By Kevin L. Shepherd

What deserves your attention most is the last thing to get it.
-Epictetus

One afternoon, the real estate manager for a tenant in an office complex calls the company's long-time counsel. The manager has just received a bill from the landlord for the tenant's pro rata share of operating expenses for the prior lease year. She is questioning a line item in the operating expense statement that cryptically reads "Y2K Compliance."

The manager had never seen this item in any previous statements and is alarmed over the amount. She is asking a number of questions, including whether the tenant must pay its share of the "Y2K Compliance" cost. The lawyer has a copy of the lease but does not recall seeing that item in the definition of operating expenses. The lawyer's instincts are that it is probably a misprint and that a quick call to the landlord will resolve the matter. But then the lawyer vaguely recalls reading an article in his teenager's computer magazine about the year 2000 computer problem. The article used an acronym that was strikingly similar to the notation on the operating expense statement. Could there be a connection?

The Year 2000 Problem
The approaching millennium is an exciting event. Although purists contend that the millennium will not occur until January 1, 2001, most people view January 1, 2000 as the dawning of the third millennium. Despite the excitement surrounding the event, some people are dreading it and predict global technological chaos because of what is popularly referred to as the "Y2K Problem," the "Year 2000 Bug" or the "Millennium Bug." Much has been written about the year 2000 problem, but little attention has been given to the practical and legal effects it may have on the commercial real estate industry.

Two Digits Make a Difference
The year 2000 problem exists because most computers use a two digit dating system that assumes that 1 and 9 are the first two digits of a year. Without reprogramming changes, the computers will interpret the year 2000 as 1900 because the last two digits are "00." Because of this error, date sensitive calculations will fail and computers will either shut down or produce incorrect information. The fact that 2000 is a leap year compounds this problem. Most computer programs do not recognize years ending in "00" as leap years.

In the early days of computer programming, computer disk space was expensive. Over 20 years ago, one megabyte of computer disk space cost about $600,000. That same disk space now costs a dime. Andrea Rock and Tripp Reynolds, The Year 2000 Bug, Money, Feb. 1998, at 48. To save valuable programming space, computer programmers compacted the date code to two digits. This two digit month, day and year (i.e., MM/DD/YY) convention has not disappeared in today's computer programs. (In fairness to the early programmers, they had no idea that these format conventions would still be in use decades later.)

The date on which the year 2000 problem will manifest itself is known and immutable. The year 2000 problem is also global in nature. No nation or industry will be immune from its significant economic effects. One commentator has suggested that the year 2000 problem is probably the worst man-made economic disaster ever. Many economists predict a global recession in 2000 if companies do not take prompt corrective action to make their computer systems year 2000 compliant.

No Easy Solution
Unfortunately, there is no magic cure for the millenium bug. It is ironic that a technological problem cannot be corrected by technology but only by human labor. Date codes are interspersed in millions of lines of code in computer programs. Technicians must manually scour each line to identify date codes. Computer technicians usually employ a three step method to identify year 2000 problems in a program: (1) identify where the problem exists in the computer's system; (2) analyze and correct the problem; and (3) run tests to see if the curative steps have worked. These efforts are expensive, time-consuming and disruptive to a company's normal activities. For instance, Chase Manhattan Bank has publicly estimated that it will cost about $250 million to remediate its year 2000 problems, Prudential Insurance Company has estimated that its year 2000 compliance costs will be at least $110 million and Federal Express will spend $75 million to fix the problem. The compliance costs for all American commercial banks may exceed $70 billion, and the total cost to all U.S. companies may exceed $440 billion.

Federal Government Response
The federal government has jumped into the fray. On January 12, 1998, the Securities and Exchange Commission issued Staff Legal Bulletin No. 5 stating that if year 2000 issues materially affect a company's products, services or competitive conditions, the company may need to disclose these issues. http://www. sec.gov/rules/othern/slbcf5.htm. The Federal Reserve Bank has stated that it will block mergers by banks with significant year 2000 problems and has threatened to downgrade their ratings if these issues are not corrected. In 1997 the President signed the Treasury-Postal Appropriation, Pub. L. No. 105-61, 111 Stat. 1272 (to be codified in scattered sections of U.S.C.), which codified the policy that federal agencies will not buy information technology unless it is year 2000 compliant, as defined in federal acquisition regulations. A proposed bill in the Senate would require all publicly traded companies to disclose the details of their year 2000 preparation, including costs, litigation expenses, insurance policies and contingency plans. Appropriately enough, this legislation is entitled the "Year 2000 Computer Remediation & Shareholder (CRASH) Protection Act of 1997," S.B. 1518, 105th Cong., 1st Sess. (1997).

