68 Id. at 368. In support of this holding, the court quoted a short excerpt of the legislative history of § 301, and noted that state courts had continued to recognize trade secret causes subsequent to enactment of the 1976 Copyright Act.
70 522 F. Supp. at 369. The
Real-Time court did not discuss the possible differences resulting from an express preemption statute such as § 301 which has no patent law analogue.
71 Id. In a related action, the same plaintiff sued another defendant for trade secret misappropriation and breach of a confidentiality agreement.
Warrington Assocs., Inc. v. Kellogg Citizens Nat’l Bank, 215 U.S.P.Q. (BNA) 375 (E.D. Wis. 1981). Defendant in that action, having received plaintiff’s copyrighted manual under a confidentiality agreement, allegedly furnished it to the Illinois defendant in
Real-Time, who allegedly created a program similar to plaintiff’s. In denying plaintiff’s motion for partial summary judgment, the Wisconsin court did not discuss preemption.
73 The 1909 Act did not contain a preemption section analogous to § 301 of the 1976 Act.
The
Bryce court also stated by way of dictum that the 1976 Act did not preempt trade secret law. Under the 1909 Act, there was no federal copyright for unpublished literary works.
See Act of July 30, 1947, ch. 391, 61 Stat. 652, formerly codified at
17 U.S.C. § 12 (1976) (revised 1976, 1980). Copyright in published works was secured by publishing with copyright notice.
17 U.S.C. § 10 (1976) (revised 1976, 1980). However, under the 1976 Act, copyright subsists from the moment of fixation.
17 U.S.C. § 302(a) (1982). Accordingly, under the 1976 Act no step beyond fixation is necessary initially to invoke copyright protection.
74 Bryce, 319 N.W.2d at 913–914. One implicit holding of this case if that general publication, as that term is used in copyright law, does not necessarily disclosure trade secrets apparent on the face of the published material.
76 319 N.W.2d at 915–16. Here the court may have overstated the case; trade secret protection sometimes extends beyond such a relationship.
See, e.g., RESTATEMENT OF TORTS, § 757(a), (d) (1939), which mandates liability for an actor not in any prescribed relationship to the owner when discovery was by improper means, or when there was notice that disclosure was made by mistake.
See also UNIF. TRADE SECRETS ACT § 1(2)(ii)(A), (B)(I), 14 U.L.A. 286, 287 (Supp. 1986);
E.I. duPont deNemours & Co. v. Christopher, 431 F.2d 1012 (5th Cir. 1970),
cert. denied,
400 U.S. 1024 (1971) (aerial inspection, not otherwise improper, of equipment for use in secret process and visible from above unfinished plant, was basis for injunctive relief directed to precluding trade secret misappropriation).
84 6 Computer L. Serv. Rep. (Callaghan) at 926 n.4.
90 Avco Corp. v. Precision Air Parts Inc., 210 U.S.P.Q. (BNA) 894 (M.D. Ala. 1980),
aff’d on other grounds,
676 F.2d 494 (11th Cir.),
cert. denied,
459 U.S. 1037 (1982);
Management Science Am., Inc. v. Cyborg Sys., Inc., 1977 U.S. Dist. LEXIS 15471, 1977–1 Trade Code (CCH) ¶ 61,472 (N.D. III. 1977);
M. Bryce & Assocs., Inc. v. Gladstone, 107 Wis. 2d 241, 319 N.W.2d 907 (Wis. Ct. App.),
cert. denied,
459 U.S. 944 (1982);
Warrington Assocs., Inc. v. Real-Time Eng’g Sys., Inc., 522 F. Supp. 367 (N.D. Ill. 1981). In three of the four cases cited, the courts interpreted the legislative history as indicating that there was no preemption of trade secret law. The fourth case.
Avco, at least arguably read the legislative history as mandating a certain trade secret preemption.
91 S. REP. NO. 983, 93d Cong., 2nd Sess. 44 (1974).
92 S. REP. NO. 473, 94th Cong., 1st Sess. 20 (1975).
93 id. at 115; H.R. REP. NO. 1476, 94th Cong., 2nd Sess. 132 (1976),
reprinted in 1976 U.S. CODE CONG. & AD. NEWS 5659, 5748.
See also HR. REP. NO. 83, 90th Cong., 1st Sess. 96–100 (1967)
94 S. REP. NO. 473, 94th Cong., 1st Sess. 116 (1975); H.R. REP. No. 1476, 94th Cong., 2nd Sess. 132 (1976), reprinted in 1976 U.S. CODE CONG. & AD. NEWS 5659, 5748.
95 248 U.S. 215 (1918). In this case, plaintiff, an association of newspaper publishers, gathered news and without affixing copyright notice, transmitted it daily to paying association members. Defendant, a rival company, obtained this news from early publication in newspapers and bulletins of plaintiff’s members. The Court held that defendant misappropriated the articles via unfair competition. This case gave rise to a doctrine generally known as “common law misappropriation.”
96 S. RRP. No. 473, 94th Cong., 1st Sess. 116 (1975); H.R. REP. No. 1476, 94th Cong., 2nd Sess. 132 (1976),
reprinted in 1976 U.S. CODE CONG. & AD. NEWS 5659, 5748.
97 Thomas E. Kauper, Ass’t Att’y Gen., Antitrust Div., Dep’t of Justice to the Hon. Hugh Scott (Feb. 13, 1976),
reprinted in 122 CONG. REC. 3836–38 (1976).
98 122 CONG. REC. 3836 (1976).
99 Michael M. Uhlmann, Ass’t Att’y Gen., Legislative Affairs, Dep’t of Justice to the Hon. Robert Kastenmeier (July 27, 1976),
reprinted in THE COPYRIGHT ACT OF 1976: DEALING WITH THE NEW REALITIES 177–92 (1976).
100 122 CONG. REC. 32,015 (1976).
101 Amendment Offered by Mr. Seiberling
Mr. SEIBERLING. Mr. Chairman, I offer an amendment.
The Clerk read as follows:
Amendment offered by Mr. SEIBERLING: Page 127, line 16, strike “including” and all that follows down through line 20, and insert in lieu thereof a period.
Mr. SEIBERLING. Mr. Chairman, my amendment is intended to save the “Federal preemption” of State law section, which is section 301 of the bill, from being inadvertently nullified because of the inclusion of certain examples in the exemptions from preemption.
This amendment would simply strike the examples listed in section 301(b)(3).
The amendment is strongly supported by the Justice Department, which believes that it would be a serious mistake to cite as an exemption from preemption the doctrine of “misappropriation.” The doctrine was created by the Supreme Court in 1922, and it has generally been ignored by the Supreme Court itself and by the lower courts ever since.
Inclusion of a reference to the misappropriation doctrine in this bill, however, could easily be construed by the courts as authorizing the States to pass misappropriation laws. We should not approve such enabling legislation, because a misappropriation law could be so broad as to render the preemption section meaningless.
Mr. RAILSBACK. Mr. Chairman, will the gentleman yield?
Mr. SEIBERLING. I yield to the gentleman from Illinois.
Mr. RAILSBACK. Mr. Chairman, may I ask the gentleman from Ohio, for the purpose of clarifying the amendment that by striking the word “misappropriation,” the gentleman in no way is attempting to change the existing state of the law, that is as it may exist in certain States that have recognized the right of recovery relating to “misappropriation” is that correct?
Mr. SEIBERLING. That is correct. All I am trying to do is prevent the citing of them as examples in a statute. We are, in effect, adopting a rather amorphous body of State law and codifying it, in effect. Rather I am trying to have this bill leave the State law alone and make it clear we are merely dealing with copyright laws, laws applicable to copyrights.
Mr. RAILSBACK. Mr. Chairman, I personally have no objection to the gentleman’s amendment in view of that clarification and I know of no objections from this side.
Mr. SEIBERLING. I thank the gentleman.
Mr. KASTENMEIER. Mr. Chairman, will the gentleman from yield?
Mr. SEIBERLING. I will be glad to yield to the gentleman from Wisconsin.
Mr. KASTENMEIER. Mr. Chairman, I too have examined the gentleman’s amendment and was familiar with the position of the Department of Justice. Unfortunately, the Justice Department did not make its position known to the committee until the last day of markup.
Mr. SEIBERLING. I understand.
Mr. KASTENMEIER. However, Mr. Chairman, I think that the amendment the gentleman is offering is consistent with the position of the Justice Department and accept it on this side as well.
Mr. SEIBERLING I thank the gentleman. Id
102 Id. See also H.R. REP. No. 1733, 94th Cong., 2nd Sess. 78–79 (1976).
103 See supra note 36 for text of § 117.
104 H.R. REP. No. 1307, 96th Cong., 2nd Sess. 23–24 (1980) (commenting on H.R. 6933. § 12 § 10 as enacted in Pub. L. No. 96–517, 94 Stat. 3015, 3028), amending §§ 101, 117 of the 1976 Copyright Act).
105 Videotronics, Inc., v. Bend Elecs., 564 F. Supp. 1471 (D. Nev. 1983);
Avco Corp. v. Precision Art Parts Inc., 210 U S P Q (BNA) 894 (M.D. Ala. 1980),
aff’d on other grounds,
676 F.2d 494 (11th Cir.),
cert. denied, 459 U.S. 1037 (1982).
Avco may be read as based on failure to plead properly, rather than preemption, while
Videotronics squarely held preemption.
106 Videotronics broadly held that trade secret law was preempted.
See supra notes 58–66 and accompanying text.
107 17 U.S.C. § 102(a)(1982) provides:
Copyright protection subsists, in accordance with this title, in original works of authorship fixed in any tangible medium of expression, now known or later developed, from which they can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device. Works of authorship include the following categories: 1) literary works; 2) musical works, including any accompanying words; 3) dramatic works, including any accompanying music; 4) pantomimes and choreographic work; 5) pictorial, graphic, and sculptural works; 6) motion pictures and other audiovisual works; and 7) sound recordings.
108 The requirements are discussed
infra at notes 111–15 and accompanying text.
111 See
supra note 16 for text of § 106.
112 See
supra note 107 for text of § 102(a).
113 17 U.S.C. § 103 (1982) provides:
§ 103 Subject matter of copyright: Compilations and derivative works
(a) The subject matter of copyright as specified by section 102 includes compilations and derivative works, but protection for a work employing preexisting material in which copyright subsists does not extend to any part of the work in which such material has been used unlawfully.
(b) The copyright in a compilation or derivative work extends only to the material contributed by the author of such work, as distinguished from the preexisting material employed in the work, and does not imply any exclusive right in the preexisting material. The copyright in such work is independent of, and does not affect or enlarge the scope, duration, ownership, or subsistence of any copyright protection in the preexisting material.
114 See
supra note 43 for text of § 102(b).
115 It is assumed here that a computer program is a “literary work,” as that term is defined in § 101 and included in § 102(a)(1), and therefore meets the preemption requirement of subject matter type.
116 See supra text accompanying notes 22–25.
117 RESTATEMENT OF TORTS § 757 (1939).
118 Through use of a type of program known as an “interpreter,” the computer executes each program statement as it is fed in.
121 The interests for which protection is sought under each form of protection may be different. For example, a copyright holder may seek to prevent slavish copying, while a trade secret owner may wish to preclude use of a concept.
122 Where there is preemption, dual protection is academic because trade secret law has been emasculated.
123 Under the 1976 Act, Copyright subsists once a work is fixed in a tangible medium of expression, without any further requirement.
17 U.S.C. § 302(a) (1982). Accordingly, the issue is framed in terms of the effect of a
claim of copyright, rather than mere existence of copyright. If this question is instead couched in terms of existence, it reduces to the preemption question.
126 See H.R. REP. No. 1476, 94th Cong., 2d Sess. 138 (1976),
reprinted in 1976 U.S. CODE CONG. & AD. NEWS, 5659, 5754.
128 It may be argued that by its activities a software licensor publishes generally. However, distributing to licensees under a confidentiality agreement apparently does not constitute publication.
See Nimmer on Copyright § 4.13.
See also H.R. Rep. No. 1476, 94th Cong., 2d Sess. 138,
reprinted in 1976 U.S.CODE CONG. & AD. NEWS 5659, 5754 (Distribution to the public, as set forth in the definition of “publication” in
17 U.S.C. § 101 (1982), means distribution “generally to persons under no explicit or implicit restrictions with respect to disclosure of its contents.”).
130 Technicon, 211 U.S.P.Q. (BNA) at 347. As the district court saw it:
[O]nce there was publication with statutory notice to any degree, the documents were at least potentially protected by the federal statute and the plaintiff was estopped from further asserting any common law copyright protection. To rule otherwise would effectively render the printed notices of copyright meaningless … . [P]laintiff cannot have it both ways: the 28 year monopoly and protection from infringement enforceable in federal court under the statute, and the perpetual protection from infringement, enforceable in state court under common law copyright.
Id.
132 Statutory estoppel has three elements: assertion of entitlement to statutory right or privilege; receipt of actual benefit pursuant to statute; and beneficiary’s subsequent assertion inconsistent with entitlement to the statutory benefits.
Technicon, 687 F.2d at 1034.
133 There would be no actual benefit until an enforcement action was successfully maintained.
Id. at 1036.
134 The court found that the deterrent effect of notice was speculative.
Id.. The court did not find it necessary to, and did not, reach the question whether the assertion was inconsistent with entitlement to copyright.
Id. at 1037.
135 Antedated notice simply causes the copyright term to commence running from the date stated: such notice is entirely accurate.
Id. 136 U.S. CONST art. VI provides: “This Constitution, and the laws of the United States which shall be made in Pursuance thereof …shall be the supreme Law of the Land: and the Judges in every State shall be bound thereby, any Thing in the Constitution or Laws of any State to the Contrary notwithstanding.”
