English High Court Says That Software is “Goods” for the Purposes of the Commercial Agents (Council Directive) Regulations 1993

The recent English High Court decision in The Software Incubator Ltd v Computer Associates Ltd [2016] EWHC 1587 is essential reading for parties to agency contracts for the sale of software in the UK.¹

Why This Case Is Important: In Summary

1. In this case the English courts have clarified that commoditised software can be "goods" for the purposes of the Commercial Agents (Council Directive) Regulations 1993 (CARs), irrespective of its mode of delivery to the customer (i.e. electronically or via physical media). The court also concluded that a "sale" can occur even where software is licensed on a limited (or non-perpetual) basis – although what counts as "limited" was not fully explored in the judgment.

2. The court awarded The Software Incubator Ltd (TSI) (the agent) a total of £500,000 even though:

(i) TSI was planning to terminate the agency contract with Computer Associates Ltd (CAL) (the principal) anyway; and

(ii) had already concluded a new agency contract with another software vendor (or principal) called "Intigua" to sell a different, but non-competing, software product in the UK.

3. The contract allowed either party to terminate on giving three months’ notice to the other. Indeed, had TSI taken that step it would not have been entitled to: (i) contractual damages; or (ii) compensation under the CARs.

4. In the event, it was CAL that sought to terminate first (i.e. before any notice was given by TSI) and, at the time, on the basis that TSI had repudiated the contract by breaching a non-compete clause in the contract through its dealings with Intigua.

5. The court held that there was no repudiatory breach and therefore no legal justification for CAL's purported termination of the contract (i.e. it was a wrongful termination by CAL).

6. The case is particularly relevant to any organisation that may be operating on the assumption that the CARs do not apply because the product supplied to customers is not "goods" and/or there is no "sale". Following TSI v CAL those assumptions may no longer apply, meaning those affected may find they are now required to pay damages and/or compensation to outgoing agents in the event of termination – subject of course to the overall requirements of the CARs and the particular circumstances involved (for example, not every type of termination triggers compensation under the CARs).

7. Finally, the case clarifies that it is possible to effectively exclude claims for commissions on transactions concluded after termination (under Regulation 8 of the CARs).

The Details

What are the CARs?

The CARs govern all agency arrangements relating to activities performed by "commercial agents" in the UK. Their aim is to provide protection for commercial agents. Key features and provisions include the following:

• The CARs only apply to commercial agents selling goods, not services. There is no definition of "goods" in the CARs.
• The CARs apply to commercial agents which are defined as self-employed intermediaries with continuing authority to negotiate and sell on behalf of their principal. The CARs do not apply to agents acting for an undisclosed principal, nor where the agent has only the right to conduct a single, one-off transaction for his principal.
• The CARs imply general duties on both agent and principal (for example, to act dutifully and in good faith).
• Where an agency relationship is terminated, the agent may be entitled to compensation based on the loss of value of the agency (but not, for example, where the principal rightfully terminates based on repudiatory breach of contract by the agent).
• The agent may also be entitled to commission for transactions concluded after termination where, for example, the transaction is "mainly attributable" to the agent and occurs within a "reasonable period" after termination.

Facts of the case

Pursuant to a non-exclusive arrangement, TSI agreed to act as agent of CAL to promote, market, and sell CAL's release automation software in the UK. TSI received a monthly consulting fee, plus commission, and was required to "devote a substantial amount of time and effort in providing the Services." The contract contained a non-compete clause.

The contract with CAL concluded in March 2013. Shortly thereafter TSI became unhappy with the arrangement. TSI preferred the approach of the previous owner of the software, a start-up called Nolio Ltd, with whom it had dealt for a number of years. Nolio had been acquired by CAL in early 2013.

As a result, TSI started talks with Intigua about becoming their UK agent for a different software product and one that, according to the Judge, HHJ Waksman QC, did not compete with CAL's release automation software.

For these reasons TSI had it in mind to terminate the contract with CAL. However, as above, CAL got in first and took action to summarily terminate the contract, alleging repudiatory breach by TSI.

CAL's principal complaint (at the time) related to the non-compete provision and TSI's interactions with Intigua. However, during the litigation other areas of complaint were put forward by CAL, including allegations that TSI failed to devote enough time and effort and that certain actions by TSI amounted to a breach of confidence.

The claim and defence

TSI took legal action and claimed:

• damages at common law for repudiatory breach limited to the monthly fee payable under the agency agreement – for the duration of the three-month notice period in the contract;
• compensation and commission under the CARs; and
• as an alternative to the commission claim under the CARs (i.e. in case the CARs claim was unsuccessful), a commission claim at common law.

In its defence CAL argued, inter alia, that:

• the activities did not involve the "sale of goods" so the CARs did not apply;
• even if the CARs did apply, TSI was itself in repudiatory breach, meaning there could be no entitlement to damages at common law or compensation under the regulations; and
• the transactions to which the commissions related were not "mainly attributable" to TSI; or, alternatively, were excluded by the contract.

The decision

Is software "goods" under the CARs?

After detailed analysis the Judge concluded that, in this case, the software was indeed "goods" for the purposes of the CARs. He did not feel constrained by the "physical" definition of "goods" under the Sales of Goods Act 1979 or obiter comments in St Albans v ICL [1996] EWCA Civ 1296 – to the effect that software is only "goods" when delivered on physical media.

He thought that those views were outdated and instead preferred the thinking in more recent cases such as Fern Computer Consultancy v Intergraph [2014] EWHC 2908, in which Mann J made obiter comments about giving a wider interpretation to the definition of "goods" in the "present digital age" and the scope for an autonomous definition under the CARs.

