Software providers and resellers should review their contracts after major new court ruling

The supply of software by electronic means (not on any physical hardware) now constitutes a sale of goods under the Commercial Agents (Council Directive) Regulations 1993 (“Regulations"). In the keenly anticipated judgment from long-running case The Software Incubator Ltd v Computer Associates UK Ltd, the Court of Justice of the EU has provided a landmark judgment with far-reaching implications. The full decision is available here.

What does this mean in practice?

The decision is likely to be of major significance to software resellers operating as commercial agents, who will now benefit from the financial protections of the Regulations even where the software is made available to customers to download (rather than provided on USB drive, CD, DVD, etc.).

By extension, this is equally significant for software providers who, as principals, engage resellers to market and supply their software to customers via download.

Potential payouts from software providers to resellers

The relevant financial protections of the Regulations arise on termination of the agency agreement. For agents selling goods (which these software resellers now are), on termination of the agreement, many are likely to be entitled to "compensation" payments, rather than "indemnity" payments. Indemnity payments are capped at one year's average commission, whereas compensation payments are generally calculated on the basis of the commission the agent would have been paid over the whole term of the contract.

Clearly compensation payments will prove significantly more lucrative for agents, and therefore considerably more expensive for principals. 

The wider context - how to define "software"

The facts of the case are that Computer Associates UK (“CAUK”, the manufacturer/marketer of the software) contracted with The Software Incubator (“TSI”, the agent/reseller of CAUK’s software) whereby TSI, as the agent of CAUK, approached potential customers for the purpose of promoting, marketing and selling CAUK’s software. CAUK terminated the contract and TSI brought a claim for compensation pursuant to the Regulations. CAUK argued the electronic supply of software does not constitute a sale of goods under the Regulations. The case went to the Supreme Court which chose to refer to the Court of Justice of the EU to determine this specific point of law.

The question for the Court was whether the electronic supply of software could constitute a sale of goods under the Regulations.

The courts have historically struggled to classify intangible goods, particularly software. Given the increased importance and size of the market in commercial software in recent decades, this has proven an increasingly difficult position to maintain. Software has frequently tended to exist in a judicial limbo, never falling neatly into the categories of goods or services. Courts had tried to assert that the medium of delivery of the software was critical (that is, goods must always be tangible items such as CDs or DVDs), however this has been increasingly difficult to justify in practice, with the commercial reality being that the software industry has moved predominantly to digital downloads for more than a decade.

The decision - can software now be classified as "goods"?

The Court of Justice decided that the supply of electronically-supplied software, provided for a fee and on a perpetual licence, can constitute a "sale of goods" under the Regulations.

This analysis was rationalised on the basis that downloading software is the "functional equivalent" of providing it on a physical medium (such as USB, CD or DVD), and there would effectively be a transfer of ownership of a copy of software where it is provided to the end-user "permanently" (that is, on a perpetual licence) and where that transfer is valued in money (that is, provided in exchange for a fee).

Potential exceptions

From this decision, the winners appear to be software resellers, while the losers will be the software providers potentially forced to pay out.

However, as ever, there are nuances to consider. This decision needs to be considered in its proper context.

First, the judgment is clear that software will only be considered goods when it is sold on a perpetual licence. As such, software sold on any terms other than a perpetual licence is unlikely to represent a "sale of goods" and potentially falls beyond the scope of the Regulations. Where software is sold under a range of licensing models (as is frequently the case), this may create uncertainty.

Second, this judgment does not expressly relate to software-as-a-service (SaaS). SaaS never involves the transfer of software on a physical medium to end-users, and it will be hosted remotely in the cloud (rather than software being downloaded on a user's computer). There is no traditional licence as such, instead the service is made available, frequently on a subscription basis (rather than a perpetual right of access). With SaaS, the software is accessed remotely through the internet (as a service). While a SaaS reselling industry has grown in recent years, on the facts of this case, it is difficult to see the logic of the Court's decision applying to SaaS.

Finally, this decision relates to the interpretation of the Regulations. The legal position under the Sale of Goods Act 1979 and the Supply of Goods and Services Act 1982 has not changed, which will have a broader application to many operators in the UK software market. Nevertheless, the current decision is likely to carry considerable weight when a case is next brought under these separate pieces of legislation in respect of licensed software.

The case will now go back to the Supreme Court. While we await its judgment, the Supreme Court is bound to follow the Court of Justice's ruling post-Brexit under the terms of the UK/EU Withdrawal Agreement. The Supreme Court's judgment will be closely monitored.

What should software providers and resellers do now?

Given the potential for significantly larger contractual payments, software providers (and resellers) should now review their reseller agreements to determine their potential financial exposure on termination of these agreements. The agency relationship is one of fact, rather than what is stated in the agreement. Therefore an audit of existing agreements would be a prudent next step, with software providers looking to agree a variation or restructure sooner rather than later to help reduce potential financial exposure.

If you are a software business (either a provider or reseller), we recommend you review your existing reseller arrangements in the light of this decision. Ashfords' Technology team can guide you through this and help protect your business.

For more information or advice, please contact Brett Lambe.

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