This article was presented at a Massachusetts Business Litigation seminar held in Boston, Massachusetts in 1986
The enormous growth in the business market for computers over the last several years has resulted in a tremendous increase in the potential for user dissatisfaction and litigation. There have already been significant recoveries against defendants and in future years it will be the rare commercial litigator who doesn’t have some exposure to a suit against a computer manufacturer or software developer which alleges delivery delay, delivery failure or failure of an installed system to perform adequately.
A lawyer inexperienced in cases of this sort faces the following practical and legal challenges:
– Frequently, he or she must make a substantial investment of time learning the basic principles of hardware and software technology in order to communicate effectively with the clients, expert witnesses and technical advisors
– Typically, there will be several defendants who will blame each other for any problem. Potential defendants include:
– hardware manufacturer
– third party software supplier
– original equipment manufacture (OEM) or value added reseller (VAR) (OEM or “original equipment manufacturer” is the industry term for a company which purchases computer hardware and systems software from a vendor and adds value in the form of applications software or other components and then resells both the hardware and software at a markup to end users.)
– system integrator
– equipment broker
– third party maintenance organization
– The problem of “finger pointing” defendants is exacerbated when the problem is not a defect with any one component but rather incompatibility between components, peripherals or software.
– There will almost certainly be warranty disclaimer and limitation of liability clauses in the contracts and license agreements, both between the end user (plaintiff) and defendants and between defendants.
– There may be legal and factual issues relating to whether there has been a “failure of essential purpose” which will allow the plaintiff to overcome warranty disclaimers. See discussion, infra .
– There may be issues relating to whether the sale/license of software is the “sale of goods” and therefore is subject to the rules of the Uniform Commercial Code, or to what extent a “bundled” sale of hardware and software is controlled by the U.C.C.
– There are problems associated with proving and maximizing the plaintiff’s damages.
II. Application of the Uniform Commercial Code
A. Sales of “Goods” . Article 2 of the Uniform Commercial Code, which in Massachusetts is found at M.G.L. c. 106 secs. 1-101 et seq ., applies to the sale of goods within the meaning of UCC sec. 2-105. The UCC does not apply to services. Typically, there is no issue regarding the applicability of the UCC to sales of hardware. Issues as to the applicability of the UCC arise where the transaction is something other than on outright sale.
1. Licenses and Leases . The UCC speaks in terms of “sales” of goods. Under section 2-106 (1) a “sale” involves “the passing of title from the seller to the buyer for a price.” However, the fact that a transaction is in the form of a license or a lease rather than a sale does not exclude it from UCC coverage. If the economic reality of the transaction is equivalent to that of a sale, the courts will generally apply the UCC, regardless of how the transaction is denominated. See, e.g., McIlroy Bank & Trust v. Seven Day Builders of Arkansas, Inc. , 1 Ark. App. 121, 613 S.W. 2d 837 (1981).
2. Mixed goods and services transactions . Courts in different jurisdictions have taken different approaches when dealing with mixed goods and services transactions. Some courts have divided the elements and treated them separately. See, e.g., Raritan Trucking Corp. v. Aero Commander, Inc. , 458 F.2d 1106 (3rd Cir. 1972), while others have determined whether goods or services are the predominant element and treated the other element as incidental. See, e.g., Coakly & Williams, Inc. v. Shatterproof Glass Corp. , 706 F. 2d 156 (4th Cir. 1983). Some courts have focused merely on the final product provided, Aluminum Co. of America v. Electro Flo Crop. , 451 F. 2d 1145 (10th Cir. 1971), while others have determined the applicability of Article 2 on public policy consideration. See, e.g., Newmark v. Gimbel’s Inc. , 54 N.J. 585, 258 A. 2d 697 (1969); Worrell v. Barnes , 87 Nev. 204, 484 P.2d 573 (1971).
B. Software: “Good” or “Service ”? There is an issue as to whether software alone is a “good” or a “service” under the UCC. The judicial trend seems to be in the direction of recognizing software as a good, and therefore making it subject to the UCC.
– In RRX Industries, Inc. v. Lab-Con, Inc. 772 F.2d 543 , (9th Cir. 1985), the court held that custom software licensed for use in a medical laboratory was goods within the meaning of the UCC. The court stated:
“In determining whether a contract is one of sale or to provide services we look to the essence of the agreement . . . . when a sale predominates, incidental services provided do not alter the basic transaction . . . . Because software packages vary depending on the need of the individual consumer, we apply a case-by-case analysis.
