Are Computer Software Programs "Goods" or "Services?"

By: Jay Hollander
Date: 1998

Jay Hollander, Esq. is the principal of Hollander and Company LLC, www.hollanderco.com, a New York City law firm concentrating its efforts in the protection and development of property interests relating to real property, intellectual property and commercial interests, as well as related litigation.

The content of this article is intended to provide general information relating to its subject matter. Providing it does not establish any attorney-client relationship and does not constitute legal advice. Personal advice in the context of a mutually agreed attorney-client relationship should be sought about your specific circumstances.

Article

A fundamental aspect of any contract negotiation which a client requires its attorney to be fully familiar with concerns the legal standards which will apply to interpreting and resolving disputes under the contract which the attorney negotiates on behalf of the client. Without knowing what the law is, it is a given that effective negotiation of a contract with predictable and known rights and responsibilities will be impossible.

Nowhere is this more true than in the area of contracts concerning computer goods and services. While few businesspeople would still consider this area an "emerging" one, given the explosion of high technology business which has come to define the modern economy throughout the eighties and nineties, the legal system has been slow to catch up. As a result, both astute lawyers and informed clients increasingly need to better understand the implications of the law governing these contracts in order to succeed at them.

One of the questions which has proven most troublesome along these lines has been determining whether a given computer related contract concerns a sale of "goods" on the one hand or "services" on the other.

The difference between the two makes quite a bit of difference in that sales of "goods" are covered by the Uniform Commercial Code ("UCC) a set of rules adopted by virtually every jurisdiction in the country, intended to lend, as its name implies, "uniformity" to the administration of commercial transactions and to resolution of disputes concerning them.

By contrast, contracts which concern other areas of commercial enterprise denominated as "services" are not accorded the same types of uniform treatment and protections. 

To be sure, these distinctions will be significantly modified in the near future, upon the final releaseand adoption of the planned UCC Article -2-B, a new section intended to deal with the unique needs and issues of the digital and computer industry. Until then, however, courts have been left to make the decision, so that practitioners and their clients need to study the law of their particular state.

While determining the "goods" or "services" nature of a particular contract's subject may proceed differently depending upon the aspect of computer or high technology which is directly or predominately implicated by it, a useful example for understanding the implications of the answer to the "goods/services" question would be a contract concerning either the development, updating, or modification of a program, as well as a contract concerning the transfer or distribution of rights in a program.

This writer had occasion to be involved in just such a dispute, this time representing the owner of rights in a software program involved in a dispute with its exclusive distributor.

In Software Engineering Carmel v. Central Point Software, Inc., a foreign owner of rights to a popular anti-virus software program conveyed those rights to a well known distribution company pursuant to an exclusive sales and distribution agreement.

Under the Agreement, the original program was sold by its owner to the distributor and further enhancements and modifications were promised to be made and delivered exclusively to the distributor, in exchange for which the distributor was to market and support the product to its ultimate consumer audience and pay unit based royalties to the original owner of the program accordingly.

When the exclusive distributor's company was acquired by the makers and distributors of the program's largest direct competitor, the original program owner sued for breach of its exclusive sales and marketing contract, claiming that the new owners had breached their duties under the UCC. The owner argued that the UCC required the distributor's "best efforts" in such an exclusive dealing contract, and that, by diminishing its efforts to promote and support the program in favor of the acquiring company's product, in a claimed effort to kill the competition, the distributor breached the contract. Very quickly, the distributor moved to dismiss the Complaint, claiming, in part, that the UCC did not apply to the case, because a contract for the sale and update of a computer program constituted a contract for "services" rather than "goods".

After extensive motion practice and oral argument, the Court found that those portions of the Complaint which alleged that the distributor had breached obligations under a software sales and distribution contract relating to "goods" contracts was governed by the UCC.

As a result, the original program owner was able to sue for the full extent of damages claimed to be owed, and attempt to hold the Defendant to a UCC provided "best efforts" standard, a result which would have been much more difficult, if not impossible, had the contract been one for mere services.

While courts across the country are still struggling with these issues, a consensus has emerged conferring UCC "goods" contracts protections to many such contracts.

In determining whether or not a particular computer contract concerns "goods" or "services", the cases show that it is important to consider which of the "goods" or services" aspects of the transaction predominate, even if they both concern the product of intellectual labor.

For example, is the contract one to actually provide a software product such as a program, or is it merely to provide data entry or processing services? What about the form of compensation. Is a party to be paid for its efforts by the hour, a method most often associated with services, or is it to be paid royalties based upon number of units sold or licensed, a payment method more commonly found in goods contracts?

Similarly, what will be considered adequate performance of the contract, a hard disk full of coded or imaged information, or a product for packaging and resale? Finally, is the contract for a custom installation, not to be repeated in the same way elsewhere, or is the contract for a program which, when marketed, can be sold again and again.

While there are no simple answers to these questions, and while, until the adoption of UCC Article 2B, courts have tended to evaluate these issues on a case by case basis, the factors mentioned above serve as useful guideposts for consultation between a client and its attorney and can provide a very helpful jumping off point for contracts so that the parties will better know the type of deal into which they're getting involved

Copyright © Jay Hollander, 1998. All Rights Reserved.