Introduction - What Is Essential in UCITA

Memorandum July 10, 2000

To: Commissioners

From: Staff

Re: UCITA - Summary of current issues

CONTENTS

Introduction - What is essential in UCITA I. Choice of Law II. Choice of Forum III. Relation to other Law A. Federal preemption B. Public policy C. Electronic commerce, manifesting assent, conspicuousness and consumer protection rules 1. Electronic commerce 2. Manifestation of assent 3. Conspicuousness 4. Conforming UCITA to UCC Article 2 D. Exclusion of “reverse engineering” in certain transactions IV. Scope A. Interface between UCC Article 2 and UCITA B. Categorical exclusions from scope 1. Exclusions from Scope approved by the NCCUSL Executive Committee a. Exclusion for “media industries.” b. Exclusion for regulated telecommunications contracts. c. Exclusion for an “insurance services transaction.” 2. Exclusions submitted to this Commission Exclusion for libraries. V. Statute of Frauds VI. Contract formation VII. Transfer of title to a copy VIII. Warranties IX. Financing arrangements X. Computer self-help XI. Conforming amendments

Introduction - What is essential in UCITA

The Commission has asked staff to identify those portions of UCITA which are essential. This memorandum approaches that issue in the context of reviewing the issues

UCITA Project - Memorandum July 10, 2000 - Page - 1 /ucita/ucitaM071000.doc presented by UCITA which the Commission has already considered, as well as some additional issues.

Note that just what provisions are regarded as essential to UCITA can be looked at both functionally and from the perspective of the policy underlying the Act. Functionally, there are numerous provisions in UCITA which could be either amended or eliminated altogether without impairing the usefulness and coherence of the Act as a whole. Many of the individual provisions covered in this memorandum fall into that category, including the provisions on choice of law, choice of forum, the electronic commerce rules, etc. The provisions which contain categorical exemptions from UCITA are not essential except from the political perspective (what categories of transactions should be excepted in order to avoid political opposition to its passage). On the other hand, the subpart on financing arrangements should be regarded as essential because there currently are no legal rules which define and support these arrangements.

Identifying the provisions which are important from a policy standpoint requires the identification of the underlying policy of the Act. In a broad, general sense, the policy of UCITA is to maximize the ability of the vendors of the products and services that fall within the scope of the Act to define the terms of transactions to the fullest extent possible within the confines of federal law and other general legal principles and be assured that those terms will be enforceable. This is accomplished operatively by defining any transaction within the scope of the Act as a limited license unless the vendor defines it otherwise. From the perspective of this policy judgment, the contract formation rules of UCITA are essential, as they permit vendors to set the default provisions of a transaction without negotiation. The transfer of title provision discussed in this memorandum is also essential from this perspective. Any significant change in these core provisions would begin to impinge upon the central policy judgments embodied in UCITA.

One line of discussion at Commission meetings has been whether UCITA could be reduced to a series of provisions that would fit into UCC Article 2. Staff views on whether this would be possible have evolved over time. While this is possible in theory, it would be extremely time-consuming, highly non-uniform, and almost certain to vary greatly from the central UCITA policy expressed above, given the underlying contract- formation rules of UCC Article 2. The result would not only not be "UCITA," it would not be UCC Article 2 either.

It is noted with respect to some of the provisions discussed in this memorandum that the Commission might consider deleting them entirely. Depending upon which particular provisions the Commission might consider recommending for deletion, additional work may be required in order to recommend appropriate amendments to any related provisions.

Interspersed with suggestions for deletions of various provisions are proposals for amendment of certain provisions UCITA. Some of the proposals and issues are staff- generated, others have been received from various interest groups.

UCITA Project - Memorandum July 10, 2000 - Page - 2 /ucita/ucitaM071000.doc Please note that the relevant provisions of UCITA which are referenced in this memorandum have been reproduced in an appendix to this memorandum for convenient reference. Also included in the appendix to this memorandum is the full text of the UCITA amendments which are being presented to the National Conference at the NCCUSL Annual Meeting at the end of this month. Note that the second of the proposals for amendment which was presented to the Commission by Bell Atlantic, and which was set aside for later discussion at the last Commission meeting, is included in the amendments being presented to the Annual Meeting.

I. Choice of law

The Commission has considered the UCITA choice of law provisions at some length. UCITA 106 permits the parties to a transaction to choose the law applicable to the transaction, subject to the general limitations in UCITA of good faith and unconscionability. The choice is also limited by the requirement that if a non-US jurisdiction is chosen it must have a legal regime that provides "substantially similar" protections to a party not located in that jurisdiction. Finally, there are special rules governing the consumer law that applies. There is no requirement in UCITA that the jurisdiction chosen bear any relationship to the transaction.

At the May meeting the commissioners expressed the view that the New Jersey Legislature would be unlikely to countenance any erosion of New Jersey consumer law. Staff was directed to prepare an amendment to that effect. A number of alternatives are set forth below.

First, the choice of law provision applicable to UCC Article 2 transactions is UCC 1-105. The UCC rule on choice of law, unlike the UCITA rule, requires that the chosen jurisdiction have a "reasonable relation" to the transaction, and provides that in the absence of agreement on choice of law "this Act," (i.e., the UCC as adopted in this State) applies. With respect particularly to choice of law in consumer transactions, the requirement of that the choice of law have a "reasonable relationship" to the transaction is a helpful limitation from the standpoint of the expectation of a party to a consumer transaction.

