Battling over the Bug: Y2K and US Court Cases

Susan McGhie Sang is an associate solicitor at Myers Fletcher& Gordon, Hammersmith, London and can be contacted on 0171 610 4433.

The Millennium Bug is perhaps the best known personality of 1999. As theworld prepares for 1 January, 2000 in the hope that most of its anticipatedcomputer problems will have been solved or minimised by then, some have alreadybeen battling with the Bug and its creators in court – the courts of theUnited States of America to be precise. The writer has not been able to find anydecided cases in respect of Y2K non-compliance problems in England, Canada orAustralia. However several cases have already been decided in the USA and thereare at least 40 pending actions.

General Overview of the Fate of the Claimants

An examination of the decided cases reveals some general trends which areperhaps not surprising. Most of the cases appear to have been broughtprematurely before any damage had actually occurred. As a result, in all thedecided cases discovered, the claimant has lost. The only favourable results forclaimants have been achieved by settlements.

One rather bizarre example of a case certainly doomed to fail for lack ofproof of damage was Mario Yu v International Business Machines Corporationand Medic Computer Systems Inc.¹ The claimant, adoctor, sued in respect of medical software for which a fix had been supplied tohim and installed free of cost by the defendants. There was no question that thefix worked to make the system Y2K compliant. The claimant however applied forclass certification so that he could continue his case on behalf of otherdoctors who had initially paid for the upgrade. The judge dismissed theclaimant’s action on the basis that the claimant had suffered no damage, nothaving paid for the upgrade himself. The court left open the possibility of aclaim by the doctors who had in fact paid for the upgrade.

In Faegenburg v Intuit Inc heard with Stein v Intuit Inc and Chilelliv Intuit Inc² the claimants had purchasedQuicken software from the defendants. The software was non-compliant in relationto its online banking functions. The defendant made a free fix available topurchasers of Quicken 98 but not to purchasers of earlier versions. Theclaimants claimed damages for breaches of implied warranties of merchantabilityand fitness for purpose, breaches of the Magnuson-Moss Consumer Product WarrantyAct and violation of the general business law for deceptive or misleading acts.They alleged that the owners of previous versions would suffer economic loss inhaving to purchase the upgrade. However, the software had not yet malfunctionedand the claimants had not yet paid for an upgrade. The court therefore held thatthe claimants had suffered no damage and dismissed all the claims for failure toprove damage.

In many of the other cases, in addition to holding that no damage had yetoccurred as a result of software not being Y2K compliant, the court held that itwould be necessary for the claimant to prove that damage due to Y2Knon-compliance occurred during the relevant warranty period.

The examples of claimants succeeding in negotiating settlements include thecase of Produce Palace International v Tec-America Corp et al.³The claimant had purchased a computer system to operate the cash registers andkeep track of the store inventory. The system was unable to process credit cardswith expiry dates after 31 December 1999 and, as a result, crashed repeatedly.One could therefore see that damage was already occurring as a result of the Y2Knon-compliance of the software. The manufacturer, the first defendant, arguedthat they had not entered into a contract with the claimant but had distributedthe equipment to the second defendant which sold the system to the claimant andinstalled it. On 15 June 1998 the court dismissed the claimant’s claims incontract against the first defendant. However, the claimant’s claim wassubsequently settled by mediation, with the first defendant paying the claimant$250,000 and the second defendant, the retailer and installer, paying $10,000.

The class actions against Medical Manager Corporation (including Collettiv Medical Manager Corporation)⁴ and against RealWorld Corporation (including Qualcraft Industries Inc v Real WorldCorporation)⁵ were also settled, with theclaimants being provided with free upgrades to make older versions of thesoftware complained of Y2K compliant.

The decided cases so far have all dealt with Y2K non-compliance of software.The claimants have relied on various causes of action, including breaches ofexpress and implied warranties, breaches of consumer legislation, fraud anddeceit and negligence.