The year 2000 problem will manifest itself in widely differing areas, including commercial leasing, commercial property ownership and sales, hotel reservations and mortgage lending. The real estate industry may be more prepared than other industries to meet the year 2000 challenge. The industry has long needed to track dates beyond 2000 for mortgage loan maturity dates, lease renewals and purchase options. Despite this optimism, experts agree that most industries are ill prepared to handle the year 2000 problem and are not taking the necessary steps to minimize its adverse consequences.

Commercial Leasing
One aspect of real estate, commercial leasing, can illustrate the magnitude and effect of the year 2000 problem. Landlords, tenants, due diligence consultants, property managers, leasing agents and lenders all rely, to some extent, on computers to manage their daily operations and long-term needs. For example, many building operational systems, such as elevators, heating, ventilation and air conditioning systems, security systems and other building components increasingly rely on computer chips that suffer from the year 2000 problem.

These chips, known as micro- computer, minicomputer or programmable logic controllers, are embedded in each operational system and facilitate the smooth and efficient operation of "smart" buildings. These chips track maintenance and inspection cycles and will shut off equipment if the chips detect that the component has not been timely serviced. Thus, for example, an elevator may stop working at midnight on December 31, 1999 if it senses that its last service was a century earlier. Gary E. Clayton, Trends in Computer Law; First Comes the Year 2000; Then the Lawyers, Tex. Lawyer, Nov. 10, 1997, at 24. Embedded chips are often dif-ficult to locate and cannot be reprogrammed. Rather, they must be replaced, which is a time-consuming and expensive process. Experts estimate that only about 5% of embedded chips are date sensitive. Nevertheless, with a projected 25 billion chips in existence on December 31, 1999, locating, testing and replacing them will be an enormous task.

Existing Leases
One can safely assume that most existing commercial leases do not remotely address the year 2000 problem. These leases will now be viewed in the context of a technological problem that was unheard of until relatively recently. If a year 2000 problem causes building systems to stop working, will the landlord or tenant bear that risk? Which party should bear that risk? Should the parties be assumed to have bargained with the year 2000 problem in mind? There are, of course, no easy answers. The lease provisions that will affect a year 2000 analysis include the common area maintenance (CAM) charge provision, the insurance and indemnification clauses, repair covenants and the covenant of quiet enjoyment.

• CAM charges. Typical commercial leases obligate tenants to pay for their pro rata share of CAM costs. If a landlord incurs expenses in making building systems year 2000 compliant (such as in replacing embedded chips in operational systems), the landlord will probably try to pass those costs through to the tenants as CAM charges. The landlord will argue that these costs are legitimate operating expenses of the property.

  Because these costs may be significant, tenants will naturally resist the landlord's attempt to shift compliance costs to them. Tenants will need to analyze the current wording of CAM charge provisions to see if they conceivably cover year 2000 compliance costs. Unless a CAM provision contains an exclusion for this type of cost, the tenant will probably have to pay it.

  Recently proposed changes in the accounting rules will tip the scales in favor of the landlord on this issue. The Emerging Issues Task Force of the Financial Accounting Standards Board (FASB) has recommended treating year 2000 costs as current year expenses rather than as amortized expenses. Accounting for the Costs Associated with Modifying Computer Software for the Year 2000, Issue Summaries (Emerging Issues Task Force of the Financial Accounting Standards Board) (1996) (EITF 96-14).

  This recommendation buttresses the view that year 2000 compliance costs are like normal CAM charges and are not capital expenditures that should be amortized.

  Landlords and tenants should maintain hard copy records of CAM charges and statements, regardless of the record retention requirements in the lease. If a year 2000 problem arises, these records may be impor-tant to reconstruct the pertinent data.

• Insurance and indemnification. The insurance industry is becoming increasingly concerned about its potential exposure to year 2000 claims. Some insurers are beginning to write exclusions for the year 2000 problem. Others, however, are starting to write policies insuring year 2000 risks. One insurer offers a "millennium" policy providing that if a policyholder does not have a year 2000 related loss, the insurer will return 90% of the premium.

  Both landlord and tenant must review current insurance to determine whether it will cover losses triggered by a year 2000 problem. A tenant that maintains a business interruption policy may seek coverage when a year 2000 problem prevents its normal business operations. Examples include elevator and HVAC operational glitches. Year 2000 problems may also lead to property damage claims. An insured must carefully review these policies to see that they do not exclude computer system failures and that they apply from the moment of the loss of use rather than at some point after the loss of use occurs. See Patrick J. Morgan and Julie Ann Stulce Williamson, Rent Insurance: Are You Covered?, 10 Prob. & Prop. 24 (July/Aug. 1996).

