Summary of Contents
Authors
Ward K. Branch
Branch MacMaster Barristers & Solicitors
E-mail: wbranch@branmac.com
Richard J. Berrow
Russell & DuMoulin Barristers & Solicitors
Class actions greatly alter the balance of power between corporations and consumers. Actions that previously could not have been brought because legal fees would overwhelm any potential award suddenly make sense.
Class actions have been available in B.C. since 1995. They are also available in Ontario and Quebec.
Class actions work by creating a powerful incentive: fees for class action counsel.
In a traditional action, an individual consumer would have difficulty finding a lawyer to bring a lawsuit in which the potential recovery is less than $10,000, particularly where the defendant will be a large multinational corporation. There would be no benefit for the lawyer taking the case on a percentage basis, and it is unlikely that the prospective plaintiff would be able to pay the lawyer's hourly rates. (Moreover, the consumer would face the risk of having to pay the defendant's costs, should the action fail)
However if one thousand people have suffered the same $10,000 problem, the case suddenly becomes a $10 million lawsuit. At this level, if the lawyer can represent all one thousand, he or she would certainly be interested in a contingency fee arrangement. The class action gives the lawyer the ability to act for all one thousand at the same time.
To proceed as a class action, the case must receive court approval. Five requirements must be met:
The Y2K issue presents a spider's web of litigation opportunities. Businesses have become extremely interdependent as a result of the trend toward outsourcing, teaming and just-in-time delivery systems. The failure or slow-down of a single link in a production and distribution chain may create multiple levels of harm and liability.
Many of the types of litigation that will develop from the Y2K problem could not be brought unless they fit the class action framework. The interference or loss to any individual may be too small to sustain an individual lawsuit against a large corporate defendant. As we will see, many of these actions will fit the class action framework. This paper examines the possible areas of litigation, and in which areas class actions are likely to develop. Particular focus is placed on the prospects for products liability actions.
The most obvious targets of Y2K litigation are software and hardware vendors. The types of claims that may be advanced include:
A contract exists between the vendor and purchaser of software or hardware. Naturally the contract is the first place for dissatisfied purchasers to look for ground to sue. The contract may contain performance specifications. Also, the Sale of Goods Act (or equivalent legislation in other jurisdictions) contains a set of standard terms that are deemed to be included in every contract within the scope of the Act, including a warranty that the goods are fit for their intended purpose.
Any Y2K problems with software and hardware may be viewed as a breach of express, implied or statutory warranties of fitness. Express warranty claims will focus on advertising materials, brochures, or other written documents to show that a product failed to operate as promised or expected. The express warranty and Sale of Goods Act claims are powerful, in that it is not necessary to prove negligence. In relation to the statutory claims, the plaintiff need only establish that the product was not fit for its intended purpose (i.e., a purpose that was expressly or impliedly made known to the vendor). These statutory warranties cannot be avoided in contracts with purchasers who do not intend to use the product for business purposes. The Sale of Goods Act can only be invoked by a purchaser suing a vendor with whom the purchaser has a contract, and the contract must be for the sale of goods, not the provision of services (such as programming). The plaintiff wishing to sue a manufacturer, rather than the vendor from whom the plaintiff acquired the product, could allege that an express or implied warranty was issued directly from the manufacturer to the end use through sales material and advertising, forming a collateral contract (the consideration being the inducement of the consumer to purchase the manufacturer's product from the retailer).
Off-the-shelf software packages often enclose limited warranties and disclaimers or limitations of liability. Whether such limitations of liability are effective has been the subject of litigation and commentary in the United States, where the position seems to be that a disclaimer will be effective only if the purchaser has an opportunity to read it before purchasing the product, or to return the product for a refund after opening the package and reading the disclaimer. Not uncommon is the limitation of liability to an amount equal to the price of the product. The purchaser's exposure to loss in the event of a failure could be many times greater. If the court finds that the product was so fundamentally flawed that the purchaser did not get what it paid for, it may be possible to avoid the impact of such disclaimers.
An end user who cannot point to any form of express or implied contract with the manufacturer may have the option of a claim in negligence. In certain circumstances the law will impose a duty of care on one person to look out for the interests of another, even in the absence of a contract.
Where the plaintiff's loss is purely economic, as opposed to personal injury or property damage, showing that the defendant owed a duty of care is difficult. The law does not offer general protection for purely economic interests between parties without a contract. However, there are a number of possible ways to cross the threshold and gain the protection of a non-contractual duty of care.
One way is to show that although the loss was purely economic, under the circumstances the parties had a close relationship similar to a contractual one and deserving of the same legal protection. The legal test for establishing such a relationship is highly uncertain. Y2K litigation might well make new law in this area. As the law now stands, the one well-established basis for recovery in negligence of pure economic losses is negligent misrepresentation. That theory becomes available where the defendant made a representation to the plaintiff in advertising or packaging material, for instance that the plaintiff relied on to its detriment in some manner, for instance in going to a vendor to buy a product manufactured or distributed by the defendant. A representation that the product will take the purchaser into the next century could serve this purpose.
