1 CyberBankruptcy And Secured Lending in Cyberspace (Is a lien as mean in Cyberspace as it is in real space?) Prepared for the Home Coming CLE (November 10, 2001) Professor William E. Boyd 1

2 I.IntroductionIntroduction II.The Need to Get Up to Speed as to Computer Technology and the InternetThe Need to Get Up to Speed as to Computer Technology and the Internet III.A Prototypical Dot.Com Business FailureA Prototypical Dot.Com Business Failure IV.What Happens Now?What Happens Now? A.GenerallyGenerally B.The Decision to LendThe Decision to Lend C.Specialized Collateral Securing the LoanSpecialized Collateral Securing the Loan (1) The General Bank Account; (2) Copyrighted Property; (3) Domain Names; (4) The Website; and (5) The Going Concern as CollateralThe General Bank AccountCopyrighted PropertyDomain NamesThe WebsiteThe Going Concern as Collateral V. Some Concluding ObservationsSome Concluding Observations 2

3 I. Introduction Business is increasingly dependent on computers and high speed communications Business is conducted in a world of intangibles and borderless communities and business settings. 3

4 Law and legal systems have not gone untouched. Bankruptcy law is no exception. Beginning in April of 2000, many dot.com enterprises filed for bankruptcy and in the year 2000 alone some 1.5 billion dollars in assets were involved. 4

5 The question is whether doctrine and behaviors developed in the physical world are appropriately applied in an Electronic or Cyberspace World. 5

6 Don’t be lost in Cyberspace. 6

7 The answer is both yes and no. However, a complete discussion of why this is so is not possible in the time available for this presentation. 7

8 In his book, Cyberbankruptcy and Secured Lending in Cyberspace, Warren Agin addresses the full range of issues. The book is usefully reviewed by Robert Lawless, of the University of Missouri Law School at Columbia, in the Journal of Corporate Law, at p. 125 (Fall 2000). 8

9 My effort here will be much more modest. I will explore a few of the ways that bankruptcy law and practice will have to adapt to the rapidly changing business world. 9

10 Keep in mind that it is not just dot.com businesses that present new questions. Brick and mortar businesses increasingly have sought to develop a web presence to expand their markets and facilitate electronic transactions and their efforts pose many of the same questions. 10

11 II. Getting Up to Speed To adequately serve your clients in a high tech world you must become reasonably conversant with the basic workings of the Internet and electronic commerce. 11

12 A Mouse Driven World? 12

13 The great American philosopher, Yogi Berra, opined that if you come to a fork in the road, take it. 13

14 Learn the general meaning of URLs (Uniform Resource Locators), domain names (alphabetical equivalents of IP (Internet Protocol) numerical addresses and websites (virtual business locations created using computers and HTML programming code and which are located at the domain name address. 14

15 You also must have a sense of the workings of ICANN (The Internet Corporation for Assigned Names and Numbers) which registers domain name through a number of entities with which ICANN contracts. See /icann-pr16nov.htm 15

16 The Agin book referred to earlier provides a useful primer to help you get up to speed. 16

17 III. A Prototypical Dot.Com Business Failure To illustrate some of the issues confronted by a secured lending attorney or a bankruptcy practitioner I will examine the failure of a prototypical company. 17

18 The facts of my hypothetical business failure have been placed in the handout for easy reference. Let’s look at them together now.now 18

19 IV. What Happens Now? A. Generally At this point, things get sticky. Much of what is important will be familiar, but there will be nuances attributable to the cyber aspects of the case. 19

20 Will Surfer Bank will be better off with MallBuster in or out of bankruptcy? If so, is a Chapter 7 Liquidation or a Chapter 11 Reorganization or Liquidation preferable? 20

21 If MallBuster has preempted by filing, Surfer Bank must attempt to influence the course of the bankruptcy proceeding in its favor. Decisions made by Surfer Bank earlier will impact its fate in bankruptcy. 21

22 Bankruptcy is the “acid test” of whether Surfer Bank (actually, its attorneys) took the necessary legal and business steps when the loan was made or during the period leading up to the bankruptcy.

23 In light of the time constraints, I will focus on the some of the issues raised or impacted by the fact that MallBuster is an online company.

24 B. The Decision to Lend The fundamental decision made by Surfer Bank was whether to lend or not. Making that decision would have required considerable “due diligence” regarding MallBuster’s business plan and the market in which it would operate.

25 But, even the best laid plans can fail and Surfer Bank’s security interests provide a necessary fallback. Moreover, secured claim status gives Surfer Bank leverage, in and out of bankruptcy.

26 Surfer Bank’s security interests must be enforceable. The basic limitations on enforceability apply whether the collateral is cyber-based or not.

27 Surfer Bank's security interests must have been timely perfected so that they cannot be avoided under BRA §§ 544 and 547 (although BRA § 552 will limit enforceability of security interests in property, other than proceeds, acquired after bankruptcy).

28 Bankruptcy law looks to state law, primarily Article 9, to determine many enforceability and perfection questions. Under former and new Article 9, Surfer Bank’s security interests would have to attach to be perfected.