Breach of Express and Implied Warranty Claims

In the US cases, the absence of a specific express warranty that the softwareis Y2K compliant has been important to the claimants’ lack of success. Thecourts so far have strictly construed express warranties in the softwarelicence. In one case, Paragon Networks International v Macola Inc,⁶it was held that the clause in the licence agreement which provided that thatagreement was the complete agreement between the parties operated to exclude allimplied warranties. There was no express warranty in the licence agreement thatthe software was Y2K compliant and the claimant’s claim for breach of warrantywas therefore dismissed.

In the case of Kaczmarek v Microsoft Corporation,⁷the contract incorporated the manual by express reference. The court, strictlyconstruing the claimant’s rights under the contract, held that the softwareoperated exactly as described in the manual. The claimant could not claim thatthe software was defective and in breach of warranty. The claimant in this casewas a software developer who used the defendant’s programme to createspecialised applications for her clients. The defect complained of was that thetwo-digit date default created a 20th century date. The manual indicated that inorder to recognise dates in the 21st century it was necessary to set theprogramme to use a four-digit date.

The claimant sued inter alia for damages for breach of thedefendant’s express warranty that the software was ‘an ideal businessapplication development environment’ and breach of implied warranties ofmerchantability and fitness for purpose. She claimed that it was a defect in theprogramme for the two-digit default date automatically to create a 20th centurydate and not to trigger an error message when it did so. However the manual hadspecifically explained that this was how the program would operate. The courttook the view that if the claimant had read the manual she would have discoveredthat the program did not offer the features she desired and would have been ableto return the program within the 90-day rejection period. It was theclaimant’s own fault if she had not read the manual and not a defect in thesoftware that it operated in this way. The software was held to be Y2K compliantas it recognised dates in the 21st century in the four-digit mode. Theclaimant’s claims for breach of express and implied warranties thereforefailed.

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Endnotes

The full text of the cases referred to in this article can be found throughthe Web site http://www.thefederation.org/Public/Y2k/lawsuits.htm.

1. Circuit Court of Cook County, Illinois, decided May 28, 1999.
   
2. Supreme Court of State of New York, County of New York decided December 1, 1998.
   
3. Circuit Court for County of Macomb, Michigan filed June 12, 1997
   
4. Circuit Court of the Thirteenth Judicial Circuit in and for Hillsborough County, Florida
   
5. Superior Court of Massachusetts, Norfolk County
   
6. Court of Common Pleas, Marion County, Ohio, decided on 16 December 1998
   
7. US District Court for the Northern District of Illinois, Eastern Division, decided on March 16, 1999
   
8. Supreme Court of the State of New York, County of New York decided in April 1999
   
9. US District Court Eastern District of Michigan, Southern Division decided June 17, 1999
   
10. Advent Sys Ltd v Unisys Corp 925 F 2d 670, 675 (3d Cir. 1991)
    
11. U.S. District Court for the Western District of Pennsylvannia decided March 24, 1999
    
12. Y2K Act, Public Law 106-37, July 20, 1999 (addressed elsewhere in this issue).
    
13. See endnote 1.
    
14. See endnote 3.
    
15. See endnote 2.
    
16. See endnote 12.
    
17. See endnote 9.
    
18. See endnote 12.

The courts have also strictly construed the time periods of the warranty. Inthe Kaczmarek case⁷ the claimant had a 90-dayperiod to reject the software. Also in the case Against Gravity Apparel Inc vQuarterdeck Corporation,⁸ the court held that,as the software would not manifest a defect for two years after the 90-daywarranty period had expired, the claimant’s claim for breach of warranty couldnot succeed as the claimant had suffered no damage within the warranty period.In the Paragon case⁶ the court noted thatthere was a 90-day warranty period.

Limitation periods have also been a bar to relief as in the case of Dahlmannand Dahlmann Apartments Ltd v Sulcus Hospitality Technologies Corp et al.⁹The claimants in that case had purchased a complete property management systemincluding the software, hardware, installation, training and support servicesfrom the defendants. The system was installed in 1992 to be used for recordingreservations in their hotel but did not record reservations in the year 2000 andbeyond.

