\ Memorandum

Memorandum

To: The American Law Institute
From: Todd J. Paglia
Date: March 10, 1998
Re: Uniform Commercial Code Article 2B

______________________________________________________________________

This memo provides my analysis as a consumer advocate of draft Article 2B of the Uniform Commercial Code. At this point the draft law, with comments and supporting material, is over 200 pages long containing dozens of controversial sections. An exhaustive analysis of the draft in its entirety is beyond the scope of this paper, but I have tried to bring to your attention many of the most glaring problems from the consumer perspective.

Comments on the Overall Balance of Article 2B and the Prospects for Change

Article 2B suffers from a strong software industry/publisher bias. First time observers attending the 2B process often have the same reaction: it seems like the industry is getting together to write its own law. It is no surprise that participation at the drafting meetings is overwhelmingly dominated by the software industry and other publishing entities. What is surprising is the extent to which the drafting committee and the reporter have allowed this participation to influence the content of Article 2B. The industry perspective has become the political middle ground in 2B drafting sessions through sheer numbers. This effect has been amplified by a similar philosophical view shared by the industry and the drafting committee regarding the UCC and its application to information transactions as well as the extent to which the rights of purchasers should be taken into account in the draft law. These factors combine to make significant consumer/purchaser oriented modifications to the draft improbable.

I believe that a fair draft of Article 2B will not be realized without changed circumstances within the drafting process including the addition of drafting committee members with a background in consumer advocacy or at least academic experience without strong ties to industry. Short of these structural adjustments, the other, dimmer prospect for an improved Article 2B is a great increase in external pressure - media, citizens, advocates, law professors, etc. - for a more balanced Article 2B.

Evaluating Article 2B

Assessing the impact of 2B has also been a challenge because it is a moving target. To further complicate matters, due to a computing malfunction the most recent draft did not include the usual redlining of modifications. Fortunately, several attendees were able to perform this function themselves and the number of changes visible on these copies is quite staggering, many of which are quite substantive. The draft is still very much in flux. This factor alone militates strongly against approving Article 2B.

Further, although the draft may appear to have eliminated some objectionable sections, the real effect may be that while the form has been altered the content remains the same. For example, the draft previously contained an extremely controversial section dealing with computer viruses, 2B-313. This section provided some assurance that reasonable efforts were made by the seller to eliminate viruses for non-Internet purchases, an obligation that should have been extended to Internet transactions. It made sense to impose this obligation on a small group of sellers rather than on all buyers. Instead, the drafting committee eliminated the entire section due to objections from the software industry, including Symantec, the largest producer of virus checking software and a beneficiary of any increased need for these products. The result is that the protection provided to purchasers from irresponsible sellers is gone. In addition, because Article 2B validates shrinkwrap licenses in extremely broad fashion, software sellers will be free to include a waiver of any responsibility for viruses in the laundry list of disclaimers contained in the license. This example demonstrates the difficulty in assessing 2B due to the catch-all provided through unrestricted approval of shrinkwrap licenses. More specific problems are discussed below in a rough order of importance.

Section by Section Analysis

2B-107 and 2B-104 -- Goods and Services v. Information

Article 2B purports to preserve existing "consumer" rules in several sections, including 2B-107 Choice of Law and 2B-104(a)(3) Transactions Subject To Other Law. Article 2B transactions, however, differ from the sale of traditional consumer goods because software is characterized as an intangible product subject to a license. This may eliminate the application of consumer protection rules to 2B transactions. For example, some state consumer protection rules and the federal Magnuson-Moss Act apply to goods and/or services, not to licenses of intangible information or software. The current 2B draft will provide a huge loophole around such rules. Article 2B must be modified to ensure that such consumer protection rules and other statutory or case law based rules apply equally to goods and Article 2B transactions in the mass market.

