Law: The day of judgement

Corporate lawyers must beware the `millennium meltdown' - or they themselves could face legal action over computer chaos. By Rick Marsland

At first sight, an arcane computer problem may appear to be the last thing that lawyers engaged in advising on mergers, acquisitions and outsourcing contracts should be worried about. But as companies around the world start taking action to avoid potential computer chaos on 1 January 2000, lawyers and corporate finance advisers are now waking up to the implications for their own line of work.

Edward Marston, a partner with the transactional boutique Barnett Alexander Chart, has studied the problem. "Professional advisers do need to worry about this," he says. "I don't think it's enough simply to insert a standard warranty that refers vaguely to computer problems that may be associated with the millennium. Instead, it must be a matter of advising the client as to what the full implications could be."

However, even sorting out what those implications are is no simple task. Jonathan Berman, a lawyer with the IT specialists Halberstam Elias, says: "This area is horribly complex from a legal point of view, and people seem to be overlooking that. People who are looking into it are usually doing so from a technical and computer angle. But you can guarantee that at some point, somebody is going to sue somebody else over this - there's no question about that."

The chances of such action are increased by the likely high costs of ensuring that systems are compliant, which means that companies will be eager to find ways of spreading the cost burden to other parties.

The problem of the year 2000 has consumed yards of newsprint in the technical press, but has yet to be taken seriously in many of the UK's boardrooms. The problem is deceptively simple; it springs from the fact that many computer systems were designed to work on a dd/mm/yy date format ie they take the final two digits of the year when working out date comparisons. So when comparing 1996 and 1994, the calculation is 96 minus 94, with the correct result - two.

But when the date clicks on to 2000, this calculation goes haywire. Many systems, unprepared for life in the 21st century, will assume the year is 1900 - with unpredictable and possibly disastrous results. Stock control, payments and - worst of all - invoicing could be thrown into chaos.

Already, examples of the unexpected results are beginning to appear. Last year, a Marks & Spencer computer rejected a can of corned beef with a year 2000 sell-by date, because it calculated that the food was 95 years old. Blood banks, which have use-by dates for donated blood, are reported to have encountered similar problems.

Some experts point out that the forecasts of a "millennium meltdown" from the IT systems industry should be taken with a pinch of salt and put the panic down to self-interest. But even so, it is clear that any business which has failed to sort the issue out in advance faces a fair chance of severe financial trouble, because of the clear threat to its cash-flow.

And while IT professionals claim the problem is not especially hard to solve technically, it does require a thorough line-by-line check of every program in the system. For any substantial company, this process involves a major project running into millions of pounds [see How much will it cost?].

The implications of such a potential embedded liability are huge. Fred Damodaran, managing director of the Scottish systems consultancy Altech Computers, says he knows of a parent company which discovered that the costs of amending the 2000 problem in one of its subsidiaries would be enough to wipe out that subsidiary's annual profits. So it sold the operation off to another firm, which was unaware of the impending problem. Understandably, he declines to name the parties involved.

"The only recourse the purchaser might have is to make a claim against the people who were responsible for the due diligence - their own retained lawyers and accountants. There is now considerable concern about this whole area."

Malcolm Sterling, a director of the management consultants KPMG and a Year 2000 specialist, has heard of other corporate disposals under similar circumstances - and says the 2000 issue also brings clear implications for auditors. "It is going to be interesting to see whether auditors will need to determine the value of a company and the size of the threat," he says. "I have not heard of anyone's accounts being qualified yet because of this, but there is still enough time left to do something about the problem. It will become more serious when it's considered too late to make the required changes."

The underlying question is how an auditor can issue a "going concern" certificate for a business that has not sorted out its liability to the year 2000.

Jonathan Berman also points to a whole raft of further potential legal issues. Directors could be liable to action from shareholders if their failure to sort the issue out results in financial loss or even bankruptcy. Insurers may be unwilling to stump up for a problem that managements can hardly claim was "unforeseen", and a failure to notify the insurer of a potential problem as early as possible may invalidate future claims. And even if a company sorts out its own systems, it could be hit hard by a supplier's or customer's failure to address the issue.

"There is really no analogy in a legal sense for a situation where you know something terrible may happen in three years' time, but aren't sure what to do about it," says Berman. "Any money spent now is really mitigation of loss. My advice is that at the same time as having a technical audit done of their hardware and software, companies should do a legal audit as well." Halberstam Elias is in the process of setting up a database on its website, on which vendors will specify how their software handles dates.

As for acquisitions that later turn out to carry a liability to 2000, the position remains uncertain and untested, according to Marston. "The potential cost of the year 2000 is beginning to appear in some acquisition documents as a warranty," he says. Such warranties generally protect the purchaser against the costs of any remedial work necessary because of software proving to be unworkable after 2000.

Yet it remains to be seen how well these provisions will stand up in court, especially as any court action could well become embroiled in debate over how much any due diligence exercise could reasonably be expected to find out about the innards of a target company's computer systems. The effectiveness of the warranties would further depend on a number of factors - such as the financial and time limitations attached to the warranties, the resources of the party giving the warranty, and also their ability to meet a potential claim. What is clear is that vendors will increasingly try to ring-fence their prospective liability before agreeing to a sale.

The potential legal implications do not end with private sector takeovers. In the public sector, many local authorities have outsourced their computer operations to commercial third parties, and these contracts generally contain no provision for dealing with the costs of the year 2000. Instead, the agreements usually require the private contractor to keep the systems in good order and ensure that they continue to run efficiently.

This would suggest that the contracted party may be legally required to cover the costs of complying with 2000. However, such firms are unlikely to be willing to do so, and may argue that making a system Year 2000-compliant means going beyond mere "maintenance" into systems development. Ultimately, a computer contracting firm that is sued by its client for failing to address 2000-related issues could decide to seek compensation from the professionals who advised it on the contract - presenting another potential headache for some lawyers, and a source of work for others.

"Legal advisers have got to think very carefully about what they have advised," says Marston. "There is no sense in going half-way to meet trouble, but from now on I think every contract of this type will make people sweat nights".