July 01, 2001

E-commerce in Real Estate Transactions (2001, 15:04)

E-commerce in Real Estate Transactions

Probate and Property, July/August 2001, Volume 15, Number 4

By William P. Gardella

Momentous events have occurred in the world of e-commerce during the past two years. First, President Clinton signed the Electronic Signatures in Global and National Commerce Act (Act) into law. 15 U.S.C. §§ 7001 et seq. (2000).  

Momentous events have occurred in the world of e-commerce during the past two years. First, President Clinton signed the Electronic Signatures in Global and National Commerce Act (Act) into law. 15 U.S.C. §§ 7001 et seq. (2000). Second, the National Conference of Commissioners of Uniform State Laws (NCCUSL) approved and recommended a Uniform Electronic Transactions Act (UETA). This article reviews the key provisions of the Act and UETA and concludes with a discussion of how the integrity and confidentiality of electronic real estate transactions may be protected. A related article in this issue by Patrick A. Randolph Jr. (see p. 23) expresses concern that the Act may weaken the formal requirements governing real estate transactions currently afforded under the Statute of Frauds, to the detriment of the parties.

The Federal Act

The world is at the inception of a large-scale conversion to an information society. H.R. Rep. No. 106-462, at 4 (1999). Consumer spending in on-line transactions was estimated at $2.6 billion in 1996 and more than $32 billion in 1998. H.R. Rep. No. 106-341 (Part 1), at 6 (1999). One year later, Internet commerce on a global basis was projected at more than $100 billion and growing. S. Rep. No. 106-131, at 1 (1999). Although the growth in e-commerce transactions has been explosive, no consistent body of law has governed the use of the Internet. The House report took the position that federal preemption would most efficiently serve the national interest, although the states could serve the national interest by continuing to act as “laboratories of innovation.” H.R. Rep. No. 106-462, supra, at 4.

The Act was passed against this backdrop. The fundamental purposes of the Act are to encourage public confidence in electronic commerce, to facilitate the use of electronic commerce by clarifying the status of electronic records and signatures, and to promote the development of a consistent legal infrastructure to support electronic commerce on a national basis. Id. at 5.

Electronic Records and Signatures

The Act provides that regardless of any statute or rule of law to the contrary, a contract, signature or other record relating to a transaction that affects interstate or foreign commerce shall not be denied legal effect solely because it is in electronic form. 15 U.S.C. § 7001(a). The term “transaction” includes the sale, lease, exchange or other disposition of any interest in real property. Id. § 7006(13)(B). The parties to a contract are not required to enter into or sign a contract in an electronic form, but the Act gives them the option to do so. 15 U.S.C. § 7001(b)(2). Congress recognized that many individuals do not have Internet access and others are not familiar with electronic authentication methodologies. H.R. Rep. No. 106-341, supra, at 14.

A basic premise of the Act is that it does not alter or affect the substantive rights or obligations of the parties under applicable statutes, rules of law or regulations, other than to provide that a signature or record of a contract or transaction may be in an electronic form. A state’s acknowledgement requirements, for example, are not preempted by the Act. The Act, however, provides that acknowledgements may be taken electronically as long as the signature of the notary and each other piece of information required by applicable law for a notarized signature is attached to or logically associated with the signature. Id. § 7001(g).

An electronic copy of a contract is adequate for purposes of the Act if the electronic version accurately reflects the information in the contract and can be accurately reproduced at a later date by the parties that are entitled to access the contract. Id. § 7001(d)(1). The Act is technology neutral. It defines the term “electronic” broadly as “relating to technology having electrical, digital, magnetic, wireless, optical, electromagnetic, or similar capabilities.” Id. § 7006(2). That expansive definition is used for several reasons. First, the Act contemplates future enhancements in methods of electronic technology. Because no technology has established itself as the leader, Congress determined that it was essential that the federal legislation and any state legislation not favor any one form of technology over any other. H.R. Rep. No. 106-341, supra, at 7. Second, the Act allows contracting parties the freedom to select the electronic medium they wish to use. S. Rep. No. 106-131, supra, at 6.

The term “electronic signature” is also defined broadly. An electronic signature is, for purposes of the Act, “an electronic sound, symbol, or process, attached to or logically associated with a contract or other record and executed or adopted by a person with the intent to sign the record.” 15 U.S.C. § 7006(5). That term could include, for example, the simple act of typing a name at the end of an e-mail message or the more sophisticated act of attaching a digital signature. According to the legislative history, an “electronic signature is the digital equivalent of a handwritten signature.” H.R. Rep. No. 106-341, supra, at 7.

The Act specifically permits the parties to use an electronic agent to form a contract. 15 U.S.C. § 7001(h). The electronic agent could be the computer or other means of automated methodology that is used to produce the electronic contract, signature or record. Congress wanted to be certain that the legal effectiveness of a contract could not be denied because of the interaction of an electronic agent in its formation. S. Rep. No. 106-131, supra, at 7-8.

