Legal Issues in Contracting on the Internet


Internet Law Practice Group

Online contracting raises novel legal issues that any business attempting to set up an online contracting site should consider. However, most legal hurdles can readily be overcome by appropriately structuring the web site, entering into an electronic trading agreement, or (in the rare case) performing one or more steps of the transaction off line.

Clients frequently wonder what legal pitfalls they may encounter in setting up a web page for online contracting. In fact, contract law principles such as offer and acceptance, or the requirement of a signed writing, can generally be accommodated on the Internet. In some ways the Internet is the ideal environment for entering into contracts, as many companies are discovering. However, certain practical differences between online and offline contracting should be kept in mind.

Issues Regarding Formation of an Online Contract
Requirement of Writing on Paper and Providing a Signature
Legal Requirement of a Writing and Signature
Digital Signature Legislation
Utah's Digital Signature Legislation
California's Digital Signature Legislation
Illinois' Digital Signature Legislation
Other States' Digital Signature Legislation
The Mailbox Rule
Determining the Terms of a Contract
Special Issues Regarding Handling Money Over the Internet
Conclusion
About the Author

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Issues Regarding Formation of an Online Contract
On the Internet, as in the off-line world, a contract is formed when there is a bargain in which there is a manifestation of mutual assent to the exchange and a consideration. Various forms of online conduct can constitute an offer or acceptance, and black letter contract law states that the maker of an offer has the right to define how the offer may be accepted. Thus, on the Internet, one may post an offer and define any other reasonably appropriate online conduct ("click here to accept offer") as the only permissible way to accept the offer. However, demonstrating that a given act was intended to constitute acceptance of an offer is easier if the conduct defined as "acceptance" is clear and unambiguous. Requiring the purchaser to type "I accept" in a box is better than stating, "hit any key to accept."

The rule that the offeror is the "master of the offer" means, among other things, that an offer may dictate that it can only be accepted by a limited class of persons. The ability to define the class of persons who may accept an offer takes on additional significance online due to the cross-jurisdictional nature of Internet communications. Online offers which may be accessed by the entire world may be illegal when made to persons in certain jurisdictions, or when directed toward certain classes of person such as minors. Securities brokers, insurance companies, and others, whose ability to solicit business in regions where they are not licensed or registered is strictly circumscribed, use such disclaimers in an attempt to avoid regulatory difficulties in those jurisdictions. The good news is that regulators seem to be giving substantial weight to such disclaimers in determining whether web pages accessible in their jurisdiction constitute violations of local law.

As in the off-line world, an offer must be distinguished from a mere advertisement or display of goods as to which inquiries of interest are invited. But if an advertisement meets the requirement of an offer, that is if it manifests an intent by one party to be bound upon the acceptance by another party, the offer is good until withdrawn and can be accepted by anyone to whom it is directed. Any ambiguities on this score are relatively easy to avoid online, perhaps easier than in the off-line world, given the formalities that necessarily accompany an invitation to enter into an online contract (exchange of identity information, credit card information and the like).

It is a general principle of contract law that a party can be bound by the acts of agents endowed with apparent authority to act on its behalf. An agent has apparent authority if a party acts in such a way so as to make it reasonable for a third person to believe that the agent is acting on its behalf. In the online world, a computer program may act as an online agent, and a party will presumably be bound by offers and acceptances performed by a computer or program acting on a party's behalf.

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Requirement of Writing on Paper and Providing a Signature
As anyone who has dealt with complex contracts knows, when an agreement is spread over multiple, potentially inconsistent documents at different times it sometimes becomes difficult to determine exactly what the parties agreed upon. As a result, parties strive to reduce a contract to a single written document, or at least a limited number of separate writings which can be collected and preserved for future reference. Courts may consider the "four corners" of the contract as embodying all the necessary and agreed upon contract terms, and may disregard terms and representations contained in documents, or made orally, which are not reflected within those four corners. Many contracts contain an "integration clause" further stating the parties intent that the contract itself embodies all relevant terms.
Given the fast moving, interactive nature of the Internet environment, thought must be given in electronic contracting as to what will constitute the "four corners" of the electronic contract, how that understanding will be manifested, and how the contract terms will be preserved for future reference. Where computers communicate with one another and enter into contracts through agent software, the "contract" may be wholly unreadable by a human being without the assistance of a computer. Moreover, one cannot necessarily have the same confidence that an electronic file has been preserved unaltered since contract inception in the way that one can analyze a piece of paper for tampering.
Similarly, a signature serves certain practical functions, including (1) an evidentiary function (proving what the contact was), and (2) a cautionary and symbolic function, which makes the participant aware that his or her actions will be interpreted as having legally binding consequences. Persons engaged in electronic contracting need to consider how their contracting procedures online meet these same needs in electronic form.