  Many commercial leases contain a provision whereby the tenant indemnifies the landlord against liabilities arising out of certain acts or omissions of the tenant. Some leases contain a reciprocal indemnification obligation from the landlord. The tenant indemnity sometimes carves out an exception for the landlord's negligence or intentional misconduct. The parties should scrutinize the indemnity provisions to determine the level of protection they afford for year 2000 problems. Responsibility for year 2000
  compliance costs may be particularly unclear if a part of the landlord's computer system relies on computer data from third-party vendors. The landlord may argue that it is unfair to require it to indemnify the tenant if the year 2000 compliance problem has its genesis in a third-party computer system. The tenant may respond that, as between them, the landlord is in the best position to protect its interests and should bear that responsibility. Although the landlord could seek indemnification from its third-party vendors, it is unlikely that the landlord would willingly agree to indemnify the tenant in this context.

• Repair covenants. Many leases require the landlord to maintain building systems in good order and repair. The landlord may breach this covenant if it fails to render its systems year 2000 compliant. If the lease obligates the landlord to repair the building and its operational components, the landlord's failure to do so may also render the landlord liable in tort for breach of a covenant to repair. See Restatement (Second) of Torts 357 (1965); 1 Milton R. Friedman, Friedman on Leases 10.501a1, at 706 (4th ed. 1997) (Friedman). As noted above, although the lease may obligate the landlord to make the operational systems year 2000 compliant, the landlord will probably try to pass those compliance costs to the tenant as CAM charges.

• Quiet enjoyment. The common law doctrine of quiet enjoyment has been surprisingly flexible in responding to changes in the leasing environment over the years and may address the year 2000 problem. Most commercial leases contain an express covenant of quiet enjoyment. Even if the lease is silent, many jurisdictions imply the covenant into the lease. The general rule is that the land-lord breaches an express or implied covenant of quiet enjoyment if its wrongful conduct substantially interferes with the tenant's use and enjoyment of the premises, regardless of whether the tenant vacates the premises. Friedman, 29.201, at 1619-20.

  If the tenant does not vacate the premises, the damages are usually based on the difference in the value of the use of the property with and without the interference. If the tenant leases space on the upper floor of a highrise office building and the elevators stop working, the landlord may have breached the covenant of quiet enjoyment. By preventing the tenant's access to its premises, the landlord has wrongfully interfered with the tenant's use and enjoyment of the premises. The tenant will contend that the landlord, which was aware or should have been aware of the year 2000 problem, failed to render building systems year 2000 compliant.

• Constructive eviction. The equitable doctrine of constructive eviction may also arise in this situation. To prevail on a constructive eviction claim, the tenant must show that there has been some wrongful act or omission by the landlord, the act or omission resulted in a substantial interference with the tenant's use and enjoyment of the premises and, as a result, the tenant abandoned possession of the premises within a reasonable time. David A. Thomas, 5 Thompson on Real Property  40.22(c)(3) (Thomas ed., 1994). The act or omission must render the premises untenantable. A single, noncontinuing interference may be enough to support a constructive eviction claim. If a tenant must abandon the premises because of a year 2000 problem, it may succeed in its claim against the landlord. A word of caution, however. The tenant should review the lease to determine whether it has waived any right to bring a constructive eviction suit.

• Miscellaneous. A tenant may want to know whether its landlord has taken any steps to ensure that building systems do not fail because of a year 2000 problem. The General Services Administration (GSA), the property management arm of the federal government, has sent a letter to landlords to determine whether their building systems are year 2000 compliant. The draft letter is located on the GSA's website at http://www.itpolicy.gsa.gov/mks/ yr2000/lessors.htm. If the landlord has taken little or no action in this area, tenants may exert whatever influence they have to compel the landlord to manage the year 2000 problem. The remedy of self-help may be impractical if the noncompliant systems are out of a tenant's control. Unless a tenant had significant bargaining power, its lease probably will not permit it to abate rent if the landlord fails to provide necessary services.

  New Leases
  Absent special circumstances, landlords and tenants should address the year 2000 issue in new leases. In drafting a new lease, landlords and tenants should consider the following primary points for negotiations, as well as other issues that the circumstances trigger.

• Definition. As a baseline, the parties should agree on what is meant by the phrase "year 2000 compliant." In its acquisition regulations, the federal government has provided that information technology is year 2000 compliant if it is able to:

  accurately process date/time data (including, but not limited to, calculating, comparing, and sequencing) from, into, and between the twentieth and twenty-first centuries, and the years 1999 and 2000 and leap year calculations, to the extent that other information technology, used in combination with the information technology being acquired, properly exchanges date/time data with it.

  http://www.y2k/y2kcontr.htm#warranties. This definition should provide a useful starting point. A year 2000 compliant definition should take into account both the year 2000 problem and the leap year that occurs in 2000.