Congress recognized that completing transactions by an electronic means raised several significant issues. Because parties that engage in an electronic transaction will not be meeting face to face, establishing the identity of the parties to the transaction is an acknowledged concern. H.R. Rep. 106-341, supra, at 6-7. Also, once each party has satisfied itself that it is dealing with the party it intends to, completing the transaction in a secure environment is a second significant concern. Id. at 7. Congress did not offer any direct response to those concerns other than to express its confidence in technology to resolve those issues. According to the House Committee on Commerce, “[t]echnology, such as electronic signatures, is providing a solution and resolving many of the complex issues involved in online commercial transactions.” Id. The report also quoted a Charles Schwab & Co. executive as stating that electronic signature technology was in fact better protected against forgery than the traditional paper and ink signature. Id. (citing testimony of W. Hardy Callcott, Senior Vice President and General Counsel, Charles Schwab & Co.).

Exclusions

Certain types of contracts and transactions are excluded from the parameters of the Act. For example, the Act does not apply to contracts or records governed by laws pertaining to the execution of wills, codicils and testamentary trusts. 15 U.S.C. § 7003(a)(1). The Act also does not apply to records or contracts subject to laws pertaining to adoption, divorce or other family law matters or to court orders, notices and pleadings. Id. § 7003(a)(2).

Several provisions of the Uniform Commercial Code—UCC § 1-107 (waiver or renunciation of claim or right after breach), § 2-206 (statute of frauds) and Articles 2 (Sales) and 2A (Leases)—are covered by the Act. 15 U.S.C. § 7003(a)(3). With respect to UCC Articles 2 and 2A, Congress believed that the growth of electronic commerce in the areas of sales, licenses and leases was particularly strong. S. Rep. No. 106-131, supra, at 6. All other provisions of the UCC were excluded from the scope of the Act, however, because electronic transactions were being addressed in recent UCC revisions.

The Act specifies the types of notices that may not be sent electronically, including notices of the cancellation or termination of utility services. 15 U.S.C. § 7003(b)(2)(A). Default, acceleration, repossession, foreclosure and eviction notices related to a primary residence of an individual also are excluded from the Act. Id. § 7003(b)(2)(B). In a slightly different arena, the Act provides that documents that are required to accompany the transportation or handling of hazardous materials may not be used in an electronic form. Id. § 7003(b)(3).

Consumer Contracts

Consumer contracts fall within the coverage of the Act, but detailed disclosure procedures must be followed for these transactions. A consumer contract is one in which an individual enters into a transaction or procures services or products used primarily for personal, family or household purposes. Id. § 7006(1), (13). Before obtaining a consumer’s agreement in an electronic format, the consumer must be provided with a disclosure statement. Id. § 7001(c). This statement must inform the consumer of certain rights, including the option to proceed with the transaction in a paper or nonelectronic form and the procedures to be followed in the event the consumer elects to withdraw the consent to use an electronic format. Id. § 7001(c)(1)(B). The consumer must also be informed of the hardware and software required to complete the electronic transaction and how to obtain a paper copy of the electronic transaction. Id. § 7001(c)(1)(B)(iv), (c)(1)(C). The Act provides that a consumer’s withdrawal of consent does not affect the validity of electronic contracts or records provided before the withdrawal. Id. § 7001(c)(4).

Governmental Filings

The Act gives federal and state agencies the ability to require that filings be retained in paper form. Id. § 7004(b)(3). However, the standard that the agencies must meet appears to be somewhat murky. Federal and state agencies are permitted to require that records be retained in a tangible or paper form if there is a “compelling governmental interest” related to law enforcement and if such a requirement is essential to achieve that objective. Id. § 7004(b)(3)(B). It will be interesting to see how the compelling governmental interest test is interpreted.

State Modifications

As indicated in the Senate Report, federal preemption of state law on electronic transactions is intended to be a temporary measure. S. Rep. 106-131, supra, at 8. The Act provides that a state may modify, limit or supersede the Act by a statute, regulation or rule of law if one of two conditions is met: (1) if the state legislation constitutes the adoption of UETA as approved and recommended for enactment in all states by NCCUSL; or (2) if the state statute outlines alternative procedures for the use of electronic records and signatures that are consistent with the Act and that do not favor one form of technology over another. 15 U.S.C. § 7002. Thus, state law is to be preempted only until states adopt uniform standards that are consistent with those set forth in the Act or in UETA.

