Legal Briefing No. 41

Number 41

27 April 1998

THE YEAR 2000 PROBLEM AND
THE COMMONWEALTH

What is the Year 2000 Problem?

Early computer programmers dispensed with the two digits '19' when
signifying the current century in computer programs. This
made programming easier and quicker, creating more valuable
space and thereby saving millions of dollars. (The term 'system' in
this briefing is used to collectively refer to computer
software and/or embedded systems which utilise a microchip.)
Although people thought that these systems would be replaced
by the turn of the century, many of the systems still exist,
evolving into new programs or hidden within newer systems.

When '99' changes to '00' in the first seconds of the
year 2000, most computer systems - unless previously made
year 2000 compliant - could fail by:

  • rejecting entries
  • computing erroneous results, or
  • simply not operating.

In developing a solution, it is not possible to produce
a standard date correcting program because each system
produces a different pattern of errors. Each line of code
must be checked and corrected. The year 2000 problem may
be counteracted by modifying existing systems or, where
it cannot be fixed through modification, by replacing non-compliant
systems. Extensive programming is required in order to
scan each line of code to locate date and clock fields
for correction. Extensive testing is then required to check
the modifications.

The Commonwealth needs to ensure that its systems are
Year 2000 compliant. Sound project management and effective
contracting are essential. Given the diversity and scale
of its operations, the magnitude of achieving year 2000
compliance within the Commonwealth is significant. This
briefing discusses the risk for the Commonwealth and its
agencies under general liability and trade practices, and
contractual issues relating to year 2000 solutions.

Risk for the Commonwealth and its Agencies

The Commonwealth and its agencies may be liable in negligence
for damages or loss caused by a year 2000-related computer
systems failure. Officers employed by the Commonwealth
or agencies may also be personally sued and be held personally
liable for a year 2000 failure.

If a Commonwealth agency is a corporation its executive
officers also have obligations of duties of care and diligence
(which extend to the year 2000 problem) under the corporations
law.

Possible Damage

A year 2000 failure may cause damage in the nature of
physical injury, property damage, or it may be in the nature
of purely economic loss (where the loss is financial only
and is not consequent upon property damage or physical
injury).

Circumstances where a year 2000 failure may cause physical
injury or death may include:

  • the functional failure of building facilities owned
    or occupied by the Commonwealth, such as the failure
    of lifts and warning or security systems
  • the malfunction of transport or navigational systems,
    or
  • the failure of building or emergency systems.

Circumstances where a year 2000 failure may cause purely
economic loss might include:

  • the miscalculation of an individual's benefits and
    entitlements
  • a misdirection of funds through systems of direct crediting
    and direct debiting, or
  • a breakdown in communication systems causing business
    losses.

These are examples only and each agency should identify
what risks the year 2000 problem could present in relation
to its own operations.

Liability for Third Parties

The Judiciary Act 1903 removed the Crown's traditional
immunity from suit in tort and contract. The effect of
the removal of that immunity is that the Commonwealth can
be sued for its tortious acts and for the tortious acts
of its officials and agents.

At common law, liability in negligence will arise if a
person who owes another person a duty to take reasonable
care breaches that duty, and reasonably foreseeable and
proximate damage results.

After the decision in Northern Territory of Australia
v Mengel, governments and public officers are liable
for their negligent acts and omissions in accordance
with the same general principles that apply to private
individuals.(1)

There is clear potential for the Commonwealth (and Commonwealth
agencies) to be liable in negligence for claims arising
from loss or damage attributed to a year 2000 failure.

The year 2000 problem presents a unique and novel occurrence
as the technical reasons which have given rise to the problem
have not been encountered before. Accordingly a court will
be presented with a new category when determining the existence
or otherwise of a duty of care.

However, categories of negligence are never closed,(2) and
courts will consider whether the risk of damage was reasonably
forseeable and whether there was a sufficient relationship
of proximity between the plaintiff and the defendant.

Foreseeable Risk and Duty of Care

It has been acknowledged for some time that computer systems
that are not year 2000 compliant may malfunction at the
turn of the century. As the year 2000 draws nearer the
level of awareness relating to the impending problem has
increased.

This advance warning will make it difficult for a defendant
to argue that it was not reasonably foreseeable that a
plaintiff might suffer damage by reason of a computer system
failure attributed to year 2000 non-compliance.

Commonwealth agencies need to identify the risks which
the year 2000 problem poses to their particular operations
and activities. Some of the Commonwealth's operations will
present greater risk than others.

In those instances nothing short of replacement of the
non-compliant systems may be considered sufficient to discharge
the duty of care (particularly if it was considered that
the modification of existing software would not be sufficiently
foolproof). However in most cases existing systems may
be modified.

