Court Relies on Traditional Contract Formation Rules in Cyberspace Case

Los Angeles Daily Journal, November 2002

by Lawrence C. Waddington

Technology has changed the format and vernacular of cyberspace transactions, but judicial interpretation of electronic contracts remains remarkably informed by common law or legislation.

In Specht v. Netscape Communications Corp., 2002 WL 31166784 (2d Cir. Oct. 1, 2002), the judges explored the world of the Internet, Web sites and hyperlinks and canvassed the idioms of “clickwrap,” “cookies” and “harvesting.”

But in resolving the validity of an arbitration clause in a contract in a contract between consumers and an Internet software provider, the court wrote its opinion in familiar language dealing with contract formation, the scope of the arbitration clauses and potential application to third party beneficiaries.

The class action plaintiffs responded to a solicitation on the defendant's Web page to download a sofware program facilitating Internet use (Netscape Communicator) onto their personal computers. The plaintiffs were unaware that activation the “download icon” and signifying assent to acquire the software clandestinely enabled the defendants to distribute the plaintiffs’ personal file names to other users (via ”cookies”) and to the makers of a separate “plug-in” software program (SmartDownload).

The plaintiffs filed a complaint alleging violation of the Electronic Communications Privacy Act, 18 U.S.C Section 2510, and the Computer Fraud and Abuse Act, 18 U.S.C. Sections 1 to 30.

The defendants filed a motion under the Federal Arbitration Act, 9 U.S.C. Section 4, to compel arbitration and stay litigation of claims under these two federal “electronic eavesdropping” statues pursuant to a licensing agreement in the downloaded software purporting to mandate arbitration of all disputes between consumers and provider (except intellectual property disputes).

In response to the defendant’s motion, the plaintiffs testified (the court allowed discovery) that they agreed to subscribe to the Communicator software program. But the Web page did not include an announcement that a potential user of SmartDownload must “scroll down” and strike a computer key (“clickwrap”) affirmatively agreeing to the terms of the contract containing the license provision and its arbitration clause.

According to the plaintiffs, the arbitration clause in the license agreement applicable to the second software program (SmartDownload) did not appear on the page advertising the main software (Communicator). The complaint alleged that this second program violated the federal statutes.

To determine whether the complaint was subject to arbitration, the court initially analyzed whether the parties had formed a contract containing the arbitration clause. Under the federal Arbitration Act and the California Arbitration Act, the court initially must apply state law to determine the existence of a contract and the validity of an arbitration clause. See 9 U.S.C Section 2.

California law validates electronic signatures (Civil Code Section 1633.7(b)), as does federal law (15 U.S.C. Section 7001), but to enforce a contract, the signatory must “assent” to the terms. A prospective purchaser of an item clicking a keystroke on a computer does not form a contract if the offer did not clearly signify this act constitutes consent. Windsor Mills Inc. v. Collins & Aikman Corp., 25 Cal.App.2d 987 (1972).

In the world of paper contracts, the document typically recites the terms of the agreement, and any failure of a party to read the content is not a defense to its enforcement, although in the commercial world, numerous trades and industries agree to terms, including arbitration, by custom and practice. Register.com Inc. v. Verio Inc., 126 F.Supp.2d 238 (2002).

But in the electronic world, this assumption loses its force. An Internet seller of software must put the consumer on “notice” of the terms of the contract. Manifestation of assent in the electronic world, said the court, must be clear and unambiguous.

In Specht, the plaintiffs did not see the licensing agreement for the second software program, despite subscribing to the initial advertised program, without instruction to “scroll down” to the next page on the Web site. No contract was formed, said the court, without the provider informing the consumer of this additional act necessary to form the contract.

The court distinguished cases containing arbitration clauses in the sale of packaged software bought off the shelf or a tangible product purchased online over the Internet. In each case, the seller of the software products included printed warnings to the purchaser (“shrinkwrap”) or other methods of “notice” that arbitration serves as the forum for disputes. Hill v. Gateway 2000 Inc., 105 F.3d 1147 (7th Cir. 1997).

Although the plaintiffs did not allege fraud, California regulates online transactions in its consumer fraud statue, Businesses & professions Code Section 17538.

Because the parties had signed the original software contract for Netscape Communicator and were bound by its licensing agreement containing the arbitration clause, the court had to determine whether its terms were broad enough to include coverage of the second and related agreement (SmartDownload).

As a general rule, if a court finds a contract valid and enforceable under state law, the arbitration clause is tested under principles of “arbitrability” to determine its scope; i.e., the issues and parties subject to arbitration. The typical “broad” arbitration clause is entitled to a presumption of arbitrability, and, in Specht, this characterization applied to language in the licensing agreement that “all disputes relating to this Agreement… shall be subject to final and binding arbitration in Santa Clara County, California.”

The court measures the scope of an arbitration clause by reviewing the complaint and determining whether the claim asserted implicates issues of contract construction or the rights and obligations of the parties under it. If the complaint presents neither of these issues and is collateral to the terms of the arbitration clause, its scope is exceeded and inapplicable. The court focuses on the factual allegations in the complaint, no the legal nomenclature in resolving that issue.

In reading the allegations in the Specht, complaint, the court concluded that the plaintiffs had clearly distinguished between the two software programs and specifically identified only SmartDownload as violative of the federal act.

The court concluded that the complaint alleging violation of federal statutes prohibiting “electronic eavesdropping” did not include issues of contract construction or the rights and obligations of the parties under its terms. Although both statutes sound in "fraud", the court adopted the factual allegations of the complaint rather than its legal conclusion.

In Specht, the court chose to rely on venerable rules of contract formation. Despite the technological revolution, the common law rules retain their vitality. The court concluded with an admonition: “Reasonably conspicuous notice of the existence of contract terms and unambiguous manifestation of assent to those terms by consumers are essential if electronic bargaining is to have integrity and creditability.

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