29 Did MallBuster have sufficient rights in the various collateral to support attachment and was the collateral was adequately described? It is worth noting that new Article 9 section facilitates the creation of security interests in software licenses by denying effect to prohibitions on security transfers.

30 The security interests in familiar collateral, such as equipment, present no new issues as to dot.com debtors, although licensing agreements may impact the extent to which computers and "bundled" software can be treated together as goods.

31 C. Specialized Collateral Securing the Loan 1. The General Bank Account Under former Article 9, the creation and perfection of security interests in general bank accounts (deposit accounts) as original collateral were governed by law outside Article 9.

32 It is worth noting that security interests in deposit accounts as original collateral, other than in consumer transactions, now are within the scope of new Article 9, new section 9-109(d)(13).

33 However, under new section (b)(1), security interests in deposit accounts as original collateral may be perfected only by control and filing a financing statement is ineffective.

34 2. Copyrighted Property Dot.com operations are likely to own or license various forms of intellectual property or property the value of which is tied to some intellectual property interest.

35 Surfer Bank has security interests in movies that MallBuster is licensed to sell, but the copyrights most likely are held by others. Surfer Bank also has a security interest in the shopping cart software as to which MallBuster is the copyright holder.

36 New Article 9, section 9-408, facilitates the creation of security interests in license agreements governing the sale or other distribution of copyrighted property. However, to survive bankruptcy, the security interests in the licensed movies and shopping cart software must have been properly perfected.

37 The National Peregrine and In re Avalon decisions hold that security interests in copyrights and copyrighted property must be perfected under federal law, specifically the U.S. Copyright Statute, and cannot be perfected by filing an Article 9 financing statement.

38 I examine the matter of perfection of security interests in copyrights and other IP in a chapter from a work in progress that I authored, entitled CANINE (The Complete Article Nine). You can visit the material at: neweb/chapter19/chapter19.html

39 In my view, the thrust of the National Peregrine and In re Avalon decisions will continue to be viable under new Article 9. Consequently, perfecting security interests in a copyright or copyrighted property requires that the interests be recorded in the U.S. Copyright Office.

40 Although a copyright can be enforced without its being registered with the U.S. Copyright Office, a security interest transfer cannot be recorded unless a copyright has been registered.

41 All transfers associated with copyrights and copyrighted property are indexed according to the identification in the registration (and not according to the debtor's name). Only the copyright holder can register a copyright and Surfer Bank should have made sure the copyrights in the movies were registered.

42 Surfer Bank likewise should have made sure that its security interests in the movies was recorded in the U.S. Copyright Office. The situation with respect to the shopping cart software is more complicated.

43 The registration, and hence the recording, scheme employed by the U.S. Copyright Office requires that every copyrighted item be separately registered. Every revision, modification and derivative of the shopping cart software would have to be separately registered.

44 Surfer Bank would have to monitor MallBuster to be sure that the registrations all were timely made. It also would have to take steps to assure the security interests in the various items must be separately recorded as to the original software product and later registered products.

45 The perfection process as to security interests in copyrighted property is time-consuming and expensive, but necessary to assure that a security interest will escape avoidance in bankruptcy. The copyright recording system also impacts searches.

46 Searching is the flip side of recording or filing. To know where to record or file is to know where to search. A proper search of the copyright records could also be very time- consuming and expensive, but again, necessary.

47 If Surfer Bank did not do a proper search (if, for example, it looked only for Article 9 filings), Surfer Bank may well have failed to discover security interests held by other creditors that could subordinate Surfer Bank's interests.

48 Even if Surfer Bank searched and recorded properly, there still is the question of what the collateral is worth. If the VHS analogue movies have become completely or substantially obsolete then the value of the inventory of movies, and the security interests in it, is very likely to be nil.

49 If the inventory of movies is valueless and a contract to allow the sale of DVD's cannot be negotiated, then MallBuster's business is not viable and could not be effectively reorganized with or without Surfer Bank's input as a secured claimholder.

50 The shopping cart software has value (subject to its having been replaced by a superior product) both as a part of a reorganization that includes a re- negotiated licensing agreement and as a stand-alone product. As to the latter, a liquidation sale, under either Chapter 7 or Chapter 11, would seem to be in order.

51 But, whether Surfer Bank benefits in any way again depends on whether it has a properly perfected security interest in the shopping cart software.

52 It finally should be noted that both National Peregrine and In re Avalon held that security interests in accounts generated by the sale or other distribution of copyrighted property also must be perfected by having the security interests recorded in the U.S. Copyright Office.

53 Consequently, even if Surfer Bank properly perfected its interests in the licenses and software, if it did not record security interests covering accounts receivables it could find itself unsecured as to the receivables.

54 3. The Domain Name Domain names are valuable assets. They give a business visibility in cyberspace by assisting individuals and search engines to find the company’s website.

55 A domain name easily associated with a particular business, such as IBM.com or Panasonic.Com or MS.com, increases the likelihood that a potential customer will visit a companies website.

