As this article will demonstrate beyond any doubt, the Uniform Commercial Code ("the UCC" or "the Code") applies to most computer technology transactions. Whether the transaction involves hardware, software or both, the rights and obligations of the parties to that transaction will be determined not just by their agreement, but by Article 2 of the UCC as well.
The Year 2000 Crisis has been the subject of industry conferences, television and radio programs, internet sites and newspaper and magazine articles. It is easy to understand the nature of the problem. It is, however, far more difficult to remedy the problem and even harder to understand the far-reaching consequences it might have.
Let's focus on the cause of the Year 2000 Crisis. Since the inception of computers almost 50 years ago, systems designers and programmers have almost always treated the "date field" as having only two digits. For example, the year 1990 would, for data processing purposes, be treated in a data field as "90", the year 1995 would appear as "95" and so on. By creating a data field of only two digits, rather than with four or even three digits, computer systems were given more efficient storage for important data and, perhaps more significantly, were able to process date-related calculations faster. These calculations were for functions such as recording payments on account, invoice dating, receivables aging, the calculation of interest on overdue payments and many other purposes.
Until the last few years, almost every computer system has been designed with a two digit date field, and within the past year or so industry has recognized that this design technique, if not remedied, will cause a serious problem once the clock passes midnight and the year 2000 arrives. Once we enter the year 2000, computers which have used a typical two digit date field will go from "99" (for the year 1999) to "00" for the year 2000. At that moment, the computer may view that new date as 1900. It is even possible that the new date of "00" will be unrecognizable to the computer. In either case, chaos could result. Some experts predict that the Year 2000 computer problem will cause the collapse of our economy, or the destruction of the Internal Revenue Service and the like. Others conclude that the problems caused by the Year 2000 Crisis are greatly exaggerated and that it will turn out to be no more than a minor inconvenience. All experts, however, conclude that the Year 2000 Crisis will be (and, indeed, it already is!) a bonanza for lawyers who practice information technology law. It has also been a godsend to older programmers who know the early programming languages such as COBOL, for they are now very much in demand.
The Year 2000 Crisis must be considered from two very fundamental and quite different perspectives. The first, and arguably the most important, point is technological - what must a company do to remedy the condition to assure that none of the dreaded Year 2000 consequences attack it? If it hasn't already done so, a company must undertake a comprehensive analysis of all of the computer systems which it uses throughout the world. To deal with the Year 2000 Crisis, a company must then carefully design and execute a comprehensive remediation plan, which may very well include the acquisition of new hardware or upgrades, and the purchase, development or licensing of new software. The remediation plan may involve a combination of all of these.
If a company is going to acquire hardware of some type, Article 2 of the UCC will apply to that transaction. If a company is going to acquire a turnkey computer system, including hardware and software, as part of the remediation plan, that transaction will be covered by the Code. If the company is going to purchase or license "packaged" software, then Article 2 of the UCC will likely apply. Indeed, the Code may even apply to specially developed software used in the Year 2000 remediation. In these instances, the agreement between a company and its hardware supplier, software seller, licensor, or software developer will be governed by Article 2 of the Code. By contrast, if the remediation process involves only some programming services, such as the correction of some data fields, then it is unlikely that the Code will apply.
Clearly, the UCC will be implicated by most companies' Year 2000 remediation plans. But there is yet another way in which the UCC will require consideration during the remediation process. As this article will demonstrate, the vendor of the hardware and/or software which contains the year 2000 data field problem may be liable for the damages suffered during the remediation process, and even beyond. To assess the potential liability of a vendor, one must consider whether the UCC applied to the initial transaction in which the hardware and/or software was acquired. If it was a transaction covered by the Code, what is the applicable statute of limitation? What theories of liability might be pled? What remedies would be available under the UCC to a successful claimant? Of course, these questions and others should be asked even if the original acquisition was a non-Code transaction.
1. The Scope of the UCC in Information Technology Transactions
Whether you are representing a client negotiating an agreement with a Year 2000 vendor, or a client who is considering a Year 2000 claim against a former vendor, you must initially determine whether your client's rights are governed by Article 2 of the UCC. If the Code does apply, then a whole set of important rules governing such issues as the making of the agreement, the construction of the contract, the making of warranties, performance issues, notice of breach requirements, remedies and the statute of limitations apply. These Code rules, and their consequences, will be sharply different from those in a non-Code transaction. You cannot proceed to counsel or represent a client in a Year 2000 matter without first determining whether the UCC applies.
