Inventory, or stock in trade, is important to retailers, wholesalers and those who extend credit to either group. Some stock in trade is computer programs embedded on disks, as anyone who has bought an "Oregon Trail" or "Sim City" compact disk at Wal-Mart knows. Some stock in trade is heavy equipment, such as computer-guided lathes sold by a manufacturer. We often think of all such stock in trade as "inventory." A revision to Nebraska’s statutes will change that, at least in legal parlance.

Analyzing this important change in the law requires some background about "embedded" computer programs. Sometimes computer programs are "embedded" in tangible property such as a new lathe or tractor. When one purchases the lathe or tractor, one assumes one also is acquiring the embedded computer program.

Now for some legal definitions under the current Uniform Commercial Code on secured lending ("UCC Article 9"): "Inventory" is "goods" held by one who holds them for sale or lease or furnished or to be furnished under a service contract, or certain raw materials. UCC 9-109(4). The catch for computer programs is that "goods" have to be tangible, not intangible. Maybe the stock in trade of programs is "goods" once they are imbedded on disks, and thus "inventory" of, say, Wal-Mart. After all, the disk is tangible (touchable).

A further catch under current law is, it is not always clear whether an embedded program becomes "goods" like the tangible property for purposes of "UCC Article 9" or constitutes license rights or other intangibles legally defined as "general intangibles." One may obtain and perfect a security interest in "goods" such as the lathe by filing a UCC financing statement or obtaining possession of the lathe. If the computer program is a general intangible, however, possession is ineffective and the secured party must have both a written grant of a security interest and a UCC financing statement filed with the proper government office to have a perfected security interest.

Moreover, it is not uncommon for a company with numerous creditors to have one with a first security interest in "goods" or "equipment" and another with a first security interest in "general intangibles" and accounts receivable. If Surprised Creditor, say, with a first security interest in the company’s equipment only, went to repossess the lathe, it could be frustrated under existing law if the company’s bankruptcy trustee or a competing creditor established that the embedded computer program really was a "general intangible" and thus not within Surprised Creditor’s first security interest.

Nebraska has passed the revised version of UCC Article 9. Although the operative date for Nebraska’s enactment is July 1, 2001, Nebraska creditors and business borrowers should familiarize themselves with the revised law now. So should creditors and business borrowers in Iowa and surrounding states: Revised Article 9 is sweeping the nation.

For our Update’s first column on revised Article 9, we note clarifications it makes in existing law on embedded computer programs. Revised Article 9 expressly establishes that "goods" include "a computer program embedded in goods and any supporting information provided in connection with a transaction relating to the program if (i) the program is associated with the goods in such a manner that it customarily is considered part of the goods, or (ii) by becoming the owner of the goods, a person acquires a right to use the program in connection with the goods." The definition of "goods," however, "does not include a computer program embedded in goods that consist solely of the medium in which the program is embedded." The last proviso is intended to keep programs on computer disks from being considered "goods" merely because the disk is tangible property. After all, the marketplace treats such programs in many borrower’s proprietary intellectual property libraries, say, as radically different from programs embedded in a sophisticated tool such as a tractor or lathe.

Some consequences of the revised Article 9 that will take effect next July thus are:

  • As of July 1, 2001, security interests that do not mention "software" or, more broadly, "general intangibles," but rely "inventory" or "goods" likely will not include a stock of computer disks maintained for sale by a wholesaler or retailer of such disks. Secured creditors of dealers who stock computer programs for sale thus should review their collateral and perfection procedures to confirm that they have perfected security interests in general intangibles in addition to "inventory" or "goods."
  • A party can obtain and perfect a security interest in the computer program embedded in a machine by possessing the pertinent tangible property (e.g., possessing the lathe) or by filing with the pertinent government office.
  • A creditor with a written security agreement describing tangible property that has embedded computer programs (e.g., if the security agreement describes "three John Deere tractors" or "two lathes") would typically be deemed to have a security interest in the computer programs embedded in the property. This is good news for secured lenders, who under current law may have to hassle with a borrower or borrower’s bankruptcy trustee about the extent to which a description that does not include "general intangibles" encompasses the embedded programs.
  • A security interest that merely describes "all software" likely will not be deemed to include computer programs embedded in a machine where the programs are not otherwise possessed by a borrower. Revised Article 9-102(a)(75) expressly excludes from "software" a "computer program that is included in the definition of goods."

Revised Article 9 typically applies to then-existing loans, as well as loans occurring thereafter. Thus, creditors and business borrowers should begin planning now to avoid unpleasant surprises and the resulting legal fireworks in July, 2001.

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