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JILT 2000 (1) - Noriko Kawawa


Contents

 Abstract

1.

Classification of Contracts

 

1.1

The Structure of Classification

1.2

Contracts for Goods

1.3

Contracts for Services

1.4

Contracts for Information

1.5

Contracts for Information in Electronic Form

2.

The Effect of Classification

 

2.1

The General Purpose

2.2

Evidence

2.3

Limitation Period

2.4

Implied Obligation

2.5

Comparison: England and US

3.

Uncertain Nature of the Criteria in Classification

 

3.1

General Factors in Classification

3.2

Delivery of a Chattel

3.3

Substance of the Contract

3.4

Analysis of the Different Approach and the Statute of Fraud Defence

3.5

Different Factors of Consideration and Contracts Relating to Information in Electronic Form

4.

Nature of Licensing Agreements - Relationship with Intellectual Property

5.

Cases in England

 

5.1

Effect of Classification

5.2

Classification and Application of Statute

5.3

Obligation Specific to Contracts Involving Computer Programs

5.4

Physical Medium & Intangibles

5.5

Breach of Express Duties (Obligations) Cases

5.6

Professional Liability

5.7

Classification and Implied Terms and Express Terms

6.

The Cases in the US

 

6.1

Different Tests for Classification

6.2

Predominant Test, Contract for the Sale of Goods

 

6.2.1

Turn-key Computer System

6.2.2

Customised (Bespoke) Software

 

6.3

Predominant Purpose Test, Supply of Services

6.4

Gravamen of the Action Test, Contract for the Supply of Services

6.5

Factors Considered in the Classification

 

6.5.1

Important Factors

6.5.2

Physical Configuration

6.5.3

Process of Performance

6.5.4

Method of Distribution

6.5.5

Remuneration

6.5.6

Comparison with Traditional Subject Matters

7.

Explanation of the Difference Between English and US Law

8.

The Effect of the Enactment of the UCITA

9.

Conclusion

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Contract Law Relating to
Liability for Injury Caused by Information in Electronic Form: Classification of Contracts -
A Comparative Study,
England and the US

Noriko Kawawa
University of Osaka Prefecture
kawawa@eco.osakafu-u.ac.jp

(I would like to thank my academic supervisor, Professor Tapper (Magdalen College, Oxford University), my college advisors, Professor Rudden and Mr. John Davies (Brasenose College), Dr. Smith (St. Hugh's College) and Mr. Peel (Keble College) for their valuable suggestions and comments. I would also like to thank Yamada Public Trust Foundation for Promotion of Researchfor providing me with generous funding to support my research.)

Abstract

The economic value of information has increased dramatically due to the development of technology. Information is now a commodity in itself, independently of goods or services. Transactions involving information in electronic form have become an essential part of business and social life in modern society. A defect in information held in electronic form may cause serious economic and personal damage. Such defects may cause serious economic and personal injury. Because of the increasing number of transactions involving information in electronic form and the analysis of the liabilities concerning defects in information in electronic form is essential in the era of information technology law. Analysis of such issues may help in establishing the standard of quality in supplying information in electronic form.

In this article, I am focusing on the effects of the classification of contract regarding transactions involving information in electronic form. Within the type of information in electronic form, my main concern is transactions with respect to supply of computer programs and other services such as data processing and business consultancy related to the supply of computer program.

Between the contracting parties, the classification of the contract is crucial in determining the level of liability imposed in relation to the subject matter. Contractual liabilities may differ in accordance with the legal form or classification of a given transaction as sale, supply of services, licence etc.

I will first examine the difficulties in classifying contracts for information in general. Second, I will explore the effect of classification, different factors considered in determining classification and evaluation of such factors. Third, I will examine different factors considered in determining classification with respect to transactions involving information in electronic form and how the classification of contracts is affecting the outcome of the actual cases. By conducting comparing analysis of law in England and United States, I will attempt to articulate the purpose of classification in transactions involving information in electronic form and evaluate the relevant provisions in newly enacted Uniform Computer Information Transaction Act in United States.

Keywords: Electronic transactions, classification of contracts, UCITA


This is a Refereed Article published on 29 February 2000.

Citation: Kawawa N, 'Contract Law Relating to Liability for Injury Caused by Information in Electronic Form: Classification of Contracts - A Comparative Study, England and the US.', 2000 (1) The Journal of Information, Law and Technology (JILT). <http://www.law.warwick.ac.uk/jilt/00-1/kawawa.html>.New citation as at 1/1/04: <http://www2.warwick.ac.uk/fac/soc/law/elj/jilt/ 2000_1/kawawa/>.



1. Introduction - Classification of Contracts

1.1 The Structure of the Classification

Certain forms of information, such as computer programs and databases play essential roles in modern society. Such new subject matters are questioning the validity of the existing law as applied to them. The purpose of this article is to consider the role of the classification of contracts in relation to contracts for information in electronic form, especially computer programs, in England and in the United States and compare the way in which both countries have dealt with the issues of classification.

The important question to be asked is, why does the law distinguish between contracts? Prior to answering this question, it is helpful to look at the structure of how our present law classifies contracts in accordance with their subject matter and the process by which the subject matter is supplied.

The classification of the contract is crucial in determining the level of liability imposed in relation to the subject matter. These categories relevant to information in electronic form are:

1) contracts for goods;

2) contracts for services; and possibly

3) contracts for information.

There are two types of injuries in relation to these subject matters. One is injury based on the quality of the subject matter itself, and the other relates to the process by which the subject matter is supplied[1].

1.2 Contracts for Goods

Contracts for goods are placed at one end of the category of default rules providing imposition of liability. Default rules in statutory laws provide for an implied term or warranty as to the quality of the product[2]. There are variations depending on how widely those goods are diffused. Specifically-made goods are placed in a stricter category than are mass-marketed goods[3]. Statute provides for an implied term or warranty as to the specific purpose intended by parties.

1.3 Contracts for Services

Under the common law principle, the supplier has a duty to carry out services with reasonable care and skill[4]. There are no implied terms or warranties as to the result of the subject matter supplied[5]. Contracts, which contain both elements of services and goods, are neither pure contract for goods nor services. There are different ways to find applicable statutes for these types of mixed contracts. English law treats the two elements separately in accordance with the different principles of law[6]. A majority of the United States' cases asks whether goods or services predominate in a mixed goods and services contract as a whole[7]. The basis of such determination is not always clear. In the United States, careful drafting of the Uniform Computer Information Transaction Act ('UCITA') was necessary specifically for information in electronic form in order to avoid making this determination[8].

1.4 Contracts for Information

A significant part of the contracts to supply information, however, belongs to the categories of sale of goods or supply of services. For instance, information supplied in the form of software is deemed 'goods' in many cases in England and the United States[9].

On the other hand, parties may agree to provide legal services or accounting services, where information is created as a result of the rendition of such services[10].

However, contracts for information contained in newspapers, books or magazines, distributed to the public, seem to involve different obligations from contracts for goods and services. Neither the immediate suppliers nor the publishers seem to be subjected to implied obligations as to the accuracy of the content of the publication unless there is an express agreement for accuracy or there exists a 'special relationship'[11] between the parties.

The determination as to whether there was a special relationship may depend on factors including:

1) the type of statement, for instance, financial or defamatory;
 

2) the type of business the defendant is involved;
 

3) concern about freedom of speech;
 

4) the number of plaintiffs involved;
 

5) reliance by the plaintiffs;
 

6) the amount of remuneration paid; and,
 

7) difference in the level of knowledge between suppliers and plaintiffs[12].

There may also be a difference in the level of liability regarding content for immediate suppliers and the publishers. Physical properties of books and the information they contain have two distinct characteristics. The readers may have direct contractual relationships with the immediate distributors. The immediate suppliers 'sell' these newspapers, books or magazines as tangible, physical properties. A distributor may be considered a passive conduit and a newspaper is more than a passive conduit for news, comment and advertising[13]. Therefore, though the immediate suppliers may be liable for physical defects in newspapers and magazine, they are not to be held liable for the content of the information, unless they know or have reason to know the content of the information[14].

Publishers of ordinary newspapers or magazines may not have a direct contractual relationship with their readers. There are different ways in which publishers distribute information. For instance, publications such as the Wall Street Journal may be distributed by intermediate distributors to members of the general public[15]. Publications may contain financial information or defamatory information[16]. Publishers may also provide specific investment recommendations directly to their readers[17]. Publishers of loose-leaf summaries of the business operations and finances of a large number of corporations, containing information on securities, may have direct subscription agreements with readers to supply supplements each month[18]. However, even if there are contracts between readers and publishers, such as subscription agreements, the courts are not likely to find any implied obligations for the content of the information supplied. The majority of cases holds that a news service or a publisher is not liable to its readers for a negligent false statement[19]. It maybe feared that unless the liability is limited, the publisher may become liable to an undefined, infinite class of readers[20].