Article 2 of the UCC applies to "transactions in goods." The term "transactions" has been construed to include sales, leases and even licenses. The issue, therefore, is what constitutes a "good" for the purpose of determining whether Article 2 of the Code applies.
"Goods" are defined in UCC §2-105 as:
"All things (including specially manufactured goods) which are movable at the time of identification to the contact for sale other than the money in which the price is to be paid, investment securities (Article 8) and things in action. 'Goods' also includes the unborn young of animals and growing corps and other identified things attached to realty as described in the section on goods to be severed from realty (Section 2-107)."
The core issue is, therefore, whether a computer transaction involves a contract for goods or a contract for services. Article 2 of the UCC applies to goods, whether they are sold, leased or licensed. Service contracts are governed by the common law and other statutes.
Courts have consistently held that computer hardware is a "good" under the UCC. See, e.g., Investors Prelimium Corp. v. Burroughs Corp., 389 F.Supp. 39 (D.C.S.C. 1974). It also is well established that a sale of an integrated or "turnkey" system, consisting of hardware and software, is a transaction governed by the Uniform Commercial Code. Triangle Underwriters, Inc. v. Honeywell, Inc., 604 F.2d 737 (2d Cir. 1979); Chatlos Systems, Inc. v. National Cash Register Corporation, 479 F.Supp. 738 (D.N.J. 1979), aff'd and remanded 635 F.2d 1081 (3rd Cir. 1980), appeal after remand 670 F.2d 1304 (1982), certiorari dismissed 102 S.Ct. 2918, 457 U.S. 1112, 73 L.Ed.2d 1323 (1982).
The more difficult issue is whether an agreement for software or programming services is covered by Article 2 of the UCC. It is now generally agreed that software, by itself, is a "good" and that the UCC is applicable to a contract for the sale or license of software. See Advent Systems v. Unisys, 925 F.2d 670 (3rd Cir. 1991); Colonial Life Insurance of America v. Electronic Data Systems Corp., 817 F.Supp. 235 (D.N.H. 1993); RRX Industries v. Lab-Con, Inc., 772 F.2d 543 (9th Cir. 1985). In fact, many courts now hold that specially developed software is a "good" covered by the UCC. See, e.g., Data Processing Services, Inc. v. L.H. Smith Oil Corp., 492 N.E.2d 314 (Ind. B Ct. App. 1986).
Pure service transactions will not be treated as "transactions in goods." Programmers hired to rewrite code on users' systems probably will not be deemed to be engaged in the sale of "goods". If the predominant nature of the transaction is for services, even if goods are incidentally supplied, then the UCC will not apply. See Computer Service Centers, Inc. v. Beacon Manufacturing Co., 328 F.Supp. 653 (D.S.C. 1970), aff'd, 443 F.2d 906 (4th Cir. 1971).
Many different provisions of the UCC will affect the rights and obligations of parties to a "transaction in goods." The balance of this article will focus on some of the more important Code provisions.
2. Express Warranties Under UCC 2-313
Whether you are negotiating a Year 2000 remediation agreement with a hardware or software vendor, or assessing the liability of a previous vendor, you must begin with a consideration of the warranty provisions in UCC 2-313, which provides several ways in which express warranties arise:
"(1) Express warranties by the seller are created as follows:
(a) Any affirmation of fact or promise made by the seller to the buyer which relates to the goods and becomes part of the basis of the bargain creates an express warranty that the goods shall conform to the affirmation or promise.
(b) Any description of the goods which is made part of the basis of the bargain creates an express warranty that the goods shall conform to the description.
(c) Any sample or model which is made part of the basis of the bargain creates an express warranty that the whole of the goods shall conform to the sample or model.
"(2) It is not necessary to the creation of an express warranty that the seller use formal words such as warrant or guarantee or that he have a specific intention to make a warranty, but an affirmation merely of the value of the goods or a statement purporting to be merely the seller's opinion or commendation of the goods does not crate a warranty."
Section 2-313 of the UCC thus provides that an express warranty will result from any affirmation of fact or promise, description of the goods, and/or sample or model which "becomes part of the basis of the bargain." The Code states specifically that an express warranty may be created without the seller's use of such words as "warrant" or "guarantee" nor must the seller specifically intend to make a warranty. See Official Comment 3 to UCC §2-313. The Code further provides, however, that a statement purporting to be merely the seller's opinion will not create such a warranty.