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Legal Requirement of a Writing and Signature
The Uniform Commercial Code ("UCC") has been adopted as a matter of state law with slight variations in the various states. It contains a provision referred to as the "statute of frauds" which requires that contracts for the sale of goods over $500 be in writing:

"A contract for the sale of goods for the price of $500 or more is not enforceable by way of action or defense unless there is some writing sufficient to indicate a contract for sale has been made between the parties and signed by the party against whom enforcement is sought or by his authorized agent or broker."

The UCC defines a "writing" to include, "printing, typewriting, or any other intentional reduction to tangible form." It defines "signed" to mean the use of, "any symbol executed or adopted by a party with present intention to authenticate a writing."

In paper communications these requirements are met in various, flexible ways. Courts have accepted telegraph communications as a writing, even though the written piece of paper generated at the receiving end of the telegraph line was not the same piece of paper handed to the operator by the sender. Telecopied communications have also been accepted on the same principle.

Little authority exists regarding whether electronic files can be regarded as writing within the meaning of the UCC or other laws. Parties that trade together frequently may eliminate some of the ambiguity that continues to surround the requirement of a writing or a signature by entering into a trading agreement that specifies that electronic communications satisfying certain criteria are deemed by the parties to constitute a signed writing. The American Bar Association Model Electronic Trading Party Agreement is available as a model. In such an agreement the parties may specify, for example, that any document received electronically with adequate identifying characteristics and which is subsequently maintained in a form which allows it to be reduced to a paper copy will be effective between the parties as a signed writing.

The uncertainties of enforcing electronic writings or signatures in court are irrelevant to most online merchants. Such concerns are material only when the size of individual transactions is significant, payment is not obtained prior to delivery of the good in question (i.e., where no credit card number is obtained), and where there is no other ongoing relationship of trust, leverage or agreement between the parties. As a result, the legal uncertainties surrounding writing and signature requirements are not substantial impediments to most parties desiring to transact electronically.

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Digital Signature Legislation
Partly in an effort to address these concerns, an enormous amount of electronic and digital signature legislation has been introduced in state legislatures and the federal Congress in the past two years.

Such legislation typically aims to achieve one or both of the following goals: (1) requiring courts and governments to accept electronic signatures as meeting the writing and signature requirements already present in the UCC and other laws, and (2) setting up protocols and procedures for the use of a special category of secure electronic documents which will presumptively be considered valid and accurate.

Over seventy different laws have been passed dealing in one form or another with electronic signatures in the past several years. Many of them deal only with limited subject matters, such as requiring one or more state agencies to accept electronic documents in satisfaction of a statutory or regulatory requirement of a writing, as in the area of government procurement or regulatory filings. Others merely attempt to put electronic documents and signatures on an equal footing with paper documents and ink signatures. The three examples below reflect the different approaches being taken by the various states.

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Utah
Utah passed the first digital signature legislation in 1995. The Utah Digital Signature Act defines "digital signature" to mean only messages encrypted with asymmetric cryptography. In this sense it is prescriptive and lacks flexibility in recognizing new encryption technologies that may arise. Digital signatures are presumed to be valid and enforceable under the statute. The statute further provides that certification authorities will be licensed by the Utah Department of Commerce.

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California
California was also one the first states to pass digital signature legislation. Assembly Bill 1577, enacted in 1995, provides that any digital signature will have equal legal effect as a written signature as long as it meets the following criteria: "(1) it is unique to the person using it, (2) it is capable of verification, (3) it is under the sole control of the person using it, (4) it is linked to data in such a manner that if the data are changed the digital signature is invalidated, (5) it conforms to regulations adopted by the Secretary of State."

Although the California legislation is limited in that it applies only to signatures in communications with public entities, the California model of digital signature legislation has been influential in the debate over digital signatures because it is "non-prescriptive" (i.e. it does not specify that any particular technology be used).

The regulations referred to in the statute were adopted in June, 1998. They provide that either public key encryption or signature dynamics are acceptable security technologies, and impose a duty of care on a person in possession of an encryption key to prevent disclosure of the key to unauthorized third parties. The regulations also set up a system for the qualification of certifying authorities, and provide a framework under which new security technologies can be approved in the future.

