Y2K Bug’s Most Painful Bite Could Come From Liability Issues

The biggest Y2K issue on the horizon for small business is not technology but liability.

When computer snafus happen because chips improperly read the year 2000 as 1900, will your business be caught in a courtroom wringer?

“One of the big problems in Y2K-defect litigation is going to be figuring out who is actually responsible,” said Los Angeles attorney Eleanor Southers. “We’re going to have layers of defendants.”

That means that even though your company may have fixed its Y2K bugs, problems arising elsewhere in your chain of business could force you into court with a group of defendants.

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To be sure, no one knows how serious the Y2K problem will be. But small-business owners who look to their business insurance policies for protection may be surprised to find scant help there. And federal legislation that sought to provide some measure of protection has run aground.

California’s wealthy high-tech community, the U.S. Chamber of Commerce and the Assn. of Trial Lawyers of America have been slugging it out for months over Senate Bill 96, sponsored by Republican Sen. John McCain of Arizona. Despite dozens of revisions, McCain’s measure sits moribund. His staff members morosely shrug their shoulders and say further progress is up to Senate leaders, who have been engaged in a dispute with Democrats that has strangled the bill.

Meanwhile, insurance carriers for the last year have dedicated teams of attorneys and staff people to research the Y2K issue from a legal liability standpoint. They will be well prepared to deflect liability, and the harried small-business owner will be at a distinct disadvantage if a crisis hits.

“Small-business owners should not sit back and say they are covered; it’s simply not the case,” said attorney David Schack, a partner with Mitchell Silberberg & Knupp in West Los Angeles. “It’s advisable for the small-business owner to think what problems could arise and affect the business, and talk to an insurance professional now and try to determine whether they have any likelihood of getting coverage.”

The main reason small-business owners may find it hard to collect from their insurance companies is that the typical property or fire policy, called a first-party policy, covers accidents or unexpected occurrences that bring losses to the company. A business owner would be hard-pressed to argue that a Y2K problem was unexpected with all the media stories on Y2K; chamber of commerce workshops on the issue; announcements by software companies; and help from Web sites, government agencies and independent consultants.

Further, the typical property policy doesn’t cover economic losses to business. For example, if a computer malfunctions and you can’t get your billings out or you can’t ship your products, you won’t be covered, Schack said.

The insurance “covers a fairly specific set of perils, like flood, fire or lightning,” he said. “If a Y2K problem caused a fire, it’s conceivable you could be covered. But if it just stops your business . . . you’re unlikely to be covered.”

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Most businesses also have commercial general liability insurance, or CGL, but that probably won’t provide Y2K protection. CGL insurance typically covers property damage or physical injury suffered by someone else who files a claim against your company. You might be covered if someone is physically injured or his or her property is damaged as a result of a Y2K problem that arises from products or services supplied by your company, Schack said. But if the Y2K problems result only in delays or non-delivery and no physical injury or property damage occurs, you are unlikely to be protected against lawsuits filed by customers seeking to recover losses, Schack said.

Even business-interruption insurance might not cover your business, because Y2K might not be specifically listed as one of the covered items. If your policy has no mention of Y2K, insurance companies can more easily argue that it is not covered, said Schack, who deals with insurance agencies on behalf of business owners.

As for specific Y2K insurance, only a few companies are offering it. But it’s expensive, with a large deductible and a required pre-coverage audit by a Y2K consultant. It’s generally for large companies with catastrophic exposures and not for small businesses, Schack said.

While the insurance picture may appear somewhat bleak, the legislative picture is even bleaker. That’s in contrast to the enthusiasm late last year when a coalition of lobbyists from the high-tech industry, the U.S. Chamber of Commerce, the National Federation of Independent Business and the National Assn. of Manufacturers put their heads together with Republican leaders to come up with legislation that would protect business from Y2K problems.

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Among the provisions were a $250,000 cap on punitive damages, a prohibition on claims for economic loss, establishment of a good-faith defense against Y2K-damage claims and elimination of joint liability (a type of liability commonly used against big defendants with deep pockets, allowing damages to be collected from them in amounts exceeding their actual liability).

Unfortunately, the bills--HR 775, sponsored by Reps. Thomas M. Davis (R-Va.) and David Dreier (R-San Dimas), and SB 96 by McCain--drew heavy fire. The U.S. Chamber of Commerce was accused of throwing in its long-sought tort reforms, drawing opposition from the trial lawyers and politicians. Meanwhile, President Clinton vowed to veto the bills.

That pleased Republicans, who planned to cite it in the 2000 election campaigns as an example of how the Democrats once again had failed business.

While the fate of the McCain bill is uncertain, San Jose Democrat Zoe Lofgren, a high-tech supporter in the House, is trying to get a more reasonable bill passed there. Work on it is scheduled this week.

Its provisions include a 90-day cooling-off period before a Y2K lawsuit can be filed, provisions for alternative dispute resolution, limitations on liability for small companies, and discouragement of frivolous lawsuits by requiring that material defects be identified and damages factually shown.

Southers, whose legal practice focuses on mediation, is heartened by the call for it in legislation and believes that negotiation may well be the best resort for small businesses facing Y2K claims.

“The problem I see for small businesses is, first of all, whether they can get any insurance to help them and, second, being dragged into these things even if they’re not the correct defendant,” she said. “I think they should look to mediation in the very beginning of any claim they might have brought against them.”

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Times staff writer Vicki Torres can be reached at (213) 237-6553 or at [email protected].