Ways to Avoid Electronic Contract Killers in Second Life

The creators of Second Life ' an online virtual community ' faced some real-life problems in a Pennsylvania court recently. In Bragg v. Linden Research, Inc., No. CIV.A06 4925 (E.D.P.A. May 30, 2007), Judge Eduardo C. Robreno, denying a motion to compel arbitration, offers attorneys and their clients some useful guidelines to consider when drafting standard electronic form contracts.

Life Away from Life

Second Life, an Internet-based virtual world developed by Linden Research Inc. (Linden Research), gives users the opportunity to create their own virtual character (an 'avatar') that can interact with other characters in a simulated online environment. Second Life permits users to buy, sell, lease, and improve virtual real property for a type of currency called 'Lindens.' Users can also buy and sell virtual personal property. Lindens may be exchanged into U.S. dollars outside of the game.

Second Life creator Philip Rosedale recently stated, Second Life 'is real and it is yours. … You can make money.' This ability for users to enforce their ownership rights in virtual personal and real property outside the Second Life environment has landed Rosedale and his company, Linden Research, at the center of a real-world court battle.

Background

The plaintiff, Marc Bragg, himself an attorney, sued the creators of Second Life alleging that they had unlawfully confiscated his property and denied him access to the virtual community. Bragg, a Second Life participant for almost two years, had been actively involved in purchasing virtual property in Second Life. Bragg had also established a 'business' in Second Life selling virtual fireworks to other users for a profit.

In May 2006, Second Life froze Bragg's account alleging that he had fraudulently acquired a parcel of virtual land. The land Bragg purchased was seized, and his membership was suspended. This had the effect of confiscating any property or currency still held by Bragg in his Second Life account.

When Bragg began using Second Life, he agreed to Linden Research's terms of service by clicking a button indicating his acceptance of the conditions (a 'clickwrap' standard form contract). One of the conditions contained in the contract was a clause requiring all users, including Bragg, to resolve their disputes with Linden Research through binding arbitration. The arbitration was to take place close to Linden Research's offices in San Francisco. In addition to arbitration, Bragg also assented to a California choice of law provision and a forum selection clause. All of these conditions were grouped together in the thirteenth paragraph of the contract under the heading, 'General Provisions.'

Bragg, desiring to avoid the time and expense of arbitrating his claim in California, sued Linden Research in his home state of Pennsylvania. Linden Research responded by bringing a motion to compel arbitration of the dispute in California ' which Linden Research claimed was the only contractual remedy open to a dissatisfied user of Second Life.

Real Lessons in Virtual World

Standard electronic form contracts are vulnerable to attack where there is either procedural or substantive unconscionability, or both. The procedural unconscionability component may be satisfied where there are unequal bargaining positions or where surprise results from hidden terms, which are typical of adhesion contracts. The substantive unconscionability component focuses on the one-sidedness of the contract terms. The procedural and substantive components operate on a sliding scale. Where there is more procedural unconscionability, the terms of the contract must be more substantively reasonable, and vice versa. A contract will be analyzed by a court based on the plain meaning of its terms, but also based on the circumstances surrounding the signing of the contract, as well as the contract's purpose and effect.

Judge Robreno, in denying the motion to compel arbitration in California, offers useful hints to attorneys and clients on how to avoid pitfalls when drafting standard electronic form contracts. The following are some of the factors the court relied upon to support its conclusion that the standard electronic form contract signed by Bragg was unconscionable and thus unenforceable.

Procedural Factors

A critical factor in an unconscionability analysis is the manner in which the contract or disputed clause was presented and negotiated. When a party of weaker bargaining strength is presented a contract on a 'take it or leave it basis' without any room for negotiation, the contract is more likely to be held unconscionable.

If there are no reasonably available market alternatives (i.e., another online game similar to Second Life), the terms of the contract must be more fair to the purchaser to avoid being found unconscionable.

