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Judge Eduardo Robreno of the United States District Court for the Eastern District of Pennsylvania has handed down a very interesting judgment dismissing two motions by Linden Labs (the makers of Second Life) in a lawsuit brought by lawyer Marc Bragg.

Bragg signed up to Second Life in 2005. He said he was induced into “investing” in virtual land by representations made by Linden and Rosedale in press releases, interviews, and through the Second Life website, and paid real money as “tax” on his virtual land.

On April 30, 2006, Bragg purchased a parcel of virtual land named “Taessot” for $300. Linden then emailed him, saying that the land had been acquired through an exploit of the site, then froze his account.

Bragg sued Linden and its Chief Executive Officer, Philip Rosedale, in the Court of Common Pleas of Chester County, Pennsylvania. The defendants removed the case to the Federal District Court, and filed a motion to compel arbitration, based on the terms of service (TOS) that Bragg had accepted when he installed the game. (Rosedale also filed a motion to dismiss against him personally for lack of personal jurisdiction, which the Court denied.)

Bragg conceded that he clicked the “accept” button before accessing Second Life. Buried in the TOS was the following boilerplate:

Any dispute or claim arising out of or in connection with this Agreement or the performance, breach or termination thereof, shall be finally settled by binding arbitration in San Francisco, California under the Rules of Arbitration of the International Chamber of Commerce by three arbitrators appointed in accordance with said rules. . . . Notwithstanding the foregoing, either party may apply to any court ofcompetent jurisdiction for injunctive relief or enforcement of this arbitration provision without breach of this arbitration provision.

Because the lawsuit involved plaintiff and defendants being residents of different states (diversity jurisdiction) the Federal Arbitration Act (FAA) applied, and the applicable substantive law was California law. Section 2 of the FAA provides that written arbitration agreements “shall be valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract.” Bragg pleaded that the arbitration provision in the TOS was “both procedurally and substantively unconscionable and is itself evidence of defendants’ scheme to deprive Plaintiff (and others) of both their money and their day in court.”

The Judge examined unconscionability under California law, which “has both procedural and substantive components”:

The procedural component can be satisfied by showing (1) oppression through the existence of unequal bargaining positions or (2) surprise through hidden terms common in the context of adhesion contracts. … The substantive component can be satisfied by showing overly harsh or one-sided results that “shock the conscience.” … The two elements operate on a sliding scale such that the more significant one is, the less significant the other need be.

Judge Robreno found that the arbitration provision was both procedurally and substantively unconscionable.

It was procedurally unconscionable because it was a contract of adhesion. Such a contract is:

a standardized contract, which, imposed and drafted by the party of superior bargaining strength, relegates to the subscribing party only the opportunity to adhere to the contract or reject it. … When the weaker party is presented the clause and told to ‘take it or leave it’ without the opportunity for meaningful negotiation, oppression, and therefore procedural unconscionability, are present

Such was the case here. First the element of one-sidedness:

Linden presents the TOS on a take-it-or-leave-it basis. A potential participant can either click “assent” to the TOS, and then gain entrance to Second Life’s virtual world, or refuse assent and be denied access. Linden also clearly has superior bargaining strength over Bragg. Although Bragg is an experienced attorney, who believes he is expert enough to comment on numerous industry standards and the ‘rights’ or participants in virtual worlds, … he was never presented with an opportunity to use his experience and lawyering skills to negotiate terms different from the TOS that Linden offered.

Secondly, there was also the element of “surprise”, because “although the TOS are ubiquitous throughout Second Life, Linden buried the TOS’s arbitration provision in a lengthy paragraph under the benign heading GENERAL PROVISIONS.’ ”

The TOS was also substantively unconscionable for five reasons. First, because of its one-sidedness and lack of mutuality:

The TOS proclaim that “Linden has the right at any time for any reason or no reason to suspend or terminate your Account, terminate this Agreement, and/or refuse any and all current or future use of the Service without notice or liability to you.” … Whether or not a customer has breached the
Agreement is “determined in Linden’s sole discretion.” … Linden also reserves the right to return no money at all based on mere “suspicions of fraud” or other violations of law. … Finally, the TOS state that “Linden may amend this Agreement … at any time in its sole discretion by posting the amended Agreement [on its website].”

In effect, the TOS provide Linden with a variety of one-sided remedies to resolve disputes, while forcing its customers to arbitrate any disputes with Linden. This is precisely what occurred here. When a dispute arose, Linden exercised its option to use self-help by freezing Bragg’s account, retaining funds that Linden alone determined were subject to dispute, and then telling Bragg that he could resolve the dispute by initiating a costly arbitration process. The TOS expressly authorized Linden to engage in such unilateral conduct.

Secondly, the TOS also contained a provision that three arbitrators must be engaged to resolve the dispute, and that the Rules of the International Chamber of Commerce (“ICC”) in San Fransisco would apply. Those rules require the plaintiff in an arbitration to prepay half of the estimated cost of the arbitration. Under California law, however, a requirement of pre-payment has been used to render contracts substantively unconscionable where they “impose[] on some consumers costs greater than those a complainant would bear if he or she would file the same complaint in court.” The Court found that this requirement was unconscionable.

Thirdly, the TOS required that any arbitration take place in San Francisco. In circumstances where Linden serves millions of customers across the United States but where the average transaction through or with Second Life involves a relatively small amount, “it it not reasonable for individual consumers from throughout the country to travel to one locale to arbitrate claims involving such minimal sums”. The Court paraphrased another case which went so far as to state that: “Indeed, “[l]imiting venue to [Linden’s] backyard appears to be yet one more means by which the arbitration clause serves to shield [Linden] from liability instead of providing a neutral forum in which to arbitrate disputes.”

Fourthly, the confidentiality provisions meant that individual plaintiffs would be denied the ability to obtain any precedent for similar claims, but Linden would be able to “accumulate[] a wealth of knowledge on how to negotiate the terms of its own unilaterally crafted contract.” This would place Linden “in a far superior legal posture”.

Finally, Linden did not offer any evidence that “business realities” justify the one-sidedness of the dispute resolution scheme that the TOS constructs in Linden’s favor.

As a result, the Court struck out the clause, and did not permit it to be cured or reinstated in narrower form.

The result in the case is very important. For Bragg, it means his case will proceed in the court of his choosing, and as a court case, not an arbitration. But for businesses and consumers more broadly, the case has significant implications. Strong, one-sided boilerplate clauses are very common in computer and internet-related contracts. The biggest, perhaps, are those clauses excluding liability (and disclaiming all warranties) to the extent that statute law provides. There must be a significant question as to whether these licence terms (assuming they are a contract) would fall foul of a similar analysis.