Y2K Legislation Alert

On July 1, 1999, Congress passed the Y2K Act, which is intended to encourage Y2K remediation efforts and informal dispute resolution while limiting frivolous lawsuits arising out of Y2K failures. The law was transmitted to President Clinton by e-mail (a first in federal legislative procedure), and the President is expected to sign it soon.

The Y2K Act creates important new protections from litigation and liability arising out of Y2K failures, and includes new liability allocation and dispute resolution procedures. However, the Act expressly excludes from coverage a number of significant categories of litigation, includes many limitations and conditions, and contains complexities and ambiguities in terminology that likely will require judicial interpretation. Accordingly, businesses will continue to face significant Y2K liability risks, and should proceed with implementation of Y2K remediation plans and programs intended to reduce or eliminate those risks.

Businesses should continue to work on minimizing potential liability for Y2K failures. Here are some suggestions:

The most effective way to avoid potential Y2K-related liability is to prevent Y2K failures. These failures can occur in virtually any software, computer, computer chip, or electronic device that processes date information. Businesses should identify immediately all safety- and mission-critical systems, equipment, and facilities that might in any way be affected by Y2K failures, and to undertake full remediation programs as quickly as possible.

Interdependencies with business partners, critical suppliers, and customers present a major risk of Y2K failures to many companies. Reducing this risk requires cooperation - sharing information about Y2K preparedness and identifying ways that parties can work together to resolve or minimize the effects of potential failures. In many cases, businesses have entered into Y2K confidentiality agreements, requiring them to hold Y2K-related information confidential and not use that information for purposes of litigation. Businesses also may agree to a number of additional contractual provisions that will facilitate cooperation and reduce likelihood and impact of disputes. For more information on these contractual options, please request a copy of our Year 2000 Contract Tool Kit (January 1999). Finally, businesses should consider developing a Y2K communications program (including web site disclosures), with appropriate input from counsel.

Because it generally is impossible to eliminate all Y2K risks, businesses should develop contingency plans to mitigate the effects of any potential Y2K failures that do occur. Contingency plans may include options such as identifying manual work-arounds for automated processes, identifying alternative sources of supply, and maintaining additional inventory during critical transition periods.

Effective Y2K planning requires a comprehensive, coordinated effort, with support at the highest level of management. Many businesses have designated a Y2K Transition Director to manage effective implementation of this process. Under the Y2K Act, companies will need to identify a Y2K Transition Director or other appropriate official for purposes of receiving prelitigation notices under the Y2K Act.

While taking all possible measures to avoid Y2K failures, businesses also should take steps to protect themselves in the event that litigation does occur. To help minimize risks of liability, businesses should develop a policy for managing, reviewing, and retaining all documents that may relate to Y2K problems or mitigation efforts. This should include developing a system to record and document potential Y2K disruptions, efforts taken to remediate Y2K problems, and the consequences of Y2K disruptions. Businesses also should design and enforce corporate policies concerning disclosure of Y2K information to third parties with supervision of corporate or outside counsel. Finally, insurance coverage should be evaluated and supplemented as appropriate.

The Y2K Act applies to any civil action, in federal and state courts, as well as in proceedings before a government agency board of contract appeal, where (1) the plaintiff’s alleged harm or injury arises from or is related to a Y2K failure, or (2) a claim or defense arises from or is related to a Y2K failure. The term Y2K failure is defined broadly to include virtually any failure to accurately process dates in the years 1999-2001. The Act expressly does not apply to actions arising under securities laws, claims for personal injury or wrongful death, and most enforcement proceedings brought by government agencies.

Before bringing any Y2K action (other than actions seeking injunctive relief only), prospective plaintiffs will be required to send to each prospective defendant a written notice that includes specific detailed information describing (1) the alleged Y2K defects or failures, (2) any harm or loss suffered by the plaintiff, (3) the plaintiff’s proposed remedy, and (4) the basis for seeking that remedy. Parties receiving prelitigation notices are required to provide a written response within 30 days describing the actions that have been or will be taken to address the Y2K problem described by the prospective plaintiff. The response also must state whether or not the prospective defendant is willing to participate in alternative dispute resolution ("ADR"). The Act provides that these written statements generally will not be admissible in any federal or state Y2K litigation.

If a prospective defendant has responded to a prelitigation notice by offering proposed remedies or by agreeing to participate in ADR, then the prospective plaintiff must wait at least 90 days (unless the parties agree to a different time period) from the defendant’s receipt of the notice before bringing suit. If the defendant fails to respond or provides an incomplete response to a prelitigation notice, the plaintiff may bring suit 30 days after the defendant receives the plaintiff’s notice. If a plaintiff files a Y2K action prematurely, the defendant may notify the court and request a stay of any judicial proceedings pending the running of the remediation period.

The Y2K Act imposes class action notice requirements that are more stringent than those generally applied under federal court rules, and places two limits on class action suits based on alleged Y2K failures. First, in order to certify a class, state and federal courts must find that the alleged defect would be material in relation to the performance of the underlying product or service as a whole. Second, the Act requires plaintiffs to bring proposed class action suits in state courts in certain circumstances (e.g., where the proposed plaintiff class has fewer than 100 members or where the aggregate amount in controversy is less than $10,000,000 and the plaintiffs do not seek punitive damages).

