Advent Systems v. Unisys

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Advent Systems v. Unisys, 925 F.2d 670 (3rd Cir. 1991)

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WEIS, Circuit Judge.

In this diversity case we conclude that computer software is a good within the Uniform Commercial Code; in the circumstances here a non-exclusive requirements contract complies with the statute of frauds . . .

Plaintiff, Advent Systems Limited, is engaged primarily in the production of software for computers. As a result of its research and development efforts, by 1986 the company had developed an electronic document management system (EDMS), a process for transforming engineering drawings and similar documents into a computer data base.

Unisys Corporation manufactures a variety of computers. As a result of information gained by its wholly-owned United Kingdom subsidiary during 1986, Unisys decided to market the document management system in the United States. In June 1987 Advent and Unisys signed two documents, one labeled "Heads of Agreement" (in British parlance "an outline of agreement") and, the other "Distribution Agreement."

In these documents, Advent agreed to provide the software and hardware making up the document systems to be sold by Unisys in the United States. Advent was obligated to provide sales and marketing material and manpower as well as technical personnel to work with Unisys employees in building and installing the document systems. The agreement was to continue for two years, subject to automatic renewal or termination on notice.

During the summer of 1987, Unisys attempted to sell the document system to Arco, a large oil company, but was unsuccessful. Nevertheless, progress on the sales and training programs in the United States was satisfactory, and negotiations for a contract between Unisys (UK) and Advent were underway.

The relationship, however, soon came to an end. Unisys, in the throes of restructuring, decided it would be better served by developing its own document system and in December 1987 told Advent their arrangement had ended. Unisys also advised its UK subsidiary of those developments and, as a result, negotiations there were terminated.

Advent filed a complaint in the district court alleging, inter alia, breach of contract, fraud, and tortious interference with contractual relations. The district court ruled at pretrial that the Uniform Commercial Code did not apply because although goods were to be sold, the services aspect of the contract predominated.

A jury found for Unisys on the fraud count, but awarded damages to Advent in the sum of $4,550,000 on the breach of contract claim, and $4,350,000 on the count for wrongful interference with Unisys U.K. The district court granted judgment n.o.v. to defendant on the interference claim but did not disturb the verdict awarding damages for breach of contract.

On appeal Advent argues that the Distribution Agreement prohibited Unisys from pressuring its UK subsidiary to terminate negotiations on a corollary contract. Unisys contends that the relationship between it and Advent was one for the sale of goods and hence subject to the terms of statute of frauds in the Uniform Commercial Code. Because the agreements lacked an express provision on quantity, Unisys insists that the statute of frauds bans enforcement. In addition, Unisys contends that the evidence did not support the damage verdict.

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II.

SOFTWARE AND THE UNIFORM COMMERCIAL CODE

The district court ruled that as a matter of law the arrangement between the two parties was not within the Uniform Commercial Code and, consequently, the statute of frauds was not applicable. As the district court appraised the transaction, provisions for services outweighed those for products and, consequently, the arrangement was not predominantly one for the sale of goods.

In the "Heads of Agreement" Advent and Unisys purported to enter into a "joint business collaboration." Advent was to modify its software and hardware interfaces to run initially on equipment not manufactured by Unisys but eventually on Unisys hardware. It was Advent's responsibility to purchase the necessary hardware. "[I]n so far as Advent has successfully completed [some of the processing] of software and hardware interfaces," Unisys promised to reimburse Advent to the extent of $150,000 derived from a "surcharge" on products purchased.

Advent agreed to provide twelve man-weeks of marketing manpower, but with Unisys bearing certain expenses. Advent also undertook to furnish an experienced systems builder to work with Unisys personnel at Advent's prevailing rates, and to provide sales and support training for Unisys staff as well as its customers.

The Distribution Agreement begins with the statement, "Unisys desires to purchase, and Advent desires to sell, on a non-exclusive basis, certain of Advent hardware products and software licenses for resale worldwide." Following a heading "Subject Matter of Sales," appears this sentence, "(a) Advent agrees to sell hardware and license software to Unisys, and Unisys agrees to buy from Advent the products listed in Schedule A." Schedule A lists twenty products, such as computer cards, plotters, imagers, scanners and designer systems.

