Courts Struggle With the Application of Contract Law to Internet Transactions

In order to answer the question, a buyer or seller must first determine what law governs the contract.

THE U.C.C.

In general, the courts will turn to Article 2 of the Uniform Commercial Code to interpret the terms and conditions applicable to an e-commerce transaction. Promulgated in 1951, every state but Louisiana adopted the U.C.C. by 1968. Article 2, which applies to transactions in goods, defines goods as “all things (including specially manufactured goods) which are moveable at the time of identification to the contract for sale.”

E-commerce often involves the sale of commercially valuable information, such as software products. Unlike goods, information is an intangible commodity that, although it may be recorded in tangible form, can be possessed or used by an unlimited number of people.

A seller who seeks to control the dissemination of information and prevent unauthorized uses must obtain from the user a commitment to use or transfer the information in a limited manner. Sellers use the licensing framework in order to avoid the first-sale doctrine and establish a basis in state contract law for preventing unauthorized use.

However, the purchase of software does not involve the transfer of ownership of the information, but rather permits the buyer to use the information, and that would seem to take the transaction outside of the purview of the U.C.C. See� 2-106 (sale involves “passing of title from the seller to the buyer for a price”).

UCITA

Because of these shortcomings, an uneasiness about the application of the U.C.C. to e-commerce transactions began to grow, and the National Conference of Commissioners on Uniform State Laws sought to create a new U.C.C. Article 2B that would apply to information and software licensing. The conference abandoned those efforts and in turn began to draft the Uniform Computer Information Transactions Act.

In July 1999, the conference approved and recommended UCITA for enactment. At its core, UCITA codifies the practice of using mass-market licenses. UCITA provides relevant definitions of mass-market license and mass-market transaction at www.ucitaonline.com.

The terms of a mass-market license are usually contained within the software’s packaging or made part of the program itself. Unlike a typical contract, the buyer of a product subject to a mass-market license does not become aware of the license’s terms and conditions until after the product is purchased. If the purchaser failed to return the product, UCITA would bind the purchaser to the terms contained in the mass-market license.

Many commentators have criticized UCITA for giving too much power to the sellers of computer information and only Virginia, the home of America Online’s corporate headquarters, has completely enacted UCITA. SeeBrian D. MacDonald, “Contract Enforceability: The Uniform Computer Information Transaction Act,” 16 Berkeley Tech. L.J. 461 (2001).

Maryland enacted a modified version of UCITA, while Arizona, Delaware, the District of Columbia, Illinois, New Hampshire, New Jersey (introduced May 4, 2000), Maine and Oklahoma have introduced the legislation but have not voted on its enactment.

Finally, Alaska, Iowa, Minnesota, Nebraska, North Carolina and Utah have rejected UCITA. SeeCarol A. Kunze, “What’s Happening to UCITA in the States,” at www.ucitaonline.com

Iowa took the most extreme position when it passed “bomb shelter” legislation that forbids any party from enforcing UCITA and allows Iowa consumers and businesses to void any provision that makes UCITA governing law. SeeIowa Code � 554D.104 (2001). When addressing issues of contract formation and enforcement, UCITA affects the analysis only if Virginia, Maryland or Iowa law governs the transaction.

While UCITA languishes, the majority of courts that have addressed these issues have found that software qualifies as goods under the U.C.C.

As the Massachusetts district court stated in :

[this] Court will not overlook Article 2 simply because its provisions are imperfect in today’s world. Software licenses are entered into everyday, and business persons reasonably expect that some law will govern them. For the time being, Article 2′s familiar provisions — which are the inspiration for UCITA — better fulfill those expectations than would the common law. Article 2 technically does not, and certainly will not in the future, govern software licenses, but for the time being, [this] Court will assume it does.

UETA

When assessing e-commerce contract law, the Uniform Electronic Transactions Act and the federal Electronic Signatures in Global and National Commerce Act, known as the E-sign Act, may also come into play. New Jersey introduced UETA for enactment on March 27, 2000. See www.njleg.state.nj.us.

In substance, the E-sign Act is substantially similar to UETA. Like UETA, the E-sign Act affords electronic signatures the same legal effect as pen and paper signatures for parties entering into a transaction. In addition, the contract or agreement itself may be entirely in electronic form and still be legally enforceable. This permits the parties to a transaction to conduct business from start to finish over the Internet without ever exchanging documents in paper format.