Computer law decisions addressing the issue hold that an express warranty may be created orally as well as in writing. See e.g., Chatlos Systems v. National Cash Register Corp., 479 F. Supp. 738 (D.N.J. 1979), aff'd and remanded 635 F.2d 1081 (3rd Cir. 1980), appeal after remand 670 F.2d 1304 (1982), certiorari dismissed 103 S.Ct. 2918, 457 U.S. 1112, 73 L.Ed. 2d 1323 (1982); Acme Pump Company, Inc. v. National Cash Register Corp., 337 A.2d 672 (Ct. Com. Pl. Conn. 1974).
In most computer law cases, breach of express warranty claims are based upon written or oral statements made by the vendor concerning the performance specifications of the computer system. See, e.g., Consolidated Data Terminal Co. v. Applied Digital Systems, Inc., 708 F.2d 385 (9th Cir. 1983). Even general statements regarding the suitability or performance level of the computer system will give rise to actionable breach of express warranty claims. See e.g., Bruffey Contracting Co. v. Burroughs Corp., 522 F. Supp. 769 (D. Md. 1981).
Express warranties relating to specific performance standards or to the general suitability of the computer system are often found in advertising brochures and literature, and vendor's proposals containing boilerplate provisions. In addition, such express warranties are often created by the oral statements of overzealous salesmen, systems analysts and other vendor representatives. As a result, when examining whether a client has a claim for breach of express warranty, you must look beyond the four corners of the written contract and examine all of the written and oral communications occurring between the parties up to the execution of the contract.
As a result, when negotiating a contract with a remediation vendor, you must obtain sufficient express warranties, drafted in the clearest language possible, warranting that the new hardware and/or software being furnished by the vendor will solve the Year 2000 problem. Of course, this warranty must be in addition to the panoply of warranties, representations and performance standards which should always be contained in a carefully negotiated and drafted technology transfer agreement.
If you are seeking to assess the liability of a prior vendor, UCC 2-313 is the place to start. You must ask your client to furnish you with all contract documents and all correspondence, memoranda, proposals and promotional literature received from the old vendor. These documents and others should be carefully combed to ascertain whether any express warranties have been made (e.g. "This computer will suit you well into the next century!"), thus forming a basis for liability. It is also important that you interview people, some of whom may no longer be employed by your client, to determine whether any statements were made during the sales cycle which could form the basis of an actionable express warranty. These may have been verbal statements by salespersons, programmers, system analysts and others.
3. The Implied Warranties of Merchantability and Fitness
As noted above, a computer transaction is often defined by the express warranties, whether oral or written, made by the vendor or its salesman and technical employees. Most computer transactions also involve two implied warranties created under the UCC -- the implied warranty of merchantability and the implied warranty of fitness for a particular purpose.
UCC §2-314 creates an implied warranty of merchantability:
"(1) Unless excluded or modified (Section 2-316), a warranty that the goods shall be merchantable is implied in a contract for their sale if the seller is a merchant with respect to goods of that kind. Under this section the serving for value of food or drink to be consumed either on the premises or elsewhere is a sale.
"(2) Goods to be merchantable must be at least such as:
(a) pass without objection in the trade under the contract description; and
(b) in the case of fungible goods, are fair average quality within the description; and
(c) are fit for the ordinary purposes for which such goods are used; and
(d) run, within the variations permitted by the agreement, of even kind, quality and quantity within each unit and among all units involved; and
(e) are adequately contained, packaged, and labeled as the agreement may require; and
(f) conform to the promises or affirmations of fact made on the container or label if any.
"(3) Unless excluded or modified (Section 2-316) other implied warranties may arise from course of dealing or usage of trade."
UCC §2-314 thus provides that in any transaction where the seller is a "merchant" with respect to the goods, a warranty of merchantability is created. The warranty of merchantability essentially means that the goods will pass without objection in the trade and are fit for the ordinary purposes for which the goods are used. In a computer transaction, merchantability means that the computer system (or hardware or software if sold separately) will work in a reliable, trouble-free manner and that the computer system will produce data which is reliable and correct.
The second implied warranty in most computer transactions is the implied warranty of fitness for a particular purpose. UCC §2-315 provides:
"Where the Seller at the time of contracting has reason to know any particular purpose for which the goods are required that the Buyer is relying on the Seller's skill or judgment to select or furnish suitable goods, there is unless excluded or modified under the next section an implied warranty that the goods shall be fit for such purpose."
