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Electronic Contract

Posted on Nov 12, 2004

Posted By Varun Shivhare

Varun Shivhare

In the traditional notion of contract formation, negotiating parties must come to a "meeting of the minds" on the terms of an agreement. In the course of negotiation, there may be invitations to make offers (e.g., price lists are generally not offers, but invitations) and counter-offers, but the general rule is that formation requires an offer and acceptance to be communicated between the parties.

Generally, a contract is formed when acceptance is communicated to the offeree. In face-to-face negotiation, this rule provided few problems. However, the development of methods of communicating over distances, and the associated reliability problems, the case often arises when the offeree has dispatched an acceptance which either is never received by the offeror or arrives after the expiry of the offer. The issue to be resolved in each case is whether the acceptance is communicated to the offeree when it was sent or when it arrives. Case law tends to distinguish between delayed forms of communication, such as mail and telegrams, and virtually instantaneous forms of communication, such as the telephone, telex and fax machine. The courts have yet to consider the electronic message.

Early case law saw the development of the "mailbox rule" for ordinary mail, wherein acceptance is deemed to be communicated to the offeree when it enters the postal system. This rule has been extended to telegrams and even couriers. The offeror, however, is free to put conditions on the communication of the acceptance (e.g., offer must be received; must be by telephone). In contrast to the "mailbox rule", acceptances communicated using instantaneous or virtually instantaneous means, such as the telephone , telex , and fax, are formed when the offeror receives the acceptance. These means are analogous to face-to-face communications; presumably both parties will be aware of any break in the connection and be able to take corrective action.

There is little case law on acceptance by electronic message. On the one hand, some cases suggest the general rule is that the acceptance must be received by the offeror and that the mailbox rule is only a narrow exception. On the other hand, receipt of electronic messages may not be instantaneous and since the mailbox rule has been extended to telegrams, it could be argued that it should be extended to electronic mail. Although some electronic message systems, such as private EDI networks, provide almost immediate transmission, anecdotal evidence suggests that Internet e-mail is inconsistent and could take minutes, hours or even days to reach its destination.

Another justification for a mailbox-like rule for electronic mail is the offeror's role in delivery. While telexes and faxes are received at the recipient's location almost immediately after they are sent, some electronic mail systems use mail servers operated by third parties that are not located at the recipient's location. Even after receipt by the mail server, the recipient has to take steps to connect to their `mailbox' on the mail server before the communication is complete. Since the offeror is partially responsible for ensuring delivery, it may not be appropriate to allocate the entire risk in the delivery of electronic mail to the offeree.

It is also quite possible that no simple rule will govern electronic messages. In a recent case involving telex communication, England's House of Lords seemed to be backing away from the application of a general rule:
The message may not reach, or be intended to reach, the designated recipient immediately: messages may be sent out of office hours, or at night, with the intention, or on the assumption, that they will be read at a later time. There may be some error or default at the recipient's end which prevents receipt at the time contemplated and believed in by the sender. The message may have been sent and/or received through machines operated by third persons. And many other variations may occur. No universal rule can cover all such cases; they must be resolved by reference to the intentions of the parties, by sound business practice and in some cases by a judgment where the risks should lie.

As with the contract formality issue, EDI trading partners try to resolve the communication of acceptance rule in their trading partner agreement. The standard TPA has an interesting way of balancing the risk. The TPA states that no document is legally binding until received, thereby eliminating the possibility of the "mailbox rule" being applied. The sender, therefore, bears the risk of transmission failure. However, this risk is reduced by provisions requiring recipients to promptly acknowledge receipt of any message as well as notify the sender of any communication it reasonably suspects is incomplete, inaccurate, corrupted in transmission, or not intended for him.

