The ubiquity of computer technology is experienced by all of us. ¹ Typing is done on a word processor, banking transactions are performed at automatic teller machines, and cash registers at many store check-out counters are computer terminals which instantaneously transmit sales and inventory data to a central computer. Computers ² are also used in routing telephone calls, in synchronizing traffic lights, in the operation of complex medical equipment, and in the use of everyday things such as cameras and microwave ovens. ³ Additionally, small desk top computers are used at work or at home for tasks ranging from balancing a checkbook to purchasing stock. ⁴

It is inevitable that this growing use of computers has raised many legal issues. ⁵ One facet of computer technology presenting particularly difficult legal issues is the treatment of software. ⁶ The tremendous expenditures of both time and money required to develop software coupled with the explosive growth of the software industry ⁷ has led to increased litigation. ⁸

The question addressed by this article is whether article 2 of the Uniform Commercial Code (hereinafter U.C.C.) applies to computer software. ⁹ This question is of more than academic significance ¹⁰ in light of the size of the computer industry. As of 1982 computers outnumbered people. ¹¹ Additionally, the total investment in software in the United States already exceeds $200 billion despite the fact that the computer industry is only in its infancy. ¹² Moreover, the software portion of the computer industry is rapidly becoming the largest segment; by 1990 it is estimated that 80% of the expenditures for computers will be for software. ¹³ Consequently, failure to bring software transactions within the domain of article 2 leaves an enormous commercial industry subject to individual state statutes and state common law. ¹⁴

A major drawback of excluding software transactions from article 2 coverage is that it pushes the software industry back to pre-U.C.C. days, when legal formalities controlled instead of business and commercial practices. ¹⁵ For example, under the common law if a computer software buyer sent a standard purchase order form to a software producer who responded with a standard purchase order confirmation promising delivery, both parties would assume that a binding agreement was created. However, since in almost all cases the purchase order and the confirmation forms contain different terms, the common law would treat the purchase order as an initial offer and the confirmation as a counteroffer. ¹⁶ Therefore, absent action by the software buyer that amounted to acceptance of the counteroffer, no contract was created. ¹⁷ To eliminate the potential problems that can arise in such a typical commercial transaction involving an exchange of forms, article 2 substantially changes the common law rule and allows a contract to be created in the above situation. ¹⁸

Additionally, omission of terms in an agreement and reliance by the parties on prior performance under the agreement, or under other contracts between the parties, or on industry customs and practices, can be problematic under the common law. ¹⁹ Article 2, however, recognizes that business entities engage in business in this manner, and therefore it contains 'gap- filler' sections which supply omitted terms. ²⁰ Also, performance by the parties and industry practices are given great weight by article 2 and in some cases may form part of the contract. ²¹

Another drawback of reliance on state common law is the lack of uniformity among different jurisdictions. This lack of uniformity was a major problem prior to the enactment of the U.C.C. and its elimination was one of the main objectives of the U.C.C. ²² The need for uniformity in commercial law is even more important today since most businesses operate in national markets. A disturbing trend is already evident in the computer area. Various states are beginning to pass specific legislation for the computer industry. ²³ A continuation of this trend will ultimately create a confusing body of law which will vary among jurisdictions and subject software companies to the difficulty of attempting to comply with different laws in different states when they engage in nationwide marketing. ²⁴

Application of article 2 to software transactions avoids overemphasis on legal formalities and the potential consequences of non-uniformity in the law since it has been adopted by forty-nine states. ²⁵ The underlying policy of the U.C.C. is to simplify and clarify the law so it reflects the realities of the commercial marketplace and provides a uniform and predictable body of law. ²⁶ Such goals have positively affected commercial transactions within the domain of article 2 and will necessarily enhance development of commercial law as it applies to software.

The applicability of article 2 to software depends upon two determinations. First, software must be a good as defined by article 2. ²⁷ Second, software must be either sold or supplied via a non-sale transaction which is determined to be within the domain of article 2. ²⁸

Disagreement exists about whether software is a good because of the confusing and contradictory usage of terminology in the computer industry. ²⁹ Rapid advances such as the unbundling of hardware and software ³⁰ and the reduced need for custom software ³¹ have led to the formation of independent software producers who create and mass-market over-the-counter or canned software which is often usable on more than one computer. ³² These rapid advances limit the long term precedential value of prior judicial decisions and thereby create confusion when such decisions are looked to despite changes in the computer field. ³³ Confusion between the intellectual property aspects of software ³⁴ and the physical medium containing the software ³⁵ have also created uncertainty about whether software is a good. Additionally, the recognition that software represents a culmination of an abstract idea transformed into a physical medium embodying the software has raised questions about the status of software as a good.

A comparison of software with the many things routinely viewed as goods under article 2 buttresses the conclusion that software is also a good.³⁶ Despite the confusing terminology and the continual advances in technology, software embodied in a physical medium is analogous to goods such as a book or an automobile which may embody intellectual property and represent the transformation of intangible ideas and knowledge into a physical form.

Assuming software is a good, if it is sold article 2 is applicable to the transaction. However, software is typically licensed to users to protect the value of the software by controlling its use. ³⁷ Jurisdictions which view the U.C.C. as a statute and therefore apply it literally would find such licensing transactions outside the scope of article 2 since title to the software is not transferred in the typical license transaction. However, an increasing number of jurisdictions treat the U.C.C. as a code and have extended the coverage of article 2 to both leases and bailments. ³⁸ A further extension to software license transactions is supported by the same logic used to bring leases and bailments within the scope of article 2. ³⁹

Hybrid transactions involving both goods and services have also been a source of confusion. Various judicial decisions have espoused different analyses which vary the outcome of a particular hybrid transaction. ⁴⁰ Therefore, the determination of whether article 2 applies to software provided with support services, ⁴¹ custom programming, ⁴² time-sharing arrangements ⁴³ or service bureau contracts ⁴⁴ may depend upon which hybrid analysis is utilized in a particular case. This uncertainty can be avoided by recognizing and applying the U.C.C. as a true code, thus allowing article 2 to be applied to all transactions which involve goods as defined by article 2. Such an expansive view furthers the underlying code policies of uniformity and predictability ⁴⁵ and is mandated by commercial practice which is increasingly utilizing non-sale transactions in lieu of traditional sales transactions. ⁴⁶ Otherwise, article 2 will slowly decrease in importance as fewer true sales transactions are utilized.

This article will examine the question of whether software is within the article 2 definition of a good. Despite disagreement among commentators, a careful analysis indicates general judicial agreement that software is a good. An examination of the tangible and intangible property aspects of software plus a comparison of software with typical article 2 goods further supports the conclusion that software is a good. The extension of article 2 to software transactions which typically involve licensing in lieu of sales will be explored. In addition, the article will analyze whether the U.C.C. is a code or a statute, and examine the general treatment of lease, bailment, and hybrid transactions. A comparison of these types of transactions with software transactions, coupled with the determination that the U.C.C. is a code leads to the conclusion that software transactions are within the domain of article 2.

I. SOFTWARE: IS IT A GOOD UNDER ARTICLE 2 OF THE U.C.C.?

A. Sources of Confusion About the Status of Software

The determination of whether software is within the scope of article 2 of the U.C.C. is controlled by two seemingly simple sections. Section 2-102⁴⁷ makes article 2 generally applicable to 'transactions in goods' and section 2-105(1) ⁴⁸ generally defines 'goods' to be all 'movable' things. Despite these two sections being clear on their face, much confusion and resulting disagreement exists among commentators about the status of software. ⁴⁹

This uncertainty regarding article 2 treatment of software is inconsistent with the expansive definition of goods developed by the courts for other products. In Lobianco v. Property Protection, Inc., ⁵⁰ the Pennsylvania Superior Court said that goods under the U.C.C. embraces every species of property other than real estate, choses in action, and investment securities.⁵¹ In accordance with this expansive view numerous things have been held to be goods under article 2. ⁵² It is confusion about the nature of software that has engendered much of the controversy regarding its status under article 2.