Shrinkwrap Licenses 2B-208

Under the rubric of "freedom of contract," UCC 2B claims to propose a neutral model for information transactions. But in the context of broadly validating shrinkwrap licenses, this freedom applies only to the authors of the license agreements. Consider the measure of "freedom of contract" granted by 2B to a typical software purchaser has: After the product has been purchased, a license agreement appears during the installation process. At this point the purchaser is interested in continuing the installation process, and may not even realize that the transaction is still occurring under Article 2B. In itself, this disjunction between the act of consummating the transaction (in the purchaser's view, by paying for the product) and "agreeing" to a license as part of installing a program, works against the purchaser.

In a typical software transaction, how many purchasers will realize the following: 1. Although it seems as though the product is simply being installed, they are being asked to consent to a license, and 2. The license is legally binding. Relatively few purchasers will realize either of these points. But how many of this small group will know that, even though they already paid for the product and have begun installation, they are able to refuse to agree to the license terms and return the product for a refund? Even fewer purchasers would make it to this point. Assuming that a purchaser gets this far, what have they accomplished? They have to start the process all over in the hopes that their second choice product will have more reasonable license terms. This system will exhaust even the most persistent consumers and it is unworkable.

When viewed in any realistic context, the broad validation of shrinkwrap licenses in 2B presents many dangers to purchasers and tilts the balance of power far in favor of the drafters of license agreements. Consumer advocates have an unlikely ally in our objections to these take-it-or-leave-it licenses that Article 2B seeks to approve. In testifying before the Federal Trade Commission on "Innovation-Based Competition," Kenneth Wasch, president of the Software Publishers Association, objected to licenses that are dictated by a licensor who is able to demand extremely favorable terms:

In these situations, the licensor effectively dictates the terms of the required license -- essentially on a take-it-or-leave-it basis.(1)

One-sided licenses are a problem for SPA's members for obvious reasons. And for equally obvious reasons (which somehow elude Mr. Wasch in this context), these licenses are unfair to consumers.

Under the current draft of Article 2B, information sellers will be unfettered in their ability to dictate one-sided license agreements which will go largely unchallenged due to the use of forum selection clauses (discussed below). Not only are the policy issues underlying this choice potentially devastating, but this extremely broad validation of shrinkwrap licenses is premised upon industry practice and one judge's opinions.(2) This is scant authority for such a sweeping, anti-consumer law.

Conspicuousness 2B-102(8)

The Article 2B drafting committee has steadfastly refused to define "conspicuous" in a way that is meaningful in the real world. This presents a situation in which Article 2B requires that certain license terms must be "conspicuous," meaning that a reasonable person against whom it is to operate ought to have noticed it. License terms satisfy conspicuousness under 2B, however, even where they are concealed from the purchaser until after the product has been purchased and is being installed. This complete contradiction between Article 2B's use of a term and its ordinary meaning to the public is unacceptable and will present tremendous hurdles to enactment, to say nothing of the loss of credibility engendered by section of the draft law. Whatever may be the drafting committee's intent in defining conspicuous to include its antonym, 2B-102(8) will work to deny information to purchasers and to conceal terms that would discourage a buyer from first, purchasing the product, and second, completing the transaction.

Comments have repeatedly been submitted to the drafting committee, most recently by the American Bar Association's Section on Science and Technology, requesting that important terms be brought to the buyer's attention at the point of sale (http://www.webcom.com/software/issues/guide/docs/abast.html). The terms that should be highlighted to the purchaser before a purchase is made include but are not limited to those that Article 2B requires to be conspicuous. Any limitations on use should also be brought to the buyer's attention before purchase. If the terms are not brought to the buyer's attention before the sale is made, they should not be enforceable.

Industry claims that there is not enough room on software packaging to provide consumers with this important information cannot be taken seriously. There is not enough room for these purposes as long as publishers place a higher value on space dedicated to marketing compared to space intended to inform consumers. Electronic transactions present similar competing demands for marketing space, but consumers must be provided basic information with which to make informed purchasing decisions. And it is difficult to sympathize with those that prefer to conceal information such as disclaimers and use restrictions: this information need only take up valuable advertising space on the packaging or on web pages if the publisher refuses to stand behind its product by issuing a disclaimer or restricting its use.