56 A first step in setting up a new business today or in creating a web presence for an existing business is to create and register a domain name.

57 For a time, there were many cybersquatters operating. These folks registered names without the intent to use them and sold them to the highest bidder.

58 There now is federal anti- cybersquatting legislation. See nit_cybersquatting_consumer_prote ction_act.html

59 A more common problem is finding a name that has not already been registered -- one name to a customer. A successfully registered name can encounter tradename and trademark challenges. If the domain name infringes a trademark the result is a loss of the domain name or worse.

60 Doing an effective search that avoids infringement is difficult -- especially because there are common law trademarks and internationally registered trademarks. Most lawyers will not offer any real guarantee against trademark infringement claims.

61 Still, Surfer Bank should have done all it could to be sure that the MallBuster.com name was duly registered and free of the more apparent infringement claims.

62 A more serious problem here is that the domain name may have value only as associated with the online movie business. If the business folds, the name is of no value.

63 If the business reorganizes effectively (through a re-negotiation of the license or by settling on a new product to market) and the name still works, then the domain name has value.

64 Domain names tend to epitomize the problem with many cyberspace assets, namely, that they have value only as they are tied to a particular online business or related business that is viable.

65 Beyond the registration and lawsuit concerns, there is the question of how an enforceable security interest can be created in a domain name and how any such interest should be perfected.

66 There has been an ongoing controversy as to whether a domain name is property or simply a contractual right with ICANN.

67 If the domain name is property then a security interest in it may be created in the usual ways. Given the absence of any federal scheme of perfection comprehensive enough to displace Article 9, an Article 9 filing should suffice.

68 If the domain name gives rise only to a contract right, then BRA § 365 might apply to the domain name right as an executory contract. If so, there would be issues about the extent to which the contract right could be assumed and assigned.

69 If the domain name is a contract right, whether or not the domain name contract is governed by BRA § 365, there still would be issues of how an enforceable security interest in the contract right can be created and perfected.

70 Arguably, the collateral would be a general intangible but it could be an account under the expanded definition of an account under new Article 9, section 9-102(a)(2). In either case, an Article 9 filing should do.

71 4. MallBuster's Website as Collateral A website is a complex composite of hardware, software, IP rights, domain name, and search engine identity, all mixed together in a place that at root is not really a place. Treating a website as collateral may requires separate treatment of its salient parts.

72 However, the website is an essential piece of a going concern. Indeed, the site may have no value as a site except as part of an ongoing business.

73 5. MallBuster as an Ongoing Business As noted, some of the property in which Surfer Bank has security interests could have liquidation value, but in the aggregate the collateral has value only as part of a going concern.

74 Surfer Bank may wish to offer and support efforts to save MallBuster. MallBuster might be reorganized around re-negotiated movie marketing licenses or to market a different product or so that its basic structure and business plan could encompass an entirely new business.

75 Once again, Surfer Bank's ability to influence the outcome of the bankruptcy proceeding in a way that serves Surfer Bank's interests is a function of its claimholder status.

76 If Surfer Bank has properly perfected enforceable interests in the various items of collateral, then Surfer Bank will be a secured claimholder and its leverage will be correspondingly higher.

77 However, if Surfer Bank has failed to take the actions necessary to preserve its secured status then its leverage will be reduced to that of an unsecured creditor and could well be nil.

78 V. Some Concluding Observations The decisions as to whether MallBuster should be in bankruptcy or not and, if so, what type of bankruptcy, depend significantly on whether Surfer Bank (its attorneys) acted wisely and properly when the loan was made to MallBuster and during the period leading up to the financial distress.

79 The most significant decisions made earlier will be whether MallBuster had a viable future, whether the various assets of the business offered as collateral had and would retain value, and whether Surfer Bank had acted so that its security interests would survive bankruptcy.

80 Of course, Surfer Bank could not know that DVD technology would be MallBuster's undoing, but it could well have anticipated that something could change to negatively impact the business.

81 Surfer Bank most assuredly could have learned enough about online businesses to be able to value the various specialized collateral and to properly perfect its security interests in that collateral.

82 There are ways that bankruptcies involving dot.com companies or brick and mortar companies with a significant Net presence may be unique. Most are dealt with at some length in the Agin book referred to above.

83 One matter that may be peculiar to cyberbankruptcy (or at least more pronounced as to such bankruptcies) is that of where the bankruptcy case can be filed.

84 Jurisdiction under BRA § 109 is determined by such things as the location of a debtor, or a debtor's assets and place of business. As has been noted, location is an elusive matter when it comes to cyberspace and the Net World.

85 To some extent, an online business is located nowhere in particular but everywhere in general. This increases the options for places to file bankruptcy for a secured party, but it also may give a debtor wider choices and some may not be appealing to a secured party.

86 It may be that such "forum shopping" opportunities will have to be dealt with by bankruptcy courts as matters of venue or even through abstention. But, this is just one of many issues yet to be addressed with regard to cyberbankruptcy. Remember ---

87 It is a Mouse Driven World

88 Don’t be lost in Cyberspace!