Supp. 647, 649-50 (N.D. Ill. 1993); Lidecker v. Kendall College, 550 N.E.2d 1121, 1124 (1st Dist. 1990). Courts also have required showing of justifiable or reasonable reliance with resulting damages and proof by clear and convincing evidence. Lionel Trains, 831 F. Supp. at 650. Other limitations have emerged in case holdings, and before filing any consumer fraud claim an attorney should read the significant decisions on the statute. Generally speaking, courts do not favor Consumer Fraud Act claims.
Alleging and proving fraud is not easy. Thinking outside of the box in this area may be helpful. For example, in Capellan v. Symantec Corp., No. CV 772147, http://www. thefederation.org/Public/Y2K/Symantec%20Demurrer%20Order%203_24_99.pdf at 2 (Cal. Super. Ct., Santa Clara Cty., Mar. 23, 1999), the defendant allegedly concealed a "work around" to a product's Y2K problem while telling users that they must purchase an upgrade. The court found this allegation sufficient to state a claim for unfair (fraudulent) business practices.
7. Violation of the Deceptive Trade Practices Act
A related act, the Uniform Deceptive Trade Practices Act, 815 ILCS 510/1, sometimes confused in its relationship to the Consumer Fraud Act, probably will not apply to most Y2K claims brought by consumers. The DTPA provides a remedy for, among other things, representing that goods have characteristics, ingredients, uses, or benefits that they do not have. 815 ILCS 510/2(5). On its face, it may appear to apply to many consumer disputes.
But courts have found that it was enacted to prohibit unfair competition and was not intended to be a consumer protection statute. Chabraja v. Avis Rent A Car System, Inc., 549 N.E.2d 872, 876 (1st Dist. 1989). Rather, it allows for injunctive relief and was designed to focus on acts between competitors. Smith v. Prime Cable of Chicago, 658 N.E.2d 1325, 1337 (1st Dist. 1995).