One source of this confusion is technical illiteracy, ⁵³ which is exacerbated by the confusing use of computer terminology by experts in the field, who themselves disagree on the meaning of many terms. ⁵⁴ This renders it almost impossible for the technically unsophisticated to appreciate the merits of a legal controversy concerning this subject matter. One judge expressed his frustration over computer terminology by stating:

"After hearing the evidence in this case the first finding the Court is constrained to make is that, in the computer age, lawyers and courts need no longer feel ashamed or even sensitive about the charge, often made, that they confuse the issue by resort to legal 'jargon,' Law Latin or Norman French. By comparison, the misnomers and industrial shorthands of the computer world make the most esoteric legal writing seem as clear and lucid as the Ten Commandments or the Gettysburg Address; and to add to the Babel, the experts in the computer field, while using exactly the same words, uniformly disagree as to precisely what they mean."⁵⁵

The use of the term software to describe different things exemplifies the confusing nature of computer terminology. ⁵⁶ Not only are different definitions of software advanced, but software generally refers to a computer program regardless of its stage of development or the medium used to contain a program. ⁵⁷ A program expressed as a flowchart, ⁵⁸ or in source code ⁵⁹ or object code, ⁶⁰ is still called software. ⁶¹ A computer program will be referred to as software if the program is embodied in a hard disk, a diskette, a reel of magnetic tape, or a deck of punched paper cards.⁶² The manuals which explain the operation of a particular program are considered software by some people, while others do not include these within the definition of software. ⁶³ The hiring of a programmer to create software to be used exclusively on the purchaser's computer may also be referred to as purchasing software, rather than as the rendition of services.⁶⁴

In contrast, music, for example, is described using different terms, depending on the form it takes. Music sold as notes written on a scale is called sheet music. Accompanying words to the music are called lyrics. If music is recorded on a phonograph record it is generally referred to as a record. Music recorded on audiotape will be referred to as a cassette or a reel-to-reel tape depending on the type of tape medium utilized. Finally, hiring a band to play music at a party involves a service contract to provide music. It is therefore necessary to look beyond bare terminology to ascertain the status of software. The proper determination of whether software is a good must focus on its stage of development and the medium in which it is embodied.

Another source of confusion arises from rapid changes in computer technology. The legal system places great emphasis on precedent, but the technology and market conditions for computers have changed so significantly and rapidly in the last decade that the factual considerations upon which many decisions were based may no longer exist. ⁶⁵

One major change, for example, was the transformation of software from an incidental part of a computer system designed to operate only on that system to a separate product which is increasingly independent of the hardware. ⁶⁶ When computers first began to be used commercially they were expensive machines requiring specialized software to be custom written for the computer user. ⁶⁷ Generally, this software was written by experts provided by the computer manufacturer. In other cases, standardized software produced by the manufacturer especially for the computer being sold could be used. The sale of a computer with software and programming services was accomplished via a bundled transaction in which the sale price was the same whether the buyer wanted only the hardware or in addition, the software and programming services. ⁶⁸ Antitrust considerations eliminated bundled transactions and divided the computer industry into two distinct segments-hardware manufacturers and software manufacturers. ⁶⁹

As a result of this division, computer manufacturers today sell hardware which usually includes only operating systems software. ⁷⁰ They may also separately sell some applications software, but such software is increasingly being provided by independent software companies who provide both custom programming services and mass-marketed or canned software. ⁷¹ Although large computer systems still require custom programming, the sale of canned software is rapidly becoming a growing segment of the software industry, especially with the advent of powerful small computers which provide a ready market for mass produced canned software. ⁷² Additionally, advances in computer technology have resulted in software being capable of use on many computers. Consequently, software which was once viewed merely as a part of a particular computer system must now be viewed as a product that is distinct from the computer hardware in which it is used. ⁷³

B. Software: Distinguishing Between Tangible and Intangible Property Aspects

Understanding the general process of how software is created is important because the software's state may be relevant to whether it is a good under article 2. ⁷⁴ Additionally, an understanding of the development process assists in distinguishing between intangible intellectual property aspects of software ⁷⁵ and tangible property aspects represented by tangible objects or mediums which embody intellectual property. ⁷⁶ In determining the scope of article 2 it is imperative to maintain the distinction between these different property interests because even though intellectual property may not fit within the article 2 definition of goods, a tangible object which embodies such intangible property is still a good. ⁷⁷

Software which starts out as an idea for performing a specific function on a computer is an intangible at this stage. Since computers do not comprehend ideas, before such an idea can be employed by a computer it must be reduced to a computer language which can be encoded onto a physical medium such as magnetic tape, punched paper cards, or a diskette. ⁷⁸ At this point the physical medium containing the software is a tangible object. ⁷⁹

The particular stage of the software development process or the medium containing the software is therefore relevant to whether it is a good under article 2. This is not a novel concept. Property law recognizes that something may be classified as different types of property depending on its use or form. Additionally, a change in use can alter the property classification of an item. ⁸⁰ For example, a growing forest is considered real property. Once the trees are cut down, milled into lumber, and placed in a lumber yard as inventory they are personal property. If the lumber is then used to construct a house it is treated, at least for many purposes, as realty. ⁸¹ Similarly, information provided by a professor in a lecture is not a good under article 2; but if the professor publishes the same information in a book or records it on a phonograph record, the resulting book or record would be a good under article 2. ⁸² Likewise, software in its early stages of development, when it is only an intangible idea, is not a good. However, when this idea is translated into a specific computer language and embodied in a tangible medium such as a diskette, a 'movable' thing within the article 2 definition of a good exists.⁸³

Even though software in the form of a tangible medium such as a diskette is a movable thing within the article 2 definition of a good, it may simultaneously incorporate intangible intellectual property which falls outside the scope of article 2. ⁸⁴ In Triangle Underwriters, Inc. v. Honeywell, Inc., ⁸⁵ a sale of a computer system consisting of hardware, standard software, and custom software resulted in breach of contract claims when the system failed to function properly because the software did not operate as promised. In determining that the system as a whole was within the article 2 definition of goods, the court noted that the software consisted of both intangible intellectual property aspects, represented by ideas and concepts, and the resulting products of those intellectual property aspects which was software. ⁸⁶

This distinction between intangible intellectual property and tangible⁸⁷ mediums embodying such property has also been identified in other contexts. In Apple Computer, Inc. v. Franklin Computer Corp., ⁸⁸ a case deciding that software was subject to copyright protection, the defendant argued that software contained in a ROM was not copyrightable since copyright protection did not extend to tangible physical objects such as a ROM which is really a part of the computer. ⁸⁹ The court, however, understood the distinction between intangible intellectual property and tangible objects containing such property, and held that although the ROM itself was not subject matter covered by copyright, the software embodied in the ROM contained intangible intellectual property that could be subject to copyright protection. ⁹⁰ Other courts and commentators have confused this distinction by declaring simply that software is an intangible collection of ideas or concepts. ⁹¹

An examination of some typical article 2 goods further elaborates the distinction between intangible intellectual property and tangible physical objects embodying such property. A book is a good under article 2. ⁹² However, a book comprises ideas which anyone is free to read and utilize since ideas are in the public domain. For example, if someone purchases a book describing how to build a house, the reader is free to use the construction techniques and other valuable knowledge imparted by the book to build a house. The reader is not, however, free to duplicate the book a house. machine if the author claims copyright protection for the book. ⁹³ The copyright law entitles the author to protect the form of expression of the information in the book. ⁹⁴ The book itself, however, is a tangible object consisting of paper, ink and glue which can be freely resold ⁹⁵ and is a good under article 2 despite the existence of intangible intellectual property rights in the book under the copyright law. ⁹⁶

An automobile is also a good under article 2. ⁹⁷ However, despite purchasing and taking title, the owner's rights in the automobile may be restricted. Novel inventions incorporated in the automobile may be protected by patent law which would prevent the owner from examining the patented invention and reproducing and using it elsewhere, such as in another vehicle, without the permission of the patent owner. ⁹⁸ Again, in this case something can be a good within article 2 despite the existence of intangible intellectual property rights in the good under the patent law.

