By Ira T. Kasdan
Y NOW YOU'VE HEARD all about the Year 2000 software problem. From all the hype in the press you know that as things stand today, on Saturday, January 1, 2000, your corporation's computers and data bases will "think" that it is Monday, January 1, 1900 -- if they "think" at all. You have yet to hear from your CEO or CFO, but you know that sooner rather than later they will be seeking your opinion on the legal ramifications stemming from the problem. Are you prepared? Do you have a game plan? Do you even know what the legal issues are? Ready or not, you ought to be considering the following action items.
There are at least five legal areas of concern, some of which are interrelated: (1) D&O liability; (2) licensing, copyright, warranty and related questions; (3) employment/personnel matters; (4) insurance coverage; and (5) lawsuits by and against your company.
ONE, IF NOT A MAJOR, responsibility of in-house counsel is to advise directors and officers of their individual exposure to liability. While in-house counsel, in their representation of the corporation, may be conflicted from representing board members and company officers in their individual capacity, corporate lawyers can protect directors and officers when the corporation's interests coincide with the interests of the corporation's executive management. The Year 2000 problem represents such an instance.
Most states require directors and officers to exercise a duty of care consistent with that of an ordinary prudent person in similar circumstances. That means (at the very least) that, if your competitor is addressing the Year 2000 problem and your company is not, there will be D&O exposure to liability. Simply stated, if a corporation does not take appropriate steps to assess and rectify the Year 2000 problem, and the corporation suffers financially as a result, blame will be laid squarely at the doorstep of directors and officers.
Thus, action item no. 1 for in-house counsel is to ensure that your board and officers are aware of the Year 2000 problem. With that awareness, the corporation should designate appropriate people and/or committees to analyze the scope of the Year 2000 problem and begin implementing remedial steps to address it.
For their own and the corporation's protection, the actions taken by management to identify and rectify the Year 2000 problem should be documented and preserved. Although a "paper trail" could contain (at best) embarrassing and (at worst) "damaging" information that can be discovered in subsequent litigation, this problem is outweighed by the risk of not being able to evidence the diligence with which the corporation pursued corrective action. Of course, this does not mean that one should not exercise care before committing something to writing. Nonetheless, the "Business Judgment Rule," under which courts will not impose liability for honest mistakes of business judgment, should shield the corporation and its helmsmen from the perils normally associated with a "paper trail" -- provided that there is no fraud, illegality or conflict of interest, which, in any case, the "Business Judgment Rule" obviously would not protect.
Action item no. 2 is to analyze what (if any) disclosures must be made to shareholders. Matters to be considered for disclosure include, but are not necessarily limited to, the degree of the company's Year 2000 problem, the projected costs of remediation and whether such costs will materially affect the company's bottom line. In making this latter determination, a critical issue will be whether the costs will be treated as capital expenditures that can be spread over a number of years or will be considered business expenses that can be written off immediately. It is highly advisable for in-house counsel, the company's CFO and its outside auditors to coordinate the company's stance on these issues.
LICENSING, COPYRIGHT, WARRANTY and RELATED ISSUES
IT WILL BE UP TO management to decide whether to replace or repair computer systems affected by the Year 2000 problem. In order to make an informed decision, management will need to know, through its in-house staff or outside experts, the flexibility it may have to modify existing source code. This, in turn, will depend on the various restrictions contained in the agreements and licenses that govern the computer systems and source code.
Consequently, action item no. 3 is for corporate counsel to initiate an audit of all software agreements and licenses to determine what contractual provisions will come into play if the company chooses remediation over replacement. The company's rights to remediate will require a careful review of clauses in the original agreements with outside vendors that cover the use of the program, ownership of the technology, copyright grants, warranties and remedies for system failures. At the same time, the legal auditors should look out for contractual provisions, such as limitations on liability clauses, that may figure prominently in potential, future litigation against the original software providers.
Even if management decides to replace rather than to repair software, there is an important role for counsel. The last thing a company needs is to spend millions and later discover that its newly installed systems are not Year 2000 compliant. Action item no. 4, therefore, is for company attorneys to ensure that contracts for the purchase or installation of replacement components precisely define what Year 2000 "compliance" is and how it will be demonstrated well in advance of the turn of the century. In this regard, the parties may agree upon the need for third party certification that a system is Year 2000 compliant. Appropriate provisions must be negotiated and drafted to cover these and related matters, such as the remedies available to the company should a newly installed system fail.
