Unconscionable Terms Prevent Enforceability of e-Commerce Contract Clauses

The Internet allows one party to mass market a product under terms it believes appropriate in light of the price it is charging for and another party is paying to acquire an item or, sometimes, a service ' or that a buyer may refuse to acquire; either way, the consumer's choice marks the assent. As e-commerce expands, the logic of marketplaces in any medium or location demands that sheer volume of dealings will raise the number of e-transactions with unconscionable terms.

Traditionally, adhesion contracts share four elements:

1. They are drafted to drastically favor one party;
2. They are general enough to apply to numerous transactions;
3. They are offered with the representation that, except for price, the drafting party will enter into the transaction only on the terms contained in the document; and
4. They reduce to a minimum the actionable obligations of the adhering party, predominantly to the payment of the money.

As a rule, a court will not enforce an unconscionable contract clause. An unconscionable clause is one:

• For which the purpose is contrary to public policy;
• That is overly harsh; or
• That has one-sided results that shock the conscience of the court. For instance, a clause that purports to release one party for its intentional torts would be unconscionable and unenforceable.

(Editor's note: For more discussion of Internet-contract terms, see, 'I Signed WHAT?!' in this issue.)

California Leads, Again

California courts have been at the vanguard of deeming e-commerce contract clauses unconscionable and, hence, unenforceable. In Comb v. PayPal, Inc., 218 F. Supp. 2d 1165 (N.D. Cal. 2002), for instance, the court found that the e-commerce agreement obligated users to arbitrate their disputes pursuant to the commercial rules of the American Arbitration Association, which is cost-prohibitive in light of the average size of a PayPal transaction. Accordingly, the court denied motions by PayPal to compel users who commenced putative class-action suits arising from PayPal's allegedly inappropriate handling of customer accounts, complaints or both types of conduct to resolve their claims via arbitration.

The court noted several important factors in deciding why Paypal's contract clauses were unconscionable: The court reasoned that PayPal could issue binding amendments to the User Agreement at any time without notice to users. Furthermore, the court argued that PayPal's dispute-resolution program was unconscionable because:

• It was mandatory and required that disputes be resolved in Santa Clara County, CA, where PayPal is located;
• PayPal maintained possession of customer funds until any dispute is resolved; and
• No class actions were allowed.

The court found that these provisions were an attempt by PayPal 'to insulate itself contractually from any meaningful challenge to its alleged practices.'

More recently, the court in Bragg v. Linden Research, 487 F. Supp. 2d 593 (2007), found that an Internet site's arbitration provision could not be enforced on the basis that it was procedurally and substantively unconscionable. In this case, the plaintiff, an owner of virtual property on an Internet site, sued defendants ' operators of the Internet virtual world at issue ' for the removal of certain virtual property he purchased from the virtual world and for freezing the plaintiff's account. The defendants contended that the site's terms-of-use agreement compelled arbitration.

In this matter, the arbitration provision was buried in a take-it-or-leave-it set of terms presented to customers before they could participate on the site. The provision's lack of mutuality, the costs of arbitration, the forum-selection clause and the confidentiality provision demonstrated that the arbitration clause favored the site operators over the participants. Consequently, the court denied the motion to compel arbitration.

e-Contracts Usually Aren't Dynamic

Virtually all e-commerce contracts are prewritten. The three most prevalent e-commence contracts are:

• Internet site terms-of-use agreements;
• Click-wrap agreements; and
• Implied agreements.

To begin with, click-wrap agreements allow users to manifest their intent to adhere to the seller's terms by clicking an I agree icon, or by typing in a set of specified words in a specified place. Internet site terms-of-use agreements and e-commerce implied agreements, on the other hand, are distinct from click-wrap agreements because the user accepts the terms by manifesting some action associated with use. In the case of a terms-of-use agreement, the user accepts the terms by using the Internet site; in the case of an implied agreement, the user accepts those terms by making a purchase.