It has been asserted, however, that when a purchaser or licensor of software contained in a medium such as a diskette pays for such software, they are really paying for the intangible ideas represented by the software and not the diskette, which has little value unless it is encoded with the software. ⁹⁹ Although this argument may initially seem logical, it breaks down when applied to the many things held to be goods. ¹⁰⁰ Books and magazines are goods under article 2 even though their value lies in the intangible information they contain, and not in the paper, binding, or ink used to produce them. ¹⁰¹ It is difficult to discern any distinction between software embodied in a physical medium and a writer's ideas or stories embodied in a physical medium. Both start out as intangible ideas which are ultimately refined and incorporated into a physical form. Software can be contained on a diskette, a magnetic tape or on other mediums ¹⁰² while a story can be embodied in a printed book, or on a record or a magnetic tape. In both cases the initial idea existing in the author's mind is an intangible, which is not a movable thing, and therefore not a good under article 2. ¹⁰³ However, once this intangible idea is converted into a tangible object which embodies the idea, a movable thing exists which is a good under article 2. A cassette, reel-to-reel tape, or record from which a story can be listened to are all tangible objects that are movable things and therefore goods under article 2. ¹⁰⁴

It is illogical to reach a different result for computer software.¹⁰⁵ Both magnetic computer tape embodying software and magnetic audio tape containing a voice reading a story must be inserted into appropriate equipment to produce the desired output. It seems clear, therefore, that this magnetic tape is a good whether it contains an audio recording or a computer program. Otherwise, one has the incongruous result that magnetic tape encoded for use by a tape recorder to produce audio output is a good while magnetic tape encoded for use by a computer to produce audio output is not a good. ¹⁰⁶

If the existence of underlying intangible ideas or property in a resulting tangible product divested a tangible object of its status as a good, few products would be considered goods under article 2. In Crescent Amusement Co. v. Carson ¹⁰⁷ the court said:

"There is scarcely to be found any article susceptible to sale or rent that is not the result of an idea, genius, skill and labor applied to a physical substance. A loaf of bread is the result of the skill and labor of the cook who mixed the physical ingredients and applied heat at the temperature and consistency her judgment dictated. A radio is the result of the thought of a genius, or several such persons, combined with the skill and labor of trained technicians applied to a tangible mass of substance. An automobile is the result of all these elements, and of patents, etc.; and so on, ad infinitum." ¹⁰⁸

Many products routinely viewed as goods under article 2 are really of value only because they encompass intangible property in the form of a novel idea or unique method of accomplishing a task. A television, an automobile tire, a medical x-ray machine, a telephone, and computer hardware all have value because they represent an embodiment of intangible ideas. In many cases, the above products, along with millions of other products, embody novel ideas or features which are intangible property protected by patent law. ¹⁰⁹

Other products are made by secret processes which are also intangible property. Such processes are maintained by the manufacturer as a trade secret to preserve the value of the product by preventing others from duplicating it.¹¹⁰ One ubiquitous example is Coca-Cola. ¹¹¹ The process for making Coca-Cola is a closely guarded secret because the product resulting from that secret has enormous economic value. ¹¹² Other products such as books or magazines have value because, among other things, they encompass intangible intellectual property rights protected by copyright. ¹¹³ Trademarks, which are words or symbols used to identify goods, are another form of intangible intellectual property which may substantially increase the value of a good. ¹¹⁴ For example, clothing which prominently displays a 'Gucci' or 'Izod' trademark may have significantly enhanced value simply due to the presence of the trademark.

Consequently, things which are tangible movable objects and therefore goods covered by article 2 are not stripped of their article 2 status simply because they either embody or result from intangible intellectual ideas or property.¹¹⁵ A contrary approach would frustrate the application of article 2 since a significant number of goods universally viewed as being within article 2 would fall outside by virtue of patent, copyright, trade secret, or trademark rights incorporated in or associated with the goods. Since article 2 does not contain an explicit exemption for software, there is no valid reason to treat software any differently than other goods which embody intangible intellectual property. Underlying facts should therefore be the appropriate guideposts rather than unclear terminology and confusing distinctions.

Looking beyond the terminology and the distinctions between tangible objects and the intangible intellectual property they may embody leads to the conclusion that software contained in a tangible object is a good within article 2.

C. The Status of Software: The Judicial View

A careful analysis of the case law does not reveal great judicial uncertainty about whether to treat software as a good. ¹¹⁶ The weight of authority treats computer software as being within the article 2 definition of a good without lengthy analysis or discussion.

In RRX Industries v. Lab-Con, Inc., ¹¹⁷ the court found the California version of the U.C.C. applicable to a contract for the purchase of software. The court, noting that for the U.C.C. to apply the software must be a good, had no difficulty concluding without analysis that the software was a good under U.C.C. section 2-105. ¹¹⁸

The court then made a factual determination as to whether the services provided with the sale of the software were a predominant or incidental part of the transaction. ¹¹⁹ This determination was necessary since, under California law, a contract for the sale of goods would be classified as a service contract outside the domain of article 2, if services provided with the sale of goods were the predominant aspect of the transaction. It follows from this decision that the court views software as a good; the investigation of the services provided in a particular transaction was merely to ascertain whether the predominant feature of the transaction was the sale of goods or the providing of services. ¹²⁰ The court concluded in RRX Industries that the seller's contractual obligation to install the software, to repair any software errors, and to train the buyer's employees in the operation of the software were merely incidental services, ¹²¹ and therefore the transaction fell within article 2.

In Compu-Med Systems Inc. v. Cincom Systems Inc., ¹²² a contract for the purchase of software resulted in an action for fraud and breach of contract against the seller when the software allegedly failed to perform as represented by the seller. In denying the seller's motion to dismiss the complaint or in the alternative to grant summary judgment, the court relied upon two section of article 2. The court found that the buyer had given the seller adequate notice of the alleged breach of contract, as required by section 2-607(3)(a), ¹²³ and therefore the buyer was not barred from bringing the action. Additionally, the court found section 2-719(2) ¹²⁴ applicable to the question of whether the contract provided an exclusive remedy that precluded the buyer's recovery of consequential, special, or indirect damages. The court applied article 2 to this transaction without addressing the threshold question of whether software is a good; therefore, it must be assumed that the court viewed software as a good within the domain of article 2.

In W. R. Weaver Co. v. Burroughs Corp., ¹²⁵ a computer user leased a Burroughs computer from the defendant and purchased application software to run on that computer. When the computer and software failed to operate as warranted the computer user sought consequential damages based on theories of express and implied warranty and strict liability. The appellate court specifically found article 2 inapplicable to the computer hardware portion of the transaction since the hardware was leased and article 2, at least in Texas, is limited to sales. ¹²⁶ Article 2 was held applicable to the software sale, however, and therefore the statute of limitations embodied in section 2-725 ¹²⁷ and the warranty exclusion contained in section 2-316 ¹²⁸ were applicable to the software sale. ¹²⁹ Although the court did not directly address whether the software was a good, such a conclusion is implicit in the court's application of article 2 to the software transaction.

