President Clinton Signs Y2K Act

By David M. Nadler and Geoffrey Bestor*

On July 20, 1999, President Clinton signed the Y2K Act. Although the Act does not provide immunity for Y2K failures, it creates significant disincentives to litigation in certain instances. As such, the Act represents the first federal effort designed to mitigate the impact of potential Y2K litigation on businesses and individuals. The key provisions of the Act are as follows:

30-Day Notice Period – requires a plaintiff to submit a 30-day notice to a defendant regarding the plaintiff’s intention to sue and a description of the alleged Y2K problem. If the defendant responds with a plan to remediate or engage in alternative dispute resolution ("ADR"), then an additional 60 days is allowed to resolve the problem. If the defendant does not agree to fix the problem, the plaintiff can sue on the 31st day.

Cap On Punitive Damages – establishes a punitive damages cap of $250,000 or three times compensatory damages, whichever is less, for small businesses with fewer than 50 employees and for individuals with a net worth of up to $500,000.

Proportionate Liability – limits the damages a defendant must pay in a non-contract action to the percentage of the total damages equal to the percentage of the defendant’s responsibility for the harm as determined by the trier of fact. If the plaintiff is unable to collect from a responsible party (e.g., because of bankruptcy), defendants are liable for the "orphan" share in proportion to their percentage of responsibility, except when the plaintiff is an individual of modest means, in which case the defendants are jointly and severally liable for the orphan share. Defendants shown to have specifically intended to injure the plaintiff or to have committed intentional fraud will not benefit from this provision and will be subject to applicable state rules concerning proportionate or joint and several liability.

Preservation Of Contract Rights – provides for the enforcement of written contract terms unless a state statute (generally the UCC, which governs the sale of goods) in existence on January 1, 1999, specifically prohibits the term. For contracts governed by the common law rather than statute (e.g., software licensing contracts), written contract provisions, such as disclaimers of warranties, prevail unless prohibited by the doctrine of unconscionability as recognized in controlling judicial precedent.

Duty To Mitigate – prohibits plaintiffs from collecting damages they could have avoided through their own reasonable efforts. This additional duty to mitigate does not apply in instances of intentional fraud and securities claims, and supplements, but does not replace, existing state law regarding the duty to mitigate.

Sunset Provision – restricts application of the Act to Y2K failures occurring on or before January 1, 2003.

Federal Jurisdiction Over Class Actions – grants federal jurisdiction over class actions involving more than $10 million in claims and more than 100 plaintiffs, or any class action in which punitive damages are sought.

Economic Loss Rule – prohibits recovery of economic damages in tort cases except where the defendant committed an intentional tort arising independent of a contract.

The following is an analysis of the primary sections of the Act.

A. Application Of The Act (Section 4)

The Act applies to all lawsuits filed after January 1, 1999, for a Y2K failure occurring before January 1, 2003, or for a potential Y2K failure that could occur or has allegedly caused harm or injury before January 1, 2003. The Act defines "Y2K failure" as:

Failure by any device or system (including any computer system and microchip or integrated circuit embedded in another device or product), or any software, firmware, or other set or collection of processing instructions to process, to calculate, to compare, to sequence, to display, to store, to transmit, or to receive year-2000 date-related data, including failures – (A) to deal with or account for transitions or comparisons from, into, and between the years 1999 and 2000 accurately; (B) to recognize or accurately process any specific date in 1999, 2000, or 2001; or (C) to accurately account for the year 2000’s status as a leap year, including recognition and processing of the correct date on February 29, 2000.

The Act specifically does not: (1) create new causes of action, (2) expand existing causes of action, (3) limit existing defenses, (4) apply to personal injury claims, or (5) with one exception, apply to securities litigation. The Act requires strict enforcement of warranties and other contractual provisions that limit or exclude Y2K liability. Finally, the Act protects consumers from foreclosures on residential mortgages as a result of "an actual Y2K failure that results in an inability to accurately or timely process any mortgage payment transaction."

