Apr. 2003 to
Summary of Key Problems with UCITA
for Business Users of Software
by Principal Financial - Fall 1999
[This page was not obtained from Principal Financial. I was, instead, obtained from a different source which I trust. Aside from the title there is nothing to "confirm" that it is "from" them. I have not yet confirmed that this material is, in fact, from Principal Financial.]
Business licensees are very concerned about the Uniform Computer Information Transactions Act (UCITA), the proposed uniform act approved by the National Conference of Commissioners on Uniform State Laws (NCCUSL) in July 1999 which is being introduced in various state legislatures. Although our concerns are numerous and pertain to themes woven throughout the proposed uniform act, some of the key areas are listed below.
Before summarizing these concerns, it is helpful to describe briefly the major components of the software marketplace. The most familiar and visible component is the "shrinkwrap" market, in which businesses and consumers both acquire essentially similar and often identical commodity products. The shrinkwrap market is characterized by relatively low prices ($50 to $200 per typical transaction), many transactions, multiple distribution channels, and in-kind competition. Typically, roughly half of the software purchased by large businesses is shrinkwrap software, and it is usually acquired by simply issuing a purchase order to a reseller rather than by negotiating a license agreement with the licensor.
equally significant is the market for mainframe and midrange system software, which is used by business, government and institutions and is characterized by niche products at high prices (typically $100,000 to many millions per transaction), few transactions, direct negotiation with the licensor, little or no competition, and, more often than not, a "mission critical" application such as corporate payroll, tax accounting, claims payment, or safety, health and environmental systems.
General Comments on the effect of UCITA on Businesses:
In response to criticisms that UCITA is imbalanced in favor of licensors over licensees, it has been suggested that business licensees do not need protection in UCITA because they have the negotiating strength to include provisions in their agreements that will override the provisions of UCITA or provide protections that UCITA does not provide. In reality, other market forces often work against licensees, large and small alike. There are numerous examples of software licensors who dominate entire market segments, and simply will not negotiate the terms of their license agreements. Often, particularly in niche applications and in large system software, there is only one viable product available in the marketplace. Further, even a large corporate licensee may not enjoy the clout of repeat business with a licensor, because the purchase of a niche product may be seen by both parties as a one-time sale.
The argument that freedom of contract can take care of all problems in UCITA for business licensees is also flawed because a large portion of the licenses currently governing software used by businesses large and small are not negotiated agreements, but rather are shrinkwrap or clickwrap licenses for off-the-shelf software. If businesses were forced to start negotiating all license agreements to overcome potential problems with the provisions of UCITA, the additional time, effort and resources required would be very significant. This additional cost, of course, would likely be passed on to customers of the business.
Another way in which UCITA will have an effect even on negotiated license agreements is that the provisions in UCITA that favor vendors will be pointed out and used by vendors to argue that their position on the particular contract provision is supported by black-letter law, and therefore it is the licensee who is being unreasonable by trying to negotiate something different.
Finally, the notion that business licensees, due to their bargaining power, should be unconcerned about what UCITA says is belied simply by the fact that a number of these licensees attended and attempted to participate in the Article 2B/UCITA drafting committee meetings. If business licensees in fact had such great bargaining power that they need not have been concerned about UCITA and its predecessor UCC Article 2B, these licensees would not have invested the time, money and effort to send observer-spokespersons to the drafting committee meetings. Businesses usually do not invest resources in activities that are only of abstract interest.
Specific Comments on Certain Provisions of UCITA:
Restrictive definition of "mass-market transaction" -- Section 102 (a) (46)
Under UCITA, a purchase of off-the-shelf shrinkwrap software by a business does not qualify as a "mass market transaction" unless the number of copies purchased is "consistent with an ordinary transaction in a retail market". This means even the smallest business buying more than one or two copies of word processing software at a time will be excluded from the "mass market" protections sprinkled here and there in UCITA. Most of the protections for "mass market" transactions in UCITA are available under current law to everyone, including businesses. Thus, by excluding most business purchases of shrinkwrap software from the definition of a "mass market transaction" in Section 102(a)(46), UCITA deprives business customers of rights under current law.