In Hi Neighbor Enterprises v. Burroughs Corp., ¹³⁰ a buyer entered into two contracts for the purchase of computer hardware and accompanying training, support services and other material. The buyer also executed two contracts for the purchase of software and computer education courses. Dissatisfaction with the seller's performance under the contract led the buyer to sue for breach of contract and fraud. In analyzing the enforceability of damage and warranty limitation clauses of the contracts, the court, applying Florida law, determined that sections 2-719 ¹³¹ and 2-316 ¹³² of article 2 rendered the clauses valid. ¹³³ Like the court in W.R. Weaver Co., the Hi Neighbor court also failed to expressly address whether software was a good and simply implied this conclusion by finding article 2 applicable to contracts for the sale of software.

Two courts have expressed some uncertainty about whether software is a good within article 2. In Samuel Black Co. v. Burroughs Corp., ¹³⁴ a buyer contracted to purchase a computer as well as software for the computer. The software was never completed and the buyer returned the computer and sued the seller for, among other things, breach of contract. The court found that Michigan law controlled the transaction and stated that 'there is reason to doubt whether the courts of Michigan would treat the computer system transaction . . . as falling within the scope . . . of the Uniform Commercial Code's ('UCC') article on sales.' ¹³⁵ The court then declined to resolve the question of the applicability of article 2 because it felt the outcome of the case would be the same whether article 2 did or did not apply. ¹³⁶ Based on this reasoning the court simply applied article 2 to the transaction by analogy. ¹³⁷

In Hartford Mutual Insurance Co. v. Seibels, Bruce & Co., ¹³⁸ the court was also unsure whether software was a good under article 2. In this case a buyer obtained software under a license agreement and brought suit in tort and under the warranty provisions of article 2 when the software allegedly failed to operate properly. The court recognized that the application of article 2 depended, in part, upon a finding that the software was a good. ¹³⁹ However, the court declined to decide whether the software in question was a good within article 2 since the court was deciding a motion for summary judgment and facts relevant to whether the software was within article 2 were in dispute. ¹⁴⁰

The various decisions addressing the question of whether software is a good under article 2 have either explicitly or implicitly found software to be a good, or at worst have left the question open. This treatment of software, combined with the superficial nature of the analyses supporting the judicial conclusions that software is a good within article 2, indicates only limited judicial uncertainty about the conclusion that software is a good. ¹⁴¹

II. TRANSACTIONS WITHIN THE SCOPE OF ARTICLE 2

A. Background

The determination that software is a good within the article 2 definition does not automatically make article 2 applicable to software. Before article 2 can apply an inquiry must also be made into the type of transaction involved. ¹⁴² Although general agreement exists that the sale of goods is subject to article 2, disagreement exists about whether transactions other than pure sales are within the scope of article 2. The applicability of article 2, for example, to the leasing of goods and hybrid transactions involving both the sale of goods and the rendering of services varies depending on the jurisdiction. ¹⁴³ This is significant for software since it is usually provided to users via license agreements which are non-sale transactions. ¹⁴⁴ It is therefore necessary to examine and compare judicial treatment of various non-sale transactions to determine how software should be treated.

B. The Uniform Commercial Code: True Code or Statute?

The basic question of whether article 2 extends to non-sale transactions depends, in part, on whether the U.C.C. is viewed as a statute or as a code.¹⁴⁵ A judicial conclusion that the U.C.C. is a statute or a code is determinative, at least to some extent, of its scope. ¹⁴⁶ As will be shown below, if viewed as a statute, non-sale transactions generally would be excluded from article 2 coverage while such transactions might be covered by article 2 if the courts treated the U.C.C. as a code.

Although 'statute' and 'code' are frequently used as synonyms, a true code is distinctly different than a statute. ¹⁴⁷ One well know commentator, Professor Grant Gilmore, provided the following explanation of the difference between a code and a statute:

"A 'statute,' let use say, is a legislative enactment which goes as far as it goes and no further: that is to say, when a case arises which is not within the precise statutory language, which reveals a gap in the statutory scheme or situation not foreseen by the draftsmen (even though the situation is within the general area covered by the statute), when the court should put the statute out of mind and reason its way to a decision according to the basic principles of the common law. A 'code,' let us say, is a legislative enactment which entirely pre-empts the field and which is assumed to carry within it the answers to all possible questions: thus when a court comes to a gap or an unforeseen situation, its duty is to find, by extrapolation and analogy, a solution consistent with the policy of the codifying law; the pre- Code common law is no longer available as the authoritative source. We may take another, subsidiary distinction between 'statute' and 'code.' When a 'statute,' having been in force for a time, has been interpreted in a series of judicial opinions, those opinions themselves become part of the statutory complex: the meaning of the statute must now be sought not merely in the statutory text but in the statute plus the cases that have been decided under it. A 'code,' on the other hand, remains at all times its own best evidence of what it means: cases decided under it may be interesting, persuasive, cogent, but each new case must be referred for decision to the undefiled code text." ¹⁴⁸

An examination of the historical considerations leading to the creation of the U.C.C. indicates that it was intended to produce a single uniform body of law to which commercial lawyers and businessmen could look to answer all commercial questions and solve all commercial problems.¹⁴⁹ Express U.C.C. language supports the view that the U.C.C. is intended to be a true code. ¹⁵⁰ Section 1-104 states that the U.C.C. is intended as a uniform coverage of its subject matter. The official comment to this section clarifies this position further by stating that the U.C.C. is 'intended as a uniform codification of permanent character covering an entire 'field' of law.' ¹⁵¹

The U.C.C. also acknowledges that commercial law changes and therefore the U.C.C. should be liberally construed to promote the underlying policy of permitting continuous expansion of commercial practices. ¹⁵² An official comment states that the U.C.C. is intended to be developed in light of unforeseen and new circumstances and practices. ¹⁵³ Other official comments go further by implying areas outside the express language of the U.C.C. which could be subject to U.C.C. principles. ¹⁵⁴ The U.C.C. also deals with the possibility of gaps which will inevitably arise both from unforeseen problems and from changes in commercial transactions and practices.¹⁵⁵ Section 1-103 allows the common law to be used to fill in gaps that may be discovered. ¹⁵⁶ A careful reading of this section supports the conclusion that the U.C.C. is a true code since the common law is subordinate to U.C.C. provisions. ¹⁵⁷

Proponents of the position that the U.C.C. is a statute look to the very basis of our system of jurisprudence which finds its roots in the English common law. ¹⁵⁸ A common law system narrowly construes statutes to limit their application to situations explicitly within the statutory language.¹⁵⁹ Judicially developed principles, known as common law, are then utilized to deal with situations not within the domain of a statute. ¹⁶⁰ Great emphasis is attached to these decisions. ¹⁶¹ In contrast, a civil law system relies on codes which are intended to be the source of general principles applicable to situations falling both within and without the express code language. ¹⁶² The underlying policy of a code is therefore contrary to the common law basis of our legal system.