If important provisions, such as arbitration provisions, are buried in a 'miscellaneous' section, these provisions are less likely to be enforceable. Arbitration clauses should be highlighted, or should be listed under a separate heading.

The cost and rules of the contractually required arbitration should be explicitly spelled out in the agreement.

Substantive Factors

1) Allowing a range of remedies for the stronger party while forcing the weaker party to arbitrate claims is more likely to be held unconscionable.

2) Where terms of service can be changed without prior notice and without liability to the stronger party, the agreement is more likely to be held unconscionable.

3) Where a plaintiff is required to arbitrate his or her claims before bringing a civil action and where a plaintiff is required to pay for a share of the arbitration costs which will be well in excess of the cost of bringing a civil action, such a clause is more likely to be held unconscionable.

4) If an arbitration clause in a contract specifies a location or procedure that is unreasonably expensive for an aggrieved user, such a clause is more likely to be held unconscionable.

5) Requiring that arbitration proceedings be kept confidential can potentially disadvantage other plaintiffs facing similar disputes with the defendant corporation. Confidentiality clauses, even if required under the rules of arbitration, may weigh against enforcement.

6) A 'margin of safety' may be built into a standard form contract by a party with stronger bargaining power so long as there are legitimate business realities for this special advantage. Such realities must be explained in the contract itself and must be factually established.

Drafting Guidelines

Below are some drafting guidelines to consider when creating a standard electronic form contract:

• Arbitration clauses should appear under a separate heading, as opposed to appearing under a 'General Provisions' or 'Misc-
  ellaneous' heading.
• If using an arbitration clause in a contract, consider carefully where the arbitration will occur. Linden Research required users to arbitrate in San Francisco, where their corporate headquarters was located. The court ruled this made arbitration unreasonably expensive for aggrieved users.
• Arbitration clauses should be bolded or highlighted so as to set them apart from the rest of the text in the contract.
• The cost and applicable rules of the arbitration should be clearly indicated in the contract.
• Although face-to-face arbitration may be desirable, alternative forms of communication, such as teleconferencing or video conferencing, should be made available if permitted by the rules of arbitration. These forms of communication may reduce the overall cost of arbitration, and would therefore reduce the overall burden of arbitrating claims.
• Users should preferably be required to click on a separate box to accept binding arbitration, in addition to any click-box indicating acceptance of the overall contract.
• Should the terms of service change, users should be given prior notice of the change. Requiring users to consent to an amended contract before they can access the online content may be one method of providing adequate notice to users.
• Where legitimate business realities exist, such as avoiding the burden of litigating claims across the country or avoiding the negative publicity that may result from lawsuits in the absence of a confidentiality clause, then such business realities should preferably be clearly explained in the contract. Where possible, factual evidence proving or supporting these business realities should also be included in the contract.

Conclusion

While the case has yet to be decided on its merits, Bragg scored an early victory over Linden Research. Judge Robreno ruled that Linden Research may not compel Bragg to submit to a costly arbitration process because the standard form contract all Second Life users are required to sign is both procedurally and substantively unconscionable. Judge Robreno wrote:

Taken together, the lack of mutuality, the costs of arbitration, the forum selection clause, and the confidentiality provision that Linden unilaterally imposes through the [Terms of Service] demonstrate that the arbitration clause is not designed to provide Second Life participants an effective means of resolving disputes with Linden. Rather, it is a one-sided means which tilts unfairly, in almost all situations, in Linden's favor … Linden appears to be attempting to insulate itself contractually from any meaningful challenge to its alleged practices.

Judge Robreno's decision opens the door to this and future civil actions against Linden Research. However, the ruling on this motion to compel arbitration can and should be a lesson to both attorneys and companies considering using standard electronic form contracts in their business transactions.

This article originally appeared in the New York Law Journal, a sister publication of this newsletter.

David M. Klein is a partner in Paul, Hastings, Janofsky & Walker LLP, specializing in the structuring and negotiation of complex technology
and technology-related transactions, including outsourcing transactions. Keith Marlowe, a summer associate at the firm, assisted in the preparation of this article.