138 Also, plaintiff permitted potential customers to examine documents comprising the payroll system after executing a nondisclosure agreement.
140 This case was governed by the 1909 Copyright Act, 319 N.W.2d at 913.
141 See supra notes 72–82 and accompanying text.
144 When a notice required by § 401 has been omitted, the infirmity may be cured if (a) it was omitted on only a relatively small number of copies publicly distributed: (b) registration is made not later than five years after publication without notice, and reasonable effort is made to add notice to all copies publicly distributed in the United States after discovery of omission; or (c) omission of notice violated an express written condition of the copyright owner’s authorization of public distribution.
Id. § 405.
An interesting issue is raised as to whether international omission is curable. The precedents differ on this point.
See, e.g.,
Hasbro Bradley, Inc. v. Sparkle Toys, Inc., 780 F.2d 189 (2d Cir. 1985) (statute does not plainly intend to exclude all deliberate omissions);
Innovative Concepts in Entertainment, Inc. v. Entertainment Enters., Ltd., 576 F. Supp. 457 (E.D.N.Y. 1983) (intentional omission curable);
Beacon Looms, Inc. v. S. Lichtenberg & Co., 552 F. Supp. 1305 (S.D.N.Y. 1982) (intentional omissions not curable);
O’Neil Developments, Inc. v. Galen Kilburn, Inc., 524 F. Supp. 710 (N.D. Ga. 1981) (intentional omission curable).
153 Id. § 412. However, for published works registration within three months of publication is sufficient.
156 However, copies deposited in satisfaction of the latter requirements may be used to satisfy the registration requirement.
Id. § 408(b).
159 Id. § 220.20(c)(2)(vii).
161 U.S. COPYRIGHT OFFICE,
supra note 1, § 324.05(a).
162 Copyright Office Letter GL R–70. July 1981,
reprinted in Nimmer on Copyright § 4.05. While the Copyright Office considers source code to the “best representation of the copyrightable authorship in a computer program.” U.S. COPYRIGHT OFFICE,
supra note 1, § 324.03, it will accept object code where the applicant is unable or unwilling to supply source code accompanied by such a letter.
Id. § 324.04.
163 48 Fed. Reg. 22.951–52 (1983).
165 When the Copyright Office refuses to register based on a submission in proper form of deposit, application, and fee, the applicant may nevertheless institute an infringement action.
17 U.S.C. § 411(a) (1982).
171 5 U.S.C. § 552 (1982). The FOIA provides generally provides generally that federal agencies must provide copies of documents in their possession to any person requesting them, except in certain enumerated situations.
173 Chrysler Corp. v. Brown, 441 U.S. 281 U.S. 281 91979). It is uncertain whether the fact that the deposit is copyrighted would render Copyright Office compliance with an FOIA request copyright infringement. Perhaps such compliance would constitute fair use, or otherwise be exempt from the general dictates of the copyright law.
180 On the protectability of trade secrets ascertainable by significant reverse engineering, see, e.g.,
Analogic Corp. v. Data Translation, Inc., 371 Mass. 643, 358 N.E. 2d 804, 807 (1976):
Thermotics, Inc., v. Bat-Jac Tool Co., 541 S.W.2d 255, 260–61 (Tex. Civ. App. 1976).
184 See supra Section IV.A.I.
186 6. Computer L. Serv. Rep. (Callaghan) at 924
190 RESTATEMENT OF TORTS § 757 comment b (1939).
197 412 U.S. 546 (1973). Without authorization and without paying royalties, defendants bought, copied and sold recordings at reduced price. This occurred prior to the time when federal copyright protection was extended to sound recordings.
203 See supra Sections 11 B. C
205 See 17 U.S.C. §§ 408(b)(1),
409 (1982). The 1909 Copyright also provided for statutory copyright protection in certain unpublished works, although literary works (into which category computer programs seem to have been regulated) were not included. Act of Mar. 4. 1909, ch. 320 § 11, 35 Stat. 1075, 1078.
206 See, e.g., White v. Kimmell, 193 F.2d 744 (9th Cir. 1952). The limited pulbication doctrine afforded the courts the flexibility to work around the rule that any publication would force a divesting of common law rights. Now only a “general” publication triggers divestment. This concept is vital since a work placed in the public domain might not claim statutory copyright under the current law. The court in
White offered a judicial definition of a limited publication as one “which communicates the contents of a manuscript to a definately selected group and for a limited purpose, without the right of diffusion, reproduction, distribution or sale.”
193 F.2d at 746.
116 The Advisory Commission on Patent Law Reform,
Report to the Secretary of Commerce, 5 (Aug. 1992).
120 17 U.S.C. § 301(a) provides in pertinent part for the preemption of “all legal or equitable rights that are equivalent to any of the exclusive rights within the general scope of copyright as specified by section 106 in works of authorship that are fixed in a tangible medium of expression and come within the subject matter of copyright as specified by sections 102 and 103.”
121 17 U.S.C. § 301(b)(3) provides: “Nothing in this title annuls or limits any rights or remedies under the common law or statutes of any State with respect to … (3) activities violating legal or equitable rights that are not equivalent to any of the exclusive rights within the general scope of copyright as specified by section 106. …”
122 Altai slip opin. at 54.
123 Plaintiff relied on Section 757(c) of the Restatement of Torts (II) which holds liable a defendant who learns of a trade secret with notice of the fact it was secret and that the disclosure to defendant breached a duty to the owner.
124 Altai slip opin. at 57.
126 The software had been taken from plaintiff by its ex-employee, who then used it on behalf of defendant.
127 982 F.2d at 718. It would appear that implicit in such a holding is the notion that “use” of a program requires the making of a “copy,” an issue treated by neither the district court nor the appellate court. On this point, see the discussion of MAI v. Peak in § 4.01[1] in this Treatise.
128 The court also noted that, inasmuch as the district court had denied defendant’s motions to dismiss and for summary judgment based on failure to plead and preemption, defendant was on notice that it was accused of trade secret misappropriation.
131 Diagnostic programs are used to identify hardware failures, so as to isolate particular components responsible for problems.
131.1 “The antitrust claims are intriguing because they present a curious conflict, namely, whether (and to what extent) the antitrust laws, in the absence of any statutory exemption, must tolerate short-term harm to the competitive process when such harm is caused by the otherwise lawful exercise of an economically potent ‘monopoly’ in a copyrighted work.”
36 F.3d at 1152, 32 U.S.P.Q.2d at 1386.
131.3 But that court stated that not every extra element would suffice. For example, the court noted that elements of intent and knowledge would not suffice.
131.4 Grumman argued that here the misappropriation was equivalent to unauthorized copying because defendant did not learn the trade secrets. That made no difference to the court.
132 The court distinguished this case from
Computer Assoc. Int’l, Inc. v. Altai, Inc., 775 F. Supp. 544, 564 (E.D.N.Y. 1991) because there plaintiff’s sole trade secret theory was defendant’s copying and use of plaintiff’s software. Here plaintiff alleges wrongful acquisition in breach of a duty.
In connection with other claims made in Data General v. Grumman, the court held that a claim for conversion was not preempted; a claim for unfair competition was preempted as equivalent to copyright because the only unfair competition alleged was common law misappropriation (but “palming off” would not be pre-empted); and unjust enrichment for violating plaintiff’s “right to control” its software was preempted.
136 The claims are “identical: defendants have allegedly reproduced and/or sold, without authorization, copies of plaintiff’s software programs. … In short, plaintiff has pleaded that one act constituted both misappropriation … and … infringement.”
Id. 139 The opinion does not appear to consider whether the adaptation was “created as an essential step in the utilization of the computer program in conjunction with a machine. …” as required by Section 117.
141 Gates Rubber Co. v. Bando Am., Inc., C.C.H. Computer Cases ¶ 46,765 (D. Colo. 1992).
144 Originally created beginning in 1969 at Bell Telephone Laboratories, for certain types of computers and applications the Unix family of programs grew to become one of the more popular operating systems commercially available. Even in the mid-1990’s, a quarter century after its origination, the popularity of this software was growing.
145.2 The district court found that the attractiveness of the demonstration software lay in its advanced user interface.
145.3 Marketing subsequently generated revenues of almost $200,000.
145.6 30 U.S.P.Q.2d at 1371. The appellate court rejected without discussion defendants’ contention that any trade secret was lost by virtue of demonstrating the program to clients.
145.8 Architectronics, Inc. v. Control Systems, Inc., ____ F.Supp. ____, Andrews Comp. & Online Ind. Lit. Rep. p. 22825 (20 Aug. 1996) (SDNY 1 Aug. 96).
145.11 The court did, however, grant summary judgment for defendants on the contract claims, as it found that no valid contract claims were pleaded.
152 The district court had read the pleadings to allege that defendant made an unauthorized distribution of a copy, an interpretation the appellate court saw as unsupported. The court of appeals interpreted the pleadings as alleging unauthorized use by defendant of a copy.
153 The court stated: “We must consider whether a limitation on the uses to which a licensee may put a licensed work are preempted even though those uses do not involve the exclusive copyright rights.”
1993 U.S. App. Lexis 6926 at 12. Inasmuch as “use” here inherently involves copying, it is unclear just what the court meant.
158 Whereas development of plaintiff’s machine required almost ten months, defendants produced theirs in one and one half weeks.
160 The court found some pre-emption with regard to the conversion and unfair competition claims. With regard to conversion (“an act of willful interference with the dominion and control over a chattel done without lawful justification, by which any person entitled to the chattel is deprived of its use and possession”), the Complaint alleged that defendant used the converted materials to design a copy. “Although copyright law does not protect possession, per se, implicit in the ownership rights conferred by § 106 is the power to control the use of the copyrighted materials.” The court saw this as “identical” to plaintiff’s exclusive right to copy.
As to unfair competition, the Complaint alleged that defendants disparaged plaintiff’s reputation, misrepresented their machine as plaintiff’s, copied the appearance of plaintiff’s machine and other materials, hired key plaintiff employees, and diverted orders. The court held that § 301 pre-preempted plaintiff from asserting such a claim with regard to use of the blueprints and databases, because copyright protected those items from this type of activity. However, the remainder of the unfair competition claim was not pre-preempted.
163 The court’s analysis of the four cited cases does not seem entirely consistent with this contention.
166 The appellate opinion did not deal with preemption of misappropriation.
169 To be sure,
Kewanee dealt with the possible preemption of trade secret law by virtue of federal patent policy, so that the issues there are not entirely analogous to those in the instant case.
171 The court cited H.R.
Rep. No. 1476, at 51 (1976), 1976 U.S.C.C.A.N. 5659, 5747, the legislative history of the 1976 Copyright Act.
173 R.C. 2913 (A) provides: “No person shall knowingly use of operate the property of another without the consent of the owner or person authorized to give consent.”
174 Amicus curiae Microsoft took the positing that there is a presumption against preemption under § 301(a). The court disagreed.
177 U.T.S.A. § 2(a), 14 Unif. Laws Ann. (West 1990).
181 See id. ;
Allis-Chalmers Mfg. Co. v. Continental Aviation & Eng’g. Corp., 255 F. Supp. 645 (E.D. Mich. 1966);
Emery Inds., Inc. v. Cottier, 202 U.S.P.Q. 829 (S.D. Ohio 1978);
B. F. Goodrich Co. v. Wohlgemuth, 117 Ohio App. 493, 192 N.E.2d 99, 137 U.S.P.Q. 804 (Ohio App. 9th Dist. 1963);
Fountain v. Hudson Cush-N-Foam, 122 So.2d 232 (Fla. App. 3d Dist. 1960);
FMC Corp. v. Varco Int’l, Inc., 677 F.2d 500, 505 (5th Cir. 1982);
Air Products & Chemical, Inc. v. Johnson, 442 A.2d 1114 (Pa. Super. 1982);
Electronic Data Systems Corp. v. Powell, 524 S.W.2d 393 (Tex. Civ. App. 1975),
writ ref’d n.r.e. 184 In this case, the court expressed doubt as to the ex-employee’s contention that he would use his best efforts to avoid using the ex-employer’s information. The district court did not credit these contentions, and the court of appeals characterized the ex-employee as displaying a lack of forthrightness, and as having lied.
185 See Essex Group, Inc. v. Southwire Co., 501 S.E.2d 501 (Ga. 1998) (injunction with possible 5-year duration);
Cardinal Freight Carriers, Inc. v. J.B. Hunt Transport Services, Inc., 987 S.W.2d 642 (Ark. 1999);
Insure New Mexico, LLC v. McGonigle, 995 P.2d 1053 (N.M. App. 2000) (preliminary injunction granted, permanent injunction denied);
Sperry Rail, Inc. v. Herzog Services, Inc., 1996 U.S. Dist. Lexis 13134 (D. Kan. 1996);
Novell Inc. v. Timpanagos Research Group Inc., 46 U.S.P.Q.2d 1197 (Utah 1998);
Delphine Software Int’l S.A.R.L. v. Electronic Arts, Inc., 1999 U.S. Dist. LEXIS 12629 (S.D.N.Y. 1999) (suggesting distinction between inevitable disclosure, appropriate for injunctive relief, and inevitable use, remediable by damages);
Merck & Co., Inc. v. Lyon, 941 F. Supp. 1443 (M.D.N.C. 1996);
Hydraulic Exchange and Repair, Inc. v. KM Specialty Pumps Inc., 690 N.E.2d 782, 46 U.S.P.Q.2d 1291 (Ind. App. 1998);
Procter & Gamble Co. v. Stoneham, 140 Ohio App. 3d 260, 747 N.E.2d 268 (Ohio App. 2000);
Branson Ultrasonics Corp. v. Stratman, 92 F. Supp. 909 (D. Conn. 1996);
DoubleClick, Inc. v. Henderson, 1997 NY Misc. Lexis 577 (N.Y. Sup. Ct. N.Y. Co. 1997);
Teradyne, Inc. v. Clear Communications Corp., 707 F. Supp. 353 (N.D. Ill. 1989);
La Calhene, Inc. v. Spolyar, 938 F. Supp. 523 (W.D. Wis. 1996);
Ackerman v. Kimball Int’l, Inc., 652 N.E.2d 507 (Ind. 1995);
Southwestern Energy Co. v. Eickenhorst, 955 F. Supp. 1078, 42 U.S.P.Q.2d 1824 (W.D. Ark. 1997);
Uncle B’s Bakery, Inc. v. O’Rourke, 920 F. Supp. 1405 (N.D. Ia. 1996).