Note that the current UCC provision does not have any special rules applying to consumer transactions. In UCC Article 2 transactions, the effect of the Article 1, to the extent that it permits parties to agree upon a choice of law, is limited in consumer transactions by the effect of UCC 2-102 which provides that the provisions of Article 2 do not "impair or repeal any statute regulating sales to consumers, farmers or other specified classes of buyers." One approach to the issue of choice of law in consumer transactions is to eliminate the special choice of law rules for consumer transactions and include a provision similar to UCC 2-102 in UCITA. This approach is also set out below in the material on "Relation to other law."

UCITA Project - Memorandum July 10, 2000 - Page - 3 /ucita/ucitaM071000.doc Second, upon adoption in Virginia, the UCITA choice of law provision was modified to provide as follows:

Virginia Code

§ 59.1-501.9. Choice of law.

(a) The parties in their agreement may choose the applicable law. However, the choice is not enforceable in a consumer contract to the extent it would vary a rule that may not be varied by agreement under the law of Virginia. (b) In the absence of an enforceable agreement on choice of law, the contract is governed by the law of Virginia.

Thus, in the Virginia version of this section, the parties are free, it appears, to choose the law of any jurisdiction (given the absence of language requiring a "reasonable relationship"), and in the absence of an agreement, UCITA, as adopted in Virginia, applies. Choice is limited in a consumer transaction to the extent that the choice would "vary a rule that may not be varied by agreement." While this is some limitation, it is not clear just what constitutes a rule that may not be varied by agreement.

Among the approaches that the Commission might take to this issue are the following:

1. Re-draft the UCITA provision to be consistent with UCC Article 1 (limiting choice of law to a jurisdiction which has a "reasonable relationship" to the transaction), and include a provision similar to that in UCC Article 2 which provides that Article 2 does not "impair or repeal" a law applicable to consumers.

2. Amend the UCITA provision as adopted in Virginia.

3. Recommend UCITA without this provision. This option would leave choice of law under UCITA to the common law.

II. Choice of forum

This issue has been treated at length in prior memoranda to the Commission. Among the concerns discussed was the potential of forum selection clauses to deprive a party of an effective remedy in a dispute of relatively small value, if forum selection clauses requiring resort to a distant forum are enforced.

The alternatives for treatment of this issue, previously presented, are as follows.

1. Amend UCITA 110 to make forum-selection clauses unenforceable in cases involving mass-market transactions of moderate value. One way of defining "moderate value" would be to refer to the amount in controversy provisions of small claims actions in the Special Civil Part (currently $2,000). Another way of defining "moderate value" would

UCITA Project - Memorandum July 10, 2000 - Page - 4 /ucita/ucitaM071000.doc be to adopt the threshold amount specified in UCITA 201, the Statue of Frauds provision, $5,000.

2. Amend UCITA 110 to limit the enforcement of forum-selection clauses in all mass- market transactions.

3. Recommend UCITA without this provision. Note that currently UCC Article 2 has no provision with respect to choice of forum.

In the discussion of this provision at the January meeting, the Commissioners voted on these alternatives, with three Commissioners favoring the elimination of the provision, and three Commissioners favoring either of the first two alternatives outlined above. The Commissioners were unanimous, however, in the view that consumer transactions and mass-market transactions be treated identically.

III. Relation to other law

UCITA 105 contains a number of provisions which are concerned with the relationship between UCITA and other bodies of law, including federal law and other areas of State law.

A. Federal preemption

UCITA 105(a) states the principle, which the drafters recognize as both obvious and controlling, that a provision in UCITA which is preempted by federal law is unenforceable to the extent of the preemption. It is not this principle itself which is in dispute, but rather, just what particular provisions of UCITA are unenforceable, and to what extent, particularly under federal intellectual property law. This provision, while it has no particular operative effect, can safely be left in place.

B. Public policy

UCITA 105(b) states that if a contract violates a "fundamental public policy," it is unenforceable to that extent, as provided in the section. As noted in previous memoranda, this provision reflects current law as expressed in the Restatement (Second) of Contracts, except that the Restatement does not require a public policy to be "fundamental" in order to be the basis for invalidating or limiting the enforceability of a contract term. If the Commission is of the view that the inclusion of the term "fundamental" might unduly limit the applicability of this provision, the Commission may consider recommending that this particular word be deleted.

C. Electronic commerce, manifesting assent, conspicuousness and consumer protection rules

UCITA 105(c) provides that "except as provided in subsection (d), if this Act conflicts with a consumer protection statute or administrative rule, the consumer

UCITA Project - Memorandum July 10, 2000 - Page - 5 /ucita/ucitaM071000.doc protection statute or rule governs." Subsection (d) of UCITA 105 contains electronic transacting rules (UCITA 105(d)(1) and (2)), and also provides that consumer protection laws and rules are superseded by UCITA's rules governing assent to a transaction and the definition of conspicuousness. See UCITA 105(d)(2) and (3). These last two sub- subsections are significant exceptions to the general rule of this subsection, that consumer protection laws govern in any conflict with UCITA.

1. Electronic commerce

The purpose of the exception in UCITA (d)(1) and (2) from the consumer protection laws is to enable electronic commerce despite any State consumer protection laws which would require a paper document in place of an electronic record or that a writing be "signed" in a traditional fashion. In light of the enactment of the federal e- commerce preemption legislation, UCITA (d)(1) and (2) should be deleted, as federal law now controls on these issues. (See the corresponding recommendation for the deletion of other UCITA electronic transaction rules, UCITA 107 and UCITA 212 through 215, below.)

2. Manifestation of assent

The UCITA rule on manifesting assent is embodied in Section 112. That section, which is quite lengthy, has conceptual parallels in the Uniform Commercial Code, but no precisely equivalent defined term.

