Pearl Investments, LLC v. Standard I/O, Inc.
2003 U.S. Dist. LEXIS 6890, 2003 WL 1741211, 257 F. Supp. 2d 326 (2003)
Premium Feature
Subscribe to Lexplug to listen to the Case Podcast.
Rule of Law:
A contract for the development of a custom software system from scratch, where the developer is paid on a time-and-materials basis, is predominantly a contract for services, not for the sale of goods, and thus falls outside the scope of the Uniform Commercial Code (UCC).
Facts:
- Pearl Investments, LLC ('Pearl'), an automated stock-trading company, hired Standard I/O, Inc. ('Standard'), a custom software firm owned by Jesse Chunn ('Chunn'), in April 2000 to create an automated trading system (ATS).
- Chunn signed a non-disclosure agreement (NDA) assigning to Pearl the rights to all 'Discoveries,' including software systems and methods, conceived during the contract term.
- Standard was paid on a time-and-materials basis to develop the software for Pearl's ATS from scratch.
- During the engagement, Standard conceived of and presented a design document for a non-arbitrage trading system called the 'Scalper' to Pearl, but Pearl postponed its development for budget reasons.
- While the business relationship was winding down in early 2001, Chunn opened a personal trading account, purchased his own server, and began developing his own experimental automated trading system on his own time.
- In November 2001, Pearl discovered Chunn's server connected to its network equipment at a third-party data center.
- An employee at the data center, acting on a request from Pearl to install a new operating system on Pearl's server, mistakenly installed it on Chunn's server, overwriting and destroying Chunn's custom code.
- Upon discovering the server, Pearl's CEO, Dennis Daudelin, took possession of it to preserve it as evidence and refused Chunn's immediate demands for its return.
Procedural Posture:
- Plaintiff Pearl Investments, LLC ('Pearl') filed an eight-count complaint against Defendants Standard I/O, Inc. ('Standard') and Jesse Chunn in the U.S. District Court for the District of Maine.
- Defendant Chunn filed a four-count counterclaim against Pearl and a third-party complaint against Pearl's CEO, Dennis Daudelin.
- Plaintiff Pearl and third-party defendant Daudelin filed a motion for partial summary judgment on certain counts of the complaint and the counterclaim.
- Defendants Standard and Chunn filed a cross-motion for summary judgment on all counts of the complaint and on one count of the counterclaim.
- The United States Magistrate Judge reviewed the cross-motions and issued a Recommended Decision.
Premium Content
Subscribe to Lexplug to view the complete brief
You're viewing a preview with Rule of Law, Facts, and Procedural Posture
Issue:
Is a contract for the custom development of a software system from scratch, billed on a time-and-materials basis, predominantly a sale of 'goods' subject to the Uniform Commercial Code (UCC), or a contract for 'services' outside the UCC's scope?
Opinions:
Majority - Cohen, United States Magistrate Judge
No, a contract for the custom development of a software system from scratch is predominantly one for services, not goods, and is therefore outside the scope of the UCC. The court applied the 'predominant factor' test to determine whether the contract was for goods or services. Unlike cases involving the sale of pre-existing software with custom modifications, Standard created Pearl's ATS 'from scratch (concept to realization)' and was compensated on a 'time and materials basis.' This payment structure and development process indicates that Pearl was bargaining for Standard's programming skill and labor, not for a tangible end product. Therefore, the service element dominates the transaction, making Article 2 of the UCC and its implied warranties of merchantability and fitness inapplicable.
Analysis:
This decision reinforces the critical distinction between contracts for custom software development and the sale of existing software for purposes of UCC applicability. By categorizing 'from scratch' development as a service, the court clarifies that common law contract principles, rather than the UCC's statutory framework for goods, govern such agreements. This has significant implications for implied warranties, as the UCC's automatic warranties of merchantability and fitness for a particular purpose do not apply to service contracts. The ruling provides guidance for practitioners drafting software development agreements, highlighting the importance of including express warranties if such protections are desired.