Validation of unilateral shrinkwrap "agreements" -- Section 209
Section 209 of UCITA would dramatically change current law by validating and making enforceable shrinkwrap and clickwrap license "agreements". These contracts of adhesion, rarely read by anyone, have been considered unenforceable by most courts, although there has been some recent authority to the contrary. Moreover, UCITA validates these unilateral "agreements" without imposing adequate restrictions on the types of provisions that the licensor may include in the license. Presumably, the unconscionability limitation set forth in Section 111 would apply to business licensees, even though there is no specific mention of unconscionability in Section 209 as there is in Section 210 (the latter dealing with "mass market" licenses). However, as those in the legal community know, the circumstances in which courts find contract provisions to be unconscionable are extremely limited and rare. Many provisions that are overreaching will not be held unconscionable.
The only other UCITA limitation on the types of contract terms that a licensor may unilaterally impose is the "fundamental public policy" limitation in Section 105(d).
An example of the problems this creates may be helpful. Some shrinkwrap licenses include a provision prohibiting the licensee from disclosing adverse information about the performance of the software to any third party (which would include other potential customers or the press). Most would agree that licensors should not be able to include such provisions in their shrinkwrap licenses and have them be enforceable. If UCITA becomes law, licensees will have to guess whether a court would determine such a provision to be unconscionable, or whether it violates a public policy that is sufficiently "fundamental". Rather than take the risk, licensees may choose to comply with such disclosure restrictions. Thus, UCITA will have a "chilling effect" on the free flow of information about shrinkwrapped software products.
It should further be noted that most businesses -- even those with sophisticated software purchasing and legal departments -- normally do not review the terms of shrinkwrap or similar licenses prior to purchasing this type of software. If UCITA becomes law, the validation of shrinkwrap licenses without imposing minimum standards may force businesses to hire additional staff and expend large amounts of time and money to review and attempt to negotiate these licenses. This will add to the cost of doing business and to the ultimate cost of products and services to consumers.
Reversal of current commercial practice on number of users -- Section 307 (c)
Section 307(c) of UCITA provides that if a license is silent as to the number of persons who may use the licensed software, then the license is for a "reasonable" number of users, rather than an unlimited number of users. Moreover, "reasonableness" is determined with reference to the commercial circumstances that existed at the time the parties entered into the license agreement. Thus, if a business has 100 employees at the time it obtains a mainframe software license that specifies no limit on the number of users, the business will face the risk of a license breach if it later grows to 150 employees and continues to allow all of its employees to use the software. This is contrary to current commercial practice, where it is widely understood that if the licensor intends to restrict the number of users, the license must state the restriction.
Reversal of current commercial practice on license duration -- Section 308 (2) (A)
UCITA also establishes a general rule that if a software license is silent as to its duration, the license is for a "reasonable" time. This is contrary to the currently prevailing commercial expectation that if the licensor wishes to limit the duration of the license, the time period must be stated in the license. Section 308(2)(A) goes on to provide that a software license is deemed to be perpetual only if the total amount of the license fee is established at or before the time the software is delivered AND the license does not include a license of source code. Each of these requirements is an unreasonable prerequisite to a license being deemed perpetual in duration.
Regarding the "total amount" requirement, businesses often enter into software license agreements where they are provided with a master copy of the software and allowed to make (and later report and pay for) as many copies as they need. Only a per-copy price is established prior to delivery of the master copy, not the "total" license fee. There is no reason why the license for each copy made under such an agreement should not be deemed to be perpetual, but under UCITA they would not. Another problem is that UCITA, by requiring the "total amount" of the license fee to be established before the copy of the software is delivered, would prevent a license from being deemed perpetual in the relatively frequent situation where the licensor delivers a copy to the licensee for evaluation prior to the negotiation and signing of a license agreement.