According to the UCITA comment, the term is adopted from the Restatement of Contracts (Second) sec. 19(1), which provides that a manifestation of assent “may be made wholly or partly by written or spoken words or by other acts or by failure to act.” Article 2 of the UCC also recognizes conduct as the basis for an agreement, in provisions carried forward in UCITA in virtually identical language. Compare UCC 1-201(3) (defining agreement as “the bargain of the parties found from circumstances including course of dealing, usage of trade or course of performance) with UCITA 101 (same, in virtually identical language).

UCITA expands upon the Restatement concept of "manifesting assent" in several respects. First, "conduct" of an “electronic agent” is a means of manifesting assent. Second, assent may be inferred by a party if another party intentionally engages in conduct or makes statements with reason to know that the party or its electronic agent may infer assent from the conduct or statement. Lastly, manifestation of assent expressly includes conduct that follows either knowledge or "an opportunity to review" a record or a term. The term "opportunity to review" is also defined in UCITA 112. All of these individual provisions are consistent with general approach taken in the operative provisions of UCITA concerning contract formation.

The question to be considered with respect to the use of the term "manifesting assent" in UCITA 105(c) is whether deference should be given to UCITA over existing consumer protection statutes and rules. Eliminating subsection (c) entirely, or sub-

UCITA Project - Memorandum July 10, 2000 - Page - 6 /ucita/ucitaM071000.doc subsection (c)(4) in particular, would leave the current consumer protection law in place, to be applicable to on-line transactions according to their terms, as may be modified, or not, by the recently-enacted federal e-commerce preemption legislation..

3. Conspicuousness

The UCITA rule on conspicuousness is contained in the definition of that term in the general definitions section, see UCITA 102(a)(14). It is similar to the definition of the term in UCC Article 2, which is as follows:

UCC 1-201 General definitions

"Conspicuous": A term or cause is conspicuous when it is so written that a reasonable person against whom it is to operate ought to have noticed it. A printed heading in capitals (as: "NON-NEGOTIABLE BILL OF LADING) is conspicuous. Language in the body of a form is "conspicuous" if it is larger or other contrasting type or color. But in a telegram any stated term is "conspicuous." Whether a term or clause is "conspicuous" or not is for decision by the court.

UCITA 102(a)(14) tracks the UCC definition above but varies it is ways that are particularly significant when information is presented in an on-line format. The UCITA definition also takes into account the use of so-called "electronic agents."

Like the UCC definition, the UCITA definition defines a term to be "conspicuous" if it is in type which is larger or of a contrasting color, and adds "or set off from the surrounding text by symbols or other marks that draw attention to the language." The example in the comment to this section is that a set off in the following fashion - *****this language is conspicuous***** or <<<<>>>>.

The UCITA definition is controversial in two aspects. First it also defines a term as "conspicuous" if it is "prominently displayed" in another record or display "which is readily accessible or reviewable from the record or display." This accounts for the ability, in electronic documents or on-line presentations for one document to contain a link to another document.

Second, the UCITA definition also defines as "conspicuous" a term which is "so placed in a record or display" that either a person or an electronic agent "cannot proceed without taking action with respect to the particular term or reference." This provision accounts for the use of check- and click-boxes in on-line documents, such as a screen which requires a user to click on a box labeled "I agree" in order to proceed further in the installation of software or access to on-line material. Note, however, that these check and click-boxes often are presented with a display of a small portion of a lengthy agreement.

An example of a typical presentation of an agreement is included in the appendix (Appendix D); this particular agreement is presented when the free "Napster" music

UCITA Project - Memorandum July 10, 2000 - Page - 7 /ucita/ucitaM071000.doc software is downloaded from the Napster web site and the installation procedure is followed. Note that this is merely a typical presentation; some presentations include a series of click-boxes that require the person to work through an entire document containing very specific information, while others may be less specific that this example. The actual screen display contains only the portion of the two-page, single-spaced agreement which is outlined within the box in the appendix document. The screen display itself contains the following information:

------

[at top of screen]

Please read the following agreement. Press the PAGE DOWN key to see the rest of the agreement.

[text box with scroll bar, displaying text marked with a box in appendix document]

[at bottom of screen]

Do you accept the terms of the preceding license agreement? If you choose No, Setup will close. To install this product, you must accept this agreement.

[the following "buttons" are displayed at the bottom of the screen]

As in the case of "manifesting assent," discussed above, the question presented with respect to this term in UCITA 105(c), is whether the UCITA definition of conspicuousness should prevail over any contrary consumer protection statute or rule. If subsection (c) is deleted, or sub-subsection (c)(3) in particular is deleted, current consumer protection statutes and rules would be left in place, to be applicable, or not, to on-line transactions according to their own terms, as may be modified by the recently- enacted federal e-commerce preemption legislation.

4. Conforming UCITA to UCC Article 2

As an alternative to simply deleting UCITA 105(c) entirely, the Commission may wish to consider revising subsection (c) to track the parallel rule in UCC Article 2, which provides that "this Chapter," i.e., the Uniform Commercial Code, "does not impair or repeal any statute regulating sales to consumers, farmers or other specified classes of buyers." The reference to farmers in this provision can safely be eliminated, leaving the following language in place of current UCITA 105(c):

This Act does not impair or repeal any statute regulating transactions with consumers or other specified classes of buyers.

UCITA Project - Memorandum July 10, 2000 - Page - 8 /ucita/ucitaM071000.doc Replicating the UCC rule concerning consumer transactions in UCITA would leave current consumer protection law undisturbed. This would also leave the interface between current consumer protection law and electronic transacting to the recently- enacted federal law, to the extent that consumer protection statutes and administrative rules may be read to require a traditional writing or signature in a transaction.