Illinois
On August 14, 1998, Illinois adopted the Illinois Electronic Commerce Security Act. The Illinois statute operates at several levels. At the most basic level, it provides that an electronic signature is valid for most documents (although not for wills or for documents of title as to which a paper original is required to exist). It also creates a higher category of electronic document called a "secure electronic signature," defined as an electronic document employing a "qualified security procedure." Such documents are entitled to various evidentiary presumptions of validity, which may be rebutted with appropriate evidence. A "qualified security procedure" is one that is either agreed to by the parties in advance or approved by the Secretary of State. The statute goes on to provide, similar to the Utah statute, that digital signatures using asymmetric cryptography and bearing a certificate of an authorized certifying authority meet the requirements of the statute for a "qualified security procedure." Since the statute contains both non-prescriptive and prescriptive elements, it is sometimes referred to as a hybrid statute.

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Other State Legislation
A recent survey indicated that at least fifteen states have passed digital signature legislation that applies to a broad range of circumstances and transactions, and nineteen states have passed legislation which authorizes the use of digital signatures in narrower fields, such as public filings. Digital signature initiatives are also being considered by the National Conference of Commissioners on Uniform State Laws. Drafts of those model laws have generally taken an approach similar to the Illinois law, in that they perform multiple functions, recognize the validity of electronic signatures in general, and provide presumptions of validity to documents whose authenticity is certified through the use of some form of certified and encrypted digital signature. Like the California and Illinois statutes, these draft model acts generally leave room for the future development of new security devices and do not prescribe that only one technology will satisfy the definition of a secure document or digital signature.

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The Mailbox Rule
Web-based contracting may also help eliminate uncertainty and unfairness inherent in application of the so-called "mailbox rule." Where the method for making an offer and acceptance inevitably requires a time delay of some magnitude, such as where the mail is used, courts apply the so-called mailbox rule. That rule provides that where an offer can be accepted by mail, the mere mailing of the acceptance is deemed to seal the contract regardless of any delays that may result in the receipt of the acceptance by the offeror, or even the failure of the offeror ever to receive it. However, attempts by the offeror to revoke an offer are not effective until received by the offeree. The one-sidedness of the so called "mailbox rule" in favoring offerees means the burden is on the offeror to specify the method by which the offer can be accepted in a way that eliminates any unacceptable risk due to delay in communicating an acceptance.

Note that the mailbox rule applies only in circumstances in which the delivery of the offer and acceptance are necessarily delayed -- it does not apply to contracts negotiated over the telephone, or telex, or in person, or perhaps by fax. The question therefore is whether the courts will consider E-mail and other forms of Internet-based communication to be essentially instantaneous, in which case the mailbox rule will not apply, or to be more analogous to the mail or telegraph, where the rule does apply.

A Web page can be set up so as to eliminate any ambiguity as to when or how a contract is entered into, thereby eliminating concern over application of the mailbox rule. E-mail is not so simple. Sometimes E-mail messages are essentially instantaneous, and sometimes they can be delayed for hours. Where non-instantaneous forms of electronic acceptance are contemplated, the careful offeror will consider this issue and structure the offer in a way to avoid ambiguity. In general, however, the Internet is a favorable environment to avoid contracting ambiguities such as those presented by the mailbox rule.

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Determining the Terms of a Contract
One of the ways in which the Internet is an ideal environment for contracting is in its potential to eliminate confusion over the terms of a contract when offer and acceptance terms differ.

When a party receiving an offer responds with a conditional acceptance, or an acceptance that attempts to vary the terms of the contract, ambiguities result which can result in uncertainty as to the contract terms, or even as to whether there is a contract at all. For example, under the UCC, the rule as between merchants is that if a party accepts an offer to contract but at the same time states additional or varying terms, a contract is still deemed to have been formed. The new or varying terms are considered part of that contract if the acceptance explicitly states that the acceptance is conditional on agreement to the new terms. But those new terms will not be considered binding if the offer stated expressly that acceptance would be limited to the terms of the offer, nor will the new terms apply if they materially change the contract, or if notification of objection to the new terms is sent in a reasonable time.

The problem often occurs when parties exchange pre-prepared form contracts, purchase orders and the like, with conflicting terms, resulting in the so-called "battle of the forms." As long as there is agreement on key terms such as number, price, timing, etc., the parties may not even notice that conflicts exist as to some of the more obscure terms such as choice of law and choice of forum clauses, arbitration clauses and the like.

The UCC handles this issue by providing, first of all, that despite lack of perfect agreement on contract terms, if the parties proceed to act as if a contract is in place (i.e., by actually exchanging goods or money) a contract will be held to exist. The terms of the contract will be the terms on which the parties specifically agreed, although other terms may also be made part of the contract by the UCC.