Section 2-315 of the UCC thus provides that if the seller has reason to know the buyer's particular requirements and that the buyer is relying upon the seller's recommendation, an implied warranty will arise that the goods will be suitable for the buyer's particular purposes.
These UCC implied warranties -- of merchantability and fitness for a particular purpose -- thus serve two different purposes. The warranty of merchantability provides only that the computer system will serve the ordinary purposes for which it is used. In contrast, the warranty of fitness for a particular purpose ensures that a buyer, who reasonably relies upon the seller's judgment in recommending a computer system, will be protected in the event the computer system fails to satisfy the buyer's particular needs.
Few computer cases discuss the warranty of merchantability in detail. The reason for this is clear. If the requirements of UCC §2-315 are satisfied such that a warranty of fitness for a particular purpose arises, or if an express warranty was breached, then it is unnecessary for the court to determine whether a warranty of merchantability has also been breached. Indeed, this was the case in Chatlos Systems v. National Cash Register Corporation, 479 F. Supp. 738 (D.N.J. 1979), aff'd and remanded 635 F.2d 1081 (3rd Cir. 1980), appeal after remand 670 F.2d 1304 (1982), where the district court, in a computer breach of warranty/fraud case, noted that because it concluded that "NCR breached express warranty and the implied warranty of fitness for a particular purpose, it is unnecessary to discuss and rule upon whether there existed an implied warranty of merchantability and if so, whether it was breached." 479 F. Supp. at 743 n.2.
As noted above, most computer law decisions find liability on the basis of express warranties and the implied warranty of fitness for a particular purpose. The warranty of fitness is directed not to the general standard of a computer system's performance, but rather to whether a system is suitable to a buyer's particular needs. In Chatlos Systems v. National Cash Register Corp., NCR held out in order to have expertise in the computer field. After the plaintiff made NCR's salesman aware of its particular needs, the salesman recommenced a particular computer system which, the salesman stated, would meet those needs. The Court found that NCR was well aware that the plaintiff was relying upon its skill and judgment. As a result, the court concluded that an implied warranty of fitness under UCC 2-315 arose. See also, Computerized Radiological Service v. Syntex, 595 F. Supp. 1495 (E.D.N.Y. 1984).
With regard to the implied warranty of fitness for a particular purpose, arising under UCC 2-315, it may be possible to argue that such a warranty was created that the computer system would be able to process data in the year 2000 and beyond. If so, a Year 2000 defect would breach that implied warranty. For example, if your client acquired a computer system in 1996 and told the vendor that it needed a system which could be used for at least seven years, and the vendor recommended hardware and/or software, then it is arguable that an implied warranty was created that the system would perform into the year 2000 without the need for Year 2000 remediation. Of course, each case must be evaluated on its own facts. For example, it would be more difficult to establish such an implied warranty of fitness if the computer system were acquired 10 or 15 years ago.
The implied warranty of merchantability arising under UCC 2-314 might also be available to support a Year 2000 breach of warranty claim against a prior vendor. For example, it may be possible to argue that one of the "ordinary purposes" of a client's computer is to process data year-to-year into the next century. After all, there is nothing particularly special or mystical about this requirement. As a result, a court could hold that implied warranty of merchantability includes a warranty that the computer would process data reliably in the year 2000 and beyond. As with the implied warranty of fitness for a particular purpose, however, the rights of a user, whether in connection with a Year 2000 remediation contract and/or a claim against a prior vendor, may be limited by contractual exclusions or modifications of warranties (see UCC 2-316), and any limitations on the user's remedies (see UCC 2-719). We will now turn to these sections of the Code.
4. Exclusion or Modifications of Warranties Under UCC 2-316
As noted earlier in these materials, if there are no exclusions or modifications in the contract, every contract for the sale or license of hardware and/or software governed by the UCC contains an implied warranty of merchantability and, if the seller has reason to know of a particular purpose for which the goods are required, an implied warranty of fitness for a particular purpose. Express warranties are created if the seller makes an affirmation of fact or promise to the buyer which becomes part of the bargain between the parties.
How does a vendor effectively exclude express and implied warranties? Section 2-316 of the Uniform Commercial Code provides:
"(1) Words or conduct relevant to the creation of an express warranty and words or conduct tending to negate or limit warranty shall be construed wherever reasonable as consistent with each other; but subject to the provisions of this Article on parol or extrinsic evidence (Section 2-202) negation or limitation is inoperative to the extent that such construction is unreasonable.