D. Exclusion of "reverse engineering" in certain transactions

The Commission has received a request from the American Committee for Interoperable Systems (ACIS), an organization that supports the interoperability of computer systems. Among its members are Sun Microsystems, Inc., and 3Com Corporation. A Fact Sheet with information on ACIS is attached, as is a copy of the email received from Howard Freedland, Chairman of ACIS. (See Appendix E.) ACIS supports the exclusion of certain "reverse engineering" activities from the scope of UCITA. The reason for the exclusion is to prevent vendors from prohibiting by contract certain reverse engineering activities that are permitted under federal intellectual property law. Reverse engineering involves the disassembly or deconstruction of software or hardware in order to determine its workings. In general, reverse engineering is considered "fair use" under federal law and permitted under state trade secret laws if the product is obtained in the public marketplace.

ACIS seeks the addition of the following language to UCITA 105:

SECTION 105. RELATION TO FEDERAL LAW; FUNDAMENTAL PUBLIC POLICY; TRANSACTIONS SUBJECT TO OTHER STATE LAW.

[NEW SUBSECTION] In a retail transaction for a copy of a computer program, a term which has the effect of prohibiting a licensee from reverse engineering for Interoperability or academic research is unenforceable to the extent those activities are not prohibited by other law.

IV. Scope

A. Interface between UCC Article 2 and UCITA

Article 2 of the UCC governs "transactions in goods." UCITA governs "computer information transactions." Some transactions may involve both "goods" and "computer information" as defined in UCITA. A primary example of such a transaction is shrink- wrapped, off-the-shelf computer software, which has been routinely treated as "goods" falling under UCC Article 2. Another category is software embedded in goods, sometimes referred to as "smart goods."

The drafters of UCITA dispute the treatment of boxed software as "goods," stating that while the box and accompanying diskettes, etc., may be "goods," right to use

UCITA Project - Memorandum July 10, 2000 - Page - 9 /ucita/ucitaM071000.doc the computer program itself is a license, not a good, and should be covered by UCITA. Thus, UCITA provides that when a transaction involves both computer information and goods, both UCITA and UCC Article 2 apply. This approach necessitates elaborate rules for determining what part of a transaction is covered by UCITA, and what part is covered by Article 2. UCITA also contains additional rules which permit parties to these mixed transactions to "opt-in" to UCITA entirely. The UCITA scope provision does, however, attempt to exclude "smart goods" from its scope, unless the "smart goods" are a computer or computer peripheral.

Despite the position taken by the drafters of UCITA, courts have had no difficulty in treating a sale of boxed software as a "goods" transaction which also involves intellectual property, no more than they have had treating the sale of a book or a music CD as a transaction in goods which also involves intellectual property, dealing separately, if necessary, with any intellectual property issues which may be involved in the transaction. Similarly, the courts have had no difficulty in treating "smart goods" as a goods transaction. To the extent that the general transactional rules of Article 2 and UCITA differ (and they do differ, as noted in the paragraphs above), having a set of rules apply to the sale of a music CD and a book which is different from the rules which apply to a similar sale of a boxed computer program creates unnecessary confusion and is contrary to the expectation of ordinary parties to such a transaction.

It should be noted that the ALI, at its most recent Annual Meeting, considered a provision in the current draft of the revision of Article 2 of the UCC that would have deferred to UCITA in transactions involving goods and computer information. A copy of the March 2000 draft provision (draft 2-102 SCOPE) is included in the Appendix to this memorandum. The ALI rejected that approach, as reported in the summary of actions taken at the meeting which is on the ALI web site, as follows: "In response to motions articulated by Neil B. Cohen, the house favored the view that the scope of Article 2 should be expanded from its articulation in current law so as explicitly to govern not only goods, but also, in many contexts, closely associated computer information, such as that contained in "smart goods" and other such goods as embedded software."

The revised provision being presented to the NCCUSL Annual Meeting at the end of this month (without the approval of the ALI) generally replicates the scope provisions currently contained in UCITA itself, which leaves within Article 2 all goods transactions, but brings all or most aspects of any transaction involving computer information and goods into UCITA. The revised provision does not appear to follow the "sense of the house" action taken at the ALI annual meeting with respect to the scope issue. A copy of the revised provision in the approval draft (draft 2-103 SCOPE), along with the draft commentary which accompanies it, is included as Appendix C to this memorandum.

One approach to the resolution of this issue, which favors the applicability of UCC Article 2, is to amend UCITA 103 to make it clear that in a transaction involving computer information and goods, the transaction continues to be governed by Article 2. The following additions and deletions would keep transactions involving goods, whether

UCITA Project - Memorandum July 10, 2000 - Page - 10 /ucita/ucitaM071000.doc or not they also involve computer information, within UCC Article 2. The "predominant aspect" test incorporated in the proposed language is taken from current case law.

SECTION 103. SCOPE; EXCLUSIONS.

(a) This [Act] applies to computer information transactions.

(b) If a computer information transaction involves computer information that is either in the form of goods or is embedded in goods, Article 2 of the UCC applies to the transaction. If a computer information transaction involves both goods and computer information that is not either in the form of goods or embedded in goods, Article 2 of the UCC applies to the transaction if the goods are the predominant aspect of the transaction. Except for subject matter excluded in subsection (d) and as otherwise provided in Section 104, if a computer information transaction includes subject matter other than computer information or subject matter excluded under subsection (d), the following rules apply:

(1) If a transaction includes computer information and goods, this [Act] applies to the part of the transaction involving computer information, informational rights in it, and creation or modification of it. However, if a copy of a computer program is contained in and sold or leased as part of goods, this [Act] applies to the copy and the computer program only if:

(A) the goods are a computer or computer peripheral; or

(B) giving the buyer or lessee of the goods access to or use of the program is ordinarily a material purpose of transactions in goods of the type sold or leased.

