The American Law Institute (“ALI”) approved the Principles of the Law of Software Contracts (the “Principles”) on May 19, 2009. I have discussed these Principles in the past in this blog http://lawandlifesiliconvalley.com/blog/?p=134. Although the Reporters (the title given those managing the project) have made some changes to the earlier draft, the current draft continues to have significant flaws. The Principles were meant to clarify the ambiguity created by conflicting legal decisions and  the application of multiple laws to software licenses, such as intellectual property law (including, most importantly, copyright), Article 2 of the Uniform Commercial Code (“Article 2”) and various consumer laws (the federal Magnusson Moss Warranty Act and state laws such as the Song Beverly Warranty Act in California). Unfortunately, they have made the situation worse because many of their recommendations relating to ”best practices” are new and not consistent with existing law.

The Principles have the stated goal of summarizing the case law and recommending best practices, but the Reporters have included many new concepts which impose consumer type protections on both consumer and business software licenses. Yet consumer and business licenses are quite different because of the negotiation leverage of licensees who are businesses as well as the ability of businesses to enforce their rights. The result is a significant lack of flexibility in negotiating the terms of the license for businesses. Moreover, this dramatic change does not appear to be addressing any significant problem in the market.

The best example of this approach is the new “non disclaimable” warranty of no hidden material defects. This warranty provides that licensors are liable for “hidden” material defects if they are aware of them at the time of the transaction. Yet this warranty is not otherwise found in the case law and incorporates new and difficult concepts, such as “hidden” and “material”.  In addition, the concept of a “non disclaimable” warranty is fundamentally inconsistent with the approach of existing laws including Article 2  and both federal and state consumer warranty statutes. This warranty, if adopted, is likely to lead to significant litigation without any clear benefit to licensees.

The concern about the Principles in the software industry has led to unusual bedfellows: Microsoft Corporation and the Linux Foundation, who are fierce competitors with radically different approaches to licensing, sent a joint letter to the ALI to express their concern about  the provisions in the Principles and request a delay in their approval. The Principles were, nonetheless, approved.  

Despite these flaws, software licensors need to deal with the likelihood that the courts will be influenced by the Principles and need to review their agreements and processes. I will be providing a more detailed discussion of the major provisions in a series of blog posts. The Principles can be purchased at the ALI website at http://www.ali.org/.

The American Law Institute (”ALI”) has recently published the first draft of the ALI Principles of the Law of Software Contracts (”Principles”) http://www.ali.org/index.cfm?fuseaction=projects.proj_ip&projectid=9 <http://www.ali.org/index.cfm?fuseaction=projects.proj_ip&projectid=9> . The ALI was founded in 1923 and has a membership consisting of judges, practicing lawyers, and legal scholars from the United States as well as some foreign countries, selected on the basis of professional achievement and demonstrated interest in the improvement of the law. ALI is a very prestigious non profit institution whose purpose is to: “publishes various Restatements of the Law, model codes, and legal studies to promote the clarification and simplification of the law and its better adaptation to social needs, to secure the better administration of justice, and to encourage and carry on scholarly and scientific legal work.”

These Principles have great potential to clarify the difficult issues of software licensing and, when adopted, will have a significant effect on software licensing. The Principles have been developed by a committee of law professors with limited input from an advisory committee. The Principles are now available for public comment and I want to encourage the community to provide comments on the Tentative Draft (see below).

I, as general counsel of OSI, and Karen Copenhaver, as general counsel of the Linux Foundation have written a letter expressing our concern that several of the proposed terms represent very dramatic changes from existing law which are likely to have a very negative effect on the open source software industry. Although a number of provisions in the Principles will be of interest to the open source community, I want to focus on two recommendations which could have a significant negative impact on open source licensors and contributors.

The Principles recommend the creation of two new “non disclaimable” warranties which would result in significant problems for the open source community. The warranties are the (1) warranty of non infringement of intellectual property rights (such as patents or copyrights) if the contributor knew or should have known of the infringement and the contributor holds himself out by occupation as having knowledge or skill peculiar to the software and (2) warranty of no hidden material defects. Current law (and all OSI approved licenses) permit the contributor (and any licensor) of open source software to completely disclaim all warranties i.e. promises about performance or non infringement which could result in liability to a contributor or a licensor(so called AS IS provisions).

Despite some discussion in the Summary Overview of Section 3 suggesting that these warranties would not apply to open source licensors, the actual language of the first warranty, Section 3.01, would apply it to most open source software licensors and contributors. The relevant section follows:

§3.01 Indemnification Against Infringement

a. Except as provided in (c) or as excluded or modified under (d), a transferor that deals in software of the kind transferred or holds itself out by occupation as having knowledge or skill peculiar to the software must defend at its own expense any action brought by a third party against the transferee that is based on a claim under the laws of the United States or a State thereof by way of infringement or the like if the transferor knew or should have known of the infringement at the time of transfer. The transferor must pay those costs and damages finally awarded against the transferee in any such action that are specifically attributable to such claim or those costs and damages agreed to in a monetary settlement of such action.

The exceptions to the obligation are modest: the obligations would not apply if the licensee uses the software outside the scope of the license or the software was developed based on specifications provided by the licensee. The ability to disclaim this warranty is not permitted under the Principles for the following category of software: “Standard Form Transfer of Generally Available Software” (a defined term in the Principles) . The Principles state that open source software is included in this category. Given the view expressed in the Section Overview, we hope that the provision can be clarified to make the warranty disclaimable for open source licensors.

The second warranty, Section 3.05, would apply to all open source software licensors and contributors and appears to present a more difficult problem. The relevant section follows:

§3.05 Other Implied Quality Warranties

b. The transferor warrants to any party in the normal chain of distribution and to the end user 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.

“Disclosure of a material hidden defect occurs when a reasonable transferee would understand the existence and basic nature of a defect. Disclosure ordinarily should involve a direct communication to the transferee, if feasible. A mere posting of defects on the transferor’s website generally should be insufficient.” From Comment b, following § 3.05.

These recommendations also raise similar concerns for commercial licensors. OSI and the Linux Foundation will be soliciting comments on the Principles and expect to have a mechanism to receive those comments by the end of June and will post how to provide comments on our sites. We look forward to hearing from you.