There is no valid reason for the requirement that the license not include source code in order to be deemed perpetual. Businesses that negotiate for source code to be included in a software license pay extremely large license fees for this right, and they do so only because the software is crucial to their business. Since UCITA provides that the inclusion of source code prevents the entire license agreement (as to object code AND source code) from being deemed perpetual, businesses that include source code in their most important licenses will be subject to having those licenses terminated just when they most need them, by a vendor who claims that a "reasonable" time has expired.
Restriction of geographic scope of implied non-infringement warranty, and reversal of default rule on express noninfringement warranties -- Section 401 (c) (2)
Under UCC Article 2, the implied warranty of noninfringement is not limited in geographic scope. UCITA would detract from licensee rights by making the implied warranty of noninfringement apply only to U.S. rights, even when the license grant allows use of the software in countries outside the U.S. This means that if the software infringes on a Canadian copyright and the innocent licensee is sued for infringing use of the software, there will be no implied warranty to provide recourse against the licensor that sold the infringing software to the licensee.
UCITA Section 401(c)(2) further erodes licensee rights by reversing the common sense interpretation of the geographic scope of an express warranty of noninfringement. Under current practice, an express warranty that "the software does not infringe any copyright", for example, is considered to be unlimited in geographic scope unless there is language that limits the warranty to United States copyrights or those of other specified countries. If UCITA were to become law, that same express warranty against infringement of "any copyright" would (contrary to the plain meaning of the words) be limited to United States copyrights unless the licensee remembered to negotiate for inclusion of the word "worldwide".
Imbalance in disclaimability of infringement obligations -- Sections 401(a), 401 (d)
UCITA provides an implied warranty of noninfringement in Section 401(a), and then tells licensors how they can disclaim this implied warranty (an invitation they will most certainly accept) in Section 401(d). On the other hand, UCITA imposes on licensees an obligation to indemnify a software developer against claims of infringement under certain circumstances, but does not provide any means for the licensee to avoid its infringement indemnification obligation to the licensor. This is another example of UCITA's imbalance in favor of licensors.
Lack of warranty of conformity to documentation -- Section 402 (a) (1)
Section 402 (a)(1) of UCITA provides that affirmations of fact about a software product which are made in any manner by a licensor create express warranties, but only if such statements become "part of the basis of the bargain". The most common place for licensors to make statements of fact about how the software will operate is in the product documentation. Often the documentation is the only source that describes such software specifications in explicit detail. Software users have a right to expect that the software will do what the product documentation says it will do. However, given the lack of uniformity among the courts as to what constitutes the basis of the bargain, the basis of the bargain restriction in Section 402(a)(1) could be applied to mean there is no warranty of conformity to documentation unless the user reads the documentation before paying the license fee. In reality, the documentation is almost never available to the user before paying the fee. Therefore, licensees could be left with no remedy when they purchase software that fails to do what the documentation says it will do. There may be no express warranty created under Section 402(a)(1), and clearly there is no implied warranty of conformity to documentation in UCITA. The only implied warranty applicable in such a situation (in the rare case where it is not disclaimed) would be the Section 403 warranty that the computer program is "fit for the ordinary purposes for which such computer programs are used", a warranty that will not necessarily cover all of the functionality described in the documentation even when the functionality is material to the purchaser.
Restriction of "perfect tender" rule -- Section 704)
Under UCC Article 2, both business and consumer licensees benefit from the "perfect tender" rule -- a rule that the buyer may refuse a product if it fails in any respect to conform to the requirements of the contract. UCITA retains the perfect tender rule only in a "mass-market transaction" (which excludes most business software purchases by definition, even when off-the-shelf shrinkwrap software is involved). Purchasers who do not come within the restrictive "mass-market" definition are allowed to refuse defective software only if the defect can be considered a "material" breach of the contract requirements. This is another example of how UCITA would detract from licensee rights under current law.
