Yesterday, the Consumer Product Safety Commission (CPSC), in conjunction with fast-food giant McDonald’s®, voluntarily recalled about 12 million Shrek Forever After™ collectible drinking glasses sold or awaiting sale at McDonald’s® locations throughout the U.S. after someone in Representative Jackie Speier's (D-CA) office alerted the CPSC that the movie-character illustrations on the glasses contained cadmium, prolonged exposure to which may pose a serious long-term health risk.
McDonald's web site addresses the recall through a series of FAQs (and answers). (For the benefit of those with short attention spans, every answer to which the statement would be germane includes the statement "the CPSC has said the glassware is not toxic.") Arc International deployed a press release. Representative Speier posted a statement on her web site, which also includes a link to a Los Angeles Times article about the recall. Only DreamWorks™ appears to be mum on the subject -- so far, at least. (Perhaps the Shrek-iverse's creators didn't retain all of the product licensing-rights like George Lucas did, not so long ago and not so far away, with the original Star Wars™ trilogy or they made McDonald's pay a non-refundable lump sum to market the glassware.) Rumors of a replacement glass featuring an image of McDonald's CEO Jim Skinner that transmogrifies into a Shrek-alike when filled with any non-Coca-Cola® brand soft or sport drink appear to be completely unfounded.
Last month, I posted a call for proposals for a program and print symposium on the recently-approved Principles of the Law of Software Contracts. Here's an overview and remarks from Reporter Bob Hillman for the benefit of those who have not already read them on Concurring Opinions or ContractsProf.
Maureen O’Rourke, the Associate Reporter on the Principles of the Law of Software Contracts, and I are posting the following to acquaint readers with the Principles and also to respond to some criticism of one section of the Principles that creates, under certain circumstances, an implied warranty of no known material hidden defects in the software.
On May 19, the membership of the American Law Institute unanimously approved the final draft of the Principles of the Law of Software Contracts. As the Introduction to the project states, the Principles “seek to clarify and unify the law of software transactions.” The Principles address issues including contract formation, the relationship between federal intellectual property law and private contracts governed by state law, the enforcement of contract terms governing quality and remedies, the meaning of breach, indemnification against infringement, automated disablement, and contract interpretation.
The Introduction to the Principles explains further that “[b]ecause of its burgeoning importance, perhaps no other commercial subject matter is in greater need of harmonization and clarification. . . . [T]he law governing the transfer of hard goods is inadequate to govern software transactions because, unlike hard goods, software is characterized by novel speed, copying, and storage capabilities, and new inspection, monitoring, and quality challenges.” Many of the rules of Article 2 of the UCC therefore apply poorly to software transactions or not at all, and the Principles are intended to fill the void.
The Principles are not “law,” of course, unless a court adopts a provision. Courts can also apply the Principles as a “gloss” on the common law, UCC Article 2, or other statutes. Nor do the Principles attempt to set forth the law for all aspects of a transaction, but instead rely on sources external to the Principles in many areas.
The Principles apply to agreements for the transfer of software or access to software for a consideration, i.e., software contracts. These include licenses, sales, leases, and access agreements. The project does not apply to the exchange of digital media or digital databases. It applies a predominant purpose test to determine applicability to transactions involving embedded software or software combined in one transfer with digital media, digital databases, and/or services.
We are the Reporter and Associate Reporter of the software principles. We have been greatly aided by our advisors, consultative group members, ALI Council members, liaisons from the National Commissioners on Uniform State Law, Business Software Alliance, and the American Bar Association, and many additional lawyers from industry and other groups who, over the last five and one-half years, have met with us, talked with us on the phone, and exchanged e-mails with us. We believe the project moved along smoothly largely because of the efforts of all of these groups and individuals.
Nevertheless, in the two weeks leading up to approval in May, we received communications from a few software providers evidencing concern largely with one section of the Principles. Section 3.05(b) creates a non-excludable implied warranty that the software “contains no material hidden defects of which the transferor was aware at the time of the transfer.” The section only applies if the transferor receives “money or a right to payment of a monetary obligation in exchange for the software.” Because the section may be the most controversial provision, we devote the rest of this post to the issue.
Despite concerns that section 3.05(b) creates “new law,” it simply memorializes contract law’s disclosure duties and tort’s fraudulent concealment law. The section makes clear that these rules apply to software transfers in order to allocate the risk to the party best able to accommodate or avoid the costs of materially defective software. Obviously this is the transferor in situations where only it knows of the material defect and the transferee cannot protect itself. The section requires that the transferor knows of the defect at the time of the transfer (negligence in not knowing is not enough to trigger liability), the defect is material, and it is hidden.
A few software providers have concerns that the concepts of “hidden,” and “material defect” are obtuse and will “increase litigation” or require a flood of “detailed notices” to prospective users. These concepts, however, are hardly unknown to the law. A comment to section 3.05(b) says that a “hidden” defect occurs if the “defect would not surface upon any testing that was or should have been performed by the transferee.” This is nothing new. See, e.g., UCC 2-316(3)(b) (“there is no implied warranty with regard to defects which an examination ought in the circumstances to have revealed to [the buyer]”).