186 See Campbell Soup Co. v. Giles, 47 F.3d 467, 33 U.S.P.Q.2d 1916 (1st Cir. 1995);
Utah Medical Prods., Inc. v. Clinical Innovations Ass’ns, Inc., 79 F. Supp. 2d 1290 (D. Utah 2000);
Motion Control Systems, Inc. v. East, 546 S.E.2d 424 (Va. 2001);
Hoskins Mfg. Co. v. PMC Corp., 47 F. Supp. 2d 852 (E.D. Mich. 1999);
Carboline Co. v. Lebeck, 990 F. Supp. 762, 45 U.S.P.Q.2d 1922 (E.D. Mo. 1997);
Lexis-Nexis v. Beer, 41 F. Supp. 2d 950 (D. Minn. 1999);
H & R Block Eastern Tax Services, Inc. v. Enchura, 122 F. Supp. 2d 1067 (W.D. Mo. 2000);
Bridgestone/Firestone, Inc. v. Lockhart, 5 F. Supp. 2d 667 (S.D. Ind. 197);
Glaxo, Inc. v. Novopharm Ltd., 931 F. Supp. 1280 (E.D.N.C. 1986);
Earthweb v. Schlack, 71 F.2d 299 (S.D.N.Y. 1999), remanded on other grounds, 205 F.3d 1322 (2d Cir. 2000);
Dulisse v.Park Int’l Corp, 45 U.S.P.Q.2d 1688 (N.D. Ill. 1998);
Int’l Paper Co. v. Suwyn, 966 F. Supp. 246, 258 (S.D.N.Y. 1997);
APAC Teleservices, Inc. v. McRae, 985 F. Supp. 852 (N.D. Ia. 1997);
Bendinger v. Marshalltown Trowell Co., 338 Ark. 410, 994 S.W.2d 468 (1999);
In re Wilson, 149 F.3d 249 (4th Cir. 1998).
188 The court noted there was precedent for according trade secret status to techniques for self-improvement (although not specifically spiritual self-improvement). It stated that it was aware of no authority for excluding any type of information from trade secret status.
190 Divestment would not necessarily take place if publication was “sufficiently obscure or transient or otherwise limited so that it does not become generally known to the relevant people, i.e., potential competitors or other persons to whom the information would have some economic value.”
A model software license agreement embodying many of the precepts discussed below is printed as Appendix 4A[4] of this Treatise.
The license is generally restricted to a single particular computer (identified in the agreement by serial number). If use on more than one computer is desired, the additional computers are treated as calling for additional licenses (often at reduced royalties). One exception commonly found in licenses is that in the event the identified computer fails to function properly, temporary use may be made on a “back-up” computer. Limiting use to a single computer is regarded as an important method of limiting improper proliferation.
The license will specify the form of the program to be provided to the licensee. Generally, the source code form is more valuable to the licensee, and may cost more and be subject to more restrictions. If source code is provided, flow charts and listings may also be provided. A licensor concerned about protecting his program, however, may transfer only the object code form, accompanied by as little documentation as possible.
Much of the agreement should deal explicitly with the protection of proprietary rights. The licensee may acknowledge the licensor’s ownership of intangible property in the program, be it trade secrets, confidential information, patent rights, or copyrights. Where trade secret material is involved, the agreement should explicitly establish a confidential relationship, and may specify that all tangible materials transferred to the licensee remain the licensor’s property. The licensee should be obligated not to engage in any use, transfer, or disclosure of licensed materials and information except as expressly set forth in the agreement. He should further be obligated to inform his employees and agents who may come into contact with the materials of their confidential nature, and should agree to take reasonable precautions to prevent any unauthorized use, transfer or disclosure and, failing this, to report all such instances to the licensor. The licensee should also agree to cooperate with the licensor in the event of any litigation concerning the matter.
The specific uses to which the licensee may put the transferred material should be set forth. In particular, the matter of how much and what type of copying (if any) is to be permitted, should be expressly set forth. The licensee may be obligated to keep records of his copying, and even to number his copies. Of great importance is that each copy bear the appropriate notice, be it a notice that an algorithm is patented, that a program is copyrighted, or of a proprietary interest. If possible, all notices on programs should be present in human-readable form on the programming device, and in machine-readable form at the beginning and end of the program (and perhaps at certain intermediate locations).
Most licenses do not permit sublicensing, but where it is permitted (as when the licensee is a service bureau operating, for lease on a time-sharing basis, a computer and numerous programs for use on it), the licensee must agree to impose restrictions on his sublicensees if there is any way the licensee can obtain access to the program code.
When a program is licensed in source code, the licensee may make modifications (unless prevented by the agreement), so it is well for the agreement to state what the parties’ rights will be to those modifications. The licensee should also agree that on termination of the license, the licensed program will be deleted from any modification.
Finally, the agreement should set forth the disposition of all licensed materials and copies thereof at termination of the agreement. Return to the licensor may be best, but most licenses provide in the alternative for destruction and certification thereof. Further, any confidentiality provision should survive the agreement.
A device used increasingly in marketing relatively inexpensive (often less than $100) consumer software packages is the “shrink-wrap.”
1 The program package is enveloped by a plastic wrapper, through which is visible a sheet of paper stating that any person opening the wrapper agrees thereby to be bound by a set of conditions, recited on the paper and visible through the wrapper, regarding, e.g., non-duplication. This is an interesting attempt to deal with the problem of protecting mass-marketed, low-priced software. In such a market, the consumers are too numerous, and each transaction is of insufficient value, to justify an effort to secure an executed license agreement imposing a confidence between licensor and licensee, or otherwise restricting the latter. However, the shrink-wrap method is not without its problems, e.g., the evidentiary problem of showing informed consent, or the lack of capacity to contract inherent in minors.
Louisiana, in 1984
2, and Illinois, in 1985
3, are the first states to have given legislative support to shrink-wrap licenses. These “software license enforcement” statutes purport to overcome the contract law obstacles noted above that inhere in the shrink-wrap device, and to give the imprimatur of enforceability to licenses which meet specified criteria.
Quaere, the effect of the preemption statute
4 on such legislation.
In the competitive scramble to offer software houses a hospitable business climate, a number of other states have pending in their legislatures similar bills. Yet the mere passage of such legislation does not necessarily secure the software publisher and distributor the rights it purports to secure; litigation testing the validity of such legislation as against public policy concerns has already commenced in Louisiana and is likely in Illinois.
The ultimate force of the common shrink-wrap license therefore remains to be seen.
The duration of a license agreement may be perpetual, or may be a fixed term. If enhancements are included, the agreement should probably be for a fixed term so as to accommodate changes in licensing policy.
Royalties may be payable as a single lump sum, or as periodic payments. The programs licensed should be identified (perhaps on an appended schedule), and there may be provision for adding programs in the future. It should be made clear whether the license for the stated royalty includes maintenance, enhancements, training, and any modifications necessary to fit the licensee’s system. Most program licenses are non-exclusive (otherwise the parties would probably agree to a sale), and most licensors prefer them to be non-transferable so they know who has their program, and who is supposed to be paying for its use.
A typical agreement also attempts to resolve the issue of liability in the event of program malfunction (e.g., limited to royalty paid; including indirect and consequential damages) and discusses warranty matters (e.g., “as is” without warranty; disclaimer of warranty of merchantability or fitness; warranty only of conformity to printed specifications; warranty acknowledging use). The agreement may also include a provision concerning indemnification (including legal expenses) for patent or copyright infringement or trade secret/confidential information misappropriation.
5 Where ongoing royalty payments are required the agreement may also provide for periodic audits of perhaps two year intervals at the vendor’s option. The parties can negotiate payment of auditor’s expenses, e.g., with the vendor paying unless the licensee has underestimated the royalty by more than five percent.
In addition, antitrust considerations may be involved. For a discussion of current U.S. Department of Justice thinking on appropriate and inappropriate restraints in licensing, see U.S. D.O.J., “Antitrust Enforcement Guidelines for International Operations,” pertinent portions of which are reproduced in Appendix 4A[28] infra.
Generally, the licensee may terminate at will, and the licensor may terminate for cause (e.g., breach of agreement, including breach of confidence or failure to pay royalties; or indications of bankruptcy). Other matters which may be dealt with in the agreement are responsibility for any applicable taxes, choice of law, and an integration clause.
6 The licensor must take all reasonable steps to see that his proprietary interests are not compromised. If he seeks patent protection, he must proceed in timely fashion. If he relies on copyright, he must be careful to place his copyright notice appropriately. In the case of trade secret protection, he should mark all programs and documentation with appropriate legends, and maintain good internal security predicated on distribution on a “need to know” basis, employee confidentiality agreements, notice to employees as to what materials are confidential, and in some cases even secured (guards, fences, etc.) premises. Most importantly, this must all be part of a program, so that the existence of regular procedures can be established in the event of litigation.
In the event of copyright or trade secret protection it may be helpful to introduce into each licensed program a “house mark” consisting of a few trivial and non-functional instructions whose only purpose is to indicate the licensor as the source of the program. The same house mark may be used in all programs, or each package shipped may contain a different one in an attempt to trace any “leak.”
Finally, in policing any infringements or misappropriations, the licensor will be hard-pressed to identify the (presumably) occasional instance where a pirate uses the program unlawfully. However, occasional user piracy generally will not inflict severe economic harm. Where a pirate attempts to market the program in competition with its rightful proprietor, the unlawful conduct is much more likely to come to the latter’s attention. In this situation, if the proprietor has carefully preserved his rights, he may be able to persuade or compel the pirate to cease and desist, and to remedy any injury.
When rights are obtained under a license to a software package, the only type of code usually transferred from the licensor to the licensee is object code.
7 So long as that code executes properly, and so long as the precise version of the program supplied to the licensee meets his requirements, the licensee has no need for source code or system documentation.
8 But object code, whose form is a string of zeros and ones, is difficult for even most experienced programmers to read. Generally, in order properly to debug or modify a program, source code is necessary and system documentation is quite helpful if not necessary. Accordingly, when bugs are detected or when modifications or enhancements are desired for the program, the licensee possessing only object code is unable to satisfy his requirements. It is only when he has source code and system documentation that the licensee can be independent of the licensor.
In those instances where the licensee has source code and system documentation the licensee’s own staff usually corrects bugs and makes any necessary modifications to the program. More often, however, the licensee does not have source code or system documentation, and these services (generally known as “program maintenance”) are supplied to the licensee by the licensor or (less frequently) by a third party. In many an instance, the licensee’s business relies quite significantly on one or more programs. In such a situation, the inability to correct a bug or to make necessary modifications would have substantial if not drastic ramifications for the licensee’s business. Thus, the prudent licensee must inquire into the continuing availability of program maintenance.
Probably the single most important element in seeking to assure the availability of maintenance is to license the package from a reliable licensor (or make arrangements with a reliable maintenance company). Moreover, the licensee should take pains to seek a maintenance agreement which will place squarely upon its contracting party the onus of keeping the system up and running on a timely basis. However, even a good choice of maintenance contractor, coupled with a well fashioned agreement, cannot guarantee perpetual effective timely maintenance, and many perceptive licensees today demand something beyond a good contract with a reliable licensor or contractor. What these licensees are increasingly demanding is a device known as the “source code escrow.”
To be sure, so as to protect their interests in this regard, the licensee’s first choice would be title to and possession of a copy of the source code and system documentation. But licensors generally are reluctant to part with source code and documentation for fear of losing trade secrets they maintain in those entities. Where source code is maintained by the licensor as a trade secret, a copy of source code will generally not be transmitted to licensees. It is conceivable that if licensors of software packages shift their reliance more toward copyright and away from trade secret, if attitudes change, or if commercial realities change, more licensors will be willing to part with title and possession to a copy of the source code and documentation. However, that has as yet not happened.
The next best thing to title, in the mind of many licensees, would be to have possession of a copy of the source code and documentation. But for the same reasons, licensors generally have not accommodated licensees on this point.
Yet despite their inability to obtain title or possession to a copy, licensees in increasing numbers have been able to secure a certain degree of protection through a source code escrow. Through this mechanism, the licensor places into the possession of an independent third party (and may pass title to the third party) a copy, continually updated, of the source code and appropriate documentation. Although this device is not without practical and legal infirmities, as discussed below, it is a potential solution to this recurring problem, and is being pursued with increased frequency.
The problem of assuring program maintenance is far from academic. One article gives a brief case history of a company that was left in the lurch when its software developer went out of business.
9 While it poses a real problem generally where technical information is licensed, it is particularly acute in the software area because so many of the developers and purveyors of software are small, new companies of doubtful financial viability. Accordingly, there is often a real possibility that the company offering the software will not be around a year hence to maintain it.
The concept of the source code escrow is meant to cover situations where the program has been written by the programmer in a high order language,
10 which is the typical situation. However, the source code escrow will prove useful also where the program was originally written in assembly language
11 or in object code.