* * * * *
Here, the sales aspect of the transaction predominates. The employee training repair services, and system upgrading were incidental to sale of the software package and did not defeat characterization of the system as a good.”
– In Triangle Underwriters, Inc. v. Honeywell, Inc. , 457 F. Supp. 765 (E.D.N.Y. 1978), aff’d in part and rev’d and remanded on other grounds , 604 F.2d 737 (2d Cir. 1979), the court found that software was a good in the context of a turnkey system. After concluding that the sale of a turnkey system did not consist principally of the rendition of services, the court stated:
Although the ideas or concepts involved in the customer designed software remained Honeywell’s intellectual property, Triangle was purchasing the product of those concepts. That product required efforts to produce but it was a product nevertheless and, though intangible, is more readily characterized as “goods” than “services.” Intangibles may be goods within the meaning of UCC sec. 2-106.
In Shapiro, Budrow & Associates, Inc. v. Microdata Corporation , 84 Civ. 3589 (S.D. N.Y. Feb. 24, 1986), the court assumed without discussion that UCC warranties extended to the sale of software in a mixed hardware/software transaction.
But see Hartford Mut. Ins. Co. v. Seibels, Bruce and Co. , 579 F. Supp. 135 (D. MD. 1984), where the court held that whether software constituted goods is a question of fact to be determined by a jury.
See also Note, Computer Software as a Good Under the Uniform Commercial Code: Taking the Byte Out of the Intangibility Myth , 65 Boston University Law Review 129.
C. Policy issues relating to the software as goods or services issue
From the vendor perspective, UCC applicability would provide national uniformity of legal treatment. From the purchaser’s perspective, software usually is viewed as part of an overall system that is equated primarily with hardware, not intangible intellectual property.
III. Warranties and Warranty Disclaimers
A. Warranties Generally
UCC 2-313 broadly defines express warranties to include any affirmation of fact relating to the goods sold which becomes a part of the basis of the transaction between the seller and purchaser. Express warranties may be embodied in sales and promotional material, demonstrations of like equipment, manufacturer’s specifications or descriptions, and the representations of sales personnel, as well as explicit warranties in the contract itself.
UCC 2-314 and 2-315 create two implied warranties which accompany every sale of goods. Specifically, the implied warranty of mechantabilityrequires that the goods be fit for the ordinary purposes for which they were intended. The implied warranty of fitness for particular purposerequires that where the seller has reason to know that the purchaser is relying on the seller to select or furnish goods for a particular purpose, or that the purchaser is relying on the seller’s skill and judgment to provide goods for the purchaser’s specific needs, then the purchaser must provide goods that will so perform.
B. Warranty Disclaimers
UCC 2-316 permits a seller to exclude or modify all express warranties and, if certain technical requirements are met, to exclude or modify the implied warranties or merchantability and fitness for a particular purpose.
1. Relationship Between Warranty
Disclaimers and Integration Clause
UCC 2-316 (1) provides that the negation or limitation of warranties and words or conduct relevant to the creation of an express warranty “shall be construed wherever reasonable as consistent with each other.” Section 2-316 (1) also provides that “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.”
In effect, this means that if there is no integration or merger clause in the written agreement than it is not intended as a final expression between the parties, and therefore the purchaser can assert the existence of prior oral and written express warranties which could not have been disclaimed by the written agreement.
2. Limitations on Warranties and
UCC 2-719 permits the parties to limit by agreement what may be recovered by way of damages in the event of a breach of a sales contract. Typically, sellers limit purchasers’ remedies to the repair or replacement of non-conforming goods or parts.
UCC 2-719 also permits a contractual limitation on, or the total exclusion of, the recovery by the purchaser of consequential damages. Consequential damages include lost profits, loss of goodwill, liability and legal fees of purchasers to third parties, cost of unsuccessful attempts to repair warranted goods, and, generally, any loss that can be translated into monetary terms limited only by the common law Hadley v. Baxendaleforeseeability test.
See discussion in section V, A, 6, infra .