2B-105 Issues Relating to Federal Copyright Law

The debate over copyright has centered around the McManis Motion proposed and approved last Spring at the ALI annual meeting. The motion called for the inclusion of the following section in 2B-308 (now 2B-208) which would invalidate certain license terms:

(h) A term that is inconsistent with 17 U.S.C. Section 102(b) or with the limitations on exclusive rights contained in 17 U.S.C. Sections 107-112 and 117 cannot become part of a contract under this section.

Instead of incorporating the McManis Motion into the draft, the following section was added:

SECTION 2B-105. RELATION TO FEDERAL LAW. A provision of this article which is preempted by federal law is unenforceable to the extent of such preemption.

Even this weak addition may be eliminated in the final draft. With or without 2B-105 as it is currently drafted, UCC 2B's broad validation of shrinkwrap licenses will serve as private copyright legislation for information providers. The tension here is due to the rights given to information users and the extent to which they might be waived by "agreement." By making shrinkwrap licenses enforceable without limitation, anyone clicking on an "I Agree" icon may be "agreeing" to waive copyright privileges. The broad validation of these licenses will disturb the balance achieved in copyright law and erode the rights traditionally granted to information users. Licenses may include terms that prohibit: reverse engineering of software, decompiling of software; quoting a portion of the text; etc. The unprecedented ubiquity of these licenses on the Internet and in information transactions, coupled with their presumptive validity under 2B, will change the face of copyright law and shift control and power toward publishers and away from information users.

2B-609 Perfect Tender

In 2B-609(c) is an example of a provision that may work for a goods transaction, but must be modified for it to have any meaning for software products. It provides that refusal must occur before acceptance and within a reasonable time of tender. This is critical because once the software is accepted, the licensee is bound to the purchase price unless that acceptance can be revoked due to a material breach. Before acceptance, the licensee can reject for a failure to provide "perfect" quality (even though "perfect" has many exceptions in the case law, it is a higher standard than would otherwise apply).

In a goods transaction, the relatively short duration before acceptance occurs may suffice in most cases -- often the purchaser has an opportunity to inspect a physical item and can gain a fair amount of information in little time. In software transactions, almost nothing is known about the item purchased until it is loaded on the purchaser's computer and actually run through a reasonable range of its functionality, which could take weeks of normal usage. Article 2B is being written because information transactions are different from other types of transactions. The perfect tender rule is an important area where this difference should be taken into account by providing 30 days before acceptance occurs. This provides certainty for industry and modifies the perfect tender rule to reflect the kind of transactions controlled by 2B. The amount of information a purchaser of a clock-radio is able to obtain in a short amount of time is vastly different from the information gained in the same amount of time by a purchaser of Microsoft Word. Without a modification in 2B to reflect this fact there is no effective perfect tender rule.

2B-108 Forum Selection

Section 2B-108 permits a seller to dictate the forum in which a purchaser is permitted to bring suit. This section provides as follows:

(a) The parties in their agreement may choose an exclusive judicial forum unless the choice is unreasonable and unjust.

(b) A choice-of-forum term is not exclusive unless the agreement expressly so provides.

This section adopts Carnival Cruise Lines, Inc. v. Shute, 111 S. Ct. 1522 (1991) as its default provision. This is a poor policy choice for several reasons. Carnival Cruise Lines is among the most criticized cases in recent jurisprudence and several states addressing the issue have either categorically overruled it or have carved out exceptions to the enforceability of forum selection clauses.(3)

In addition, Article 2B proposes to join ubiquitous adhesion contracts and forum selection clauses -- an anti-consumer combination with significant negative impacts. Due to the small amount in controversy in most consumer transactions, the cost of traveling to a distant forum to file an action will create a barrier to such actions. Article 2B's forum selection clause will have the effect denying mass market purchasers the ability to pursue their legal rights in a court of law.(4)

2B-115 Attribution of Electronic Messages

Section 2B-115 sets up a system of potentially unlimited liability for Internet transactions. A message is attributable to a person if the receiving party used an attribution procedure to make a good faith determination that the message was sent by the person from whom it purports to be sent. One problem with this section is that it does not require a reasonable person standard but only a showing of good faith -- liability will therefor exist where a recipient honestly believes the message is genuine even if a reasonable person would not come to that conclusion ( 2B-115(a)(2)).

