Letter from Society for Information Management (SIM) to NCCUSL Opposing UCC 2B
March 23, 1998
To: Carlyle C. Ring, Jr.
From: Society for Information Management (SIM)
Business licensees are very concerned about certain provisions of the current draft for UCC Article 2B. Although our concerns are numerous and pertain to themes woven throughout the draft, some of the key areas are listed below. Although these comments are directed to provisions of the March 1998 draft of Article 2B, SIM has not yet had an opportunity to fully review the March 1998 draft. Further review may well reveal additional significant concerns.
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 2B on Businesses:
It has been suggested that large businesses do not need protection in Article 2B because they have the negotiating strength to include provisions in their agreements that will override the provisions of Article 2B or provide protections that 2B 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 candidate. Further, even a large corporate licensee may not enjoy the clout of repeat business with a licensor, because a single license (seen by the licensor as a one-time sale) may be leveraged across the needs of the whole corporation, as with a mainframe, corporate-wide EDI system, for example. It is therefore untrue that large corporate licensees necessarily have great negotiating strength.
The argument that freedom of contract can take care of all problems in 2B for large licensees is also flawed because a large portion of the licenses currently governing software used by large companies 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 Article 2B, 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 2B will have an effect even on negotiated agreements is that provisions in 2B that are favorable to vendors will be used by vendors to argue that their position is supported by black-letter law, and therefore it is the licensee who is being unreasonable by asking for something different.
Finally, the notion that large licensees, due to their bargaining power, should be unconcerned about what 2B says is belied simply by the fact that licensees are participating in the Drafting Committee meetings. If business licensees in fact had such great bargaining power that they need not be concerned about 2B, they would not be investing the time and resources to participate in the Drafting Committee process. Businesses usually do not invest resources in activities that are only of abstract interest.
Specific Comments on Certain Provisions of the March 1998 Draft:
The "mass market" concept purports to extend to certain business licensees some of the same protections currently available to everyone under existing Article 2 and retained under 2B with respect to consumers. (Note that this issue pertains to the shrinkwrap market.) In the current Draft, however, only a very narrow slice of the business market will qualify as "mass market" transactions. The definition has been crafted to exclude the distribution channels favored by most businesses, via a requirement that the quantity be consistent with ordinary retail transactions. This quantity restriction can be construed to mean a single copy per transaction. If the "mass market" concept is to be retained, the quantity restriction and reference to retail should be removed; alternatively, existing Article 2 protections should continue to prevail without discrimination as to market segment.
This section creates special remedies for the "mass market" which, by definition, will exclude the vast majority of business transactions. Thus the appearance of equitable treatment across various classes of customers is in fact discriminatory.
This section provides for a refund in situations where the purchaser of software does not have an opportunity to review the shrinkwrap license terms until after the software has been paid for. There is no reason a purchaser of shrinkwrap software (from whatever source) should get less protection in this regard simply because the purchaser buys more than one copy.
For contracts created by conduct, scope of use issues default to terms in the licensor's standard form. Comments to the Draft rationalize this choice saying "it is only the licensor who is aware of what can be granted." This analysis suggests that scope of use disputes revolve around the licensor's right to grant the license, which in practice is almost never at issue in software licenses. Frequently, however, scope of use disputes arise as a purely commercial negotiation around changing or unanticipated business conditions. It is unfair to bias these negotiations in favor of the licensor as a matter of law. Usage of trade, course of dealing, and course of performance are more relevant in this context than either party's form, which did not fully contemplate the particular facts.
Prior drafts of this section provided that if a license is silent as to number of users, then only one user is permitted at a time. The current Draft at least broadens this to a reasonable number of users, but still misses the point. Throughout the history of software licensing and continuing today, countless licenses have been negotiated in which the right to use is limited to a geographic site, certain entities, specific computers, or other mutually agreeable basis, with no reference at all as to number of users. A site license, for example, is widely understood to include an unlimited number of users. Consistent with current practice, the default should be an unlimited number of users, unless otherwise stated in the license.
2B-308 (2) (A)
The proposed default rule here is that the duration of a software license is perpetual if the agreement requires payment of a single fee fixed at the outset of the contract. If the UCC is to reflect current commercial practice, then it should recognize that the vast majority of software licenses are perpetual. A significant number of perpetual licenses provide payment terms other than a single fixed fee at the outset (e.g., one-third upon execution of the license agreement, one-third upon delivery of the software, and one-third after the software has passed acceptance testing). Sometimes, especially with shrinkwrap software, a licensee is provided with a "gold disk", from which it may make unlimited copies, each of which is subject to a perpetual license, with payment based on a periodic accounting. But even in this example of a practice in which payment is extended, the licenses are perpetual. The default rule should be that the license duration is perpetual, unless otherwise stated in the license.