IV. Causes of Action
A. Breach of Contractual Warranty
Damages are available under UCC 2-714 and UCC 2-715 for breach of express and implied warranties, but this cause of action is subject to the disclaimer of warranties or limitation on damages by the seller. B. Fraud
Proving fraud is difficult in computer related cases, but if the action succeeds it has the advantage of completely overriding contractual limitations that may preclude a breach of warranty action. UCC section 2-721 provides that “remedies for material misrepresentation or fraud include all remedies available under this Article for nonfraudulent breach.” Thus, the plaintiff who is able to sustain an action for fraud gets the best of both worlds: a way around warranty disclaimers and damages limitations and the remedies provided by the Code.
Elements : The plaintiff must prove that
(1) defendant made a statement of material fact which it knew to be false or which was made with reckless disregard for the truth;
(2) defendant intended that plaintiff rely on the statement;
(3) reliance by the plaintiff; and
(4) damage to the plaintiff as a result of this reliance.
See the following cases:
Applications, Inc. v. Hewlett-Packard Co. , 501 F. Supp. 129 (S.D. N.Y. 1980). Contract found to exclude all express and implied warranties. Integration clause found to preclude parol evidence. Defendant’s motion for summary judgment allowed on breach of warranty claims. However, case ordered to proceed forward to trial on plaintiff’s cause of action for fraudulent misrepresentation. Moreover, defendant’s argument that plaintiff may not recover consequential damages on this count rejected, since “if plaintiff’s claims for fraudulent misrepresentation is heard at trial, the contractual limitation precluding recovery of consequential damages is ineffective.”
Invacare Corp. v. Sperry Corp. , 612 F. Supp. 448 (N.D. Ohio 1984). Contract clause providing that defendant shall not be liable for “incidental, indirect, special or consequential damages” of no effect if “the contract itself was induced through fraud.” Id .
See also Accusystems, Inc. v. Honeywell Information Systems, Inc., 580 F. Supp. 474 (S.D. N.Y. 1984); Computer System Engineering, Inc. v. Quantel Corp., 740 F.2d 59 (1st Cir. 1984); Badger Bearing Co. v. Burroughs Corp., 444 F. Supp. 919 (E.D. Wisc. 1977); Glovatorium, Inc. v. NCR Corp., 684 F.2d 658 (9th Cir. 1982); AMF, Inc. v. Computer Automation, Inc., 573 F. Supp. 924 (S.D. Ohio, W.D. 1983); Shapiro, Budrow & Associates, Inc. v. Microdata Corp., 84 Civ. 3589 (S.D. N.Y. Feb. 24, 1986).
Virtually all states refuse to allow recovery for purely economic loss incurred as a result of negligent design or manufacture of goods. See, e.g. ,Jones & Laughlin Steel v. Johns-Manville Sales , 626 F.2d 280, 287 (3rd Cir. 1980) (“a large majority of courts . . . have held that economic losses are not recoverable under claims sounding in tort law”). In Massachusetts this rule was recognized in Marcil v. John Deere Industrial Equipment Co. , 9 Mass. App. Ct. 625, 631 (1980). The court stated that “we . . . hold that the purchaser of a manufactured product who claims as damages only economic loss for damage caused by the product itself cannot maintain a claim for negligent design or manufacture.”
But see Invacare Corp. v. Sperry Corp. , 612 F. Supp. 448 (D. Ohio 1984). In this highly confusing opinion, the court denied the defendant’s motion for summary judgment in the sale of a computer system, stating that “Negligence in a business setting is clearly actionable.” Id . at 453.
D. Computer or “Professional”
In an interesting twist to the negligence theory some buyers have attempted to impose liability on the basis of professional malpractice. This theory has been rejected in Triangle Underwriters, Inc. v. Honeywell, Inc., 604 F. 2d 737 (2d Cir. 1979) and Chatlos Systems, Inc. v. National Cash Register Corp. , 479 F. Supp. 738 (D. N.J. 1979), aff’d , 635 F.2d 1081 (3rd Cir. 1980). In Chatlos the court expressly rejected the invitation to create a new tort of “computer malpractice,” stating: “Plaintiff equates the sale and servicing of computer systems with established theories of professional malpractice. Simply because an activity is technically complex and important to the business community does not mean that greater potential liability must attach.” Id . at 741 n. 1.