Of even greater concern, this section makes it extremely difficult for a consumer to defend herself from potentially unlimited liability. Assume John has stolen Jane's security information by: taking it from Jane's computer when it was being repaired; taking it from the computer when Jane was not in her office; or getting it through an Internet based hacking system that downloads portions of Jane's computer. In this situation, a message received by Acme Software ordering a program costing several hundred dollars may appear to be from Jane, even if Acme uses an attribution technique such as encryption. Section 2B-115(b) creates a presumption that the messages sent by John will be attributed to Jane because he has obtained her security information. In this situation, Jane will probably not know how her security information was taken and it will be extremely difficult for her to rebut 115(b)'s presumption.

Further, 115(a)(3) creates liability for Jane if Acme Software relies to its detriment on the message and the message appears to have come from Jane due to Jane's failure to exercise reasonable care. Proving that she exercised reasonable care will be difficult because in many cases she will not know when the information was taken from her computer.

Each of these scenarios runs counter to the suggestions made at last year's ALI annual meeting to limit liability of purchasers to a small sum, possibly $50. Rather than make commerce on the Internet one where buyers must bear tremendous risks, UCC 2B should be formulating attribution rules that inspire consumer confidence. A $50 liability limitation should be included in 115 for all transactions covered by 2B, and at the very least this cap on liability should extend to all mass market transactions (for additional suggestions on ways to limit liability exposure see Cem Kaner's excellent paper at http://www.badsoftware.com/digsig.htm).

2B-402 and the Benefit of the Bargain

Section 402 limits the ways in which a vendor's representation -- in advertising or product documentation -- may become an express warranty by requiring that the statement become part of the "basis of the bargain." In some courts this means that the statement or representation becomes part of the basis of the bargain only where the consumer relies upon the statements in making a purchase. In a May 1997 memorandum to the drafting committee, I suggested that a clearer and fairer rule would eliminate this reliance requirement (see Attachment A). The Software Publishers Association and other software representatives expressed some concern but did not rule out the suggestion, and it seemed that consensus could be achieved. Nonetheless, the reporter and drafting committee refused to adopt the suggestion. This was a lost opportunity because a uniform rule by which software companies stand by their product documentation and advertising would have been an improvement to 2B.

2B-703 Contractual Modification of Remedies

Article 2B makes it extremely easy for a publisher to dictate a remedy and then fail to fulfill its requirements with few repercussions (the draft refers to this as an "agreed remedy" which is a specious label in the context of adhesion contracts). Under 2B-703(c), the enforceability of other disclaimers is unaffected -- even where the agreed remedy is not fulfilled or is found unconscionable -- so long as the disclaimers are made "expressly independent" of the performance of the agreed remedy, a simple drafting issue:

(c) Failure or unconscionability of an agreed remedy does not affect the enforceability of terms excluding or limiting consequential or incidental damages if the contract makes those terms expressly independent of the performance of the agreed remedy.

This is a troubling approach because it allows the seller to dictate a specific remedy -- which it can fail to fulfill without impacting any other portion of its agreement.