The development of technology has altered the method of distribution. Information is increasingly provided on line, without intermediate distributors. The readers may have a direct contractual relationship with the publishers to gain access to the on-line databases. Still, the change in the technology does not seem to affect this approach taken by the courts. The relationship between the information provider and an on-line subscriber was not adequate to find the provider liable in Daniel v. Dow Jones & Co., Inc[21]. The court determined that the 'special relationship' required for an action for negligent misstatement must be greater than the relationship between the ordinary buyer and seller. The court stated in a footnote that 'even though the exact nature of the 'contract' cannot be definitely determined on the record here, that does not effect the disposition.' In this case, it was not established that the agreement was formed between the parties and there was no proof that the plaintiff agreed to a limitation of the defendant's liability as a part of the on-line sign-up procedure.

On the contrary, the courts may not be able to deny the existence of a direct contractual relationship in the cases of LEXIS or WESTLAW subscriptions. Despite the existence of such a contractual relationship, it is unlikely that the court will find a 'special relationship.' As shown in the diagram, authorities tend to refer to a 'special relationship'[22] without differentiating whether or not there was a contract between the parties. The reason may be that they are placed in the same category of contractual relationship, which does not create liability.

The comments to Section 403 of the UCITA[ 23], give an example in which there is no implied warranty for the website which contains published informational content on restaurants. The same is true of a restaurant review in the New York Times. Information systems that are analogous to newspapers, magazines, or books are treated as such for purposes of contract law. However, some online databases tend to be relied on, and are believed to be kept up to date. Online databases are easily transferred for further secondary use. Therefore, not all online database suppliers may become be free from liability for supplying defective information.

As far as the default rule is concerned, the intensity of the liability is diminished in accordance with the category into which the particular contract falls. However, the position fluctuates by various terms or conditions agreed upon between the parties. Express terms or warranties as to the quality of the services can impose additional liability on the suppliers of service contracts. Suppliers of information may charge a higher price for supplying accurate information. Clients rely more on the information when they pay a higher price for the accuracy of the information supplied. On the contrary, if suppliers of information charge a low price, a lesser duty may be imposed. The classification of the subject matter of the contract and the process in which the subject matter is supplied are essential in determining the liability of the supplier of the subject matter. This categorical classification seems to provide a clearer and more unambiguous set of rules regarding goods and services than those rules regarding information. Rules concerning information cannot be fully incorporated into this structure.

Lastly, as discussed above, a special relationship can also be found between non-contractual parties. The information provider owes duties of care to clients and also to the foreseeable parties without a contract relationship, if there is a special relationship.

As stated in Hedley Byrne & Co. Ltd. v. Heller & Partners Ltd.[24], by Lord Devlin, wherever there is a relationship equivalent to contract, there is a duty of care[25]. Lord Reid also stated that there must be a special relationship between the parties such that the defendant knew or ought to have known that the plaintiff might reasonably rely upon the defendant's representation[26]. Therefore, suppliers of information in a special relationship even without contracts may be held liable for the content of the information.

However, any attempt to expand the scope of a special relationship for the imposition of liability outside the contract may open doors to a liability to an indeterminate amount for an indeterminate time to an indeterminate class[27]. This concern is equally applicable to the category within the contractual relationship but without this special relationship. Considering the determination of liability issues, the type of information and the process by which it is supplied seem to be important factors. The law is reluctant to impose liability based on relationships other than those in the special or fiduciary category.

The diagram below shows the structure describing the 'special relationship' within both contractual and tortious relationships.


Contractual Relationship

Tortious Relationship

Special

Professional

Attorney

Accountant

Relationship

Raritan River Steel Co. v. Cherry, Bekaert & Holland,[28]

Hedley Byrne & Co. Ltd. v. Heller & Partners Ltd.[29]

No Special

Newspapers, magazines
(contractual relationship with the distributor; no direct contractual relationship with the publisher)

On-line databases

Relationship

Ultramares Corporation v. Touche[30]

Caparo v. Dickman [31]

Table 1: 'Special relationship' within contractual and tortious relationships.


1.5 Contracts for Information in Electronic Form

Transactions involving information in electronic form have been categorised as contracts for goods, contracts for services and contracts for information. Categorisation is difficult because a single transaction often contains elements of all the categories. The development of technology has created complex transactions, which cannot readily be categorised without detailed analysis of each transaction.

2. The Effect of Classification

2.1 The General Purpose

In this section, I intend to clarify why it might matter whether a particular contract be classified as one of sale of goods, supply of goods, or supply of services. There are mainly three reasons why classification may affect the transactions: evidence; limitation period; implied obligations.

2.2 Evidence

The Statute of Frauds imposed formal requirements for only some types of contracts. In England and Wales, written evidence for contracts for the sale of goods of ten pounds and more was required in accordance with the Sale of Goods Act 1893[32]. Therefore, the buyers were able to plead lack of written evidence in an action by the supplier to recover the contract price for specifically-made goods[33]. Under the present law, as provided in the Sale of Goods Act 1979, no written formalities are required in relation to contracts for sale of goods[34]. On the other hand, in the United States, Section 2-201 of the U.C.C. provides that a contract for the sale of goods for the price of 500 dollars or more is not enforceable unless there is some writing indicating that the contract for sale has been made between the parties. Therefore, it is possible, in the United States, to claim that a contract for the sale of goods is not enforceable because of the statute of frauds[35].

2.3 Limitation Period

In England and Wales, the Limitation Act 1980[36] provides that an action founded on tort or simple contract should be brought within six years from the date on which the cause of action accrued. In the United States, the limitation period varies in accordance with state laws. Ordinarily, tort claimants are entitled to a longer statute of limitation[37]. Section 2-725(1) of the U.C.C. provides that an action for breach of any contract for sale must be commenced within four years after the cause of action has accrued.

2.4 Implied Obligation

In England, if the contract is construed as sale of goods, the Sale of Goods Act 1979 is applicable unless expressly excluded or varied. Under Section 14(2), as amended in 1994, if the seller sells goods in the course of a business, there is an implied term that the goods supplied under the contract are of satisfactory quality. Under Section 14(3), if a particular purpose is made known so as to show reliance on the seller's skill and judgement, there is an implied term that goods supplied under the contract are reasonably fit for that purpose.

If the contract is classified as a mixed contract of goods and services, or one for the supply of goods and services, the Supply of Goods and Services Act 1982 is applicable. Section 4(2) of the Act, as amended in 1994, provides that there is an implied condition that the goods supplied for the contract for the transfer of goods in the course of a business are of satisfactory quality. Sections 4(4) and (5) provide that if a particular purpose is made known to the transferor, and the transferee rely, or it is reasonable for the transferee to rely, on the skill or judgement of the transferor, there is an implied condition about quality or fitness for that particular purpose. Section 13 of the 1982 Act provides that there is an implied term that the supplier will carry out service with reasonable care and skill, provided that the supplier is acting in the course of a business.

If the contract is construed as one for the supply of services, the reasonable care and skill standard under Section 13 is applicable.

In the United States, if the contract is classified as one for services, the common law is applicable. A party can refuse to proceed with performance if the breach is material. Substantial performance is performance without a material breach[38]. If the contract is classified as one for sales, U.C.C. Article 2 is applicable. Article 2 provides for an implied warranty that the goods be merchantable under Section 2-314, and an implied warranty that goods be fit for the intended purpose where the seller had a reason to know of any particular purpose for which the goods were required, under Section 2-315.

If the contract is classified as one for mixed goods and services, the courts have to determine which type of law is applicable. In determining the type of law, the majority view asks whether the contract is predominantly or primarily a contract for the sale of goods or the supply of services, and the minority view asks whether the underlying action is brought because of alleged defective goods or because of the quality of service rendered. In the latter view, if the gravamen of the action focuses on goods, then the U.C.C. governs. If the focus is on the quality of the services rendered, then the common law applies[39].

In both jurisdictions, if the contract is classified as one for sale of goods or for the transfer of property in goods[40], a result-oriented term or warranty is attached; if the contract is classified as one for supply of services, there is no result-oriented term or warranty. The supplier of the services owes solely a process-oriented duty of care to perform with reasonable care[41]. Therefore, the main difference of the classification is whether there is a 'guarantee' as to the result of the transaction.

However, the classification is obviously not important if the court finds that an express duty is breached.

2.5 Comparison : England and the United States

In England, there is no difference in the outcome in terms of the issues involving evidence and the limitation period. With respect to implied obligation, English law treats two elements of one contract, the sale of goods and the supply of services, separately in accordance with the different principles of law[42].

However, in the United States, the outcomes of the cases are different in terms of the issues involving evidence, limitation period, and implied obligations. With respect to the issues of the implied obligations, the majority of the cases treat an entire contract as one object, consisting of either a transaction entirely in goods or one entirely involving services[43].

3. Uncertain Nature of the Criteria in Classification

Examples of actions by suppliers to recover payment for the work done in cases where customers refuse to accept.