Non-contractual recovery for pure economic loss is also available for fraud. In cases where the defendant's statements were made without an honest belief in their truth (i.e. deliberate or reckless falsehood), it may be possible to make out a case for fraud.
Another way to cross the threshold would be to show that the loss to the plaintiff is not purely economic but is in fact a form of property damage. The law is more receptive to economic loss claims based on a tangible loss, in the form of property damage or personal injury ("consequential" rather than "pure" economic loss). In some circumstances a software failure can cause tangible loss. What about the loss of data alone? Is the loss or corruption of electronic data itself, without tangible consequences, a form of property damage. The one Canadian case on point says no. In Seaboard Life v. Babich, a trial judge refused to award damages to a life insurer that lost data as a result of a power failure caused by the defendant's truck striking a power pole nearby. No Canadian or other authority was cited for the conclusion that the loss of data constitutes only economic and not physical damage. The Court did recognize that in some other, undefined circumstances electronic data might constitute property. It would not be surprising to see this finding overruled, but in B.C. at least a decision of the Court of Appeal may be required.
In a similar U.S. decision, the purchaser of a defective disk drive failed to recover for the loss of data stored on the disc drive: Transport Corp v. IBM. The court took the view that the data was "integrated" into the disc drive. Apparently, the rule against recovery (outside of contract) for pure economic loss in the form of a defective product also precluded recovery for loss of other property integrated with it (in the law of Minnesota, at least). Like the Seaboard Life decision, this case can be criticized for failing to recognize the modern commercial reality that electronic data has a life of its own, separate from the hardware that stores and processes it.
Having crossed the economic loss threshold (in one way or another), the key issue in any negligence claim will be whether the defendant met whatever standard of care the court chooses to apply. This will typically be the standard evident in the industry, although courts occasionally rule that even a well established practice does not meet the standard of care required in the circumstances.
Given the change in industry practice relative to the Y2K issue, litigation may centre on when the industry standard changed from two digit to four digit coding. It may also involve an assessment of whether the manufacturer was reasonable to assume that their software or hardware would no longer be in use by Y2K.
There are American authorities to which Canadians can look for support for the underlying claims against the manufacturers. In The Glovatorium Inc. v. NCR Corp. the court confirmed an award of punitive damages against a computer vendor for intentional misrepresentation of a system's performance. In Sierra Diesel Injection Serv. Inc. v. Burroughs Corp., the court found a warranty disclaimer in a computer sales contract ineffective to limit liability of a computer vendor for breach of warranty.
Several of the first individual Y2K actions against software manufacturers in the U.S. have reportedly been settled by the manufacturers.
The key question for class action certification will be the extent to which the case presents common issues, the resolution of which will substantially advance the litigation (relative to whatever individual issues may remain).
CLASS ACTION POTENTIAL: High for off-the-shelf software and hardware. Low for custom software.
Several class actions concerning off-the-shelf software products have already been commenced in the United States. The Defendants in these actions include:
This was the first company to be hit with a Y2K related class action in the United States. The action alleged that the defendant improperly required customers to pay substantial fees to purchase upgrades in order to obtain software that was Y2K compliant. The defendant has settled the class action by promising to provide a free patch and agreeing not to oppose attorneys fees of up to $565,000 for plaintiff's counsel. Under the terms of the settlement announced October 13, 1998, the defendant will provide a free "Century Date Kit" to users of the Pro Series 3.0i and Vision Point 8.1 software, and give discounts on Y2K upgrades to owners of prior versions. The court must approve the agreement.
The class action in relation to this accounting and business software has reportedly been settled in exchange for Realworld's provision of Y2K compliant free modules and discounts to licensees of early versions of the software. The upgrade will be made available through a special website. Customers who already purchased a Year 2000 compliant version prior to the class action suit will have the ability to receive a 50% discount on the list price of the software.
Class action by doctors alleging that version 7.0 and 8.1 were not compliant. The complaints alleged that Medical Manager was charging $10,000 for the Y2K complaint version 9.0 of the software. The software is a management system that covers patient care, clinical, financial and management applications. The complaints alleged that the functions were critical to patient care and could endanger patients if not corrected. Functions included: patient flow tracking for radiology, quality care treatment guidelines based upon the patient's age, sex and other factors, prescription tracking, and laboratory interface. The defendant has settled this litigation. Approximately half of a $1.455 million settlement pool is set to be allocated to pay the fees of the nine law firms representing the various proposed representative plaintiffs. Licensees of non-complaint version going back to version 7.0 will receive a free, newly created version 8.12, which is compliant. Licensees who upgraded to version 9.0, which is also compliant, may choose to receive a free software module or share in the settlement pool. The class settlement has been approved. This approval has substantive implications for the prospects for class certification since U.S. courts were recently instructed by their Supreme Court not to lower the threshold for class certification in cases involving settlements.