A few software providers also worry about the meaning of “material defect.” The comments to section 3.05(b) point out that the section simply captures the principle of material breach: Does the defect mean that the transferee will not get substantially what it bargained for and reasonably expected under the contract? The criticism that “materiality” is too vague, if accurate, would mean that contract law would have to abolish its material breach doctrine too.
Putting together the requirements of actual knowledge of the defect at the time of the transfer, that the transferee reasonably does not know of the defect, and that the defect constitutes a material breach means that a transferor would be insulated from liability in situations identified by the concerned software providers as problematic. These include where the transferor has received reports of problems but reasonably has not had time to investigate them, where the transferee’s problems are caused by uses of which the transferor is unaware, where the transferor learns of problems only after the transfer, and where the problems are benign or require reasonable workarounds to achieve functionality. The best example of when section 3.05(b) would apply is, as comment b to the section says, where the transferor already knows at the time of the transfer that the software will require “major workarounds . . . and cause[] long periods of downtime or never [will] achieve[] promised functionality,” the transferee cannot discover this for itself, and the transferor chooses not to disclose the defect.
As we have already said, the section simply memorializes existing law. Under the common law, a contracting party must disclose material facts if they are under the party’s control and the other party cannot reasonably be expected to learn of the facts. Failure to disclose in such circumstances may amount to a representation that the facts do not exist and may be fraudulent. See, e.g., Shapiro v. Sutherland, 76 Cal. Rptr. 2d 101, 107 (Cal. Ct. App. 1998) (“Generally, where one party to a transaction has sole knowledge or access to material facts and knows that such facts are not known or reasonably discoverable by the other party, then a duty to disclose exists.”); Hill v. Jones, 725 P.2d 1115, 1118-19 (Ariz. Ct. App. 1986) (“[U]nder certain circumstances there may be a ‘duty to speak.’ . . . [N]ondisclosure of a fact known to one party may be equivalent to the assertion that the fact does not exist. . . . Thus, nondisclosure may be equated with and given the same legal effect as fraud and misrepresentation.”). The Restatement (Second) of Contracts section 161(b) states that “[a] person’s non-disclosure of a fact known to him is equivalent to an assertion that the fact does not exist . . . where he knows that disclosure of the fact would correct a mistake of the other party as to a basic assumption on which that party is making the contract and if non-disclosure of the fact amounts to a failure to act in good faith and in accordance with reasonable standards of fair dealing.” Section 161, comment d of the Restatement (Second) adds “In many situations, if one party knows that the other is mistaken as to a basic assumption, he is expected to disclose the fact that would correct the mistake. A seller of real or personal property is, for example, ordinarily expected to disclose a known latent defect of quality or title that is of such character as would probably prevent the buyer from buying at the contract price.”
One concern of a commentator is that fraudulent concealment is a tort, implying that it has no place in the Principles. But the principle appears prominently in the Restatement (Second) of Contracts section 161. And why not memorialize a principle that discourages a party in a contract setting from hiding material facts that the other party reasonably does not know? The commentator notes that fraudulent concealment requires intent to deceive, but wouldn’t that be the usual inference if a transferor licenses software it knows is materially defective and knows the transferee cannot discover it?
A few organizations also are concerned that section 3.05(b) cannot be disclaimed. But there are plenty of cases that do not allow a party to contract away liability for concealment. One critic wonders why a statement such as “I am not giving any assurances about there being no defects in this software,” should not insulate a transferor from liability. A reasonable licensee, assuming the good faith of the licensor, would believe that this licensor does not intend to make any express warranties or implied warranties of merchantability or fitness, not that the licensor knows that the software is materially defective so that the software will be largely worthless to the licensee. A transferor playing this game is surely in bad faith and, frankly, engaging in reprehensible conduct. But there is a way to ensure no liability under this section, namely to disclose material hidden defects. In effect, disclosure is the disclaimer.
Bob Hillman and Maureen O’Rourke
June 2, 2009
The Concurring Opinions post -- which Bob asked me to re-post, with the blessings of the Concurring Opinions folks -- has provoked several comments and has been the subject of a follow-up post by David Hoffman, one of Concurring Opinions's regular contributors. Dave's post has generated its own comments. While we here at Commercial Law might have a vested interest in generating site traffic, it may be more efficient to funnel feedback through a single conduit. Because Concurring Opinions got the ball rolling, feel free to comment, or to respond to existing comments, there.