For transactions caught by the International Sale of Goods Act, the "mailbox rule" does not apply. Instead, the Act sets out that the acceptance of an offer becomes effective at the moment the indication of assent reaches the offeror.
In the U.S., reformers have proposed changes to the U.C.C. to deal with the formation issue specifically for electronic transactions. The proposal differs from the International Sale of Goods Act by acknowledging the offeror's role in the delivery process. While the proposal states the contract is created when the acceptance is received by the initiating party, it goes on to provide rules for determining when an electronic message is received. When the message reaches the electronic mail system used by the recipient, it is deemed to be received. Therefore, the offeree does not bear the risk for the time between the message reaching the mail system and the offeror retrieving the message from the system.

While much of the contract formation discussion revolves around the use of computer technology as a means of communication by contracting parties, a far more difficult issue is beginning to emerge with the automation of the contracting process itself. Traditional contract doctrine centres around the requirement of a `meeting of the minds'. The involvement of two or more people, negotiating either face-to-face or through some means of communication is an underlying assumption. However, modern technology is evolving with a goal of eliminating human involvement in transactions. How traditional contract doctrine will accommodate situations where the only `minds' that meet are programmed computer systems is uncertain.

Interactive EDI is already beginning to emerge in business transactions. The following describes a possible interaction:
...a sending computer, on its own initiative, will make an offer to a recipient computer for the purchase of goods based on the sender's inventory needs. The recipient computer will accept the offer if the recipient has the quantity of product in stock. This two-way conversation between computers will further culminate in negotiations. One computer will make an offer to buy 100 widgets, and the other will respond with a counteroffer of 50 widgets due to a shortage in stock. The computer that made the original offer will thereafter decide on its own whether to accept the 50 widgets or reject the counteroffer and search for another vendor.

Automated transactions will not be limited to business-to-business transactions. According to Colin Crook, head of technology at Citibank, in the future "You're going to hand off your personal affairs in cyberspace to automatic agents who represent you."

In a fully automated system, human decisions are involved in creating the system and making it accessible; humans assent to the system, not specific transactions. Traditional contract doctrine looks at the intention of the parties surrounding the offer and acceptance of the specific agreement in dispute. As such, it is not clear whether people can be bound by offers or acceptances made by their computer on their behalf. They may have had no knowledge of, let alone intention to enter, a given transaction.

The main issue is one of attribution -- when do the actions of an agent become attributed to the principal. While agency law plays a role in attribution when using human agents, human judgements, such as voluntary assent and reliance, are major themes in this area of law. Therefore, the existing law of agency may not be very helpful in determining attribution with automated agents.

With automated transactions, another challenge for the courts is determining where the communication system ends and the legal agent begins. The challenge is separating responses that are part of the functional communication process, such as those acknowledging receipt of a message, from responses that are part of the contract formation process, such as an acceptance of an offer.

In a recent U.S. case, the court dealt with an automated order taking system. In holding that the order tracking was merely a functional acknowledgement of the order, the court stated "Such an automated, ministerial act cannot constitute an acceptance." However, one can envision a more sophisticated system that verifies the identity of the orderer, checks the inventory level, allocates a portion of the inventory to fulfilling the order, then issues the order tracking number. This is no less automated or ministerial, yet it may be in both parties' interests to consider it a legal acceptance.

As this is an emerging issue, legal response has been limited. Standard trading partner agreements still assume human involvement in the process. The UN's Draft Model Law on Legal Aspects of EDI includes a similar assumption. In the U.S., law reformers have begun to address this issue, but the UCC proposal was admittedly only a first-step to promote policy discussion of many unresolved issues.

In addressing the attribution issue in electronic contracting, the proposal focuses not on humans who make decisions on specific transactions, but on how risk should be structured in an automated environment. The object is to create default rules for attributing a message to a party. The party described in the message as the originator will be bound by the terms of the message if the message was authenticated using a procedure previously agreed to by the parties. This provision gives primacy to authentication procedures in trading partner agreements. In addition, a fault provision attributes the message to a party if the relationship between the wrongdoer and that party enabled the wrongdoer to gain access to and use the authenticating method.

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