(2) In all other cases, this [Act] applies to the entire transaction if the computer information and informational rights, or access to them, is the primary subject matter, but otherwise applies only to the part of the transaction involving computer information, informational rights in it, and creation or modification of it.

(c) [no change]

(d) [no change]

(e) [no change]

UCITA Project - Memorandum July 10, 2000 - Page - 11 /ucita/ucitaM071000.doc SECTION 104. MIXED TRANSACTIONS: AGREEMENT TO OPT-IN OR OPT-OUT.

[This entire section would be deleted.]

B. Categorical exclusions from scope

1. Exclusions from Scope approved by the NCCUSL Executive Committee

After UCITA was approved in July 1999 by the National Conference, the Executive Committee of NCCUSL continued to negotiate with various interest groups which threatened to oppose UCITA in the State legislatures. The language of the exclusions has been approved by the NCCUSL Executive Committee and is being considered for ratification by the National Conference at its 2000 Annual Meeting at the end of this month. Note that the materials on the NCCUSL web site indicates that some of these exclusions were negotiated "as a package"; the "package" includes amendments to other sections of UCITA, as will be noted below.

a. Exclusion for "media industries."

The UCITA scope provision being presented this month to the National Conference excludes agreements involving the production or distribution of "motion picture or audio or visual programming" except in a mass-market transaction. The exclusion language would take out of UCITA all such transactions of a business-to- business type, but leave within UCITA all such transactions which fall within the UCITA definition of "mass-market." The term "mass-market" in UCITA includes all consumer transactions, as well as certain other similar transactions.

Note, however, that the "package" of amendments of which this exclusion is a part expressly includes in UCITA certain kinds of idea submissions which are governed by a new provision, UCITA 216. The justification for this addition to UCITA is contained in the Comment to the section, a copy of which is attached. This provision seeks to codify certain judicial decisions which have limited the rights of parties who submit development ideas to media companies, including ideas which are submitted pursuant to a contract. Note that while the general effect of the agreed-upon package of amendments pertaining to media industries is to remove development agreements in these industries from the scope of UCITA, this provision is an "exception to the exception." Thus, this provision serves the pro-industry purpose of limiting potential lawsuits over the submission of development ideas, while leaving these industries generally unaffected by the provisions of UCITA in their development activities.

b. Exclusion for regulated telecommunications contracts.

This exclusion was presented to this Commission by Bell Atlantic, to deal with the fact that Bell Atlantic's contracts with its customers are governed by federal and State

UCITA Project - Memorandum July 10, 2000 - Page - 12 /ucita/ucitaM071000.doc regulators. Note that, as indicated previously, the drafters of UCITA believe that this issue is already covered in UCITA 103(d)(3) but they have agreed to this amendment; it is included in the amendments being submitted this month to the National Conference. The amendment provides that if products or services are provided to a party pursuant to federal or state tariffs or pursuant to a pricing agreement subject to approval by a state or federal regulatory authority, the transaction is excluded from UCITA.

c. Exclusion for an "insurance services transaction."

The insurance industry has negotiated an exclusion from UCITA's scope provision for an "insurance services transaction." This term is defined as ""an agreement between the insurer and the insured that provides for, or a transaction that is, or entails access to, use transfer, clearance, settlement, or processing of: (A) an insurance policy, contract, or certificate, or (B) a right to payment under an insurance policy, contract, or certificate."

2. Exclusions submitted to this Commission

The Commission has received the following recommendation for exclusion from the scope of UCITA.

Exclusion for libraries.

This exclusion has been previously discussed. The libraries are concerned that UCITA would impact their rights under the "first sale" doctrine by enforcing agreements under State law that would limit their right to lend and re-convey materials. They are also concerned more generally with the "assent" provisions in UCITA which, they feel, would support the enforcement of shrink-wrap and click-wrap agreements that they do not have the power to negotiate or scrutinize before becoming bound. In a prior memorandum we proposed language that would exempt libraries, as defined in the federal Copyright Act, from the scope of UCITA. The proposed language is set forth again below:

SECTION 103 SCOPE; EXCLUSIONS …. (d) This [Act] does not apply to: … [new sub-subsection] A transaction with a library or archives that is (A) open to the public, or (B) available not only to researchers affiliated with the library or archives or with the institution of which it is a part, but also to the other persons doing research in a specialized field.

V. Statute of Frauds

On the general issue of writing requirements, the Commissioners will recall that the drafters of Article 2 of the UCC originally determined to delete the Statute of Frauds provision in Article 2; the drafting committee decision was then overruled by the

UCITA Project - Memorandum July 10, 2000 - Page - 13 /ucita/ucitaM071000.doc National Conference, and the provision was restored. The decision of the National Conference in favor of retaining a writing requirement is also reflected in UCITA Section 201 Formal Requirements. The text of the provision is set forth below. With respect to the idea that writing requirements have a consumer protection effect, note that the UCITA provision applies only to transactions in excess of $5,000, a figure which will remove from the operation of the provision most consumer transactions.

The retention of this type of requirement is inconsistent with prior Commission recommendations concerning New Jersey's general Statute of Frauds, recommendations which were enacted into law in 1995. The Commission may wish to consider whether it should recommend that all or part of the UCITA provision be deleted in order to conform it to this State's general Statute of Frauds.

