Legal briefing | 19 Oct 2021 |

Why it matters whether software is "goods" or "services"

A recent judgment of the Court of Justice of the European Union (CJEU) has significant consequences for software providers which conduct sales of software to their customers through agents, both in the EU and the UK. It also highlights a wider debate around whether software should be treated as goods or services and why this matters.

What happened in this case?

In March 2013, Computer Associates UK Ltd (CAUL) entered into an agreement with The Software Incubator Ltd (TSI) for TSI to market CAUL's automation software (a product which helps businesses to co-ordinate and deploy other software). However, the arrangement between the two parties was short lived, as CAUL served notice to terminate the agreement seven months later. Following termination, TSI brought a claim against CAUL for post-termination payments under the Commercial Agents Directive 86/653 (the Directive) at the High Court.

What is the Commercial Agents Directive?

The Commercial Agents Directive was implemented into UK law by the Commercial Agents (Council Directive) Regulations 1993 (the Regulations) and applies to certain commercial agency relationships relating to the "sale of goods".

Several terms are implied into commercial agency arrangements by virtue of the Regulations. Examples include rights to reasonable remuneration, minimum periods of notice and - relevant to this case - a right to a "compensation" or an "indemnity payment" on termination of the agency agreement.

Is software "goods" under the Directive?

For the Regulations to apply, the intermediary must be involved in the sale or purchase of goods, but the term "goods" was not defined in the Directive. CAUL argued that as the software was electronically supplied to the end customer (i.e. downloaded, rather than delivered in tangible form on a disc or bundled with hardware) it did not amount to "goods". This argument was unsuccessful in the High Court, which awarded TSI post-termination compensation of £475,000. The Court of Appeal overturned that ruling, taking the view - in line with the general approach of the English courts in previous cases – that software was only likely to be goods for the purposes of the Directive if supplied on a physical medium such as a disk or USB stick. Following this, the matter was referred to the CJEU by the Supreme Court.

The CJEU ruled that for the purposes of the Directive, software is a "good" regardless of the medium on which it is supplied. Consequently, computer software supplied to customers by granting a perpetual licence does constitute a "sale of goods".

Why is this judgment significant?

The CJEU's ruling means that agreements between software providers and commercial agents which market the former's software in the UK (or the EEA) are likely to be subject to the Regulations. This means that the software provider will be liable for termination payments in the form of indemnity or compensation payments (unless limited exceptions apply, such as the agent's repudiatory breach of the agreement). Any such payments could be significant, particularly where the agent has generated a significant volume of sales for the software provider. It is also conceivable that there could be historic claims from agents whose agreements were previously terminated, subject to relevant limitation periods.

A further key takeaway is that this judgment marks a significant departure from case law to date which maintained the traditional stance that software could only be classified as a good if supplied on a physical medium.

After Brexit, why is this relevant to the UK?

The Regulations remain in force post-Brexit by operation of the European Union (Withdrawal) Act 2018. Furthermore, the CJEU's judgment still applies to the UK because although the Brexit transition period expired on 31 December 2020, Articles 86 and 89 of the Withdrawal Agreement provide that CJEU judgments on matters referred from UK courts before the end of the transition period are binding on the UK.

Unless settled by the parties, the case will now return to the Supreme Court (SC), which must decide how to apply the CJEU's opinion to the precise facts of this dispute. The SC, together with the Court of Appeal and other courts at the same level, has power to diverge from retained EU caselaw (which includes CJEU rulings up to 31 December 2021); when it comes to CJEU rulings after that date, the general rule is that UK courts can have regard to them but are not required to follow them. On the face of it, this ruling would seem to belong in the latter category. However, as noted above, Article 89 of the Withdrawal Agreement provides for such rulings to be binding on the UK – implying that the CJEU's judgment in this case should be treated in the same way as retained EU caselaw. Either way, it is just possible that – in the UK at least – the CJEU's opinion could be side-lined by the SC. That said, it would seem odd for the SC to have referred to the matter to the CJEU only to then ignore its opinion, especially given that the dispute essentially relates to the law as it stood in 2013, when the UK was still a fully-fledged EU member state. To the extent that CAUL argues that there are good reasons for divergence, the SC may simply respond that these are matters for Parliament, not the courts.

What should software providers do now?

Following this ruling, software providers should consider their distribution arrangements and identify any which now fall within the scope of the Regulations. Whilst you cannot contract out of the Regulations, it is possible to draft agreements relating to the UK in a way that allows the principal to cap its potential termination payment at one year's commission (averaged out over the previous five years). Software providers may also want to take this opportunity to evaluate whether other alternative methods of sales, such as use of distributors (i.e. master licensees for a given territory) are now, on balance, more attractive (as, in the UK at least, there is no legislation requiring business to make post termination payments to a distributor).

Are there wider ramifications?

Strictly speaking, the CJEU's judgment only settles the question of whether software is goods in relation to the narrow issue of the Directive. However, it highlights a wider debate as to the treatment of software. For example, in relation to consumer law, a separate category for "digital content" has been created under the Consumer Rights Act 2015 which gives consumers largely the same rights of redress as when buying "goods". However, in a B2B setting, English courts have tended towards the approach taken by the Court of Appeal in the above case; this means that (outside the context of commercial agents) most software supplied to business is likely to be regarded as a service (because most of it is now downloaded, rather than supplied on a physical medium).

Looking more broadly, whether software counts as "goods" or "services" is also a live issue in relation to international trade. This is significant because WTO Member States have made different commitments (and are subject to different rules) depending on whether the trade in question amounts to goods or services.

It remains to be seen whether, assuming this case returns to the Supreme Court for consideration, it will provide some guidance as to how software should generally be treated from an English law perspective.