The creators of Second Life ' an online virtual community ' faced some real-life problems in a Pennsylvania court recently. In Bragg v. Linden Research, Inc., No. CIV.A06 4925 (E.D.P.A. May 30, 2007), Judge Eduardo C. Robreno, denying a motion to compel arbitration, offers attorneys and their clients some useful guidelines to consider when drafting standard electronic form contracts.

Life Away from Life

Second Life, an Internet-based virtual world developed by Linden Research Inc. (Linden Research), gives users the opportunity to create their own virtual character (an 'avatar') that can interact with other characters in a simulated online environment. Second Life permits users to buy, sell, lease, and improve virtual real property for a type of currency called 'Lindens.' Users can also buy and sell virtual personal property. Lindens may be exchanged into U.S. dollars outside of the game.

Second Life creator Philip Rosedale recently stated, Second Life 'is real and it is yours. … You can make money.' This ability for users to enforce their ownership rights in virtual personal and real property outside the Second Life environment has landed Rosedale and his company, Linden Research, at the center of a real-world court battle.

Background

The plaintiff, Marc Bragg, himself an attorney, sued the creators of Second Life alleging that they had unlawfully confiscated his property and denied him access to the virtual community. Bragg, a Second Life participant for almost two years, had been actively involved in purchasing virtual property in Second Life. Bragg had also established a 'business' in Second Life selling virtual fireworks to other users for a profit.

In May 2006, Second Life froze Bragg's account alleging that he had fraudulently acquired a parcel of virtual land. The land Bragg purchased was seized, and his membership was suspended. This had the effect of confiscating any property or currency still held by Bragg in his Second Life account.

When Bragg began using Second Life, he agreed to Linden Research's terms of service by clicking a button indicating his acceptance of the conditions (a 'clickwrap' standard form contract). One of the conditions contained in the contract was a clause requiring all users, including Bragg, to resolve their disputes with Linden Research through binding arbitration. The arbitration was to take place close to Linden Research's offices in San Francisco. In addition to arbitration, Bragg also assented to a California choice of law provision and a forum selection clause. All of these conditions were grouped together in the thirteenth paragraph of the contract under the heading, 'General Provisions.'

Bragg, desiring to avoid the time and expense of arbitrating his claim in California, sued Linden Research in his home state of Pennsylvania. Linden Research responded by bringing a motion to compel arbitration of the dispute in California ' which Linden Research claimed was the only contractual remedy open to a dissatisfied user of Second Life.

Real Lessons in Virtual World

Standard electronic form contracts are vulnerable to attack where there is either procedural or substantive unconscionability, or both. The procedural unconscionability component may be satisfied where there are unequal bargaining positions or where surprise results from hidden terms, which are typical of adhesion contracts. The substantive unconscionability component focuses on the one-sidedness of the contract terms. The procedural and substantive components operate on a sliding scale. Where there is more procedural unconscionability, the terms of the contract must be more substantively reasonable, and vice versa. A contract will be analyzed by a court based on the plain meaning of its terms, but also based on the circumstances surrounding the signing of the contract, as well as the contract's purpose and effect.

Judge Robreno, in denying the motion to compel arbitration in California, offers useful hints to attorneys and clients on how to avoid pitfalls when drafting standard electronic form contracts. The following are some of the factors the court relied upon to support its conclusion that the standard electronic form contract signed by Bragg was unconscionable and thus unenforceable.

Procedural Factors

A critical factor in an unconscionability analysis is the manner in which the contract or disputed clause was presented and negotiated. When a party of weaker bargaining strength is presented a contract on a 'take it or leave it basis' without any room for negotiation, the contract is more likely to be held unconscionable.

If there are no reasonably available market alternatives (i.e., another online game similar to Second Life), the terms of the contract must be more fair to the purchaser to avoid being found unconscionable.

If important provisions, such as arbitration provisions, are buried in a 'miscellaneous' section, these provisions are less likely to be enforceable. Arbitration clauses should be highlighted, or should be listed under a separate heading.