3.1 General Factors Considered in Classification

Of the contracts involving computer programs, many can be classified either as contracts for the sale of goods or as contracts for the supply of services. The courts consider different factors before determining classification. The main factors are: the nature of the subject matter created, the process of performance, and the methods of distribution.

Before discussing the cases regarding defects in computer programs, I intend to enumerate the basic reasoning for classification in earlier and relatively uncomplicated English cases. This is to examine whether there has been a definite and clear standard in determination, whether the same factors are used in determining the classification in relation to transactions involving computer programs, and whether the factors should be reconsidered in the light of the development of computer technology. Another important question to be asked, subsequent to the discussion of the cases regarding defects in computer programs, is whether the basic categories of contract law, the sale of goods, the supply of services and information, are still valid as applicable to information in electronic form.

3.2 Delivery of a Chattel

In Lee v. Griffin[44], in determining that the contract to make artificial teeth was a contract for the sale of goods, Crompton, J. stated that 'The distinction between these two causes of action is sometimes very fine; but where the contract is for a chattel to be made and delivered, it clearly is a contract for the sale of goods. There are some cases in which the supply of the materials is ancillary to the contract, as in the case of a printer supplying the paper on which a book is printed'[45]. However, in some service contracts, for instance, a contract to paint a portrait, a chattel is to be made and delivered. Furthermore, the court did not clarify as to when the supply of the materials is ancillary to the contract.

In England, if the contract is construed as one for sale of goods and the defence was the Statute of frauds, the recovery of compensation for labour done and materials provided was not possible. On the other hand, if the contract was construed as a contract for skill and labour, the statute of frauds did not apply, so the recovery of compensation for the work done was possible. For instance, the recovery for the full amount of the agreed fee minus expenditure saved may be available to the plaintiff-supplier[46].

3.3 Substance of the Contract

In Robinson v. Graves[47], determining that the contract to paint a portrait was a contract for work and labour, Greer L.J. stated that 'If you find, as they did in Lee v. Griffin, that the substance of the contract was the production of something to be sold by the dentist to the dentist's customer, then that is a sale of goods. But if the substance of the contract, on the other hand, is that skill and labour have to be exercised for the production of the article and it is only ancillary to that there will pass from the artist to his client or customer some materials in addition to the skill involved in the production of the portrait, that does not make any difference to the result, because the substance of the contract is the skill and experience of the artist in producing the picture'[48].

The court could not use the reasoning based on the fact that 'the contract is for a chattel to be made and delivered' [49] used in Lee v. Griffin, as the painting of a portrait was to be delivered, and it also had difficulty in clarifying the 'substance' of the contract and the standard to differentiate the contracts.

In J.Marcel Ltd. v. Tapper[50], the court found that even though skill, labour and materials were required to make the fur coat, the transaction involving specifically ordered materials was still the sale of goods. In the absence of a memorandum, the transaction was not enforceable for lack of writing.

3.4 Analysis of the Different Approach and the Statute of Fraud Defence

The court seemed to have difficulties in clearly articulating what the standard is, and neither the 'chattel to be made and to be delivered' argument nor 'substance of the contract' seems to provide clear guidance when applied to cases other than those with a relatively simple subject matter. As regards sale of goods, the requirement of a written memorandum ('the statute of frauds defence') was repealed in 1954. There was thus no longer a need to classify for this purpose in England. The situation is different in the United States[51].

3.5 Different Factors of Consideration and Contracts Relating to Information in Electronic Form

There are different factors considered significant in determination of classification. The most traditional and obvious factor concerns the nature of the subject matter created; whether it is an artistic or functional object or whether it is tangible or intangible. The second factor concerns the process of performance. The third concerns the methods of distribution.

In the first factor, the court considered whether the chattel was to be made and to be delivered. With regard to this factor, if a subject matter is considered an artistic object, such as a sculpture, it may be difficult to question the performance standard in reference to the final result. Therefore, it may be more suitable to judge the standard of the performance by reference to the process in which the work was performed. If a subject matter is considered a functional object, such as a washing machine, it is more suitable to judge the standard of the performance by reference to the result of the performance. In a contract to clean a house or to play a musical instrument, there is no tangible result, therefore, it may be more suitable to judge the standard of performance by reference to the process in which the work was performed. However, the criteria in determining the performance standard under the contract to clean and the contract to play a musical instrument are quite different.

In the second factor, the courts may consider whether the process of performance involves the special skill of the supplier, continuing reference to the customer's needs or whether no other contact is required. When considering this factor, it may not be possible to judge the standard of performance by reference to one part of the performance rather than the whole.

In the third factor, the courts may consider whether the method of distribution is mass delivered or uniquely delivered. Most of the mass-delivered subject matters are supplied with standardised terms of the contracts, and there is no opportunity for the users to negotiate the terms.

However, no one factor is definitive. A commissioned portrait can also be mass distributed. An intangible artistic music performance may be mass distributed in the form of a cassette tape due to the development of recording technology. Musical performance may also be uniquely distributed in the form of a cassette tape to a client who commissioned the music from the composer. There might not be so much difference between the portrait and the made-to-order fur coat in terms of the process of performance and in terms of the methods of distribution.

This means that classification may become arbitrary in unprecedented cases. Therefore, the courts may be able to draw conclusions which seem most appropriate to serve justice, based on the facts of the cases.

In a transaction involving computer technology, a tangible or intangible thing, hardware, software, or a combination of both may be delivered. Subject matters can be mass delivered or uniquely delivered from beginning to end of the transactions, with or without a maintenance or support service. Considerable knowledge or skill may be involved in the whole transaction. Software itself is intangible, but it can perform visible tasks.

Therefore, these transactions may contain all the elements of the manufacturing of artificial teeth, the painting of a portrait or the cleaning of houses, especially in cases of the supply of customised computer systems. This is part of the reason why classification may be difficult in some cases.

4. Nature of Licensing Agreements -Relationship With Intellectual Property

Transactions involving computer technology often, though not necessarily, involve the transfer of intellectual property rights. Transactions regarding computer programs and other digitised information ordinarily take the form of licensing agreements. However, discussion as to whether the software is a good and whether the software is protected by intellectual property should be separated when considering a liability issue alone, as this fact does not weaken the responsibility of the licensor of the intellectual property. The fact that the intellectual property law protects certain software is relevant only in relation to determining the enforceability of the licence clauses restricting the use of intellectual property rights and other rights, including the right to transfer the intellectual property rights regarding the subject matter[52]. In any case, the end user of the subject matter should be allowed to utilise the subject matter permitted under the principles of intellectual property law, irrespective of the intention of the licensor[53].

There are possibly two contracts to which end-users may be a party in the transaction involving information in electronic form. One is between the end-user and the immediate supplier and the other is between the end-user and the proprietor of the information. In order to understand the complex nature of such transactions, it is useful to distinguish the 'supply' side of the transaction from the 'licence' side.

The immediate supplier is mainly involved with the supply element of the transaction involving computer technology. The immediate supplier may supply the black box 'package' to the user; however, the immediate supplier may not have any control over the terms of the licensing agreements attached to the 'package'[ 54].

The proprietor of the intellectual property has control over the terms of the licensing agreement both in terms of the supply and the licence elements. This 'licence' element of the transaction is concerned with the use or transfer restrictions of the intellectual property. The 'supply' element is concerned with the performance of the subject matter in general[55].

Liability issues are concerned with the 'supply' element of the transaction, in which both the immediate supplier and the proprietor are concerned[56]. Therefore, the fact that intellectual property is involved should not be used to weaken the responsibility for defects in transactions.

5. Cases in England

5.1 Effect of Classification - Samuels v. Davis[57]

Samuels v. Davis is helpful in considering the effect of classification in England prior to the consideration of actual computer program cases. Scott L.J stated that 'it is a matter of legal indifference whether the contract was one for the sale of goods or one of service to do work and supply materials'[58] The plaintiff was a dental surgeon, who sued to recover the price of making a denture for the defendant's wife. The defendant claimed that the denture was so unsatisfactory that his wife was unable to use it. The defendant also claimed that the contract was for the sale of goods or alternatively for work done and materials supplied. In either case, there was an implied condition that the denture was reasonably fit for the purpose. The court agreed with this assertion. The court stated that, by reason of the relationship between the parties, and the purpose for which the contract was entered into, the contract must import terms that the dentist would achieve reasonable success in the work done, provided that there was reasonable co-operation from the patient.

Even if the contract was not for goods, the court seemed to have imposed the duty to create a result- oriented outcome by reason of the specific relationship between the parties. In this case, the dentist was 'contracting to make a denture which will fit the patient's mouth' and 'he is bound to take reasonable care and to show such skill as may be expected from a qualified practitioner'. If the supplier has the special skill and such skill was expected from the supplier, the imposition of the duty to attain a result-oriented outcome is possible. This position does not seem to have been changed in some of the more recent cases.