12 Accordingly, the concept of the source code escrow has been advanced and used. A third party, which may be an agent of one of the parties to the license, or may not be an agent, takes possession of and possibly title to source code and appropriate documentation. On the occurrence of one of a number of specified triggering events, possession and possibly title may be transmitted to the licensee. If adequate agreements are fashioned to control the situation, the source code escrow may meet the legitimate needs of both parties to the license agreement. But problems arise both in drafting the agreements so as to fairly meet these various needs, and also with regard to the bankruptcy laws.
Among those entities now serving as escrows are firms (generally of relatively recent vintage) established solely or primarily to serve in such functions; banks (especially their Management Information Systems Departments); accounting firms; and attorneys. A number of items generally should be covered in the agreement or series of agreements pertaining to the source code escrow. First, there should be a duty imposed on the licensor to deposit in escrow source code and sufficient documentation of both the version of the program then in existence, and of all subsequent versions embodying modifications, enhancements, and fixes. The parties may attempt to list the various types of documentation that must be deposited, or they may simply characterize it in functional terms, e.g., as whatever flow charts, programmer documentation, and system documentation are sufficient to enable a competent programmer, without the expenditure of undue time, to understand all details pertaining to the algorithms embodied in, and the operation of the program.
Another determination to be embodied in the agreement goes to whether the escrow will play a passive or an active role. A passive escrow functions solely as a repository from which retrieval may be had under specified conditions. An active escrow, in addition, makes certain assessments as to the materials deposited with it. For example, it might be called upon to verify the identity of the source code deposited with it. It might do this by compiling that source code into object code which it compares with the marketed version of the program. On an even more active level, the escrow might be required to make its own analysis of the deposited materials and render an opinion on whether they suffice to give a competent programmer everything he or she would need to learn enough about the program in a reasonable amount of time so as to undertake its maintenance. A passive escrow need have little expertise in programming, whereas an active escrow may (especially where an opinion is required) need to be expert in programming.
An additional provision necessary in a source code escrow agreement will specify the rights which the escrow acquires in the deposit. This right may be limited solely to possession and right totransfer in accordance with the provisions of the agreement; alternatively, title to the copies deposited in escrow (and conceivably even title to the intellectual property embodied within them) may be transferred to the escrow.
A critical provision in any source code escrow agreement is that which seeks to define, with reasonable clarity, those events which will trigger transfer of the deposited materials to the licensee. Typically these events will include:
the licensor’s cessation of business;
the licensor’s inability or failure to undertake maintenance for the licensee;
death or incapacity of the licensor in the case of an individual; and
an incident of licensor bankruptcy, such as declaration of bankruptcy, seeking protection under the bankruptcy laws, or being forced into bankruptcy by creditors.
Bankruptcy laws inject significant elements of doubt into the use of a source code escrow, as discussed below. A consideration of the effect of the bankruptcy laws must play a major role in the fashioning of the particular arrangement used.
Equally important is that the agreement establish the possibility of a quick release to the licensee of the deposited materials, on notice of a triggering event. The major object of the source code escrow is to afford the licensee the ability to obtain a copy of source code and documentation quickly when needed; that object would be thwarted if implementation were time-consuming. One example of such a quick-release scheme would have the licensee giving notice of a triggering event to the escrow company and simultaneously to the licensor. At that point the licensor would have a short period of time in which to contest the licensee’s statement that a triggering event had taken place. Absent any contest within this period, the escrow would be required to turn over the deposit forthwith to the licensee.
In the event of contest, an efficient and quick arbitral mechanism would adjudicate the single issue of whether a triggering event had occurred. One way of effecting this is simply to leave it to the traditional rules of civil litigation. The licensee would then be free to seek a temporary restraining order and if necessary a preliminary injunction in state or federal court. The agreement may recite a choice of forum clause so as to make a particular forum mandatory, or to waive objections to venue and jurisdiction in that forum. It will be to the licensee’s advantage to include in the agreement a provision wherein the parties acknowledge that the deposited materials are unique, that the licensee will suffer irreparable harm if their release is wrongfully delayed, and that the licensee will therefore be entitled to an injunction precluding the licensor from any conduct which would unjustifiably delay the release.
Alternatively, the agreement may embody an arbitration clause. However, traditional arbitration often moves too slowly to afford relief in the appropriate time frame. One modification of this concept is to engage in arbitration, but of an abbreviated variety. For example, the agreement might provide that in the event of contest, arbitration directed solely to the triggering event issue would commence not more than three days after receipt of the licensor’s response to the licensee’s notice; that each party would have one day to present its case; and that the arbitrator would rule within two days thereafter.
Another alternative or additional solution to the triggering event problem is a liquidated damages provision. At the time of executing the agreement, it is difficult to assess damages a licensee would suffer in the event of unjustifiable delay. The agreement might even provide that a licensor unjustifiably resisting release will be liable for liquidated damages on a per day basis.
Because of the possibility that the escrow will be subject to conflicting demands, it seems reasonable that the parties indemnify the escrow.
The agreement or agreements should also deal with the issue of who pays for the escrow services. Not infrequently, the licensor sets up a single escrow to handle all of its licensees for the package in question. In such circumstances, it is not uncommon to have the licensor pay the costs of escrow.
13 Finally, a confidence must be imposed on the escrow lest proprietary rights in the deposit be lost.
AUTHOR’S NOTE: For an excellent practical treatment of how to handle bankruptcy issues in software licensing, the reader is directed to John T. Westermeier’s 2009 article, “Information Technology Strategies Relating to the US Bankruptcy Laws,” reproduced with permission at Appendix 4A[49] of this Treatise.
For many years, software licensees have been concerned that the licensor’s bankruptcy may deprive them of rights under the license agreement. This fear materialized for one licensee in
Lubrizol v. Richmond Metal,14 discussed below in this subsection. As a result of the wave of indignation (and lobbying) that followed,
Lubrizol legislation was enacted in 1988 in an attempt to rectify that problem. The format of § 4A.02[3][c] is as follows. Subsection (i) discusses the nature of executory contracts, an important concept under the bankruptcy code; subsection (ii) describes pertinent sections in the Copyright Act; subsection (iii) discusses methods that had been suggested (and used) for avoiding the problem prior to enactment of the 1988 bankruptcy revision, on the possibility that some of these suggestions will prove valuable in the present regime; and subsection (iv) discusses the 1988 legislation and its effect.
One of the difficulties resulting from the licensing of computer software
15 is that a licensee could be deprived of its contractual right to use the software in the event that the licensor files a petition in bankruptcy. Pursuant to
11 U.S.C. § 365(a), a bankruptcy trustee or debtor in possession is authorize, with approval of the court, to assume or reject any “executory contract” of the debtor. Courts have held that at least some technology licensing agreements are executory. No definition of “executory contract” is set forth in the Bankruptcy Act. In the bankruptcy context, courts in several jurisdictions have cited with approval the definition offered by Professor Vern Countryman:
”…a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing the performance of the other.“
16 With specific reference to licensing, the executory elements have been held to include the continuing obligations to maintain confidentiality, restrict use of copying and prevent transfer of the software.
Rejection of the license agreement by the trustee in bankruptcy is not automatic. Courts have held that sound business judgment will be the basis on which an executory contract is rejected. But absent evidence of the trustee’s bad faith or gross abuse, courts are reluctant to interfere with his or her judgment.
In
Select-a-Seat17 the court explicitly adopted the
Countryman definition in holding executory an exclusive software license agreement involving an initial payment of $140,000 and a royalty fee. The licensee argued that the contract was no longer executory because it had involved acquisition of a property interest in exchange for the initial lump sum payment. In rejecting this argument, the court noted that the licensee had also agreed to pay the bankrupt/licensor a five percent annual royalty fee. The failure to make such payment would have constituted a material breach of the contract, justifying revocation of the contract. Moreover, the agreement was executory from the bankrupt/licensor’s point of view because it required that the licensor not license its software packages to other parties, a continuing obligation, violation of which would have been a material breach of the license agreement.
In reaching these conclusions, the court distinguished obligations concerning the tangible property transferred to the licensee (a non-executory portion of the contract), from the continuing warranty and exclusive dealing obligations. Moreover, the court noted that the trustee attempted to revoke, not the license itself, but merely the exclusivity provision. Finally, the court held that the licensee’s rights were protected; if the licensee had been injured by the rejection of the executory licensing provisions, it could still file a claim for damages as a creditor of the estate.
The
Countryman test for executory contracts also has been upheld in the Fourth Circuit. Citing both
Countryman and
Select-a-Seat, supra, the court held in
Lubrizol18 that an exclusive license agreement for the utilization of a metal coating process technology was an executory contract subject to rejection by the bankruptcy trustee. While this agreement did not require exclusivity, it did provide that the licensor owed the licensee a continuing obligation to notify the licensee of any further licensing of the process and also provided for the reduction of the licensee’s royalty rate to meet any more favorable terms granted to subsequent licensees. The court specifically rejected consideration of certain equities that favored the non-bankrupt licensee:
”It cannot be gainsaid that allowing rejecting of such contracts as executory imposes serious burdens upon contracting parties such as Lubrizol. Nor can it be doubted that allowing rejection in this and comparable cases could have a general chilling effect upon the willingness of such parties to contract at all with businesses in possible financial difficulty. But under bankruptcy law such equitable considerations may not be indulged by courts in respect of the type of contract here in issue. Congress has plainly provided for the rejection of executory contracts, notwithstanding the obvious adverse consequences for contracting parties thereby made inevitable. Awareness by Congress of those consequences is indeed specifically reflected in the special treatment accorded to union members under collective bargaining contracts, and to lessees of real property. But no comparable special treatment is provided for technology licensees such as Lubrizol. They share the general hazards created by § 365 for all business entities dealing with potential bankrupts in the respects at issue here.“
Id. at 1048 (citation omitted).
The bankruptcy court interpreted the statute as requiring use of a two step inquiry to determine the propriety of rejection: whether the contract was executory, and whether rejection would be to the advantage of the bankrupt party. It answered both questions in the affirmative, but was reversed on both points by the district court.
The court of appeals reversed the district court, concluding, first, that at the critical time the contract was executory. It was executory as to the licensor because the licensor owed the licensee a continuing duty of notification as to any further licensing, with a most favored licensee obligation and notification of any suits, along with defense of those suits and indemnification for certain losses. The agreement was executory as to the licensee, because it had a continuing duty to account for and pay royalties over the agreement’s lifetime, and because it was obligated to maintain the licensed technology in confidence.
19 The Lubrizol court noted that a mere duty to make fixed payments or to cancel specified indebtedness under the agreement would not make it executory as to Lubrizol.
On the question of advantage to the bankrupt, the issue before the bankruptcy court was whether the debtor’s conclusion that rejection would be advantageous to him was”so manifestly unresonable that it could not be based on sound business judgment, but only on bad faith, or whim or caprice.“
20 The issue is one of fact, reviewable under the”clearly erroneous“standard. There was unrebutted evidence that the technology was the debtor’s principal asset and that its sale or licensing represented its primary potential source of funds. Moreover, there was factuaally uncontested testimony that marketing the technology would be facilitated by stripping Lubrizol of its rights. Accordingly, the court of appeals held clearly erroneous that district court’s factual finding that debtor’s decision to reject was not a sound business judgment, and the court of appeals reversed.
21 As a policy concern, Lubrizol urged that it would be unwise to permit rejection of contracts such as this license because the rejection would have a general chilling effect on the willingness of parties to contract with businesses in possible financial difficulty. But the court deferred to the wisdom of Congress in this regard.
22 Thus, Lubrizol brings to life the nightmare shared by many licensees under software agreements. Although Lubrizol deals with a metal processing technology, it is difficult to distinguish it on that basis, and its holding would appear to apply equally to software license agreements. Nor is it an easy task to distinguish Lubrizol on its facts from the typical software licensing situation. The provisions of a typical software license agreement would be at least as likely to fall into the”executory“bailiwick as did those in Lubrizol. Moreover, in many situations where a licensor would be involved in bankruptcy, rights to the software package in question would be the debtor’s most valuable asset; further, it might well be within the exercise of sound business judgment to determine that rejection of licenses would be to the debtor’s advantage.
A similar result was reached in Chipwich,
23 in which a Chapter 11 debtor’s license agreements with the licensee for sale of eggnog and dairy shakes under the debtor’s trademark was held to be an executory contract because the licensee was required by agreement to furnish the debtor with monthly sales reports, allow inspection of books, protect debtor’s trademark rights and because the debtor was required to notify licensee of any infringements and to halt such infringements.
In
University of Conn. v. Germain (In re Biopolymers),24 where the licensee was the bankrupt party, the issue was whether a license agreement was executory on the date of the petition’s filing. A state agency granted to the debtor an exclusive license under a patent application, to make, use, sell and grant sublicenses (on consent of licensor, not to be unreasonably withheld) for the life of the patent. Debtor was obligated to pay a fixed amount up-front, make ongoing royalty payments, submit reports, and use its best efforts. The debtor contended that the agreement was not executory because the agency-licensor’s obligations were “illusory, de minimis, remote and/or insufficient.” Using Professor Countryman’s definition of “executory,” the court looked to
Lubrizol, where it was held that licensor’s obligations of notice (of other licenses granted) and forbearance made the contract executory as to licensor. The bankruptcy court suggested that even forbearance alone would have sufficed.