Voice-processing system and computer-telephone integration product challenged as non-compliant.
Circuit City, Fry's Electronics, The Good Guys, CompUSA, Office Depot, Staples and OfficeMax: This is a class action on behalf of customers of major retailers of personal computer-related products. The complaint alleges deceptive sales practices and the sale of unnecessary Y2K upgrades, and seeks to cause the retailers to: 1) post signs with a toll-free number to call for compliance information; 2) cause their employees to tell people when a product is not compliant; 3) put Y2K compliance information in their marketing materials; 4) offer 50 percent discounts on fixes; 5) pay the plaintiff's attorneys' fees.
Software attacked is a dealership management and accounting system. Defendant allegedly informed dealers that the software contained a Y2K defect in October 1997, and that it would terminate existing service and maintenance contracts on December 31, 1998.
Plaintiff's allege that accounting software prior to version 7.0 is non-complaint. Plaintiff also alleges that the user manuals represent that the software will be able to handle Y2K.
The action is brought on behalf of all persons and entities who purchased Norton AntiVirus software prior to Version 4.0 (which was introduced in September 1997). Symantec officials have replied they charge an additional fee for a software upgrade that includes a Y2K fix because the upgrade software contains several substantial technological advances beyond the Y2K capability. This fails to answer the question why a separate (and free) Y2K patch is not provided to customers.
This software manufacturer is being sued for allegedly selling version 4.0 of its popular Procomm Plus memory management software for Windows 95 between November 1996 and July 1997 without disclosing its non-Y2K compliant status.
Action alleges that Micron produced non Y2K complaint motherboards and is now requiring purchasers of the PCs to pay $79 for motherboards that will remedy the defect. The plaintiffs seek damages and a court order requiring Micron to provide the Year 2000-compliant motherboards at no charge and to refund monies customers have already paid for them.
Action involving defendants copier and telephone billing systems called "Equitrac Disbursement Teletrac". The upgrade allegedly costs an additional $2000. The plaintiff in one of the lawsuits is a law firm. The complaint alleges that the Defendant's system maintenance agreement requires it to ensure that the customer's system is Y2K compliant. The contract apparently requires the Defendant "to keep the Equipment and Software in, or restore the Equipment and Software to good working order."
The challenged software performs cash register, inventory and account management functions. The judge rejected the defendant's request for a six-month stay, noting the plaintiff's contention that the software could fail as early as January 1, 1999.
Action against "Big Blue" for the Y2K non-compliance of a bundled hardware and software packing that is used by over 11,000 medical offices, which costs approximately $20,000 each. The Defendants allegedly disclosed the plaintiffs about their product's non-compliance in December, 1998.
Software for the garment industry. The applicable license calls for a term of 50 years. However, Garpac Corp has allegedly already advised class members that the software is not Y2K compliant.
Class action against telecommunications provider claiming violations of New Jersey's unfair trade practices statute, and breach of warranty.
Defendant is manufacturer of the SoftDent Practice Management System, a dental office management software program. The Plaintiff seeks an injunction requiring the defendant to provide an update free of charge.
This class action alleges that members of the class, who purchased credit card processing equipment from defendants, were each improperly assessed charges of $80.00 by defendants for Y2K remediation work.
The Macola Progression Series Software Version 6.0 is used in manufacturing and enterprise resource planning. The action was dismissed on the basis that the company had met all of its contractual obligations.
Intuit has been hit with lawsuits on behalf of all purchasers of Quicken releases 5 and 6 for Windows, and versions 6 or 7 for Macintosh. The action alleges that customers will have Y2K difficulties with online banking functions. The actions seek damages and injunctive relief to compel Intuit to correct all problems without charge. After the action was filed, Intuit promised to provide a free fix. The initial complaints in California and New York were then dismissed on the basis of: 1) prematurity, and; 2) failure to give an opportunity to cure under the relevant consumer statute. The plaintiffs were given leave to amend. An amended complaint has been filed in California which emphasizes the problems users will have using non-compliant versions prior to January 1, 2000. For example, the complaint alleges that Quicken users will not be able to schedule online payments in advance for dates beyond January 1, 2000. The complaint also alleges that the free fix is insufficient remedy because Intuit could rescind the offer at any time, the offer was not broadly publicized, and some class members have already paid for an upgrade.
Action alleged that the database development tools in FoxPro 2.5-2.6 and Visual FoxPro 3.0 were non-compliant. The plaintiff stated in her complaint that these FoxPro versions were defective because the default date setting was a two-digit, rather than the Y2K-compliant four-digit, field. The software had a four-digit date field option, but it needed to be turned on. Further, the plaintiff stated that a user who mistakenly entered a two-digit figure into the four-digit field would not be notified of the error. This action was dismissed on March 16, 1999. The court held that the action lacked merit because the plaintiff could not establish that an inherent defect existed in the software. The court said that, because the program at issue could be configured by the user to eliminate Year 2000-related miscalculations, the ills complained of by the plaintiff were the result of human, not computer, error. The court said that no defect existed because the FoxPro versions in question are Y2K complaint and come with instructions clearly detailing how to employ four-digit date fields:
There is nothing inherently wrong with computer software that assumes a two-digit year entry means the Twentieth Century, particularly when the default setting is disclosed as part of the contract ... Moreover, FoxPro is Y2K compliant: a developer can use the Century On feature to provide a four-digit year field when a client needs an application that will process dates occurring later than Dec. 31, 1999 something, we assume, is occurring with greater frequency as that date approaches.