VI. Contract formation

UCITA contains several contract formation rules. E.g., UCITA 202 (Formation in General), UCITA 204 (Acceptance with Varying Terms), UCITA 205 (Conditional Offer and Acceptance), UCITA 208 (Adopting Terms of Record), UCITA 209 (Mass- Market License), UCITA 301 (Parol or Extrinsic Evidence) and UCITA 304 (Continuing Contractual Terms). These rules differ from those the Commission proposed in the Standard Form Contract Act. UCITA primarily relies upon consent to support contracts while the Standard Form Contract Act relies upon the act of entering into a sale to support them. UCITA and the SFCA intersect most closely under UCITA’s concept of mass-market transaction where the terms of the contract are binding even though the buyer did not have access to the contract terms when he “manifested assent” to them. Like the SFCA, the buyer has the right to rescind the contract if he objects to the terms.

However, the mass-market transaction in UCITA is limited to consumer transactions and to transactions directed to the general public as a whole. The mass- market transaction may not cover sales to businesses, small or large, a distinction the SFCA deliberately disregarded. UCITA’s mass-market transaction also excludes “access contracts,” those contracts involving access to information over the Internet, such as Lexis-Nexis or America On Line. The SFCA applies to any standard form contract reflecting the view that the nature of the contract formation process, not the content of the contract, is the object of appropriate legal regulation.

In an earlier memorandum, staff proposed amendments to UCITA that would harmonize the Act, though imperfectly, with the SFCA. These amendments would require surgery to several UCITA provisions. See Memorandum dated February 14, 2000, M000214. The following sections would require amendment: UCITA 102, UCITA 202, UCITA 204, UCITA 205, UCITA 208, UCITA 209, UCITA 301 and UCITA 304. If amended as proposed, UCITA would approximate the approach taken to standard form contracting in the SFCA. However, the two Acts differ fundamentally in their approach making it impossible to achieve a seamless integration.

UCITA Project - Memorandum July 10, 2000 - Page - 14 /ucita/ucitaM071000.doc The Commission has the following options: (1) amend UCITA as proposed by staff or (2) leave the Act in its current form. The proposed amendments would introduce the Commission’s global approach to standard form contracting and would not completely disturb UCITA’s concept of mass-market transaction. But the amendments would eliminate any virtue of uniformity for the benefit of mass-market sellers. Leaving the Act in its current form would not harm New Jersey buyers but would fail to achieve the deliberately simple and more elegant approach to standard form contracting found in the SFCA.

VII. Transfer of title to a copy.

One of the most controversial provisions in UCITA is Section 502, which contains rules governing a transaction which involves the "transfer of title to a copy." This is one of the core provisions of UCITA, because it expresses the central view of the Act that computer information transactions are, at the election of the vendor, a limited license the incidents of which the vendor controls almost completely.

The provision is controversial in part because of its interface with federal copyright law, which affords important rights to the purchaser of a copy of a copyrighted work under the "first sale" doctrine if the transaction involves the "transfer of title" to the copy. Under federal copyright law, if a transaction involves a "first sale," the licensor cannot restrict further transfers of the copy, either by lending or re-sale. It is by virtue of this provision of the Copyright Act that a purchaser of a book has the right to read the book and then lend or sell the book to another party. Note that the first sale doctrine does not make it lawful for the transferee in such a transaction to duplicate the copy, it only validates the purchaser's right to re-sell, lend or give away the copy.

The opponents of UCITA characterize this provision as an attempt to evade the provisions of the federal Copyright Act, which ultimately control what constitutes the transfer of title to a copy of a copyrighted work; the drafters of UCITA present it as a codification of state law contract principles which permit a licensor to control by way of contract whether the transaction involves the transfer of title to a copy.

A single federal case is cited in the comment for the proposition that "In general, title does not vest in the licensee if the license places restrictions on use of the information on that copy that are inconsistent with ownership of the copy." DSC Communications Corp. v. Pulse Communications, Inc., 170 F.3d 1354 (Fed. Cir. 1999). Ironically, the circuit court in that case rejected the view propounded by Professor Raymond Nimmer, the UCITA reporter, on behalf of one of the litigants, that "when a copy of a software program is transferred for a single payment and for an unlimited term, the transferee should be considered an 'owner' of the copy of the software program regardless of other restrictions on his use of the software."

It may be argued that Professor Nimmer's view as expressed in his treatise is probably consistent with the expectation of the purchaser of shrink-wrapped software or other discrete goods, at least in a consumer or mass-market transaction. This expectation

UCITA Project - Memorandum July 10, 2000 - Page - 15 /ucita/ucitaM071000.doc is defeated, however, by the default rule embodied in UCITA 502(a)(1). Like other provisions of UCITA, Section 502 should always be considered in light of the contract formation rules of the entire Act, which broadly validate the use of shrink-wrap and click-wrap agreements and enforcement of licensor-imposed terms, including those proffered after the completion of the transaction. Thus, in general UCITA provisions give full effect to the terms of a license agreement enclosed in a shrink-wrapped box containing software to the extent that those terms declare render the transaction a limited license rather than the transfer of title to a copy, regardless of the other incidents of the transaction. That is the effect of UCITA 502(a)(1): "In a license ... title to a copy is determined by the license."

The DSC Communications Corp. case involved a series of license agreements negotiated between represented parties in a business-to-business transaction; UCITA Section 502, which is consistent with the principles articulated by the court in that case, would apply to all UCITA transactions, including consumer and mass-market transactions, whether or not there was any opportunity to negotiate, or whether the restrictive provisions which would change the character of the transaction from the sale of a copy to a limited license were proffered after the transaction was completed.