However, another case has considered equities or countervailing factors in upholding the license agreement and in overturning the trustee’s rejection of the executory contract. In Petur,
25 the court considered a license agreement that placed the debtor under a number of continuing obligations, including providing product formation, know-how and consulting services in exchange for the payment of royalties for the period of the agreement. Under that agreement, failure to perform by either party would have constituted a material breach. The court held that such a contract was executory and concluded that the debtor had”properly exercised its business judgment and that rejection could well create additional profits and aid in reorganization.“
Id., at 563. Nevertheless, the court refused to authorize the debtor’s rejection of the licenseagreement because rejection would have destroyed the non-debtor license and been disproportionate to any benefits received by general creditors. The court based its decision on the presence of five factors: (1) lack of evidence that the debtor could reorganize even if allowed to reject the executory contract; (2) the passing of 120 days since the filing of the Chapter 11 without a plan being proposed by the debtor; (3) speculative profits envisioned by the debtor; (4) failure by the debtor to produce evidence of new capital investment; and (5) evidence that the licensee was a profitable and ongoing business.
A more recent decision has followed the reasoning in
Select-a-Seat,
supra. In
Logical Software, Inc.,
26 a Chapter 11 debtor engaged in developing, licensing and maintaining computer software, moved for authority to reject as executory a distribution agreement. The court held that such a contract was executory. Moreover, the court examined the relationship between the licensor and licensee, including the continuing legal battle between them, in deciding that the debtor’s decision to reject the agreement was valid.
The court also considered the licensee’s modification of its business orientation in reliance on the license agreement, along with licensee’s modifications to the code and the development of additional source code. However, the court decided that such factors should not overcome the interests of the debtor in rejecting the contract.
”Notwithstanding a provision in an executory contract…, an executory contract… of the debtor may not be terminated or modified, and any right or obligation under such contract… may not be terminated or modified, at any time after the commencement of provision in such contract… that is conditioned on—
(A) The insolvency or financial condition of the debtor at any time before the closing of the [bankruptcy proceeding]
(B) The commencement of a [bankruptcy proceeding]; or
(C) The appointment of or taking possession by a trustee [in bankruptcy] or a custodian before such commencement.“
Another potential infirmity posed by bankruptcy law arises from the provision rendering non-enforceable any “ipso facto” clause. An ipso facto clause is one which by its language purports to be invoked by the occurrence of some incident of bankruptcy, e.g., filing for bankruptcy.
11 U.S.C. § 365(e)(1) in pertinent part provides:
According to the legislative history of this section its purpose was to invalidate the ipso facto clause in executory contracts.
Other possible bankruptcy problems are posed by
11 U.S.C. § 363(b), which states that the trustee, “after notice and a hearing, may use, sell, or lease, other than in the ordinary course of business, property of the estate.”
11 U.S.C. § 542 may also be the basis for concern “… an entity… in possession, custody, or control during the [bankruptcy proceeding], of property that the trustee may use, sell, or lease under Section 363 of this title… shall deliver to the trustee, and account for, such property or the value of such property…”
The first decision under § 365(n) amendment.
EI International, involved a software license.
27 The bankrupt software licensor filed for Chapter 11 bankruptcy and rejected its executory license pursuant to § 365. Licensee had neither formally elected to terminate the agreement under § 365(n)(1)(A), nor moved to retain rights under the agreement pursuant to § 365(n)(1)(B). The court, therefore, concluded that licensee’s claim had to be dealt with as though the contract had been rejected under § 365(n)(1)(A). Accordingly, licensee had no right to enforce the damages provisions of the contract, and its damages were limited to the out of pocket costs it sustained prior to the Chapter 11 filling.
Section 101 of the Copyright Act,
17 U.S.C. § 101, provides that an exclusive license is a transfer of ownership:
“A ‘transfer of copyright ownership’ is an assignment, mortgage, exclusive license, or any other conveyance, alienation, or hypothecation of a copyright, whether or not it is limited in time or place of effect, but not including a non-exclusive license.”
”Any of the exclusive rights comprised in a copyright, including any subdivision of any of the rights specified by § 106, may be transferred… and owned separately. The owner of any particular right is entitled, to the extent of that right, to all of the protection and remedies accorded to the copyright owner of this title.“
Moreover, recognition that a license is a form of ownership is found in case law.
28 At least one author has suggested that a transfer of ownership under the Copyright Act can be limited to given rights at a particular time, no matter how limited.
29 The Copyright Act appears to provide that copyright ownership is divisible and that an exclusive licensee is an owner in his own right. However, no case law to date has interpreted the apparently contradictory provisions of the Bankruptcy Code and the Copyright Act concerning the licensee’s rights in the event of a bankruptcy. In the future litigation, licensees are likely to claim that they hold property rights as opposed to contractual rights. However, the court may still attedmpt to reconcile the provisions of the two acts by severing the license agreement into its property and contractual provisions; such a reconciliation would hold ownership to be the primary right of the licensee with the other rights, including exclusive use, viewed as separate contractual rights subject to the provisions of the Bankruptcy Code concerning”executory contracts.“
Subsection 4A.02[3][c][iii] describes a number of techniques suggested and employed by some licensees prior to the enactment of the bankruptcy revision. Perhaps some of the concepts described here will be of use even in the present regime, where licensees have the benefit of the revised statute.
1. SALE. The arrangement that offers the greatest protection for the licensee involves the outright transfer of property rights as opposed to the creation of contractual rights,
30 and includes sale or long-term lease of the property to the user. One possible contractual provision calls for sale of the software to the user with the purchaser licensing the software back to the seller for his use. Such a contract might also allow the seller an option to repurchase the software on the default of the purchaser of its license obligations or upon the termination of such a license.
While this kind of arrangement may appear most suitable from the licensee’s point of view, it is also likely unsuitable from the licensor’s point of view, especially where the copyright is the licensor’s only real asset of the licensor.
2. SECURITY AGREEMENTS. A second proposed solution is use of a security agreement giving the licensee an interest in the copy of the software (and related documentation) in his possession as security for the licensor’s obligations under the contract. Such an agreement would have the theoretical effect of converting an unsecured damages claim into a secured claim:
”Under the security agreement proposed, the licensor would have no ongoing obligations at all. There would be no requirement of patent indemnity, maintenance or other executory promise. One could go so far as to consider an express statement in the security agreement that the licensor-debtor has no executory obligations thereunder. The absence of executory promises on the part of the licensor should be enough to place the contract beyond the reaches of § 365.“
31 From the perspective of some licensees, exorcizing executory promises might be important enough to justify foregoing intellectual property indemnities, etc. In the event of the bankruptcy, the licensee would be able to move for relief from the automatic stay provisions embodied in Section 362 of the Code.
32 Despite the possible advantages of such an agreement, it is not clear that it provides a watertight solution to the licensee’s difficulties in the event of bankruptcy. In the event of a bankruptcy the trustee may argue that the security agreement is, in fact, part and parcel of the license agreement and that the two must be read together as a whole contract; the trustee may assert that the agreements were drafted in an attempt to avoid the consequences of § 365.
33 It has been suggested that the collateral description securing the property must be very specific.
34 Failure adequately to describe the property subject to the security agreement may result in the licensee’s possession of an”uncertain lien priority status“
35 in the event of bankruptcy.
3.TRUST. An other mechanism proposed for the protection of the license software in the event of a bankruptcy of the license software in the event of a bankruptcy is transfer of ownership of the software to a trust. The trust in turn becomes the licensor of the intellectual property to the licensee. The trustee in such an arrangement holds legal title to the software and the”licensor“would continue to hold the beneficial interest for the duration of the trust. A trustee in bankruptcy presumably could not reject the license agreement as executory because the agreement between the trustee and licensor/bankrupt would ba a cpmpleted transfer and not executory.
The trust also has obvious drawbacks. For one thing, it is unlikely that licensor would be interested in transferring the property to the trust, over which it has no direct control. Moreover, such an arrangement could be viewed as an attempt to circumvent the provisions of the Bankruptcy Code and could be overruled by the court.
4.DIVISIBLE CONTRACTS. The parties might also attempt to create two series of contracts, rather than a single one, between licensor and licensee. One of the agreements, requiring complete performance by both parties, would each fall outside the definition of executory contract. Even negative obligations such as the duty not to license software to competing parties could be placed in a separate document supported by distinct consideration. However, there is a real possibility that the two physical documents, despite the art with which they are drafted or the remonstrations of licensee could be held to constitute one contract.
5.ESCROW AGREEMENT. Under an escrow agreement, licensor transfers control of essential elements typically source code and system documentation to an escrow entity, allowing the escrow to release those elements to the licensee upon notification of the licensor’s breach or failure to perform its license agreement. The agreement should have provisions allowing the licensor to rectify or contest the alleged failure to perform. During this period, the escrow would retain possession of the property until the breach is rectified or the contest between the parties is resolved.
It would appear that the escrow agreement itself might be subject to rejection pursuant to
Section 365 of the Bankruptcy Code based on the licensor/bankrupt’s duties to the entity pursuant to the agreement to provide updates concerning updates of programs—if those obligations are in the same agreement. However, such obligations may be embodied only in the agreement between licensor and licensee. Additionally, the executory obligations of the escrow entity himself to hold or release the software according to certain specified events may be executed. Moreover, software held in escrow may also constitute the property of the bankrupt’s estate in view of the broad definitions of property set forth in § 541 of the Code.
36 On September 20, 1988, proposed legislation was passed by the Senate, and the same bill was passed by the House on October 4, 1988; the President signed it into law on October 18, 1988, whereupon it became the “Intellectual Property Bankruptcy Protection Act of 1987.” “The purpose of the legislation is to promote the development and licensing of intellectual property by providing certainty to licensees in situations where the licensor files bankruptcy and seeks to reject the license agreement as an executory contract.”
37 Summarizing the new legislation does not restrict the trustee’s right to reject an executory intellectual property license but does, in that event, permit the licensee to continue use of the licensed technology for the full term of the agreement (including any renewal periods permitted). To the extent the license was exclusive, the licensee would continue to enjoy exclusive rights. However, other rights accorded to the licensee would be unenforceable. Of particular note, any licensor obligation to provide training or updates of software would be terminated by the rejection. Royalty payments would continue to be due, but the licensee would lose its right to set them off against any monies it claims are owed it by the debtor. A licensee electing to retain rights would continue to be obligated generally under the provisions of the license contract, except for obligations so closely related to duties from which the licensor has been released, as to make it inequitable to bind the licensee. The legislation does not include a provision dealing with any licensee obligation to maintain confidentiality, but only because Congress believed that existing
§ 107(b)(1) of the Bankruptcy Code,
38 affords adequate protection of confidential information. The licensee who elects to continue use of the technology will still retain a general claim for damages arising from rejection.
As described above, for years technology licensees have feared that the bankruptcy of their licensors would adversely affect their rights under the license agreements. This concern dramatically was enhanced by the
Lubrizol39 case, discussed above, in which such a result did indeed transpire, as the trustee in bankruptcy was permitted to reject the license agreement, thereby divesting the licensee of its rights in the technology. The alarm resulting from that case sparked an amendment to the bankruptcy laws, so as to accommodate these concerns.
11 U.S.C. § 365(n), effective in cases commenced after October 17, 1988, provides that, where a debtor is an intellectual property licensor, if the trustee in bankruptcy rejects an executory contract,
40 the licensee may elect either to treat the contract as terminated, or to retain its rights
41 under the license contract “and under any agreement supplementary to such contract.”
42 Moreover, Section 365(n)(3) provides that when a licensee electing to retain rights so requests, the trustee shall, to the extent provided in the license agreement or any agreement supplementary to such contract, provide to the licensee any intellectual property held by the trustee, and shall not interfere with licensee’s right to obtain that intellectual property from a third party. The term “any agreement supplementary to such [license] contract” would appear to include a source code escrow agreement. The statute is not directed uniquely at software, and applies to the licensing of intellectual property generally, except for trademarks, service marks and trade names.
43 Thus, the amendment gives the software licensee the opportunity to retain its rights under the license agreement, and also the right to enforce a source code escrow agreement permitting the licensee to obtain the deposit from the escrow entity.
The legislative history of this statute is illuminating.
44 As mentioned, the statute was sparked by a number of cases (primarily
Lubrizol) that permitted the trustee unilaterally to reject the license agreement.
45 Supplementary agreements in the nature of source code escrow agreements were expressly considered and are to be included as sources of contractual rights which the licensee was permitted to retain. Similarly, the right to enforce an obligation to provide a tangible representation of source code was expressly recognized.
46 However, the legislative history states that Sections 365(n)(3) and (4) do not include any intellectual property that comes into existence after the petition for bankruptcy is filed. Accordingly, future updates, enhancements, etc., are not included.
One wrinkle has appeared in the general applicability of section 365(n).
Precision v. Qualitech46.1 dealt, not with a license, but with a lease. The debtor sold the building in question, rejecting the lease. The issue was whether the tenant could retain its leasehold interest, notwithstanding the debtor’s rejection.
Section 365(f) of the Bankruptcy Code provides that property of the debtor may be sold “free and clear,” and the bankruptcy court ordered that the sale of the building and other assets would, with non-pertinent exceptions, be “free and clear of all liens, claims, encumbrances, and interests.” Section 365(h) is analogous to section 365(n), and provides that a non-residential tenant may continue in possession notwithstanding rejection of the lease by the debtor. Section 365(n) does not deal expressly with a situation where the intellectual property is sold.
The sale order permitted the buyers to designate executory contracts for assumption or rejection, and the buyer of the building rejected the lease. When the tenant challenged this rejection, the bankruptcy court ruled that the right to sell free and clear under section 365(f) prevailed over the tenant’s rights under section 365(h). The district court reversed.