Furthermore, the court said, if two digits are mistakenly entered into the four-digit year field, "it is human error, not program error" that would result in a date processing error. "Such human error cannot be attributed to Microsoft," the court said. The court noted that the Plaintiff's remedy was to return the FoxPro software within the warranty period to the store for a refund had she wanted a program that featured a four-digit date field as the default, which reading the instructions would have told her was not the case with the FoxPro versions in question.
Kaczmarek claims it was unreasonable to expect her to read the 2,200-page manual within the 90-day period, but this argument is neither here nor there; a party's failure to read a contract is not a reason to invalidate the contract..In any event, there is nothing unreasonable about expecting computer professionals to familiarize themselves with software particularly something as basic as date fields when the Y2K problem has been so prominent within 90 days.
The court concluded stating:
As we near the Twenty-First Century, the media has focused on many potential Y2K problems," the court said. "This focus will inevitably lead to much litigation ... which the courts will need to determine is meritful or meritless. Unfortunately for the plaintiff, we find this lawsuit falls in the latter category.
Obviously the software industry has a shield against class action suits: offer the Y2K fix for free. As one lawyer has stated:
If I buy a television and the tube has a defect, the manufacturer doesn't tell me to buy a new television with a more advanced picture tube. They fix it. That's the way of the world.
If manufacturers intend to offer a free fix, there is an incentive to do so quickly. If the manufacturer waits until after a class action is commenced, it may be characterized as a settlement proposal that must be managed through the class action (with the accompanying fees payable to the plaintiff's counsel). Once a class action is certified, there are restrictions on the extent to which defendants may communicate with class members.
The potential for class certification would seem quite high given the uniformity of software versions, and the Canadian court's welcoming attitude towards products liability class actions. There are several Canadian precedents approving class action litigation for product defects: Bendall v. McGann; Harrington v. Dow Corning; Doyer v. Dow Corning (breast implants); Tremaine v. A.H. Robins (Dalkon shield); Endean v. Canadian Red Cross (blood products); Chace v. Crane Canada (cracking toilets); Campbell v. Flexwatt Corp. (heating panels); Assoc. des Consommateurs de Quebec v. WCI Canada (clothes dryers).
Note that class actions have been approved even where the damage involves personal injury (which is inherently more individual than property damage or pure economic loss). Very few products liability cases in each jurisdiction have been rejected.
Certain U.S. commentators have suggested that certification is not inevitable. Defendants in Year 2000 suits may invoke the following arguments to defeat certification:
With custom software or hardware, the prospect of class action litigation is reduced. Any problem will be unique to the commercial relationship between the two particular parties. There will be no "common issues" to resolve within such litigation that are applicable to others.
The potential for Y2K difficulties is not restricted to the computer on the desktop. Microprocessors ("embedded chips") in clock radios, microwave ovens, and a host of other consumer products may also be affected.
The types of legal claims that may be advanced in this context are the same as those available against the software and hardware manufacturers. Again, in the absence of some form of contract between the parties, the plaintiff may face difficulties in mounting a negligence claim for pure economic loss, as distinct from property damage or personal injury.
CLASS ACTION POTENTIAL: High.
One of the first Y2K-related proceedings in the U.S. did not involve a desktop or mainframe computer. It involved a cash register. On August 6, 1996, the Produce Palace grocery chain filed an action against its cash register vendor TEC America Inc. and the point of sale service provider. The cash register failed to identify credit cards with post-1999 expiry dates. The case has been settled for $260,000.00.
There will be little effort to correct these consumer product problems in advance of Y2K at least for low-cost consumer products. The cost/benefit analysis does not warrant action being taken. Sending a service agent out to correct and diagnose a Y2K problem in a $19.99 clock radio simply doesn't make sense. However, given the ability to aggregate small claims through class action litigation, manufacturers will not necessarily be able to escape unscathed any longer. They may well be held to account by plaintiff's counsel.
What are the implications for directors and officers of corporations with Y2K exposure? The possible exposure fall into two categories: claims in the name of the corporation itself for breach of the duties of care and loyalty associated with managing its affairs, and claims by shareholders. This section addresses the first type, while the following section examines shareholder actions.
