According to Black's Law Dictionary, “incorporation by reference” is defined as “the act of including a second document within another document by only mentioning the second document.” This practice is a staple of public filings with the U.S. Securities and Exchange Commission, and in fact, the SEC proposed rules on Jan. 2, 2018 to eliminate “redundancies in rules governing incorporation by reference.” See also 17 C.F.R. 240.12b-23 (set of certain rules). The phrase is also a staple of trust and estates law, going back to common law, and is specifically referenced in a provision of the Freedom of Information Act.

Fast forward to 2018. For instance, incorporating by reference is considered now essential to limiting or broadening e-discovery in litigation and arbitration alike. As incorporation by reference is an integral concept in “traditional” contracts, so too is it in software, hardware, cloud computing and myriad other digital age agreements. You name a category and there's a good chance the concept has been incorporated by reference into such agreements.

A recent case in federal court in Illinois deals with interpreting an “incorporation by reference” provision in two software licenses and a related deferred payment agreement. See D&B II Enters. v. Universal Tax Sys., No. 13 C 5702, 2018 WL 14617277 (N.D. Ill. March 31, 2018). There, the parties disputed whether the “incorporation by reference” provision in a deferred payment agreement was worded broadly enough to include a disclaimer of implied warranties in an associated license.

Facts and Procedural Background

Plaintiff D&B II Enterprises (D&B) purchased tax preparation software (the Software) from Defendant Universal Tax Systems d/b/a CCH Small Firm Services (CCH). D&B licensed the Software between 1991 and 2012. On Aug. 16, 2012, CCH sent D&B a “Deferred Payment Agreement,” which entitled D&B to an early renewal discount (DPA). The DPA linked to a number of related agreements, including its refund policy.

Section 3(c) of the DPA stated that, by purchasing and using the Software, D&B accepted and acknowledged that the DPA “in no way modifies or amends” a 2011 CCH SFS Software License Agreement “to which [D&B] acknowledges it is subject to by purchasing the software” (the “2011 License”) (emphasis added). Section 8.3 of the 2011 License, titled “Limited Warranty”, disclaimed in capitalized letters, among other warranties, the implied warranty of merchantability. The 2011 License included an entire agreement provision stating that “[t]his agreement … and any other terms referenced by this Agreement but otherwise published by [CCH] outside of this Agreement, constitutes the entire and exclusive agreement … between [D&B] and CCH with respect to the Software … .”

D&B executed the DPA shortly thereafter. On Sept. 4, 2012, CCH published an updated standard license (the 2012 License) at the URL previously hosting the DPA and 2011 License. The relevant provisions of the 2011 and 2012 License were “materially identical” aside from section renumbering, from §8 to §7.

D&B received the Software in November or December 2012. While uploading the Software, a pop-up box appeared on the screen. The pop-up box displayed the first paragraph of the 2012 License, which informed the installer that “[b]y using or installing the Software or by otherwise indicating acceptance … of this Agreement, Customer acknowledges agreement to the terms set forth below,” including the implied warranties set out in §7.3. The installer then clicked a button at the bottom of the pop-up screen assenting to the terms of the 2012 License.

According to D&B, the Software was beset with problems from the outset. It “crashed” immediately, the following days and several times thereafter. The Software also “processed data slowly, failed to 'roll over' customers' returns from previous years, [] was unable to 'complete complex business returns,'” and produced tax calculations on “printed forms” dissimilar to what was later included in electronic returns actually filed with the Internal Revenue Service. D&B's founder and president testified that, although it succeeded in filing approximately 1,300 returns using the Software, the Software caused “errors” on certain filings and required D&B to reimburse a customer $500.

D&B filed initial and amended complaints alleging, inter alia¸ that the Software breached the implied warranty of merchantability. Of D&B's four claims, only the implied warranty claim survived CCH's first motion for summary judgment. D&B filed a second amended complaint and CCH again moved for summary judgment.

Legal Analysis and Conclusions

D&B first argued that it never agreed to the 2012 License, and the DPA (to which it admittedly agreed to) did not incorporate the 2012 License because the phrase “subject to” in §3(c) was “insufficiently specific and clear.” Plaintiff relied on the Seventh Circuit's decision in 188 LLC v. Trinity Indus., where the appeals court refused to incorporate into the contract a provision from a separate form notwithstanding that the contract claimed to be “subject to the general terms and conditions on the reverse side [of the contract].” See 300 F.3d 730, 733 (7th Cir. 2002).

The court in the instant case found the contract easily distinguishable from that at issue in 188 LLC. The contract language in 188 LLC referenced only “general terms and conditions on the reverse side of the contract,” which did not constitute a sufficiently specific reference to the form in question nor any delineated set of terms of conditions. Id. at 736-37. Moreover, the 188 LLC court did not consider the impact of the phrase “subject to” at all.

According to the court here, 188 LLC does not stand for the proposition that incorporation by reference via the phrase “subject to” is, “as a matter of law, insufficient evidence of the parties' intent to incorporate another document by reference.” Rather, it is the parties' particularity when referring to the purportedly incorporated contract that prevails. Since the DPA referenced the 2012 License by name, it “did more than simply mention the existence” of the 2012 License, but instead incorporated it by reference, as it could not precisely describe, such as by laying out the name and date, the 2012 License which had yet to be executed.

D&B also argued that the DPA's description in the title of §3.1(c) of the 2011 License as an “other” agreement, in purported contrast to references elsewhere in the DPA to “this” agreement, meant that the designation of the 2012 License as an “other” agreement excluded it from incorporation by reference. The court rejected this argument on grounds that differentiating language does not preclude incorporation by reference. In fact, such language “may be a prerequisite for incorporation by reference, as the concept of incorporation by reference implies the existence of an incorporating document that is distinguishable from the document being incorporated” (emphasis in original).

Finally, the court agreed with CCH that whether the DPA incorporated the 2012 License is “arguably superfluous” in that D&B agreed to be bound by the 2012 License by clicking the pop-up box presented on the screen immediately prior to installation of the Software. D&B claimed that it did not manifest mutual assent to be bound by terms that were not included in the DPA in part because the DPA “is not conditioned on the later acceptance of a license agreement[.]” D&B is bringing a defense that the DPA is a “shrink wrap” agreement, which is a contract that does not inform the customer of the existence of additional terms until after the purchase. Generally, “shrink wrap” agreements are not enforceable unless the agreement provided adequate notice and the purchaser subsequently could reject the objectionable additional terms by returning the product.” See also ProCD v. Zeidenberg, 86 F.3d 1447 (7th Cir. 1996) (one of the first federal appeals court cases to analyze “shrink wrap” contracts and requiring for a valid agreement notice, subsequent terms, and a refund right).

The DPA satisfied these elements. It referred to an additional agreement to which D&B's use of the Software would be “subject to” (ultimately, the 2012 License) and (unsurprisingly) the CCH's refund policy expressly granted D&B a full refund on the Software if returned by a certain date and not after D&B had used the software to prepare more than one tax return.

“In sum,” the court rejected D&B's argument that it could not be bound by the disclaimer of the implied warranty of merchantability in the 2012 License. The court separately rejected D&B's claims that the 2012 License was procedurally and substantively unconscionable and that the 2012 License included a provision imposing on it an implied-in-fact obligation to repair any defects in the Software. The court granted CCH's summary judgment motion and entered judgment on April 2.

Richard Raysman is a partner at Holland & Knight and Peter Brown is the principal at Peter Brown & Associates. They are co-authors of “Computer Law: Drafting and Negotiating Forms and Agreements” (Law Journal Press).