Assuming a duty of care can be established, liability
in negligence will depend on whether the Court considers
that the Commonwealth has reasonably done everything possible
in order to avoid or lessen the plaintiff's injury or loss.
Where no action has been taken and injury or damage ensues,
it will generally be difficult to assert that the year
2000 failure was unavoidable, as solutions now exist.

A claim for indemnity, however, will lie where the Commonwealth
can, through a contractual right, shift the full extent
of its liability onto another party, such as a software
contractor that provided a year 2000 compliant warranty
to the Commonwealth.

Potential Liability under the Trade
Practices Act

As a general proposition, the Commonwealth could be liable
for damages under the Trade Practices Act 1974 (the
TPA) if (in its trading activities) it misleads or deceives,
or falsely represents to a person that its software or
a particular company's software is year 2000 compliant
when it is not, and that person suffers loss or damage.
An example would be where the Commonwealth or an agency
is selling software or is involved in its distribution.

The provisions of the TPA only apply to the Commonwealth
or its agencies if they are engaged in business activities.
Possible causes of action against the Commonwealth under
the TPA could be:

  • Under section 52, businesses are required to tell the
    truth or refrain from giving an untruthful impression.
  • Under section 53, a corporation is prohibited from
    making certain prescribed false representations in respect
    of goods or services it is supplying. Unlike section
    52, a contravention of section 53 constitutes an offence
    and is punishable by a fine.

Although the Commonwealth is not liable to be prosecuted
for an offence under the TPA, an authority of the Commonwealth
is exposed and actions for pecuniary penalty or a prosecution
may be brought against it by the Australian Competition
and Consumer Commission.

  • Under division 2 of part V, some conditions and warranties
    are implied in contracts for the supply of goods and
    services to consumers as defined under the TPA.

In relation to year 2000 compliance, a relevant condition
would be that software products should be fit for their
purpose beyond the turn of the century.

Personal Liability of Officers

In the absence of statutory immunity, officers employed
by the Commonwealth or agencies may be personally sued
and be held personally liable. The fact that an employer
is vicariously liable for the negligence of an employee
provides no legal protection to an employee because, at
common law, the employer has a right to obtain a full contribution
from the employee where the employee is wholly at fault.(3)

The High Court recently confirmed this principle in FAI
General Insurance Co Ltd v A R Griffiths Sons Pty Ltd.(4)

Under new financial legislation, the position in relation
to the provision of legal assistance to officers varies
according to whether the person is employed with an 'agency' to
which the Financial Management and Accountability Act
1997 (FMA Act) applies or is employed with a 'Commonwealth
authority' or 'Commonwealth company' to which the Commonwealth
Authorities and Companies Act 1997 (CAC Act) applies.

For persons employed where the CAC Act applies, the authority
or company is expected to indemnify their officers (see
Finance Circular 1997/19). The position for persons employed
where the FMA Act applies (which covers agencies which
have no separate financial existence from the Commonwealth,
including departments), is set out in the recently announced
policy entitled Commonwealth Policy for Assistance to
Officials in Relation to Legal Proceedings. (5) The
policy states in paragraph (5) that
assistance would be provided where the official was acting
reasonably and responsibly in the interests of the Commonwealth.

Personal Liability of Directors and Executive Officers

The year 2000 problem may result in loss to a Commonwealth
authority. Avoiding that loss will depend, among other
things, on the quality of decision-making by the directors
of the corporation (or the executive officers of the authority).
Generally, Australian courts will not review the business
judgment of directors unless the results are such as to
indicate an actual breach of the duty of care which a director
owes to the corporation. Such duties arise through general
law as well as from statute.

In the case of general law the obligations may arise from
contractual obligation (where the director is executive
director, employed under a contract of service), as well
as from common law and equity. In the case of statute,
the corporations law imposes duties of care and diligence.

The position is virtually the same for executive officers
of Commonwealth authorities. The CAC Act imposes the same
requirements in relation to care and diligence as the corporations
law. There is also some authority for the proposition that,
as for company directors, executive officers of Commonwealth
authorities would be under a general law duty to exercise
reasonable skill.

Whether or not a director will be personally liable for
loss will depend whether their behaviour failed to reach
the standards of care, skill and diligence required by
the law. That standard will vary on the basis of a number
of factors. The test varies according to the origin of
the duty (general law, contract, statute) and the type
of duty (care, skill, diligence).