Directors have a duty to act with the care, diligence and skill of a reasonably prudent person in exercising their powers to manage the affairs of the company. Where the director has acted negligently, the company can sue the director to recover its loss. Generally speaking, the shareholders themselves cannot. However, a shareholder can apply for and obtain the leave of the court to bring a "derivative action" in the name of the company (against a present or former director, or anyone else whom the company has a right to sue) where the company has refused to do so.
Mismanagement of the company's Y2K affairs, bringing loss to the company, could attract a negligence action against its present or former directors, directly or as a derivative action. Loss to the company can of course take the form of third party exposures where others have been affected by Y2K non-compliance of the company's own operations or products.
Generally speaking, the courts apply a "business judgment rule" calling for some judicial deference to the business decisions of corporate directors (so long as the directors have not breached their duty of loyalty, discussed later).
a) Failure to Adopt an Adequate Remediation Plan
If a corporation's competitors are assessing and addressing the Y2K problem or if its competitors are already Y2K complaint, the directors and officers of a corporation who have not addressed the problem may have failed to meet the applicable standard of care. As a result, they may be jointly and severally liable for breach of fiduciary duty. Similarly, adoption of an inadequate or tardy remediation plan could attract liability.
In terms of ensuring that the legal standard is met, one author recommends the following:
Management will have to demonstrate that, once informed of the problem, they appropriated the necessary investment for the technical fixes to be made, ordered a full risk assessment (including economic, safety, and organizational factors), and established a contingency plan to handle crises created by the Year 2000 fallout. The minutes of top management meetings and boards of directors' meetings will be scrutinized to determine whether care was taken to correct or minimize the problem. A successful defence also will include management's insight into the health of the company's key vendors and suppliers, to avoid second-hand infection by trading partners.
Claims may also challenge management decisions in relation to the retainer of Y2K remediation service providers and contractors.
The publication of the Call for Action document by the Year 2000 Task Force in February, 1998 may be among the key dates used to assess the standard of care. However, certain commentators report that U.S. litigators are referring to an earlier "Dilbert" standard, in light of the fact that "Dilbert" cartoons discussing Y2K were apparently published as early as 1995.
Management decisions concerning remediation planning should receive some protection from the business judgment rule, so long as they have in fact exercised their judgment rather than just ignoring the problem. Management of one company might, for instance, decide that the point of diminishing returns has been met and the risks brought to an acceptable level, though not eliminated completely. Management of another, more risk-averse company might go further in attempting to eliminate risks.
b) Failure to Monitor Third Party Compliance
Directors and officers may be held to account for failing to determine whether the corporation's key suppliers and customers are Y2K complaint, and whether their data interfaces are compatible so that a corporation's compliant systems will not be "reinfected" by a third party's failure to be Y2K compliant and/or to have compatible data.
c) Targets of Mergers and Acquisitions
If a company merges or acquires a company that has substantial Y2K problems, litigation may result. The Y2K compliance of merger targets as well as joint venture partners should be reviewed to determine whether the corporation is receiving a "fair" deal. Suitable representatives and warranties should be sought from merger and joint venture candidates.
The law imposes on directors a fiduciary duty, requiring the director to avoid any conflicts between his or her personal interest and that of the company. Remedies for breach of fiduciary duty can be quite severe. Common examples of fiduciary breach in the corporate world include the director who misappropriates a business opportunity belonging to the company, or causes the company to resist an advantageous take over in order to protect his own position.
Y2K negligence claims will probably figure more prominently than fiduciary claims against directors. However, even in ordinary times the cut and thrust of corporate life inevitably produces temptations for directors, and in one way or another Y2K issues may do as well.
Under Canadian company legislation, a director or any other corporate insider who uses confidential information to trade in the company's securities can be called to account to the company for his or her profit, and required to compensate the company and the other party to the transaction. A director who sells shares in the company after receiving confidential negative information regarding the company's Y2K affairs could be liable to both the company, the innocent purchaser of the shares for the loss suffered on the shares after the information gets out and the market drops, or to the company for the benefit obtained. Conversely, a director who buys shares on the strength of confidential good news can also be liable (but this scenario seems less likely to arise as a Y2K issue).
CLASS ACTION POTENTIAL: None, for injuries to the company itself, since the company itself is the only plaintiff. However, derivative actions (which in Canada are brought in the name of the company) are likely. A derivative action has been commenced in the U.S. against the principals of Medical Manager flowing from the exposure to the company in the aforementioned class action by software purchasers.
If a company's share price falls after public disclosure of Y2K problems, investors may seek a remedy against the company itself as well as its directors, officers, and advisors (including for instance securities underwriters). The complaint will allege that disclosure should have occurred at an earlier date, which would have affected the investor's decision whether or not to purchase or hold the shares. The claim will allege that the company painted an excessively rosy picture of its Y2K compliance.
The exposure in such a lawsuit will be quite different from the action in the name of the company itself, discussed above. First, the action can be brought partly against the company itself, putting the company's own assets at risk. Secondly, the investors will not seek losses suffered by the corporation. Rather, the action will seek to recover the difference in the share value between the price at which the shares were purchased, and the value the shares would have had if disclosure had been made in a more timely fashion.