The E-sign Act pre-empts state law to a limited degree. A state cannot pass legislation that favors one type of technology over another when affording legal effect to an electronic signature. This prevents states from trying to legislate the type of technology used to complete transactions and ensures the parties to the transaction that the contract can be enforced provided some form of electronic signature is used.

Parties may consummate e-commerce transactions in a variety of ways. However, the seller in an e-commerce transaction will usually offer the terms of the contract or license in one of three ways: a shrink-wrap agreement, a click-wrap agreement or a browse-wrap agreement.

SHRINK-WRAP AGREEMENTS

The term shrink-wrap license or agreement refers to the fact that the license begins when the purchaser reads its terms and tears open the cellophane wrapping or shrink-wrap that surrounds the package.

The first shrink-wrap licenses were visible prior to purchase and a purchaser could read the terms before opening the packaging.

Most recently, the wrapping makes reference to more detailed licenses contained within the package itself. Courts are split over whether such licenses create enforceable agreements.

In Step-Saver Data Systems, Inc. v. Wyse Technology, 939 F.2d 91 (3d Cir. 1991), the 3rd U.S. Circuit Court of Appeals held that a shrink-wrap agreement limiting a seller’s liability was not enforceable because it was a proposed agreement under U.C.C. � 2-207 to which the purchaser never agreed. The court refused to imply assent because it considered the term material and � 2-207 requires affirmative assent before a party can add a material term to the contract.

The opinion also examined the history of licensing in the software industry and concluded that the subsequent changes to the first-sale doctrine rendered the need to characterize the transaction as a license “largely anachronistic.” Other courts have reached similar conclusions. See SoftMan Products Co. v. Adobe Systems Inc., 171 F.Supp. 2d 1075 (C.D. Cal. 2001) (notice on box cannot bind purchaser) and Klocek v. Gateway, Inc., 104 F.Supp. 2d 1332 (D. Kan. 2000) (under U.C.C. � 2-207 vendor had not made acceptance of license condition of purchase).

The 7th Circuit reached the opposite conclusion in ProCD, Inc. v. Zeidenberg, 86 F.3d 1147 (7th Cir. 1996).

The defendant in ProCDpurchased software that contained a licensing agreement in the box and encoded on the disk. The packaging for the software noted that it came with restrictions contained in an enclosed license.

In enforcing the license, the court held that license terms contained inside a box of software bind customers who use the software after having had the opportunity to read the terms and to reject them by returning the product. In accepting the logic behind ProCD, the court in i.Lannoted that a shrink-wrap agreement permits contract formation on a “money now, terms later” basis.

The 7th Circuit expanded on its ProCDholding in Hill v. Gateway 2000, Inc., 105 F.3d 1147 (7th Cir. 1997).

The customer in Hillpurchased a computer by placing an order over the telephone. The manufacturer enclosed a license agreement with the computer that would “govern unless the customer returned the computer within 30 days.” The court held that the seller “may invite acceptance by conduct” and that “by keeping the computer beyond 30 days, the Hills accepted Gateway’s offer.”

Other jurisdictions have adopted this reasoning in enforcing shrink-wrap agreements. See M.A. Mortenson Co., Inc. v. Timberline Software Corp., 998 P.2d 305 (Wash. 2000) and Brower v. Gateway 2000, Inc., 676 N.Y.S.2d 569 (N.Y. App. Div. 1998) (enforced agreement identical to that in Hill).

By their very nature, shrink-wrap agreements present questions as to a party’s assent to the terms of the agreement. A shrink-wrap agreement seeks assent through inaction. By not returning the product, a seller believes that a buyer has agreed to the terms of the license.

However, it remains unclear if the buyer actually received notice of the existence of the license or whether the buyer knew the seller conditioned the sale on the acceptance of the license. These questions are fact sensitive and not susceptible to bright-line rules.

CLICK-WRAP AGREEMENTS

Given the uncertainty surrounding shrink-wrap licenses, many e-commerce vendors began to use “click-wrap” agreements. A click-wrap agreement allows a buyer to manifest assent to the terms of a contract by clicking on an acceptance button that appears while the buyer obtains or installs the product.

The buyer may not obtain or use the product until he or she has clicked on the acceptance button. Click-wrap agreements remove the uncertainty regarding a buyer’s knowledge of the license terms and his or her acceptance of the terms.