The terms-of-use agreement and the implied agreement share their basis for validity and their enforcement legal difficulties with shrink-wrap agreements. Shrink-wrap agreements are normally associated with retail software packages that are covered in plastic. This type of agreement normally contains written licenses for the use of the software that become effective as soon as the customer tears the wrapping from the package. The legality of shrink-wrap agreements and their e-commerce counterparts have been validated by the Uniform Commercial Code ('UCC'). In particular, UCC '2-204 (1) states that a contract for the sale of goods may be made in any manner sufficient to show agreement, including conduct by both parties, which recognizes the existence of such contract.

The e-commerce and shrink-wrap agreement are adhesion contracts, and share procedural and substantive aspects. In particular, they each share the following three characteristics.

First, these contracts are not entered into between the parties as a result of meaningful negotiation.

Second, the agreements are impossible to change.

Third, the buyer's or user's assent to the terms may be either absent or ambiguous.

It is these three distinguishing traits that form the legal basis for challenging the enforceability of such agreements.

In Carnival Cruise Lines, Inc. v. Shute, 499 U.S. 585 (1991), the Supreme Court found that adhesion contracts are valid. In particular, it found a forum-selection clause in the cruise line's passage-contract ticket ' a type of standard form contract printed on the back of the ticket ' to be enforceable. It emphasized that forum-selection clauses contained in form-passage contracts were subject to judicial scrutiny for fundamental fairness. It specifically disagreed with the Court of Appeals' determination that a non-negotiated forum-selection clause in a form-ticket contract is unenforceable because it is not subject to negotiation.

Subsequently, in the case ProCD, Inc. v. Zeidenburg, 86 F.3d 1447 (7th Cir. 1996), the court found that shrink-wrap license agreements were valid. It found that an enforceable contract may be formed when the buyer used the software after having an opportunity to read the license at leisure.

Contracts of adhesion differ significantly from the traditional process of contract formation. In an adhesion contract, the parties do not negotiate, because the terms and conditions that are presented to adherents are non-negotiable. The lack of meaningful bargaining between the parties leaves the adherent in the position of accepting the deal, or there is no deal. The adherent may only passively accept whatever is being offered and bears whatever obligation is being imposed ' and thus arises the issue of whether the adherent has in fact assented to the agreement's terms. It has been argued that adherents have not made a meaningful choice by clicking on an icon or downloading software. In some cases, when clicking the I agree icon, adherents did not even know they made a choice-of-law determination associated with their Internet contract.

Assent Is Crucial

Assent is a rudimentary concept of contract formation. It stems from the settled legal principle that the formation of a contract requires the mutual assent of the parties. Contracts of adhesion, at first glance, do not conform to the norm of mutual assent. It appears that contracts of adhesion fail to have a legitimate basis for finding the parties' assent. Courts, however, have found that an adherent's ability to refrain from engaging in the agreement is the legal basis for supporting his or her actions when entering into the adhesion contract.

In the case of In re RealNetworks, Privacy Litigation (2000 WL 631341 (N.D.Ill. 2000), it was alleged that RealNetworks' software secretly accessed and intercepted users' electronic transmissions. An arbitration clause barred a suit in Illinois in favor of arbitration in Washington. The court specifically addressed the conscionable act of requiring a consumer to cross the country to submit to arbitration. It found both parties intended to be bound. This finding is consistent with the application of existing law to traditional agreements. In particular, arbitration provisions containing forum-selection clauses have previously been upheld. Take a look, for instance, at Doctor's Ass'n. Inc. v. Hamilton, 150 F.3d 157, 163 (2d Cir. 1998), which upheld the forum-selection clause in the arbitration clause designating Connecticut as forum.

But some courts have used a two-factor theory to find an Internet contract clause unconscionable. As the theory's name implies, a court must find two factors present to deem an Internet contract clause unconscionable. The two-factor theory was set forth in Discover Bank v. Superior Court, 36 Cal. 4th 148 (2005). The court found that a contract clause becomes unconscionable when it is both part of a consumer contract of adhesion and it involves small amounts of damages. Under such conditions, the party with superior bargaining power can deliberately cheat numerous consumers out of small sums of money with impunity. When these two conditions are met, certain clauses, such as foreign-jurisdiction clauses, become exculpatory clauses that protect the wrongdoer and prevent consumers from employing the most effective method of redress.

