petitors from using deceptive advertising to indicate that a product is Y2K compliant. If a company uses deceptive language to suggest that its products are Y2K compliant, a false advertising claim brought by a competitor may be the result.
General defenses
Apart from defenses particular to one kind of claim, sellers also will raise general defenses in Y2K suits. The principal defense that has been raised in Y2K lawsuits brought to date is that the damages have not yet manifested themselves. Some courts have granted motions to dismiss based on this argument. See, e.g., Faegenburg. supra; Capellan, supra.
Another approach is an argument that the court should stay the action to allow the manufacturer to cure the problem before it manifests itself. This argument has been accepted as well. See, e.g., Peerless Wall and Window Coverings, Inc. v. Synchronics, Inc., 1998 WL 906542 (W.D. Pa. Nov. 19, 1998) (granting stay to cure problem).
Other Y2K lawsuit categories
This article cannot cover all categories of lawsuits. However, there are a few that are worth noting. First, there will be insurance coverage suits. One of the interesting expected claims is a claim that "advertising injury" coverage in general liability policies includes Y2K lawsuits. Such clauses are defined to include unfair competition claims, which some argue include deceptive business practices claims.
Another kind of lawsuit expected from the Y2K bug is one against the directors and officers of a corporation for breach of fiduciary duty and negligence. Related lawsuits may include securities suits alleging the breach of an obligation to disclose Y2K-related issues that may have a material effect on the company's financial statements.
Finally, businesses who fail to provide services based on Y2K bugs may face lawsuits for their failures, lawsuits indirectly caused by the Y2K bug. They may seek coverage from insurance carriers or seek to bring into the suit the maker of the software to account for such injuries in consequential damages.
These lawsuits are just a few of the many expected. After we reach the year 2000, the Y2K bug will do its dirty deed and more lawsuits will follow. Until then, hopefully the fear of litigation will cause software developers to do what they can to save us from it.
_______________
Author: Todd Flaming is a Partner at Schopf & Weiss, www.sw.com in Chicago, concentrating in business and corporate litigation. He is a tireless, knowledgeable speaker and writer on issues concerning legal technology and cyberspace law, and is an Adjunct Professor of Law at the John Marshall and Chicago-Kent Law Schools. He serves on the American Bar Association Committee on the Law of Commerce in Cyberspace, and is the a former Chair of the Illinois State Bar Association Standing Committee on Legal Technology. His "Illinois Lawyer's Start Page" http://www.toddf.com/start.html lists every known source for Illinois law and related information. In his spare time, he writes a Law Office Technology column for the Illinois Bar Journal. He can be reached at todd@toddf.com .
Insurance coverage issues for the Y2K computer crisis
By Roger L. Rutherford
As the new millennium draws near, the Year 2000 (Y2K) computer problem may disrupt communication, manufacturing, transportation, security systems, electronic data processing operations and many of the other daily activities that we take for granted. These disruptions could prove serious to commerce, resulting in work stoppages, production delays, an inability to buy and sell stocks, to place or take orders for all types of goods, or to conduct normal banking transactions, and have many other consequences beyond our imagining.
The estimated global cost to assess the problem, reconfigure devices and replace computer chips, components and systems, ranges from $600 to $700 billion worldwide, and it is predicted that these problems will result in an estimated one trillion dollars worth of litigation, which has already begun.1
As we move closer to January 1, 2000, many business managers are searching for answers to such questions as:
1. Who will bear the burden of Year 2000 losses?
2 Will lost income and expenses be covered by business interruption insurance?
3 Will commercial property insurance pay for losses to property caused by Year 2000 problems?
4 Will insurers specifically attempt to exclude Year 2000 problems from traditional insurance coverage?
5 Will commercial general liability insurance provide defense and indemnity against the inevitable third party claims?
6 Will insurers provide specific policies to cover Year 2000 damages, and if so will the cost be prohibitive?
7 Should I file a claim now for potential Year 2000 liability under my existing policy, or wait until a claim is made?
Review all business insurance policies
Any business which may suffer a loss related to the Year 2000 or become the subject of a Year 2000 lawsuit should look to its liability and property insurance policies to determine what coverage, if any, may exist. Spend time now reviewing insurance policies (e.g., general liability, business interruption, directors and officers, errors and omissions, products liability, etc.). In addition, consider that insurance carriers should possibly be put on notice of potential material claims. All renewal and other applications for any such coverages should also be reviewed to ensure they take into account potential Y2K liabilities.