Authorization of electronic self-help -- Sections 815 and 816)
The electronic self-help provision in Section 816 of UCITA imposes certain notice requirements that a licensor must satisfy before electronically disabling the licensed software in the event of a dispute. This has been touted as a "protection" for licensees that is not available under current law. However, most business licensees feel this is "protection" they would prefer to do without. Current law, which neither authorizes nor prohibits electronic self-help, is preferable to a flawed provision like Section 816. Before explaining the flaws in Section 816, some background on the use of electronic self-help by licensors will be helpful.
Licensors have argued that a provision authorizing electronic self-help is necessary to protect them from a licensee's nonpayment. In practice, a purported license breach is not likely to involve something as clear-cut as nonpayment. More typically, disputes between licensors and licensees arise over issues such as permitted uses of the software.
For example, a licensee may use the licensed software to process data for its corporate affiliates, which are distinct legal entities. There arises a dispute concerning whether such use is permitted under the license. This involves disagreement about how various definitions and the license grant language should be interpreted, and about the degree of the licensee's control of the corporate affiliates. Both parties have arguable positions and each feels it is acting in good faith. Contrast this with a case in which a financially strapped lessee of equipment willfully elects to default on its lease payments in order to pay another creditor. Should the licensor in the first example be entitled to the same self-help remedy as the lessor in the second example? It is inappropriate to apply in the licensing context the remedies of other commercial transactions in which timely payment is usually the only issue.
electronic self-help is of particular concern to licensees in mainframe and midrange software applications, which are likely to be "mission critical" and apply to an entire corporation, such as corporate payroll, tax accounting, customer claims processing, or safety, health, and environmental systems. Furthermore, replacement software is often either unavailable or very costly and impractical to implement without major business disruption. The balance of harm to be done via exercise of electronic self-help is so overwhelmingly against the licensee that the mere threat of its use puts the licensee in an unfair position.
The Draconian remedy of electronic self-help provides the licensor undue leverage in a dispute even if the remedy is not used. Faced with a crippling and possibly even fatal disruption of its business, a licensee could be intimidated into relinquishing license rights and setting up precedents for its further disadvantage. This is because the threat to the licensee is costly, certain and immediate upon exercise of the self-help remedy, while the risk to the licensor that it will be held to have acted improperly is distant, indefinite and discountable.
The concern held by licensees is not theoretical. Using the threat of electronic self-help, licensees already have been subjected to substantial claims for highly dubious alleged breaches, where the amount sought by the licensor is calculated to induce a settlement, versus the cost and risk of litigation.
For the above reasons, business licensees who participated in the UCITA drafting process repeatedly argued that the proposed uniform act should prohibit electronic self-help, rather than authorize it. If this would result in small licensors not being able to afford to use judicial procedures to halt a licensee's use of the software when justified, a fee-shifting provision would better resolve the problem than the approach taken by Section 816.
Some of the specific problems with Section 816 are as follows:
- Section 816(c) discusses requirements for a contract term authorizing electronic self-help. There is no requirement that the license term be conspicuous, authenticated or separately authenticated. The requirement for separate assent could be satisfied by a mouse-click.
- On a first reading of Section 816 one gets the impression that electronic self-help may not be used in the absence of a contract term authorizing such use and meeting the requirements of Section 816(c). However, a closer reading reveals that no such requirement is actually stated.
- Section 816 permits the licensor to give notice of its intention to use electronic self-help by means of an e-mail message. This is a serious loophole. The person designated by the licensee to receive such notices could be on vacation and never read the message during the 15-day period. Unlike a certified letter or fax which is likely come to the attention of others at the place of business when the designated person is gone, an e-mail message is likely to go wholly unnoticed until the designated individual returns.
- Unless a licensee obtains a court determination that it did not materially breach the contract, there is no adverse consequence to the licensor if it chooses to exercise electronic self-help without giving the required notice. This encourages licensors to engage in electronic self-help without giving the statutory notice, in the hope that the licensee will either be unwilling or unable to obtain such a court determination.