Advent was to invoice Unisys for each product purchased upon shipment, but to issue separate invoices for maintenance fees. The cost of the "support services" was set at 3% "per annum of the prevailing Advent user list price of each software module for which Unisys is receiving revenue from a customer." Services included field technical bulletins, enhancement and maintenance releases, telephone consultation, and software patches, among others. At no charge to Unisys, Advent was to provide publications such as installation manuals, servicing and adjustment manuals, diagnostic operation and test procedures, sales materials, product brochures and similar items. In turn, Unisys was to "employ resources in performing marketing efforts" and develop "the technical ability to be thoroughly familiar" with the products.

In support of the district court's ruling that the U.C.C. did not apply, Advent contends that the agreement's requirement of furnishing services did not come within the Code. Moreover, the argument continues, the "software" referred to in the agreement as a "product" was not a "good" but intellectual property outside the ambit of the Uniform Commercial Code.

Because software was a major portion of the "products" described in the agreement, this matter requires some discussion. Computer systems consist of "hardware" and "software." Hardware is the computer machinery, its electronic circuitry and peripheral items such as keyboards, readers, scanners and printers. Software is a more elusive concept. Generally speaking, "software" refers to the medium that stores input and output data as well as computer programs. The medium includes hard disks, floppy disks, and magnetic tapes.

In simplistic terms, programs are codes prepared by a programmer that instruct the computer to perform certain functions. When the program is transposed onto a medium compatible with the computer's needs, it becomes software. . .

The increasing frequency of computer products as subjects of commercial litigation has led to controversy over whether software is a "good" or intellectual property. The Code does not specifically mention software.

In the absence of express legislative guidance, courts interpret the Code in light of commercial and technological developments. The Code is designed "[t]o simplify, clarify and modernize the law governing commercial transactions" and "[t]o permit the continued expansion of commercial practices." 13 Pa.Cons.Stat.Ann. Sec. 1102 (Purdon 1984). As the Official Commentary makes clear:

"This Act is drawn to provide flexibility so that, since it is intended to be a semi-permanent piece of legislation, it will provide its own machinery for expansion of commercial practices. It is intended to make it possible for the law embodied in this Act to be developed by the courts in the light of unforeseen and new circumstances and practices."

The Code "applies to transactions in goods." Goods are defined as "all things (including specially manufactured goods) which are moveable at the time of the identification for sale." The Pennsylvania courts have recognized that " 'goods' has a very extensive meaning" under the U.C.C.

Our Court has addressed computer package sales in other cases, but has not been required to consider whether the U.C.C. applied to software per se. . .

Computer programs are the product of an intellectual process, but once implanted in a medium are widely distributed to computer owners. An analogy can be drawn to a compact disc recording of an orchestral rendition. The music is produced by the artistry of musicians and in itself is not a "good," but when transferred to a laser-readable disc becomes a readily merchantable commodity. Similarly, when a professor delivers a lecture, it is not a good, but, when transcribed as a book, it becomes a good.

That a computer program may be copyrightable as intellectual property does not alter the fact that once in the form of a floppy disc or other medium, the program is tangible, moveable and available in the marketplace. The fact that some programs may be tailored for specific purposes need not alter their status as "goods" because the Code definition includes "specially manufactured goods."

The topic has stimulated academic commentary with the majority espousing the view that software fits within the definition of a "good" in the U.C.C.

Applying the U.C.C. to computer software transactions offers substantial benefits to litigants and the courts. The Code offers a uniform body of law on a wide range of questions likely to arise in computer software disputes: implied warranties, consequential damages, disclaimers of liability, the statute of limitations, to name a few.

The importance of software to the commercial world and the advantages to be gained by the uniformity inherent in the U.C.C. are strong policy arguments favoring inclusion. The contrary arguments are not persuasive, and we hold that software is a "good" within the definition in the Code.