The cost and rules of the contractually required arbitration should be explicitly spelled out in the agreement.

Substantive Factors

1) Allowing a range of remedies for the stronger party while forcing the weaker party to arbitrate claims is more likely to be held unconscionable.

2) Where terms of service can be changed without prior notice and without liability to the stronger party, the agreement is more likely to be held unconscionable.

3) Where a plaintiff is required to arbitrate his or her claims before bringing a civil action and where a plaintiff is required to pay for a share of the arbitration costs which will be well in excess of the cost of bringing a civil action, such a clause is more likely to be held unconscionable.

4) If an arbitration clause in a contract specifies a location or procedure that is unreasonably expensive for an aggrieved user, such a clause is more likely to be held unconscionable.

5) Requiring that arbitration proceedings be kept confidential can potentially disadvantage other plaintiffs facing similar disputes with the defendant corporation. Confidentiality clauses, even if required under the rules of arbitration, may weigh against enforcement.

6) A 'margin of safety' may be built into a standard form contract by a party with stronger bargaining power so long as there are legitimate business realities for this special advantage. Such realities must be explained in the contract itself and must be factually established.

Drafting Guidelines

Below are some drafting guidelines to consider when creating a standard electronic form contract:

• Arbitration clauses should appear under a separate heading, as opposed to appearing under a 'General Provisions' or 'Misc-
  ellaneous' heading.
• If using an arbitration clause in a contract, consider carefully where the arbitration will occur. Linden Research required users to arbitrate in San Francisco, where their corporate headquarters was located. The court ruled this made arbitration unreasonably expensive for aggrieved users.
• Arbitration clauses should be bolded or highlighted so as to set them apart from the rest of the text in the contract.
• The cost and applicable rules of the arbitration should be clearly indicated in the contract.
• Although face-to-face arbitration may be desirable, alternative forms of communication, such as teleconferencing or video conferencing, should be made available if permitted by the rules of arbitration. These forms of communication may reduce the overall cost of arbitration, and would therefore reduce the overall burden of arbitrating claims.
• Users should preferably be required to click on a separate box to accept binding arbitration, in addition to any click-box indicating acceptance of the overall contract.
• Should the terms of service change, users should be given prior notice of the change. Requiring users to consent to an amended contract before they can access the online content may be one method of providing adequate notice to users.
• Where legitimate business realities exist, such as avoiding the burden of litigating claims across the country or avoiding the negative publicity that may result from lawsuits in the absence of a confidentiality clause, then such business realities should preferably be clearly explained in the contract. Where possible, factual evidence proving or supporting these business realities should also be included in the contract.

Conclusion

While the case has yet to be decided on its merits, Bragg scored an early victory over Linden Research. Judge Robreno ruled that Linden Research may not compel Bragg to submit to a costly arbitration process because the standard form contract all Second Life users are required to sign is both procedurally and substantively unconscionable. Judge Robreno wrote:

Taken together, the lack of mutuality, the costs of arbitration, the forum selection clause, and the confidentiality provision that Linden unilaterally imposes through the [Terms of Service] demonstrate that the arbitration clause is not designed to provide Second Life participants an effective means of resolving disputes with Linden. Rather, it is a one-sided means which tilts unfairly, in almost all situations, in Linden's favor … Linden appears to be attempting to insulate itself contractually from any meaningful challenge to its alleged practices.

Judge Robreno's decision opens the door to this and future civil actions against Linden Research. However, the ruling on this motion to compel arbitration can and should be a lesson to both attorneys and companies considering using standard electronic form contracts in their business transactions.

This article originally appeared in the New York Law Journal, a sister publication of this newsletter.

David M. Klein is a partner in Paul, Hastings, Janofsky & Walker LLP, specializing in the structuring and negotiation of complex technology
and technology-related transactions, including outsourcing transactions. Keith Marlowe, a summer associate at the firm, assisted in the preparation of this article.