Many liability insurance policies such as errors and omissions ("E & O") policies and directors' and officers' ("D & O") liability policies, provide coverage on a claims-made basis, meaning that so long as the claims made during the effective period of the policy, insurance coverage should be available for the claim.
Let me review a few specific types of coverage issues that will undoubtedly arise regarding the Y2K problems:
D & O Insurance Coverage
Company Directors and Officers are likely to become frequent targets of claimants who allege that they have suffered losses caused by the company, which the Directors and Officers failed to address. In addition to making sure that its own company's computer systems are Year 2000 compliant, officers and directors must verify that the companies with which they interface are compliant, as well.
Allegations of complaints against officers and directors are likely to result from claims that the company's Year 2000 compliance program was mismanaged, and thus failed to remedy the problems in a timely manner, or that the company failed to properly disclose the magnitude of the company's Year 2000 problem. To protect against either type of claim, it would be prudent to consider available insurance coverage under the company's D & O liability insurance policies.
Many such policies define "wrongful act" as a breach of duty, neglect, error, misstatement, misleading statement, omission or act by a director or officer. As to the Year 2000 problem, if officers and directors are sued on any theory of not preventing it, not anticipating the effects of it, not remedying it in a timely manner, or not adequately or properly disclosing the Y2K problem, all such allegations are likely to be deemed "wrongful acts" for which D & O insurance will likely provide coverage under the company's D & O liability policy.
Indemnification may nullify coverage
The language of many D & O insurance policies provides insurance coverage to its policyholder provided that the loss was incurred by an officer or director arising from a claim made during the policy period for actual or alleged wrongful acts, except when and to the extent that the company has indemnified the directors or officers.
Duty to defend
Most D & O policies do not require that the insurance company provide a defense to a lawsuit against the officers and directors. Instead, the insurance company must reimburse the policyholder for defense costs. However, policyholders should know that the courts have consistently held that notwithstanding the language of many such policies, under D & O liability policies, courts have required insurance companies to pay their policyholders' defense costs as they are incurred.2
E & O insurance
Businesses which provide computer services and consulting will have to look to their professional malpractice insurance (often known as E & O Liability Insurance) to cover losses and liabilities arising from Year 2000 claims. Typical provisions in such policies obligate the company to pay on behalf of the insured such sums which the insured becomes legally obligated to pay as damage because of a negligent act, error or omission in the performance of the insured's professional services.
"Negligent" errors and omissions?
There have been attempts by insurance companies to reduce the scope of insurance coverage under such policy language by arguing that "negligent" modifies not only "act", but "error or omission" as well. While there have been different conclusions in different courts, several decided cases have found that there is insurance coverage for non-negligent errors, and as such an insurance company cannot deny coverage by arguing that "negligent" modifies "error and omission" as well as "act."3
The scope of "professional services"
Further attempts to limit E & O coverage have to do with the meaning of the term "professional services." Many cases have dealt with an insurance company's attempt to defeat coverage by arguing that the alleged activity does not constitute "professional services"--which is not always defined in such policies. The issue of what constitutes "professional services" under the terms of an insurance policy has been the subject of much debate and discussion.
A leading case defining what constitutes "professional services" is Marx v. Hartford Accident and Indemnity Co.157 N.W. 2d 870 (Neb. 1968) which held that:
A "professional" act or service is one arising out of a vocation, calling, occupation, or employment involving specialized knowledge, labor or skill and the labor or skill involved is predominately mental or intellectual, rather than physical or manual.
One would think that in the context of Year 2000 lawsuits by claimants against computer-related businesses, such as software or hardware developers, vendors or computer consultants, it should be clear that the claim is based on activity undertaken was in the context of the delivery of "professional [computer] services." However, policyholders should expect to see defense firms arguing to defeat coverage by disputing the meaning of the term "professional services." Policies should be carefully reviewed to determine whether any such language appears in the insuring provision of the policy, its exclusionary language, or in a subsequent endorsement to the policy. If it does, the business should be prepared to refute such defenses vigorously.