If a transaction involving the transfer of a copy does not result in a transfer of title to the copy, it probably constitutes the transfer of a contractual interest only (unless it involves transfer of ownership of informational rights under UCITA 501), and is dealt with under UCITA 503 through 508. UCITA 503(4) provides that "a term that prohibits transfer of a contractual interest under a mass-market license by the licensee must be conspicuous." Thus, any limits that a licensor places on the transfer of a mass-market licensee's contractual interest must be "conspicuous" within the meaning of UCITA 102(a)(14)("...so written, displayed, or presented that a reasonable person against which it is to operate ought to have noticed it....).

Note that several other options set forth in this memorandum bear on this issue. The effect of shrink-wrap licenses on the right to lend or otherwise transfer copies of copyrighted works is one of the concerns expressed by the organizations representing libraries; the exclusion of transactions involving libraries from the provisions of UCITA would solve the problems presented particularly by this section in transactions involving those institutions. In addition, excluding transactions which involve both goods and computer information from the provisions of UCITA would remove many consumer and mass-market transactions from the effect of this provision. However, the above amendments would not address the remaining category of consumer and mass-market transactions which may not be transactions in goods, such as purchases of software and other "computer information" products electronically.

Some approaches to this issue might include:

1. Leave the provision as it is. It reflects the most fundamental of the policy judgments made by the drafters of UCITA, that the rights of vendors to control the incidents of their transactions should be given the greatest deference.

UCITA Project - Memorandum July 10, 2000 - Page - 16 /ucita/ucitaM071000.doc 2. Adopt the position advocated by Professor Nimmer in his treatise, that when a transaction involves a transfer of a copy "for a single payment and an unlimited term" it constitutes the transfer of title to the copy.

3. Adopt the above rule only for mass-market transactions (which includes all consumer transactions by definition).

The following amendment would accomplish the above results (to the extent the issue is not controlled under federal law); the bracketed information would limit the effect of the amendment to mass-market transactions.

SECTION 502. TITLE TO COPY.

(a) In a license:

(1) title to a copy is determined by the license, except that [in a mass-market transaction] if the transaction consists of a transfer for a single payment and for an unlimited period of time, the transaction constitutes the transfer of title to the copy;

Note that although the issue is not entirely clear, there is probably some point at which federal law and policy controls the determination of what constitutes the transfer of title to a copy. It may be that in some types of transactions a federal court, looking at all of the incidents of the transaction, would deem the transaction to constitute the transfer of title to a copy, regardless of the provisions of state law or the terms of the license agreement. In other words, if it walks like a duck and quacks like a duck, it's a duck, regardless of whether it is carrying a sign that says "I'm a dog."

VIII. Warranties

Warranties

UCITA sets forth its warranty provisions in Part 4. The main warranty provision provides that the information is free of third party claims, licensed patent rights affecting the information are valid and the rights granted to the licensee are exclusive and valid. S. 401. Three sections cover implied warranties: (1) merchantability of computer program, (2) accuracy of informational content and (3) fitness for a particular purpose. S. 403, 404 and 405. UCITA permits vendors to disclaim or modify these latter warranties under s. 406.

The question arises whether New Jersey should prohibit the disclaimer of the implied warranty of merchantability for mass-market transactions contrary to UCITA s. 406. The Standard Form Contract Act takes the position that merchants regularly engaged in the business of selling products should not have the option to disclaim this warranty because, in the case of new products, it is indistinguishable from the civil obligation to

UCITA Project - Memorandum July 10, 2000 - Page - 17 /ucita/ucitaM071000.doc manufacture a defect-free product. The Standard Form Contract Act in s. 11 prohibits sellers from disclaiming that the product matches its description and from disclaiming that the product is free from defects unless the disclaimer is prominently placed on the product.

Related to this issue, but not dispositive of the question, is the possible application of the Magnuson-Moss Warranty Act to certain UCITA transactions. The Magnuson- Moss Warranty Act applies to “consumer products” costing the consumer more than $15 and governs written warranties provided with the product. The MMWA does not require that a seller give a warranty on a consumer product, but if a warranty is given, it must comply with the terms of the Act. Where written warranties are given, the MMWA invalidates attempts to disclaim implied warranties. 15 U.S.C.S. 2398(a).

Assuming that “computer information” transferred to a consumer is a consumer product within the meaning of the MMWA, then the latter pre-empts s. 406 of UCITA permitting the disclaimer of the implied warranty of merchantability if the vendor gives the consumer a written warranty. But the question of whether the MMWA applies to “computer information transactions” is not answered by statute, regulation or case law.

The types of warranties found in UCITA address issues specific to rights in information such as non-infringement, noninterference and accuracy of information. Neither UCC 2 nor state law directly addresses these issues. The warranty provisions, therefore, may be considered essential to the Act.

Nevertheless, the Commission has two options: (1) leave Part 4 in its Official Text version or (2) amend s. 406 to exclude mass-market transactions involving the transfer of new products. The latter amendment would make UCITA consistent with the Standard Form Contract Act. However, it would introduce non-uniformity in a part of UCITA that is arguably an essential part.

IX. Financing arrangements.

A previous memorandum to the Commission stated that the provisions in UCITA Part 5, Subpart B concerning financing arrangements were duplicative of the provision of Article 9 of the UCC. The drafters pointed out in response that while the UCITA provisions duplicate (generally) the result in Article 9, the UCITA provisions are intended to cover those financing arrangements which do not involve an Article 9 security interest. In fact, the provisions are carefully drafted to defer to Article 9 where there is any conflict between the two. Thus, these provisions do in fact provide a legal basis for financing arrangements that are not covered under current law, and they should be retained in UCITA. The relevant provisions are UCITA 507 through 511.