The claimants claimed damages inter alia for breaches of express andimplied warranties. They argued that the contract was for the supply ofservices, and that as such they had a general claim for breach of contract forwhich the limitation period would be six years. The courts in the US have heldthat a sale of software is a sale of goods and is therefore governed by theUniform Commercial Code (UCC) provisions dealing with the sale of goods.¹⁰The court in the Dahlmann case decided that, under Michigan law, thesupply of the computer system by the defendants was a supply of goods under theUCC since the predominant purpose of the contract was to supply software. Theservices provided were merely incidental to the sale of the software. Thefour-year limitation period for claims for breach of warranty and breach ofcontract under the UCC therefore applied and barred the claimant’s claim.

In deciding the time from which the breach should be measured, the UCCprovided that, unless the warranty in the contract provided specifically that itcovered future performance of the goods, a breach of warranty occurred when thegoods were delivered. In this case the warranty provided that the goods wouldfunction for a year. The court held that, even if the one-year warranty periodwere construed to extend the time after delivery within which the claimant oughtto have discovered the defect in the system, the claimant was still out of timeas the action was brought more than four years after the expiration of thewarranty period. It did not matter if the claimant did not become aware of thebreach within the limitation period.

It would seem, based on the Against Gravity Apparel case⁸and the Faegenburg v Intuit Inc case² (whereit was held that the implied warranty of merchantability and fitness forordinary purpose had not been breached where software had not yetmalfunctioned), that even if the claimant had discovered the breach and suedwithin the limitation period the claimant would still have failed unless he hadalready suffered damage at the time he brought the action.

Breach of Consumer Laws

Most of the claimants have also brought claims under the consumer legislationapplicable in their particular state. However these claims have failed for thesame reasons as the breach of warranty claims. The claim for violations of theMagnuson-Moss Consumer Product Warranty Act (which provides a remedy to aconsumer where a product does not comply with an implied warranty) failed in Faegenburgv Intuit Inc² because no damage had been proved.Similarly in the case of Kaczmarek v Microsoft Corporation⁷the claim for breach of Illinois’ consumer protection laws based onallegations that the defendant misrepresented the operation of the softwarefailed as the claimant had not proved the software to be defective.

Fraud and Deceit

In most of the actions decided so far, these claims have failed mainlybecause the claimant has not been able to prove:

• knowledge by the defendant of a defect in the software;
  
• that the defendant had misrepresented that the software was Y2K compliant, or
  
• that the claimant had suffered damage.

The case of Dahlmann and Dahlmann Apartments Ltd v Sulcus HospitalityTechnologies Corp et al⁹ is an example of such acase. The court held that a statement by a representative of the defendant thatthe software was well suited to the needs of the claimant’s business was notfalse and could not be construed as a statement that the system was Y2Kcompliant. Further, the claimant had no direct proof that the defendant knew ofthe defect in the system but was merely relying on an argument that thedefendant ought to have known that the system was not compliant. This was notsufficient to establish fraud or deceit.

Negligence

So far in most of the cases (for example in the Kaczmarek case)⁷the claimant has been unable to establish damage which is an essential elementof the tort of negligence. However, the court has also been reluctant to find acause of action in negligence where there is a contract governing therelationship between the parties. Sunquest Information Systems Inc v DeanWitter Reynolds Inc & Compucare Co¹¹involved the take over of a company which marketed medical software. Thesoftware forming the assets of the company taken over was not Y2K compliant. Themain issues in the case turned on whether the claimant could sue for negligenceor fraudulent misrepresentations in relation to the non-disclosure of this factand the position under Pennsylvannia law where a party is induced to enter intoa contract by misrepresentations. However the court held that the stock purchaseagreement, under which the shares of the company were purchased, provided forthe sale of shares and not a sale of the assets of the company. The case may beregarded as relevant for other jurisdictions to the extent that the courtdismissed the claimant’s claims in negligence against the second defendant onthe basis that there was a contract between them which stated that itincorporated all the terms of the agreement. One party could not then rely onthe law of negligence for a remedy against the other party to the contract. Thecourt’s position in this regard was similar to the English courts’reluctance to consider claims in the tort of negligence between parties to acontract. The court left open the possibility of the claimant being able toestablish a claim against the first defendant which introduced the parties andwith whom there was no contract.