This section requires a licensee who "furnishes specifications to the licensor" to hold the licensor harmless against any claim of infringement that arises out compliance with the specifications. Unlike specifications for goods, specifications with respect to software are often nothing more than functional specifications or high level business requirements that must be further refined by the developer. The developer usually selects the method for meeting these requirements. The hold harmless obligation should apply only to a "licensee that furnishes detailed technical specifications to the licensor and selects the method for meeting those specifications". (At one point, the draft of this section had been modified to use the phrase "technical specifications", which was at least an improvement over "specifications", but now even that improvement has disappeared from the draft.) In addition, this subsection should be revised to state that the hold harmless obligation does not apply if the licensee had no reason to know that compliance with the specifications would result in infringement, but the licensor did have reason to know and failed to inform the licensee. Finally, the bracketed language at the end of Section 401 (a) should be adopted, but revised to read as follows: "except for claims that result from the failure of the licensor to adopt a commercially reasonable noninfringing alternative that was available to it."
2B-401 (c) (2)
The implied warranty of noninfringement applies only to U.S. rights and any other countries "specifically named" in the license. Most mainframe and midrange system software licenses are worldwide and benefit from the unlimited warranty of noninfringement under existing Article 2. The proposed Draft will force licensees to name specific countries to be covered. (even using the term "worldwide" in a license would be of no avail under the current draft since this does not specifically name any countries.) Often, the specific countries where the software may be used over the perpetual term of the license will be impossible to anticipate. This provision makes it harder for the licensee to obtain the warranty that is available today. The existing Article 2 warranty of noninfringement should be retained.
In Alternative A, Subsection (a) extends the implied warranty of merchantability to "mass market" only, while under Subsection (c) (2) other customers receive only a warranty of substantial conformance to documentation. The existing Article 2 warranty of merchantability should be retained without discrimination as to market segment. Adoption of Alternative B would accomplish this. However, Subsection (b) (5) in Alternative B should be changed to read: "conform to the promises or affirmations of fact made on the container or label, if any, and in the documentation provided by the licensor at or before the delivery of the program." The software should be warranted to conform not only to statements made on containers or labels, but also to those made in the documentation.
2B-406 (c) (2)
Software is sometimes provided to prospective licensees for a free trial or evaluation period of typically thirty to ninety days, with no obligation to take a subsequent license. This section provides that "there is no implied warranty with respect to a defect . . . that would have been discovered by the licensee if it had made use of a reasonable opportunity provided to it before entering into the contract . . ." It is questionable how a licensee in a limited time period could be expected to discover defects, the warranty for which is routinely disclaimed by licensors who have the knowledge, resources, and a much longer time to correct. Subsection (c) (2) should be deleted.
While Section 503(a) confirms the enforceability of an express contract provision prohibiting transfer of a license of informational property rights, Section 502(2) deals with the situation where the license is silent on the issue of transferability. The current draft of Section 502(2) adopts a rule that in such a situation the license is nontransferable unless:
The Reporter's Notes to Section 502 assert that this rule of nontransferability is required by federal patent and copyright law. In support of this proposition, the Notes cite five federal court cases. An analysis of these cases and others reveals that this issue may be a developing one in the federal courts, at least in the copyright area. In addition, it is quite possible that Congress may choose to amend the copyright or patent statutes to expressly allow certain transfers that would not be allowed under the current draft of Section 502. It would be inappropriate for Article 2B to codify a rule that may contradict future developments in federal statutory and case law. Section 502(2) should simply state that the licensee may transfer its rights under a nonexclusive license unless prohibited by other law.
The primary case relied on in the Reporter's Notes is everex Systems, Inc. v. Cadtrak Corp. Interestingly, everex involved a patent license that expressly stated that the license was "non-transferrable". 89 F.3d at 674. Therefore, it does not appear to be particularly good authority for the proposition that a nonexclusive license is not transferable when the license is silent on the issue. Moreover, the everex court noted that "not insignificant questions" had been raised about the "actual holdings, relevance and continued vitality of the nineteenth-century Supreme Court decisions which are cited for the origins of the federal rule" of nonassignability of a nonexclusive patent license absent licensor consent. 89 F.d3 at 679-80. Although everex decided to follow the precedent despite the questions that had been raised, those same questions may eventually lead to new developments in the federal case law, or lead Congess to change the rule by statute.
In the copyright arena, the rule does not seem to be as entrenched as in the patent cases, and in fact seems to be derived from the patent cases. In the Harris v. Emus Records Corp. case cited in the Reporter's Notes, the issue was one of first impression in the Ninth Circuit at that time (1984). The court noted a dearth of authority on the issue in the copyright arena, and therefore turned to patent cases for guidance. 734 F.2d at 1333.
In a more recent copyright case, the court noted that the general rule "seems to be" as stated in Harris, but noted that this was an issue of first impression in the First Circuit. The court found it unnecessary to decide the issue. Fritz v. Arthur D. Little, Inc., 944 F. Supp. 95 (D. Mass. 1996).
