Neilson Business Equipment Center, Inc., a Delaware Corporation, Defendant Below, Appellant,

v.

Italo V. Monteleone, M.D., P.A., A Delaware Professional Association, Plaintiff Below, Appellee

Supreme Court of Delaware

524 A.2d 1172 (1987)

Moore, Justice. Following a nonjury trial in the Superior Court, defendant Neilson Business Equipment Center, Inc. (Neilson), appeals a judgment awarding plaintiff, Dr. Italo V. Monteleone, P.A., damages of $ 34,983.42 for breaches of the warranties of merchantability and fitness arising from a lease contract for computer hardware, software and related services. The trial court found that the objects of the lease constituted "goods" under the Uniform Commercial Code and granted relief under the Code's implied warranties of merchantability and fitness. 6 Del.C. @@ 2-314(1) and 2-315.

Neilson's primary contentions are that the trial court erred (1) in classifying the computer software and related technical services as goods, and (2) in applying the Uniform Commercial Code's warranties to this transaction. Thus, we address for the first time the issue of computer software (programs) being treated as "goods" under the Code.

*** We find that the classification of the contract as one involving "goods" is supported by substantial evidence. Accordingly, we affirm the judgment relating to breaches of the implied warranties of merchantability and fitness ***

I.

Dr. Monteleone is a neurologist. In March, 1982, his office began investigating various computer information systems, since record keeping was entirely manual. The doctor gave Toni Reed, his bookkeeper and office manager, complete authority to acquire a suitable computer system. However, Ms. Reed had no prior experience in buying computer technology.

She initially considered four possible computer dealers, including Neilson. An advertisement in the local telephone directory listed Neilson as a dealer in microcomputers. Ultimately, Ms. Reed chose Neilson, in part because she had previously purchased an office photocopier from the defendant with satisfactory results.

After an initial meeting at Neilson's office, the company sent two representatives to study Dr. Monteleone's manual billing system. The parties ultimately signed a lease/purchase option agreement covering hardware equipment and software. As part of the agreement, Neilson agreed to customize the computer system to meet Dr. Monteleone's needs. The purchase price was $ 18,995, but Dr. Monteleone chose to lease the equipment in order to obtain favorable cash flow and tax benefits. The total of all lease payments amounted to $ 32,800.80. Dr. Monteleone retained an option to purchase the system at the end of the lease at fair market value, not exceeding 10% of the original purchase price. In addition to the lease, the parties executed a separate maintenance agreement valued at 2,182.00. To facilitate the transaction, Neilson sold the equipment and software to Tri-Continental Leasing Corporation, who in turn leased the items to Dr. Monteleone.

Although Neilson did not design the software, it renamed the program it had acquired elsewhere the "Neilson Medical Office Management System." However, Neilson did alter the program at various times in an attempt to make it meet the doctor's needs.

The computer was delivered in July, 1982, and problems immediately developed. For example, the system printed a separate bill for each treatment rather than one bill encompassing the doctor's services to a patient for a specific period; the bills and medical insurance forms were not compatible with Dr. Monteleone's records; patient information was not as detailed as required; and incorrect balances appeared in the accounts receivable register. Attempts to modify the system failed, and in August, 1982, Neilson hired a program consultant to solve the problems.

In February, 1983, Dr. Monteleone notified Neilson that the lease was terminated for cause. Thereafter, plaintiff stopped using the computer, although in March, 1983, Neilson's program consultant successfully effected some modifications. In June, 1983, Neilson took possession of the system pursuant to an agreement which allowed Neilson to try and resell it. While in possession of the computer, Neilson modified the billing program and returned the system to Dr. Monteleone's office. The doctor never used the machine after its return, but continued timely lease payments under the contract.

The Superior Court ruled that the transaction involved goods and applied the warranty provisions of the Uniform Commercial Code. The trial court found that Neilson had breached the implied warranties of merchantability and fitness for a particular purpose, and awarded Dr. Monteleone damages totaling $ 34,983.42, with interest from March 11, 1983.

II.