If the U.C.C. is viewed as a statute, it follows that the scope of article 2 is limited to the exact wording of article 2. Section 2-101 states that the title for article 2 is 'sales.' If article 2 is read in light of principles of statutory construction which promote internal consistency it appears to be limited to sale transactions. A sale is expressly defined to be the passing of title from the seller to the buyer for a price. ¹⁶³ A careful reading of the entire text of article 2 indicates that only ten sections fail, at least in part, to explicitly mention 'sale,' 'buyer' or 'seller.' ¹⁶⁴ However, seven of these sections refer either directly or indirectly to 'contracts' or 'agreements' which are defined by section 2-106 to refer to contracts or agreements for the present or future sale of goods. ¹⁶⁵ Consequently only three sections in article 2 are not explicitly limited to the sale of goods, and therefore if it is viewed as a statute its scope is primarily limited to sales. ¹⁶⁶ Agreements to provide software by nonsale transactions, such as by licenses, would not, under this approach, be generally covered by article 2. ¹⁶⁷

The one difficulty with this approach is the statement in section 2-102 that article 2 is generally applicable to 'transactions in goods,' a significantly broader area than sales transactions. ¹⁶⁸ At least one commentator has argued that the express statement in section 2-102 that article 2 applies to transactions in goods is misleading due to the inadvertent use of the word 'transactions' in place of 'sales.' ¹⁶⁹ However, section 2- 102 also states that article 2 applies to transactions in goods unless the context otherwise requires. It can therefore be argued that this broad statement of scope is not meant to undermine the explicit references to sales in almost every section of article 2. ¹⁷⁰ Instead, this broad scope is simply for purposes of accuracy since some sections of article 2 deal both with sale of goods and with matters collateral to the sale of goods. ¹⁷¹

Judicial decisions have not expressly confronted the issue of whether the U.C.C. is a statute or a code. The general approach of the case law has been to focus on a particular non-sale transaction to determine if it should be covered by article 2 rather than examining the underlying question of whether the U.C.C. is a code or a statute. This approach is exemplified in Hertz Commercial Leasing Corp. v. Joseph. ¹⁷² In this case a dispute arose over a leased muffler pipe-bending machine and the court was confronted with the question of whether the U.C.C. applied to equipment leases. ¹⁷³ Rather than analyzing whether the U.C.C. was a code or a statute the court instead carefully examined the particular transaction involved. The court concluded that the reasons for and the extent of equipment leasing today justified holding that such leases were covered by the U.C.C. ¹⁷⁴ An analysis of the decisions that have examined whether to extend article 2 beyond sales transactions indicates a judicial split. Some courts appear to view the U.C.C. as a statute and consequently limit it to its express language ¹⁷⁵ while other courts seem to view it as a code by broadly applying U.C.C. principles to transactions outside the express scope of the relevant section. ¹⁷⁶

C. Lease and Bailment Transactions Generally

The use of leases in lieu of outright purchases is a recent and rapidly expanding practice ¹⁷⁷ which challenges the judiciary to decide how to view the U.C.C. In Bona v. Graefe, ¹⁷⁸ the court treated article 2 as a statute and rejected the application of the article 2 warranty sections to the lease of a golf cart. The court made its position very clear by stating that 'if the draftsmen had intended the sections to apply to leases of goods as well as to sales, they should have said so.' ¹⁷⁹ The court then emphasized its view of article 2 as a statute by stating that the extension of article 2 to leases would be improper judicial legislation. ¹⁸⁰ The same logic prevailed in W. R. Weaver Co. v. Burroughs Corp., ¹⁸¹ which involved a lease of a computer coupled with the sale of software to be used to operate the computer. Article 2 was held applicable to the software since it was sold but inapplicable to the computer since it was leased and therefore not within the scope of article 2. ¹⁸²

In contrast to this statutory approach, Hertz Commercial Leasing Corp. v. Transportation Credit Clearing House ¹⁸³ recognized that the failure to expressly include leases in article 2 was a gap in article 2. The court looked to the underlying policy of article 2 to bridge the gap rather than simply dismissing the code as inapplicable and resorting to the common law. ¹⁸⁴ Hertz Commercial Leasing Corp. recognized that the leasing of equipment is a recent device which is often equivalent to a sale but is resorted to for tax purposes. ¹⁸⁵ Furthermore, the court realized that it would be anomalous if this expanding volume of commercial transactions structured as leases were subject to different rules than outright sales when both transactions resulted in identical economic results. ¹⁸⁶

Although most cases discussing the scope of article 2 involve leases, the question of whether bailments are covered by article 2 has also arisen. In Mieske v. Bartell Drug Co., ¹⁸⁷ the Supreme Court of Washington, sitting en banc, extended article 2 to a bailment transaction. ¹⁸⁸ In this case, a customer delivered thirty-two fifty foot rolls of developed movie film to a store to be spliced onto four larger reels. The film company to which the stores sent the film lost or destroyed the film. In awarding damages to the customer, the court utilized article 2 provisions to find an exclusionary clause on the film receipt which limited damages to be unenforceable. In analyzing the applicability of article 2 the court focused on section 2-102 which declares that article 2 applies to 'transaction in goods.' ¹⁸⁹ The court then concluded that the drafters of article 2, by including section 2-102, intended its scope to be broader than sales, and therefore the bailment involved in this case came within article 2. ¹⁹⁰

Hertz Commercial Leasing Corp. and Mieske exhibit judicial recognition of the U.C.C. as a code rather than a statute and a consequent willingness to apply article 2 to transactions that are not within the express wording of article 2. However, the majority of courts take a middle ground between viewing article 2 as a statute or a true code. For example, only when a lease transaction is determined to be analogous or equivalent to a sale will many courts apply article 2 to the transaction. ¹⁹¹ Additionally, rather than applying article 2 in its entirety to lease transactions, most courts apply article 2 on a section-by-section basis. ¹⁹² A direct consequence of this approach is that a court must first determine if the lease transaction in question is the type within the scope of article 2, and second, if it is subject to article 2, which article 2 sections apply. ¹⁹³ Both of these findings are heavily dependent on factual circumstances and therefore they are not conducive to easy determination or predictability. Consequently, this approach, although laudable in its attempt to liberally construe the U.C.C., in reality leads to uncertainty because whether a particular lease is within the domain of article 2 and which sections of article 2 apply depends on the particular facts of each case. ¹⁹⁴ Such a result is contrary to the goals of clarity, stability, and uniformity in the law which were basic policy reasons for the creation of the U.C.C. ¹⁹⁵

D. Sale and Lease of Software

The outright sale of software alone is within the domain of article 2 if software is a good. ¹⁹⁶ Additionally, the sale of software coupled with the sale of a computer system is within the domain of article 2 if both the software and the hardware are goods. In Triangle Underwriters ¹⁹⁷ a computer system that included both hardware and software was sold. ¹⁹⁸ When the system failed to operate properly because the software did not perform as promised the buyer brought suit for breach of contract. The court held that the transaction was a sale of goods and applied the statute of limitations found in section 2-725 of article 2 to bar the action. ¹⁹⁹

The judicial trend, already discussed, of extending article 2 to leases in general applies with equal force to software leasing. In Office Supply Co. v. Basic/Four Corp., ²⁰⁰ the court had no difficulty applying article 2, with regard to warranties, remedy limitations, and the statute of limitations, to both the sale of hardware and the lease of software. The court noted that, although the software transaction was technically a lease, it was structured as a lease simply for purposes of copyright protection and therefore did not affect whether article 2 applied. ²⁰¹ Additionally, the court noted that neither party to the suit had contended that the software lease had any effect on the applicability of article 2. ²⁰² Likewise, United States Welding v. Burroughs Corp. ²⁰³ assumed, without discussion, that the warranty provisions of article 2 were applicable to a transaction involving the lease of both computer hardware and operating software. ²⁰⁴

It is apparent, therefore, that the leasing of software is not treated, for purposes of applying article 2, any differently than the leasing of any other equipment or personal property. Once a determination is made that software is a good, the same rationales that allow article 2 coverage to extend, in many jurisdictions, to leases of other goods also applies to software leases.

