UK: Computer Systems And The Year 2000 - Legal Issues

Last Updated: 1 July 1997
All businesses will now be aware of the Year 2000 date change issue. Many will be carrying out technical audits to assess the scale of the problem and the steps necessary to solve it. It is less likely that many will have appreciated the legal issues involved in making computer systems Year 2000 compliant. This bulletin highlights some key legal implications and the action that companies need to take now to minimise the potential legal risks.

The Challenge For Business

Year 2000 compliance is a challenge for the entire business - not only for the IT department. Companies failing to address the issues in good time risk liability to customers, employees, trading partners, investors and regulatory bodies - not to mention the potential harm to their business in the event of an IT systems malfunction.

There are far-reaching implications which extend across many aspects of a business. For example:

  • Software performance - both existing computer systems and new systems need to be made Year 2000 compliant, against what is already a tight deadline.
  • Date-sensitive equipment - much everyday equipment such as air conditioning systems, bar code scanners, lifts, telecommunications equipment or underground cabling includes 'embedded' date-sensitive software. Any Year 2000 risk audit must take account of this and contact must be made with relevant equipment suppliers as early as possible.
  • Employment contracts - with experience relevant to Year 2000 in huge demand, IT users and suppliers should ensure that enforceable provisions are in place in employment contracts, and consultancy and service agreements, to deter 'poaching' of specialist staff.
  • Insurance - business interruption and disaster recovery arrangements should be reviewed in light of the uncertainties which are bound to apply during the Year 2000 transition. Software houses are being asked by their insurers to enter into revised professional indemnity and product liability insurance arrangements too.
  • European Monetary Union - if a system is being replaced, it may be worthwhile building in EMU compliance at the same time to avoid the costs of a further rewrite within a short space of time.
  • Annual accounts - guidance expected shortly from the accountants' professional bodies may recommend that auditors qualify their reports where adequate compliance plans are not in place.
  • Corporate acquisitions - legal due diligence is required into the Year 2000 plans of any business being acquired. A compliance problem may reduce the value of a deal. This can be a significant issue in share or asset purchases, but may also affect joint ventures, minority investments, and venture capital and loan arrangements. Each party's responsibilities must be clearly defined in the relevant commercial agreements.

Existing Software Systems

As far as existing IT systems are concerned, companies should review past computer contracts to establish whether their third party software suppliers can be held legally responsible to provide compliance. The contract position will rarely be clear-cut.

Can You Bring A Claim Against Your Supplier?

Most existing software contracts and technical specifications contain no express commitments on the Year 2000. Therefore, an analysis of existing agreements will typically centre on so-called 'implied terms' ie unwritten provisions which it is reasonable to apply to the contract. If either packaged or bespoke software is classified as 'goods', standards of 'satisfactory quality' and 'fitness for purpose' are implied by law, so that the supplier may be in breach of those for supplying software which malfunctions over the Year 2000 date change.

Case law indicates that a contract term may also be implied that software will operate past the Year 2000 if "it goes without saying" that that is what each party intended. The crucial test is what the law decides was the parties' intention at the time the contract was signed.

Relevant factors include industry practice, the expertise of both parties, and the expected useful life of the product - which may be based on the depreciation policy adopted for accounting purposes.

Time Limits

Even if a user appears to have a good legal claim in principle, the time limit for bringing the claim may have expired under the six-year rule for contract litigation. The parties will need to consider carefully from when the time period runs; how long it lasts; whether it can be extended; and how the relevant rules for negligence litigation differ from contract litigation.

Limitations Of Liability

Existing agreements are almost certain to contain limitation of liability clauses seeking to restrict the compensation available from the supplier. Users need to consider whether these are enforceable and to what types of losses they apply eg direct loss, consequential loss, wasted expenditure etc.

Support And Facilities Management (FM) Agreements

A software support provider or facilities management company is more likely to be liable to achieve compliance under written terms, because the parties have an ongoing relationship. However, there may be 'get-outs', such as the termination of many support and FM agreements in 1999.

Record-Keeping

Companies which believe they may have a claim against a third party supplier must keep a detailed ongoing written record of the time spent, activities undertaken, and expenses incurred on Year 2000 compliance efforts. These may prove vital in recovering costs in a future action.

Dispute Resolution

Customers who believe they have a strong legal claim can preserve their legal position by putting the supplier on written notice and, if necessary, by issuing a holding writ. However, threatening legal action may prejudice a commercial relationship at precisely the moment when a constructive partnership approach is needed. Alternatively, the parties may wish to invoke non-confrontational dispute resolution procedures to preserve the relationship while sharing costs for getting the compliance job done, but this takes time and will be a distraction from the essential task.

Retrospective Compliance

Many companies are seeking compliance warranties from their IT suppliers for the supplier's past work. From the supplier's viewpoint, such warranties are a one-way variation of the contract with retrospective effect which rewrite the contract with the benefit of hindsight and look to place the entire cost and responsibility of compliance on the supplier. Properly advised suppliers will usually resist signing, but will seek a negotiation instead.

Using Third Party Contractors

Even if a supplier is liable, it may lack the resources to carry out the compliance work within the required timeframe or a customer may wish to engage another contractor with greater expertise. In such situations, the new contractor may require a warranty that the user has the right to grant the new contractor access to the relevant software source codes (which will be owned by the original supplier and will usually be valuable trade secrets).

Going Forward

Clearly, all new software contracts must address Year 2000 issues expressly but it is easier to describe intuitively what is meant by 'Year 2000 compliance' than define it legally.

It is easier to describe intuitively what is meant by 'Year 2000 compliance' than to define it legally

Guidelines published recently by the British Standards Institution state that software is compliant if "neither the performance nor the functionality of the software shall be affected by dates prior to, during and after the year 2000" and then list specific features of such "performance and functionality".

New Contracts

In software arrangements going forward, customers should:
  • include Year 2000 compliance requirements in invitations to tender;
  • require Year 2000 compliance warranties in supplier agreements and ensure that suppliers' limitation of liability clauses are not unduly wide;
  • ensure that Year 2000 compliance is part of acceptance testing; and
  • ensure that they can gain access to the software source code and modify it lawfully under a software escrow agreement, if the supplier fails to support Year 2000 compliance after the software has gone live

Compliance - Practical Issues

Before finalising compliance arrangements (for both existing and new systems), the parties will also need to consider crucial practical issues such as:

  • What are the legal implications of carrying out a priority compliance programme on business-critical systems but only 'spot checks' on other systems, because the resources do not exist to do a line-by-line audit?
  • What account should be taken of matters which the software supplier cannot adequately control eg:
- third party data, software, or equipment;

- how different companies' computer systems operate with the customers';

- the customer's own IT platform; and
- inputs from sub-contractors?

  • How should a supplier deal with the interrelationship between Year 2000 warranties for each of the elements of a typical client/server system, including hardware operating systems, a large database, tools, application software and bespoke software, plus respective upgrades?

Further information

For further information or advice on any of the legal issues involved in the Year 2000 problem, please contact us.

This bulletin is correct to the best of our knowledge and belief at the date shown below. It is, however, written as a general guide; it is essential that relevant professional advice is sought before any specific action is taken. Garretts is a member of the international network of law firms associated with Arthur Andersen and is regulated by the Law Society in the conduct of investment business.

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