E. Negligent Recommendations
The theory of negligent recommendation is not that the defendant is liable for having sold defective or nonconforming goods to the plaintiff (although the defendant may have sold hardware of software to the plaintiff), but that the defendant recommended to the plaintiff that it use the services or products of another vendor, such as a hardware peripherals manufacturer or a software developer. See Shore v. Tandy Corp. , Civ. No. 85-4373 (E.D. Pa. March 1986), where the plaintiff alleged that Tandy had negligently recommended a programmer to provide services to the plaintiff. After a trial, the court found held Tandy not liable, finding that the plaintiff had been able to independently assess the programmer’s capabilities and that the plaintiff had retained the programmer without relying on Tandy’s recommendations.
F. Strict Liability
Strict products liability is not a viable theory on which to recover for purely economic loss.
V. Overcoming Contractual Warranty Disclaimers and Damages Limitations
In the typical case, the biggest problem that the plaintiff faces is getting past the contractual warranty disclaimers and damages limitations. Absent an exception, the rule in almost all jurisdictions is that such contractual provisions are effective as to the sale of commercial goods. See e.g . ,Transurface Carriers, Inc. v. Ford Motor Co. , 738 F.2d 42 (1st Cir. 1984);Marcil v. John Deere Industrial Equipment Co. , 9 Mass. App. Ct. 625, 631 (1980); New England Watch Co. v. Honeywell, Inc. , 11 Mass. App. Ct. 899 (1981).
A. Failure of Essential Purpose
1. Section 2-719 (2)
Plaintiffs’ attorneys have experienced the greatest success in overcoming contractual limitations on warranties and damages by asserting the “failure of essential purpose doctrine.” UCC section 2-719 (2) provides:
“Where circumstances cause an exclusive or limited remedy to fail of its essential purpose, remedy may be had as provided in this Act.”
2. “Repair and Replace” Warranties
Before turning to some of the cases which have applied this section of the UCC, it is important to have in mind a typical or “model” contractual disclaimer. Sellers rarely cut off purchasers from all remedies (to do so would be to risk an unconscionability argument by the purchaser). Rather, the standard approach is the “repair and replace” warranty together with a complete exclusion of damages. A typical “repair and replace” clause is as follows:
Vendor warrants that at the time of delivery of PRODUCT and for a period of one (1) year thereafter, PRODUCT will be free from defect in materials and workmanship. During the one (1) year warranty period, Vendor will repair or replace , at its option, any defective products or parts at no additional charge. THE FOREGOING WARRANTY IS IN LIEU OF ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING, BUT NOT LIMITED TO, THE IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. (italicized emphasis added).
Note that in this clause the seller has properly disclaimed the implied warranties of merchantability and fitness for particular purpose by expressing the disclaimers in a “conspicuous manner” and using the magic word “merchantability,” as required by UCC section 2-316 (2).
3. Limitation on Damages
In addition to the above “repair and replacement” warranty disclaimer, the typical contract will contain a limitation on damages in the nature of the following:
Except as specified in this paragraph or elsewhere in this agreement, Vendor shall not be liable for any loss or damage that may arise in connection with the furnishing, performance or use by Purchaser of the PRODUCT including, without limitation, any incidental or consequential damages, expenses, lost profits, lost savings, or other damages arising out of the use of inability to use the PRODUCT. The remedies of Vender set forth under [the paragraph disclaiming warranties] shall be the sole and exclusive remedies of the Purchaser for any breach of any obligations of Vendor hereunder or otherwise and in no event shall Purchaser be entitled to any monetary damages against Vendor.
4. Cumulative Effect of Warranty Disclaimer and Limitation on Liability Clauses
Before turning to some of the cases which have applied this section of the UCC, it is important to have in mind a typical or “model” contractual disclaimer. Sellers rarely cut off purchasers from all remedies (to do so would be to risk an unconscionability argument by the purchaser).
The combination of warranty disclaimers and limitations on liability illustrated by these two contract clauses has proven extremely effective for vendors. The case law is replete with cases which have been dismissed on summary judgment based on similar provisions.
See, e.g., Office Supply Co., Inc. v. Basic/Four Corp. , 538 F. Supp. 776 (E.D. Wisc. 1982); Samuel Black Co. v. Burroughs Corp. , 33 UCC Rep. Serv. 954 (D. Mass. 1981); Jaskey Finance and Leasing v. Display Data Corp. , 564 F. Supp. 160 (E.D. Pa. 1983); Bruffy Contracting Co. Inc. v. Burroughs Corp. , 522 F. Supp. 769 (D. Md. 1981); Applications Inc. v. Hewlett-Packard Co. , 501 F. Supp. 129 (S.D. N.Y. 1980); H. Neighbors Enterprises, Inc. v. Burroughs Corp. , 492 F. Supp. 823 (N.D. Fla. 1980).