THE CURRENT CONSENSUS is that there are not enough adequately trained programmers available to complete the remediation process in the government and private sectors by 2000. And the predictions are that the situation will only get worse.
It is worth to bear in mind that much of the Year 2000 problem lies in so-called "legacy systems" in which today's programmers are not necessarily well-versed. The upshot is that a company that has qualified programmers to fix the problem will need to hold on to them, while companies without the necessary talent pool will seek to hire them away. Action item no. 5 for in-house counsel is to craft contract terms that will safeguard the continued employment of important company personnel. It will be the responsibility of counsel to recommend employment agreements (especially for a level of employee where comprehensive agreements probably were not used in the past) containing reasonable non-compete clauses and appropriate provisions to enable a company to obtain necessary injunctive relief to preserve its workforce. But more importantly, management inevitably will be required to offer incentives -- bonuses, stock options, extended employment beyond the turn of the century (assuming the Year 2000 software problems are solved by then) and/or lucrative buy-outs and severance terms -- to retain employees crucial to the remediation process. These employment contract clauses, too, will need to be drafted by counsel.
REGARDLESS WHAT a company does to remedy its Year 2000 problems, it will cost money -- substantial amounts of it. J.P. Morgan & Company conservatively estimates that the total expenditures in the private and public sectors will be in the $200 billion range. Others estimate that the remediation costs will reach $600 billion. Who will be liable to pay these enormous sums? Action item no. 6 is for corporate counsel to examine the company's own liability policies, as well as the company's D& O insurance policies, to determine whether there is coverage under general liability and/or errors and omissions provisions, or whether coverage is excluded by other provisions. At the same time, if there is coverage, it is important to ascertain whether the coverage is on an "occurrence" or "claims made" basis (which, in turn, may govern which year's insurance policy applies).
In addition, action item no. 7 for in-house counsel is to advise management on new insurance policies that are intended to address Year 2000 issues specifically. As of this writing, it appears that some insurance carriers will cover Year 2000 system failures. However, these policies must be scrutinized carefully by company lawyers to ensure the broadest possible coverage. By the same token, exclusionary provisions must be reviewed just as carefully and, to the extent possible, limited or negotiated out in order to maximize the company's rights.
Finally, as part of action item no. 8, counsel should advise company officers that outside remediation services provided to the company must be backed by appropriate insurance, which at a minimum should name your company as an additional insured, and extend through at least the year 2001. It will be counsel's task to request and review those insurance contracts and provide guidance to the company on whether the coverage is adequate from a legal perspective.
IS NOW THE TIME to be thinking about litigation -- so far in advance of the turn of the century? You better believe it. Especially so if, when push comes to shove, by December 31, 1999, your company or your suppliers will not be fully Year 2000 compliant.
What preparations should you be taking now? At the very least, action item no. 9 is to identify the potential parties that your company may wish to sue and the parties that would sue your company.
The former list will begin to emerge upon your review of the agreements and licenses of vendors that supplied the ineffective software. In addition, you may add to that list companies on which your company relies but which themselves do not meet Year 2000 compliance standards. None of this is to say that your company actually will, or will even want to, sue anyone. Indeed, once the lists are readied, the advisable course will be to open lines of communication in order to avoid disputes and lawsuits (provided, of course, that you are not creating a statute of limitations problem by merely talking instead of litigating). Certainly, the earlier a company initiates negotiations with software and other service providers, the better the chances it will be able to elude a litigious end. On the other hand, you should be ready to draft the appropriate demand letters when and if it becomes appropriate to do so.
As to the list of potential parties that may sue you -- such as shareholders or other parties who rely on your company's services and that would be damaged by your company's Year 2000 non-compliance -- it will never be too early to prepare. With regard to shareholder suits, the precautionary steps to be taken, as outlined above in connection with director and officer liability, obviously should be followed. With regard to those relying on your company's services, it obviously is most prudent for counsel to be able to monitor developments along the way and offer appropriate advice in order to posture the case in the most favorable light for your company.
Finally, you and your company should also keep in mind that pursuing available means of alternative dispute resolution ("ADR"), such as arbitration or mediation, may be a better course of action than courtroom litigation to resolve Year 2000 disputes. Indeed, ADR may be dictated by applicable contracts in certain instances.
And so we come to action item no. 10: Prayer. Pray that your company listens to those who are warning of the perils of inaction; pray that management heeds those warnings and takes action; and pray that management allows you to implement action items 1 through 9.
Web Law Review, 1998
Text and Photo ©
1998, Ira T. Kasdan
Web Package © 1998, EagleLink