From the Nolo eCommerce Center

Contracts created online are now as legal as those on paper.

Understanding the basic legal principles governing contracts (how they are formed and what makes them valid) is important when you’re figuring out how to create a contract or evaluating whether an agreement you’ve already made is legally binding. (This article does not discuss these fundamentals.) While contract basics generally apply to any contract, regardless of form (typed in a formal document, scratched on a cocktail napkin, or sometimes even not written at all), there are some new and emerging rules that apply specifically to contracts created online – that is, via email or on the Web.

Thanks to federal legislation recently signed into law, as of October 1, 2000, electronic contracts and electronic signatures are just as legal and enforceable as traditional paper contracts signed in ink. The law, known as the Electronic Signatures in Global and International Commerce Act, removes the uncertainty that previously plagued e-contracts. Its proponents herald a more efficient paperless world, but consumer groups worry that the law doesn’t adequately protect against online fraud and may create disadvantages and penalties for consumers who prefer printed agreements.

What Are Electronic Contracts and Electronic Signatures?

An electronic contract is an agreement created and “signed” in electronic form – in other words, no paper or other hard copies are used. For example, you write a contract on your computer, email it to a business associate, who emails it back with an electronic signature indicating acceptance. An e-contract can also be a “Click to Agree” contract, commonly used with downloaded software; the user clicks an “I Agree” button on a page containing the terms of the software license before the transaction can be completed.

One of the stickier electronic contract issues has been whether agreements made in a purely online environment were “signed” and therefore legally binding. In a paper and ink world, the traditional way to indicate your acceptance of a contract (and most other binding documents) is to sign it with your unique signature. Since a traditional ink signature isn’t possible on an electronic contract, people have used several different ways to indicate their electronic signatures, including typing the signer’s name into the signature area, pasting in a scanned version of the signer’s signature, clicking an “I Accept” button, or using cryptographic “scrambling” technology.

Keep in mind that while lots of folks use the term “digital signature” for any of these methods, it’s becoming standard to reserve the term “digital signature” for cryptographic signature methods (see Are E-Signatures Secure? below), and to use “electronic signature” for other paperless signature methods.

Are E-Signatures Secure?

Cryptography is the science of securing information. It is most commonly associated with systems that scramble information and then unscramble it. Security experts currently favor the cryptographic signature method known as Public Key Infrastructure (PKI) as the most secure and reliable method of signing contracts online. PKI uses an algorithm to encrypt online documents so that they will be accessible only to authorized parties. The parties have “keys” to read and sign the document, thus ensuring that no one else will be able to sign fraudulently. Though its standards are still evolving, it is expected that PKI technology will become widely accepted and that consumers and businesses will own and use e-signatures, much like we now use PINs for our bank cards. Many other e-signature systems are being developed, including a method for digitally recording a fingerprint and hardware that electronically records your signature. A good (though slightly tech-heavy) source for more information on PKI technology is the Center for Information Technology Standards – Public Key Infrastructure (PKI) Standardization Home Page. Also, the American Bar Association has published a helpful online tutorial on digital signature guidelines (http://www.abanet.org/scitech/ec/isc/dsg-tutorial.html).

No Paper Needed

The most significant legal effect of the new e-signature law is to make electronic contracts and signatures as legally valid as paper contracts. In other words, an unhappy party to an electronic contract cannot challenge its validity simply because it’s not on paper – or because an electronic signature was used to sign it.

The fact that electronic contracts have been endowed with solid legal support is great news for companies that conduct business online, particularly companies that provide financial, insurance and household services to consumers. Under the law, consumers can now buy almost any goods or services – from cars to home mortgages – without placing pen to paper. The law also benefits B2Bs (business-to-business websites) who need enforceable agreements for ordering supplies and services. For all of these companies, the new law is essential legislation because it helps them conduct business entirely on the Internet. This may result in substantial savings to businesses, which can be passed on to consumers. For example, one online company estimated that eliminating paperwork fees reduced the cost of processing a home loan by $750.

