Software Council of Southern California

By, Clara Martin and David Oshinsky
Shaw Pittman LLP

Here we go again. Thanks to a recent appellate court decision, the enforceability of shrinkwrap licenses-and of their electronic and online counterparts, so-called "click-wrap" and "browse-wrap" licenses-is being questioned.

The cause for the recent frenzy? Specht v. Netscape Communications Corp. A Second Circuit appeals court decided this case in October 2002, upholding a lower court's refusal to enforce an arbitration clause. The clause in question had been included in a license agreement for a Netscape "plug-in" application (called "SmartDownload"), which worked with Netscape's Communicator web browser.

The court's ruling serves as a cautionary note to software developers and Web site operators who don't want to require users to take extra steps prior to accessing or using software or Web sites. The message is that if you fail to require users to review and agree to license terms or terms of use, a court may refuse to enforce those terms.

When providing SmartDownload, Netscape did not require its users specifically to read and agree to the terms of the applicable license agreement. License terms were available for review, but users had to scroll down below the "download" button and click on a hyperlink in order to read the terms. In addition, at no time were users actually obligated to indicate their agreement to those terms.

Netscape argued that the act of downloading the software signaled a user's agreement, but the court disagreed: "clicking on a download button does not communicate assent to contractual terms if the offer [to enter into the license agreement] did not make clear to the consumer that clicking on the download button would signify assent to those terms."

On its face, the court's refusal to enforce terms of a click-wrap agreement seems to run contrary to the majority of cases that have considered the enforceability of agreements of this type, tracing back to a 1996 case called ProCD, Inc. v. Zeidenberg. ProCD was an early test case, upholding the enforceability of "shrinkwrap" license agreements (so termed because they came packaged inside the plastic packaging-or "shrinkwrap"-of a box of software). Because a software user did not have the opportunity to review and accept these license agreements before opening (and, thus, before purchasing) the software packages, many had questioned the legal enforceability of these agreements.

The federal appeals court in the ProCD case held that a shrinkwrap license is enforceable, provided that: 1) customers have an opportunity to review the terms of the license before making a final decision regarding use of the software, and 2) the license contains no terms that are objectionable (or "unconscionable"). A consumer signaled his or her agreement to the terms of the license by installing and using the software. The court did not require evidence that the consumer actually read the entire license, only that they had an opportunity to review it.

Since the mid 1990s, when the ProCD case was decided, the Internet and the World Wide Web have changed how consumers purchase software. More and more, online purchasing and delivery via download is used in place of packaged software products. This shift raises new questions about licenses that appear electronically in dialog boxes, rather than on paper in cardboard boxes.

Notwithstanding the transition from paper to electrons, courts have continued to enforce click-wrap licenses, provided that they meet the requirements outlined in the ProCD case. Legally, the Specht case has not changed the law or told us anything we didn't already know. The criteria highlighted in the ProCD case -opportunity to review and reasonableness of terms-continue to apply, and parties to a contract must still affirmatively indicate their agreement. Practically, however, the Specht case suggests that it is time to re-evaluate certain online behaviors that have become commonplace in the world of Internet commerce.

In the wake of the initial district court decision in the Specht case, an American Bar Association working group convened to assess strategies for creating enforceable click-wrap agreements, ultimately recommending the following six principles as guidance in the structuring and implementation of online agreements:

No single, "right" way exists to implement these principles, and the particular manner of implementation will likely vary depending upon the type of product offered and the means by which that product is provided to users. In addition, these principles do not address the substance of click-through agreements, and companies should keep in mind that courts may reject any terms that they deem "unreasonable" or "unconscionable." The question of what is reasonable depends on the facts and circumstances of each licensing transaction, and clear standards have yet to emerge. In fact, courts that have been asked to answer this question have not been consistent in their conclusions.

Earlier this year, two federal courts reached seemingly opposite results when evaluating similar clauses in the context of click-wrap agreements. In California, a federal district court refused to enforce a click-wrap agreement governing online payment services offered by PayPal, Inc., finding two "unreasonable" aspects of the agreement. First, the court criticized a provision that required all disputes with the company be submitted to binding, individual arbitration. Second, the court objected to a forum selection clause that required arbitration take place in Santa Clara, California.

Why did the court find these clauses unreasonable? Simply put, the expense of complying with either of these clauses effectively left those consumers who had simple, small-dollar-amount disputes with no remedy. In most instances, when a large number of consumers have small dollar claims, the claims are aggregated and handled through class action litigation. PayPal's requirement that complaints be handled through arbitration entirely eliminated the possibility for class action suits. In addition, the forum selection clause requiring consumers fly to Santa Clara to have cases heard further eliminated the likelihood that someone with a small claim could get the matter resolved.

Because the court found these two elements unreasonable, they refused to enforce the entire agreement. The court denied PayPal's attempt to compel binding arbitration and allowed a class action lawsuit to proceed.

By contrast, in a case decided in the same week, a Washington, D.C. appeals court upheld a forum selection clause included in a click-wrap agreement for high-speed Internet service offered by Verizon Communications. The clause provided that subscribers to Verizon's Internet service "consent to the exclusive personal jurisdiction of and venue in a court of competent jurisdiction located in Fairfax County, Virginia." The court held that it would not be unreasonable to require consumers to bring suit against Verizon in Virginia, even though it would entail travel to Virginia and require the consumer forgo the right to a class action lawsuit since the state does not permit them. The court was not persuaded by the plaintiff's argument that a class action would be the only practical remedy for the type of claim he was pursuing, given the relatively small dollar amount at stake.

While this question of what is "reasonable" continues to be debated, companies should consider whether their click-wrap agreements contain any terms that could be considered surprising or unfair by the average software consumer. Such terms include arbitration clauses, forum selection clauses, and limitations on liability for damages. (Although it is worth noting that many courts have considered and upheld these types of terms in click-wrap agreements.)

To increase the likelihood that click-wrap agreements survive enforcement challenges, companies are advised to create click-wrap licenses that follow the American Bar Association principles. Agreements structured in accordance with the ABA's principles have the following characteristics:

Ultimately, the Specht case confirms what we've known all along about contracts-that parties need to be informed of all contract terms and must affirmatively indicate their agreement to those terms. The Specht case therefore suggests that, in addition to software click-wrap agreements, Web site owners and developers should consider the viability and enforceability of "click-free" agreements such as Web site terms of service in which users are expected to review terms on their own and are not typically required to indicate their assent to any terms. Instead, users are told that their continued use of a Web site or software product signals their agreement to all of the terms and conditions contained in the terms of service or agreement update, which is sometimes made available to be viewed by following a hyperlink.

Further, companies that update or revise their license agreements simply by posting a notice to their Web sites should consider instead obtaining users' specific agreement to the revised terms.

With the Specht case as a precedent, simple agreement-by-use conditions may no longer be sufficient to bind users. If Web site operators are serious about enforcing terms of service, and if software companies want better assurance that users will be bound by updated license terms, it would be wise to actually present the terms to users and require consent to the terms. In the case of Web sites, this should be done before permitting a user access to the Web site. While such measures may cause some unwanted technical hassles, a little technical hassle could go a long way toward preventing unwanted legal exposure.

Clara Martin and David Oshinsky practice in the areas of corporate, licensing, technology and Internet law with Shaw Pittman LLP. Their clients include organizations in the entertainment, software, hardware, telecommunications, wireless and interactive game industries.