At general law, a director is expected to exercise such
care and diligence as an ordinary person might be expected
to exercise in looking after their own interests. The statutory
test (in the Corporations Law at section 232(4) requires
a director or executive officer to exercise such care and
diligence as a reasonable person 'in a like position in
a corporation would exercise in the corporation's circumstances'.
There is a similar provision in the CAC Act at section
22(4) in respect of directors and officers of Commonwealth
statutory authorities.

In relation to skill, there is a difference in what is
expected of executive directors compared with non-executive
directors. In the case of non-executive directors, the
general law provides virtually no objective test (compared
with other professions such as medicine or engineering).
This is because historically, there has been no body of
professional learning associated with being a director.

Nevertheless, where a director does possess special knowledge
or experience, he or she is expected to use that in the
affairs of the corporation. In the case of executive directors,
however, the existence of a contract of service means that
there is an express or implied contractual undertaking
by the director, that they have the skills required for
the performance of the job, including appropriate skills
in financial management. No statute provides any requirement
or test in relation to the level of skill which must be
exercised by a director.

Implications for Clients

The case law has led to some statements of what might
be expected of directors in a positive sense, although
this relates to financial management rather than the issues
raised by the year 2000 problem. A director is expected
to:

  • have at least a certain minimum level of knowledge
    and continuing understanding of the business of the corporation
  • have at least a minimal knowledge of financial statements
    and reporting obligations, and
  • attend board meetings and monitor the financial status
    of the corporation.

Where the decision-making relates to managing risk in
relation to a technical matter, such as the year 2000 problem,
the formulation of the statutory duty of care and diligence
referred to above gives a useful guide to the standards
which might apply.

What constitutes an acceptable standard of care and diligence
will depend very much on what measures other corporations
have adopted in similar circumstances, and on the specific
role that particular directors have in such a company.

The general position may be different where a director
appointed to the board has specific expertise and knowledge
in relation to the technical area in question, or where
a director is appointed for the purpose of advising the
board on these issues. In such a case the standard which
the person is judged against would be subjective and therefore
higher. Where such a director is an executive director,
their contract of service may impliedly or expressly provide
for the exercise by that director of skills at a particular
level.

Contractual Issues Relevant to the Year
2000 Problem

Management

The real key to solving the year 2000 problem lies in
management. While many Commonwealth information technology
functions will be outsourced by the year 2000, agencies
cannot rely on contractors to provide solutions under outsourcing
arrangements. Decisions need to be made now on a range
of matters. Existing systems need to be audited and decisions
taken about systems owned by agencies. With systems that
have been supplied from software houses as licensed software,
agencies need to ascertain and have confirmed when the
suppliers will be able to deliver their year 2000 compliant
solutions. The software will need to be integrated with
all the other software that is required for the operation
of an agency's solutions.

This will often mean that agencies will need to negotiate
with their software suppliers about a large range of matters
including the extent of year 2000 compliance, delivery
dates, compatibility with other products, acceptance testing
and the extent to which the solution is warranted etc.
Agencies will also need to make decisions about replacing
existing systems with new solutions. This will also involve
the management of issues such as new working arrangements,
training etc that come with the integration of new products.
In other circumstances managers may need to take decisions
about whether particular functions should be performed
at all or whether they should be outsourced.

With all these changes taking place with the software
that agencies need for their business, it may be necessary
to engage an external organisation to manage audits, reviews
of terms and conditions of existing licences and advise
on strategies for the implementation of changes to an agency's
network. These are important tasks (with a very limited
timeframe) that will need to be performed in the market
in which your agency will be competing.

Agencies are finding it increasingly harder to get contractors
to perform this work and are having to take on significant
risks which they have previously passed on to contractors.
This means that it is vital that agencies have good project
management and effective contracts in place.

Clauses in Existing Contracts

The clauses in the standard Commonwealth common use contracts,
even before the year 2000 clause was added, provide many
features that are designed to protect the interests of
the customer. In the case where the contractor is continuing
to supply maintenance to licensed software products there
is likely to be at least an implied understanding that
the software will be made compliant prior to the year 2000.
Those contracts also contain a requirement that the product
be fit for the purpose and comply with the customer's functional
specification. While these concepts operate from the time
the contract was entered into, they may well have continuing
relevance without the need for a specific reference to
the year 2000.

Managing Year 2000 Contract Disputes

In general terms, the Commonwealth may take action against
a contractor under contract law through the terms and conditions
of the contract or through implied terms of the contract.

There are two main issues to consider:

  • existing contracts without mention of year 2000 compliance,
    and
  • information technology contracts being executed now
    during the lead-up to the year 2000 which contain the
    year 2000 warranty

and what action may be taken in either case should there
be a failure of the product or service provided under those
contracts.