Similarly, a California Court of Appeals for the Second Appellate District found that the forum-selection clause in defendant EarthLink Inc.'s membership contract was unconscionable. Specifically, the court found the contract to be one of adhesion and also found that some California consumers travel 2,000 miles to Georgia to recover claims of about $50. (See, Aral v. Earthlink, Inc., 134 Cal. App. 4th 544 (2005).)

In e-commerce agreements, so far the three clauses that are most likely to cause legal difficulties are those related to dispute resolution. They are:

• An arbitration clause providing for resolution of disputes through arbitration;
• A choice-of-forum clause designating a jurisdiction to which the disputes, if they arise, are to be submitted for adjudication; and
• A choice-of-law clause selecting an applicable law by which the contract in question will be governed.

These three clauses are easy to manipulate and are on the whole determinative of the outcome of any contract dispute. In freely negotiated contracts, these clauses are the result of extensive bargaining. In contracts of adhesion, however, dispute-resolution clauses frequently become the means by which businesses maintain legal certainty and predict their own advantage. For example, the forum-selection clause, which commonly appears in e-commerce agreements, is employed by the licenser to bring certainty to Internet-based transactions that lack any fixed geographic location.

The normal process for an adherent to bring these dispute-resolution clauses into play is by claiming that the contract writers didn't adequately bring these clauses to the adherent's attention, so the adherent may claim it did not manifest assent to the clauses. This tactic is successful because dispute-resolution clauses are not highlighted.

Few exceptions to enforceability of e-commerce agreements will be found and those that are most often found can be explained by flaws in how terms were presented. To ameliorate unexpected outcomes, e-commerce contracts should place the dispute-resolution clauses near the I agree icon or provide a separate I agree icon for the dispute-resolution clauses. This procedure will reduce unconscionability claims due to lack of affirmative assent.

e-Commerce, like traditional commerce, relies on contracts. But unlike traditional commerce, e-commerce typically relies utterly on agreements drafted and presented by one party on a 'take-it-or-leave-it' basis. The validity of such contracts arises from the recipient's 'adherence' to the terms given. These so-called adhesion contracts are enforceable, except to the extent that a court finds a term unconscionable.

Of an increasing degree of comfort to consumers, but an increasing degree of discomfort to e-commerce entrepreneurs and their counsel, however, is that courts are discovering unconscionable e-commerce contract clauses and refusing to enforce them.

Courts have long tolerated e-commerce adhesion contracts because they are important to the Internet marketplace. Initially, e-sellers used adhesion contracts to facilitate Internet transactions, and offer a standard operating procedure for what were then novel transactions. More recently, though, their use is intended to give e-commerce merchants a decidedly unfair advantage over consumers in transactions.

The Internet allows one party to mass market a product under terms it believes appropriate in light of the price it is charging for and another party is paying to acquire an item or, sometimes, a service ' or that a buyer may refuse to acquire; either way, the consumer's choice marks the assent. As e-commerce expands, the logic of marketplaces in any medium or location demands that sheer volume of dealings will raise the number of e-transactions with unconscionable terms.

Traditionally, adhesion contracts share four elements:

1. They are drafted to drastically favor one party;
2. They are general enough to apply to numerous transactions;
3. They are offered with the representation that, except for price, the drafting party will enter into the transaction only on the terms contained in the document; and
4. They reduce to a minimum the actionable obligations of the adhering party, predominantly to the payment of the money.

As a rule, a court will not enforce an unconscionable contract clause. An unconscionable clause is one:

• For which the purpose is contrary to public policy;
• That is overly harsh; or
• That has one-sided results that shock the conscience of the court. For instance, a clause that purports to release one party for its intentional torts would be unconscionable and unenforceable.

(Editor's note: For more discussion of Internet-contract terms, see, 'I Signed WHAT?!' in this issue.)

California Leads, Again

California courts have been at the vanguard of deeming e-commerce contract clauses unconscionable and, hence, unenforceable. In Comb v. PayPal, Inc. , 218 F. Supp. 2d 1165 (N.D. Cal. 2002), for instance, the court found that the e-commerce agreement obligated users to arbitrate their disputes pursuant to the commercial rules of the American Arbitration Association, which is cost-prohibitive in light of the average size of a PayPal transaction. Accordingly, the court denied motions by PayPal to compel users who commenced putative class-action suits arising from PayPal's allegedly inappropriate handling of customer accounts, complaints or both types of conduct to resolve their claims via arbitration.