E. Licensing of Software

If article 2 is viewed as a statute strictly limited to its express language, then courts finding leases to be outside article 2 because a sale has not occurred will probably determine a license of software to be outside article 2 for the same reason. ²⁰⁵ In both cases a transfer of title has not occurred and therefore a sale, which is required by the express wording of almost all sections of article 2, has not taken place. ²⁰⁶

If article 2 is viewed as a code, the judicial trend of extending article 2 to leases should also apply to the licensing of software. ²⁰⁷ In Mieske the same logic was used to extend the coverage of article 2 to a bailment for mutual benefit. ²⁰⁸ This logic also applies to software licensing. Establishing a separate body of law to cover each new type of non-sale transaction used in place of a sale would undermine the original impetus behind the U.C.C. which was to unify and clarify commercial law. ²⁰⁹

Hertz Commercial Leasing Corp. and other cases which apply article 2 to leases look beyond the name given to a transaction. These cases focus on the underlying reason for the transaction and whether the transaction is equivalent or analogous to a sale. ²¹⁰ The growing field of equipment leasing in lieu of a sale is used for tax, financing, and other commercial purposes.²¹¹ For example, in some cases leases are structured with options to buy the goods at the end of the lease term for a nominal cost, such that the leases are really analogous or equivalent to a sale. ²¹² The effect of software license transactions and the underlying rationale for such transactions must therefore be examined, since this is the most common method of providing software to users. ²¹³

An understanding of why software is licensed requires an examination of how new products in general are protected from duplication. When a new product is created and marketed, the development costs are normally recouped through mass production and sale of the product. However, many products can easily be copied and sold at a fraction of the developer's cost since the copier does not have any development costs to recoup. ²¹⁴ To combat this problem companies rely on trade secret law if the product can be made in such a manner as to make duplication impossible. ²¹⁵ Additionally, products only made available to a limited number of users may be confidentially licensed as trade secrets if the use of the product can be controlled to maintain secrecy. ²¹⁶ Otherwise, patent and copyright law may be utilized to erect legal impediments to copying a product. ²¹⁷

The applicability of patent law to software is unclear, ²¹⁸ but even if applicable, rapid changes in computer technology would eliminate the value of any patent protection, which is both costly ²¹⁹ and time consuming to obtain. ²²⁰ A patent typically takes several years to obtain and the software may be obsolete or have greatly reduced value by the time a patent is issued. ²²¹ Trade secret protection was formerly the most widely used method of protecting software. ²²² However, its current use is restricted at most to specialized software which is individually licensed on a limited basis and therefore subject to secrecy and control. ²²³ The use of trade secret law in the rapidly growing market for canned software, designed for use in small inexpensive computers used at home and by small businesses, is questionable since no practical method exists for ensuring that a tremendous number of users will maintain the software as a trade secret. ²²⁴ Such confidential use by all users would be necessary for trade secret protection to be successful since a single public disclosure of a trade secret vitiates trade secret protection. ²²⁵

The ease with which software can be duplicated, ²²⁶ the questionable applicability and suitability of patent law to software, and the limited utility of trade secret law have resulted in increased reliance on copyright to protect software. ²²⁷ There are certain limitations, however, to copyright protection. ²²⁸ Although copyright law prohibits unauthorized duplication of software even if it is sold, ²²⁹ sale of the software by the software producer allows the buyer to freely resell or transfer the software to someone else. ²³⁰ Copyright does not protect the underlying algorithms or processes upon which a computer program is based even if these are proprietary information of the software producer. ²³¹ Copyright also does not restrict use of a program, so it is possible for several users to share the same software. For example, the software can be loaded into a single computer so it is available to multiple users who have access to the computer via remote terminals. ²³²

Due to the limitations of copyright protection, software producers have been forced to resort to additional methods used in conjunction with copyright to protect their investments in the creation of software. Technical methods such as copy protection schemes have provided one source of protection. ²³³ Licensing of software provides additional legal protection, especially when the software is already protected by copyright. ²³⁴

Under the copyright law, the copyright owner has several exclusive rights which include the right to control the making of copies and the public distribution of copyrighted works. ²³⁵ This means that copyrighted software can not be reproduced or distributed without the permission of the copyright owner. However, the so-called 'first sale doctrine' provides that the sale of a copy of the copyrighted work embodied in a tangible medium extinguishes the copyright owner's distribution right with regard to the particular copy sold. ²³⁶ As a result, once software embodied in a tangible medium such as a diskette is sold, the buyer is free to sell or otherwise dispose of that diskette without permission of the copyright owner. ²³⁷ However, the first sale doctrine includes an express limitation. It does not apply to anyone who has obtained possession of the tangible medium containing the copyrighted work 'from the copyright owner by rental, lease, loan, or otherwise, without acquiring ownership of it.' ²³⁸ Therefore, if a software vendor retains ownership in all of the copies of his software by only selling users a license to use the software, the effect of the first sale doctrine is avoided. ²³⁹ This allows software producers to restrict disposition of the software by users.

Software licenses are also used to attach additional conditions to the use of software. ²⁴⁰ One typical condition is that the software user must protect the underlying algorithms ²⁴¹ and processes used in the software which are beyond the scope of copyright protection. ²⁴² Typically this underlying information is alleged to be a trade secret of the software producer which the software user is required to maintain in confidence. ²⁴³ This condition, which is certainly valid for software that is individually licensed on a limited basis, is also included in many shrink-wrap or tear-me-open licenses²⁴⁴ accompanying mass-marketed or canned software. ²⁴⁵ Although the validity of requiring shrink-wrap licensees to protect underlying algorithms and processes as trade secrets is questionable in light of established principles of trade secret law, ²⁴⁶ both Louisiana and Illinois have enacted explicit statutes making such a license provision enforceable. ²⁴⁷ Therefore, by licensing software the software producers are attempting both to control its use by limiting its transfer to others and to protect the underlying algorithms and processes contained in the software. ²⁴⁸

Although licensing of software is not an actual sale under article 2 since the software producer retains title to the software, it has many of the incidents of a sale. ²⁴⁹ Canned software obtained subject to a shrink-wrap or tear-me-open license is most analogous to a sale. A typical license of this type would be classified as a perpetual paid-up license since the one time license fee paid for the software is all that is required. ²⁵⁰ Furthermore, the license is perpetual, provided there is adherence to its terms. In this type of transaction the software producer has effectively sold the software despite retention of title, since the producer has no realistic expectation of ever getting the software back. ²⁵¹ The extension of article 2 to such software transactions therefore seems justified on the same basis that article 2 has been extended to leases and bailments. Article 2 has been applied to leases based on the realization that leases are often used for tax or other purposes, and therefore they are really analogous if not equivalent to a sale. ²⁵² Shrink-wrap or tear-me-open software licenses are likewise equivalent to a sale since they are utilized, not to avoid a sale per se, but rather for purposes of copyright ²⁵³ and protection of proprietary information. ²⁵⁴

Individual licensing of special purpose software on a limited and carefully controlled basis to preserve trade secrecy has fewer incidents of a sale. The software producer will have more control over how the software is used, periodic license fees may be required, and the software may be subject to return to the licensor once the license is terminated. The duration of such a license may be critical however. In H.M.O. Systems, Inc. v. Choicecare Health Serv., Inc., ²⁵⁵ software was provided via a non-expiring or perpetual license; thus, the lack of title transfer does not seem relevant since a permanent right to use the software existed. ²⁵⁶ Additionally, the exponential advancement of computer technology can render a license which is limited to a specific duration of time equivalent to a sale. In State v. Central Computer Service ²⁵⁷ a ninety-nine year license was given for the use of software. ²⁵⁸ The advancement of computer technology guarantees that this software will be useless prior to the termination of the license term. ²⁵⁹ Therefore, although the licensor has retained title to the software the licensor has no expectation that the software will ever be returned by the licensee because it will be worthless long before the license term ends. If the duration of the individually negotiated license is for a very limited time then this type of transaction is less analogous to a sale. However, despite the fact that some software license transactions may have fewer incidents of a sale than others, most of these transactions are, to a greater or lesser degree, closely analogous or equivalent to sales.