The same can be said regarding the materials provided for repair work done to a car in G.H. Myers & Co. v. Brent Cross Service Co.[59], Du Parcq J. stated that 'a person contracting to do work and supply materials warrants that the materials which he uses will be of good quality and reasonably fit for the purpose for which he is using them, unless the circumstances of the contract are such as to exclude any such warranty'[60]. The same principle can be applicable in transactions involving the repair and the maintenance of computer programs.

5.2 Classification and Application of Statute

In Saphena Computing Ltd. v. Allied Collection Agencies Ltd.[61], the court stated that the law governing these contracts regarding software was precisely the same whether they were contracts for the sale of goods or for supply of services. This statement should have been made on the presumption that the software itself is a good. Both the Sale of Goods Act 1979 and the Supply of Goods and Services Act 1982 impose the same implied obligations for goods.

In this case, a plaintiff entered into a contract for the supply of certain hardware and software for use in the defendant's business of debt-collection. The plaintiff supplied and installed software for batch operation and on-line software, but both sets of software had defects. The software for batch operation was corrected and the on-line software was in the process of getting repaired. Before the repair, the contract was terminated by mutual consent after the instalment of on-line software. The plaintiff sued the defendant for breach of contract and copyright infringement. The plaintiff claimed that the defendant had not paid for the on-line software and had retained and used copies of the software's source code to enhance the software provided. The defendant counterclaimed for damages for breach of implied terms that the software be reasonably fit for its purpose. The recorder found that there was an implied term as to the fitness of the software for the purposes for which it was required. Software had to be 'reasonably fit for such purposes as had been notified to the suppliers before the orders were placed or were notified subsequently and accepted by suppliers.' The recorder also found that this obligation had not been fulfilled by the suppliers when the parties agreed to end their relationship. However, as 'software is not a commodity which is delivered once, only once and for all, but one which will necessarily be accompanied by a degree of testing and modification,' when the purchaser decided to terminate the contract, the reasonable time in which the suppliers should have the right to test and modify the software supplied had not expired. Therefore, the plaintiffs were not liable on the counterclaim for the cost of repairing defects[62]. The court denied the defendant's counterclaim for damages for breach of an implied term that the software would be reasonably fit for its purpose because both parties terminated the agreement by mutual consent. Therefore, the main issue of this case was on interpretation of the bargain rather than an interpretation of implied terms.

Likewise in St. Albans City and District Council v. International Computers Ltd.[63], the classification did not seem to matter. The court stated that the same principle of law for transfer of goods with respect to implication of terms as to quality or fitness for purpose should be applicable to contracts for supply of services in relation to computer programs. The court held that in the absence of any express term as to quality or fitness for purpose, or any term to the contrary, a contract for the transfer into a computer of a program intended by both parties to instruct or enable the computer to achieve specified functions is subject to an implied term that the program will be reasonably fit for, ie reasonably capable of achieving, the intended purpose. It can be said in this case as well, by reason of the relationship between the parties, and the purpose for which the contract was entered into, the contract must import terms that the computer programmer would achieve reasonable success in the work done, provided there was a reasonable co-operation by the user.

As computer programs are ordinarily supplied to achieve certain functions, any transactions involving computer programs may become subjected to an implied term that the program will be reasonably fit for its intended purpose in England.

The court seemed to consider that computer programmers, like dentists, are expected to exercise expertise and special skills to achieve specified functions, if they represented themselves capable of achieving such a result-oriented outcome and their expertise was relied upon. The consequence of this statement made by Sir Iain Glidewell has the effect of construing a computer program as a good, thereby adopting the performance standard applicable to goods under the Sales of Goods Act 1979, as amended in 1994 and in the Supply of Goods and Services Act 1982, as amended in 1994.

5.3 Obligation Specific to Contracts Involving Computer Programs

Both in St. Albans City and District Council v. International Computers Ltd.[64],and in Saphena Computing Ltd. v. Allied Collection Agencies Ltd.[65], a contract for the transfer of software to achieve a specific, known purpose was subject to an implied term that the program will be reasonably fit for the intended purpose. As stated in Samuels v. Davis[66], by reason of the relationship between the parties, and the purpose for which the contract was entered into, the contract must import terms that the supplier would achieve reasonable 'success' in the work done.

However, it is also stated in Saphena Computing Ltd. v. Allied Collection Agencies Ltd.[67], that mere delivery of customised software does not constitute a complete performance, and that the suppliers are allowed the time to make any necessary modification. In this case, the supply first started in September 1985 and by 11 February 1986, the reasonable time had not expired.

In transactions involving computer technology, performance may be judged by reference to the outcome of work done; however, continuous performance for a reasonable time may be needed to complete the performance.

5.4 Physical Medium and Intangibles

In St. Albans City and District Council v. International Computers Ltd.[68], Sir Iain Glidewell stated that the contract was not a sale of goods because the transfer of a disk or any other tangible thing was not involved. It is not acceptable to use the tangibility of the subject matter as the sole criterion to determine which law is applicable to a particular transaction, because there are many ways in which a transaction could be executed in the light of current technology[69].

There may be two elements physically involved in the transaction involving computer programs, one is the physical medium or hardware and the other is the software or intangible code. However, this distinction is not useful as transactions to transfer software do not require any physical medium. Furthermore, the same function of computer programs can be achieved either by the hardware or the software. As the computer programmers or manufacturer may distribute the software on the internet, there may be only one contract between the proprietor and the customer.

As stated in the Australian case of Toby Constructions Products Ltd. v. Computer Bar Sales Pty Ltd[70]:

It would be too simplistic altogether to say that the supply of the system was a sale of goods merely because the bulk of the cost related to the hardware. Rather I think it is necessary to look at all the features of the object of the sale and the various ingredients such as price, the nature of the material which was to be supplied, the terms of installation, and the work which the system was designed to effect.

The court suggested that mass production was a relevant criterion in determining whether there was a sale of goods[71]. The court determined that the sale of a computer system, comprising both hardware and software, constituted a sale of goods[72].

The English case of Eurodynamics Systems Plc v. General Automation Ltd.[73], seems to have the same approach as Toby in the sense that it focused on the 'reality of the transaction':

Although the ideas and concepts involved in software remained [the defendant's] property, the reality of the transaction is that there has been a transfer of product[74].

Lord Penrose in the Scottish case of Beta Computers (Europe) Ltd. v. Adobe Systems (Europe )Ltd.[75], stated that the supply of proprietary software for a price is a contract sui generis which may involve elements of nominate contracts such as sale, but would be inadequately understood if expressed wholly in terms of any of the nominate contracts. He also stated that it is unattractive to consider that software contracts involve two distinct contracts, one for supply of the storage devices containing the software and a second for licensing the use to which these could be put, as such an idea emphasises the role of the physical medium, and relates the transaction in the medium to the sale or hire of goods. In this case, the defendants tried to return the shrink-wrap package unopened and the plaintiff argued that the contract was made prior to the point in time at which the conditions were presented to the defenders on delivery of the product they ordered. The court determined that the supplier tendered goods with an offer to complete the bargain in terms of the conditions derived from the author and the defendants were entitled to reject the software.

As discussed above, it may be helpful to think that there are two elements involved in transactions involving computer technology. However, this idea does not necessarily emphasise the role of the physical medium, as these two elements are not the supply of storage devices and licence. The two elements are the 'supply' element and the 'licence' element of computer technology, where the former element is concerned with the performance of the subject matter including express or implied terms, and the latter element is concerned with the grant and the restriction to use the proprietary right.

The owners of the intellectual property and the immediate suppliers are both involved in the 'supply' element of the transaction, and the 'licence' element of the transaction does not weaken the obligations in relation to the 'supply' element.

5.5 Breach of Express Duties (Obligations) Cases

As mentioned above, the classification does not matter if express duties are breached. In Eurodynamics Systems Plc. v. General Automation Ltd.[76], the court determined that it was not critical to decide whether software was a good, as the breach of implied terms of merchantability and fitness for purpose alleged had not been established. Instead, the court found that the express obligation of the supplier was breached. Eurodynamics Systems Plc. (ED) sued General Automation (GA), for damages for material misrepresentations or, alternatively, breach of contract. ED designed and developed bespoke computer application software for small to medium mainframe computers. ED specialised in business/technical and accounting software and wanted to expand its business and to sell both its own software and the computers on which the software was designed to operate. In order to accomplish this purpose, ED became a franchisee of GA with a view to purchasing computers and associated programmes.

The express provisions of the franchise agreement imposed an obligation on GA to support COBOL software. After the agreement, GA started both to refuse to meet the extant technical complaints and to provide future support for COBOL-based software to ED. The court found that GA was in breach of express terms and awarded the sum of £94,500 based on the estimate that, during the relevant period, ED would have succeeded in making at least seven turnkey systems and seven application packages.