Furthermore, this section will limit the effect of the already constricted unconscionability concept. Not only is unconscionability difficult for consumers to prove in litigation, but the rare uses have been in the area that 703 seeks to exclude. According to the summer 1997 draft of Article 2-105 dealing with unconscionability:

There are very few cases in the last 10 years where the courts have found a contract or clause unconscionable under former Section 2-302. Of the fourteen cases that granted some relief, only nine involved Article 2 and most involved the enforceability of agreed limitations on warranties and remedies. These cases, however, do not include commercial cases arising under Section 2-207 where findings of unfair surprise excluded terms from the apparent agreement.(5)

The assumptions found in 703 should be reversed. If a publisher is permitted to choose a limited remedy, a failure by the publisher to adhere to that remedy or if the remedy is found unconscionable, should result in the failure of the publisher's limitations/exclusions on incidental or consequential damages. To do otherwise is to strip away what little usefulness exists in the unconscionability provision and allow the publisher to both select a limited remedy and then ignore the remedy it chose without consequences.

2B-703 Disclaimer of Incidental Damages

Incidental damages may be disclaimed under 2B-703(d), a policy choice that will unfairly harm purchasers. Many software companies charge for technical assistance (as much as $25 per call or charges that accrue on a per minute basis, both of which can quickly exceed the cost of the product). This is the case even where the purchaser is having difficulty due to defects in the software. Purchasers should not be forced to bear the expense of poorly made products. Article 2B should include a non-disclaimable duty for information producers to reimburse reasonable incidental expenses incurred due to a defective product.

2B-709 Licensee's Damages

Section 2B-709 limits the licensee's damages to the contract price where the licensor has breached in section 709(a)(1)(C) with the following language:

(C) if the licensee has accepted performance from the licensor and not revoked acceptance, the present value, at the time and place of performance, of the difference between the value of the performance accepted and the value of the performance had there been no defect, not to exceed the agreed contract fee or other contractual consideration required for the performance[.]

If the market price of programs that perform x, y, and z functions is $200, and Jane buys a program that purports to perform those functions for $150, she should not be limited to $150 if the product fails to deliver on its promise. This denies the purchaser the benefit of any bargain they have obtained.

2B-109 Material Breach

The definition of material breach is too narrow and a poor substitute from the purchaser's perspective for the Restatement provisions. During the last meeting of the drafting committee several comments were made on how the language should be tightened up. This narrowing will no doubt continue, making it more difficult for a purchaser to prove material breach. Section 214 of the Restatement of Contracts provides a far better standard. In addition, it avoids the problem of the industry being able to successfully "fine tune" an abbreviated version of the Restatement in such a way that proving a material breach will become increasingly difficult.

2B-102(31) Mass Market -- Customization Exception

The definition of mass market may include an unnecessarily broad escape route for publishers seeking to opt out of this category. Even fairly mundane "customization" of a computer program would seem to satisfy this section's exception which includes:

(C) a transaction in which the information is or becomes customized or otherwise specially prepared for the licensee;

For example, in a web based software transaction, if the purchaser is able to choose certain features to appear on their version of the software it might be viewed as customized. The following examples might satisfy this section: 1. Allowing a consumer to mix and match different functionality according to their preference or the capabilities of their personal computer; 2. Providing a purchaser with a choice regarding various aspects of graphical user interface (color schemes, task bars, etc.); 3. Marketing a music CD that includes songs chosen by the purchaser. All of these involve some amount of customization that may satisfy the exception in 2B-102(31), which will permit an easy escape from the mass market definition.

2B-707 Measurement of Damages

A purchaser's ability to recover damages is unfairly limited by 2B-707 because this section erects an affirmative duty that the purchaser must satisfy in anticipating possible malfunctions of the product they licensed. Article 2B creates a condition precedent which must be satisfied in order for an innocent purchaser to recover damages from a publisher that has produced and put on the market a product that is defective. As 2B-707(c) states:

(c) Except as otherwise provided in the agreement or this article, an aggrieved party may not recover compensation for that part of a loss that could have been avoided by taking measures reasonable under the circumstances to avoid or reduce loss, including the maintenance before breach of contract of reasonable systems for backup or retrieval of information. The burden of establishing a failure to take reasonable measures under the circumstances is on the party in breach.