The current judicial trend of expanding the domain of article 2, ²⁶⁰ although not uniformly followed, ²⁶¹ should therefore be applied to all software license transactions. Just as the court in Hertz Commercial Leasing Corp. recognized that leases analogous or equivalent to sales should be treated as being within the scope of article 2 to avoid creation of a separate body of law for an increasingly common type of transaction, ²⁶² software licenses should also be covered by article 2 for the same reasons. Software is typically licensed to protect certain rights provided by copyright and to protect underlying information utilized in creating the software. ²⁶³ In all other respects most software license transactions resemble sales and should therefore be treated as being within the scope of article 2. ²⁶⁴

The fact that different types of software licenses have differing incidents of sale should not affect the application of article 2 to such transactions. The underlying U.C.C. policy of promoting uniformity in the law requires this result. ²⁶⁵ Otherwise, whether a particular license transaction was within the domain of article 2 would depend ultimately on an individual case by case evaluation of the factual circumstances of each license transaction.

F. Hybrid Sale/Service Transactions Generally

Software is often provided in combination with various types of services ²⁶⁶ or used in the performance of service contracts. ²⁶⁷ Before examining such software transactions in detail, judicial treatment of analogous hybrid sale/service transactions generally must be reviewed.

Pure service contracts - the opposite end of the spectrum from pure sales transactions - generally fall outside of the domain of article 2. ²⁶⁸ However, pure service and pure sale transactions represent the extreme ends of a continuum. ²⁶⁹ Most transactions are hybrids involving both the sale of goods and the performance of services. ²⁷⁰

In Skelton v. Druid City Hospital Bd., ²⁷¹ a hospital patient was injured during a surgical procedure when part of a suturing needle used by the surgeon broke off and remained in the patient's body. The needle, which is a good under article 2, was simply an inexpensive tool used by the surgeon in performing the operation. Although surgery is primarily a service, the use of the needle in performance of the service resulted in the court finding a transaction in goods within the scope of article 2. ²⁷² This approach, although not widely followed, exemplifies the broad application of article 2 beyond its express language, in accordance with the philosophy that the U.C.C. is a true code. ²⁷³

Another approach is to apply article 2 only to the portion of a hybrid transaction which involves goods. In Foster v. Colorado Radio Corp., ²⁷⁴ a contract for the sale of a radio station involved a totality of assets of which no more than ten percent were goods under article 2. ²⁷⁵ The court therefore applied article 2 to those assets which were goods, and non-code law was applied to the remaining assets. ²⁷⁶ Although this approach seems equitable at first glance, it fails to promote uniformity and simplicity in commercial transactions since different aspects of a transaction will be subject to different bodies of law. ²⁷⁷

Despite the approach followed by Skelton and Foster a contrary common law rule for dealing with hybrid sale/service contracts seems to have survived enactment of the U.C.C. ²⁷⁸ Prior to adoption of the U.C.C. a contract was examined to determine if it predominately involved the performance of services or the sale of goods, and it was then classified according to the predominate feature. ²⁷⁹ This approach is still the most frequently utilized analysis when a court is faced with a contract involving both goods and services.²⁸⁰ Like the other approaches, this treatment of hybrid transactions also fails to promote uniformity in commercial transactions. Additionally, it creates a lack of predictability because whether a hybrid transaction is designated as a sales contract or a service contract depends on the particular facts of each transaction. ²⁸¹ Consequently, this approach necessitates a case by case approach which promotes a lack of uniformity and is inherently unpredictable.

Several other tests have also been developed by the courts to determine if a contract involving both goods and services falls inside or outside the scope of article 2. ²⁸² In Bonebrake v. Cox, ²⁸³ the court ascertained the main thrust of the transaction by examining the intent of the parties. The transaction, which involved a contract to deliver and install bowling equipment, was determined to be a contract for the sale of goods within article 2 since the sale of the equipment, rather than its installation, was found to be the main thrust of the contract. ²⁸⁴ In Lake Wales Publishing Co. v. Florida Visitor, Inc. ²⁸⁵ a contract for printing pamphlets was held to be covered by article 2. The court focused on the final product resulting from the contract and concluded that since the end product, pamphlets, fit the article 2 definition of goods, article 2 applied to the contract despite the extensive printing services involved. ²⁸⁶ In Wivagg v. Duquesne Light Co., ²⁸⁷ a printing shop owner sued a public utility for damages to the owner's business due to a fire caused by faulty electrical wiring maintained by the utility. The court determined solely on public policy considerations that providing electrical service was sufficiently analogous to a sale that article 2 applied. ²⁸⁸

The variety and amorphous nature of the analyses used to determine how to treat hybrid sale/service transactions is a model of the lack of uniformity in the law. ²⁸⁹ Eliminating this lack of uniformity was one of the motivating forces behind enactment of the U.C.C. ²⁹⁰ An examination of how software transactions, which typically involve the licensing of software provided with various services, would be treated under the various analyses discussed above strongly supports the extension of article 2 to such transactions.

G. Hybrid Transactions Involving Software

Software is usually supplied with support services to assist the software user in utilization of the software. ²⁹¹ Support services for mass-marketed over-the-counter or canned software are typically provided in the form of an accompanying looseleaf book or manual which explains in detail how to use the software. Support services in this form should not alter the designation of software as a good since the accompanying manual is itself a good. ²⁹²

However, complex software designed for a large computer system may require more extensive support services. In addition to detailed manuals, personnel provided by the software vendor will install and debug ²⁹³ the software and train the software user's personnel in the operation of the software. ²⁹⁴ In this case the transaction involves both goods, in the form of software, and services provided to use the software. In the majority of jurisdictions the transaction will be classified as a contract involving goods or a service contract depending upon which feature predominates. ²⁹⁵ If the installation, training, and debugging are merely incidental to providing the software, then the goods aspect will predominate and article 2 will apply. However, it may be possible for the service aspects to be so extensive that a court could conclude that they predominate and therefore find that the transaction is a service contract outside the scope of article 2.

