Congress Passes Y2K Act to Limit Liability for Year 2000 Computer Failures
 
September 1, 1999
 

On July 20, 1999, President Clinton signed into law the Y2K Act, Public Law No. 106-37, (1), landmark legislation reached through political compromise, and intended to limit liability for Year 2000-related failures. The new Act will impact the many thousands of businesses that are hurrying to prepare for transition to the Year 2000. If Year 2000-related failures emerge despite those preparations, the new law serves to limit liability for those failures.

The Y2K Act Will Govern Nearly All Y2K Lawsuits

The Act will affect almost every civil action that arises from a Y2K problem, whether brought in state or federal court, or before a federal agency board of contract appeals. The language of the Act explicitly applies to any civil action brought after January 1, 1999, involving any Y2K failure - actual or potential - occurring before January 1, 2003. This means that the two most common types of Y2K claims - claims for actual failures, and claims for repairing systems to prevent potential failures - are covered by the Act. The Act also addresses Y2K government contract disputes.

If the Act covers litigation that stems from a Y2K failure, so too will the Act cover any related appeal, remand, stay, or other judicial, administrative or alternative dispute resolution (ADR) proceeding. The Act applies only to defined Y2K actions, and does not apply to actions that allege personal injury. Private securities actions are also generally excluded from the coverage of the Act.

The Act affects Y2K liability in three ways. First, the Act limits the bases of liability - the grounds on which a Y2K lawsuit can be brought. Second, the Act limits the potential damages that can be awarded in Y2K actions. Third, the Act imposes new procedural requirements, intended to slow - and discourage - frivolous Y2K lawsuits, as well as encourage alternative dispute resolution measures.

Liability Limits: Contracts vs. Torts

How the Act limits liability will depend largely on the type of Y2K claim made. If the claim is for breach or repudiation of a contract, the new law requires that the contract be strictly interpreted and liability limited to the "express terms of the contract." Defendants will likely argue that this means that new duties - such as Y2K compliance - should not be read into existing contracts.

The Act also strictly limits the damages recoverable in tort. The Act embraces the so-called "economic loss" rule adopted by many states (2). Under this rule, as set forth in the Act, economic loss damages are not recoverable by a party seeking recovery for non-intentional torts. "Economic losses" include lost profits, business interruption costs, and losses that arise because of third parties' lost business opportunities. Under the Act, recovery for such losses as a result of Year 2000 failures (or prospective failures) should flow from an action for breach of contract, not tort.

The Act attempts to codify additional elements of the economic loss rule adopted by many states, with regard to losses to property. Under the Act, economic losses resulting directly from damage to tangible personal (3) or real property caused by a Y2K failure may be recoverable. On the other hand, the Act prohibits award of economic loss damages relating to the property that is the subject of the parties' contract; or, where there is no contract, relating to the property that experienced the Y2K failure.

Punitive Damages Limited for Small Businesses

The Act further protects small businesses by capping exposure to punitive damages (4). Punitive damages assessed against a small business cannot exceed the lesser of three times the amount awarded for compensatory damages or $250,000. The cap applies both to individuals with a net worth of less than $500,000, and to small businesses with fewer than 50 full-time employees. No cap will apply, though, if the plaintiff is able to show by clear and convincing evidence that the defendant acted with specific intent to injure the plaintiff (5).

Distributing Loss Through Proportionate Liability

The Act will allocate damages, in non-contract cases, among defendants by an assessment of "proportionate liability." Under this proportionate approach, a jury will determine the varying degrees of fault for each defendant with regard to the particular Y2K injury at issue. In determining the proportionate shares of responsibility, the jury (or the court in the absence of a jury) will evaluate both the nature of the conduct of each defendant and the strength of the causal link between the defendant and the resulting damages. Thus, if the defendant's relationship with the plaintiff was tenuous or if the defendant's conduct did little to cause the resulting Y2K injury, then the defendant will bear a smaller share of the Y2K liability.

Proportionate liability under the Y2K Act largely replaces "joint and several" liability in Y2K actions. Joint and several liability imposes full liability for all of a loss on each individual tort defendant. Ordinarily, a tort plaintiff can, if necessary, recover all of the damages awarded from a single defendant, even if that defendant was responsible for only a small share of the damages. Under the proportionate approach of the Y2K Act, plaintiffs normally will be able to recover only partially from defendants that share responsibility for a loss. The Act also creates safeguards that will allow a disappointed plaintiff to return to the court, if the plaintiff cannot recover payment from certain defendants, to demand that the court require additional - albeit limited - payments from the other, paying defendants.

Joint and several liability is prescribed, however, where a jury in special interrogatories, or the court in its findings, determines that the defendant acted with specific intent to injure the plaintiff, or knowingly committed fraud. Recklessness alone will not trigger joint and several liability. Under the Act, reckless conduct does not constitute either an intent to injure, or the knowing commission of fraud, and so will not trigger joint and several liability.

