Directors' Liability for Year 2000 Failures

• Publication year: 1999
• Pages: 37
• Citation: Vol. 28 No. 1 Pg. 37

28 Colo.Law. 37 Colorado Lawyer 1999.

1999, January, Pg. 37. Directors' Liability for Year 2000 Failures

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37

Vol. 28, No. 1, Pg. 37

The Colorado Lawyer
January 1999
Vol. 28, No. 1 [Page 37]

Specialty Law Columns
Business Law Newsletter
Directors' Liability for Year 2000 Failures
by Carole Jeffery

Although no one knows what actually will happen, many commentators are predicting that computer systems will be unable to create, store, represent, and process data on or after January 1, 2000.1 This "problem" is variously called "Year 2000," "Y2K" and the "Millennium Bug." For ease of reference, it will be referred to in this article as "Y2K."

It has been estimated that as many as 15 percent of companies and governments in the United States will experience at least one mission critical system failure as a result of Y2K.2 Ten percent of the failures will last three days or longer. The cost to recover from a single failure is estimated to range between $20,000 and $3.5 million.3 Thus, it will come as no surprise when the lawsuits begin. Already, plaintiffs have filed several lawsuits against hardware and software vendors for existing and anticipated Y2K problems.4 While the number of suits is currently low, the true litigation deluge is not expected to arrive until after the close of 1999

At that time, in addition to other anticipated types of litigation, courts will begin to see shareholder suits alleging that a company's directors have failed to exercise the appropriate level of care in performing their duties, including their analysis and response to Y2K problems. In addition, shareholders also may sue directors for failure to disclose material information relating to the potential or actual impact of Y2K problems on their company's business

Shareholder Litigation

There are three types of shareholder litigation against directors that can be expected to arise as a result of Y2K issues

derivative suits for breach of fiduciary duty;

derivative suits to recover Y2K losses arising from (a) a failure to acknowledge or correctly measure year 2000 risks, (b) a failure to implement adequate Y2K remedial efforts, and (c) waste of corporate assets; and

securities litigation for adverse Y2K impact on stock price arising from (a) inadequate disclosures; (b) inadequate due diligence to support disclosures; (c) materially false or fraudulent disclosures concerning the scope of the problem; (d) inadequate disclosure of contingent liabilities; (e) misrepresentation of estimated costs to correct the problem; and (f) insider trading.

Liability for these issues arises under both federal securities laws and state fiduciary duty laws. In general, all rise or fall on the question of whether the directors fulfilled their duties to their corporation and its shareholders.

Directors as Fiduciaries

It is a basic principal of Colorado corporate law, as elsewhere, that directors of a corporation owe fiduciary duties both to the corporation and to its shareholders. As fiduciaries, directors are liable for losses of the corporation caused by their bad faith or willful and intentional departures from duty, their fraudulent breaches of trust, their gross or willful negligence, and their acts outside the scope of their authority.5

As stewards of the corporation's assets, directors are vested with authority to control the business affairs of the corporation.6 In doing so, they must take reasonable care. The usual prescription for avoiding breaches of the duty of care is careful attention to procedures that assure full access to, and assessment of, relevant information, and time for considered decision-making before corporate action is taken.7 Colorado has codified the standards of conduct required of directors.8 The statute provides that directors must perform their duties in good faith, with the care an ordinarily prudent person in a like position would exercise under similar circumstances, and in what they believe to be the best interests of the company.9

Included within the directors' duties is the requirement to conduct a reasonable inquiry before making decisions.10 While a failure of internal computer systems would have been an inconvenience thirty years ago, the same failure today would cripple most businesses.11 This fact imposes on directors a heightened duty to evaluate and solve Y2K problems in order to avoid litigation.

Unfortunately, not all companies are analyzing and remediating their Y2K problems. In general, companies that do not deal aggressively with Y2K issues fail to do so for one or more of the following reasons: (1) the potential impact of the problem is viewed as minor; (2) the belief that the media, commentators, and vendors are exaggerating the issue; (3) the costs of remediation are viewed as alarmingly high; (4) major competitors are not actively seeking Y2K compliance either; and (5) resources have been diverted to the problem of the conversion of European currency rather than to solving Y2K problems.12

These failures to analyze and remediate Y2K problems have led one commentator to evaluate the probability that Y2K damages will be serious enough to trigger personal lawsuits. He has estimated a 55 percent probability of lawsuits against individuals who fail to...