Termination

While every effort should be taken to negotiate year 2000
issues with contractors there may be a need to enforce
agencies' rights. Rights under a contract normally include
termination for breach or repudiation and recision for
misrepresentation or mistake. These rights should be contained
in the clauses of the contract. They vary depending on
the terms of the contract and may be subject to certain
restrictions, such as the refusal to allow the enforcement
of penalty clauses, as well as general principles of equity.
These remedies are, however, only useful when the relationship
between the parties has broken down.

No matter how serious a breach of contract may be it does
not automatically lead to the right to terminate the contract
unless the parties have clearly expressed an intention,
through the terms of the contract, that this should be
the result. Termination is a matter of election on the
part of the party not at fault which implies that they
are entitled to terminate for breach. The party who takes
steps to terminate must follow the process as described
in the contract.

Remedies for Breach

There are two types of breach of contract to consider:
failure to perform, and anticipatory breach. A contractor
may fail to perform, without lawful excuse, by its failure
to discharge a contractual obligation at the time specified
within the contract period for that performance.

An anticipatory breach would occur when the Commonwealth
justifiably terminates the contract prior to the time agreed
by the parties for performance under the terms of the contract.
The termination will be justified if the words or conduct
of the contractor or the contractor's actual position gives
rise to a repudiation of the obligation to be performed,
or indicates that the contractor has been prevented from
performing the contract.

The major distinction here is that there must be a failure
to perform at the expiry of the time for performance, whereas
an anticipatory breach precedes the time of performance.
Further, a failure to perform does not necessarily give
rise to a right to terminate whereas an anticipatory breach
arises on termination of the performance of the contract.

In relation to the year 2000 problem, the user of the
product will know there is a breach during or after 1 January
2000. However, in the latter case the user will know before
that date.

The most common remedies for breach of contract are:

  • an award of damages, including liquidated damages and
    recovery of sums specified under the contract
  • specific performance, and
  • injunction.

Damages

The remedy of damages is not dependent on any term in
the contract expressly conferring the right of recovery.
The failure to discharge an essential term or primary contractual
obligation may give rise to a secondary obligation to provide
compensation implied by law in the absence of a term to
the contrary. The Commonwealth does not have to terminate
in order to recover damages for breach.

However, the Commonwealth must terminate in cases of anticipatory
breach where no right to damages accrues unless and until
termination occurs.

Specific Performance

Specific performance will not be ordered unless a breach
of contract has already occurred. The fact that the contract
is breached means that the plaintiff has a remedy in damages,
and the main basis for ordering specific performance of
the contract is that a damages award is, in the circumstances,
an inadequate remedy.

Recent court decisions indicate that this form of remedy
is difficult to obtain. For the remedy to be ordered, the
whole contract must be the subject of the order unless
the order relates to a severable part of a severable contract.
However, specific performance may be a remedy the Commonwealth
might seek when dealing with a year 2000 problem. Commonwealth
agencies may seek an order requiring the contractor to
achieve year 2000 compliance with its product or service.

Implied Terms

The law in relation to implied terms in a contract is
particularly important to the Commonwealth's position.
There are many IT contracts in existence throughout Commonwealth
agencies relating to products and services that will be
affected by the year 2000 problem. These contracts often
do not contain a year 2000 compliance clause or any warranty
or guarantee in relation to possible
year 2000 problems.

A court will imply a term into a contract for the following
reasons:

  • to give business efficacy to a contract - that is to
    ensure that a contract will operate in a business context
  • when it is apparent that from the nature of the contract
    itself or the obligations that it creates that a term
    was meant to be included and is therefore implied into
    the contract, and
  • when there may be a statutory obligation missing from
    the contract and therefore a court will imply a term
    so that the contracting parties fulfil their statutory
    obligations.

Reasonableness and policy are more important to legal
implication and a term may be implied by law, on the ground
that it is reasonable to do so, even though the 'business
efficacy' and 'obviousness' criteria of terms implied in
fact are not satisfied.
A court may consider that year 2000 compliance was reasonable, particularly
when the contract was concluded in the latter years of this century. This may
be the case even though a contractor may argue that it was not considered effective
business practice at the time.

However, it should be noted that in a case where the materials
of a particular brand were specified by the customer it
was found that it was unreasonable to imply a warranty
in the contract.(6) This is
often the case when Commonwealth agencies specify their
preferences for particular IT products.

ISSN 1448-4803 (Print)
ISSN 2204-6283 (Online)

The material in this briefing is provided
for general information only and should not be relied
upon for the purpose of a particular matter. Please contact
the Legal Practice before any action or decision is taken
on the basis of any of the material in this briefing.

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