"(2) Subject to subsection (3), to exclude or modify the implied warranty of merchantability or any part of it the language must mention merchantability and in case of a writing must be conspicuous, and to exclude or modify any implied warranty of fitness the exclusion must be by a writing and conspicuous. Language to exclude all implied warranties of fitness is sufficient if it states, for example, that 'There are no warranties which extend beyond the description on the fact hereof.'
"(3) Notwithstanding subsection (2)
(a) unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like "as if", "with all faults" or other language which is common understanding calls the buyer's attention to the exclusion of warranties and make plain that there is no implied warranty; and
(b) when the buyer before entering into the contract has examined the goods or the sample or model as fully as he desired or has refused to examine the goods there is no implied warranty with regard to defects which an examination ought in the circumstances to have revealed to him; and
(c) an implied warranty can also be excluded or modified by course of dealing or course of performance or usage of trade.
"(4) Remedies for breach of warranty can be limited in accordance with the provisions of this Article on liquidation or limitation of damages and on contractual modification of remedy (Section 2-718 and 2-719)."
Most courts have held that it is nearly impossible to disclaim an express warranty. See Gladden v. Cadillac Motor Car Division, 83 N.J. 320, 330 (1980). However, in commercial, non-consumer sales, the implied warranty of merchantability and fitness for a particular purpose may be easily disclaimed. Under UCC §2-316, a disclaimer of warranty of merchantability must mention "merchantability" and, if in writing, be conspicuous. To exclude or modify an implied warranty of fitness, the exclusion must be in writing and conspicuous. "Conspicuous" is defined in §1-201(10) of the UCC as follows:
"A term or clause is conspicuous when it is so written that a reasonable person against whom it is to operate ought to have noticed it . . . language in the body of a form is 'conspicuous' if it is in larger or other contrasting type or color. . ."
In Office Supply Co., Inc. v. Basic/Four Corp., 538 F.Supp. 776 (E.D. Wisc. 1982), the district court held that the disclaimer of warranty provision was not conspicuous because the disclaimer was on the reverse side of the contract, it was not near the buyer's signature line, and, although italicized, the provision only slightly contrasted with the remainder of the contract. However, the district court followed a line of cases which held that if a buyer is actually aware of a warranty disclaimer, then the disclaimer would be effective even if not conspicuous. In Office Supply Co., Inc., plaintiff's representative had, in fact, read the disclaimer and it was, therefore, enforceable although not conspicuous.
Most vendor form contracts contain a provision excluding all implied warranties. A typical exclusion or modification of warranty provision, complying with UCC §2-316, reads as follows:
"EXCEPT AS SET FORTH HEREIN, THERE ARE NO WARRANTIES EXPRESS OR IMPLIED INCLUDING BUT NOT LIMITED TO THE WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE."
UCC §2-316(4) also states that remedies for breach of warranty can be limited in accordance with the provisions of Sections 2-718 and 2-719, which relate to limitations on the buyer's damages and remedies. Thus, a vendor's form of contract typically contains two additional provisions. First, the agreement states that the remedy available to the buyer's computer system is limited to replacement or repair of defective parts. Second, the contract often provides that the vendor shall have no liability for consequential damages. These UCC provisions are discussed at length in Sections (G) and (H) below.
As with the sections discussed earlier, the Year 2000 Crisis implicates UCC 2-316 in two different ways. First, when contracting for remediation hardware or software to remedy the Year 2000 problem, an attorney negotiating and drafting the agreement must be aware that typically a vendor may attempt, by using the "magic" words required by UCC 2-316, to eliminate from the agreement all express and implied warranties except those specifically expressed in the contract document itself. The vendor will attempt to exclude all express warranties made by its representatives, orally and in writing, as well as the implied warranties of merchantability and fitness for a particular purpose. It is important to be aware of the consequences of this contract language and, if necessary, try to eliminate it from the final version of the agreement. Of course, if all the warranties and representations relied upon by your client -- including an express warranty that the computer is Year 2000 compliant -- are carefully and expressly set forth in the agreement, then the language limiting or excluding warranties will be of much less concern since a court will clearly enforce the express warranties set forth in the written contract, despite the language attempting to exclude them.