This section specifically names maintenance of "reasonable systems for backup or retrieval of information" as a practice that the purchaser must adopt to recover damages. But it has been brought to the attention of the drafting committee and it is widely known that many if not most computer users do not regularly back-up their computer files. Thus, Article 2B sets a requirement for recovery of damages that most computer users do not meet. This section will be aggressively used as an offensive tool by the software industry to deny recovery for damages caused by products that were in fact defective.

2B-103 Scope

The scope definition of 2B seems to allow for the inclusion of many items that would now be considered Article 2 transactions. As 103(c)(2) states, a sale of a computer program embedded in goods is covered by 2B, unless:

(C) the program was subject to a separate license with the transferee of the goods;

Many common consumer goods -- toasters, microwaves, etc. -- are increasingly reliant on imbedded software to control their operation. Other items such as automobile braking and fuel systems are also controlled by imbedded software. All of these can become subject to article 2B by the inclusion of a separate license. This may present disparate liability levels depending on whether the manufacturer has opted for Article 2B or whether they are still subject to other areas of law. Whether a manufacturer decides to try to get into 2B should not influence the type of liability owed to a purchaser should the item malfunction and cause property damage or personal injury.

Sincerely,

/s/ Todd J. Paglia

____________________________________________

1.

1 Federal Trade Commission Hearings on Global and Innovation-Based Competition, Testimony of Ken Wasch, President, Software Publishers Association, Washington, D.C., December 20, 1995 (http://www.spa.org/gvmnt/papers/kentest.htm).

2.

2 The ProCD v. Zeidenberg, 86 F.3d 1447 (7th Cir. 1996) and Hill v. Gateway 2000, Inc., 1997 WL 2809 (7th Cir. 1997) decisions, both written by Judge Easterbrook of the Seventh Circuit, are the most recent but certainly not the only authority in this area. Contrary authority is found in Step-Saver Data Systems, Inc. v. Wyse Technology, 939 F.2d 91 (3rd Cir. 1991); Arizona Retail Systems, Inc. v. The Software Link, Inc., 831 F.Supp. 759 (D. Ariz. 1993); Vault Corp. v. Quaid Software Ltd., 847 F.2d 255 (5th Cir. 1988). See also Mark Lemley, Intellectual Property and Shrinkwrap Licenses, 68 S. CAL. L. REV. 1239 (1995).

3. 3 See Michael Mousa Karayanni, The Public Policy Exception to the Enforcement of Forum Selection Clauses, 34 Duq.

L. Rev. 1009 (1996); see also Montana ex rel. Polaris Industries v. District Court, 695 P. 2d 471 (Mont. 1985); Davenport v. Adolph Coors, 314 NW 2d 432 (Iowa 1982); Cerami-Kote, Inc. v. Energywave Corp., 116 Idaho 56, 773 P.2d 1143 (1989); Disctronics Ltd. v. Disc Mfg. Inc., 686 So. 2d 1154, (Ala. 1996) ("[C]ontractual forum selection clauses are not enforceable in Alabama's courts."), though Alabama has since validated a forum selection clause in a commercial transaction, Professional Ins. Corp. v. Sutherland, 700 So. 2d 347 (Ala. 1997), it is doubtful that the court would enforce one in Article 2B's context, particularly in the mass market; North Carolina's statute overruling forum selection clauses, N.C. Sess. Laws 436, N.C. Gen. Stat. 22B-3 (1994).

4.

4 Cem Kaner and I offered the following compromise which was made into a motion before the drafting committee but was rejected : "We recommend that if (a) the contract is mass-market and (b) the amount in controversy is within the customer's home state's small claims court jurisdictional limit, then the customer can bring an action in his home state or, if he cannot obtain personal jurisdiction over the defendant in his home state, then anywhere where he can obtain jurisdiction over the defendant. The adhesion contract can specify a choice of forum, and it will be enforced if the amount in controversy (aggregated over all plaintiffs, in a class action suit) is greater than the small claims court jurisdictional limit." See http://www.cptech.org/ucc/dec5-97.html

5. 5 Article 2 Draft for the July 25-Aug. 1, 1997 meeting of NCCUSL, page17, note 3 to section 2-105.