In particular, HHJ Waksman QC said:

"…I believe that as a piece of sophisticated, commercial non-bespoke software, it [i.e. the software product in this case] would be regarded, at the very least as a "product". It would not be regarded, nor is it, a "service". Like other pieces of software, it is "commodified" i.e. it is capable of transfer and commercial exploitation. Moreover, so far as "tangibility" is concerned, while software itself is intangible and its method of delivery may be electronic, it can only operate in a tangible environment i.e. (a) being loaded onto a hard disk or server or some other permanent storage system, somewhere, and (b) when it runs, it will be run on a computer, tablet, reader, mobile phone (depending on the software) and so on. In that sense it is akin to digital music. As Professor Clark of University College Dublin put it in an article called "The Legal Status of Software" in March 2016, "Digital content… possesses a functional equivalence to goods." (paragraph 36)

"These days I would suggest that the essential characteristics of a piece of software … cannot depend on its mode of delivery any more than the nature of tangible goods depends on whether they are transported by rail, sea or air." (paragraph 39)

"Working from first principles, therefore, I would consider that the Product would today, be regarded as "goods" albeit that it is not tangible." (paragraph 40)

Was there a "sale" of those goods?

The Judge also concluded that there was a "sale" of those goods and appeared to place significant weight on the fact that the "vast majority" of customers (i.e. not all) to whom the software was sold received a perpetual licence.

However, what is less clear from the judgment is exactly what situations or licensing models the Judge had in mind when he went on to say that this conclusion was not affected where products are supplied on a limited (i.e. non-perpetual) basis. In that regard he said:

"The fact that sometimes the Product might be supplied on a limited licence does not affect this conclusion because one has to decide whether TSI was a "commercial agent" in the round and having regard to the principal way in which the Product was supplied." (paragraph 69)

The judgment does not set out the licensing limitations referred to so there is no real guidance that might help in determining whether a sale has occurred in other situations where a limited licence may be involved.

Stepping away from the facts of the case and by way general observation, it is hard to see how it could be said that a "sale" has occurred or that a licensee has somehow taken ownership of software in circumstances where the licensing model adopted is limited in the sense that it is a subscription-based or "pay as you go" type licence. In those situations (none of which is mentioned in the judgment so may not have been present on the facts of the case) ownership does not pass and the licensor effectively leases or rents the software to the licensee.

Moreover, at paragraph 62 of the judgment, HHJ Waksman QC himself says that "the intention, as with the sale of any product, is that the purchaser has the unfettered ability to use it forever subject to copying restrictions and so on."

This general statement appears to support the view that, in cases where software is sold on a subscription or "pay as you go" type basis, the CARs will not apply because it cannot be said that the user or licensee has an unfettered ability to use the software forever.

It is also worth considering the point in light of the decision in UsedSoft GmbH v Oracle International Corp (Case C-128/11), which looked at the exhaustion of rights on first sale of software licences. In that case the European Court of Justice was clear that a licensor making a copy of software available, in any form, for use by a customer for an unlimited period and for a one-off fee amounted to a "sale" (rather than merely a licence) for the purposes Article 4(2) of Directive 2009/24/EC. Although the Court did not comment specifically on whether a limited licence could also amount to a "sale", that scenario, at least for the purposes of Article 4(2) of the Directive, would appear to fall outside the scope of the decision. Indeed the approach in this case was noted with approval by HHJ Waksman QC in TSI v CAL.

Repudiatory breach?

TSI was not in repudiatory breach:

• TSI was only obliged to "devote a substantial amount of time and effort" – which it did even though it was in start-up mode to operate as agent for another software vendor (Intigua);
• there were some breaches by TSI – cancelled meetings/calls and disclosure of confidential information to Intigua – but they were minor (i.e. not repudiatory); and
• the Initgua products marketed by TSI did not compete with CAL's software product.

Compensation and damages

The Judge awarded compensation under Regulation 17 of the CARs in the sum of £475,000. He looked at the value of the agency at the date of termination and what a hypothetical buyer would pay for it – following the approach in Lonsdale v Howard & Hallam Ltd [2006] EWCA Civ 63.

It should be remembered that if TSI (and not CAL) had terminated the arrangement then no compensation or damages would have been payable.

In relation to the claim for commission on post-termination sales under Regulation 8 of the CARs, the Judge found that it was effectively excluded under the contract but that contractual claims were not. He therefore awarded £8,724 under the contract.

Accordingly, principals wishing to exclude this type of claim (i.e. under Regulation 8) may wish to consider the approach in this case and whether wording can be included in future contracts that excludes both: (i) claims under the regulations; and (ii) contractual claims.

The Judge also awarded the sum of £15,000 for CAL's breach in terminating the agency contract with TSI without giving the required three months' notice.

Concluding Remarks

This is a notable UK case that may have a significant impact on parties to agency arrangements, particularly those organisations that may have structured their business models and risk profiles on the basis that the CARs do not apply.

Where required, those models and profiles should be revisited in order to account for the decision in this case. It may be worth considering the relative merits of different models – for example an employed (rather than self-employed) sales force, an undisclosed agent, or a distributor.

Where the CARs do apply, there may, in some cases, be scope for principals to increase their protection through the use of exclusions clauses – for example, to exclude the application of Regulation 8 which was permitted on the facts of the TSI v CAL case.

Whilst the case provides helpful guidance in certain areas (for example, clarifying that software can be goods for the purposes of the CARs) it does leave open the question as to the status of transactions involving limited licensing arrangements – particularly annual, subscription, or "pay as you go" licenses – as opposed to situations in which a perpetual end-user license has been granted.