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Software Contracts and the Predominant Factor Test to Determine UCC Applicability

By Martha L. Arias

It is complex to determine whether the United States Commercial Code (UCC) applies to software contracts. The UCC applies to the sale of goods and software can be considered goods in some cases but service in other situations. Thus, the analysis must be made in a case-by-case basis. To help in this analysis, some state courts apply the predominant factor test.  This article informs on how some courts apply this test and what the most relevant factors to be considered are.

Most states in the United States (U.S.) have adopted the UCC; although states have also introduced specific modifications that are relevant and most be taken into consideration when contracting software products. For instance, North Carolina's adoption of the UCC defines goods as "all things (including specially manufactured goods) 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 (article 8) and things in action." This definition is consistent with the majority of the U.S. states" definition of goods, but when entering into a software contract it is worth to review the specific state definition.

Software contracts may involve both the sale of goods and the provision of services; this characteristic creates confusion when determining the applicable law.  Some U.S. courts developed the predominant factor test to help solve contractual disputes regarding software -11^th Circuit, 4^th Circuit, 2^nd Circuit, etc. Other courts have used the "general trend test" -1^st  Circuit,- and the  "modern test" -10^th Circuit.  The predominant factor test establishes that the most important inquiry is not whether the sale of goods or provision of services are mixed in the contract, but whether "the predominant factor, the trust, their purpose, reasonably stated, is the rendition of service, with goods incidentally involved. . . or is a transaction of sale, with labor incidentally involved."   

Under the predominant factor test, courts, depending on the jurisdiction applying it, have examined several factors, but have not reached a specific list of determinative factors.  The mostly common factors examined are (1) the language of the contract, (2) the intrinsic worth of the software, (3) the nature of the software supplier business, (4) the manner in which the contract is billed, among others.

Smart Online, Inc. v. Opensite Techs., Inc., 2003 from the North Caroline Superior Court is a good example of how the state of North Caroline applies the predominant factor test.  In Smart Online, buyer and seller entered into a computer software agreement in which seller licensed software to buyer. At some point, buyer was not satisfied with seller's software and commenced legal action for breached of contract and other cause of action.  The court analyzed whether the UCC applied in this case and concluded that this specific contract was for the sale of goods and that UCC applied.  The court used the predominant factor test to reached the conclusion that the software bought by buyer was a prepackage software considered goods.  It was proven that some customization was needed in this case but when applying the factor of this test, the court concluded that the customization was not sufficient to create a service contract.  Buyer bought preexisting software that was not specifically developed for buyer.    The court took into consideration the language of the contract, the price and manner in which the software was billed, and the fact that the contract did not include the payment of services.

Therefore, careful analysis of the UCC state rules and the test applied by state courts to determine whether the UCC applies is an important consideration when drafting software contracts or when negotiating those contracts. 

 

Full post as published by IBLS Internet Law Blog on June 11, 2009 (boomark / email).