May 11 2009

Flawed ALI Software Contract "Principles"

The proposed draft of the fundamentally flawed ALI Principles of the Law of Software Contracts has been published and, given the in-bred politics of the American Law Institute, will almost certainly be approved.  But then the Principles should be left to die a quiet and quick death.

   Although written by two respected academics, the Principles are fundamentally flawed in part because they were drafted with virtually no input from commercial software producers and drafted under the influence of a group dominated by people and companies who failed to achieve their goals in UCITA or in drafting revisions of Article 2.  They thus shifted over to a friendly forum they could dominate.  I will have more to say about this, but let’s start with an illustration – a misguided, non-disclaimable warranty that no “hidden” “defects” exist in software.


“Principles” § 3.05 suggests that: “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.”


I put aside the facts that the form of this language (and followed throughout the “Principles”) reads as if it were a statute even though it was not vetted through any legislative process and will never be.  The fundamental flaw is that this alleged warranty is not supported in any body of contract law.  Any body of contract law!  It is not present in the Restatement of Contracts.  It does not exist in UCITA.  It does not exist in UCC Article 2 or Article 2A.


The Reporters’ Notes cite several cases allegedly in support of this purported, non-disclaimable warranty.  But one case, cited twice, granted summary judgment against liability for a non-disclosed defect (because of a damages limitation clause).  And all of the cited cases that supported liability did so under the law of fraud, not contract law.  Further, there are many cases in the law of fraud that hold that there is no duty to disclose in arm’s length deals.  In fact, at least two of the cited cases did not involve an implied obligation, but liability for express lies. 


There is no support in law for the purported warranty under contract law.  The law of fraud contains numerous limits on liability that are not present under a non-disclaimable warranty.  Indeed, since fraud liability requires reliance, it can be disclaimed by statements that disavow any assurances in reference to the allegedly hidden problem.  Many cases in the area of fraud law enforce specific disclaimers as defeating a claim of fraud.  The “Principles” reverse that rule as a matter of contract law.  If I say to you: “I am not giving any assurances about there being no defects in this software”, why should that statement not be effective when it clearly would be under the law of fraud?


So, why, you might ask, is this “principle” a bad rule?  One answer is simply that, if the “principle” were followed, the software industry would be subject to a rule that does not apply to any other industry.  Why discriminate against one of our few burgeoning industries?


But there are several other points:


First:  The scope of the obligation is obscure.  What does the word “hidden” mean?  Is a “defect” “hidden” unless it is affirmatively disclosed?  Or, is it hidden only if the producer or other licensor actively conceals it?  Is it hidden if the defect, once discovered, is discussed on the Internet, but the particular licensee is not aware of that discussion?  Does the idea of a “hidden” defect require intent to deceive such as is ordinarily required under the law of fraud?


Second: The coverage of the “principle” is obscure.  What does the word “material” mean?  It is not defined.  Remember that the “principle” is not limited to the immediate person to whom the software is transferred, but to all others in the “normal” chain of distribution.  If a defect is not material to the person with whom I deal, why am I still liable to a later person for whom it is material?


By the way, whatever happened to the idea of contractual privity?


By the second way, what constitutes a “defect”?  There is a body of research that suggests that it is impossible to create software with no flaws.  Is any flaw a “defect” that creates liability if it is not disclosed and it happens to have a material impact on some party down the distribution chain?  If so, the “principle” extends the notion of contract liability beyond reason.  The car that I drive has a plastic cover over the track on which the driver’s seat rests.  The “flaw” is that the plastic breaks if you step in the wrong spot when entering the car.  Is that a “defect” that is a breach of contract if it was “hidden”, e.g., not affirmatively disclosed?  Is that the type of breach that should be non-disclaimable?


Third: The idea that the supposed warranty is non-disclaimable and runs to all persons in a distribution chain creates a veritable circus of potential liability and resulting costs.  The people who will pay are the purchasers subjected to higher prices for ordinary software.  The beneficiaries are ---------?


Fourth:  The concept, such as it is, of this “principle” is to require disclosure of what is often proprietary (trade secret) information.  In a risk adverse company, how does one decide what “flaw” is a “defect” that may be “material” to unknown users?


Enough said: if it were adopted, this is a bad rule applied on a discriminatory basis to one of our few vibrant industries.  It should be rejected or, simply, ignored.


Oh…..  One last thing.  The “principle” is limited to entities that charge “money” for the software.  This is intended to exclude “open source” participants and providers, including FSF.  So, in “principle”, they do not need to disclose, but Adobe does.  I sure hope the discrimination in this rule is not based on the idea that all users can read software code and find and cure defects.  I certainly cannot do so.  Recall what I said above: the Principles were drafted in a political context dominated by people who had lost their pet positions in UCITA and Article 2, but now dominated a friendly forum.



Written By:D. C. Toedt On May 13, 2009 7:49 AM

Bravo Ray. Software vendors could live with the nondisclaimable hidden-defects warranty, I think, if they could limit the remedy to repair-replace-refund. But under Section 4.01 of the Principles, apparently that's not possible either.

It's also troubling that you have to pay $40 to get a PDF copy of a document that is transparently intended to serve as an amendment to the UCC.

Judges ought to treat these Principles as in essence an amicus brief in support of the customer. The trick is going to be to keep them from reflexively assuming that the Principles have the same stature as, say, the Restatement Second of Contracts.

Written By:Matt On May 18, 2009 2:18 PM

Thanks for pointing this out Ray.

One question, I didn't see any mention of time limits for this new warranty. If I sell someone a product and they are still using it 10 years from now, am I still liable for these defects?

And I am NOT paying $40 to read the document, as this is close to extortion as it can influence the canon of law and should be publicly disclosed.

Written By:D. Lowry On May 20, 2009 1:10 PM

One quick nit: in the last paragraph Mr. Nimmer notes that the "Princples..." would not apply to the FSF (Free Software Foundation) because they don't charge money (for software). This is not correct. Software licensed under FSF licenses such as the GPL, LGPL, etc. can be (and is) sold, provided the seller makes the sources freely available. Parties can also charge money for support and maitenance of the software.

Obviously this is a minor point to the theme of Mr. Nimmer's post, but it helps emphasize his point because it means that the proposed non-disclaimable implied warranty *could* apply to certain software licensed under terms promoted by the FSF.

Written By:DaSean A. Jones On May 24, 2009 10:28 AM

Interesting read. It does not seem fair or well "game-planned". Revisions often play out when the laws are integrated in real-world scenarios, rather than sterile, notional think tanks. I wonder why application is not key, the rules should be "tested" more thoroughly.

Written By:V. Bunch On July 30, 2009 2:38 PM

Big Bravo to Ray. I am absolutely shocked at the ALI's position; it is reckless as counter to how technology transactions simply must be structured with respect to warranties and limitations of liability. Technology moves too fast. It is simply stupid to proffer a regime where everyone in the distribution channel will be in breach of contract - period. Everyone knows "software has bugs", its 101 licensing. D. C. Toedt's comment above is spot on - the warranty is repair or replace, or refund. The ALI are either buffoons or political tools for the FSF. I assume the latter.

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