These types of securities lawsuits are one of the most popular areas for class actions in the United States. Any substantial drop in share price will often by accompanied by a flurry of class action filings. The economic pressure created by these actions can be overwhelming. Rather than having the actions looming over its head, the company will often settle the lawsuit while complaining of "corporate blackmail".
U.S. companies have been told by their regulators to discuss Y2K issues as part of compliance with continuing disclosure obligations. In Canada, the Canadian Securities Administrators have also recommended disclosure. Failure to make proper and prompt disclosure may be providing class action plaintiff's counsel with an easy (or at least a tempting) target.
The defendants in investor actions may include auditors and other outside advisors, particularly if the ability to recover from the company itself has been placed in jeopardy by the Y2K problem.
CLASS ACTION POTENTIAL: Medium to high.
Bill Lerach is the leading securities class action counsel in the United States. He has stated his intention to attack any management team that fails to ready its company's computer systems for Y2K and suffers financial consequences as a result:
If the company's operations are affected, and the company has not adequately disclosed that, there's no question that a suit can be filed for failing to disclose the material fact... Similarly, if a company's management fails to address the issue, it's absolutely clear that if something bad happens, they can be sued for breach of fiduciary duty.
Y2K-related securities class action litigation has already begun. Bill Lerach's firm has filed a class action against PRT Group Inc. alleging the company overstated its Y2K remediation business. A tentative settlement has been reached in the action. A similar lawsuit filed against Command Systems Inc. was settled for $5.75 million. The settlement fund less attorney's fees will be distributed to shareholders who purchased the common stock between March 12, 1998 and April 29, 1998.
Another lawsuit by Lerach's firm against Micro Focus alleges that as part of its merger with Intersolv. Inc., Micro Focus intentionally withheld information regarding the defection of members of its Y2K staff. Micro Focus offers Y2K products and operations. The price of the shares dropped when it was announced that the sales of the merged company would be below expectations as a result of the loss of the key personnel. Peritus Software, a Y2K remediation software manufacturer, and certain of its officers and directors have been hit with a class action for failure to disclose certain facts regarding a takeover target. Medical Managers' directors and officers, have been sued by shareholders on the basis that they misrepresented the life span of the software in an initial public offering in 1997.
Shareholder class actions in the U.S. are assisted by a civil statutory remedy in the U.S. Securities Act preventing misleading statements about listed companies at any time, as well as a legal theory grafted onto the statute called "fraud on the market". The fraud on the market theory states that an individual who purchases shares in a public company is presumed to rely on all information available in the market, regardless of what the investor actually read or heard. In other words, even where an individual investor has not relied on the company's disclosure, the price at which he transacts is set by the market which is presumed to have done so. Hence an investor who purchases shares in the secondary market can sue, without having to show personal reliance on the company's disclosure as it existed at the time of the purchase.
In Canada, the civil statutory remedies are limited to share purchases pursuant to a prospectus or a take-over bid. In these limited situations there is deemed reliance by investors. The fraud on the market theory has not yet been adopted in Canada for the benefit of purchasers in the secondary market and indeed has been expressly rejected in one Ontario decision (where the plaintiff invoked it to support a certification application): Carom v. Bre-X. If that decision remains the law in Ontario or is followed in other provinces, applications to certify secondary market class actions will face a significant obstacle. The statutory deemed reliance rule should make class actions easier to certify, where it applies. Unless Canadian law changes, secondary market investors will have to rely on traditional common law remedies in which each individual investor must show that he or she relied on and was misled by a some representation which constituted a material misrepresentation or nondisclosure. Hence, there exists a sharp distinction in Canada between statutory (prospectus) and common law (secondary market) plaintiffs. Legislation is being considered by the Canadian Securities Administrators that would bring in U.S. style remedies.
To date, investor class actions in Canada have had mixed results. Class actions were approved in Peppiatt v. Nicol and Maxwell v. MLG Ventures Ltd., but denied in Abdool v. Anaheim Management Ltd. Maxwell involved a situation where the statutory deemed reliance rules applied. The key problem raised by the court in Abdool in rejecting the action was the need to establish reliance on the misrepresentation in each individual case.
Some further guidance on this issue should come from the ongoing Carom v. Bre-X litigation. If this case is certified, the market for investor class actions will expand dramatically. If it is defeated, it will likely deter such actions unless and until Canadian legislatures pass new proposed legislation containing U.S.-style remedies.
Companies may rely on existing or new outside contractors to assist in correcting Y2K problems. Certain outside companies have advertised their ability to solve Y2K problems. If these efforts are unsuccessful, what remedies are available?
Claims against these vendors could include contractual breach, negligent design or negligent misrepresentation. However, an American arbitrator recently found that a systems integrator was not liable to one of its customers for $3.9 million in Y2K remediation expenses. The Plaintiff INCO Alloys Intl Inc. had alleged that the expenses were included in a five-year outsourcing contract entered into with the Defendant ASE Ltd.. The arbitrator found that the 1995 contract did not expressly impose any Y2K obligations on the Defendant. The dispute arose with INCO tried to terminate the contract and halt making substantial payments to ASE.