5. The Vendor’s Failure to Repair or Replace
Where goods fail to perform according to specifications as warranted despite the seller’s efforts to repair, a limited “repair” remedy fails of its essential purpose and the purchaser may pursue remedies “as provided in this Act.” U.C.C. section 2-719 (2).
a. Cases where the courts have refused to apply the failure of essential purpose doctrine in favor of the plaintiff
Consolidated Data Terminals, Inc. v. Applied Digital Data Systems , 708 F.2d 385 (9th Cir. 1983). Defendant warranted that computer terminals would operate at 19,200 baud (1920 characters per second). The terminals did not do so, and defendant’s efforts to correct the problem were unsuccessful.
S. M. Wilson & Co. v. Smith International, Inc. , 587 F.2d 1363 (9th Cir. 1978). Leading California case on failure of essential purpose doctrine. Defendant delivered a tunnel boring machine which bored at a rate slower than warranted and broke down frequently, greatly prolonging expected duration of plaintiff’s project.
Office Supply Co., Inc. v. Basic/Four Corporation , 538 F. Supp. 776 (E.D. Wisc. 1982). Plaintiff purchased computer hardware and leased computer software for office management and accounting applications. Software malfunctioned, producing incorrect balances in accounts receivable module. Defendant worked on the problem and solved it temporarily, but it continued to recur. Problems continued for three years, at the end of which time they were repaired by plaintiff’s own programmer.
AES Technology system, Inc. v. Coherent Radiation , 583 F.2d 933 (7th Cir. 1978). Laser sold by seller failed to operate at specified output power. Seller was unable to correct the problem over a one year period. The court’s opinion states ( Id . at 939):
In a properly functioning system, a defect is noticed (a small breach of warranty) and the repair or replacement is quickly made (the remedy). Within a reasonable period of time and after a reasonable number of failures, the steady-state performance should be reached whereby the product performs as specified. If after repeated efforts by a seller to place a product into warranted condition, and the seller cannot or will not do so, the remedy of repair and replacement may be deemed to have failed of its essential purpose and other remedies under the U.C.C. may be called into play.
Fiorito Bros., Inc. v. Fruehauf Corp. , 747 F.2d 1309 (9th Cir. 1984). Defendant sold plaintiff truck bodies to be installed on separately purchased trucks and warranted that trucks were suited for carrying wet concrete. When used to carry concrete, truck bodies bulged and bowed and cracks and tears appeared in the corners and welds of the bodies. Appeals court held that trial court was correct in holding that repair and replacement warranty failed of its essential purpose and in not sending this issue to the jury.
b. Cases where the courts have refused to apply the failure of essential purpose doctrine in favor of the plaintiff
Samuel Black Co. v. Burroughs Corp. , 33 UCC Rep. Serv. 954 (D. Mass. 1981). On August 25, 1977 seller and buyer contracted for sale of computer system. Hardware was delivered in December 1977, but purchaser gave seller written extensions for delivery of software, ultimately extending delivery date until November 1, 1987. Seller was not meeting informal interim deadlines during mid-1978, and in August 1978 plaintiff canceled the contract. The court held that there could be no failure of essential purpose where the parties had agreed that performance would not be due until November 1, 1978 and the plaintiff had terminated before that date. The court (Freedman, J.) stated ( Id . at 964):
For a remedy provision to have failed of its essential purpose, that provision must have been resorted to on occasion and found wanting. Here, the undisputed facts reveal that the time for Burrough’s final performance was November 1, 1978. Regardless of what rights Black may have under UCC section 2-609, or its common law counterpart to demand adequate assurances of performance, in August 1978 the exclusive remedy provision had not yet been brought into play, much less had failed of its essential purpose.
Xerox Corp. v. Hawkes , 475 A.2d 7 (N.H. 1984). Court refused to apply the failure of essential purpose doctrine despite the fact that the defendant was unable to correct defects in copying machine over a period of seven months.