Congress enacted these provisions to ensure uniformity among legislation governing electronic signatures and electronic transactions. As of September 27, 1999, 44 states had adopted some type of electronic signature statutes. H.R. Rep. 106-341, supra, at 7. But the legislation of no two states was identical, which resulted in a hodgepodge of inconsistent legislation regulating electronic signatures and documents. H.R. Rep. No. 106-341, supra, at 7. As of January 26, 2001, 23 states had adopted a version of UETA, and it is being considered in eight other states.

Uniform Electronic Transactions Act

The intent of UETA is consistent with the intent of the Act: to remove restrictions on entering into contracts and signing documents in an electronic format and to assure that electronic signatures, records and contracts will be treated in the same manner as those in written form. Unif. Elec. Transactions Act § 7 cmt. 1, 3 (1999). UETA is designed to remove the requirement of the pen and ink medium for the effectiveness of a contract, record or signature, but it does not otherwise affect substantive law.

Electronic Media

Consistent with the Act, UETA uses a broad definition of the term “electronic” to assure that UETA will be applied as new electronic technologies are developed. Id. § 2(5). Examples of electronic formats include audio and video tape recordings, electronic mail and facsimiles. Id. § (2) cmt. 6. UETA endorses electronic methods so long as the electronic record accurately stores and reproduces the information. Id. §§ 8(a), 12(a). UETA also confirms that computers and other machines may function as the electronic agent of the parties to a transaction. Id. § 14.

Electronic Signatures and Acknowledgements

Whether a party has provided a signature in an electronic format is a question of fact to be addressed in accordance with existing substantive law. Id. § 9. UETA simply permits a signature to be furnished in an electronic format. An electronic signature may be provided, for example, as part of a click-through process in which a party designates its agreement. Id. § 2 cmt. 7. The critical element is whether the electronic symbol or process evidences an intention to be legally bound.

UETA provides that to the extent the law requires that a signature be notarized, acknowledged or verified, the requirement is satisfied if the electronic signature of the person is attached to or “logically associated” with the signature. Id. § 11. UETA would not remove any requirement that a notary appear in the same room where a document is being executed. It merely permits the signature of the notary to be obtained in an electronic format. Id. § 11 cmt.

Effect on Real Estate Transactions

The Act is intended to cover real estate transactions. To reach that conclusion, one must look no further than the definition of “transaction,” which includes references to real property. 15 U.S.C. § 7006(13)(b). The comments to UETA also indicate that it should apply to real estate transactions. Unif. Elec. Transactions Act, supra, § 3 cmt. 3. Does this mean that the days of transporting large quantities of documents to closings are over for the real estate practitioner? Although the legislation is promising and exciting, the conversion to an electronic process will be gradual.

Although UETA is intended to apply to real estate transactions, it gives states the option to exclude certain types of transactions from its coverage. Unif. Elec. Transactions Act, supra, § 3(b)(4), cmt. 9. Similarly, the Act permits a state to except matters from the coverage of UETA if those exceptions are not inconsistent with the Act. 15 U.S.C. § 7002(a)(1). A state may, therefore, exclude real estate transactions from its version of UETA. Similarly, a state may refuse to permit electronic filings of real estate transactions. As a result, the parties may be able to enter into a contract electronically yet be required to use the traditional paper and pen approach for recording purposes. But if the transaction involves interstate or foreign commerce, the parties may elect to proceed electronically, because the Act preempts inconsistent state law. It will be interesting to see whether the parties and title insurance companies will be willing to rely on the Act’s preemption of inconsistent state law without judicial confirmation.

Both the Act and UETA speak in terms of signatures, documents and records in a transaction between parties that have agreed to conduct the transaction electronically. It is unclear, however, whether ancillary documents sent to third parties, such as tenant and vendor notification letters, may be furnished electronically.

The definitions of an electronic signature and document are so broad as apparently to include such things as voice mail and e-mail messages. Unif. Elec. Transactions Act § 2 cmt. 6. A person planning to enter into an agreement would tend to give more thought before putting pen to paper than before leaving a voice mail message or hitting the send key. It may come as a surprise to learn, therefore, that the Statute of Frauds may not save a party from an ill-worded voice mail or e-mail message. See the article by Patrick A. Randolph Jr. at p. 23. Perhaps the legislation will give rise to the use of boilerplate disclaimers that will accompany or be “logically associated with” voice mail and e-mail messages.

Confidentiality and Authentication

As indicated above, neither the Act nor UETA requires any party to complete a transaction electronically. But if the parties are willing to proceed electronically, they will need to satisfy themselves that appropriate precautions have been taken concerning confidentiality and authentication issues. Although a detailed analysis of digital signatures is beyond the scope of this discussion, the following descriptions give practitioners some basic knowledge of how the technology works and the issues that may result from its application.