However, UCC 2-316 could conclusively determine whether a prior vendor is liable for damages resulting from a Year 2000 problem. If your client seeks to rely upon an express warranty made outside the four corners of the prior written agreement to establish liability, such reliance may be prevented by the parol evidence rule contained in UCC 2-202 (see discussion below). If your client seeks to rely on the implied warranties of merchantability, they will not be available if the agreement contained language meeting the requirements of UCC 2-316. Of course, a contractual exclusion or limitation of warranties will not be enforceable if it is shown that the user was fraudulently induced by the vendor into signing the agreement. In any event, it is likely that a prior vendor will try to shield itself from Year 2000 liability by using the warranty disclaimer in the agreement.
5. The Parol Evidence Rule
As noted above, oral or written statements, even if they are express warranties under UCC 2-313, would be inadmissible if the agreement contains a "merger" or "integration" clause. For contracts governed by the UCC, this issue is covered in UCC 2-202, which is the Code's version of the traditional parol evidence rule.
The parol evidence rule and UCC §2-202 preclude the use of parol or extrinsic evidence to contradict the terms of the written document intended to be the final agreement of the parties. The court may consider evidence of consistent, additional terms unless it finds the writing to have been intended also as a complete and exclusive state of the terms of the agreement. To this end, a vendor's form contract often will contain an integration or merger clause which is intended to demonstrate that the written contract is the final agreement of the parties and that no prior or contemporaneous oral representations by a salesman or others should be admissible. A typical integration or merger clause will read as follows:
"This agreement constitutes the entire agreement, understanding, and representing, express or implied, between the parties with respect to any equipment or services provided hereunder. This Agreement supersedes all prior statements, whether written or oral, and all oral or written proposals."
An integration clause may present the vendor with a defense to claims that a computer salesman made additional oral or written representations and warranties regarding the suitability of the computer system. Although some courts have found that an integration clause will not bar extrinsic evidence of such representations, see Chatlos Systems v. National Cash register Corp., supra; Acme Pump Company, Inc. v. National Cash Register Co., 337 A.2d 672 (Ct. Com. Pl. Conn. 1974), most courts have held that an integration clause will effectively bar such evidence, see Bakal v. Burroughs Corporation, 43 N.Y.S. 2d 541 (Sup. Ct. 1972). Of course, there are a number of exceptions to this rule such as where parol evidence is offered to explain an ambiguity, or to show duress, or to establish fraud in the inducement.
In the context of the Year 2000 Crisis, this section of the Code can have dramatic consequences. Why so? If a user is seeking to establish the liability of a prior vendor for Year 2000 damages, it is likely to rely upon either statements made outside the four corners of the agreement or upon the implied warranties of merchantability and fitness for a particular purpose. As noted earlier, the implied warranties would likely be effectively excluded by contract language meeting the requirements of UCC 2-316. An express statement outside the document would be inadmissible under UCC 2-202 if the contract document is fully integrated by virtue of a merger or integration clause. In this event, a user, though promised by a salesman that the system could be used well into the next century, would have no recourse in a breach of warranty action.
6. The User's Right of Rejection
The Code has a series of provisions governing acceptance, rejection and revocation of acceptance of goods which can have grave implications for a user seeking to assert a Year 2000 claim against a prior vendor. If a computer transaction is governed by Article 2 of the UCC, then those UCC provisions in Section 2-601 et seq. governing acceptance and rejection of goods will apply.
UCC §2-602 governs the manner in which the buyer must reject computer technology. The user of a computer system or hardware or software must reject the goods within a reasonable time after their delivery or tender. UCC §2-605 essentially provides that the buyer rejecting computer technology particularize, in writing, defects which are ascertainable by a reasonable inspection. Failure to particularize these defects will preclude the buyer from relying on the unstated defects to justify his rejection or to establish the vendor's breach where the vendor could have cured the defect. §2-606 provides, inter alia, that acceptance of a computer technology occurs when the buyer fails to make an effective rejection when he has had a reasonable opportunity to inspect the computer system.
Taken together, the foregoing UCC sections provide that the user of a computer system, or hardware or software, has the duty to inspect the technology and to notify the seller of his rejection, if any, within a reasonable period of time. Failure to so notify the seller will constitute an acceptance of the goods. Moreover, failure to accompany rejection with a particularization of observable defects may preclude the buyer from relying upon those defects in establishing his breach of warranty claim. These UCC provisions, as well as those relating to the subsequent revocation of acceptance (UCC §2-608), will apply to computer products covered by Article 2 of the UCC. As a result, a vendor may successfully argue that the buyer has waived his rights and accepted the goods, where the buyer has failed to reasonably reject the computer system, or where, if properly rejected, the buyer has failed to particularize the defects.