The relationship at issue here is a typical mixed goods and services arrangement. The services are not substantially different from those generally accompanying package sales of computer systems consisting of hardware and software.

Although determining the applicability of the U.C.C. to a contract by examining the predominance of goods or services has been criticized, we see no reason to depart from that practice here. As we pointed out in De Filippo v. Ford Motor Co, segregating goods from non-goods and insisting "that the Statute of Frauds apply only to a portion of the contract, would be to make the contract divisible and impossible of performance within the intention of the parties."

We consider the purpose or essence of the contract. Comparing the relative costs of the materials supplied with the costs of the labor may be helpful in this analysis, but not dispositive.

In this case the contract's main objective was to transfer "products." The specific provisions for training of Unisys personnel by Advent were but a small part of the parties' contemplated relationship.

The compensation structure of the agreement also focuses on "goods." The projected sales figures introduced during the trial demonstrate that in the contemplation of the parties the sale of goods clearly predominated. The payment provision of $150,000 for developmental work which Advent had previously completed, was to be made through individual purchases of software and hardware rather than through the fees for services and is further evidence that the intellectual work was to be subsumed into tangible items for sale.

We are persuaded that the transaction at issue here was within the scope of the Uniform Commercial Code and, therefore, the judgment in favor of the plaintiff must be reversed.

III.

THE STATUTE OF FRAUDS

This brings us to the Unisys contention that the U.C.C. statute of frauds bars enforcement of the agreement because the writings do not contain a quantity term.

* * *

In the distribution agreement, Unisys agreed to engage in the business of selling identified document systems during the two-year term of the contract and to buy from Advent on stated terms the specified products necessary to engage in that venture. The detailed nature of the document, including as it does, such provisions as those for notice of breach, opportunity for cure, and termination leaves no doubt that the parties intended to create a contract.

The parties were obviously aware that they were entering a new, speculative market and some uncertainty was inevitable in the amount of sales Unisys could make and the orders it would place with Advent. Consequently, quantity was not stated in absolute terms. In effect, the parties arrived at a non-exclusive requirements contract, a commercially useful device. We do not consider that in the circumstances here the arrangement raises the statute of frauds bar.

The Code recognizes exclusive requirements contracts in section 2-306, and imposes on the parties to such agreements a duty of good faith. For present purposes, the salient factor is that exclusive requirements contracts satisfy the quantity requirements of the statute of frauds, albeit no specific amount is stated.

The reasons for excepting exclusive requirements contracts from the strictures of the statute of frauds are strong. The purchasing party, perhaps unable to anticipate its precise needs, nevertheless wishes to have assurances of supply and fixed price. The seller, on the other hand, finds an advantage in having a steady customer. Such arrangements have commercial value. To deny enforceability through a rigid reading of the quantity term in the statute of frauds would run contrary to the basic thrust of the Code--to conform the law to business reality and practices.

By holding that exclusive requirements contracts comply with the statute of frauds, courts have decided that indefiniteness in the quantity term is acceptable. If the agreement here does not satisfy the statute of frauds because of indefiniteness of a quantity term, then neither does an exclusive requirements contract. We find no reason in logic or policy to differentiate in the statute of frauds construction between the contract here and an exclusive requirements arrangement.

The same reasons that led courts to dispense with a specific and certain quantity term in the exclusive requirements context apply equally when a continuing relationship is non-exclusive. The same regulating factor--good faith performance by the parties--applies and prevents the contracts from being illusory. The writings here demonstrate that the parties did not articulate a series of distinct, unrelated, simple buy and sell arrangements, but contemplated what resembles in some respects a joint venture or a distributorship.

A construction of the statute of frauds that does not recognize the quite substantial difference between a simple buy and sell agreement and what occurred here is unduly restrictive. Section 2-306 in recognizing exclusive requirements and output contracts does not purport to treat them as the only permissible types of open quantity agreements. We do not read section 2-306 as an exclusionary measure, but rather as one capable of enlargement so as to serve the purposes of the Code.