B. Limitation On Punitive Damages (Section 5 )

Section 5 of the Act prohibits the award of punitive damages in Y2K actions unless a plaintiff proves by clear and convincing evidence that the applicable standard for awarding punitive damages has been met. If a plaintiff is awarded punitive damages, the award is limited to the lesser of three times the amount awarded in compensatory relief or $250,000 if the defendant is a small business (fewer than 50 full-time employees) or an individual whose net worth does not exceed $500,000. The Act’s limitations on punitive damages do not apply to larger businesses or more affluent individuals. The cap on punitive damages also does not apply if a plaintiff demonstrates by clear and convincing evidence that the defendant acted with the specific intent to injure the plaintiff. Finally, the Act prohibits the award of punitive damages against a government entity, regardless of the entity’s intent.

C. Proportionate Liability (Section 6)

The Act generally precludes a court from applying joint and several liability in non-contract Y2K cases. Instead, the Act requires proportionate liability, limiting a defendant’s liability to the percentage of the defendant’s fault in causing the alleged harm. This provision is designed to prevent plaintiffs from hunting for deep-pocket defendants. To establish proportionate liability, the legislation requires the judge or jury to make specific findings to determine who is at fault and by what percentage. A defendant can be found jointly and severally liable (if permitted by state law) if a judge or jury finds that the defendant specifically intended to injure the plaintiff or knowingly committed fraud. In multi-defendant cases, individual plaintiffs whose net worth is less than $200,000 and/or individual consumers of consumer products can jointly and severally recover portions of an uncollectible judgment from other defendants if a particular defendant is deemed judgment-proof. Defendants that settle Y2K actions out of court are discharged from any subsequent claim of contribution for joint and several liability. This exemption from subsequent liability will likely prove to be a strong incentive to settle disputes. In essence, a defendant that settles its share of a dispute forecloses the possibility of subsequently being sued for contribution by another defendant. Finally, the Act does not preempt or supersede state laws that impose more restrictive liability caps and/or provide defendants with a greater degree of protection from joint and several liability.

D. Prelitigation Notice/Mandatory Cooling-Off Period (Section 7)

Section 7 of the Act creates a mandatory cooling-off period, during which a complaining party is precluded from filing a Y2K suit. Prior to filing a Y2K lawsuit (except suits for injunctive relief), a prospective plaintiff must send by certified mail a written notice to every prospective defendant’s registered agent or other representative. The notice must contain "detailed information" about:

the impact of any material defect alleged to have caused harm or loss;
the harm or loss allegedly suffered by the prospective plaintiff;
how the prospective plaintiff would like the prospective defendant to remedy the situation;
the basis of the prospective plaintiff’s proposed remedy; and
information regarding an individual that has authority to negotiate resolution of the dispute.

A prospective defendant must send by certified mail a written statement within 30 days of receiving the notice, acknowledging receipt, describing the actions the prospective defendant has taken or will take to address the situation, and stating whether the prospective defendant is willing to engage in ADR. Written statements of a prospective defendant are inadmissible as evidence in any subsequent litigation. A prospective plaintiff may immediately file suit if a prospective defendant fails to respond in a timely fashion.

If a prospective defendant proposes a remediation plan to address the Y2K problem or expresses a willingness to engage in ADR, the prospective plaintiff must allow an additional 60 days from the end of the 30-day notice period to implement the plan or initiate the ADR proceeding. This interim period can be extended by the mutual consent of the parties. The statute of limitations is tolled during the notice and remediation periods. A prospective plaintiff is prohibited from filing suit during this "cooling-off" period. If a Y2K suit is filed before notice has been provided, or prior to the completion of the notice period, the defendant may treat the complaint as the required notice, notify the court of the plaintiff’s failure to provide adequate notice (resulting in a stay of all proceedings), and thereby initiate or reinitiate the cooling-off period.