An action against Arthur Anderson for consulting services was withdrawn in December, 1998 following a mediation.
Any new service vendors will likely take steps to limit or exclude liability for Y2K problems.
CLASS ACTION POTENTIAL: Low, unless the customer itself is a target of a class action suit.
The merits of any litigation against a service vendor will depend on the particular relationship and contract at each particular site, and the particular promises and statements made to each customer. As such, the variable fact patterns are not amenable to a class action by customers a particular service vendor. There may well be litigation, but it is unlikely to be on an individual basis.
However, service vendors may become embroiled in class actions if the customer itself is the target of a class action, since the company itself may seek to pass responsibility along to the vendor.
This may be the most frightening area of litigation for defendants. These claims will not be actions by people who have faulty software or hardware. Rather, these are claims by people who suffer loss because of a Y2K failing within an organization with which they deal.
Retail businesses have a large exposure in this area given their direct contact with a large consumer base. Lost or inaccurate account balances, incorrect interest charges and errant notices of default all could result from Y2K computer problems. Similarly, providers of consumer services, including governments, utilities, telephone and cable television companies, could face a multitude of otherwise small claims aggregated into massive class actions. A more serious example of this type of claim is the potential for transportation disasters.
The good news is that the consumer disruption is likely to be temporary and, while annoying, unlikely to cause individual consumers substantial direct damage. However, the aggregation effect of class actions can make even small claims substantial. The only brake on such claims will be the restrictions on pure economic loss discussed above. Where there is a contract to provide the service however, it should be possible to support a claim.
CLASS ACTION POTENTIAL: High. These actions normally could not be brought any other way given the small value of each individual claim. There will usually be a useful common issue i.e. should the company have done more to protect against Y2K?
There are precedents supporting class actions in this area. Travel class actions complaining of delayed trips or inferior accommodation have been very popular in Quebec. A class action by patients inconvenienced by an illegal hospital strike was both certified and successful on the merits.
It is probably that any such litigation will permeate throughout the chain of supply of the product or service. A company facing a class action be end users will be compelled to attempt to pass responsibility up the chain.
The state of Alabama has already been hit with a variation on such an action. In Miller v. Alabama, the plaintiff alleges the State of Alabama and several of its administrative agencies have failed to deliver essential services -- such as child support payments and food stamps -- and have repeatedly lost personal information necessary for the continued receipt of benefits due to the Y2K problem and other problems with the computers. The suit seeks to cause the state to appropriate sufficient funding to remediate all of its noncompliant systems.
The issue of insurance is dealt with in greater detail elsewhere in these materials. However, given the litigation implications, the issue is reviewed here in general terms.
Companies obviously wish to share the risk of Y2K litigation. Risk sharing is usually accomplished through insurance, particularly first party insurance, covering the policyholder's own property (such as property and business interruption insurance), and third party liability insurance, covering claims asserted against the policy holder by others. The extent to which insurance will cover Y2K risks is an uncertain and (in view of revisions to policy language) changing question.
There are two key questions which must be considered:
Question (1) raises a host of issues. Prominent among these is the question of fortuity. As a matter of general principle, insurance is meant to respond to uncertain or fortuitous events, not events that are certain to occur. On the other hand, the insured's own negligence in failing to avoid harm to its own property or to the interests of third parties is meant to be insured. An insurer could argue that at the time a policy was acquired, in say 1999, the insured's Y2K losses had become inevitable. While this position may have some intuitive appeal, it may be difficult for insurers to maintain outside of cases where the insured very clearly ignored or (in the jargon of the law) "courted" the risk. Although the authorities are not numerous, in other contexts Canadian courts have not been notably sympathetic to arguments that the fortuity doctrine removes coverage for even calculated business risk. In the Y2K context, users down the chain from the software manufacturer have different levels of information and knowledge about the Y2K problem. Organizations with well implemented and documented formal Y2K action plans may be in the best position to argue that any damage that they sustained was sufficiently fortuitous to be covered, even if they did not do everything possible to avert it.
Related to the fortuity doctrine is the rule that an insured must, when applying for coverage, exercise the utmost good faith in disclosing everything material to the risk. Failure to meet that standard can (within limits) entitle the insurer to repudiate the policy as a whole. Hence an insured who has reason to know that a covered loss is in progress or has already occurred, and claims are in the offing, but fails to disclose the problem, could face loss of coverage.
Further coverage issues will likely arise under property and business interruption policies. There may be disputes as to whether software and data will be accepted as coming withing the definition of "insured property", or whether the problem qualifies as "physical loss or damage". "Latent defect" exclusions may also apply.