Public Key Cryptography

As mentioned earlier, both the Act and UETA are technology neutral; each allows the marketplace to determine the type of electronic technology to be used. One type of digital technology that appears to be quite popular, however, is public key cryptography, which is an electronic method of allowing parties to communicate electronically over an open network such as the Internet with a reasonable expectation of privacy. Cryptography is a system of writing by using secret characters. Public key cryptography involves the use of two electronic “keys,” one a private key and the other a public key. A message encrypted with the private key can be decrypted only with a corresponding public key, and a message that is encrypted with the public key can be decrypted only by the corresponding private key. Therefore, only the users of a corresponding pair of private and public keys can scramble and unscramble messages.

Messages that are sent with the corresponding private and public keys also include a “hash function.” The hash function enables the users of the keys to confirm that their messages have not been intercepted and changed in transit. The hash function produces a number called a message digest. If a hacker were to intercept and make a change in the message, the message digest would also change. For example, suppose a Seller transmits a deed to a Buyer using public key cryptography. The Seller encrypts or scrambles the deed with its private key and sends it along with a message digest to the Buyer. The Buyer decrypts the deed with its public key. To confirm that the deed has not been altered, the Buyer runs the message through a hash function. If the message digest produced by the hash function is the same as the one that accompanied the Seller’s message, the Buyer has confirmed that the deed was not changed in transit.

Public key cryptography also involves the role of a third party, called a Certificate Authority or CA, to provide assurances to the parties regarding the identity of those using the keys. For example, a bank may act as a third party to provide the Buyer with a “digital certificate” that confirms the Seller’s identity. The digital certificate may contain other information such as a reliance limit and a description of the level of due diligence that the Certificate Authority performed to confirm the identity of the Seller. For more information on public key cryptography, see The Basics of Public Key Cryptography and Digital Signatures, Commonwealth of Massachusetts, Information Technology Legal Department (Dec. 19, 1996); and Digital Signature Guidelines, Information Security Committee, Electronic Commerce and Information Technology Division, Section of Science and Technology, American Bar Association (Aug. 1, 1996).

The description of public key cryptography is complicated. Computer hardware and software packages exist to make the system functional and transparent to the users. But users of this system should consider several issues. A party that applies to a Certificate Authority for a digital certificate, for example, should consider the scope of the transactions that may be covered by the certificate and the number and identity of the parties that may rely on the certificate. Similarly, before a party relies on a digital certificate, the party should consider its scope and the potential number of other parties that may also rely on it, because that will have an impact on the potential exposure of the Certificate Authority if defects later arise. In a significant transaction it would be to both the subscriber’s (the Seller in our example) and the relying party’s (the Buyer) benefit for the scope of the digital certificate to apply only to their one specific transaction.

The subscriber, the Certificate Authority and the relying party should reach an agreement that outlines the rights and obligations of the parties. The agreement may set forth the boundaries for the use of the digital certificate, who may rely on it and when, the limits of liability, requirements for the Certificate Authority to maintain a stated financial level (through the issuance, perhaps, of surety bonds), and the Certificate Authority’s practice statement. To evaluate the Certificate Authority’s financial responsibility, it would be useful to require the Certificate Authority to disclose the number of certificates that it has issued and its aggregate financial liability under those certificates.

The Certificate Authority’s practice statement may outline such matters as its technical and due diligence standards and an agreement to notify the subscriber and the relying parties of the revocation of the certificate. The Certificate Authority should be required to revoke the certificate if the Certificate Authority has reason to believe that information provided to it is inaccurate or if access to the subscriber’s private key has been compromised in some way. The Certificate Authority should also contractually agree to be responsible for maintaining the integrity, confidentiality and availability of the data. These issues should be considered and addressed in an agreement where there is contractual privity among the affected parties.

Although other forms of technology may perhaps prove to be more popular, the discussion of public key cryptography illustrates the significance of the real estate practitioner‘s having some basic knowledge of the technology or access to consultants who do. That knowledge enables the practitioner to identify the issues that should be considered in the context of electronic commerce.

Conclusion

Electronic transactions have exploded on the marketplace during the past several years, forcing Congress and the states to play catch-up with legislation regulating this new way of doing business. Congress took a significant step in 2000 by enacting the Electronic Signatures in Global and National Commerce Act, which recognizes the general validity of electronic transactions and lays the groundwork for further legislation by the states. The main concern of this Act and of the Uniform Electronic Transactions Act proposed by NCCUSL a year earlier is uniformity in the development of laws governing this new use of technology.

These laws are just in their infancy, however, and many issues and questions remain to be answered. Customs and practices for dealing with these issues will undoubtedly develop, and judicial interpretation will eventually exist. Until that point is reached, a gradual and deliberate transition to electronic closings through the use of carefully crafted contracts among all parties involved can be expected. The future does look bright, though: it holds a promise that one day the real estate practitioner’s burden (physical, at least) may be lessened.


William P. Gardella is Associate General Counsel in the Legal Department of Metropolitan Life Insurance Company in New York City.