  Representations. A tenant should request the landlord to represent and warrant that building operational and information systems are year 2000 compliant. The landlord's lender will likely seek identical representations and warranties. If the landlord is unable to make these representations and warranties, the tenant should determine the source of the landlord's inability (e.g., the landlord has not undertaken any year 2000 compliance actions) and gauge the potential severity of noncompliance on the tenant's operations. If the systems are presently not year 2000 compliant but the landlord is taking steps to make them so, the lease should reflect those efforts and obligate the landlord to continue its compliance efforts, allowing sufficient time for testing. The GSA has developed year 2000 compliance language for its leases, which appears in the box accompanying this article.

  A landlord should make sure that a year 2000 compliance clause does not eviscerate the standard lease language that exonerates the landlord from liability for interruptions in services and utilities to the building.

  One commercial lease in use in the Midwest provides that the landlord warrants that all building services "shall continue without interruption throughout the term of this Lease including and beyond December 31, 1999 (Millennium Date), without any defect or abnormalities and at least at the same level of service as would otherwise be provided before the Millennium Date." Curiously enough, this tenant oriented provision uses the year 2000 problem as a wedge to ensure that no interruption in building services will occur, no matter what the cause. Few landlords would willingly assume this obligation.

  CAM charges. If a building and its information systems are not year 2000 compliant, the parties should reach a clear understanding on how compliance costs will be funded, by focusing on the CAM provisions and specifically allocating responsibility for these costs.

  Due diligence. A prospective tenant may need to add year 2000 compliance as a due diligence check-list item. A leasing broker will probably have little or no information on whether the building is year 2000 compliant, but the tenant has several options. The tenant may simply ask the landlord what it is doing to render the building systems year 2000 compliant. Depending on the tenant's level of expertise in this area, the tenant may want to hire a consultant to assess year 2000 compliance. Of course, the tenant will need permission for its consultant to enter the property. Although the consultant may be able to gauge the landlord's year 2000 compliance level, it may be difficult to determine whether the landlord has resolved year 2000 problems with vendors with which the landlord exchanges electronic information.

  Duty to disclose. More modern buildings, particularly "Class A" buildings, have sophisticated computer controlled operational systems and raise unique disclosure issues. Do owners and brokers have a duty to disclose year 2000 compliance issues or concerns? Should brokers be charged with knowledge of this type of problem? What if the brokers have specialized expertise in Class A office buildings? Should they be held to a higher standard of care than brokers of Class B or lower grade properties? Vendor compliance. Landlords should review vendor and supplier contracts, particularly those that deal with property operational systems. A landlord should insist that its systems be year 2000 compliant. Owners should obligate property managers to comply with year 2000 requirements. Owners should review their agreements with property managers to make sure that these agreements adequately address this issue.

  Other Real Estate Transactions
  The year 2000 problem is not confined to commercial leasing. Recent loan documents from major money center banks now contain year 2000 compliance clauses. Borrowers must either negotiate these clauses out of the loan documents or perform the due diligence necessary to make the representations. The year 2000 problem also affects property acquisitions. A new item on a buyer's due diligence checklist is a year 2000 compliance review. The widely varying nature of real estate (e.g., office building, lodging facility, retail shopping center or industrial or warehouse facility) makes it difficult to project the scope of a year 2000 compliance audit. Buyers will probably need to hire consultants to assess whether property is year 2000 compliant and will seek year 2000 compliance representations and warranties from sellers. In turn, sellers will likely resist making these representations and warranties.

  Conclusion
  The grandest celebration of this century will occur on December 31, 1999, less than 18 months away. This celebration will usher in an age of increased technological advancement and hopefully rekindle optimism for a successful third millennium. This new beginning, however, will be inauspicious if technological gridlock occurs. As John Keats noted long ago, "[t]here is an old saying 'well begun is half done'_'tis a bad one. I would use instead_Not begun at all till half done." Heeding Keats' admonition, much needs to be done in little time to avoid or minimize the impact of the year 2000 problem. Real estate lawyers need to focus on the year 2000 problem in their transactions. Government and industry must work together, quickly, to exterminate the millennium bug. There is no alternative.

  Kevin L. Shepherd is a partner with Venable, Baetjer and Howard, LLP, in Baltimore, Maryland, and is the Supervisory Council Member for the Group B committees of the Section's Real Property Division.