By: Joe Blackhurst

For nearly a century, United States contract law has relied on the default contractual rights, rules, and limitations of Article 2 of the Uniform Commercial Code (UCC) to guide parties and resolve disputes surrounding the sales of goods.[1] In walks the 21st century with the kicker: the UCC applies solely to transactions of “goods” and does not expressly mention software.[2] In a digital age increasingly reliant on streaming services such as Netflix, software licenses like Adobe Creative Suite, and ecommerce sites such as Amazon, more and more businesses will necessarily become parties to complex transactions for the sale and purchase of such online intangibles that neither intuitively qualify as a “good,” as opposed to a “service.” This blog aims to inform entrepreneurs of how courts have struggled with the classification of software as a good or service in the context of the UCC and provide entrepreneurs with a map of the treacherous legal landscape created by this seemingly impossible question.

 

New Tech, New Problems

 

            The UCC’s definition of goods being “all things which are moveable” was drafted at a time when goods were not only clearly physical but also held more value to buyers than any accompanying service.[3] In the early 21st century, most courts held that computer software clearly qualified as a “good.”[4] The logic went something like this: software can be purchased on a physical disc and the fact that it is later installed and becomes non-physical does not make it any less of a “good,” case-closed, easy-peasy.[5] As operating systems and artificial intelligence have become more and more sophisticated, however, most software contracts now include the core software in addition to ongoing, continuous services which are to be provided via interconnected devices or the software itself.[6] “The value of physical devices more and more is defined by the embedded software inside them or the control software that helps to manage them.”[7] Therefore, whether such hybrid transactions should still qualify as sales of “goods” governed by the UCC vexes courts to this day but an understanding of the following two approaches taken by courts can inform tech startups of how to intentionally place their transaction into either the “UCC” or “no UCC” bucket.[8]

 

The Predominant Purpose Test

 

            When determining whether the UCC applies to sales involving software, most courts have adopted the predominant purpose test.[9] The predominant purpose test weighs a series of factors to determine whether the transaction, on the whole, is predominantly for the sale of goods or for services, whether they be performed by humans or artificial intelligence.[10] These factors include: the contract’s language, whether the goods and services are priced separately, whether the purchaser would expect full property ownership in the total package, and the value of the goods as opposed to the value of the services, to name only a few of the factors courts consider.[11]

Several problems arise from the predominant purpose test: first, the list of factors to be considered is non-exhaustive and therefore courts are unpredictable in what factors they consider; second, because of this unpredictability, courts often come to opposite conclusions on very similar facts; and lastly, because of this unpredictability, courts rarely provide a clear analysis and instead merely “state the facts and then declare an answer.”[12]

Take the following example to understand the uncertainty this test creates. More and more commercial printers now incorporate an internal function that automatically orders ink refills when the cartridges reach a certain low level. This function is by all definitions a “service” being provided by the software itself, or in other words, being provided by the “good” itself. An analysis of the predominant purpose factors might go something like this: (1) are the goods and services priced separately? On one hand, the automatic ink-ordering function is part of the original price for the printer and software, on the other hand each refill ordered is given its own invoice. (2) Does the value of the goods outweigh the value of the service? On one hand, the printer and software costs more initially, but in the long term the price of ink refills may become greater. Even further, Is it the price of the refills we should be considering, or rather the metaphysical “value” of an automated ink-ordering function. The proper application of the test is far from concrete.

 

The Gravamen of the Claim Test

 

The second approach used by courts in determining applicability of the UCC to software transactions is called the gravamen of the claim test. The test determines applicability of the UCC based on whether the dispute of the litigation concerns the goods or the services; if the dispute concerns the services, the UCC does not apply.[13]  The problems with this approach is that it does little to guide parties of how to draft the contract to avoid such litigation in the first place and it enables plaintiffs to unilaterally determine the applicability of the UCC merely by drafting their complaint to focus on the goods or the services aspect of the contract despite the core of the dispute actually being over the other aspect.[14]

Let’s return to our example of the commercial printer that orders its ink automatically. Say the purchaser became dissatisfied with the printer itself and wanted its money back. If the UCC’s rules do not favor the purchaser, they might bring a complaint focusing on the automatic ink-ordering service aspect of the purchase to bypass the UCC entirely even though their subjective dissatisfaction is with the printer itself. Again, the test is less than ideal.

 

Conclusion

 

Unfortunately for entrepreneurs and startups, both of the primary tests used by courts have created a state of the law akin to “your guess is as good as mine” when it comes to informing parties of how to draft software transactions which intentionally allow or disallow application of the UCC’s default rules. The best strategy to avoid litigation regarding applicability of the UCC is to expressly specify its applicability or inapplicability to the transaction in the provisions of the contract itself while mindfully drafting to avoid any provisions which might suggest the contrary.

[1] U.C.C. § 2-102 (Am. Law Inst. & Unif. Law Comm’n 1977).

 

[2] Richard Raysman, The UCC  and Software Contracts: Recent Developments, Holland & Knight Law (Feb. 18, 2011).

 

[3] U.C.C. § 2-105 (Am. Law Inst. & Unif. Law Comm’n 1977).

 

[4] Surplus.com, Inc. v. Oracle Corp., 2010 WL 5419075 (N.D. Ill. Dec. 23, 2010).

 

[5] See Id.

 

[6] See Stacy-Ann Elvy, Contracting in the Age of the Internet of Things: Article 2 of the UCC and Beyond, 44 Hofstra L. Rev. 839, 841 (2016).

[7] See Vincent Smyth, 2016 Trends: The Internet of Things and Software Monetization, IT PRO PORTAL (Dec. 31, 2015).

 

[8] See Stacy-Ann Elvy, Hybrid Transactions and the INTERNET of Things: Goods, Services, or Software?, 74 Wash. & Lee L. Rev. 77 (2017).

 

[9] See Abby J. Hardwick, Amending the Uniform Commercial Code: How Will a Change in Scope Alter the Concept of Goods?, 82 WASH. U. L.Q. 275, 280 (2004)

 

[10] Id.

 

[11] Colorado Carpet Installation, Inc. v. Palermo, 668 P.2d 1384 (Colo. 1983).

 

[12] See Linda J. Rusch & Stephen L. Sepinuck, Commercial Law: Problems and Materials on Sales and Payments, 24 (2012).

 

[13] See J.O. Hooker & Sons, Inc. v. Roberts Cabinet Co., 683 So. 2d 396, 400 (Miss. 1996)

 

[14] See, Austin Bodnar, Mixed Transactions for Goods and Services: The Need for Consistency in Choosing the Governing Law, 27 Saint Thomas L. Rev. 225, 238 (2015)