The court of appeals reversed the district court. The Seventh Circuit held in Precision that section 365(f) prevailed over section 365(h), so that the tenant had no right to remain in possession. That court based its determination on the fact that subsection (f) provided for the sale free and clear of “any” interest, a term that merited a broad interpretation, and one that included the tenant’s interest. Section 365(h) applies only when the trustee rejects an agreement, which was not the case here (where the buyer elected not to assume it). Construing subsections (f) and (h) together, the court concluded that subsection (h) does not apply to a sale of the debtor’s assets. The court also noted that subsection (e) permits a party with an interest that may be adversely affected by the sale of the debtor’s property to apply to the court for “adequate protection,” but that adequate protection here would not necessarily mean continuing in possession.
There is an analogy between subsections (h) and (n), with both applying to a situation where a trustee has rejected an executory contract. Thus, in the event of sale of intellectual property, subject to a license, under an order directing that the property be sold free and clear, a court might well hold that the licensee’s rights were extinguished. The licensee’s remedy would be to seek relief under section 365(e) before such an order were entered, arguing that the order should be conditioned on the licensee’s rights as set forth in section 365(n).
The question here is whether a vendor can impose its terms and conditions on a vendee by setting out those terms in a shrink-wrap, click-wrap, or browse-wrap environment. Answering this question involves such familiar contract-related issues as whether there was notice of the offer, whether there was assent by the offeree, at what point assent was effective, whether subsequently offered terms are part of any contract and, even if the formal conditions necessary for a valid contract have been met, whether there is a basis for unenforceability. In the fairly numerous, and now rapidly accumulating, cases, the two major issues have been whether there is a “meeting of the minds” and whether any agreement is enforceable.
The majority of the wrap cases suggest that a vendor who provides prominent and definite notice, and requires some form of unmistakable “trigger” to denote assent, can structure an environment in which the terms will likely be held to constitute a valid contract. The issue of enforceability is generally not a difficult one where the terms are negotiated between the parties. In that situation, the terms are generally enforceable. But enforceability is a more difficult issue where the terms are “standard,” and offered on a “take it or leave it” basis. The issue there turns largely on the receptivity of the particular state’s law or public policy to arguments that, for one reason or another, the terms (or certain of them) are sufficiently unreasonable as to render them unenforceable. Thus far, in the “wrap” environment, standard terms have generally survived unconscionability arguments except in California. Where California law applies, or California is the forum, the vendor with standard, non-negotiated terms is likely to be out of luck.
In most of the wrap cases thus far, the term the vendor seeks to enforce is either an arbitration term, or a choice of forum provision. In both of those situations courts have had interesting things to say about enforceability.
We deal here with attempts to impose contractual obligations on a vendee absent the traditional paper document executed by the handwritten signature of each party. The devices, used in an attempt to effect such a result, that are in widespread use may be divided into three categories: shrink-wrap, browse-wrap, and click-wrap. The shrink-wrap is the oldest of these, and has several guises. It is widely used in the marketing of consumer software, usually in floppy diskette or CD-ROM form. Originally, it comprised a sheet of paper, enclosed in (and visible through) a transparent wrapper that also contained the program copy (hence the name “shrink-wrap”). On this sheet the owner of the vendor set forth a list of conditions and restrictions to which it wished to subject vendees. Today the shrink-wrap is more often manifested by a printed statement on the box in which the program copy is marketed; that statement may set forth restrictions, or it may state that the software is subject to restrictions that are recited within the box. In either event, it may state that a vendee who does not agree to those terms may return the package to the vendor or its agent within a specified period of time for a full refund.
The click-wrap is the online version of the shrink-wrap. It sets forth a set of restrictions affecting the user’s utilization of some online content or function, and seeks to bind the user by requiring some definitive act, often clicking on a button that states “I agree.” Sometimes it simply states that a user who moves forward and uses the application thereby agrees to the conditions. The browse-wrap is used in the same online environment as is the click-wrap, but differs in not requiring the definitive act. A browse-wrap sets forth the conditions, but does not require some discrete act to indicate assent.
An ancillary issue posed by many shrink-wraps is whether certain terms often recited in such agreements are enforceable. One such instance occurred in
Bowers v. Bay-State,
46.2 where the issue was whether a reverse engineering prohibition in a shrink-wrap agreement was enforceable. The court analyzed whether the provision was pre-empted by section 301(a) of the Copyright Act,
46.3 and concluded there was no such pre-emption, and that the provision was therefore enforceable. The original unanimous panel opinion to this effect, rendered in August 2002 was vacated in January 2003 and replaced with a split opinion, also to this effect.
46.4 Applying the law of the First Circuit,
46.5 the majority concluded that a contract claim was qualitatively different from a copyright claim, in that the former required an “extra element.” The First Circuit had earlier concluded that a trade secret claim was not pre-empted by the Copyright Act, but in that opinion it noted that a claim might be pre-empted if it had extra elements that were illusory, being “mere labels attached to the same odious business conduct.” While the First Circuit had previously not decided whether a contract claim was pre-empted, the Federal Circuit opined that the
Data General rationale would lead to a judgment that it was not.
The Federal Circuit’s view was perhaps influenced by the fact that most courts that had opined on the issue had so held. The court adopted the view expressed in ProCD, to the effect that mutual assent and consideration render a contract claim qualitatively different from copyright infringement. The latter is a right “against the world,” whereas the former generally affects only parties to the contract. The court did not address the possibility of pre-emption by virtue of a conflict with copyright policy.
Judge Dyk dissented to that portion of the majority opinion dealing with pre-emption, stating that the majority “permits state law to eviscerate an important federal copyright policy reflected in the fair use defense … .” He believed the test should be whether the state law substantially impeded public use of otherwise unprotected material. Acknowledging that the First Circuit uses the “additional element” test, he stated that, where that additional element merely concerned the extent to which authors could prohibit unauthorized copying by third parties, the claim was pre-empted.
Judge Dyk saw the fair use defense as an important limitation on copyright. Among other things, it was necessary lest copyright not extend to ideas, etc. He believed a state was not free to eliminate that defense. “Enforcement of a total ban on reverse engineering would conflict with the Copyright Act itself by protecting otherwise unprotectable material.” He agreed that a state could permit parties to contract away a fair use defense (or agree not to engage in uses of copyright-protected material) if the contract were freely negotiated. But he believed that shrinkwrap licenses were contracts of adhesion. He also felt there was “no logical stopping point to the majority’s reasoning.” For example, the first sale doctrine might be next.
He believed that
Vault v. Quaid46.6 held that state law authorizing contracts that prohibited reverse engineering was pre-empted because it conflicted with a portion of the Copyright Act.
ProCD was not to the contrary, as a restriction to non-commercial use was not equivalent to any right in the Copyright Act.
“I conclude that Vault states the correct rule; that state law authorizing shrinkwrap licenses that prohibit reverse engineering is preempted; and that the First Circuit would so hold because the extra element here ‘merely concerns the extent to which authors and their licensees can prohibit unauthorized copying by third parties.’ ”
To understand what a shrink-wrap, or browse-wrap, or click-wrap “contract” is, and why copyright owners might seek to use one, it is necessary to travel back in computer history. The first digital computers were mainframe computers, typically costing hundreds of thousands or millions of dollars. Except for software that was developed and marketed by the hardware manufacturers, software at the time was entirely customized, and the development of any significant software cost tens (or hundreds) of thousands of dollars. Then, slowly, the program package took hold. But still, the typical program package cost the user tens of thousands of dollars. Protection of the software was exclusively by means of trade secrets. A typical transaction involved a contract drafted, and often negotiated, by lawyers. The key element was that both the licensor and licensee were generally corporations; contracts and lawyers were a way of life to them.
But technology advanced rapidly. The price of hardware plummeted, and eventually the advent of the personal computer opened a mass market for computers. Today, most computers in use cost less than $3,000 and many cost less than $1,000. As hardware prices tumbled, the number of computers mushroomed. Today certain models enjoy sales of hundreds of thousands of units; for certain models, the number exceeds one million.
For some software companies, this was a bonanza. Today the typical personal computer program package is available for a fee in the range of $50 to perhaps $300. These personal computer program packages are marketed over the counter, embodied on a CD-ROM or on a floppy disk. Many vendees are individuals, rather than corporations, with a concomitant reduction in the expected level of commercial integrity and in the duration of the relationship between the vendor and vendee. Considering the resultant price, it is prohibitive to have a lawyer negotiating the contract at each end of the transaction. Moreover, asking a vendee to sign a contract is viewed by many marketers as an impediment to sales. However, the program may have great value, and requires some protection against abuse by the vendee.
A question arises as to why the program developer does not simply rely on copyright. The answer is that many developers perceive problems with placing reliance solely on copyright. For example: the vendor may wish to limit use to a particular CPU or terminal; copyright alone will not do that. Or the vendor may wish to protect certain trade secrets in the imbedded algorithms against reverse engineering by way of disassembly or decompilation; copyright may not do that, either.
In view of these considerations, lawyers representing vendors soon devised a method of seeking to impose contractual restrictions. These “contracts” usually purport to change what most consumers commonly viewed as an outright sale of goods between a retailer and a purchaser, into a license agreement which, for example, gives the vendee a fully paid perpetual non-exclusive right to use the intangible program contained in the programming device. Typically, the “contract” is deemed to have been entered into or consented to by the vendee when the vendee opens the box in which the programming device is marketed (shrink-wrap), proceeds on the Internet to use the system in question (browse-wrap), or clicks an “I agree” button (click-wrap). The manner in which the terms of the purported agreement are presented to the vendee vary. In the case of a shrink-wrap, a set of provisions may be visible through a transparent plastic wrapper, or it may be hidden inside a box that states (or that does not so state) that the terms of the license agreement are within. In the case of a browse-wrap, the terms are present somewhere on the website, and, in the case of a click-wrap, the terms are likewise present on the website. The shrink-wrap and the click-wrap typically state that by performing some act (e.g., tearing open the wrapper for a shrink-wrap, or clicking on an “I agree” button for a click-wrap), the vendee accepts the terms of the license agreement. But the precise manner of giving notice, and the precise manner of seeking assent, differ in each of these categories, and it is these differences that often control whether in fact a binding, enforceable agreement results.
Wrap agreements are therefore geared towards adding to the copyright protection available under federal law, by creating a contractual relationship between the vendor and vendee which, if breached, gives rise to a contractual claim for damages and/or injunctive relief. In addition to reserving title and imposing a licensor-licensee relationship, the wrap agreement usually attempts to restrict the purchaser’s right to duplicate, modify, or reverse engineer the software in question. It also often attempts to prohibit disclosure of confidential information that may be contained in the program and to proscribe incorporation of the program into other software, or the downloading of the program into a communications network or otherwise making multiple copies of it. Limitations on liability, warranty limitations, damages caps, and indemnities are also common. Sometimes software is restricted to use on the single designated central processing unit.
Some in the industry believe that “contractual” obligations of these types may dissuade some casual vendees from making unauthorized copies, and may afford copyright owners greater opportunity to curb abuse by bringing both copyright infringement and breach of contract claims. In effect the perceived necessity for the shrink-wrap lies in the ease with which a computer program may be copied, coupled with the infeasibility of obtaining a signed agreement from vendees.
Whether program copying is effected by individuals trying to save a few dollars, or by pirates seeking to make more than a few dollars, the setting affords ample opportunity for unauthorized copying and piracy. The high front end development cost of the software to the vendor is reflected by relatively high retail prices. The ease and minimal expense of copying software allows great “savings” or margins for the copiers or pirates; and the difficulty in detecting copying provides an incentive to do so. Also, there appears to be a feeling among some of the retail market that program owners are charging consumers “excessive” prices.
Whether the shrink-wrap/browse-wrap/click-wrap approach will succeed must be addressed in terms of the substantive contract law, since concepts of offer, acceptance and consideration are involved. Some central questions are whether, on the facts of a particular case, the user received reasonable notice, and whether opening a wrapper, etc., will be accepted by courts as informed consensual acceptance. The vendee may not read the fine print before opening the package, since it is human nature to unpack first and examine later. When viewing the package at the retail outlet, the vendee may genuinely assume that the printing on the package is nothing more than user instructions or simple advertising. Where this is the case, it is likely that a “sale” will have occurred for UCC purposes at the time the vendee pays the marketers. If the distributor is not the copyright owner, as is often the case, it would also be difficult to establish any third party rights in favor of the copyright owner under the sale contract. A copyright owner would, of course, retain its copyright, but in these circumstances would be unable to assert contractual rights.
If a copyright owner is successful in establishing that there is genuine consensual acceptance of the shrink-wrap license agreement, and that the printed form under the plastic wrapper is sufficient “notice” to avoid outright sale, the outcome is nevertheless still unclear. For example,
Section 2-301 of the UCC raises questions about unconscionable contract terms in consumer transactions. There is a line of established cases that are adverse to adhesion or standard form contracts in consumer transactions. Moreover, the
contra proferentem rule will apply against the drafter of a contract as to any of its provisions that are obscure. Shrink-wraps have certain similarities to statements printed on the rear of parking lot tickets, whereby operators typically attempt to limit their liability by a statement that the customer may not see prior to leaving the lot, and which the customer never acknowledges with a signature. Courts are divided on the effect of such clauses. Courts are willing to accept the proposition that there can be a valid contract despite the absence of the customer’s signature, but are nonetheless unwilling to find or enforce a contract where there is no indication the customer in fact knew of its terms. Indeed, in the context of a sale of goods, the UCC provides that the conduct of the parties may create a contract notwithstanding the absence of a signature.
ProCD v. Zeidenberg47 was the first reported decision
48 to pose, in a consumer setting, the issue of whether a “shrink-wrap” is a binding contract.