The Reporter's Notes (#4) assert that "federal law sets out a bright line test invalidating the transfer without consent and entirely independent of whether there was (or was not) actual impact on the licensor's interests." If this assertion is correct, how can Section 502 create its own exception to that rule for "mass market" licenses, as done in Section 502(2)(B)? None of the federal cases cited by the Reporter's Notes support such an exception. If the federal rule is as clear and "bright line" as the Reporter's Notes say it is, then it would pre-empt 502(2)(B).
Finally, quite independent of federal law considerations, the "mass market" exception is unfair because it excludes software purchased by businesses in quantities of more than one copy (via the "mass market" definition). As noted by Drafting Committee member David Rice in his December 8, 1997, memo to the ALI, this will effectively preclude the sale of one's business without first obtaining the consent of every software licensor, which would create an enormous due diligence burden. If there can and will be an exception for off-the-shelf-type software, it should include all such software, and not be dependent on the quantity in which it was originally purchased.
For all of the reasons indicated above, Section 502 should avoid codifying a rule prohibiting transfer of non-exclusive informational property licenses, and should leave this issue to federal law. This should be done by stating that transfer is allowed when the license is silent, unless prohibited by other law.
This Section retains the perfect tender rule only for the "mass market" (which excludes most of business by definition). Other users may refuse only on material breach. This is another example of decreased rights for business licensees versus Article 2.
2B-618 (b) (2) (A)
This Section states that in a development contract where ownership of the intellectual property rights in the software is obtained by the client under applicable law, ownership nonetheless revests in the developer if the developer cancels for breach. This model does not accord with current practice. It is common in large development contracts for the client to make progress payments upon satisfactory performance of the developer in agreed upon stages. Stages may include the development of a detailed design, the delivery of individual modules, the integration of completed modules into a system, and final installation and testing with the client's other systems. If the project terminates before completion, the usual understanding is that the client receives ownership of work included in the last stage paid for. This Section assumes single-stage development. It would alter current practice and provide the developer significant leverage against the client as projects proceed. The language should be revised to read: "but if the developer cancels the development contract for material breach of a payment obligation, ownership revests in the developer for that portion of the software or development which is the subject of the breach."
2B-618 (b) (2) (B) and (C)
Under Section 618 as currently drafted, if a development agreement contains a clause assigning to the client ownership of all computer code developed under the agreement, the developer will nevertheless retain "any ownership reserved to it under applicable law". There is no provision of copyright law which provides that the developer retains ownership of anything if there is a properly worded assignment to the client. Moreover, if this language were allowed to remain, it could be construed to mean that since copyright law reserves ownership of a copyright to the creator of the work, the developer retains ownership of the software -- certainly not the intended or expected result! Therefore, the phrase "any ownership reserved to it under applicable law" should be deleted, along with subsection (C).
This section permits the parties to contractually limit their liability, but does not provide that such a limitation cannot be used to limit a party's liability for infringement indemnification. It is widespread industry practice to "carve out" infringement indemnification obligations from a contractual limitation of liability. Software licensors routinely agree to such a provision, recognizing that it is only fair. Section 703 should be revised to reflect this fundamental fairness and industry practice, and to avoid a trap for unwary licensees who may not have considered the need to include an express carve-out for infringement indemnification. A new subsection should be added to Section 703 stating: "A contractual limitation of liability shall not apply to limit either party's obligations to the other for infringement indemnification." In addition, this provision should be added to the list of protections, in Section 2B-106, that the parties cannot vary by agreement.
This Section ("Licensor's Self-Help") permits electronic repossession or forced discontinuance of use, without judicial process, upon the licensor's unilateral determination that a breach has occurred. Usually the 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 lessor 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 proposed self-help remedy 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 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, Section 716 should provide an outright prohibition on electronic self-help, rather than authorizing it. The current Draft provides a safe harbor for the most egregious licensor over-reaching and has huge implications for harm to innocent third parties and the economy.
However, as it has become apparent that the Committee may not consider including such a prohibition in 2B, SIM would consider supporting a compromise provision permitting electronic self-help under limited circumstances. The compromise provision would have to ensure:
The current draft of Section 716 ensures none of these. Specifically:
Licensor exposure to Damages for Improper Use of electronic Self-Help
It is not only licensees who believe a licensor must be held fully responsible for the consequences of an improper exercise of electronic self-help. A recent letter to NCCUSL from the Ieee-USA (a large organization of electronics and computer engineers), included the following statement: "Self help protection can adversely affect the health and safety of people and property, and can enganger lives whether intentionally, unintentionally, or improperly activated. Those who embed self help protection in their software must be responsible for its operation, whether inadvertent or intentional and should not be disclaimable. That responsibility should not be limited by privity of contract but should extend to those persons who lawfully obtain the software or reasonably may be foreseen to be users of the software directly or indirectly."
electronic self-help is such a drastic and potentially harmful remedy that if Article 2B is not going to prohibit it, 2B should at least force licensors to think long and hard before using it. If licensors want to act without judicial process and electronically disable software that may be performing critical functions, they should have to be very sure that their claim of material breach by the licensee is meritorious. They should also know they will be held fully responsible for the consequences of their actions if the claim of breach is later determined to be without merit, or if proper procedures are not followed.