Endnotes

The full text of the cases referred to in this article can be found throughthe Web site http://www.thefederation.org/Public/Y2k/lawsuits.htm.

1. Circuit Court of Cook County, Illinois, decided May 28, 1999.
   
2. Supreme Court of State of New York, County of New York decided December 1, 1998.
   
3. Circuit Court for County of Macomb, Michigan filed June 12, 1997
   
4. Circuit Court of the Thirteenth Judicial Circuit in and for Hillsborough County, Florida
   
5. Superior Court of Massachusetts, Norfolk County
   
6. Court of Common Pleas, Marion County, Ohio, decided on 16 December 1998
   
7. US District Court for the Northern District of Illinois, Eastern Division, decided on March 16, 1999
   
8. Supreme Court of the State of New York, County of New York decided in April 1999
   
9. US District Court Eastern District of Michigan, Southern Division decided June 17, 1999
   
10. Advent Sys Ltd v Unisys Corp 925 F 2d 670, 675 (3d Cir. 1991)
    
11. U.S. District Court for the Western District of Pennsylvannia decided March 24, 1999
    
12. Y2K Act, Public Law 106-37, July 20, 1999 (addressed elsewhere in this issue).
    
13. See endnote 1.
    
14. See endnote 3.
    
15. See endnote 2.
    
16. See endnote 12.
    
17. See endnote 9.
    
18. See endnote 12.

What will Happen after Bug Day?

The cases decided in the USA so far show the courts leaning towards a strictconstruction of express warranties. There has been a reluctance to find thatimplied warranties of merchantability and fitness for purpose or broadly wordedexpress warranties should be construed to guarantee that the software wouldfunction after 1 January 2000 if it functioned properly during the warrantyperiod.

However different considerations should apply to Y2K cases after 1 January2000 where software or hardware fails as a result of Y2K non-compliance.Claimants should then be able to prove damage. It will be important to considerwhether upgrades were made available by the supplier and whether these solvedthe problem. If there were upgrades available which made the software fullycompliant, the court would probably be reluctant to find for a claimant who didnot take steps to mitigate his loss by buying or installing the upgrade. The Y2KAct in the US also imposes a duty to mitigate.¹²Many companies have made upgrades available free as in the Yu case.¹³The claimant would also be unlikely to succeed if an upgrade was available at acost less than the loss claimed. Software users should therefore ensure thatthey have the latest available upgrades or patches and do their best to maketheir systems Y2K compliant.

It is unlikely that the software will be supplied with an express Y2Kwarranty. Users should therefore examine the date of purchase of anynon-compliant software, the type and length of the warranty provided and whenthe warranty expired. In future actions, the court is likely to consider whenthe software complained of was purchased and the time periods stated in theexpress warranties. It will be important to be able to show that the breach ofwarranty occurred within the warranty period and that the damage was sufferedwithin the relevant limitation period. If the warranty provides that thesoftware will function for a year, for example, a court may be unlikely to holdthat there was a breach of warranty if it had been purchased before 1 January1999.

This also raises the question of when the software developers knew about theY2K problem and when it would have been reasonable to expect them to makecompliant software. Is it reasonable to expect that software should only lastand operate properly for one year or 90 days? So far the courts have not decidedon the reasonableness of the warranty period, but may be encouraged to do soafter damage has actually occurred.

It will also be important to consider whether the manual is incorporated intothe contract. If so, relevant issues may include whether the manual accuratelydescribes how the software functions with regard to the date and whether thepurchaser had an opportunity to read the manual and reject the software if itdid not conform with what he had expected. In the Kaczmarek case,⁷the complaints that dates with two digits were recognised as 20th century dates,that this default could not be changed and that there was no error messageactivated when the default created a 20th century date were perhaps inconvenientand annoying to the claimant. However, the answer supplied by the court was thatif the software package did not operate with the features desired by theclaimant she did not have to buy it. It would therefore be important for thepurchaser of software carefully to examine the features set out in the manualregarding how the software handles dates. The onus is on the purchaser to ensurethat the features of the software are what he desires.