E. Pleading Requirements (Section 8)

The Act requires certain heightened pleading requirements. First, all complaints seeking damages must include a statement of specific information regarding the nature and amount of each element required to prove the damages sought and the factual basis supporting the damages assessment. Second, if a complaint contains allegations of material defects in a product, the complaint must include a statement of specific information regarding manifestations of the material defect and the facts supporting the plaintiff’s allegation(s) that the defect is material. Finally, if a cause of action requires a showing of the defendant’s particular state of mind, the complaint must contain a statement of the facts giving rise to a strong inference that the defendant acted with the required state of mind for each element required by the claim. These heightened pleading requirements are significant departures from the "notice pleading" standard and may present some plaintiffs with impediments in their efforts to file Y2K suits.

F. Duty To Mitigate (Section 9)

Section 9 of the Act requires a plaintiff to mitigate damages. Any damages awarded to a plaintiff must exclude compensation for damages that the plaintiff could have reasonably avoided

in light of any disclosure or other information of which the plaintiff was, or reasonably should have been, aware, including information made available by the defendant to purchasers or users of the defendant’s product or services concerning means of remedying or avoiding the Y2K failure involved in the action.

The Act’s duty to mitigate is a supplement to existing state law requirements for mitigation of damages. This supplemental duty to mitigate does not apply to instances of intentional fraud.

G. The Doctrines Of Impossibility And Commercial Impracticability (Section 10)

Section 10 provides that nothing in the Act limits or affects the ability of a defendant to invoke the defenses of impossibility or commercial impracticability. The applicability of these defenses must be determined by the state law in existence on January 1, 1999. In all likelihood, defendants will attempt to invoke these defenses to rebut the suggestion that certain Y2K failures could have been avoided. However, these defenses have traditionally been very difficult to establish.

H. Breach Of Contract Damages (Section 11)

The Act places strict limits on recoveries in breach of contract actions, deferring instead to the express agreement of the parties. A plaintiff may not claim or be awarded any category of damages for Y2K suits alleging breach or repudiation of contract, unless such category was either allowed by the express terms of the contract or, if the contract is silent regarding damages, by operation of state law at the time the contract was effective or by operation of federal law. This provision may well render effective contractual limitations on damages that would have been prohibited under existing state law.

I. Tort Damages (Section 12)

Section 12 of the Act prohibits the recovery of damages for economic loss in tort cases unless the recovery is provided for in a contract to which the plaintiff is a party or the losses result directly from damage to tangible personal or real property, and the damages are otherwise permitted under federal or state law. The Act defines economic loss damages as "amounts awarded to compensate an injured party for any loss" including:

lost profits or sales,
business interruption,
losses indirectly suffered as a result of a defendant’s wrongful act or omission,
losses that arise because of the claims of third parties,
losses that must be pled as special damages, and
consequential damages (as defined in the Uniform Commercial Code (UCC) or state equivalent).

These limitations do not apply to claims for personal injury or wrongful death. In addition, these limitations do not apply to claims of intentional tort arising independent of contract.

J. State Of Mind/Bystander Liability/Control (Section 13)

The Act applies applicable state law evidentiary standards as of December 31, 1998, to prove state of mind for all non-contractual Y2K causes of action in which the defendant’s actual or constructive state of mind is an element of the claim. The Act also limits the liability of "bystanders." In actions for money damages in which:

(A) the defendant is not the manufacturer, seller, or distributor of a product, or the provider of a service, that suffers or causes the Y2K failure at issue,

(B) the plaintiff is not in substantial privity with the defendant, and

(C) the defendant’s actual or constructive awareness of an actual or potential Y2K failure is an element of the claim under applicable law,

a defendant is not liable unless the plaintiff can prove under applicable state law that as of December 31, 1998, the defendant actually knew or recklessly disregarded a known and substantial risk that a Y2K failure would occur. This is the only section of the Act applicable to claims under the securities laws. While the scope of this provision is not entirely clear, it appears to be intended to protect consultants who assist companies in resolving Y2K problems. Additionally, the Act provides that the fact that a Y2K failure occurs "in an entity, facility, system, product, or component that was sold, leased, rented, or otherwise within the control" of a defendant is not sufficient to constitute the sole basis for recovery of damages.