49 Plaintiff’s computerized database contained information from some 3,000 phone books. A version of that database was marketed on CD-ROM’s which also contained a program that was used to search the database. As marketed to consumers, every box containing a CD-ROM stated that the contents came with restrictions that were stated in an enclosed license. The restrictions were recited in an enclosed manual, and also embodied on the CD-ROM and present on the user’s screen each time the program ran.
The restrictions limited use of the program and data to non-commercial purposes, and prohibited the user from making the program or listings in whole or in part available in any networked or timeshared environment, or from transferring the listings in whole or in part to any computer other than the one used to access the listings. Each user had a right to return the box for a refund if the terms were unacceptable, and, by using the product, the user agreed to be bound.
Defendant “bought” three consumer packages at different times, and ignored the restrictions by making the data generally available over the Internet. In arguing for the existence of a contract, plaintiff relied on a case holding that a limited warranty on the back of a sales receipt, available for inspection prior to purchase, was enforceable.
50 The district court distinguished that case because defendant here had no opportunity to inspect the user agreement before the purchase, in that it was inside the box. Plaintiff argued that the transaction was an offer subject to a right of inspection, and that therefore
Section 2-206 of the UCC controlled. But the district court held that placing the goods on the store shelf constituted an offer, and that acceptance occurred when defendant paid for them. No further action from defendant was required for a binding contract.
51 Defendant thus successfully argued that the contract was completed at the time of payment, and that the license represented additional terms to which defendant could not be bound. Both Arizona Retail and Step-Saver (both discussed below) consider an order device which relies solely on the opening of the software container to create a deemed acceptance of the contract. This type of shrink-wrap contract also involves textbook questions regarding offer, acceptance and consideration.
For example, as indicated above, it is questionable whether the simple act of opening a wrapper will be accepted by the courts as an informed consensual “acceptance”. The purchaser may not read the fine print before opening the package since it is human nature to unpack first and examine later. When viewing the package at the retail outlet, the purchaser may genuinely assume that the printing on the package is nothing more than user instructions or simple advertising. If this is the case, it is likely that a “sale” will have occurred for U.C.C. purposes at the time the purchaser pays the distributor.
52 If the distributor is not the copyright owner, as is often the case, it would also be difficult to establish any third party rights in favor of the copyright owner under the sales contract. The copyright owner would, of course, retain its copyright but, in these circumstances, would be unable to assert any contractual rights.
In both of the above instances of shrink-wrap contracts, if a copyright owner is successful in establishing that there is a genuine consensual acceptance of the license agreement, and that the printed form under the plastic wrapper is sufficient “notice” to avoid outright sale, the outcome is still not clear. For example, as noted above, in
Section 2-301 the U.C.C. raises questions about unconscionable contract terms in consumer transactions, and there is an established line of cases which are adverse to adhesion or standard form contracts in consumer transactions. Also, the
contra proferentem rule will apply against the drafter of a contract as to any of its provisions that are obscure.
In addition, as noted above, shrink-wraps have certain similarities to statements printed on the rear of parking lot tickets. In these cases, the operators typically attempt to limit their liability by a printed term which the customer may not see prior to leaving the lot, and which the customer never acknowledges with its signature (which is a similar situation to that of the shrink-wrap contract). Courts are divided on the effect of these clauses, and have come down on both sides of the issue. Courts are willing to accept the proposition that there can be a valid contract despite the absence of the customer’s signature. Finally, it should be borne in mind that denominating a contract as a “license agreement” may not withstand judicial scrutiny: the courts will not allow the title or nominal form of a contract to pre-empt the true legal relationship created by the parties’ actions.
53 Those courts therefore have looked to other methods for analyzing the application of the license terms to the transactions. Under one such theory, defendant would be bound because it opened and used the product. Under another, the license represents either a proposed modification or a written confirmation.
The circumstances surrounding the marketing of software packages are often at odds with the vendor’s attempt to create a licensor-licensee relationship, which attempt may surprise the purchaser who has formed quite different expectations as to ownership of the program.
Here, in
ProCD, the sole reference to the license was in small print at the bottom of the package, stating that purchasers were subject to the terms of an enclosed license agreement. Relying on
UCC §§ 2-207,
2-209, the district court held that, in the case of the initial package, mere reference did not provide purchasers with adequate opportunity to decide whether the terms were acceptable.
The district court found a close question in whether, in the case of subsequent packages, defendant should be deemed to have known the terms of the license. Because the seller can always change the terms, the district court thought it best to rule that the buyer should have the opportunity to inspect the terms each time it contracts. The district court held that (1)
UCC § 2-209 did not apply because it requires the buyer’s express assent, which cannot be inferred from conduct, and that (2)
UCC § 2-207 is applicable only to dealings between merchants, does not apply to a consumer situation and, in any event, would also have required defendant’s express consent. Thus, because defendant did not have the opportunity to bargain or even review the license terms, the district court held that it was not bound by the user agreement.
The court of appeals disagreed. Like the district court, the appellate court treated shrink-wrap licenses as “ordinary contracts accompanying the sale of products,” and as governed by the UCC. But the Seventh Circuit saw no reason why the entire contract had to be printed on the outside of the box.
54 The court viewed standard agreements as essential to mass distribution, and saw nothing unusual or inappropriate about transactions where the exchange of money precedes the communication of detailed terms.
55 This was the case with many consumer goods sales, where the warranty terms were enclosed in a box. Moreover, in the software industry itself, many transactions are handled over the phone or on the Internet.
The appellate court found this situation controlled by
UCC § 2-204(1), which permits the vendor to invite acceptance in any way, and the buyer to accept by conforming to the specified method of acceptance. Acceptance occurred here when defendant used the software after having an opportunity to read the license. This result was reinforced by
UCC § 2-206(1), which deems acceptance of goods to have occurred when buyer fails to reject after an opportunity to inspect. Accordingly, the Seventh Circuit held there was a valid contract, and that it incorporated the restrictions.
In
Hill v. Gateway 2000,
56 a subsequent decision of the same court that decided
ProCD (written by the same judge), a similar ruling ensued. Giving a credit card number over the phone, plaintiff ordered a PC from defendant. In due course a carton arrived, containing the PC and a list of terms (including an arbitration clause) said to govern unless the computer was returned in 30 days. Plaintiff kept the PC more than 30 days before complaining, and sued. Defendant sought to enforce the arbitration clause, which the district court refused to do. The court of appeals reversed.
Plaintiff first contended that the arbitration clause was unenforceable because it was not prominent and he did not read it. The court rejected that argument, noting that there is no requirement that such a clause be prominent.
The court found this situation factually similar to
ProCD and many other commercial transactions where people pay for a product with terms to follow, and the vendor ships with an accept-or-return offer. Practical considerations support such a way of doing business. “Customers as a group are better off when vendors skip costly and ineffective steps such as telephonic recitation, and use instead a simple approve-or-return device.
57 Plaintiff argued that ProCD should be limited to executory contracts and that here the performance of both parties was complete when the box arrived at plaintiff’s home. The court characterized this as legally and factually wrong. The question here concerned contract formation, rather than performance. And defendant still had warranty obligations.
Plaintiff also argued that
ProCD did not apply because Zeidenberg was a merchant, whereas plaintiff was not.
58 However, stated the court, the issue in
ProCD was not whether terms were added after formation, but rather when was the contract formed.
ProCD held that a vendor may propose that the contract be formed, for both merchants and consumers, after the customer has a chance to inspect both the product and the terms.
Finally, plaintiff contended that this case was distinguishable from ProCD because the ProCD box contained notice that additional terms were inside, whereas the carton here did not. But the court saw no effect to that distinction. In ProCD the box was on display to consumers in a store; here the carton was used merely to ship the PC from the factory, so that the consumer would in any event not see it until it arrived at his home. Plaintiff knew that the carton would include some important terms and made no effort to learn them in advance. Accordingly, the court vacated and remanded with instructions to require arbitration.
In
Morgan v. Micro Data Base59 one issue was whether a shrink-wrap agreement served to alter a written, signed agreement between the parties. The signed agreement contained a provision prohibiting modification except by an instrument executed by the parties. Under
UCC § 2-209(2) such a provision is enforceable. Accordingly, the court had no reason to determine whether the shrink-wrap itself was enforceable. “Although shrinkwrap licenses may, in some cases, be enforceable [citing
ProCD ] they do not trump explicit prior agreements where those agreements contain integration clauses and ‘no-modification-unless-in-writing’ clauses.”
60 In
Softman v. Adobe61 one issue was whether plaintiff was bound by defendant’s end user license agreement (the “EULA”). Defendant Adobe was a software developer, and plaintiff Softman was a distributor (largely through its website) that was allegedly distributing Adobe software in an unauthorized manner. Each copy of Adobe software was accompanied by a copy of the EULA setting forth the terms of an agreement pertaining to that copy between Adobe and the end user. The EULA was electronically recorded on the disk, and end users were asked to agree to its terms on installing the copy. The court held that there was assent, if at all, only when the user of the software begins installation. Plaintiff did not attempt to install the software it marketed. Accordingly, plaintiff did not agree to the terms of that agreement.
62 Adobe contended that there was assent because the boxes containing the software clearly indicate that use is subject to the terms of the enclosed agreement. Those terms state that the copy may be returned if the end user does not agree to the terms. But the court held that “Reading a notice on a box is not equivalent to the degree of assent that occurs when the software is loaded onto a computer and the consumer is asked to agree to the terms of the license.”
63 Accordingly, the court held that there was here no enforceable agreement.
64 In a patent infringement suit, defendant Microsoft counter-claimed for misappropriation of trade secrets resident in software marketed to over a million users, “all of whom could have access to the [asserted trade secret] by simply reverse engineering the program.”
65 Dealing with the argument that the transactions involved shrink-wrap agreements, the court commented, “Most of the products did contain shrink wrap agreements, but the ability or the effectiveness of these agreements to prevent reverse engineering is doubtful.” The court gave no rationale for its statement.
In
Klocek v. Gateway,
66 plaintiff purchaser of a computer from defendant, alleged that defendant induced plaintiff to purchase a computer with false promises of tech support, and that it breached compatibility warranties. Defendant moved to dismiss, arguing that an agreement between the parties required that this dispute be arbitrated. Gateway included in the box containing each computer four pages of “Standard Terms.” These terms began by stating, in a prominently displayed recitation, that the document contained Gateway’s standard terms and conditions, and that a purchaser who keeps the computer more than five days thereby accepts those terms. One provision in these terms stated that any dispute concerning the agreement would be arbitrated.
To compel arbitration, Gateway had to prove a contract choosing arbitration. The issue here was whether terms received with a product are part of the agreement, i.e., whether the contract of sale
67 here included the Standard Terms. In the applicable jurisdiction there was no case on point and, in the court’s view, authority on this point was split. The touchstone was whether the parties formed a contract before, or after, the vendor communicated the terms. Once that issue was determined, it would also be determined whether the shrink-wrap posed an issue of contract formation (
UCC § 2-204), or contract alteration (
UCC § 2-207). The court discussed
Hill v. Gateway,
67.1 a Seventh Circuit case with a similar fact situation that relied on Section 2-204 to conclude that, by including the license with the software, the vendor proposed a contract that could be accepted by using the software after an opportunity to read the license had been had. But in the instant case the court was not persuaded that the Kansas or Missouri courts
68 would follow the Seventh Circuit.
In particular, the court disputed the
Hill/ProCD assumption that, because each of their cases involved only one form, § 2-207 was irrelevant. Nor did the court agree with the Seventh Circuit’s conclusion that the vendor was the “master of the offer.” The court viewed the customer here as the offeror; Gateway accepted the offer. In this view, under § 2-207, the Standard Terms were the expression of acceptance, and there was no evidence the transaction was conditioned on plaintiff’s acceptance of the Standard Terms. Because this was not a transaction between merchants, different or additional terms in the Standard Terms did not become part of the agreement unless the purchaser expressly agreed to them. The court saw no such express agreement, holding that keeping the computer for the return period did not indicate express acceptance. Since Gateway did not convince the court there was an agreement to arbitrate, the court denied Gateway’s motion to dismiss.
69 In
Mortenson v. Timberline,
70 vendee used the software in question to prepare a construction bid that was almost $2 million less than it should have been, and sued the developer for breach of warranty, claiming the software was defective. For at least three years prior to installation of the software, vendee had been using a previous version of the software. When vendee moved to a new computer system for which the predecessor software was incompatible, vendee issued, for eight copies of the software in question, a purchase order (“PO”) indicating price, set up fee, delivery charges and tax, and containing no integration clause. Vendor’s retailer signed the PO and ordered the software. The software was delivered in the form of diskettes in pouches with user manuals. The full text of the license agreement was on the outside of each pouch and the inside cover of each instruction manual. The first screen appearing when the program is used referred to the license. An all-capitalized warning preceded the terms of the license agreement stating,
inter alia, that use of the program indicates acknowledgement that vendee has read the agreement and agrees to its terms, and giving the vendee an option to return the software promptly for a full refund if vendee does not agree. The license agreement, among its other terms, excluded consequential damages and placed a maximum on the amount of damages.
There was a dispute as to whether vendee opened the pouch for the first copy of the software, or whether vendor’s retailer did. The retailer installed the first copy and vendee installed the remaining seven copies. Vendee used the software to prepare the bid in question and the software malfunctioned many times, giving 19 error messages. Vendee nevertheless submitted the bid developed with the software. There was evidence that vendor was aware, prior to delivery of the software to vendee, of deficiencies that may have been responsible for the generation of the incorrect bid amount. Defendant moved for summary judgment on the basis of the exclusion of consequential damages in the license agreement. Vendee contended that its entire contract was in the PO and that it never saw or agreed to the provisions in the license agreement. The trial court granted summary judgment and the court of appeals affirmed, holding that the PO was not an integrated contract, the license terms were part of the contract, and the exclusion was not unconscionable.