So far most of the cases have proceeded without a detailed consideration ofwhether there was a contract between the manufacturer of the software and thepurchaser. However in the Produce Palace¹⁴and the Faegenburg v Intuit Inc¹⁵ cases theissue of privity was raised. Whether or not there is privity of contract betweenthe manufacturer and purchaser, for example, embodied in the terms of theshrink-wrap licence will have a bearing on whether claims can also be brought innegligence. However, in negligence claims, claimants in England are likely tohave difficulty succeeding if the only damage resulting is economic loss withoutphysical damage.¹⁶ The reluctance of the English courts to allow forrecovery in negligence for pure economic loss should limit claims where aperson’s non-compliant computer system has caused loss to another person withwhom the owner of the non-compliant system has no contract – for example, aperson further down a supply chain.

Cases alleging fraud and misrepresentation will generally be hard to provewithout the claimant being able to bring strong evidence that the manufacturerof the software knew the software was not compliant at the time it was made anddeliberately misrepresented that it was compliant. Most of the claimants in theUS alleging fraud so far seem to have been content to say that the defendantought to have known of the defect for example in Dahlmann and DahlmannApartments Ltd v Sulcus Hospitality Technologies Corp et al.¹⁷Similarly, most of the cases of consumer legislation in the US involve provingthat the defendant deliberately deceived the public in supplying defectivesoftware.

The courts in the US should be further discouraged from deciding in favour ofclaimant software purchasers in light of the government policy embodied in theY2K Act.¹⁸ The public policy stance in the US is todiscourage litigation on this issue and encourage claims to be settled byprovision of fixes and upgrades and alternative dispute resolution.

It seems so far that the Y2K legal battles have been a storm in a teacup butif damage is suffered in the next millennium, the cases are unlikely to be asstraightforward as those already decided. Perhaps the most important point to begleaned from the decisions so far is that the successful claimants have been theones who have negotiated settlements, often involving the free provision of anupgrade or fix by the software provider or manufacturer. The best approach forbusinesses may be to avoid litigation, to ensure that they have the mostup-to-date software available, to obtain compliance statements from theirsuppliers and to attempt to solve any problems arising by co-operation andalternative dispute resolution. It remains to be seen whether the action moviesof the 21st century will be based on the day the Bug struck.

Endnotes

The full text of the cases referred to in this article can be found throughthe Web site http://www.thefederation.org/Public/Y2k/lawsuits.htm.

1. Circuit Court of Cook County, Illinois, decided May 28, 1999.
   
2. Supreme Court of State of New York, County of New York decided December 1, 1998.
   
3. Circuit Court for County of Macomb, Michigan filed June 12, 1997
   
4. Circuit Court of the Thirteenth Judicial Circuit in and for Hillsborough County, Florida
   
5. Superior Court of Massachusetts, Norfolk County
   
6. Court of Common Pleas, Marion County, Ohio, decided on 16 December 1998
   
7. US District Court for the Northern District of Illinois, Eastern Division, decided on March 16, 1999
   
8. Supreme Court of the State of New York, County of New York decided in April 1999
   
9. US District Court Eastern District of Michigan, Southern Division decided June 17, 1999
   
10. Advent Sys Ltd v Unisys Corp 925 F 2d 670, 675 (3d Cir. 1991)
    
11. U.S. District Court for the Western District of Pennsylvania decided March 24, 1999
    
12. Y2K Act, Public Law 106-37, July 20, 1999 (addressed elsewhere in this issue).
    
13. See endnote 1.
    
14. See endnote 3.
    
15. See endnote 2.
    
16. See endnote 12.
    
17. See endnote 9.
    
18. See endnote 12.