The Act creates a grace period in which mortgagors may not foreclose on consumer residential mortgages if the consumer defaults after December 15, 1999 and the default was due to a Y2K failure. The defaulting borrower must notify the loan servicer within seven days of learning of the failure and in no event later than March 15, 2000. The statutory grace period lasts for four weeks following the date of the borrower’s notice. If the borrower does not make the required payment(s) prior to the end of the grace period, the mortgagor or loan servicer may then begin foreclosure proceedings.

The Y2K Act provides that in covered actions other than contract actions (a term not defined by the Act), damages generally will be required to be apportioned among all persons (including non-parties and the plaintiff) that contributed to the plaintiff’s loss, and that plaintiffs may recover from each defendant only an amount proportionate to that defendant’s share of liability. The proportionate liability provisions are not applicable to (1) non-class action suits brought by consumers concerning defects in consumer products, (2) defendants that acted fraudulently or with the intent to injure the plaintiff, and (3) certain cases where all or part of the judgment against one of the defendants is not collectible (for example, due to bankruptcy or other reasons). The Act also establishes rules for defendants seeking contribution from other responsible persons.

Where the underlying law allows the recovery of punitive damages, plaintiffs must prove by clear and convincing evidence that they meet the applicable punitive damages standards. The Act places a cap on punitive damage awards against businesses with fewer than 50 full-time employees and individuals with a net worth of less than $500,000, unless the defendant acted with specific intent to injure the plaintiff.

Under the Act, plaintiffs will not be entitled to compensation for any damages that the plaintiff could have avoided in light of any information, including disclosures by the defendant, of which the plaintiff was or reasonably should have been aware. This duty does not apply, however, to damages from a plaintiff’s justifiable reliance on a knowing, material misrepresentation by the defendant.

Stricter Knowledge Standard for Defendants Indirectly Involved in Y2K Failures.

The Act includes additional limitations on suits alleging Y2K failures that are brought against parties who did not participate directly in the relationship or activity that formed the basis for the alleged liability. These provisions apply to suits for money damages where: (1) the defendant is not the manufacturer, seller, or distributor of a product, or the provider of a service, that experiencesthe Y2K failure; (2) the plaintiff and defendant are not in "substantial privity" (a defined term) with each other; (3) the defendant’s actual or constructive awareness of the Y2K failure is an element of the claim; and (4) the claim is not a claim for negligence. In suits that meet these criteria, the Act requires the plaintiff to show, in addition to other elements required to prove a claim, that the defendant "actually knew, or recklessly disregarded a known and substantial risk" that the Y2K failure would occur.

The Act provides that a party’s control over the facility, system, product, or component that experienced a Y2K failure may not constitute the sole basis for liability. In some cases, this provision may have little practical effect, because the other elements of liability, such as duty or constructive notice, may be independently demonstrated.

The Act provides that certain elements of Y2K claims or defenses must be decided under the law as it existed on January 1, 1999, effectively preventing states from recognizing certain claims or defenses for the first time in Y2K actions. Examples include the law relating to impossibility or commercial impracticability in contracts and elements of claims involving a defendant’s state of mind. The Act also allows states to pass laws providing Y2K defendants with greater protections.

Under limited circumstances and for a limited time, the Act allows defendants to avoid penalties for "Y2K upsets," defined as the failure to comply with "federally enforceable measurement, monitoring or reporting requirements" due to Y2K failures that are "beyond the reasonable control of the defendant." Defendants may only assert the "Y2K upset" defense if: (1) the non-compliance would not threaten public health, safety, or the environment; (2) the applicable requirement did not involve regulation of securities, or the banking or monetary systems; (3) the noncompliance was not caused by "operational error or negligence"; (4) the defendant made a reasonable good faith effort to prevent the failure; (5) the defendant takes immediate action to correct the noncompliance as soon as the defendant invokes the defense; and (6) the defendant notifies the federal authority within 72 hours of learning of the Y2K upset. The Y2K upset defense does not apply to actions in which the federal agency seeks only an injunction or an order requiring the defendant to comply with the underlying requirement.

The Y2K Act provides that the provisions of the IRDA shall apply to any Y2K action. The IRDA may limit the admissibility of certain Year 2000 disclosures, but the extent of its protection is unclear. (For additional information on the IRDA, please request a copy of our November 1998 client mailing on that statute.)

As a practical matter, the protection offered by the Y2K Act likely will be limited. First, the Act does not apply to a number of significant categories of potential Y2K suits, including actions for personal injury and wrongful death. Second, many of the Act’s provisions, such as the cap on punitive damages and the proportionate liability provisions, apply only to narrowly defined subsets of Y2K suits. Third, the Act includes numerous terms and provisions that are unclear or ambiguous, making it likely that litigation will be necessary on interpretive issues and creating uncertainty as to the Act’s ultimate scope of protection. Fourth, the Act creates new dispute resolution and liability allocation issues that also may contribute to future uncertainty and litigation. Finally, the Act presents a number of potential constitutional questions, including particularly the issue whether it unduly interferes with the states’ judicial powers. Thus, while businesses should keep the Y2K Act in mind when designing Y2K remediation programs and otherwise addressing Y2K liability exposure, they should not rely on the Act to shield them from potential liability for Y2K failures.

By James R. Wrathall and David M. Kreeger

This memorandum is for general purposes only and does not represent our legal advice as to any particular set of facts, nor does this memorandum represent any undertaking to keep recipients advised as to all relevant legal developments.