Moving to a consideration of third party liability coverage, it has often been said that directors and officers insurance will furnish one of the main deep pockets in the coming storm of Y2K litigation. As a general observation, it is fair to say that they typical Canadian D&O insurance policy does respond to derivative actions (described above) against officers or directors for negligent mismanagement of the company, so long as none of several exclusions applies (including exclusions for self-dealing and dishonesty).
Liability policies frequently contain a notice provision requiring the insured to contact the insurer when there are "circumstances that could give rise to a claim". Determining when that point in time was reached for a Y2K claim could be contentious.
Many liability insurance policies are "claims made", responding to claims first made against the insured during the policy period (regardless of when the alleged wrongdoing, or the harm, occurred). Also available are "occurrence" liability policies, which respond according to when the harm occurred (or, occasionally, the date of the wrongdoing that caused it). An occurrence policy will respond to a claim asserted after the policy period, if coverage has been triggered by the occurrence having taken place within the policy period. Occurrence policies lend themselves to arguments about when the harm occurred (the "trigger" issue). Trigger issues also arise in relation to first party insurance policies responding to damage to the insured's own property sustained during the policy period. Several possible trigger theories have been suggested in relation to Y2K coverage.
Coverage litigation has begun in the United States. In Cincinnati Insurance Co. v. Source Data Systems and Pineville Community Hospital, an insurer is seeking a declaration that is not responsible for coverage in an individual Y2K action commenced against its insured.
Certain of these issues may be rendered academic if insurers implement express and enforceable Y2K exclusions. European insurers are moving in this direction. Canada's Task Force Report recommends that the insurance community should make the issuance or renewal of an insurance policy contingent on the production of a Y2K action plan. Some Canadian carriers have gone further and introduced exclusions. Others have issued "clarifications". (Insurers cannot, of course, retroactively add Y2K exclusions to previous policies, and for the reasons discussed above, previous "occurrence" policies may afford coverage.)
One remaining option will be special Y2K insurance. Several such policies have been introduced, including directors and officers coverage for Y2K-related securities class action suits. The availability of these products will be limited given their cost, and will generally be suitable only for large multinational corporations. The situation calls to mind the insurance industry's response to pollution risks: after a period of exclusion, coverage has become available, on a specialty basis, for qualified insureds, and at considerable expense.
CLASS ACTION POTENTIAL: Possible, for insurers who do not employ Y2K exclusions, or who employ incomplete exclusions.
The B.C. Court of Appeal has indicated that class actions against insurers may be allowed when the question posed is a discrete issue of policy interpretation found in a standard form insurance contract. However, if the claim relates to a claims adjustment process (such as a presumption against paying accident benefit claims in low impact motor vehicle accidents) certification will likely be refused. Generally speaking the U.S. law on certification of class actions against insurers is not encouraging.
Y2K coverage issues fall somewhere in between. For example, the issue of whether or not Y2K is a fortuitous event may not be a clean interpretation issue. A determination of this issue may depend on the nature of the particular insured's business, and the preparations made to avoid Y2K problems. The more individual the claim, the less amenable it is to class certification. A more suitable issue for certification might be whether, generally speaking, loss of data constitutes property damage within the meaning of a policy, or whether a particular form of Y2K exclusion applies to a particular type of loss.
The losses sustained by the insureds may be great. Assuming there are policies without express Y2K exclusions, there may be sufficient incentive to litigate these coverage issues against insurers, if only on an individual basis.
The ultimate protection from risk is statutory immunity.
Efforts are being made in the U.S. to obtain statutory immunity from Y2K suits. Legislation is being considered at the federal level and in several states. California, Florida, South Dakota, Virginia, Georgia, Nevada, and Hawaii have already passed legislation. The California legislation provides immunity from liability for tort damages to any person or entity, including government entities, for injury arising from information disclosed relating to the Y2K problem. It excludes protection for disclosures that are knowingly false, or where the making of the false representation was grossly negligent. Further, it does not apply to persons or entities that provide Y2K solutions for profit. Similar legislation has been passed at the Federal level, entitled the Y2K Information and Readiness Disclosure Act. The legislation in the remaining states only protects government and its agents from Y2K liability.
No legislative steps have been taken in Canadian to introduce protective legislation. Indeed, a House of Commons committee recommended that the Canada Business Corporations Act be specifically amended to make directors liable for failure to take proper steps to address the Y2K problem. The government rejected the proposal stating that existing remedies were sufficient.
If the Y2K problem is only one-tenth the size predicted, there will nonetheless be a sea of litigation. In most instances, Y2K damages will be caused to groups of similarly situated individuals. Class actions are meant to ensure that litigation by such groups is more economic and efficient.
Peter de Jager has been quoted as saying that "Y2K survival is a competitive advantage". Bill Lerach and his Canadian counsel counterparts are the hunters, stalking the Y2K forest for the weak and ill-prepared. Given the procedural and economic advantages to plaintiff's counsel through class proceedings, there is little doubt that class actions will be the weapon of choice to inflict the pain of Y2K.