6. The Effect of Failure of Essential Purpose Doctrine on Limitation of Damages Clauses
a. Cases precluding the plaintiff from recovering consequential damages
The fact that a plaintiff is able to prove failure of essential purpose does not mean that it now is able to recover unlimited damages. A number of courts have held that if the contract in question contains a limitation on consequential damage the plaintiff is precluded from recovering consequential damages, notwithstanding the failure of essential purpose of a “repair and replace” warranty.
In S. M. Wilson, supra , the court held that although U.C.C. section 2-719 (2) provides that upon the failure of essential purpose the buyer may recover the remedies “provided in this Act,” this does not mean that the bar to recovery of consequential damages should be eliminated. The court held that a purchaser in this instance is only entitled to benefit of the bargain damages, the difference between what he should have received and what he got. 587 F.2d at 1375. Since the buyer’s damages in this case were solely in the nature of consequential damages, it recovered no damages at all. However, the court did not preclude the possibility that consequential damages might be allowed in such circumstances in a future case. The court stated:
“Parties of relatively equal bargaining power negotiated an allocation of their risks of loss. Consequential damages were assigned to the buyer, . . . The machine was a complex piece of equipment designed for the buyer’s purposes. The seller . . . did not ignore his obligation to repair; he simply was unable to perform it. This is not enough to require that the seller absorb losses the buyer plainly agreed to bear. Risk shifting is socially expensive and should not be undertaken in the absence of a good reason. An even better reason is required when to so shift is contrary to a contract freely negotiated. The default of the seller is not so total and fundamental as to require that its consequential damage limitation be expunged from the contract .
Our holding is based upon the facts of this case as revealed by the pleading and record and is not intended to establish that a consequential damage bar always survives a failure of the limited repair remedy to serve its essential purpose. Each case must stand on its own facts.” (Emphasis added).
In Basic/Four, supra , the court held that if a remedy is limited to repair and consequential and incidental damages are excluded, then even if the repair remedy fails of its essential purpose, the buyer is limited to breach of the bargain damages under U.C.C. section 2-714 (2). The court stated that an exclusion of incidental and consequential damages is a “contract provision separate and distinct from a limitation of remedy to repair, and must receive separate consideration.” 538 F. Supp. at 788.
In AES Technology Systems, supra , the court held that the plaintiff who had shown failure of essential purpose was not entitled to consequential damages notwithstanding the fact that the contract in question did not specifically exclude consequential damages. The court held that “[h]ere the awarding of damages for the breach of warranty and incidental damages provides the ‘minimum adequate remedies’ mandated by section 2-719 (2).” 583 F. Supp. at 941-42.
b. Cases permitting the plaintiff to recover consequential damages
In Fiorito Bros., supra , the Ninth Circuit held that the plaintiff, who had succeeded in setting aside warranty disclaimers under the failure of essential purpose exception, was entitled to recover consequential damage, notwithstanding a provision in the contract expressly excluding such damages. The court stressed that the determination of whether consequential damages is available in such a situation is based on a “case-by-case determination method.” 747 F.2d at 1314.
In Consolidated Data Terminals, supra , the court held that the plaintiff was entitled to recover damages for lost customer goodwill, despite a contract provision that provided that “[defendant] will not be liable for any consequential damages, loss or expense arising in connection with the use of or the inability to use its products or goods for any purpose whatsoever.” The plaintiff was in the business or reselling the defendant’s computer terminals. The court read the contract language not to excludeall consequential damages, but “only such damages as result from loss of use of defective equipment.” 708 F.2d at 392. The court held that consequential damages for lost customer goodwill arising from the resale of defective terminals was not excluded by the language of the contract, and therefore upheld the award of such damages.
7. The Lab-Con decision
In RRX Industries, Inc. v. Lab-Con, Inc. , 772 F.2d 543 (9th Cir. 1985), the Ninth Circuit issued a decision that has caused consternation in the computer industry. The court held that the plaintiff was entitled to consequential damages after the failure of an exclusive repair remedy, despite a contractual provision expressly limiting damages to the license fee.
Lab-Con takes full advantage of the carefully limited holding in Wilson , quoted from above. In a critical passage, the court states:
The district court’s award of consequential damages is consistent with S.M. Wilson . The [trial] court concluded that “since the defendants were either unwilling or unable to provide a system that worked as represented, or to fix the ‘bugs’ in the software, these remedies failed of their essential purpose . . .” This is a finding that both limited remedies failed of their essential purpose. The trial judge did not state that because the repair remedy failed, the limitation of damages provision should not be enforced . . .