- The fact that Sections 815 and 816 provide for an expedited hearing is no guarantee that a party would actually have the ability to get a hearing scheduled within the 15-day time frame allowed in Section 816. It is not clear that the courts would be required to honor a statutory requirement governing the scheduling of hearings. In several areas of the country it would probably be impossible for a licensee to schedule a court hearing within the 15-day period even if it acted immediately upon receipt of the licensor's self-help notice.
- Section 816(e) provides that a licensee may recover consequential damages (under certain circumstances) from a licensor who wrongfully exercises electronic self-help "whether or not such damages are excluded by the terms of the license." The purpose of this provision is to provide a deterrent to the reckless exercise of electronic self-help. However, many software license agreements contain a cap on the total amount of the licensor's liability, and such caps are normally viewed as a "limitation" of damages rather than an "exclusion" of damages. Thus, the language of Section 816(e) may still permit these caps to limit the licensor's liability for wrongful exercise of electronic self-help. For a licensor whose license agreement limits the licensor's total liability to $1,000, for example, Section 816(e) will provide no real deterrent to the reckless exercise of electronic self-help when a dispute with a licensee arises.
- even when the license agreement does not contain a cap on the licensor's liability, the licensor's exposure to damages does not provide meaningful protection for licensees who are victims of the wrongful exercise of electronic self-help by a small judgment-proof licensor (the very type of licensor most likely to use electronic self-help if it is not prohibited). This is another reason why a prohibition of electronic self-help, coupled with a fee-shifting provision, would be preferable.
- In order to be able to recover consequential damages from a licensor, Section 816(e)(1) requires the licensee to make a written admission against interest (stating the magnitude of damages to be caused by the electronic disablement) that could be used against the licensee by third parties harmed by the disabling of the licensee's software. In addition, a court may construe Section 816(e)(1) to mean that the amount stated in the licensee's notice is a limit on recovery by the licensee.
- UCITA provides for no liability on the part of the licensor to third parties harmed by a wrongful disabling of the licensee's software. Because of this, privity of contract may be a bar to such third parties seeking to hold a licensor liable for damages suffered by them as a foreseeable result of an improper exercise of electronic self-help.
- A major concern for licensees is whether a contract provision completely barring any use of electronic self-help would be enforceable if UCITA were enacted. Section 816(h) states that "rights and obligations under this section may not be waived or varied". Although possibly drafted more with the licensee's rights and the licensor's obligations in mind, on its face this language would appear to lead to the result that a licensor's "right" to use electronic self-help may not be waived by the licensor, and that a negotiated license provision prohibiting any use of electronic self-help will not be enforceable. Section 816(h) does state that a contract term authorizing electronic self-help "may specify additional provisions more favorable to the licensee", but it does not state that the parties may agree that electronic self-help is completely unauthorized. This problem cannot even be resolved by negotiating a provision that UCITA as a whole will not apply to the license agreement Ð Section 103(e)(2) provides that even if the parties expressly agree in a negotiated license agreement that UCITA will not apply, this "does not alter the applicability of Section 816". Under current law, a contract provision barring all use of electronic self-help is enforceable, and many business licensees consider it one of the most important license provisions to negotiate for. During the drafting committee meetings that led to UCITA, business licensee opponents of electronic self-help were repeatedly told they had no ground for concern because they had the bargaining power to negotiate provisions barring electronic self-help, no matter what Article 2B/UCITA might say. Now UCITA appears to have made such provisions unenforceable. The current right of licensees to negotiate for an enforceable prohibition of electronic self-help must not be taken away by UCITA.
- There is nothing in Section 816 to prevent the licensor from proceeding to use electronic self-help if the licensee cures the claimed breach within the 15-day notice period.
UCITA Pages On
James S. Huggins' Refrigerator Door