5.6 Professional Liability

In Stephenson Blake (Holdings) Ltd. v. Streets Heaver Ltd.[77], the court held that the defendant, who was in the business of providing specialised computerised information systems and a business planning consultancy, was under a contractual duty to exercise skill and care in supplying the software and hardware regarding the acquisition of a computerised accounting system. The court imposed professional liability as the plaintiff, having no knowledge of computer technology, relied on the defendant's expertise and advice. It stated that 'once advice on the subject had been given and accepted.... it would be part of the duty of the defendant to use due care and skill to ensure that the system which they recommended conformed to it.'

This obligation may not be as strong as in St. Albans City and District Council v. International Computers Ltd.[78], and in Saphena Computing Ltd. v. Allied Collection Agencies Ltd.[79], where an implied term for the intended purpose was imposed. However, in this case, the effect of classification becomes less obvious.

5.7 Classification and Implied Terms and Express Terms

In England, uncertainty as to the criteria in classification of the contract does not seem to hinder the solution of problems involved in transactions for computer programs, since it does not matter whether the contract is for the sale of goods or for service. The common law tradition and the statutes support this. Cases in England seem to consider that computer programs are intended to perform specific tasks; the suppliers are offering expertise in computer technology and consumers are relying on such expertise. In many transactions involving the supply of computer systems which are customised to the client's needs, there is an understanding held by both parties that computer programmers are supplying programs with special skills and knowledge for a special business purpose, and that clients are relying on such skills and knowledge. The courts seem to uphold parties' intentions for the purpose of such contracts.

The authorities do not have much difficulty in incorporating a result-oriented term in the transaction to the effect that computer programs will be reasonably fit for the purpose presented regardless of classification. This approach in England, as stated in Samuels v. Davis[80], emphasises 'the reason of relationship between the parties and the purpose for which the contract was entered into' in incorporating the term in the contract.

With respect to express terms, courts are able to hold suppliers responsible for express representations, regardless of the classification, and the application of the Unfair Contract Terms Act 1977 ensures this.

In Stephenson Blake (Holdings) Ltd. v. Streets Heaver Ltd.[81], the proposition that it was the duty of the defendant to use due care and skill to ensure that the system, which they recommended, would conform to the intended purpose was upheld. As the court considers that imposition of such a higher standard of care for computer programmers is appropriate, the duty to supply with reasonable care tends to be elevated into the duty to supply the subject matter which actually works properly in accordance with the customer's needs[82]. Therefore, in these cases, the effect of classification becomes less obvious.

6. The Cases in the United States

6.1 Different Tests for Classification

As many of the contracts involving computer programs are mixed contracts for services and goods, which involve the exercise of personal skills and labour and the supply of materials or equipment[83], there are mainly two tests in distinguishing contracts for services and goods. One is the predominant purpose test and the other is the gravamen of the action test. The predominant purpose test treats an entire contract as one object, consisting of either a transaction entirely in goods or one entirely involving services[84].

In Milau Associates v. North Avenue Development Corp.[85], the court stated that it is not possible conceptually to sever the sale of goods aspects of the transaction when the transaction is for the predominant purpose of rendering services. Unless the parties have contractually bound themselves to a higher standard of performance, then reasonable care and competence owed generally by practitioners in the particular trade or profession defines the limits of an injured party's justifiable demands[86].

The predominant purpose test is often said to misapply goods-related rules to the service elements of a mixed contract. The gravamen of the action test applies different rules for different parts of the same relationship, and therefore is said to create uncertainty in the law applicable to the transaction[87]. However, as suggested by Hawkland, the gravamen of the action approach is useful in dealing with mixed contracts involving goods and services, for example, in Worrell v. Barnes[88], 'if the gas escaped because of a defective fitting or connector, the case might be characterized as one involving the sale of goods. On the other hand, if the gas escaped because of poor work by Barnes the case might be characterized as one involving services, outside the scope of the UCC'[89]. There is no reason why less obligation is imposed in relation to goods just because the transaction involves both goods and services[90].

If the gravamen of the action approach is applied consistently the same way as in England, there may not be a problem of uncertainty involved in the application.

6.2 Predominant Test, Contract for the Sale of Goods

6.2.1 Turn-Key Computer System

Neilson Business. Equipment Center Inc. v. Monteleone[91] seems to reinforce the preconceived assumption regarding the effect of classification. The defendant, Neilson Business Equipment Center, Inc. (Neilson) agreed to customise the computer system to meet the plaintiff's, Dr. Monteleone's needs. In addition to the lease, the parties had a separate maintenance agreement. The plaintiff chose to lease the equipment in order to obtain a favourable cash flow and tax benefits. The lease agreement for 'turn-key' hardware and software equipment was considered the sale of goods. The court applied a 'predominant' test in determining this.

When a mixed contract is presented, it is necessary for a court to review the factual circumstances surrounding the negotiation, formation and contemplated performance of the contract to determine whether the contract is predominantly or primarily a contract for the sale of goods... Neilson contracted to supply a turn-key computer system; that is, a system sold as a package which is ready to function immediately. The hardware and software elements are combined into a single unit - the computer system - prior to sale[92].

The court seems to have made the determination based on the fact that the hardware and software elements are combined into a single unit, as a 'computer system'. Any consulting services rendered by Neilson were considered ancillary to the contracts.

As the transaction was considered a sale of goods, there was an implied warranty of merchantability and an implied warranty of fitness for a particular purpose. In order for the computer system to be merchantable, the system must have been capable of passing without objection in the trade under the contract description, and be fit for the ordinary purpose for which it was intended. The supplied computer system failed regarding merchantability because it did not meet the plaintiff's expressed record and bookkeeping needs. The court found that the plaintiff, having no prior experience in acquiring computer technology, relied on Neilson's professional expertise to develop and deliver a satisfactory computer system for the plaintiff's specific needs.

One of the important factors in determining the liability of the supplier was that the defendant was an expert in computer technology and should have performed satisfactorily with their skills and knowledge. Therefore, even if the contract were construed as one for services, the court may have imposed the liability, based on the fact that the supplier, the expert in computer technology, did not perform with reasonable skill. In cases where the court finds that the suppliers are considered 'an expert' in the field and such expertise is relied on by the customers, the court may impose liability based on the notion that the suppliers should be held to a higher standard of care. In such cases, it is likely that the 'performance standard' of the result-oriented outcome of the performance and the process-oriented outcome of the performance would be closer than in cases where the court does not find such expertise.

The measure of damages for breach of warranty in this case was the difference at the time and place of acceptance between the value of goods accepted and the value they would have had if they had been as warranted, unless special circumstances showed proximate damages of a different amount. The plaintiff was awarded all lease payments, plus the value of the maintenance contract with interest, calculated by taking into consideration the fact that the payment of the lease became due gradually.

Although, instalment of turn-key systems requires a substantial amount of time for analysis, feedback and correct instalment, as the final product is supposed to be in immediate operation[93], it can be said that the purpose of contemplating such a transaction is on the 'completeness' of the final product. Delivery of a 'turn-key' system is more likely to involve the transfer of both software and hardware than merely software alone, as the users would be likely to implement new powerful hardware to process as much information as possible, as more speedy and powerful hardware is continuously developed and distributed in the market. The users would probably expect to use both old and new systems at the beginning to ensure that the new systems function properly. The sale of goods standard was applied to such a system to ensure a satisfactory result. This type of transaction may also be an indication of the gap in knowledge between the supplier with his or her skill and knowledge, and the ignorance of an unsophisticated user[94]. In these cases, the suppliers had reason to know their recommendations were to be relied on and the users were justified in relying on the recommendation of the suppliers.

6.2.2 Customised (Bespoke) Software

In RRX Industries, Inc. v. Lab-Con, Inc.[95], the Ninth Circuit court determined that an agreement to supply a software system for use in its medical laboratories and to correct any malfunctions or 'bugs' that arose in the system was considered a contract for goods. The court applied a 'predominant' test and found that the sales aspect of the transaction predominated, and that employee training, repair services, and system upgrading were incidental to the sale of the software package and did not defeat characterisation of the system as goods. The software system supplied turned out to be unreliable and defects continued to exist after some attempts to repair bugs. The court found that 'the defendants were either unwilling or unable to provide a system that worked as presented, or fix the 'bugs' in the software.' The court awarded consequential damages as the default of the seller was so total and fundamental that damages limitation was expunged from the contract. In this case, the court could not consider whether hardware was transferred or not, in order to find there was a transaction involving goods, as no hardware was involved, the defendant solely installing the software system.

It seems acceptable to hold that a transaction for software alone is the sale of goods as in the cases of hardware, even if the transaction involves substantial service elements and a considerable amount of time to customise software for specific business purposes. It might be reasonable for the user to expect a result-oriented outcome, for instance, in terms of implied warranties, in transactions involving customised computer programs, as the purpose of the transaction is to supply a workable system, especially in cases of a 'turn-key' system.