The Internet is an ideal environment to avoid these sorts of uncertainties. On the Internet, the offering party can restrict the other party to a limited range of options for making an acceptance. Offering a choice of one or more boxes where the other party must click or type "I accept," and leaving no possibility for the other party to modify the terms, makes it clear that the offer is being made and accepted on the terms specified in the offer, without modification. Similarly, many parties using EDI (electronic data interchange), a non-Internet form of E-commerce, provide that free text which cannot be read by the other party's computer is deemed ineffective. A similar condition could be placed on an E-commerce Web page as well to avoid the battle of the forms. In addition, web pages can readily be structured to document that the responding party has indicated its awareness and acceptance of important terms such as limited warranties.

Some of the above ambiguities can be eliminated between contract parties by entering into an agreement that specifies how the parties will handle issues such as the form of an acceptance, varying acceptance terms and the like. The American Bar Association has created a Model Electronic Data Interchange Trading Partner Agreement to achieve this purpose. The Model Agreement provides that an acceptance is valid when received by the recipient at a location held out by that person as a place for receipt of such messages (e.g., a company E-mail system). Under this provision the acceptance is valid even if the message is not read (like the mailbox rule), but it does have to be "received." Provisions also exist for acknowledging receipt of messages to further reduce ambiguity. The Model Agreement also offers the parties the opportunity to use an electronic "acceptance document" to further reduce ambiguity as to what counts as a valid acceptance. Also, unlike the common law rule, the Model Agreement provides that revocation of an offer is valid if it is received by the offeree before the acceptance is received by the offeror. The Model Agreement also deals with responsibility that attaches to a party who receives a partially garbled message.

Sometimes electronic contracting takes place in very abbreviated form, through the exchange of basic terms such as model number, price, quantity and the like. In those circumstances, legal "boilerplates," such as warranties, payment terms and conditions, delivery terms, how nonconforming goods will be handled, etc., may be omitted from the contract terms altogether. In that case the missing terms will be supplied by the UCC, or may be inferred from prior course of dealing between the parties, trade usage or the like. Parties to electronic commerce may wish to avoid these ambiguities by specifying how these matters will be handled in their master electronic trading partner agreement or in the master vendor agreement which covers all transactions, whether electronic or on paper.

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Special Issues Regarding Handling Money Over the Internet
Persons unfamiliar with contracting on the Internet frequently ask what facilities exist for making and obtaining payment over the Internet, and whether such facilities are sufficiently safe. The answer is that such facilities do exist in the form of online credit card transactions, which are in wide use today. Electronic transfers of funds are governed by a series of statutes and regulations of the Federal Reserve Board. Those same statutes and regulations would generally apply to instructions to transfer funds or change a credit card account made over the Internet.

With respect to consumer transactions, the Electronic Funds Transfer Act requires that financial institutions investigate consumer complaints of billing errors and inaccuracies and report the results to the consumer. Consumer liability for unauthorized transfers is limited to $50 assuming the consumer has promptly notified the financial institution of the loss of his or her credit card, or other facts that indicate that unauthorized transactions may be made. Consumers have the responsibility to not disclose their pin to others, for example. If a transaction is challenged, the burden of proof lies with the financial institution seeking to establish that the transaction was authorized by the consumer.

As a practical matter, any merchant desiring to set up an electronic contracting scheme, including online credit card payment capability, can do so readily. Most of the large Internet device providers will set up the electronic payment system as part of their service. Payments are usually made by credit card through a system called "secure server technology" whereby a special server (perhaps operated by ISP) is used for the transmission of credit card information. This is all unobtrusive "back office" technology, such that the person purchasing goods from a Web page need not even be aware of it.

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Conclusion
The Internet is set up and ready for business now. While numerous legislative initiatives continue to be debated regarding digital signatures and related topics, business is not waiting to go online. Any entity wishing to establish its own digital signature regime with other parties can do so by contract today, without waiting for digital signature legislation. Entities engaging in repeat transactions can contractually adopt agreed upon digital signature/electronic commerce ground rules which will be enforced. Entities engaging in single, high value transactions with parties with whom they have no ongoing relationship may still wish to utilize conservative methods such as confirming faces or paper documents.

Online contracting does raise some novel legal issues which any business attempting to set up an online contracting site needs to consider and, as a result, any such entity should consult with attorneys knowledgeable about online contracting. However, most legal hurdles can readily be overcome by appropriate structuring of the Web site, by entering into an electronic trading agreement, or, in the rare case, by performing one or more steps of the transaction off line.

  • An enormous amount of electronic and digital signature legislation has been introduced in state legislatures and the Congress in the past two years.
  • A Web page can be set up so as to eliminate any ambiguity as to when or how a contract is entered into.
  • On the internet the offering party can restrict the other party to a limited range of options for making an acceptance.

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