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Manufacturer’s Corner: Incorporating Software Into Your Products (Part 2)

In the first installment of this series, we discussed the general scope of Article 2 of the Uniform Commercial Code, and, in the broadest terms, whether and when the purchase or sale of software falls within that scope.  In this installment, we’ll move toward our goal of understanding when your purchase or sale of software is governed by Article 2 by looking at how the question has been treated by various courts over time.  Fair warning: while this column is generally written for manufacturers rather than lawyers, this particular post is a little heavier on the law.  While I generally reserve footnotes for offhand side comments, you’ll find case citations down there this time.  So maybe ignore the footnotes.

Remember that a common shorthand for the scope of Article 2 is that it covers the sale and purchase of goods.  With that in mind, early courts to confront the question of whether software falls within the scope of Article 2 relied heavily on the means of transfer.  Back then (waaaaay back in the ‘90s and early 2000s), software was sold on floppy disks or other tangible media.  Courts used that fact to shoehorn sales of software into Article 2, even though the substance of the transaction was not the purchase of a floppy disk, but rather the purchase of a license to use the software that happened to be on a floppy disk.  The Third Circuit Court of Appeals highlighted this approach in a 1991 opinion:

Computer programs are the product of an intellectual process, but once implanted in a medium are widely distributed to computer owners. . . .  That a computer program may be copyrightable as intellectual property does not alter the fact that once in the form of a floppy disc or other medium, the program is tangible, moveable and available in the marketplace.[1]

Cases like these formed the basis for the general rule – still applied today, albeit in modified form – that sale of software is typically a sale of goods subject to Article 2.  Of course, this was unsatisfying at the time because it ignored the substance of the transaction, and it is especially unsatisfying now that software often is simply downloaded from the internet, and therefore never put in tangible media transferred from seller to buyer.

Even then, however, courts were cognizant of the economic realities of software purchases.  Thus, in cases where the transaction at issue was for the license to distribute software, rather than the right to purchase and install software on the purchaser’s own computers, the transaction was considered one for “general intangibles,” which fall outside the scope of Article 2.[2]  And in some instances software purchased for incorporation into other products – an issue we’ll deal with in the next post – was considered outside the scope of Article 2.

Over time, courts collectively began to view the sale of software as falling somewhere on a spectrum, so the applicability of Article 2 to the sale was determined on a case-by-case basis depending on the facts.  On one end of the spectrum fell “off-the-rack” software sales (e.g., you went into Babbage’s[3] and bought a box with some disks in it), and on the other fell completely customized software.  This is still a common approach today.[4]

But it’s kind of a silly approach.  Here’s the Indiana Supreme Court in 2009:

On the surface, these cases might suggest that customized software is a service while pre-made software is a good, but when courts try to pour new wine into old legal bottles, we sometimes miss the nuances.  It would be a mistake, for instance, to treat software as a good simply because it was contained in a tangible medium that fits within that category.  This would conflate the sale of a book with the sale of its intellectual content, suggesting that the purchaser of the book might be buying a right to general use of the expressions contained in the volume.[5]

I generally agree that the current “spectrum” approach is deeply unsatisfying, but for slightly different reasons than those identified by the Indiana court.  First, the idea that “off-the-rack” software is a “good” merely because it used to be delivered via tangible media is ridiculous on its face: nothing in Article 2’s definition of “goods” suggests a need to consider outmoded delivery methods.  Second, the idea that some amount of customization transfers software from a good to a service is troubling because (a) the Article 2 definition of “good” specifically includes specially manufactured goods, and (b) the underlying reasoning is that custom software is primarily of value because of the intellectual effort put into it, but that’s true of a lot of things that are treated as goods (books, to take the Indiana Supreme Court’s example).

Regardless of my feelings on the matter, only one court has really made a truly accurate pronouncement on the law governing software: in 2002, the U.S. District Court for the District of Massachusetts wrote that “software licenses exist in a legislative void.”[6]  That is dead-on.  In fact, the body responsible for the Uniform Commercial Code recognized this long ago, and drafted a Uniform Computer Information Transactions Act.  Unfortunately, it was never approved, and the only states that have adopted it (I think) are Vermont and Maryland.  So the legislative void remains.

That’s the problem.  Whether a contract is governed by Article 2 or general common law on contracts impacts everything from contract formation to contract performance to available remedies to statutes of limitation.  Given the “legislative void,” we just can’t be certain about software contracts.  But, in Part 3 of this series, we’ll take a look at some of the steps you can take to increase the likelihood that your sales remain governed by Article 2 (or, if you prefer, that they not be governed by Article 2).

[Note: I’ve done a couple of posts recently on the Apple/GT Advanced Technologies spat.  You can find them here and here.  When I first posted them, I had to link to redacted copies of some of the documents.  A recently-unsealed declaration from a GTAT officer sheds light on some of the redacted provisions.  I’m not going to do a separate post on it (I’m really tempted to, but I don’t have anything nice to say about it), so that’s why you see it here. – RCH] [Updated 11/11/14 – Matt Levine wrote about that declaration here.  He’s pretty charitable toward GTAT on one major, glaring issue, but I’ll leave it to you to figure out which. – RCH] 

[1] Advent Systems Ltd. v. Unisys Corp., 925 F.2d 670, 675 (3d Cir. 1991) (applying Pennsylvania law).

[2] See, e.g., Architectronics, Inc. v. Control Systems, Inc., 935 F. Supp. 425, 432 (S.D.N.Y. 1996).

[3] Haha, remember Babbage’s?  Also: there is no case citation in this footnote!  I lied to you!

[4] See, e.g., Rottner v. AVG Technologies USA, Inc., 943 F. Supp. 2d 222 (D. Mass 2013); Bruel and Kjaer v. Village of Bensenville, 969 N.E.2d 445 (Ill. App. 2012).

[5] Conwell v. Gray Loon Outdoor Marketing Group, Inc., 906 N.E.2d 805, 812 (Ind. 2009).

[6] I.Lan Sys., Inc. v. Netscout Serv. Level Corp., 183 F. Supp. 2d 328, 332 (D. Mass. 2002).  Incidentally, this Court botched another part of the analysis, when holding that purchasing a software license couldn’t be subject to Article 2 because there is no sale.  As discussed in the opening post in this series, however, Article 2 addresses transactions in goods, not just sales of goods.