Attorneys, accountants offering Y2K advice
One area in which non-computer consultants such as attorneys, accountants and others should be very careful is the offering of their services as Y2K consultants, since it raises the risk of potential malpractice claims. There is a significant difference between providing information in an attempt to raise the level of Year 2000 awareness, and holding oneself out as a Y2K expert. Clients who suffer damages as a result of Y2K advice, or do not get their Y2K problems solved timely, will undoubtedly attempt to hold responsible the professionals who provided them with the advice--including their attorneys and accountants. We should all be cognizant of that distinction, and only hold ourselves out as Y2K experts if we truly are Y2K experts. If we're not, we should provide adequate disclaimers where appropriate.
Commercial general liability
Commercial general liability policies provide coverage for bodily injury, property damage, or personal injury caused by the insured to a third party within the policy period. Typically, the commercial general liability policy requires that there must be an "occurrence" (which the policy defines as "an event" or happening), that is neither intended nor expected from the insured's standpoint.
Was Y2K "expected?"
As we approach the new millennium and increasing awareness of Y2K, insurers are likely to regularly assert that injury or damages caused by the problem are "expected," thereby nullifying coverage. The result will likely be determined by what efforts the insured has made to correct the problem once it has been identified.
The requirement of physical damage or loss of use
Also, under a typical commercial general policy coverage requires that a claim must result from bodily injury, or from "physical injury to tangible property, or loss of use of tangible property that is not physically injured." Standard commercial general liability policies exclude damages to intangible property and economic losses without accompanying physical damage.
Anticipated insurer defenses will likely be to assert that to the extent Year 2000 problems arise in source code, data processing and other electronic media, some damage affects intangible property and such damage is therefore not covered. Regarding computers, whether the subject matter is tangible or intangible is yet to be defined. However, even the slightest amount of physical damage has been held to support coverage for any related economic injuries, including loss of use. As a result, the intangible property exclusion included in the typical commercial general liability insurance policy will likely be the source of much Year 2000 litigation.
Other exclusions
Further exclusions in typical commercial general liability policies include coverage for liability assumed in a contract, liability for damage caused by a "defect, deficiency, inadequacy or dangerous condition" in the insured's product or work, or liability for damage to property that "must be restored, repaired or replaced." These exclusions will also provide major obstacles to coverage for computer-related damages.
Is software a "product" or "service?"
In addition, the issue as to whether software is a "product" or a "service" will become important. When we review the history of whether or not software has been characterized as a product or a service, we find a mixed result. Under the Uniform Commercial Code (UCC) software has been found to be both "goods" and "services."
Software has been found to be a service when it is custom-designed and installed for a unique use. Such custom applications typically involve management and monitoring to assure customer satisfaction with the product. The work is generally performed under a contract that requires that a complicated product be created within a defined time period.
In RRX Industries, Inc., v. LabCon Inc., 772 F.2d 543 (9th Cir. 1985) and in Advent Systems Ltd. v. Unisys Corp, 925 F.2d 670 (3d Cir. 1991), software was characterized as a product if it had been mass produced and distributed over a significant geographic area.
These exclusions and discrepancies regarding policy language will undoubtedly provide a basis for significant and extensive Year 2000 litigation and coverage of Year 2000 damages under commercial general liability policies.
Property / business interruption
An area of frequent litigation will likely be a business interruption caused by Y2K, either as a result of a company's own computer failure, or as a result of a vendor's failure to deliver parts timely, or if a supplier's Y2K failure results in the company's failure to meet a contract requirement or deadline.
Insurers will likely argue this type of coverage is outside the scope of coverage since business and property interruption policies require "a fortuitous event" to initiate coverage. First, party, or "own property" policies typically require damage to be to tangible property, either from specified risks or from "all risks." If the "property" is not physically damaged and a loss occurs because software or hardware does not function as intended, coverage is unlikely under the typical business interruption policy coverage.
Additional sources of coverage
In addition to the types of policies already discussed, policyholders should also review a variety of other kinds of policies, such as inland marine policies, business owners policies and other property and all-risk liability policies. Each of us should explore what we already have in place to protect against such losses.4
Year 2000 exclusions from coverage
As the new millennium approaches, insurance companies are likely to attempt to limit their exposure to Year 2000 liability by placing new exclusions in their insurance policies as they renew coverages. The Illinois Department of Insurance has warned Illinois insurers against blanket exclusions without valid underwriting data. This has resulted in Y2K "questionnaires" being sent to policyholders, asking pointed questions regarding their Y2K exposure. If the answers indicate a risk, coverage may be specifically excluded. If the policyholder refuses to answer, coverage will certainly be specifically excluded.
