PRINCIPLES OF THE LAW OF SOFTWARE CONTRACTS

Monday, June 29, 2009 | 9:00 a.m. PST

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PRINCIPLES OF THE LAW OF SOFTWARE CONTRACTS

Mark RadcliffePartnerCorporate and SecuritiesDLA Piper

Jeffrey SternExecutive DirectorLaw DivisionMorgan Stanley

Karen CopenhaverPartnerChoate, Hall & Stewart LLP

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Mark Radcliffe

Mark Radcliffe is a partner at DLA Piper and counsels companies in their intellectual property and licensing matters.  He is the outside General Counsel of the Open Source Initiative on a pro bono basis. In 2009, he was named by Intellectual Asset Management Magazine as one of the World’s Leading 250 IP Strategists. In 1997, he was named by the National Law Journal to their list of 100 Most Influential Lawyers in the US.

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DLA Piper

The Firm

Lawyers in 67 offices and 29 countries

The US practice includes approximately 1,400 lawyers

In Europe and Asia, the firm has approximately 2,300 lawyers

The largest law firm in the world by number of lawyers and the only firm in the world with 1,400 lawyers on each side of the Atlantic

Our Clients

We represent more than 140 of the top 250 companies in the Fortune 500

We represent nearly half of the FTSE 250 or their subsidiaries

For top 200 clients, average revenue has increased more than 400% over a five-year period

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Jeff Stern

Jeff Stern is Chair of Association of Corporate Counsel's IT, Privacy & eCommerce Committee. He is an Executive Director in the Law Division of Morgan Stanley. He is Chair of the Securities Industry and Financial Markets Association Open Source Working Group and served in that capacity on Committee C in drafting the General Public License Version 3. Jeff is included in Who’s Who in the World and Who’s Who in American Law.

*The views expressed by Jeff are not necessarily those of Morgan Stanley.

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ACC IT, Privacy & eCommerce Committee (“ITPEC”)

Over 4,000 in-house counsel members practicing IT, privacy or ecommerce law Licensees, Licensors Large companies, Small Companies Range of industries

Information sharing Regular calls, presentations, events, collaboration with local chapters

Advocacy role The Principles Privacy best practices IT & ecommerce law

You are invited to join at www.acc.com if you are not a member already.

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Karen Copenhaver

Karen Copenhaver is a partner at Choate, Hall & Stewart LLP and counsels business clients in the drafting and negotiation of strategic alliances, technology transfer and licensing of intellectual property.  She is the Director of Intellectual Property Strategy at the Linux Foundation and is listed in Chambers USA. In 2009, she was named by Intellectual Asset Management Magazine as one of the World’s Leading 250 IP Strategists. 

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Choate, Hall & Stewart LLP

One of the nation’s leading law firms

Focus on core group of specialized services

200 lawyers located in Boston all under one roof

• Clients include public and private companies, private equity and venture capital firms, Fortune 500 companies, leading financial institutions and wealthy individuals

Lawyers throughout practice areas consistently receive national recognition

CHOATE HALL & STEWART LLP

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What is a “Principle”

ALI has characterized Principles as “expressing the law as it should be, which may not reflect the law as it is.”

“These Principles seek to clarify and unify the law of software transactions . . . Instead of restating the law, a Principles project accounts for the case law and recommends best practices . . . a Principles project is not the law unless and until a court adopts it.”

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Why Should You Care?

The Principles propose substantial changes to existing case and statutory law Represent a decided shift in the balance of interests underlying existing law Written for judges, these proposed changes will not go through legislative

review ALI is obviously a very prestigious and highly regarded institution and the

Principles are likely to be used by judges UNCITRAL is already considering adopting for other countries

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How did we get here?

ALI’s longstanding policies prohibit the free distribution of draft documents and are not designed to invite public comment

Many individuals and organizations tried to intercede to delay adoption and to encourage ALI to invite input from the industry and other interested parties

Letter on behalf of OSI and the Linux Foundation

http://www.slideshare.net/markradcliffe/osi-and-linux-foundation-letter

Letter on behalf of Microsoft and the Linux Foundation

http://www.slideshare.net/markradcliffe/microsoft-linux-foundation-letter1

Letter on behalf of ITPEC

http://www.slideshare.net/markradcliffe/acc-itpec-letter-and-discussion-points-re-ali-principles-of-the-law-of-software-contracts-5-11-09x

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ITPEC and the ALI Principles of the Law of Software Contracts

ITPEC not focused on the Principles until March ‘09

Principles did not receive same attention as its predecessors in UCC 2B or UCITA because same level of approval not required

Asks Judges to adopt on a “voluntary” basis significant changes in law without legislative action or common law precedent

ITPEC contacted the ALI Reporter leading the project in April

Started dialogue/scheduled comments and call

Mobilized ITPEC subcommittee to review and comment on the Principles

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ITPEC and the ALI Principles of the Law of Software Contracts

May 11, 2009 Letter to ALI Targeted a dozen areas raising concerns

“would create uncertainty, introduce cost and limit flexibility for businesses and consumers without a clear benefit”

Requested (i) broader involvement by in-house counsel, (ii) extension before Principles finalized, and (iii) draft Principles should be posted on Internet for comment free of charge

Follow up communication between ITPEC and ALI ALI agreed to incorporate some changes but agreement to disagree on

most issues

In mid-May ALI approved the Principles for publication ALI is still revising and will release final draft shortly

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Major Issues

Non-disclaimable Warranty of no Hidden Material Defects (Section 3.05)

Implied obligation to Indemnify against Infringement (Section 3.01)

Standard Form of Transfer (Section 2.02)

Disclaimer of Warranties (Sections 3.02, 3.06 and 4.01)

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Section 3.05 Other Implied WarrantiesNo Hidden Material Defect

“A transferor that receives money or a right to payment of a monetary obligation in exchange for the software warrants to any party in the normal chain of distribution that the software contains no material hidden defects of which the transferor was aware at the time of the transfer. This warranty may not be excluded. In addition, this warranty does not displace an action for misrepresentation or its remedies.”