6.3 Predominant Purpose Test, Supply of Services

In the United States, a contract for the supply of services generally requires 'substantial performance.' The test for substantial performance is whether the performance meets the essential purpose of the contract[96].

In Data Processing Services, Inc. v. L.H. Smith Oil Corporation[97], an agreement to develop computer software and to develop and implement a data processing system to meet specific needs for an accounting system was considered a contract for services. Even though the determination was made that the contract was for the supply of services, the recognition of the programmer's expertise imposed the higher duties of care of professionals on the supplier of the computer programs.

Data Processing Services, Inc. (DPS) was in the business of computer programming and L.H. Smith Oil Corporation (Smith) sold petroleum products. Smith stopped payment after paying several billings submitted by DPS and the defendant sued for breach of contract and open account. In determining the classification, the court stated that:

'...DPS sold no 'hardware' to Smith. Instead, DPS was retained to design, develop and implement an electronic data processing system to meet Smith's specific needs, ...Smith bargained for DPS's skill in developing a system to meet its specific needs. Although the end result was to be preserved by means of some physical manifestation such as magnetic tape, floppy or hard disks, etc., which would generate the recordkeeping computer functions DPS was to develop, it was DPS's knowledge, skill, and ability for which Smith bargained. The sale of computer hardware or generally-available standardized software was not here involved. ...The mere means by which DPS's skills and knowledge were to be transmitted to Smith's computers was incidental. The situation here is more analogous to a client seeking a lawyer's advice or a patient seeking medical treatment for a particular ailment than it is to a customer buying seed corn, soap, or cam shafts. While a tangible end product, such as floppy disks, hard disks, punch cards or magnetic tape used as a storage medium for the program may be involved incidentally in this transaction, it is the skill and knowledge of the programmer which is being purchased in the main, not the devices by which this skill and knowledge is placed into the buyer's computer. The means of transmission is not the essence of the agreement'[98].

The court also commented on the expertise of the computer programmers:

'Those who hold themselves out to the world as possessing skill and qualifications in their respective trades or professions impliedly represent they possess the skill and will exhibit the diligence ordinarily possessed by well informed members of the trade or profession'[99].

As DPS represented themselves to have the necessary expertise to do the work and knew it lacked the skill and expertise, the situation was considered analogous to a client seeking a lawyer's advice. DPS should have foreseen the loss to be incurred by Smith. The court found that DPS breached its implied promise of having the reasonable skill and ability to do the job for which it had contracted. Here, represented skill and expertise is the essential factor in holding the suppliers for having the reasonable skill and ability to do the job. As the transaction was deemed one for the supply of services, no result-oriented warranties were imposed. Nevertheless, this case shows that the professional skills of the computer programmers and the reliance by their customers are the factors which blur the boundary between the classifications of the contract.

As the courts impose such a higher standard of care for computer programmers, the duty to supply with reasonable care tends to be elevated into the duty to supply subject matter which actually works properly in accordance with the customer's needs. Therefore, in such cases, the effect of classification becomes less obvious.

The court calculated the sum Smith paid to DPS for services in the development of a system, additional employee time involved due to the failure of DPS's program to perform, and the cost of hiring of at least one additional employee. The court found that the amount of judgement rendered here was within the parameters of the evidence presented to the trial court. Although the trial court's conclusion that the transaction for goods to which Article 2 of the UCC applied was clearly erroneous, reversal was not necessary, as the findings of fact were sufficient to support the judgement on common law principles.

The court correctly stated that 'the means of transmission is not the essence of the agreement'. In addition, the court did not find that the reversal of the trial court's decision, which found that the transaction was for goods, was unnecessary. This clearly indicates that the imposition of the higher standard of care for computer programmers is the factor that blurs the boundary between transaction for goods and services.

However, the court also stated that DPS sold no hardware to Smith and the sale of computer hardware or generally available standardised software was not involved. Technically speaking, hardware can incorporate skills and knowledge, although it is relatively easier to incorporate a required specification to meet the client's needs into software[100]. The mere fact that the hardware was included as a part of the transaction should not transform a transaction into one for sale of goods. As stated above, many cases involving customised software are considered sale of goods. However, it is more reasonable to think that the development side of the transaction should be considered, as in England, a contract for the supply of services and be treated accordingly.

In contrast, Micro-Managers, Inc. v. Gregory[101], seems to have reached a different result. The contract to develop a new programmable controller to replace the existing equipment, where payment was to be made based on the time spent at stated rates, was deemed a contract for the supply of services. The user claimed that the software was virtually useless, that the user received no benefit from it, that the contract was not substantially performed, and that the software developed did not substantially meet or conform to the specifications mutually agreed upon. The court determined this argument to go to the quality of the work product, and not to whether the supplier used its expertise and skill to develop the software. Such an inquiry would be relevant if this were a contract for goods under the U.C.C. but, since it was not, no such inquiry was required. The court found that the supplier substantially performed its contract by using its expertise and skill.

However, the main purpose of contracts to transfer computer technology is primarily a functional one. Contracts to develop and design computer programs to assist business operations, are fundamentally different from contracts to hire an artist to paint a portrait. Therefore, as discussed above, it may not be possible completely to separate the process by which the work is done from the outcome of the work in the case of contracts to transfer computer technology. As this case shows, the 'predominant purpose' test may create harsh results for the users, by emphasising solely the labour part of the bargain. In this case, the software might have been useless even though expertise and skill were exercised. The English approach, to impose satisfactory quality, may be preferred to avoid such consequences.

6.4 Gravamen of the Action Test, Contract for the Supply of Services

In Herbert Friedman & Associates, Inc., v. Lifetime Doors, Inc.[102], in determining whether the UCC applies to a mixed goods-services contract, the court applied the gravamen of the action test[103], as the Michigan court, unlike the majority of courts, has not expressly adopted a predominant purpose test.

Herbert Friedman & Associates, Inc. (Friedman), a designer and installer of computer software systems, had an agreement with Lifetime Doors, Inc. (Lifetime) to deliver 'packages' of software as it completed the required modifications, and Lifetime to make periodic payments. Friedman sued Lifetime after Lifetime terminated the agreement before Friedman had finished installing a computer software system at Lifetime.

The court looked at whether the contract contained a single price which covered both the installation and sale of goods, and whether the claim was based 'entirely on deficiencies in the rendition of services for which the contract contained a separate price, rather than on a defect in the goods themselves.' As explained in In re Trailer & Plumbing Supplies[104], this test simply asks whether the underlying action is brought because of alleged defective goods or because of the quality of the service rendered. If the gravamen of the action focuses on goods, then the U.C.C. governs. If the focus is on the quality of the services rendered, then the common law applies[105]. The court found that the fixed cost of the contract was $250,000 for the software including the custom modifications and there was an estimated per diem charge of $550 for consulting. Friedman's damages were primarily claimed for failure to pay for the software it delivered rather than for the consulting services it rendered. In these circumstances, the Michigan court applied the U.C.C. to this transaction.

In this test, if the action were based on the way the service was rendered, the court would have applied the law pertaining to the supply of services. However, as in this case, not all the transactions can be separated. If the plaintiff's claim was based on both defective goods and quality of service rendered, it is not clear whether the court may select both laws in relation to the contract. If the court was to consider both laws on defective goods and quality of the service, the approach is similar to the one in England.

The court found that Lifetime was justified in cancelling further performance because Friedman did not perform its contract obligations within a reasonable time. However, Lifetime had to pay for the software it had accepted. The court found that the accepted package was not substantially impaired because the entire package of software had not been installed. The court found that Lifetime's complaints were partly based on the misconception about what the software could achieve and that these were not communicated sufficiently to Friedman. Even though the software was supposed to be customised to the client's needs, what Friedman meant by 'custom' was not a complete fabrication from scratch, but rather an adaptation of the defendant's software to meet a customer's needs within the parameters of the defendant's software's basic structure. Therefore, the software here was considered standardised rather than customised. Lifetime was ordered to pay at the contract rate for goods accepted, $35,000 for the payroll package, $35,000 for the accounts payable package and $15,000 for the general ledger package. The court seemed to have examined the brochures very carefully; however, the effect of advertisement should be considered more carefully in light of the relative knowledge of the customer. For instance, definition and usage of the word 'customised' should be considered sensitively so that customers with no prior experience would not be misled.

As stated above, this test seems to give a flexible approach to the complex nature of the transactions involving computer technology. However, not many authorities have adopted this test. The test is criticised for creating uncertainties as to which law is applicable to the transaction[106]. English law, which adopts the same type of criteria, seems to offer clear and comprehensive ways for separating the supply of goods and services elements in this respect.

6.5 Factors Considered in the Classification

6.5.1 Important Factors

The factors relevant in determining the classification are mainly categorised as follows: physical configuration of the subject matter, the method of distribution, the process of performance, and the remuneration. They are basically the same factors as discussed above in earlier cases.