This Court's standard and scope of review of the trial court's factual findings is governed by Levitt v. Bouvier, Del. Supr., 287 A.2d 671 (1972). Accordingly, those determinations will not be disturbed if they are supported by the record and are the product of an orderly and logical deductive process. Id. at 673.

The central issue before us is whether a contract for a computer system consisting of computer hardware, software and services constitutes "goods" under the Uniform Commercial Code. In our opinion, the parties agreed to a lease/purchase of a turn-key computer system which may properly be classified as a package constituting goods.

Article Two of the Uniform Commercial Code applies to "transactions in goods." 6 Del.C. @2-102. The contract between Dr. Monteleone and Neilson is a mixed contract for both goods and services. When a mixed contract is presented, it is necessary for a court to review the factual circumstances surrounding the negotiation, formation and contemplated performance of the contract to determine whether the contract is predominantly or primarily a contract for the sale of goods. If so, the provisions of Article Two of the Uniform Commercial Code apply. ***

Neilson urges us to separate the contract into three distinct subparts -- hardware, software and services. Defendant contends that only the hardware can be classified as "goods" under the Code, that there was nothing defective about the hardware, and thus plaintiff's claims for breaches of implied warranties fail. Neilson further argues that software is an intangible, and that intangibles do not constitute "goods" subject to the Code.

That argument is innovative, but unpersuasive. Neilson contracted to supply a turn-key computer system; that is, a system sold as a package which is ready to function immediately. The hardware and software elements are combined into a single unit --the computer system-- prior to sale. The trial court's factual conclusion that the computer system is predominantly "goods" is supported by substantial evidence. Dr. Monteleone did not intend to contract separately for hardware and software. Rather, he bought a computer system to meet his information processing needs. Any consulting services rendered by Neilson were ancillary to the contract, and cannot reasonably be treated as standing separately to escape the implied warranties of the Uniform Commercial Code. ***

Here, the parties cast their agreement in terms of a lease with an option granted Dr. Monteleone to purchase the computer system later. Although structured as a lease, it is clear that the parties intended to enter into the equivalent of a purchase and sale. Dr. Monteleone decided to lease because of favorable cash flow and tax benefits. Though structured as a lease, the substance of the transaction was a sale, and the trial court properly characterized it as such. Earman Oil Co., Inc. v. Burroughs Corp., 625 F.2d 1291, 1293 (5th Cir. 1980).

Every contract of sale entered into by a merchant includes an implied warranty that the goods sold be "merchantable." The computer system, to be merchantable, must have been capable of passing without objection in the trade under the contract description, and be fit for the ordinary purposes for which it was intended. 6 Del.C. @ 2-314(1) and (2). There is no dispute that the computer system failed in that regard. In general, the computer system did not meet Dr. Monteleone's expressed record and bookkeeping needs, even though Neilson's sales representatives informed Ms. Reed that the system would do so. The trial court correctly found that plaintiff had established all the elements necessary to prove a breach of the warranty of merchantability, namely: (1) that a merchant sold the goods; (2) that such goods were not "merchantable" at the time of sale; (3) that plaintiff was damaged; (4) that the damage was caused by the breach of the warranty of merchantability; and (5) that the seller had notice of the damage. ***

Here, Neilson knew that Dr. Monteleone, through his assistant, Ms. Reed, sought a computer system to meet specific information processing needs. Neilson admits that it was responsible for selecting the proper equipment, and also agreed to customize the software so that the computer system would be compatible with Dr. Monteleone's manual records. There could hardly be a clearer case where a buyer relies on the professional expertise of the seller than that presented here. Dr. Monteleone needed a system that would perform specific functions, and relied on Neilson's professional expertise and experience in the computer and information processing field to develop and deliver a satisfactory computer system. Neilson clearly had reason to know of Monteleone's reliance on the company's expertise and breached the warranty of fitness for a particular purpose. Its liability is established under the Uniform Commercial Code.

Accordingly, we affirm the Superior Court's finding that Neilson breached the Uniform Commercial Code warranties of merchantability and fitness ***