The Principles explain that “[a] defect exists if the software is not fit for its ordinary purposes” and that “[n]egligence on the part of transferors in failing to discover defects is not covered by the Section and is the subject of products-liability law.” The Principles state, “[s]oftware that requires major workaround to achieve contract-promised functionality and causes long periods of downtime or never achieves promised functionality ordinarily would constitute a material defect.” The Principles state that this new, non-disclaimable warranty does not replace a separate claim for misrepresentation.

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Section 3.05 Other Implied WarrantiesPotential Problems

Severely limits freedom of contract; is inconsistent with other statutes: all implied warranties are disclaimable under UCC, Magnusson Moss Warranty Act and Song Beverly Warranty Act What is the problem which this provision is determined to solve? Why is this remedy needed in the software context in particular?

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Section 3.05 Implied Warrantyof No Hidden Material Defect

What does it mean for a company to be “aware” of a hidden defect? What does “defect” mean, particularly in the context of software in which

there are tradeoffs between different legitimate development approaches that could, with the benefit of hindsight, be recast as defects? Security tradeoffs, System limitation tradeoffs, Betas/early releases

What happens when a material defect is “found” ? Opens door to litigation

Lure of unlimited liability: disclaimers, including of direct and consequential damages, do not apply

Discovery costs

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Section 3.01 Implied Indemnification Against Infringement

Similar to UCC warranty of non infringement: Software transferor who deals in software of the kind or holds itself out as

having special knowledge or skill

Receives money or a right to payment of monetary consideration

US federal or state intellectual property law at time of transfer

Indemnify and hold harmless software transferee

Disclaimer possible Only if in a “record”, is conspicuous and uses language that gives

transferee reasonable notice

Course of performance, course of dealing, usage of trade

Note: Disclaimer of all “implied warranties” is per se not sufficient

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Infringement Remedies (Section 3.01(b))

“The transferor must pay those costs and damages incurred by the transferee that are specifically attributable to such claim or those costs and damages agreed to in a monetary settlement of such claim.”

“If a court enjoins the transferee’s use of the software or holds the software infringing . . . transferor may be liable for [expectation damages] . . . and . . . must” Procure right to continue to use software Replace or modify software with non-infringing; or Cancel and refund fees (prorated)

“Transferor must also reimburse the transferee for incidental expenses incurred in replacing the software . . . .”

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Standard Form of Transfer

“Standard form of transfer of generally available software” is defined as “a transfer using a standard form of (1) a small number of copies of software to an end user; or (2) the right to access software to a small number of end users if the software is generally available to the public under substantially the same standard terms” (see Section 1.01(l)). This definition thereby extends consumer protections to both large and

small businesses

*  Examples include requirement for businesses to post license terms on Internet, no modification of terms without a “fresh” clickthrough (notice not sufficient), terms must be “reasonably comprehensible” by person of ordinary intelligence, choice of law and forum less likely to be upheld, easier for licensees to override disclaimers including by asserting express warranties, and ban on use of automated disablement

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Standard Form of Transfer

ITPEC position: Businesses can negotiate for themselves and are not in need of

heightened consumer protection Consumers also act collectively to reject undesirable license terms

For example, in response to consumer criticism Facebook recently rolled back changes to its terms of use, and

Google recently narrowed the scope of its use of information obtained from consumers licensing its Chrome browser.

The Reporter agreed with the ITPEC to clarify that Principles do not apply to business to business ecommerce or ecommerce web sites such as Amazon where the primary purpose of the interaction is to enter transactions as opposed to licensing software.

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Section 2.02 Standard-Form Transfers of Generally Available Software; Enforcement of the Standard Form

The effect of the transfer not qualifying as a “standard-form transfer” is unclear

Clause (e) seems to imply that in such cases the agreement may not be enforceable. Reporter said this was not necessarily the case and Section 2.01

(“Formation, Generally”) applies. 2.01, however, refers to contracts with one or more open terms

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Section 3.06 Disclaimer of Express and Implied Quality Warranties

Express and Implied Warranties addressed in Section 3.01 through 3.05

Section 3.06 requires that all disclaimers be “conspicuous” The comments explain that the location of the disclaimer “weighs

heavily” and that disclaimers that are not displayed on the “one of the first few screens” will not be enforceable (page 203).

Implied Warranty of No Material Hidden Defects is not disclaimable. Other implied warranties may be disclaimed by course of performance,

course of dealing, or usage of trade Consequential damages may not be limited for a breach of Implied

Warranty of No Material Hidden Defects (Section 4.01)

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Conclusions

Principles represent a significant change in the law

A move from freedom of contract to “prescriptions”

Would require expensive changes to common practices of dubious benefit

Expand consumer type protection to commercial and retail transactions in a single industry

Would add uncertainty and increase litigation

Next steps