By Alissa Fanning

Everyone is aware that the internet and e-commerce have grown substantially in recent years. Even so, the numbers are surprising. In January 2002, the worldwide internet population grew to 308.8 million users. The United States alone is adding 2 million new internet users each month and enjoyed a record $10.043 billion in retail e-commerce sales for the fourth quarter of 2001.

Until recently, it was unclear whether or not traditional contract law applied to these transactions. As a result, parties that chose to conduct a transaction electronically did so at their own risk. In the face of legal uncertainty, a two-step process was commonly used to ensure that an electronic transaction would be enforceable. First, the transaction was completed electronically, with language stating the transaction was not official until it was in paper form. Then a written contract was mailed out and returned to confirm the parties’ intent to be bound by the agreement.

Legal recognition of electronic signatures, transactions and records is desirable because it eliminates the need for the second step. This streamlined process makes transactions quicker, cheaper, and easier to complete. Another advantage of electronic transactions is that electronic records can be stored more efficiently than their paper equivalents. As businesses consider implementing electronic transactions, it is important that those in the legal profession be able to inform their clients of the additional risks involved with the use of electronic transactions to assist them in making an informed choice.

Defining the Concepts

To better understand the scope of this issue, it is helpful to define certain concepts. For example, “electronic” means relating to technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities. This broad definition would include:  (i) electronic sounds, (ii) electronic symbols, (iii) e-mails, (iv) voicemails, (v) faxes, (vi) wireless communications, and (vii) automated transactions. Thus, an “electronic signature” is any symbol executed or adopted with the intent to authenticate. The more common electronic signatures include:  (i) pin numbers, (ii) digital signatures that incorporate cryptography; (iii) click-through agreements that require the signatory to click on a button to indicate that he or she has read and agrees to the terms of the contract, (iv) smart cards, (v) e-mails sent under the company’s name and designed to serve as legal notice (e.g., a shareholder’s meeting), (vi) passwords selected and stored by a party and later used to authorize a transaction, and (vii) biometric scanners that recognize fingerprints or retinal patterns. Finally, an “electronic record” is any record created or retained electronically. Types of electronic records include: (i) scanned images of paper documents, (ii) websites, (iii) e-mails, and (iv) files created in desktop applications.

The Law:  Addressing the Uncertainty

As the use of the internet and e-commerce grew, the enforceability of electronic transactions became an area of increasing concern at both the state and national level. Concerned that states would develop different laws thereby making interstate electronic transactions difficult, the National Conference of Commissioners on Uniform State Laws developed the Uniform Electronic Transaction Act (the “UETA”) in 1999 and encouraged its adoption by all states. As more fully discussed below, the UETA gives electronic contracts, records, and signatures the same legal validity as their paper counterparts.

Recognizing the states’ need for time to adopt legislation similar to the UETA, the federal government passed the Electronic Signatures in Global and National Commerce Act (“E-Sign”) on June 30, 2002 to protect electronic transactions in the interim. Like the UETA, E-Sign provides for the enforceability of electronic signatures and transactions. States that adopt a state law similar to UETA are permitted to opt-out of E-Sign.

In 2001, the Texas Business and Commerce Code was amended to incorporate the UETA to apply to electronic records or electronic signatures created, sent, communicated, received or stored on or after January 1, 2002. The Texas version of the UETA contains four basic provisions: (i) a record or signature may not be denied legal effect or enforceability solely because it is electronic, (ii) a contract may not be denied legal effect or enforceability solely because an electronic record was used in its formation; (iii) if a law requires a record to be in writing, an electronic record satisfies the law; and (iv) if a law requires a signature, an electronic signature satisfies the law. However, all parties to the transaction must have consented to the use of electronic means.

As a general rule, an electronic record is “sent” when it is directed to the recipient’s information processing system in a form capable of being processed by that system as soon as it leaves the control of the sender or enters the control of the recipient. An electronic record is “received” when it enters the recipient’s information processing system in a form capable of being processed by that system, regardless of the awareness of the recipient.

Scope of the Texas UETA

The Texas UETA applies to a wide variety of transactions. For example, electronic signatures and records are acceptable for banking transactions, real estate transactions, licenses, sales and services agreements, insurance policies, asset purchase agreements, and employment agreements. However, there are several types of transactions for which the use of electronic signatures or records are not permitted. Among others, these include: wills, testamentary trusts, divorce and adoption decrees, official documents executed in connection with court proceedings, any notice of the cancellation of utilities, any notice of foreclosure, default, repossession, acceleration, eviction relating to a primary residence, any notice of the cancellation of health insurance or life insurance benefits, and recalls of products and materials with health or safety risks.

Steps in Reducing Legal Risk in the Use of Electronic Transactions

Despite the advantages of electronic transactions, there are also multiple risks involved with their use. These risks are in addition to the more usual challenges to a contract that a signature was forged, used without authority, or made by one lacking capacity. Although these new problems may seem to be relevant only to contracts formed after the enactment of E-Sign and UETA, these laws might impact existing contracts with respect to amendments, notices, and consents. Therefore, it is prudent to understand the risks of electronic transactions and to take steps to reduce legal risk where possible.