PROCEDURAL PROTECTIONS

The Y2K Act creates procedural mechanisms to protect a potential Y2K defendant. A plaintiff must now give a "pre-litigation notice" prior to filing a Y2K lawsuit. Additionally, the Act imposes a period during which defendants are afforded an opportunity to remedy Y2K problems before the filing of suit by a plaintiff. If this pre-litigation notice is not provided, and a defendant is sued, the defendant may treat the complaint as the required notice and the court will stay further proceedings, including discovery, until the statutory period to correct the Y2K problem has elapsed.

Notice and Response Provisions Allow an Opportunity to Remedy Y2K Problems

The pre-litigation notice required by the Act must inform the prospective defendant of:

• any alleged material defects
• the harm or loss suffered by the prospective plaintiff
• how the prospective plaintiff would have the prospective defendant remedy the problem
• the basis upon which the prospective plaintiff seeks that remedy, and
• information about any individual who has authority to negotiate a resolution of the dispute on behalf of the prospective plaintiff

ADR Is Encouraged by Y2K Act

In an attempt to stem a flood of Y2K lawsuits, the Y2K Act makes the use of alternative dispute resolution (ADR) more appealing. One of the stated purposes behind the cooling-off period imposed by the Act is to encourage the parties to engage in ADR.

Within 30 days of receipt of the notice, the prospective defendant must inform the potential plaintiff how the defendant will remedy the problem and whether the prospective defendant is willing to engage in ADR. The defendant is then granted 60 days from the end of the 30-day notice period to complete the specified remedial action or ADR (6). During this time, the plaintiff is not permitted to file suit against the defendant.

Special Pleading Requirements Are Imposed

If the cooling-off period fails, and the plaintiff files a lawsuit, the plaintiff will have to comply with certain pleading requirements. A complaint filed in a Y2K action must include specific information about the damages claimed, and about any material defect in a product or service. When an element of a claim is a defendant's particular state of mind, the facts giving rise to a strong inference that the defendant acted with that state of mind must be specially pleaded.

Limitation on Class Actions

The Act envisions that most Y2K class actions will be tried in state courts. Before a Y2K class action may be tried in federal court, the amount in controversy must exceed $10 million, computed on the basis of all claims in the action, and the plaintiff class must consist of at least 100 members (7).

Most significantly, Y2K suits may be maintained as class actions only if the court finds that the alleged defect in the product or service would be a material defect for a majority of the members of the class. A material defect for purposes of the Act is one that substantially prevents the product or service from functioning according to its design or specifications. Not covered are defects that insignificantly affect the product or service or affect only a component if the whole item substantially continues to operate as designed.

ADDITIONAL PROTECTIONS

Bystander Liability Curtailed

The Act raises new protections for those implicated in Y2K actions who are mere "bystanders" - such as a corporation's officers or directors. A defendant in a Y2K action for money damages who is not the manufacturer, seller or distributor of a product, or the provider of a service, who suffers or causes the claimed Y2K failure, is afforded certain protections by the Act. Where such a defendant - a mere "bystander" - is sued in a Y2K action, and an element of the plaintiff's claim is the defendant's actual or constructive awareness of an actual or potential Y2K failure, the plaintiff must prove that the defendant actually knew, or recklessly disregarded, a known or substantial risk that such failure would occur. This defense does not apply if the parties are in "substantial privity" (8); nor does the defense apply to negligence claims. The defense does apply to claims such as fraud, breach of fiduciary duty, and interference with contract or economic advantage.

Certain businesses, such as commercial property owners, may benefit from another provision of the Act. Under the Act, liability for a Y2K failure cannot be based solely upon a defendant's control of a business, facility, system, product or component. "Control," under the Act, includes sale, lease or rental. Thus, the mere fact that a property owner controlled a facility would not, of itself, be enough to make that property owner liable for a Y2K failure that occurred inside that facility.

"Y2K Upsets" - Limited Regulatory Exemption

The Act creates a limited defense for a "Y2K upset," defined as an "exceptional temporary noncompliance with applicable federally enforceable measurement, monitoring, or reporting requirements directly related to a Y2K failure." An entity that suffers a Y2K upset - a temporary lapse in its regular federal reporting - will be protected from liability. The defense is limited, however, in several important ways: the length of the Y2K upset generally may not exceed 15 days; the defense does not include reporting failures that would threaten public health, safety, or the environment; and, the defense does not cover reporting glitches when reports are needed to ensure the soundness of the banking system or the integrity of the securities markets.