6.5.2 Physical Configuration

In Advent Sys. Ltd. v. Unisys Corp.[107], the court stated that computer programs are the products of an intellectual property but, once implanted in a medium, the program is tangible, moveable, available in the market place and widely distributed to computer owners. However, this analysis is weak, since programs do not need to be implanted in a medium to be distributed. Nevertheless, the characteristics of computer programs available in the market place and widely distributed to computer owners may be a relevant factor in terms of the method of distribution. §2-102[108] provides that transactions subject to the Code be 'in goods.' 'Goods' are defined in §2-105(1)[109] as 'all things which are movable at the time of identification to the contract for sale other than the money in which the price is to be paid, investment securities and things in action.' This definition is a broad one, and the focus of the definition of goods is whether the thing is movable or not[110].

In many cases, the courts seem to be making determinations by considering factors other than physical tangibility. In Neilson Business Equipment Center Inc. v. Monteleone[111], and in USM Corporation v. Arthur D. Little Systems, Inc.[112], a turn-key computer system, sold as a package ready to function immediately and in which the hardware and software elements were combined into a single unit[113], was considered a good. However, as stated above, it may also be possible to argue that the emphasis was on 'ready to function immediately' for unskilled users, rather than on the physical configurations.

In Wharton Management Group v. Sigma Consultants Inc.[114], the court found that Sigma had not sold 'hardware,' but also stated that Sigma was retained after preparing a study of Wharton's existing operations, to design, develop, and install computer software which would meet Wharton's specific needs and objectives. It was Sigma's knowledge, skill and ability for which Wharton bargained, therefore, the contract was for the services rendered.

Consideration of the physical elements, namely transfer of hardware, has often been used as an important factor to distinguish between contracts for goods and services. However, as discussed above, this 'traditional factor' does not seem to provide a fully valid justification in deciding the reasoning for the classification. Technically speaking, as discussed above, the hardware can incorporate as much skill and ability as the software, although it is more usual to modify or alter software rather than hardware to satisfy the customer's specific needs. Therefore, the court should not consider computer programs in the same way they consider other tangible materials. Furthermore, there are other factors which can be more persuasive in determining the classification.

6.5.3 Process of Performance

In determining that the contract was for the supply of services, in Wharton Management Group v. Sigma Consultants Inc.[115], the court found that Sigma was retained after preparing a study of Wharton's existing operations, to design, develop, and install computer software which would meet Wharton's specific needs and objectives and it was Sigma's knowledge, skill and ability for which Wharton bargained.

However, both in Neilson Business Equipment Center Inc. v. Monteleone[116], and in USM Corporation v. Arthur D. Little Systems, Inc.[117], cases regarding the turn-key computer system, the contracts were deemed the sale of goods, despite the fact that these transactions involved analysis of the present system and custom-designing of the new turn-key computer systems. In the turn-key computer system cases, the emphasis might be on the final subject matter to be delivered. In addition, the gap between the knowledge of the supplier and user may have also been a contributing factor. Likewise, many years of data processing servicing, and the development and the customisation of the software was considered merely as a support to an 'Insurance Machine' in accommodating the business practice of the plaintiff consisting of a 'computer software product' in Colonial Life Inc. v. Electronic Data Systems[118].

A number of cases seems to consider that transactions involving software can be a sale of goods, regardless of whether or not a substantial service element to customisation is involved[119]. Therefore, the type of service rendered for customisation is not particularly helpful in classification unless the role of the supplier is clearly an advisory one, such as analysis or collection of business data. The courts seem to be making arbitrary decisions as to what is or what is not the predominant element of the transaction. If the contract is deemed one for the supply of services, there is no implied obligation for the outcome of the software or hardware supplied. If the courts impose a higher standard of care for computer programmers, a duty to supply with reasonable care might to be elevated into a duty to supply the subject matter which actually works properly in accordance with the customer's needs. However, there is no reason to distinguish goods supplied with services or without services[120]. The gravamen of the action approach and the English approach may offer solutions to this problem, as the users are just as justified in expecting a certain level of performance in terms of a result-oriented outcome.

6.5.4 Method of Distribution

In Data Processing Services, Inc. v. L.H. Smith Oil Corporation[121], in determining that the transaction was the supply of services, the court stated that the sale of computer hardware or generally available standardised software was not involved. Standardised software is not manufactured for specialised purposes, there is no contact between a user and a supplier and is distributed to the general public.

6.5.5 Remuneration

The cost of labour does not seem to be a determinate factor in determining the predominant factor. The court stated that in Advent Sys. Ltd. v. Unisys Corp.[122] comparison of the relative costs of the materials supplied with the costs of the labour may be helpful but not dispositive. This case dealt with a non-exclusive requirements contract in which the plaintiff agreed to provide the software and hardware, making up a document management system, to be sold by the defendant in the United States. In considering the purpose or essence of the contract, the court found that the main objective was to transfer 'products' and the compensation structure of the agreement focused on goods and, in the contemplation of the parties, the sale of goods predominated.

In Conopco, Inc. v. McCreadie[123], the court considered the way remuneration was paid to the defendant, in addition to examining the nature of the subject matter acquired and other ancillary services rendered. The case dealt with an agreement to provide computer management consulting services to assist the migration of information services from the old system to the new system. The defendants, the partners of Ernst & Young (E & Y), had an agreement with Faberge Inc., which was subsequently assigned to the parent company of Conopco Inc. This agreement was considered a contract for services. The plaintiff sued the defendant alleging breach of contract, professional negligence and malpractice, and breach of the implied warranty of fitness for use under the Uniform Commercial Code in connection with a computer management consulting agreement. The defendant moved for summary judgement on all three counts of the complaint.

In deciding that the contract was for the supply of services, the court first examined whether there was an acquisition of computer hardware. The court found that the defendant did not sell or provide any computer hardware or accessories to the plaintiff. Even if the defendant was involved in the selection and installation of hardware, the defendant's role was considered an advisory one, performed in conjunction with the plaintiff's staff. In addition, the defendant was compensated for each day of employee service it provided; the defendant's remuneration was not tied at all to the provision of goods.

Likewise, in Micro-Managers, Inc. v. Gregory[124], the contract to develop a new programmable controller to replace the existing equipment was deemed a contract for the supply of services. In making the determination, the court considered the fact that the payment was to be made based on the time at stated rates.

If remuneration is paid specifically for labour of services rendered and this is expressly stated in the contract between the parties, there is strong evidence that the contract was for the supply of services.

6.5.6 Comparison with Traditional Subject Matters

Essentially, there are no differences between factors considered for traditional subject matter discussed in and subject matter, involving computer technology. However, the tangibility factor is not useful in transactions involving computer technology. Furthermore, most of the transactions involve skilled suppliers and continuing performance. This makes it even harder to classify using traditional factors. The drafting of the UCITA was necessary to clarify such uncertainties involved in classification.

7. Explanation of the Difference between English Law and United States Law

The difference between English law and United States law in relating to the classification of the contract for sales and services law is based on the fact that English law considers that the obligations of a supplier in relation to the goods supplied should be, as nearly as possible, the same, whatever kind of contract is employed[125]. The Law Commission Report stated that 'It seems reasonably clear that at common law the obligations of the supplier in respect of materials supplied were regarded as the same whether the contract was classified as one of sale or of work and materials, and in either case whether the supplier worked on, or with, the materials or whether he did not'[126].

Lord Upjohn in Young & Marten Ltd. v. McManus Childs Ltd.[127] stated that:

'The distinction between a contract for the sale of goods and a contract for the provision of work and materials is one which depends on the particular nature of each individual contract, as was said as long ago as 1856 in Clay v. Yates[128] and it is frequently a question of fine distinction. It would be most unsatisfactory, illogical, and indeed a severe blow to any idea of a coherent system of common law, if the existence of an implied obligation depended upon such a distinction... Indeed, for my part I think, as a matter of common sense and justice, one who contracts to do work and supply materials ought to be under at least as high, if not a higher, degree of obligation with regard to the goods he supplies and the work he does than a seller who may be a mere middleman or wholesaler'[129].

Therefore, the same principle of law for transfer of goods with respect to implication of terms as to quality or fitness for purpose is applicable to contracts for supply of services in transactions regarding computer programs[130].

Both in St. Albans City and District Council v. International Computers Ltd.[131], and in Saphena Computing Ltd. v. Allied Collection Agencies Limited[132], a contract for the transfer of software to achieve a specific, known purpose was subject to an implied term that the program would be reasonably fit for the intended purpose. As customised software is almost always made to be fit for a specific purpose, any transaction involving customised software may fall within the scope of Section 14(3) of the Sale of Goods Act 1979 and Sections 4(4) and (5) of the Supply of Goods and Services Act 1982. These sections provide that if the special purpose is known to the supplier, there is an implied term that the goods will be fit for the intended purpose.