In the case of a Year 2000 problem, a user asserting a breach of warranty, under the Code, must have rejected the goods within a reasonable period of time after delivery or tender, and provided the seller an adequate opportunity to correct the date field problem. Alternatively, a user can try to revoke its acceptance and notify the vendor of the defect. However, under the Code, such revocation of acceptance can only be for "material" defects (arguably, the date field defect is "material"), and only if it is done within a reasonable period of time after the user "discovers or should have discovered the ground for it and before any substantial change in the condition of the goods which is not caused by their own defects. It is not effective until the buyer notifies the seller of it." UCC 2-608 (2).
Since most computer systems with a Year 2000 problem have been "accepted" under the Code, the user must try to meet the requirements for revocation of acceptance should it wish to reject the technology for Year 2000 defects. Because of the requirements of section 2-608, it may be difficult for a buyer, who has used a system for years and likely modified the software (or hardware), to claim it has effectively revoked its acceptance.
Why should you be concerned about whether the user has effectively rejected the technology or revoked it acceptance? The answer is clear. Under the UCC, the measure of damages for accepted goods (UCC 2-714) is significantly different and, likely, more restricted than when the goods have been rejected (UCC 2-713). Some courts have found that although an aggrieved purchaser would be entitled to consequential damages under a breach of warranty for rejected goods, that same buyer would not be entitled to such damages if the goods were accepted. As you can see, compliance with the Code's provisions governing rejection and revocation of acceptance can be very important to the success of a claim against a prior vendor.
7. Limitation on Consequential Damages
Even if a user can navigate the thicket of warranties, disclaimers, exclusions, and acceptance/rejection provisions, there is still another hurdle. Most computer contracts contain a limitation on the buyer's right to recover consequential damages.
The UCC provides that an aggrieved buyer in many cases is entitled to recover its consequential damages, i.e., "any loss resulting from general or particular requirements or need of which the seller at the time of contracting had reason to know . . ." UCC 2-715.
Consequential damages includes all damages reasonably foreseeable from a breach at the time of contracting, including lost profits and unrealized, but less anticipated savings. Teamsters Security Fund v. Sperry Rand Corp., 6 C.L.R.S. 951 (N.D. Cal. 1971).
The UCC, however, expressly allows the parties to shift the risk of consequential loss from the seller to the buyer. UCC §2-719(3) states that "consequential damages may be limited or excluded unless the limitation for exclusion is unconscionable." Limitation of consequential damages for personal injury in the case of consumer goods is prima facie unconscionable, but limitation of damages where the loss is commercial is not. Thus, under the Code, a limitation on consequential damages is presumed to be valid in a commercial setting.
Even in a commercial setting, a limitation on the buyer's right to recover consequential damages will be unenforceable if unconscionable. Among the factors relevant to determining unconscionability in a commercial setting are the length of the negotiation process, the length of time the buyer has to deliberate before signing the contact, the experience or astuteness of the parties, whether counsel reviewed the contract and whether the buyer was a reluctant purchaser. The commercial setting, and the purpose and effect of the allegedly unconscionable limitation clause, are also relevant as is the extent of the seller's default in attempting to fulfill its obligations on a remedy to repair. Office Supply Co., Inc. v. Basic/Four Corp., 538 F. Supp. 776, 788 (E.D. Wisc. 1982).
Recent case law also distinguishes between procedural unconscionability and substantive unconscionability. While it may be almost impossible for a commercial user to show the limitation on consequential damages was procedurally unconscionable, it may be able to show that the application of the provision to a Year 2000 claim is substantively unconscionable. See NEC Technologies, Inc. V. Nelson, 478 S.E.2d 769 (Ga. 1996). Most computer cases have upheld the limitation of damages provision since it is difficult to prove procedural or substantive unconscionability. However, it should be noted that in Consolidated Data Terminals vs. Applied Digital Data Systems, 708 F. 2d 385 (9th Cir. 1983), the court held that a consequential damages exclusion would be unenforceable where there was a design defect in the entire product line of computers.
Whether the damages sustained in a Year 2000 Crisis are "direct" or "consequential" will be important where the only damages excluded by the contract are "consequential." To determine whether an item of damage falls within one category or another is beyond the scope of this paper. (For an excellent discussion of this distinction, see Applied Data Processing v. Burroughs Corp., 394 F.Supp. 504 (D. Conn. 1975)).