Federal Law Versus State Law

The federal electronic signature law won’t override any state laws on electronic transactions provided the state law is “substantially similar” to the federal law or the state has adopted the Uniform Electronic Transactions Act (UETA), which also establishes the legal validity of electronic signatures and contracts. In other words, if the state’s law is more or less the same as the new federal law, it will remain in force – but if not, it will be trumped by the federal law. This ensures that electronic contracts and electronic signatures will be valid in all states, regardless of where the parties live or where the contract is executed.

Some Exceptions

To protect consumers from potential abuses, some legal documents and contracts are exempt from the e-signature law. In other words, electronic versions of the following documents are invalid and unenforceable:

  • wills, codicils and testamentary trusts
  • documents relating to adoption, divorce and other family law matters
  • court orders, notices and other court documents such as pleadings or motions
  • notices of cancellation or termination of utility services
  • notices of default, repossession, foreclosure or eviction
  • notices of cancellation or termination of health or life insurance benefits
  • product recall notices affecting health or safety, and
  • documents required by law to accompany the transportation of hazardous materials.

These documents must be provided in traditional paper and ink format. In 2003, Congress will reconsider these exceptions to determine if they are still necessary.

Do You Want Paper or Plastic?

If you prefer paper, the law provides a means for you to opt out of using electronic contracts. An online company must provide a notice indicating whether paper contracts are available and informing you that if you give your consent to use electronic documents, you can later change your mind. In other words, even if you agree to use electronic agreements, you can change your position later and request a paper agreement instead.

If you withdraw consent to use electronic contracts, the notice must explain what fees or penalties might apply if the company must use paper agreements for the transaction. The notice must also indicate whether your consent applies only to the particular transaction at hand, or to a larger category of transactions between the business and you – in other words, whether the business has to get consent to use e-documents/signatures for each transaction.

Prior to obtaining your consent, the business must also provide a statement outlining the hardware and software requirements to read and save the business’s electronic documents. If the hardware or software requirements change while you have a contractual relationship with the business, the business must notify you of the change and give you the option (penalty-free) to revoke your consent to using electronic documents.

Although the e-signature law doesn’t force consumers to accept electronic documents from businesses, it poses a potential disadvantage for low-tech citizens by allowing businesses to collect additional fees from those who opt for paper.

Effect on Government Filings

While the e-signature law enables individuals and private companies to do more business online, it won’t have an immediate impact on doing business with state and federal governments. Although the electronic contract law enables state governments to conduct business online, it will probably be a while before you can perform traditional functions online, such as registering your state LLC or corporation. State online systems have been categorized by one academic report as “a veneer [of online government] in front and a scrambled mess behind.”

As for the federal government, transactions between citizens and the federal government were addressed in 1998′s Government Paperwork Elimination Act (GPEA), which created requirements and incentives for the federal government to make electronic versions of their forms available online. And a good deal of progress has been made, as many online consumer transactions – such as paying taxes and registering trademarks – are now available from the feds.

Consumer Concerns

Consumer advocates are concerned because the federal electronic signature law does not define an electronic signature, or elaborate what technologies can or should be used to create an electronic signature. The law establishes only that electronic signatures in all their forms qualify as signatures in the legal sense, and leaves it up to software companies and the free market to establish which electronic signature methods will be used.

Since electronic signature technology is still evolving, many kinds of e-signatures offer little if any security. If a consumer uses an insecure signature method (such as a scanned image of a handwritten signature), identity thieves could intercept it online and use it for fraudulent purposes. It is expected that secure methods of electronic signatures will be adopted and become as commonplace as credit cards. However, stolen electronic signatures have the potential to become as widespread a problem for e-commerce as credit card scams and stolen passwords. Consumer protection groups such as the Consumers Union (http://www.consumersunion.org) and the National Consumer Law Center (http://www.consumerlaw.org) suggest caution before signing anything online.

Click here for related information and products from Nolo

© 2002 Nolo