Special Y2K Protections for Small Businesses and Homeowners

The new law creates special protections for small businesses and homeowners. The Act provides that a small business may avoid certain civil fines if, for the first time, the small business breaches federal regulations due to a Y2K failure (9). A small business may not claim this special exemption if the business violated the federal regulation within the preceding three years, or if the small business did not make reasonable efforts to avoid the Y2K failure that caused the violation. Once the small business is aware of the violation caused by the Y2K failure, the small business must notify the appropriate agency within five days, and it must take prompt measures to correct the violation. This special exemption does not extend to Y2K failures that cause actual harm or threaten public health, safety or the environment; nor does this exception apply to regulatory violations caused by Y2K failures after December 31, 2000.

Homeowners are also given some protection by the Act. If a residential homeowner cannot make a mortgage payment due to a Y2K failure, and gives the mortgage servicing company notice of the Y2K failure, the homeowner will have an additional grace period before any foreclosure proceedings can begin.

Act Encourages All Businesses - Large and Small - To Make Reasonable Year 2000 Preparations

Finally - and most importantly for the thousands of businesses preparing for the Year 2000 - the new law expresses Congress' expectation that businesses will make reasonable preparations for the Year 2000. The Act's intent is to encourage Year 2000 preparations, and the Act leaves intact the special protections that last year's federal legislation, the Year 2000 Information and Readiness Disclosure Act, gave to companies that exchange information as they rush toward Year 2000 compliance. The new Act also makes it clear that if businesses do not make reasonable preparations for the Year 2000, they will find it difficult - if not impossible - to successfully sue others should Y2K failures occur (10).

CONCLUSION

The unique nature of the Y2K problem compelled the proponents of the legislation to fight vigorously for its passage. Fearing a tide of frivolous lawsuits and unlimited punitive and economic damages, the sponsors of the legislation found need to carve out real and potential Y2K failures for special treatment in court.

At the same time, opponents of the various bills - including the White House - warned that the wrong message would be sent to the business community. Opponents feared that businesses would feel free to reduce, delay or even cease remediation efforts with the cap on liability and damages provided by the legislative proposals. The concern was also expressed that by creating a special category of contract and tort jurisprudence, the law of unintended consequences would add further uncertainties and complexities to an already uncertain and complicated problem. In the end, the legislative compromises allowed the Act to pass both houses of Congress by wide margins.

On July 20, 1999, the President signed the measure, but he expressed something less than full faith in the results to be achieved by the Act. President Clinton concluded his signing statement with the following:

I hope that we find that the Y2K Act succeeds in helping to screen out frivolous claims without blocking or unduly burdening legitimate suits. We will be watching to see whether the bill's provisions are misused by parties who did little or nothing to remediate in order to defeat claims brought by those harmed by irresponsible conduct.

In the remaining days of 1999, I hope that the business community redoubles its efforts at remediation. Preventing problems before they start, and developing contingency plans when necessary, are still the best solutions to the Y2K problem.

• The authors note with gratitude the assistance of Colleen Gillis and Brandon Elledge, summer associates with Holland & Knight, in preparing this analysis.

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1. The legislation as passed and signed provided that the Act's short title is to be the "Y2K Act," the short title in the Senate bill, S.96; H.R. 775, the bill that ultimately passed both houses (as amended) was to be known as the "Y2K Readiness and Responsibility Act." Both names are used but the official short title remains the "Y2K Act."

2. This provision codifies the rule, recognized under many state laws, that a party that has suffered only economic damages may recover those damages under contract, not tort, law. See H.R. CONF. REP. NO. 106-212, at 5072 (1999).

3. Some defendants may argue that damage to data caused by a Y2K failure does not constitute damage to tangible personal property.

4. To obtain punitive damages in a Y2K action, where permitted by applicable law, the plaintiff will have to prove the claimed tort, and the predicate for punitive damages, by clear and convincing evidence.

5. The Act also reiterates that punitive damages may not be awarded against a government agency.

6. The prospective parties may change the length of the 60-day remediation period by written agreement.

7. The Act also requires that the class members each be given certain notices concerning the nature of the action, the jurisdiction where the case is pending, and the fee arrangements with class counsel.

8. "Substantial privity" essentially means having a contract or being a named beneficiary of a contract between two or more other parties.

9. As with "Y2K upsets" (discussed above), this protection does not apply if the federal regulation at issue relates to the soundness of the banking system, or to the integrity of the securities markets.

10. Under the Act, a plaintiff in any Y2K action bears the duty to mitigate its damages. This is in addition to any duty to mitigate imposed by state law. This requirement exists in the absence of actual harm - the anticipation of harm is enough to trigger the duty. Moreover, while the duty to mitigate arises without reference to any action by the seller/defendant, it may bar an award of damages in cases where the defendant has offered to correct an actual or potential Y2K problem at no or minimal cost.