K. Special Masters (Section 14)

Section 14 of the Act permits a federal district court to appoint a special master or magistrate judge to hear the matter. The special master or magistrate judge will be responsible for making findings of fact and conclusions of law in conformity with Rule 53 of the Federal Rules of Civil Procedure. The use of special masters and magistrate judges is yet another effort to relieve crowded court dockets.

L. Class Actions (Section 15)

Section 15 of the Act addresses class action requirements. Class actions represent a significant percentage of expected Y2K lawsuits. Under the Act, Y2K actions for defective products or services can be brought as class actions only if (1) all other state or federal prerequisites are met and (2) the court finds that the defects in question are material as to a majority of class members. In addition to existing notice requirements in class actions, the Act requires that additional information be provided to members of the class, including a concise and clear description of the case, the jurisdiction in which the case is pending, and a description of the fee arrangement with plaintiffs’ counsel. Jurisdiction for Y2K class actions is vested in the federal district courts unless:
: (1) a substantial majority of plaintiffs are citizens of a single state, the primary defendants are citizens of that state, and the claims asserted will be governed primarily by the laws of that state;

(2) the primary defendants are states, state officials, or other governmental entities against whom a federal court could not constitutionally order relief;

(3) the plaintiffs do not seek an award of punitive damages and the amount in controversy is less than ten million dollars; or; (4) there are fewer than 100 members of the proposed class.; Despite these exceptions, the Act significantly expands federal jurisdiction over Y2K class action lawsuits.

M. Applicability Of State Law (Section 16)

The Act does not impact the applicability of state laws that provide greater limitations on damages and liabilities and offer greater protections to defendants. This section could prove significant to defendants in states that have taken an aggressively defensive posture against Y2K suits.

N. Admissibility Of Evidence (Section 17)

The Act applies Rule 704 of the Federal Rules of Evidence to state court proceedings, even if the forum state has not adopted a similar rule. By doing so, Section 17 of the Act allows parties to Y2K suits in state courts to elicit testimony in the form of an opinion or inference on an ultimate issue to be decided by the trier of fact. For example, a defendant may be permitted to have an expert witness testify that a Y2K software defect was not a "material" defect to the plaintiff.

O. Treatment Of Small Businesses (Section 18)

Finally, Section 18 of the Act establishes small business safeguards from civil money penalties for violations of federal rules and regulations. The Act defines a small business as a business with fewer than 50 full-time employees. These safeguards include the establishment of liaisons between executive agencies and small businesses regarding problems arising out of Y2K failures and compliance with federal rules and regulations. The Act also limits the ability of agencies, other than those regulating banking and securities, to impose civil money penalties against small businesses for first-time violations of federal rules or regulations relating to Y2K failures if:

the business made "reasonably good faith efforts to anticipate, prevent, and effectively remediate a potential Y2K failure";
the violation resulted from the Y2K failure;
the violation was unavoidable;
the small business took reasonable and prompt measures to correct the violation;
the small business informed the appropriate agency within a reasonable time (not to exceed five business days from the time the business became aware of the violation); and
the violation did not result in actual harm, or create an imminent threat, to public health, safety, or the environment.

Civil money penalties are permitted against small businesses for first-time violations if the failure to comply with federal rules and regulations results in actual harm or amounts to an imminent threat to public health, safety, or the environment. Penalties are also allowed if the business fails to correct a violation within one month after initial notification to the agency. The small business safeguards do not apply to violations occurring after December 31, 2000.

Whether the Act will achieve its intended purpose of discouraging Y2K lawsuits remains to be seen. However, the Act clearly makes it more difficult for plaintiffs to bring Y2K cases and ultimately to recover damages. This will benefit businesses by reducing the amount of Y2K litigation that they will face, as well as the settlement value of Y2K cases that are actually filed.

* David M. Nadler is a partner in the law firm of Dickstein Shapiro Morin & Oshinsky LLP in Washington, DC where he is Chairman of the firm’s Year 2000 Practice Group. He may be contacted at 202-828-2281 or NadlerD@dsmo.com. Mr. Bestor is Counsel to the firm.

Back to Main Menu