X. Computer self-help

"Self-help," in the context of computer information transactions, refers to a licensor's use of electronic means to control, terminate or impair the use of computer

UCITA Project - Memorandum July 10, 2000 - Page - 18 /ucita/ucitaM071000.doc information, including a computer software program. It is parallel in concept to the self- help repossession of goods in which a party has a security interest under Article 9 of the UCC. In a computer information transaction, self-help may be undertaken in a variety of ways, the two most-recognized being the insertion of "logic bombs" in software code, and the use of certain kinds of "secret access" to a computer systems. "Self-help" devices enable the vendor of computer software or a computer system to maintain control over the use of the system in the event of a dispute with the purchaser of the product or system. The insertion of a "logic bomb" in a computer system or software product typically entails the insertion of software code that terminates or impairs the use of the product after a certain period of time or a certain number of uses unless certain additional information, known only to the vendor, is used to counteract the "logic bomb." The use of "secret access" to a computer system may include the reservation of certain passwords or other means of access by the vendor, who can thereby continue to gain access to a system and control its usability, to the vendor's advantage in the event of a dispute with the purchaser.

The use of these types of remedies in computer information transactions has been extremely controversial under current law. The traditional limitation on self-help repossession (at common law and under UCC Article 9) is that it must be exercised without a "breach of the peace." This concept does not readily map to computer transactions, where physical control over the use of the disputed object can be accomplished without the kind of physical confrontation or breaking and entering types of behavior that might be necessary to obtain control over an automobile, the typical object of a self-help repossession under UCC Article 9. It has been argued, however, that the kind of harm that may ensue from the unilateral impairment of a computer system can be every bit as harmful, and potentially much more so, as the breaking and entry into a garage on private property to recover a car. Moreover, either of these methods of self- help may violate federal and state computer crime laws which criminalize unauthorized access to computers and the use of computer viruses and other software mechanisms to interfere with the use of a computer or a computer system.

A recent law review article surveyed the existing statutory law which might be applied to self-help in computer transactions and analyzed the current case law. It was pointed out particularly how certain uses of self-help may violate federal and state anti- tampering laws which prohibit the dissemination of harmful software code and programs as well as unauthorized access to computer systems. Indeed, in a number of such cases the users of such remedies have been charged and prosecuted under those laws. See Comment, Electronic Self-Help Repossession and You: A Computer Software Vendor's Guide to Staying Out of Jail, 48 Emory L.J. 1477, (Fall 1999). In addition, courts have imposed large penalties on vendors who have exercised self-help remedies or threatened to exercise them. The Comment states that only one case to date has found the exercise of self-help to be valid. See American Computer Trust Leasing v. Jack Farrell Implement Co., 763 F. Supp. 1473 (D. Minn. 1991), aff'd on other grounds sub nom. American Computer Trust Leasing v. Boerboom International, Inc., 967 F.2d 1208 (8th Cir. 1992).

UCITA Project - Memorandum July 10, 2000 - Page - 19 /ucita/ucitaM071000.doc UCITA 815, entitled "Right to Possession and to Prevent Use," validates the use of self-help remedies in computer information transactions, provided that they are undertaken "without a breach of the peace," and "without a foreseeable risk of personal injury or significant physical damage to information or property other than the licensed information," and provided that they comply with UCITA 816. This section sets forth the requirements for the use of self-help and limitations upon its use, including the requirement that a provision authorizing its use be negotiated and requiring that certain notices be given before it is actually used. Note that a change in UCITA 816, to expressly prohibit self-help in mass-market transactions, has been approved by the NCCUSL Executive Committee and is included in the package of changes being submitted to the National Conference this month.

The proponents of UCITA argue that this provision is preferable to existing law, because it provides clarity, and so severely restricts the use of the remedy that it is unlikely to be misused.

This provision, not surprisingly, is opposed by software users, from consumers to large businesses. One argument being made is that as a technical matter, the insertion of "logic bombs" and other such code in computer programs is a threat regardless of whether the code is ever used by the vendor to remedy a breach; the mere existence of such code represents a security hazard which may be exploited by hackers to control or damage the computer systems of users. On this basis, it is argued, the use of this code should be affirmatively prohibited rather than validated.

With respect to this issue, several approaches might be taken.

1. Leave the provision in place as is. This would permit vendors to include "self-help" features in their products, but would limit their use of those features as specified in UCITA 816.

2. Recommend the removal of UCITA 816, and any references to it, including UCITA 815(b). This would leave the use of self-help to development under the common law.

3. Draft an alternative provision which prohibits the use of self-help. Depending upon the precise language used, such a provision could merely prohibit the use of self-help, or prohibit both its use and the inclusion of self-help features in a product, regardless of whether the features were actually invoked in the event of a dispute.

XI. Conforming amendments.

The Uniform Electronic Transactions Act (UETA) contains rules which govern the manner and means of electronic transacting, some of which overlap with the provisions of UCITA. If UETA is enacted in this State, the corresponding UCITA provisions should therefore be deleted in order that there be one statutory source for rules governing electronic commerce. In the absence of any UETA enactment these rules

UCITA Project - Memorandum July 10, 2000 - Page - 20 /ucita/ucitaM071000.doc should probably be deleted in any event, as they are preempted by the enactment of the federal e-commerce preemption legislation signed by the President on June 30.

Amending UCITA to eliminate these provisions would involve the following:

1. Delete UCITA 107. This UCITA provision sets forth general rules validating electronic transactions. These rules are duplicated in UETA 7 and qualified in important ways in UETA 5 and 8, among others.

2. Delete UCITA 212 through 215. These UCITA provision comprise Subpart C. "Electronic Contracts: Generally" of UCITA Part 2. These provisions largely duplicate various provisions of UETA.

3. As noted above in the discussion of Section 105, delete sub-subsections (d)(1) and (2) of that Section, which also contains provisions which equate writings and signatures with electronic records and signatures.

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