The Supreme Court of Washington first held that the PO was not an integrated contract. Even if the PO could constitute an integrated contract, the court held that this was not the case here. It set forth an hourly rate for support, but did not specify how many hours of support would be provided; it stated that if vendor upgraded to a Windows version, vendee could upgrade at a price to be determined later; and it contained no integration clause. Vendee argued that even if the PO was not an integrated contract, the license terms were merely a request to add additional terms pursuant to
UCC § 2-207, to which vendee never agreed. Vendor contended that the terms were part of the contract. Vendee relied on
Step-Saver, but the court distinguished that case because it related to a transaction between a software developer and a value-added-retailer (rather than an end-user). There the party contesting applicability had been told the license agreement did not apply to it. Moreover, in
Step-Saver, although vendor twice asked the vendee to sign a license agreement and vendee did not do so, vendor nevertheless continued to make the software available. The parties in the instant case had used a license agreement throughout vendee’s use of the program in question and its predecessor. Thus, the court held that the case involved contract formation, rather than contract alteration, so that the appropriate UCC section was
Section 2-204.
71 Finding no Washington precedent, the court looked elsewhere, relying on
ProCD,
Hill, and
Brower.
72 The court characterized the first of these as holding that shrink-wraps are valid contracts under the UCC and enforceable unless unconscionable. And the court adopted
ProCD’s motto: “Notice on the outside, terms on the inside, and a right to return the software for a refund … may be a means of doing business valuable to buyers and sellers alike.” The court characterized
Hill as holding that competent adults are bound by a list of terms (whether read or unread) received with the computer, if the computer was not returned within 30 days. And the court commented that
Hill’s view of
ProCD was that the issue was not whether terms were added to a contract, but how and when the contract was formed and, in particular, whether a vendor may propose that a contract be formed, not in the store (or on the phone), but with payment of money after the vendee has had a chance to inspect the item and the terms;
ProCD answered that question affirmatively, for both consumers and merchants.
Brower dealt with the same license agreement as did
Hill, and concluded that shrink-wrap terms delivered following a mail order were not proposed additions to the contract, but part of the original contract.
Brower held that § 2-207 did not apply because the contract was not formed until after the return period had passed. The
Timberline court opined that the view espoused in these three cases represented the “overwhelming majority view on this issue.”
The court then reasoned that because Section 2-204 permitted a contract to be formed “in any manner sufficient to show agreement … even though the moment of its making is undetermined,” it permitted the formation of a “layered contract.” Thus, the terms of the license agreement were part of the contract here. The terms were on the shrink-wrap pouch for each of the eight copies of the software, and in the manuals accompanying the software. The fact that the software was licensed was recited on the screen each time the software was used. Vendee is bound whether or not it read the terms.
73 Further, the UCC defined an “agreement” as “the bargain of the parties in fact as found in their language or by implication from other circumstances including course of dealing or usage of trade or course of performance … .” The parties here had a course of dealing, and the evidence showed an unquestioned use of such license agreements throughout the software industry. Accordingly, the court held the limitation of remedies enforceable unless unconscionable. The court undertook an analysis of that issue (discussed
infra) and concluded that the limitation was not unconscionable.
Two judges dissented from the holding on notice and assent, on the theory that the contract was concluded when the vendor’s retailer signed the PO, and therefore the license agreement had to be viewed as a proposed modification, to be dealt with under
§ 2-209 of the UCC.
A case upholding a forum selection clause was
Forrest v. Verizon.
74 In this putative class action, plaintiff alleged that in attempting to register for and use defendant’s digital subscriber line service he was subject to frequent lengthy disruptions and low operating speeds. He alleged breach of contract and tort claims. Defendant moved to dismiss on the basis of the forum selection clause (selecting Virginia) in the subscriber agreement. The trial court granted the motion.
In affirming, the District of Columbia Court of Appeals stated that the first issue was whether the existence of the clause was reasonably communicated to plaintiff. The clause was in the final section of the main text of the 13-page agreement. Many consumers read the agreement in the scroll box of their monitors. The user enters into the agreement by clicking an “Accept” button below the scroll box. The top of the agreement states in block capitals: “Please read the following agreement carefully.” The clause is not in capital letters (although two other provisions are). The court held that notice was adequate. Absent fraud or mistake, one who signs is bound by a contract that he has an opportunity to read whether he reads it or not. In reading the agreement a person would have discovered the clause. Nor is a scroll box, displaying only a portion of the agreement at any time, inimical to adequate notice. “A contract is no less a contract simply because it is entered into via a computer.”
Plaintiff also contended that notice was improper because defendant did not highlight the significance of exclusive jurisdiction in Virginia, one of only two states that lack class action procedures so that, by agreeing to that forum, plaintiff waived a possible remedy. The court disagreed, failing to see why the absence of a particular remedy in a foreign jurisdiction should be elevated above other consequences of the forum selection clause. To show that the clause was unreasonable, plaintiff was required to show it was induced by fraud or overreaching, it was so unfair and inconvenient that in practice it deprived plaintiff of a remedy, or that enforcement would contravene a strong public policy of the forum. Stating that jurisdictions have split on whether unavailability of a class action mechanism renders a forum selection clause unenforceable, the court went with the majority (noting that the only court to disagree based its decision on a state statute). The court noted that Virginia has a small claims court and a consumer protection statute. Further, the “unreasonableness” exception refers to the inconvenience of a forum, not to the effect of applying that forum’s laws. There was nothing sinister about defendant’s choosing the law of its principal place of business, and plaintiff needed only to cross the Potomac River to litigate in Virginia.
Plaintiff also contended the clause should not apply because his injury was sustained (he made certain financial commitments) before he entered into the agreement. But the court agreed with Virginia law that holds that forum selection clauses are enforceable even when entered into after a cause arises. Moreover, plaintiff had 30 days in which to cancel for a full refund, which supports enforcement of a forum selection clause.
Finally, arguing that the clause is ambiguous and should be construed against its drafter, plaintiff contended that the clause
75 should apply only to his contract, and not his tort, claims. But the court held that non-contract claims that involve the same operative facts as a parallel breach claim fall within the scope of a forum selection clause. Accordingly, the appellate court affirmed the enforcement of the forum selection clause, and the dismissal.
In
Register.com v. Verio,
76 plaintiff was one of the several dozen domain name registrars appointed worldwide by ICANN.
77 Plaintiff maintained a “WHOIS” website to provide information about domain name ownership in response to queries. In responding to each query, the site simultaneously posted a short statement of terms of use, commencing with the following: “By submitting this query, you agree to abide by these terms.” One of the terms in this statement prohibited use of the data obtained from the site to support the transmission of mass unsolicited commercial e-mail; that term was later expanded to prohibit also use for direct mail or telemarketing. Defendant submitted numerous queries on a daily basis and conceded knowledge of the statement of terms of use that accompanied each response. Defendant used the data obtained from the site to support the transmission of mass unsolicited commercial e-mail, direct marketing, and telemarketing. When plaintiff complained to defendant, defendant ceased using the data for e-mail, but not for direct marketing or telemarketing. Defendant argued that display of the statement at the time the responses to defendant’s queries were displayed was insufficient for assent. Plaintiff sued for several causes of action, and the district court entered a preliminary injunction barring defendant,
inter alia and with certain reservations, from accessing plaintiff’s computers other than in accordance with the terms and conditions, and from using any data presently, in defendant’s possession that it could identify as obtained from plaintiff, for spam or unsolicited telephone calls or direct mail.
Defendant argued it should not be deemed to have been subject to plaintiff’s conditions when it took WHOIS data from plaintiff’s system because it had received no legally enforceable notice of those conditions. The court conceded it might so hold had defendant’s queries been sporadic and infrequent. But here defendant submitted numerous queries daily, with each resulting in the notice, and defendant conceded it knew the terms. This was sufficient for assent.
77.1 The court distinguished
Specht because there the users would not have seen the terms without scrolling down, and there was no reason for them to do so; the evidence did not demonstrate that users who downloaded the software had seen the terms. The users there had visited the site only once. Here defendant visited the site many times each day, and conceded it knew the terms. Defendant also argued it was not bound because it rejected the terms, citing
Ticketmaster, where the court declined to issue a preliminary injunction to enforce posted terms because there was insufficient proof of agreement (users were not required to check an “I agree” box).
77.2 But the court thought
Ticketmaster did not provide sufficient support for defendant here. First,
Ticketmaster was the exercise of a court’s discretion to deny a preliminary injunction. And the court here disagreed with the
Ticketmaster analysis. The
Verio court would have enforced the terms in
Ticketmaster, as it saw “no reason why the enforceability of the offeror’s terms should depend on whether the taker states (or clicks), ‘I agree.’ ” Acknowledging that such a statement of agreement is sometimes essential, the court stated it was not always necessary. When a benefit is offered subject to conditions and the offeree takes the benefit with knowledge of those conditions, that taking constitutes acceptance of the terms.
77.3 The decision of the two-judge majority was accompanied by an “Appendix” written by the third judge (the Hon. Fred I. Parker); this Appendix would have been a dissent had Judge Parker not passed away before the opinion was handed down. Judge Parker believed that assent required word or conduct evidencing an intention to contract, and that each party must either make a promise or begin (or render) performance. He distinguished the instant situation from that of the shrinkwrap and the clickwrap by noting that here access was granted prior to express agreement. He found no basis for holding that defendant manifested assent to the terms.
In
Moore v. Microsoft,
78 relying on
Brower,
ProCD, and
Specht, New York’s intermediate appellate court held that the EULA was a “validly binding contract.” The terms were prominently displayed on the screen before the program could be installed, and the user had to click on an “I agree” button before proceeding with the download. “Thus, the defendant offered a contract that the plaintiff accepted by using the software after having the opportunity to read the license at leisure.” Plaintiff also alleged unjust enrichment, but the court held that such a claim could not be made where there was a valid and enforceable contract governing the subject matter, as was the EULA here.
Hughes v. America Online79 involved an individual who sued a police officer and AOL, alleging various causes of action resulting from AOL’s release of plaintiff’s name, address and age to the officer, in response to his request. The officer had a computer print-out of a threatening e-mail message allegedly sent from an AOL account. The issue on AOL’s motion for summary judgment was whether the case should be dismissed by virtue of the exclusive choice-of-forum clause (choosing Virginia) in the “agreement” between AOL and plaintiff.
The form of the “agreement” is unclear from the opinion. The court (citing
Caspi v. Microsoft, and
Celmins v. America Online) states: “Forum selection clauses of the type used by AOL, sometimes referred to as ‘click-wrap’ agreements, have been upheld as valid and enforceable.” The court held it was “undisputed that Hughes agreed to the Terms of Service contract [containing the clause] when he became a subscriber to AOL’s services.” Noting that the “prevailing view towards contractual forum-selection clauses is that ‘such clauses are prima facie valid and should be enforced unless enforcement is shown by the resisting party to be “unreasonable” under the circumstances,’ ”
80 the court enforced the clause and dismissed the suit.
In
Williams v. America Online81 plaintiffs (seeking class action status) sued for a variety of state causes, such as unfair or deceptive acts, claiming that installation of AOL Version 5.0 caused unauthorized changes to the configuration of their computers. AOL moved to dismiss, contending that the clause selecting Virginia as the exclusive forum controlled.
The court was concerned here because plaintiffs alleged that the injury occurred before they had an opportunity to accept or reject the clause. The affidavit of plaintiffs’ expert states that the configuration was modified at the beginning of installation, before an opportunity to agree to the contract. Thus plaintiffs could claim inadequate notice of the clause. After re-configuration the customer must click either “I agree” to the contract (he or she has never read), or “Read Now.” The latter choice gives two options: “OK, I agree,” and “Read Now” again. Thus, the customer never sees the contract unless he or she clicks twice on “Read Now.” Moreover, if the customer never accepts, the modifications are apparently not reversed.
Affidavits supporting AOL state that the plaintiffs were already subscribers when they installed Version 5.0, and were bound by an earlier contract that included a forum selection clause. The court held that, because subscribers were required to agree to a new contract as a condition of installing Version 5.0, the new contract is the “governing agreement for purposes of the pending motion.”
82 Reconfiguration occurred before users had an opportunity to review the new agreement, and reconfiguration would have occurred whether or not the subscriber agreed. The court was not persuaded that plaintiffs (and other members of the putative class) had notice of the forum selection clause in the new agreement before reconfiguration.
As alternative rationales for not dismissing, the court noted that the putative class was comprised of Massachusetts residents, and that the Judicial Panel had transferred for discovery to Florida a number of AOL federal cases raising similar claims, and AOL had not opposed the Florida forum.
83 Accordingly, the motion to dismiss was denied.
In
Lieschke v. RealNetworks,
84 plaintiffs were users of defendant’s software that implemented the streaming of audio and video over the Internet. Before using defendant’s software, plaintiffs accepted the terms of defendant’s End User License Agreement, including a term that stated “unresolved disputes arising under this License Agreement shall be submitted to arbitration … .” At some point after plaintiffs’ use of defendant’s software commenced, the New York Times published an article stating that RealNetworks was engaged in monitoring the usage patterns of its licensees. Specifically, the article stated that RealNetworks collected personal information about users’ “listening habits” and websites visited. Although the user agreement notes that a feature of the software communicates over the Internet with defendant to check for the existence of software updates, the agreement mentioned no communication with defendant for any other purpose. Plaintiffs sued, alleging trespass to property and breach of their privacy rights. Plaintiffs contended that they were not required to arbitrate because the alleged communications from their computers to defendant’s were not disclosed in the user agreement. Defendant moved to stay the case, pending arbitration.