In RRX Industries the court was confronted with a software transaction that involved both the sale of software and accompanying services. ²⁹⁶ The seller contracted to install the software on the buyer's computer and to correct any errors in the software discovered after installation. The seller also agreed to train the buyer's employees in the operation of the software and to upgrade the software in the future. ²⁹⁷ The system proved unreliable, however, because the seller was unable to correct defects in the software. The buyer successfully brought suit for breach of contract and was awarded general and consequential damages. In affirming the award, the Ninth Circuit noted that the district court's award of consequential damages under article 2 of the U.C.C. could only stand if the software was a good and the software transaction was a contract for the sale of goods rather than a contract to provide services. ²⁹⁸ The court then found that the sale of goods aspect, the sale of the software, was the predominant feature of the transaction, with the services being only an incidental part of the transaction. ²⁹⁹ Consequently, the Ninth Circuit found, under the predominate feature test, that in this case the sale of software with accompanying services was a contract for the sale of goods covered by article 2. ³⁰⁰

Alternatively, if the analysis used in Bonebrake is applied the main thrust of the transaction will determine whether article 2 applies. ³⁰¹ Typically this analysis would lead to the conclusion that article 2 does apply since, regardless of the quantum of support services provided, acquiring the software will be the primary thrust of the transaction. If the final product resulting from the transaction is the focus of the analysis, such as in Lake Wales Publishing Co., article 2 would be applicable if the final product, a properly installed and operating computer program, is a good. ³⁰² If the determination depends on public policy considerations, such as in Wivagg, the determination of whether article 2 applies is uncertain. ³⁰³ A court relying on Wivagg would only apply article 2 if it felt the transaction was sufficiently analogous to a sale. Application of Foster would require differentiating between the portion of the transaction involving goods and the portion involving services. ³⁰⁴ Based on this approach article 2 could apply to the software while the service aspects of the transaction would not be subject to article 2. Finally, the determination that software is a good would render article 2 applicable under Skelton regardless of the quantity of support services involved. ³⁰⁵ The mere use of a good in a transaction is all that Skelton required for the transaction to come within the scope of article 2.

Large computer systems, such as those used by a governmental agency or a chain of nationwide retail stores, frequently require custom programming due to the systems' size and the specialized tasks being computerized. Some companies employ their own in-house personnel to do the programming, but frequently outside consultants design and implement the necessary software. Although most courts would probably determine that this involves a service contract, since the service aspect predominates, a different conclusion is also possible depending upon which analysis is used.

Despite substantial programming services, if the final product, software, is a good, the Lake Wales analysis would require application of article 2. ³⁰⁶ Likewise, under Skelton the fact that the programmer would use computer hardware, which is a good, to create software makes article 2 applicable to the transaction. ³⁰⁷ If the analysis used in Bonebrake was employed, the applicability of article 2 would depend upon whether the main thrust of the transaction was determined to be providing services or the creation of a specially manufactured good in the form of software. ³⁰⁸ Focusing on public policy considerations, as done in Wivagg, produces uncertain results, ³⁰⁹ while reliance on Foster would apply non-article 2 law to the service aspects of providing programming services. ³¹⁰

An increasingly common form of computer use is time-sharing. Time-sharing involves access to large computers containing large amounts of data or extensive computing capability by small home computers or computer terminals via telephone lines. The WESTLAW and LEXIS computer systems are examples of such time-sharing. ³¹¹ A user pays WESTLAW or LEXIS for the right to access the company's computer from a computer terminal or a small home computer which communicates with the company's computer via a telephone line. Although the user merely pays for access to the WESTLAW or LEXIS computers, such access involves the use of software in the WESTLAW and LEXIS computer systems. A similar type of computer use involves service bureaus. These bureaus receive data from customers which is subjected to computer processing by the service bureau with the resulting computer output being supplied to the customer. ³¹² A typical example is a service bureau which receives employee payroll data from a employer and utilizes a computer system to prepare payroll checks and to compile yearly employee payroll records. In this case the employer receives a tangible product in the form of payroll checks and employee wage records which were created with the service bureau's computer hardware and software.

Time-sharing and the use of service bureaus involve a direct and indirect use of software, respectively. Although courts have found such transactions to be service contracts outside the scope of article 2, ³¹³ the various analyses applied to other transactions may produce different results. The Skelton analysis would render article 2 applicable to both time-sharing and service bureau transactions since both involved goods such as computers. ³¹⁴ Lake Wales focused on the final product and therefore under this approach article 2 may apply in some cases. ³¹⁵ For example, if a service bureau produces tangible output such as a typed report or a data compilation on a computer diskette, article 2 will apply if the report or data compilation is a good under article 2. Foster would require application of article 2 only to the goods portion of the transaction. ³¹⁶ The public policy approach relied on by Wivagg ³¹⁷ and the main thrust analysis of Bonebrake ³¹⁸ would produce uncertain results while the predominate feature analysis ³¹⁹ would probably result in article 2 not being applicable.

The various approaches that can be used to determine if a hybrid transaction involving software is within the domain of article 2 fail to promote uniformity since the application of article 2 depends on both the factual circumstances and the test applied to the transaction. Rather than having the applicability of article 2 depend on which legal analysis is utilized, a decision that it is applicable to all software transactions would allow uniform results. Such a decision would allow judicial extension of article 2 to bailments and leases to be extended further to hybrid transactions involving software. ³²⁰

The determination of whether article 2 is applicable to software transactions is an important and timely question. The size of the computer industry coupled with the exceptional growth of software markets has created an enormous industry. The development of commercial law, as applied to this industry, will be greatly affected by whether article 2 is applicable. The extension of article 2 to software transactions will promote uniformity, predictability, and commercial reality which are policies underlying the U.C.C. In contrast, if software transactions fall outside the domain of article 2, the trend of developing applicable law on a piecemeal basis, which varies from state to state, will intensify. Such an approach would prove particularly troublesome for the software industry which typically markets its products on a national basis and would therefore have to comply with the individual laws of each state.

The application of article 2 to computer software transactions depends upon two conclusions. First, software must be within the article 2 definition of a good. Second, non-sale software transactions, which typically involve licensing of the right to use software, must be within the domain of article 2. Looking beyond the confusing terminology that is endemic to the computer industry, it can be seen that once software, which begins as an intangible idea, is reduced to a tangible form embodied in a physical medium, such as a diskette or magnetic tape, a good exists. The physical nature of the software in this form makes it a 'movable' thing as required by the article 2 definition of a good. The existence of intellectual property aspects in the software, typically subject to copyright or trade secret protection, does not divest the software embodied in a tangible medium of its status as a good. The software in this form is simply a good that embodies intellectual property aspects. A contrary result, if applied to all goods, would result in a substantial number of products traditionally viewed as goods under article 2, being removed from the domain of article 2. Books, telephones, automobiles, clothing, food products and innumerable other products, universally viewed as goods, frequently embody various forms of intellectual property. Therefore, if the existence of intellectual property aspects in a product eliminated its status as a good, the scope of article 2 would be severely limited. Consequently, the determination that software embodied in a tangible medium is a good seems inescapable.

Even if software is a good, however, the extension of article 2 to typical software licensing transactions must be established. Strict statutory construction of article 2 would limit its scope to sales, and therefore non- sale software licensing transactions would be beyond the reach of article 2. However, an increasing number of jurisdictions have extended article 2 to non- sale transactions such as leases and bailments. This extension has been based on a desire to apply article 2 to a growing class of transactions that are analogous or equivalent to sales, but used for tax or other financial reasons. The same logic supports extension of article 2 to software licensing since such transactions are also analogous if not equivalent to sales. Typically, software is licensed to preserve rights under the copyright law and to aid in maintaining the confidentiality of underlying proprietary information contained in the software. Therefore, the extension of article 2 to software license transactions is consistent with the extension, by some courts, of article 2 to leases and bailments.

Extending article 2 to hybrid software license transactions which involve software, which is a good, and accompanying services is more troublesome. In dealing with the analogous situation of hybrid transactions involving both sales and services, the courts have developed a variety of different analyses, which produce differing results. Application of these analyses to hybrid software transactions such as licensing of software with support services, custom programming, time-sharing arrangements, or service bureau contracts produce different results depending on the analysis used. This uncertainty can be eliminated by extending article 2 to all transactions involving goods. Such a uniform extension, which already occurs under some of the above analyses, is justifiable if the U.C.C. is viewed as a true code. This expansive approach is required if article 2 is to have any lasting vitality in contemporary commercial markets which are increasingly resorting to non-sale transactions in lieu of traditional sales transactions.