On the other hand, the predominant purpose test in the United States treats an entire contract as one object, consisting of either a transaction entirely in goods or one entirely involving services[133]. Therefore, if the contract is construed as one for supplying services, the U.C.C. is not applicable, and thus there are no result-oriented implied warranties. As discussed above in Micro-Managers, Inc. v. Gregory[134], the court held that the argument as to the quality of the work product and as to whether the supplier used its expertise and skill to develop the software were completely different in relation to a contract to develop a new programmable controller to replace the existing equipment. However, as in Data Processing Services, Inc. v. L.H. Smith Oil Corporation[135], if the courts impose such a higher standard of care for computer programmers, the duty to supply with reasonable care tends to be elevated into the duty to supply the subject matter which actually works properly in accordance with the customer's needs. Therefore, in such cases, the effect of classification becomes less obvious.

The English approach in adopting the same principle of law for transfer of goods with respect to implication of terms as to quality or fitness to contracts for supply of services and to contracts for goods seems more sensible in considering the functional characteristics of computer programs. Similarly, the approach adopted in St. Albans City and District Council v. International Computers Ltd.[136], that a contract for the transfer into a computer of a program intended by both parties to instruct or enable the computer to achieve specified functions is subject to an implied term that the program will be reasonably fit for the purpose, seems reasonable, in transactions involving computer technology.

8. The Effect of the Enactment of the UCITA - Basic Concepts

The Article 2B project in the United States started with the presumption that the current classification in distinguishing goods and services in relation to computer technology is seriously outdated[137]. At the beginning, the National Conference of Commissioners on Uniform State laws and the American Law Institute attempted to integrate the transactions in intangibles to the U.C.C. Article 2 and 2A framework. However, information is quite different from that of tangible goods, and cannot be appropriately integrated into the U.C.C. framework. Therefore, it was determined that Article 2B should not remain a project within the Uniform Commercial Code. The new Act is called the Uniform Computer Information Transaction Act. The Act was approved and recommended by the National Conference of Commissioners on Uniform State Laws at its annual conference meeting in July 1999. It represents a serious attempt to do several things: foresee problems, provide flexible tools for solving them, provide some predictability of 'outcome', and reconcile opposing interests.

With respect to warranties, the UCITA is said to blend three categories of laws: the law regarding the sale of goods, which focuses on the quality of the product; the law regarding the supply of services which focuses on the process; and the law regarding supply of informational content which disallows implied obligations of accuracy in information[138 ].

The UICTA is to be applicable to computer information transactions[139], if the computer information is the primary subject matter, the Act is applicable to the entire transaction[140].If the computer information is not the primary subject matter, the Act is applicable only to the part of the transaction pertaining to the computer information[141].

If a copy of a computer program is contained in and sold or leased as part of other goods, the Act is applicable to the program and the copy only if the other goods are a computer or computer peripheral; or giving the buyer or lessee of the goods access to or use of the program is ordinarily a material purpose of transactions in goods of the type[142 ].

The Drafting Committee made significant modifications to the previous Article 2B draft by reducing the scope of the Article to 'computer information transactions', basically to software and on-line licences and directly related services. The core businesses of movies, sound recording, print publishing and broadcasting are no longer covered. In the UCITA, 'nformation' means data, text, images, sounds, mask works, or computer program'[143]. 'Computer program' means an electronic device that accepts information in digital or similar form and manipulates it for a specific result based on a sequence of instructions[144].

On the other hand, 'Informational content' means information that is intended to be communicated to or perceived by an individual in the ordinary use of the information, or the equivalent of that information. The term does not include computer instructions that control the interaction of a computer program with other computer programs or with a machine or device'[145]. 'Informational content' refers to output that communicates to a human being, whereas 'Computer program' refers to the functional and operating aspects of a digital system. The difference between the two concerns whether the issue addresses operations (program) or communicated content (informational content). This distinction is important in determining liability, risk and performance obligation[146].

'Published informational content' means informational content prepared for or made available to recipients generally, or to a class of recipients, in substantially the same form'[147] This type of information is the most closely associated with free expression, and includes the material of newspapers, books, or motion pictures, which are outside of the scope of the Act, intended to communicate to a human being and created for or distributed to a group of recipients as a whole in generally the same form. The term does not include information provided in a special relationship of reliance[148].

As discussed above, the UCITA blends three different legal traditions[149].

Section 402 provides for express warranties, created by an affirmation of fact or promise made by the licensor to its licensee in any manner, such as advertising, which relates to the information and becomes part of the basis of the bargain. A sample, model, or demonstration of a final product may also create an express warranty[150].

Section 403 (a) provides the implied warranty similar to Article 2, that a computer program is merchantable. For the cases where a merchant in a special relationship of reliance provides informational content or services to collect, compile, process or transmit, informational content, Section 404 (a) provides for implied warranties similar to the common law duty under service contracts, to exercise reasonable care. Section 405 (b) provides that such implied warranty is not applicable to transactions for the aesthetics, market appeal, or subjective quality of informational content or published informational content.

The merchantability warranty provided in Section 403(a) and the warranty in Section 404 (a) for the accuracy of data may both apply to the same transaction. The one applies to the program and its functions and the other applies to the accuracy of data.

Section 405 (a) provides for the implied warranty for fitness for a particular purpose in cases where a licensor has reason to know any particular purpose for which the information is required. However, if a licensor was to be paid for the amount of her or his time or effort regardless of the fitness of the resulting information, there is an implied warranty that the information will not fail to achieve the licensee's particular purpose as a result of the licensor's lack of reasonable care.

9. Conclusion

By taking examples of traditional subject matters, I have shown that many of the factors in determining the classification are not determinative, therefore, classification may become arbitrary and the courts may be able to draw conclusions which seem most appropriate to serve justice. This trend may be amplified in the cases of classifying transactions involving information in electronic form because of the complex nature of transactions.

Contracts for information in electronic form involve complicated obligations and such obligations cannot be adequately defined by classifications such as contracts for goods or contracts for services. Nevertheless, the standard of performance expected with respect to transactions in relation to supply of computer programs and related services may still be determined mainly in reference to the result-oriented outcome, the process-oriented outcome. Therefore, the courts have been able to classify artificially such transactions into sale of goods or supply of goods in the manner which seem most appropriate to serve justice.

As stressed by Lord Penrose in the Scottish case of Beta Computers (Europe) Ltd. v. Adobe Systems (Europe )Ltd.,[151] the supply of proprietary software for a price is a contract sui generis which may involve elements of nominate contracts such as sale, but would be inadequately understood if expressed wholly in terms of any of the nominate contracts.

With respect to transactions involving information in electronic form, the standard of performance expected should be determined, taking into account the unique functional nature of computer technology and the reliance on the professional skills involved in exercising such technology.

In considering the nature of computer technology, both English law and United States law seem to have reached the sensible conclusion that many of the transactions involving computer programs may be treated as sale of goods, or the standard of performance in relation to computer programs may be judged by reference to a result- oriented outcome.

However, as provided in English law and as the comments to the UCITA, the dual application of different implied warranty provisions to the same transaction seems more suitable for transactions involving computer programs. As discussed above, it is more practical to focus on the different nature of each element of one transaction as done in English law, than to treat the entire contract as one object.[152] Compared to the United States courts, English courts seem more equipped to take into account the unique nature of transactions involving computer programs by treating the different nature of each element of one transaction. Nevertheless, it may be more preferable in England to enact similar law specifically designed for computer information as in the United States. The enactment of such law may allow the courts to impose different obligations in more clarified manner.

The UCITA is a valuable attempt, enacted to deal specifically with the issues relating to computer information, by taking into account the unique nature of transactions involving computer information and adopting and reinstating all the basic category of the subject matter of contracts to ensure that different elements of one transaction are treated differently in terms of the standard of performance.

It has adopted the basic structure of sales of goods provisions, including express and implied warranties and blended the basic structure with common law rules regarding service contracts and rules regarding contracts for informational contents.

In this Act, there will be no need to classify the transactions into the sale of goods, the supply of services and the supply of information. The multiple application of the different standards ensures that there will be fewer misapplication problems. Section 403 (a) provides the implied warranty that a computer program is merchantable. A sample, model, or demonstration of a final product may create an express warranty.

However, with regard to the implied warranty for fitness for a particular purpose, the courts are still required to determine which standard of performance is to be applicable to each transaction, the result-oriented, the process-oriented or the informational content standard. Furthermore, the suppliers of computer programs can claim, for instance, that they are paid for their amount of time or effort; therefore, there is no implied warranty that the information shall be fit for that purpose.[153] The reason for this comes from the complexity of obligations in transactions in relation to computer technology. It may be hard to identify the "nature" of the subject matter supplied in such transactions. As stated previously, even though the enactment of the UICTA was a big step toward the clarification of the classification issues, the United States' courts are still faced with, in more restricted manner, making the determinations as to what type of obligation is appropriate in a given transaction.

Footnotes

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