UK: The Year 2000 Software Problem - This Time Its Personal - Legal Duties Of Company Directors

Last Updated: 26 June 1998
By Andrew White and Richard Bonnar, Garretts for "Chartered Secretary" Magazine

May 1998

The Year 2000 computer problem either is now or ought to be a top level business concern. Although Prime Minister Tony Blair recently stated that "awareness of the Year 2000 problem among companies is now nearly 100%" (Computer Weekly 2 April 1998), a recent NOP survey undertaken on behalf of the Computer Software and Services Association and Microsoft indicates that over 75% of senior executives still have no understanding of how the Year 2000 problem will impact on their computer systems (quoted in CBI News April 1998).

The legal issues which arise in this unprecedented situation affect the entire management of business. They are relevant, not just on 1 January 2000, but today.

The purpose of this article is to highlight key legal responsibilities of company directors, and the possible consequences for them if they fail to address the Year 2000 problem in an appropriate way.

Directors' general duty of skill and care

Directors owe a legal duty to exercise "skill and care" in the fulfilment of their responsibilities. This requires "reasonable diligence". An objective standard is increasingly being set by the UK Courts. No-one yet knows how onerous this duty will be in the context of the Year 2000. However, undoubtedly current best Year 2000 practice will be used as a benchmark, and on this basis it is arguable that directors should at the very least:-

  • put in place a technical Year 2000 audit, to detect whether there is a problem, analyse its impact, prioritise work, identify purely trivial issues, and implement practical solutions;
  • conduct a legal audit to assess contract and regulatory liabilities, and assess rights to modify defective software; and
  • carry out a risk reduction strategy, which will involve testing of modified software, securing legal assurances from suppliers and customers, contingency planning and the taking of other Year 2000 "readiness" steps.

Defences

Do directors have a defence? The nature of the problem is now known. The deadline is immovable. Against this background directors can no longer shelter behind pleas of ignorance. While directors will usually delegate the compliance effort to Year 2000 project teams, they remain ultimately responsible.

Who could take legal action against directors for breach of duty? Technically, directors' general duties are owed to the company. Individual shareholders cannot sue, without overcoming difficult procedural hurdles and in practice legal proceedings against directors on the basis of Year 2000 default may be considered unlikely.

However, this is not to be ruled out. If current predictions of company insolvency due to Year 2000 related system failures are to be believed then receivers and/or liquidators, who have the right to sue in an insolvent company's name, may have an interest in doing this. In any event, legal issues aside, no director will wish to ignore the potential damage to his/her reputation.

The pressures to address compliance

There are so many external pressures on business to address Year 2000 compliance that it is fast becoming somewhat academic how far directors' general "common law" duties extend.

Firstly, the Government is set to reintroduce the Millennium Bill to require all companies to conduct a computer audit and report the outcome. (This was first tabled shortly before the 1997 general election before being temporarily shelved).

Secondly, suppliers and customers are seeking contractual assurances by way of compliance statements or letters. These are often being made a condition of continuing business relations. This alone is creating pressure, especially on small and medium sized companies, to achieve compliance.

Among the many further external pressures are:-

  • Companies' Act obligations to produce accurate accounts;
  • Auditors' questions;
  • Disclosure requirements;
  • Insurers' requirements;
  • Avoidance of criminal offences under health and safety laws; and
  • Avoidance of other statutory offences.

Statutory Obligations to Produce Accurate Accounts

Directors have a duty under the Companies Act 1985 to file accurate accounts.

Without either an internal or external Year 2000 compliance review, it will be difficult to assess the implications for a company, and thus give suitable accounting treatment. Year 2000 matters could impact upon accounts in many ways including:-

  • the writing down of assets such as software or software-controlled equipment that may be rendered inoperable;
  • disclosure and treatment of expenditures that can be foreseen;
  • capitalisation of costs;
  • disclosure of contingent liabilities such as valid warranty or other contractual claims by customers; and
  • consequential taxation adjustments.

Directors must be particularly alert to Year 2000 bugs lurking in their existing accounting systems which could produce wrong data before the turn of the century. If so, the directors may be keeping incorrect accounts today and even issuing misstated figures.

Auditors' Enquiries

Auditors have a statutory obligation to ensure that the directors' accounts provide a "true and fair view" of the company's business.

The Year 2000 computer problem threatens the ability of business to maintain normal operations, or, in extreme cases, the ability to trade at all. It is hardly surprising that auditors are starting to ask management searching questions.

The Auditing Practices Board (APB) has now issued a report containing what they describe as "persuasive" guidelines on the questions auditors should ask management. (APB, Preliminary Guidance for Auditors, 1998/1). The APB recommends that:-

  • auditors should explain formally with directors the extent and limits of the auditors' responsibility; and
  • auditors should directly ask what management knows about its Year 2000 problem, including business impact.

