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As the year 2000 draws closer, the construction industry has become well aware of the “Y2K” computer problem that may cause technological failures in a wide range of products, from complex software to HVAC or security systems run by microprocessors. The ripple effect of these failures may lead to business losses and legal disputes.

The risk for construction companies arises not only in your own systems, but in the systems of vendors, suppliers, and other companies with whom you may do business in the U.S. or abroad. This article outlines several issues companies should consider in managing their exposure to Y2K-realted problems.

Evaluate Your Own Systems and Programs

The first step in any Y2K Plan should be to evaluate your own internal systems and programs to determine which of them could be affected by Y2K. You should decide which systems and programs are critical for day-to-day operation of everything from payroll to inventory. If your electronic ordering system fails, will you be able to ship goods to your customers? If your scheduling system fails, do you have hard copies of the scheduling data for ongoing and prospective projects? What if a Y2K failure to your plant’s monitoring equipment results in environmental pollution?

It is important in doing your evaluation to decide whether and how the various systems might fail and how important that failure will be. To determine whether the systems are Y2K compliant, you may need to contact your vendors and service providers. Many companies have posted web sites on the internet that discuss the Y2K compliance (or lack thereof) of their products and services. In addition, you should investigate available fixes or repairs. Again, this may involve contacting your vendors and service providers. Finally, you should develop a contingency plan to prepare for failures that cannot be fixed or repaired in time.

Evaluate External Y2K Problems

Once you have determined how your internal infrastructure will handle Y2K, you must also determine how external Y2K problems will affect your business. For example, if the bank’s computer system fails and you are unable to access your accounts, can your business run for the days or weeks it may take to get the system running again? What if your suppliers are unable to provide the goods and equipment they promised? What if any owner or contractor is unable to pay you for a job you have completed?

As with your internal systems, you may need to contact the various parties you have identified to determine whether their systems are Y2K compliant. You should also develop a contingent plan to prepare for Y2K failures that may occur regardless of the representations those parties make.

Evaluate the Systems on Construction Projects

Of particular concern to the construction industry will be the various systems designed, provided, or installed on construction projects. According to the American Society of Civil Engineers (ACEC), the most Y2K-sensitive construction components are those driven by computer software and microchip technology such as (1) heating, ventilating, and air conditioning (HVAC) systems; (2) building security systems; (3) fire alarm and sprinkler systems; (4) building access and locking systems; (5) telephone and data systems; (6) emergency power systems; (7) timekeeping, lighting, and electronic systems; and (8) elevators and escalators.

Since learning of the Y2K problem, construction industry associations have been diligent in urging design professionals and contractors to notify owners of the potential problems so that problems can be addressed, thereby seeking to transfer the risk to owners to eliminate any potential damages. Nevertheless, construction industry members should evaluate the systems they have designed, provided or installed on past projects, as well as systems on future projects, to determine potential risks. It is important to realize that regardless of whether owners have been notified of potential Y2K problems, legal risks exist. Design professionals face potential claims of defective design; contractors face potential claims of breach of express and implied warranties; and product manufacturers face potential claims of misrepresentation and breach of Uniform Commercial Code (UCC) warranties of fitness and merchantability, as well as claims of strict liability for those products determined to be “ultra-hazardous.”

Reviewing Existing and Potential Contracts

Any Y2K Plan should include a review of all existing and potential contracts, including maintenance agreements, license agreements, equipment leases, supply contracts, and service contracts, to determine whether they address Y2K issues. If Y2K is not expressly addressed within the contract language (which it usually is not), who will be responsible if a Y2K failure occurs?

“Force Majeure” clauses. Most contracts contain a “force majeure” clause which protects a party when the party fails to perform due to an “act of God” or other event that is deemed to be beyond the party’s control. Because Y2K problems can be controlled with sufficient planning and resources, however, force majeure clauses will likely not protect a party who is unable to perform the contract due to aY2K-related failure.

Indemnity clauses. Owners, contractors and subcontractors should consider adding Y2K indemnity clauses to their contracts to protect future Y2K-related problems. Although some of the indemnity clauses currently being used may cover for Y2K problems, it would be advisable to review those existing clauses and specifically add Y2K to ensure protection.

Y2K warranties. In any contract for goods or services entered into over the next several years, the party purchasing the goods or services should ensure that the contract contains clauses that protect the party in the event of Y2K-related failure. For example, a subcontractor purchasing goods from a supplier should require a warranty that the goods are “date compliant, including Year 2000 compliant.” This broad warranty will ensure that any future date failure will be covered by the warranty, even if the failure does not occur exactly as 12:01 a.m. on January 1, 2000.

Insurance Coverage for Y2K

It is important for all construction firms to review their current insurance policies to determine whether those policies will cover Y2K-related problems. Although it is difficult to predict how insurers will react to Y2K issues when they arise, it is likely that most insurers will deny coverage for Y2K-related problems under most standard insurance policies.

Commercial general liability. Commercial general liability insurance (CGL) typically provides coverage for bodily injury, property damage, or personal injury caused by the insured to a third party. Two problems exist with most standard CGL policies that may prevent coverage. First CGL policies require an “occurrence” to trigger coverage. An “occurrence” is typically defined as an event that is not intended or expected. Because Y2K has been so widely publicized, many insurers may take the position that Y2K was an expected event and will deny coverage under the CGL policy. Second, “property damage” in a CGL policy is typically defined as physical injury to or loss of use of tangible property. CGL carriers will likely argue that data or source code does not constitute tangible property, thereby denying coverage for Y2K problems to those electronic media.

Business interruption. Under most forms of business interruption insurance, coverage is triggered only by interruptions that result from a “fortuitous event.” Again, because Y2K has been so widely publicized, many insurers may not consider Y2K to be a fortuitous event that will deny coverage for business interruption.

Year 2000 Information and Readiness Disclosure Act

One final issue that must be addressed is how to respond to inquiries about your own Y2K compliance. Fortunately, as of October 19, 1998, Congress put in place the Year 2000 Information and Readiness Disclosure Act. The purpose of the Act is to encourage disclosure and exchange of information regarding Y2K readiness. TO that end, the Act provides safeguards– but not immunity from liability– for those who disclose information regardingY2K readiness. Essentially, the Act provides that any lawsuit based on a “Year 2000 Statement,” which is a statement regarding a party’s Y2K readiness, must be supported by clear and convincing evidence that the maker knew that the statement was inaccurate, or made the statement with reckless disregard for its accuracy.

The Act provides additional protection for the specific subset of “Year 2000 Statements” called “Year 2000 Readiness Disclosures.” A “Year 2000 Readiness Disclosure” is a written statement that is identified on its face as a “Year 2000 Readiness Disclosure.” Under the Act, the Year 2000 Readiness Disclosures cannot be introduced into evidence in a civil lawsuit to prove the truth or accuracy of anything stated in it, subject to certain limited exceptions.

To take advantage of the protection provided by the Act, you should label any written information you disseminate dealing with your Y2K readiness, including internet web sites, as Year 2000 Readiness Disclosures. While this may not make you immune from Y2K-related litigation, it will provide you with some protection if you are sued for representations made about your Y2K readiness.

Caryn A. Kauffman. This article first appeared in the August 1999 issue of “Construction Law Update,” the legal newsletter of Faegre & Benson, LLP. The firm is located at 90 South Seventh Street, Minneapolis, MN 55402; Phone: (612)336-3000. Copyright ã 1999, Faegre & Benson, LLP. Reprinted by ConstructionRIsk.com with permission.