8. Limitations on the User's Remedies
Frequently, a vendor's contract contains language limiting a buyer's remedy such as to "replacement or repair". If the contract states that this is the buyer's "sole" or "exclusive" remedy, then it will meet the requirements of UCC 2-719 and be enforced. However, many cases have held that where a limited remedy such as "replacement or repair" fails of its essential purpose (i.e., the seller is unwilling or unable to replace or repair within a reasonable time), the contractual limitation on consequential damages becomes unenforceable. In other words, the limited remedy provision and the limitation on consequential damages are "interdependent" and not "independent" of each other. Compare Chatlos Systems, Inc. v. National Cash Register Corp., 635 F.2d 1081 (3rd Cir. 1980) with RRX Industries v. Lab-Con, Inc., 772 F.2d 543 (9th Cir. 1985).
If a user seeks to assert a Year 2000 claim against a prior vendor, it will likely encounter the argument that the damages sought are "consequential" and thus limited by the contract language. If you represent the aggrieved user asserting a breach of warranty claim, you would then have to argue either that the damages sought are not "consequential" and, thus, not covered by the clause, or (1) that the clause is unenforceable because it is procedurally or substantively unconscionable or (2) that it is unenforceable because the limited remedy of replacement or repair failed of its essential purpose.
8. The Four Year Statute of Limitation
As noted earlier, most cases now hold that the acquisition of hardware and software, whether on a "turnkey" basis or separately, are transactions governed by Article 2 of the UCC. It is important to note that Article 2 contains its own statute of limitation. Section 2-725 of the UCC provides that:
"(1) An action for breach of any contract for sale must be commenced within four years after the cause of action has accrued. By the original agreement the parties may reduce the period of limitation to not less than one year but may not extend it.
"(2) A cause of action accrues when the breach occurs, regardless of the aggrieved party's lack of knowledge of the breach. A breach of warranty occurs when tender of delivery is made, except that where a warranty explicitly extends to future performance of the goods and the discovery of the breach must await the time of such performance the cause of action accrues when the breach is or should have been discovered.
"(3) Where an action commenced within the time limited by subsection (1) is so terminated as to leave available a remedy by another action for the same breach such other action may be commenced after the expiration of the time limited and within six months after the termination of the first action unless the termination resulted from voluntary discontinuance or from dismissal for failure or neglect to prosecute.
"(4) This section does not alter the law on tolling of the statute of limitations nor does it apply to causes of action which have accrued before this act becomes effective."
In many states, the four year period of limitation set forth in UCC §2-725 differs from the period of limitation for ordinary breach of contract actions, which maybe six years from the date of accrual of a cause of action, or perhaps longer. Thus, an attorney engaged to file a year 2000 suit on behalf of an aggrieved computer user must be cognizant of the four-year period of limitation and not simply rely upon the normal statute applicable to breach of contract actions.
Moreover, UCC §2-725 provides that the parties can agree to shorten (but not extend) the four year period. UCC §2-725 states, in pertinent part:
"(1) An action for breach of any contract for sale must be commenced within four years after the cause of action has accrued. By the original agreement the parties may reduce the period of limitation to not less than one year but may not extend it."
Computer vendors often insert in their form contracts provisions shortening the period of limitation. For example, a computer contract may provide that:
"Any action hereunder for a breach or violation of any of the terms, conditions or covenants herein must be commenced within one year from the date hereof."
To an unwary lawyer, this provision may seem totally innocuous and fair to both parties. However, experience demonstrates that it often requires many months to determine whether a computer system conforms to the contract requirements. Moreover, it is not unusual for vendors to request and be granted significant additional time to correct the problems in the computer system. As a result, a contract provision arbitrarily shortening the applicable period of limitation may have drastic consequences. For a more complete discussion of the statute of limitation, see Dreier Co., Inc. v. Unitronix Corp., 218 N.J. Super. 260 (App. Div. 1986).
The four-year statute of limitation may have grave consequences for a user who seeks to assert a Year 2000 breach of warranty claim. First, it is important to note that this statute of limitation starts running from the tender of delivery, irrespective of the buyer's knowledge of the date field problem. So, many aggrieved users asserting Year 2000 claims will likely be barred by this section. To make matters worse, many computer contracts contain clauses shortening the period of limitation to as little as one year. It is axiomatic that many computer users have had their technology for several years such that their Year 2000 claims may be barred. Of course, if a user is able to establish fraud in the inducement, the statute of limitations may be longer and, in any event, it will start running when the fraudulent conduct of the prior vendor was discovered or when it should have reasonably been discovered by the user. See UCC 1-103.