The APB states that auditors may question the "going concern" assumption on the basis of the information they receive, if the Year 2000 issue has a "material effect on the financial statements being audited".

The implications for company directors are clear. Any company, the accounts of which are qualified as a result of Year 2000 liabilities, may have difficulty in raising finance or paying dividends and suffer harm to its wider shareholder and public relations. Only a credible Year 2000 compliance strategy can avert this, both in 1998 and certainly 1999.

Disclosure Requirements

Material Year 2000 liabilities have to date been generally reported by publicly quoted companies in the context of the publication of their interim and final results (see above). Directors of such companies also need to remember that, under the London Stock Exchange listing rules, their company must notify without delay any Year 2000 actual or contingent liability which would change the company's financial position and would be likely to lead to a substantial movement in its share price.

Disclosures of Year 2000 matters are also potentially highly significant in corporate transactions such as acquisitions, mergers and disposals. Directors must carefully assess the warranties and disclosures they negotiate.

Insurance

Who carries the ultimate financial risk in the face of huge Year 2000 uncertainties?

In its November 1997 Year 2000 report, the Association of British Insurers stated it was adamant that insurers cannot be expected to bail out UK industry, by being the ultimate fallback for Year 2000 computer claims.

Accordingly, major insurers have begun withdrawing cover for Year 2000 claims, unless credible compliance plans are put in place by their business clients. (This applies both to company insurance policies, and to directors' individual indemnity policies).

Directors must obviously act to keep their business properly insured as the Year 2000 deadline approaches. Without a credible compliance plan, and evidence of actual implementation, insurance cover may not be available when it is most urgently needed.

Health and Safety: Criminal Offences

One of the most serious implications of the Year 2000 problem is for the health and safety of employees and customers, including in safety-critical sectors such as transport, construction and energy.

The Health and Safety Executive's recent report entitled "Safety and the Year 2000" (HSE 1998), identifies the following relevant provisions under the Health and Safety at Work Act 1974 and related regulations:-

  • employers have a general duty to ensure, so far as is reasonably practicable, the health, and safety of their employees, and to avoid exposing third parties who may be affected by their activities to risk;
  • employers must ensure, so far as is reasonably practicable, that the operation of "control" systems do not pose any increased risk to health or safety; and
  • a company which designs, manufactures or supplies articles for use at work has a duty to those who use those articles, to notify them ("duty to warn") so far as reasonably practicable, if any matter gives rise to a risk to health or safety.

Breach of these obligations is a criminal offence, but could arise in a variety of ways in the event of Year 2000 malfunctions affecting software, hardware, or plant and equipment containing so-called "embedded systems".

The HSE is clearly signalling a willingness to prosecute. Although the company would be primarily liable, these offences can in certain circumstances be applied to company directors too.

Specific Statutory Offences

Certain other statutory offences could be committed by directors if a company fails to address its Year 2000 problem. Much depends on the industry sector. Examples include:-

  • Trade Descriptions Act 1968 - directors can be personally liable for misrepresentations to the public regarding products (this would apply to the making of incorrect or misleading compliance statements to the public about products);
  • Data Protection Act 1984 - directors could face claims by private individuals, and/or enforcement by the Data Protection Registrar, if personal data is wrongly processed, corrupted, or lost, because of Year 2000 problems.

Other relevant statutes include: the Consumer Protection Act 1987, the Financial Services Act 1986, and environmental legislation, as well as codes of industry regulators.

We are not intending to scaremonger. With proper planning, such liabilities can be avoided. However, it is as well for directors to be aware of the range of statutory provisions which could apply.

Summary

In the words of the Economist (March 1997), "the Year 2000 problem started as a system maintenance task but has turned into a risk management nightmare".

Directors must act now to assess and respond to the Year 2000 problem for their own company, and thus minimise their own legal liabilities. An effective Year 2000 compliance project can preserve the relationships, reputation and operations of the business. Time is of the essence.

No-one knows with certainty what will happen with the advent of Year 2000. However, pro-active steps by company directors must be taken. This may be an expensive and time-consuming burden. But, legally, there is no option. If it is any consolation, business competitors are likely to be in a similar situation.

Andrew White, Senior Manager Garretts, Technology Law Group, London - Tel: 0171 304 8034

Richard Bonnar, Partner Garretts, Technology Law Group, Leeds - Tel: 0113 241 6100

Article first published by Chartered Secretary magazine in May 1998 and reproduced here by kind permission.

Further Information

For further information or advice on any of the legal or internal policy issues involved in e-mail use, please contact us.
This article is correct to the best of our knowledge and belief. 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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