The court noted several important factors in deciding why Paypal's contract clauses were unconscionable: The court reasoned that PayPal could issue binding amendments to the User Agreement at any time without notice to users. Furthermore, the court argued that PayPal's dispute-resolution program was unconscionable because:

• It was mandatory and required that disputes be resolved in Santa Clara County, CA, where PayPal is located;
• PayPal maintained possession of customer funds until any dispute is resolved; and
• No class actions were allowed.

The court found that these provisions were an attempt by PayPal 'to insulate itself contractually from any meaningful challenge to its alleged practices.'

More recently, the court in Bragg v. Linden Research , 487 F. Supp. 2d 593 (2007), found that an Internet site's arbitration provision could not be enforced on the basis that it was procedurally and substantively unconscionable. In this case, the plaintiff, an owner of virtual property on an Internet site, sued defendants ' operators of the Internet virtual world at issue ' for the removal of certain virtual property he purchased from the virtual world and for freezing the plaintiff's account. The defendants contended that the site's terms-of-use agreement compelled arbitration.

In this matter, the arbitration provision was buried in a take-it-or-leave-it set of terms presented to customers before they could participate on the site. The provision's lack of mutuality, the costs of arbitration, the forum-selection clause and the confidentiality provision demonstrated that the arbitration clause favored the site operators over the participants. Consequently, the court denied the motion to compel arbitration.

e-Contracts Usually Aren't Dynamic

Virtually all e-commerce contracts are prewritten. The three most prevalent e-commence contracts are:

• Internet site terms-of-use agreements;
• Click-wrap agreements; and
• Implied agreements.

To begin with, click-wrap agreements allow users to manifest their intent to adhere to the seller's terms by clicking an I agree icon, or by typing in a set of specified words in a specified place. Internet site terms-of-use agreements and e-commerce implied agreements, on the other hand, are distinct from click-wrap agreements because the user accepts the terms by manifesting some action associated with use. In the case of a terms-of-use agreement, the user accepts the terms by using the Internet site; in the case of an implied agreement, the user accepts those terms by making a purchase.

The terms-of-use agreement and the implied agreement share their basis for validity and their enforcement legal difficulties with shrink-wrap agreements. Shrink-wrap agreements are normally associated with retail software packages that are covered in plastic. This type of agreement normally contains written licenses for the use of the software that become effective as soon as the customer tears the wrapping from the package. The legality of shrink-wrap agreements and their e-commerce counterparts have been validated by the Uniform Commercial Code ('UCC'). In particular, UCC '2-204 (1) states that a contract for the sale of goods may be made in any manner sufficient to show agreement, including conduct by both parties, which recognizes the existence of such contract.

The e-commerce and shrink-wrap agreement are adhesion contracts, and share procedural and substantive aspects. In particular, they each share the following three characteristics.

First, these contracts are not entered into between the parties as a result of meaningful negotiation.

Second, the agreements are impossible to change.

Third, the buyer's or user's assent to the terms may be either absent or ambiguous.

It is these three distinguishing traits that form the legal basis for challenging the enforceability of such agreements.

In Carnival Cruise Lines, Inc. v. Shute , 499 U.S. 585 (1991), the Supreme Court found that adhesion contracts are valid. In particular, it found a forum-selection clause in the cruise line's passage-contract ticket ' a type of standard form contract printed on the back of the ticket ' to be enforceable. It emphasized that forum-selection clauses contained in form-passage contracts were subject to judicial scrutiny for fundamental fairness. It specifically disagreed with the Court of Appeals' determination that a non-negotiated forum-selection clause in a form-ticket contract is unenforceable because it is not subject to negotiation.

Subsequently, in the case ProCD, Inc. v. Zeidenburg , 86 F.3d 1447 (7th Cir. 1996), the court found that shrink-wrap license agreements were valid. It found that an enforceable contract may be formed when the buyer used the software after having an opportunity to read the license at leisure.