Almost all of the damages that a licensee or anyone else would suffer as a result of an improper exercise of electronic self-help would be consequential damages. The vast majority of software licenses contain a provision excluding all liability (of the licensor but not the licensee) for consequential damages. Many also limit the licensor's total liability for damages of any kind to a fairly low dollar amount, often equal to the amount of the license fee. Unless 2B says otherwise, or a creative court finds a way to invalidate the limitation/exclusion, these clauses will exclude or narrowly limit a licensor's liability for improper electronic self-help.
If a licensor can contractually exclude or limit its liability for an improper exercise of electronic self-help, licensors will be able to use electronic self-help with impunity even if the claim of breach by the licensee is meritless, and even if the notice and other requirements of Section 716 have not been complied with. Section 716 could contain all the protections in the world for licensees, but these protections will be meaningless if the licensor can contractually limit its liability. This is why it is so crucial to ensure that a licensor cannot take advantage of contractual limitations or exclusions in this situation. The attached draft provides language addressing this issue.
As suggested by the Ieee, Section 716 should also provide that privity of contract will not be a bar to 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. The attached draft includes language addressing this issue as well.
ensuring effective Notice and Opportunity to Seek Judicial Intervention
Following are some of the loopholes and other problems with the current draft which result in a failure to ensure effective notice and a timely opportunity to seek judicial intervention:
The attached proposed draft of Section 716 contains language addressing all of the problems noted above.
Contractual Term Authorizing Self-Help
The current draft states that one precondition for exercising electronic self-help is that "a term in the license [which is conspicuous] [to which the licensee manifested assent] authorizes use of electronic means". It appears that the intent of the language in the second set of brackets is to require a separate manifestation of assent to the authorizing term itself and not just to the license as a whole. This is an important step toward ensuring that licensees do not inadvertently agree to electronic self-help provisions, but the language in the current draft does not make this safeguard as clear as it should be. (One could argue that the language requires assent only to the license as a whole.)
As for the language in the first set of brackets, merely requiring that the authorizing provision be conspicuous is not sufficient to ensure actual agreement in a license that is not authenticated by the licensee. A conspicuous provision in a clickwrap or shrinkwrap license is likely to go unseen. Separate assent to the authorizing provision is more likely to ensure actual agreement, and separate authentication even more likely to do so. (It is not clear how one separately manifests assent to a license term without separately authenticating it, in any event.) Section 716 should require separate authentication of the authorizing provision.
Other Problems With Section 716
Taken as a whole, Article 2B does little more than subtract from the protections available to licensees under the current state of the law. On the other hand, Article 2B provides many advantages to licensors over current law, one of the most significant of which is a uniform law validating shrinkwrap licenses. If Article 2B has any chance of being considered balanced, it must at a minimum either prohibit electronic self-help or include strong protection against its improper exercise. Far from doing either, the current draft provides a safe harbor for electronic self-help and provides "protection" for licensees that is illusory. This safe harbor for licensors is a dangerous one for the rest of the world. Adoption of the revisions shown on the attached draft of Sections 715 and 716 would help resolve the problems discussed above and help prevent abuse of this drastic remedy by licensors.
SECTION 2B-716. LICeNSOR'S SeLF-HeLP.
(a) A licensor may exercise its rights to possession and to prevent use under Section 2B-715(a) without judicial process only if this can be done:
(2) without a foreseeable risk of personal injury or
(3) when applicable, in compliance with subsection (b).
(2) the following conditions are met:
(B) the licensor
(ii) directed to a person designated by the licensee in the license
(iv) received by the licensee not less than ten business days before
(d) A licensee
(e) A licensor may not use electronic means under subsection (b)(2) with knowledge that the licensee has cured its breach.
SECTION 2B-715. RIGHT TO POSSeSSION AND TO PReVeNT USe.
(a) On cancellation of a license because of breach by the licensee, the licensor has the right:
(2) to prevent the continued exercise of informational property and other rights in the licensed information
(c) A party has a right to an expedited judicial hearing on prejudgment relief to enforce or protect its rights under this section.
(d) The right to possession under subsections (a) and (b) is not available to the extent that the information, before breach of the license
(e) When separate items of information are included under a single license, the rights to possession and to prevent use under subsections (a) and (b) do not include those items of information as to which no breach has occurred.
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