The AALS Contracts list-serve two months ago carried a stream of interesting comments around the question whether contracts should be taught in four or six hour blocks of time. These discussions have been brought by the need to inject other things into the first year curriculum, such as skills courses, constitutional law, etc... (which I am all for). However, I want to offer a different proposal than a mere reduction of hours -- maybe we shouldn't teach contracts to first year students at all. Instead perhaps we should teach students in the first semester Article 2 of sales. Here are my reasons, in no particular order of significance. By the way, you can disparage me in person if you are going to the Contracts Panel at SEALS this summer, as this will be the basics of my presentation...
1. Its a Legislative World and I'm a Legislative.... The same argument I consistently hear justifying common law contracts as a First Year Course is that it teaches students how to read cases. First, doesn't Torts, Property, Criminal Law, and Civil Procedure do equally fine jobs of teaching students how to read cases? Second, and more importantly, where in the first year curriculum are we teaching students how to read statutes and Codes. We are not, and as a result, when students come to take a code based course, they repeat their first year growing pains again by by having to learn how to read and analyze statutes. Sales provides a great opportunity to fill the legislative gap and still .....
2. Introduce Students to the basic principles of contracting. Offer, assent, parole evidence, statute of frauds, battle of the forms (of course) impossibility, remedies... Its all there. The difference is two fold: one, the material is in a more concrete format in the form of a code; and two, the material becomes more understandable because students have a familiar and definite context for understanding specific rules like parole evidence, statute of frauds exceptions and the battle of the forms. As I tell my UCC students, we have all bought candy bars by the time we get to law school and we know the essence of the process --I give you money and you give me a Snickers. We now are putting definite terms to that process.
3. Is Common Law Contracts that relevant anymore? Sure the basic principles of offer, acceptance, etc.... in some form stretch the gambit of contracting. But our legal system has created so many different types of contracts that each vary in nuanced ways from each other. Employment contracts are different from sales contracts which are different than construction contracts, which are different from licenses and so on and so on. The idea that we are teaching general principles that stretch through the curriculum falls apart when students learn that each of these different contracts have their own unique language and terminology that renders the common law of contracts at best a quaint introduction to the sport of creating obligations. Add to that fact that much of contracting gets reduced to form-negotiations and contracting as an art becomes mostly irrelevant. If contracting were taught as an exercise in transacting, I believe it would be far more effective. One of the comments from the contracts list-serve discussion that I really appreciated came from Peter Linzer, in which he said:
At a less abstract, but much more practical level, I have for a long time been advocating a shift from Contracts as a course in busted deals to a course in what real contracts lawyers do, advising clients, helping them to plan, and getting the plan on paper through good drafting. I’m still trying to slip a bit of that into my four-credit course, but I can’t really change much. Some parts of Contracts must be taught from the cases (interpretation, the parol evidence rule, remedies, the click-wrap issues (which, of course, are also part of the transactional part of the process)). But the real task of preparing students to be transactional lawyers needs to be taught differently, and can’t be covered well in a four credit course. I can teach a class of 100 how to draft, but I can’t review their work to raise them beyond the very basics. That has to be covered in a more advanced course. But if we can sensitize students to what contract lawyers really do, and the important role of drafting and planning, we can greatly improve the abysmally low level of quality among most business lawyers, especially those dealing with small businesses. That, however, needs much more time than is available in a four hour course.
I concur.
4. Teaching common law contracts does not necessarily prepare students for the bar exam. First of all, students rarely retain what the parole evidence rule is versus the statute of frauds between the end of their contracts course and the beginning of their second year (or they may just deny any knowledge of those things in class). Moreover, we have pretty well ceded bar preparation to Bar-Bri, Mishmash, or what ever other cram course students are willing to fork out $2500 to cram long-forgotten doctrines in their minds. Have we all of a sudden become less confident in bar-review's capacity to teach contract doctrine as well? It seems to me that most professors I talk to vehemently deny that they are teaching for the bar (which I do as well). So why would we teach a course on that basis.
5. For that matter, Sales does not prepare students for the bar exam either, but there is a trickle down effect. In the same way that contracts does not necessarily create a long-term knowledge of contracts doctrines, neither will Sales. Though, at least by teaching sales early, we open the door for other UCC courses to be more accessible to students. Students that take Article 9 or Article 3-4, are more likely to be prepared for courses like bankruptcy, debtor and creditor rights, taxation, and corporations. Getting students in the sales curriculum earlier rather than later aids that process.
6. Wouldn't we all be happier teaching a perspectives-esque upper level course on the theory of contracts. Really isn't that what we all really want to teach anyway. This to me is the best use of the contracts course and one that often gets pushed aside for lack of hours or because students are not quite ready to understand these nuances. This is the art of preparing lawyers: equipping them with the intellectual tools to make rational decisions regarding how contracting should be undertaken. Forcing students to struggle through Law and Economics views of contracting, moral theory of contracting, etc... before they truly understand the contracting process seems to me to be reversed. Students will learn more and professors will be happier with the result.
The only upside to the contracts course is it might make the classic movie, The Paper Chase irrelevant, though I think I can live with that -- I think.
Marc (MLR)