Contracts of adhesion differ significantly from the traditional process of contract formation. In an adhesion contract, the parties do not negotiate, because the terms and conditions that are presented to adherents are non-negotiable. The lack of meaningful bargaining between the parties leaves the adherent in the position of accepting the deal, or there is no deal. The adherent may only passively accept whatever is being offered and bears whatever obligation is being imposed ' and thus arises the issue of whether the adherent has in fact assented to the agreement's terms. It has been argued that adherents have not made a meaningful choice by clicking on an icon or downloading software. In some cases, when clicking the I agree icon, adherents did not even know they made a choice-of-law determination associated with their Internet contract.

Assent Is Crucial

Assent is a rudimentary concept of contract formation. It stems from the settled legal principle that the formation of a contract requires the mutual assent of the parties. Contracts of adhesion, at first glance, do not conform to the norm of mutual assent. It appears that contracts of adhesion fail to have a legitimate basis for finding the parties' assent. Courts, however, have found that an adherent's ability to refrain from engaging in the agreement is the legal basis for supporting his or her actions when entering into the adhesion contract.

In the case of In re RealNetworks, Privacy Litigation (2000 WL 631341 (N.D.Ill. 2000), it was alleged that RealNetworks' software secretly accessed and intercepted users' electronic transmissions. An arbitration clause barred a suit in Illinois in favor of arbitration in Washington. The court specifically addressed the conscionable act of requiring a consumer to cross the country to submit to arbitration. It found both parties intended to be bound. This finding is consistent with the application of existing law to traditional agreements. In particular, arbitration provisions containing forum-selection clauses have previously been upheld. Take a look, for instance, at Doctor's Ass'n. Inc. v. Hamilton , 150 F.3d 157, 163 (2d Cir. 1998), which upheld the forum-selection clause in the arbitration clause designating Connecticut as forum.

But some courts have used a two-factor theory to find an Internet contract clause unconscionable. As the theory's name implies, a court must find two factors present to deem an Internet contract clause unconscionable. The two-factor theory was set forth in Discover Bank v. Superior Court , 36 Cal. 4th 148 (2005). The court found that a contract clause becomes unconscionable when it is both part of a consumer contract of adhesion and it involves small amounts of damages. Under such conditions, the party with superior bargaining power can deliberately cheat numerous consumers out of small sums of money with impunity. When these two conditions are met, certain clauses, such as foreign-jurisdiction clauses, become exculpatory clauses that protect the wrongdoer and prevent consumers from employing the most effective method of redress.

Similarly, a California Court of Appeals for the Second Appellate District found that the forum-selection clause in defendant EarthLink Inc.'s membership contract was unconscionable. Specifically, the court found the contract to be one of adhesion and also found that some California consumers travel 2,000 miles to Georgia to recover claims of about $50. ( See, Aral v. Earthlink, Inc. , 134 Cal. App. 4th 544 (2005).)

In e-commerce agreements, so far the three clauses that are most likely to cause legal difficulties are those related to dispute resolution. They are:

• An arbitration clause providing for resolution of disputes through arbitration;
• A choice-of-forum clause designating a jurisdiction to which the disputes, if they arise, are to be submitted for adjudication; and
• A choice-of-law clause selecting an applicable law by which the contract in question will be governed.

These three clauses are easy to manipulate and are on the whole determinative of the outcome of any contract dispute. In freely negotiated contracts, these clauses are the result of extensive bargaining. In contracts of adhesion, however, dispute-resolution clauses frequently become the means by which businesses maintain legal certainty and predict their own advantage. For example, the forum-selection clause, which commonly appears in e-commerce agreements, is employed by the licenser to bring certainty to Internet-based transactions that lack any fixed geographic location.

The normal process for an adherent to bring these dispute-resolution clauses into play is by claiming that the contract writers didn't adequately bring these clauses to the adherent's attention, so the adherent may claim it did not manifest assent to the clauses. This tactic is successful because dispute-resolution clauses are not highlighted.

Few exceptions to enforceability of e-commerce agreements will be found and those that are most often found can be explained by flaws in how terms were presented. To ameliorate unexpected outcomes, e-commerce contracts should place the dispute-resolution clauses near the I agree icon or provide a separate I agree icon for the dispute-resolution clauses. This procedure will reduce unconscionability claims due to lack of affirmative assent.