[The district court] properly found the default of the seller so total and fundamental that its consequential damages limitation was expunged from the contract.
Why did the court reach different conclusions in Lab-Con and Wilson ? DoesWilson represent a fundamental shift of turning point in the law, or an aberration?
A. “Benefit of Bargain” Damages
U.C.C. section 2-714 (2) establishes the basic measure of damages under Article 2 of the Code, the “benefit of the bargain” formula:
The measure of damages for breach or warranty is the difference at the time and place of acceptance between the value of the goods accepted and the value they would have had if they had been as warranted, unless special circumstances show proximate damages of a different amount.
Plaintiff must prove both value as warranted and value as accepted. See, e.g., Fargo Machine & Tool Co. v. Kearney & Treaker Corp. , 428 F. Supp. 364 (E.D. Mich. 1977) (court refused to award damages where the plaintiff failed to offer proof on the value of goods accepted). Typically, expert testimony is necessary to prove the latter.
1. The Chatlos Approach
Usually, the plaintiff will focus on proving the value of the goods as delivered and let the contract price serve as evidence of the value of the goods as warranted. However, plaintiffs’ counsel should be alert to the possibility that the value of the goods as warranted may exceed the contract price, thereby providing a greater measure of damages. The best known example of this is Chatlos Systems, Inc. v. National Cash Register Corp. , 479 F. Supp. 738 (D. N.J. 1979), remanded , 635 F. 2d 1081 (3rd Cir. 1980), aff’d , 670 F.2d 1304 (3rd Cir. 1982), cert. Denied , 457 U.S. 1112 (1982). The fact is Chatlos were as follows:
a. Plaintiff purchased a computer system from the defendant for a price of $46,020.00.
b. At trial, the evidence showed that the value of the system as delivered was $6,000.00. Under the standard benefit of the bargain approach, this would yield damages of $46,020 – 6,000 = $40,020.00 .
c. Plaintiff’s expert testified that the fair market value of the defendant’s computer system as warranted was not $46,000.00, but was $207,826.50 .
d. Plaintiff received benefit of the bargain damages of $207,826.50 – 6,000 = $201,826.50, almost five times the purchase price of the goods .
The Chatlos technique can be effective in technology cases where the vendor represents its system as technically comparable to competing systems but at a significantly lower price.
B. Consequential and Incidental Damages
U.C.C. section 2-715 provides:
(1) Incidental damages resulting from the seller’s breach include expenses reasonably incurred in inspection, receipt, transportation and care and custody of goods rightfully rejected, and any commercially reasonable charges, expenses or commissions in connection with effecting cover and any other reasonable expenses incident to the delay or breach.
(2) Consequential damages resulting from the seller’s breach include:
“(a) any loss resulting from general or particular requirements and needs of which the seller at the time of contracting had reason to know and which could not reasonably be prevented by cover or otherwise; and
(b) injury to person or property proximately resulting from any breach of warranty.”
Damages to explore the possibility of pursuing include:
a. Time spent by employees dealing with hardware and software problems, including time spent performing the computer’s functions during computer “down-time” and meetings and calls to the vendor to resolve problems.See, e.g., Convoy Co. v. Sperry Rand Corp. , 672 F. 2d 781 (9th Cir. 1982);Dunn Appraisal Co. v. Honeywell Information Systems, Inc. , 687 F. 2d 877 (6th Cir. 1982); Stahl Management Corp. v. Conceptions Unlimited , 554 F. Supp. 890 (S.D. N.Y., 1983); Chatlos, supra , 479 F. Supp. at 747.
b. Time spent converting from an old computer system to a new system, including manual data entry time and monies paid to independent contractors in connections with installation and programming. See, e.g., Dunn Appraisal, supra .
c. Employee salaries which the vendor represented would be saved by the new system. Chatlos Systems, supra , 479 F. Supp. at 747.
d. Lost profits. See, e.g., State Office Systems, Inc. v. Olivetti Corp. of America , 762 F. 2d 843 (10th Cir. 1985).
e. Lost goodwill. See, e.g., Consolidated Data Terminals, supra .
f. Miscellaneous costs, such as financing expenses (interest costs), installation and removal expenses, the value of the space occupied by the computer. See, e.g., Chatlos Systems , supra , 479 F. Supp. at 744, 747;Dunn Appraisal, supra at 883.