Typical Year 2000 exclusionary endorsement language such as the following attempts to exclude coverage:
This policy does not apply to any claim arising from:
a the failure of any computer or computer system, or any component or code thereof, caused by the inability of such computer, computer system or code to properly read or process any date outside the 1990-1999 year range.
b from any assessment, audit, correction, conversion, renovation, rewriting, or replacement of, or any failure to assess, audit connect, convert, renovate, rewrite, or replacement of any computer, computer system or computer code related to Year 2000 compliance. Year 2000 compliance means insuring that all dates outside the 1990-1999 year range will be correctly processed in every level of a computer system.
In addition, the American Association of Insurance Services, an insurance industry advisory group, has drafted two insurance policy endorsements which insurance companies can use to exclude Year 2000 related claims. 5
The new Y2K policy
Some insurers are seizing the Year 2000 problem as an opportunity, and are creating insurance products to insure against such risks. However, such products are generally expensive, and underwriters have required policyholders to spend considerable amounts of money in up-front audits and in due diligence, both before and after such a product is sold. Nevertheless, this may be an option for you to advise your business clients to consider.
Notice of claims under existing liability policies--to claim or not to claim?
As a result of the uncertainty that exists regarding Year 2000 problem insurance coverages, and in part in response to the creative use of exclusionary endorsements by insurers to limit coverage, many are advocating that policyholders consider the advantages and disadvantages of filing claims under their existing liability policies now for potential Year 2000 liability.
To claim
As a general rule, a claim is said to have been made once the policyholder furnishes notice of a potential claim against it. Those advocating this approach suggest that if notice is received before an insurance company has taken the initiative to exclude coverage for Year 2000 liability issues such as at time of policy renewal, then the insured is precluded from asserting that as a defense.
Not to claim
However, a more prudent approach might be to weigh the benefit that might be derived from giving such notice now, against the risk of the insurer's possible election not to renew the policy, or to do so at a greatly increased premium cost in order to cover its potential risk.
On the other side of the equation are the possible consequences of the policyholder's failure to make the insurance company aware of potential Year 2000 liability at this time. This type of decision will have to be made on a case by case basis taking into consideration the advantages and disadvantages of such notice of such a potential claim.
The new federal legislation
The New Federal Y2K Act contained in Senate Bill 96 has become law. The bill amends the punitive damages section of the Y2K act and applies caps to small businesses with fewer than fifty employees. Punitive damage caps have been removed for all other defendants. The cap would be the lesser of three times compensatory damages, or $250,000 (in other words a hard cap of $250,000). The proportional liability section of the act has been changed so it no longer requires strict proportional liability. The act uses language derived from the Private Securities Litigation Reform Act. Under this new language, a defendant would not be entitled to proportional liability if one of the following conditions were met:
1 If the plaintiff is an individual whose net worth is less than $200,000 and whose recoverable damages are equal to or more than 10 percent of the plaintiff's net worth.
2 A defendant that acted with specific intent to injure the plaintiff or who committed knowing fraud would be jointly and severally liable for all of the damages.
The law removes the liability caps on Directors and Officers, although it provides a safe harbor for Y2K statements made in good faith. Senate Bill 96 does not change substantive state negligence law (i.e., no reasonable efforts language dealing with either contract or tort cases).
Proposed Illinois legislation
In Illinois, Senate Bill 890, which has passed both houses and awaits the Governor's signature before becoming law, grants limited liability protections to banks and consumers for problems arising out of Y2K computer malfunctions.
In addition, a more comprehensive bill, Senate Bill 230, which is on third reading in the Illinois Senate, is likely to be considered in the fall veto session. The bill is an attempt to limit Y2K liability for the business community. The legislation would create affirmative defenses for businesses that take steps to address problems before January 1, 2000, establish a two-year statute of limitations on Y2K related litigation, limit punitive damages and give businesses the opportunity to mitigate damages before a lawsuit may advance.
Conclusion
Businesses of almost every type should be aware of the potential for severe interruption in commerce due Year 2000 problems. Y2K claims are unique in that many feel that they are to a large extent foreseeable and preventable now utilizing due diligence and proper assessment procedures. However, notwithstanding, there will likely be