We emphasize once again that our focus has been on a technical requirement of the statute of frauds whose raison d'etre is dubious. We have not yet considered the importance of evidence to support a remedy, an issue we consider to be addressed by section 2-204 rather than being comprehensively covered by the statute of frauds.

The separation of the concepts advanced by the statute of frauds and section 2-204 has a very practical significance. If the statute of frauds was not satisfied, this case would be dismissed on the complaint, but by surmounting that threshold, the litigation proceeds to a point where the terms of the contract and its enforcement may be determined. This disposition comports with the goals of the Code and gives due recognition to legitimate business practices.

In sum, we hold that the writings here satisfy the statute of frauds.

IV.

ENFORCEABILITY

Having concluded that the statute of frauds is not a bar, we now confront the issue of enforceability.

Section 2-204 provides that a contract does not fail for indefiniteness even though one or more terms have been left open if the parties intended to make a contract and there is a reasonably certain basis for giving an appropriate remedy. As Professor Murray has explained:

"Rather than focusing upon what parties failed to say, the Code and RESTATEMENT 2d focus upon the overriding question of whether the parties manifestly intended to make a binding arrangement. If that manifestation is present, the only remaining concern is whether the terms are definite enough to permit courts to afford an appropriate remedy. The second requirement assists courts to determine the degree of permissible indefiniteness."

Unlike the statute of frauds issue discussed earlier, the definiteness required to provide a remedy rests on a very solid foundation of practicality. A remedy may not be based on speculation and an award cannot be made if there is no basis for determining if a breach has occurred.

Unisys argues that because there are specific non-exclusive stipulations in the agreement, they negate the implication found in most exclusive requirements contracts that a "best efforts clause" is included. That may be so, but that does not nullify the obligation of the parties to deal in good faith.

Section 1-203 of the Code provides that contracts require a "good faith performance." This requires the parties to observe "reasonable commercial standards of fair dealing in the trade."

The Pennsylvania Superior Court has concluded that in the absence of any express language, the law will imply an agreement by the parties to do those things that "according to reason and justice they should do in order to carry out the purposes for which the contract was made and to refrain from doing anything that would destroy or injure the other party's right to receive the fruits of the contract." One commentator opines that when the contract does not have a "best efforts" clause, "the law will usually imply ... that the dealer must act in good faith and use 'reasonable efforts' to sell. This implied obligation requires the distributor to do more than the bare minimum to comply with a contract; the distributor must really make some attempt to sell."

The terms of the agreement between Unisys and Advent lend themselves to imply a good faith obligation on the parties of at least some minimal effort: "A fundamental assumption of both parties is that throughout the term of this agreement, Unisys will employ resources in performing marketing efforts involving Advent Products and will develop the technical capability to be thoroughly familiar with these products."

On remand, Advent may be able to show that it was inconsistent with good faith for a party that has committed itself to engage in particular business for a specified period of time to cease devoting any resources to that venture prior to the end of the stated period. We leave open the possibility that the performance of the parties following signing of the documents and perhaps pre-contractual expectations will provide evidence to satisfy the requirements of section 2-204. See Secs. 2-208, 1-205 (course of performance, usage of trade).

On the other hand, it may be that the reason Unisys decided to devote no resources to the project of selling document systems is relevant to whether the standard of fair dealing in the trade was breached. Simply because no resources were devoted, does not mean in and of itself that there was a breach of the covenant of good faith.

Whether Advent can establish the definiteness required to sustain a remedy is a serious question. The record before us consists of evidence submitted on the basis of the pretrial ruling denying application of the U.C.C. Our contrary holding will require the parties to reassess the proofs necessary to meet the Code. We are in no position to anticipate the evidence that may appear in further proceedings and, thus, at this juncture cannot rule whether the agreement between Unisys and Advent is enforceable.

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The judgment in favor of the plaintiff on the breach of contract claim will be reversed and the case will be remanded for further proceedings.

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