Preliminary Considerations: Practicality and Potential for Fraud

Before deciding to utilize electronic transactions, a party should consider certain matters. First, the party must evaluate whether the use of electronic transactions would be practical. Forms and procedures may require extensive review and revision to accommodate electronic commerce. For example, it is important that retention procedures ensure proper maintenance, security and privacy of electronic documents. It is recommended that a party analyze the full range of technological options for electronic transactions and follow commercial trends where appropriate.

Second, a party must evaluate its risk tolerance overall and with respect to the particular transaction. Due to the lack of face-to-face contact, the use of electronic transactions may involve an increased possibility of fraud. Therefore, it is important to analyze the nature of the transaction to determine the level of risk that can be tolerated and the level of protection needed. Riskier functions, such as those that have legal significance and those involving processes historically susceptible to fraud or litigation require stricter safeguards. Similarly, data reflecting ownership or likely to be used in litigation requires the most protection. Past dealings with the other party to the transaction and the establishment of a sufficient level of trust may also be a factor.

Additional Risks Caused by the Use of Electronic Transactions

Once the decision to use electronic transactions has been made, it is important to implement policies to decrease the additional risks that they involve. As more fully discussed below, additional problems caused by the use of electronic transactions include: (i) verifying the intent to undertake an electronic transaction, (ii) verifying the authenticity of the electronic record, (iii) demonstrating that an electronic record has not been improperly modified, (iv) avoiding unintentional contract formation or amendment, (v) storing electronic records and (vi) protecting the confidentiality of information transmitted or stored electronically.

Problem: Verifying the Electronic Transaction

The verification of an electronic transaction can be problematic in the event that a signatory to the contract has died or left the company or if the software used to access the record has become outdated. Therefore, it is important to develop procedures to ensure the authenticity of electronic transactions. First, because the enforceability of electronic records is contingent upon the consent of all parties to the transaction, the documentation of such consent is crucial. One of the more common ways to manifest consent is by the use of an electronic “click-through” agreement that requires the party to indicate by clicking on an icon that it has read and agrees to be bound by the terms of the contract.

Second, it is essential to have the ability to demonstrate the integrity of the information transmitted. To that end, data error checking and correction should be part of data transmission. In addition, a party to an electronic transaction should consider collecting and retaining the following information: (i) content of the transaction, including all records that comprise the substance of the transaction or filing, (ii) information about how the transaction was processed, including dates received and changes that were made in records, and (iii) a means to authenticate the identity of all people who participated in the transaction and the scope of each person’s participation. In addition, a party using electronic transactions should have some measures in place to distinguish final documents from drafts and to ensure proper sequencing and construction of electronic records entries.

Finally, it is important to be able to prove that the contract has not been improperly modified and that the entirety of the transaction  is reflected in the record. Therefore, it is necessary to develop procedures to preserve the record. This includes ensuring that the record’s content, structure, context, audit trail and other security attributes are accurately reflected. It is also important to conduct periodic system audits, guard against accidental deletion and equipment failures, and preserve the software and hardware required to retrieve the record. Additional measures should include standard procedures for backing up data and regular refreshment of data on media such as magnetic tape to avoid loss of data due to media degradation.

Problem: Inadvertent Contract Formation or Amendment

Electronic transactions create new ways in which contracts can be unintentionally formed or amended. For example, without face-to-face contact, it may be less clear who has the authority to contract. As a result, there is an increased chance that one with mere apparent authority as opposed to actual authority may enter into a binding contract. Likewise, it may be unclear what it takes to form or amend a contract; as a result, an exchange of emails or voice mails that confirms the availability of and the intent to buy and sell a given quantity of goods may be a contract.

One way to safeguard against these types of mistakes is to use a “terms and conditions” agreement to ensure that all conditions of submission and receipt of data electronically are mutually known and understood by the parties to the electronic process. Another protective course of action that the parties might consider is the restriction of the number of individuals given the ability to create, modify and view electronic records.

Problem: Storing Paperless Records

A party that chooses to adopt electronic transactions will want electronic records to be as useful and accessible as paper documents. Thus, procedures to store and register the records and to ensure that the entire contract, including exhibits and amendments, is reflected in the record must be developed. This can include indexing the records for easy retrieval, storing the records in a form that can be easily viewed or printed, and developing a means of showing other relevant communications on a given subject.

Problem: Confidentiality of Contract Information

Like parties to a paper transactions, parties to an electronic transaction face liability in the event that confidential information contained in an electronic record is improperly used. However, the use of electronic records can cause increased security concerns. Therefore, a party to an electronic transaction must take additional steps to ensure the confidentiality of contract information. This involves both restricting the access to records and developing security procedures to protect the record infrastructure and detect tampering.

Conclusion

Although the use of electronic transactions is not yet universal, as more and more companies consider utilizing electronic transactions, the increased risks and additional problems that they involve will become more important. It is possible to safeguard against such risks, but awareness is key. Thus, it is important that those in the legal profession make certain that their clients sufficiently appreciate the risks involved and understand the steps necessary to protect their interests.

Alissa K. Fanning is an associate in the Corporate and Securities Department of Cox & Smith Incorporated in San Antonio. She is a graduate of the University of Texas, where she received her undergraduate and law degrees.

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© 2002, Legal Assistants Division State Bar of Texas