Therefore, the majority of courts that have considered click-wrap agreements have found them enforceable. See Caspi v. Microsoft Corporation, 323 N.J. Super. 118 (App. Div. 1999), and In re Real Networks, Inc. Privacy Litigation, 2000 U.S. Dist. LEXIS 6584 (N.D. Ill. May 8, 2000).

In i.Lan, the Massachusetts district court enforced the terms of a click-wrap agreement that limited a seller’s liability to the cost of product. I.Lan purchased software from NextPoint and in turn used that software in providing services to its customers. When NextPoint refused to provide i.Lan with upgrades and support, i.Lan filed suit for breach of contract. NextPoint argued that the terms of a click-wrap agreement limited its liability to the cost of the software.

Whenever someone installed the software, a licensing agreement appeared with a dialog box where the user had to click on the “I accept” button before the user could continue. The court applied the U.C.C. in finding the agreement enforceable. In so holding, the court stated that, “The only issue before the Court is whether click-wrap license agreements are an appropriate way to form contracts, and the Court holds that they are. In short, i.Lan explicitly accepted the click-wrap license agreement when it clicked on the box stating ‘I agree.’”

BROWSE-WRAP AGREEMENTS

E-commerce vendors have presented contract terms and conditions to buyers through the use of browse-wrap agreements. As the court stated in Specht v. Netscape Communications Corp.,150 F. Supp. 2d 585 (S.D.N.Y. 2001), with a typical browse-wrap agreement, “notice of a license appears on the [seller's] Web site. Clicking on the notice links the user to a separate Web page containing the full text of the license agreement, which allegedly binds the user of the information on the site.”

Because most browse-wrap agreements do not require a user to affirmatively click on an icon to proceed, or for that matter to even view the terms and conditions, these agreements can have the same shortcomings as shrink-wrap agreements.

In Pollstar v. Gigmania Ltd., 2000 U.S. Dist. LEXIS 21035, (E.D. Cal. Oct. 17, 2000), the court noted that many visitors to the site would not notice the license agreement calling into question its enforceability. But in Register.com v. Verio, Inc.,126 F.Supp. 2d 238 (S.D.N.Y. 2000), the court stated that the posting of license terms on a Web site is sufficient to create a contract.

In Specht,Netscape sought to enforce an arbitration provision against a number of plaintiffs who had downloaded free software from its site. The district court framed the issue before it as follows: “Thus, I am asked to decide if an offer of a license agreement, made independently of freely offered software, nevertheless binds the user to an arbitration clause contained in the license.”

The court began its analysis by determining that Article 2 of the U.C.C. governed the transaction and that under � 2-204, a contract for sale of goods requires some manifestation of assent.

The court held that Netscape’s browse-wrap agreement did not provide sufficient proof of assent to the terms of the license by the users.

Netscape’s failure to require users of SmartDownload to indicate assent to its license as a precondition to downloading and using its software is fatal to its argument that a contract has been formed. … Before downloading the software, the user need not view any license agreement, and need not do anything to manifest assent to such a license agreement other than actually taking possession of the product. … The only hint that a contract is being formed is one small box of text referring to the license agreement, text that appears below the screen for downloading and that a user need not even see before obtaining the product.

The court concluded its analysis by stating, “The case law on software licensing has not eroded the importance of assent in contract formation. Mutual assent is the bedrock of any agreement to which the law will give force.”

Technology presents an almost infinite number of ways for parties to exchange and notify each other of terms and conditions. However, the true challenge is obtaining unequivocal assent to those terms and conditions.

Businesses, consumers, attorneys and the courts will continue to struggle with the application of common law and statutory principles to e-commerce transactions as the Internet continues to grow.

The parties to e-commerce transactions have struggled to determine whether they entered into a sale or a license, whether the U.C.C., UCITA or some other law should govern, and whether the parties had notice or manifested an intention to be bound.

However, these struggles can be distilled down to the elements that every lawyer learns in first-year contracts: Was there an offer, acceptance and consideration?

While vendors and consumers push the envelope of technology, it is important that those who counsel them keep in mind these decidedly low-tech concepts developed in English common law.

The author is counsel with the commercial litigation practice group at Porzio, Bromberg & Newman, www.pbnlaw.com, of Morristown.