Articles
Client Alert - Perfecting Security Interests in Unregistered Copyrights: New Developments
By Baila Celedonia & Joel Karni Schmidt
Oct. 3, 2002
Is it possible to perfect security interests in unregistered copyrights under the Uniform Commercial Code? Until recently, the prevailing answer to this question had been no. Only security interests in registered copyrights could be perfected through a federal filing at the Copyright Office. State methods of recording security interests under the Uniform Commercial Code appeared not to apply to security interests in registered or unregistered copyrights. However, in a recent decision, the Ninth Circuit broke new ground and held that it is possible to perfect a security interest in unregistered copyrighted works by filing a U.C.C. financing statement. This decision has important ramifications for lenders and borrowers alike, and will require lenders to reevaluate the steps they take to perfect, protect and maintain their security interests in copyright collateral.
Perfecting Security Interests in Copyrights
Since January 1, 1978, the effective date of the 1976 Copyright Act, 17 U.S.C. §101 et seq., which did away with common law copyrights, copyright rights have been governed by federal law. Security interests, on the other hand, are generally governed under state law through the Uniform Commercial Code. In re Peregrine Entertainment, Ltd., 161 B.R. 194 (C.D. Cal. 1990) established that a security interest in rights under copyright must be recorded in the Copyright Office in order to perfect the security interest. Parallel U.C.C. filings were held to be ineffective. The reasoning underlying this decision, and the decisions that followed, was based both on the Copyright Act, 17 U.S.C. §205, principles of preemption of state law and on U.C.C. §9-311(a) or former U.C.C. §9-302(3)(a). The courts noted that the Copyright Act contains comprehensive provisions for recording security interests in copyrights, and held that these provisions preempted state U.C.C. methods of perfecting security interests in copyrights.
The Problem with Peregrine
Because the Copyright Office is ill-equipped to handle lien filings, Peregrine and its progeny had created tremendous problems for secured lenders. First, under the federal Copyright Act system, it is only possible to record security interests against registered copyrights. Federal filings cannot be made against the debtor, but only against the particular works identified by their title or registration number. Under the U.C.C. state system, filings are made and indexed against the debtor and searching is done by checking under the debtor's name. Because of the way liens are recorded in the Copyright Office, searching is difficult using the debtor's name.
Moreover, in the Copyright Office, documents, including security interests, can only be filed against registered copyrights. So a filing in the Copyright Office cannot include after-acquired collateral of the same type—a common provision in most loan agreements. Consequently, new works (whether newly acquired or newly created) must first be registered and only then can a security interest be filed against the new registration. Under the Copyright Office system, perfection would not occur at the instance of the creation or acquisition of a copyrighted work by the borrower. This problem has been exacerbated by the fact that fewer and fewer works are being registered today because registration is no longer a necessary prerequisite to the existence of federal copyright rights.
Although a copyright registration is generally a prerequisite to bringing an action for infringement and has other benefits, if a company's copyrightable works are not likely to be infringed, a company may reasonably decide not to register a work unless and until it has actually been infringed. Further, there are many different types of company assets that are rarely registered with the Copyright Office, such as brochures and other marketing materials, technical manuals, drawings, designs and blueprints, and logos and other graphics. In most cases, it is not worth the even modest registration fee to register the copyright in such works. In other cases, companies simply do not want to make a public record of works that are still in the early stages of development. Given Peregrine and its progeny, however, such reasonable business decisions appeared to make it impossible for a lender to perfect a security interest in such copyrights and thereby deterred lenders from accepting such unregistered copyrights as collateral.
This requirement of registration in order to perfect has been particularly problematic for software development companies, which constantly create new software or update existing software (derivative works), but seldom register their claim to copyright in such software, especially interim versions. Following Peregrine, the court in In re Avalon Software Inc., 209 Bankr. 517 (Bankr. D. Ariz. 1997), held that a security interest in unregistered copyrights, including after-acquired copyrights, was governed by the Copyright Law. Finding the lender unperfected, this Court held that it was impossible to perfect against unregistered copyrights.
Aerocon Engineering v. Silicon Valley Bank
Recently, the Ninth Circuit, in Aerocon Engineering v. Silicon Valley Bank, 2002 U.S. App. LEXIS 18642 (9th Cir. 2002), distinguished and narrowed the Peregrine decision. While confirming that registered copyrights can only be perfected by recording in the Copyright Office, the Ninth Circuit held that unregistered copyrights are perfected under the U.C.C.
The case resulted from a complex bankruptcy contest among a bank and various entities over ownership of unregistered copyrights in drawings, technical manuals, blueprints and computer software used in connection with modifying airplanes. Briefly, the bank held a security interest in the copyrights that it obtained in exchange for financing an entity that later went bankrupt. Prior to the bankruptcy, the bank had perfected its security interest pursuant to California's version of Article 9 of the U.C.C. In the course of the bankruptcy, the appellant had purchased the copyrighted works along with other assets from the bankruptcy trustee and had attempted to avoid the bank's security interest through a purchase by a related entity of the trustee's right to avoid the security interest. When the bank foreclosed on the copyrights and sold them to a third party, the appellant sued to avoid the bank's security interest, arguing that the bank did not have a perfected security interest in these unregistered copyrights. The bankruptcy court determined that the bank had a perfected security interest, and its decision was affirmed on appeal to the district court.
On further appeal, the Ninth Circuit upheld the district court's decision, holding that a secured creditor can perfect a security interest in an unregistered copyright (but not a registered copyright) by filing a U.C.C. financing statement. The court reasoned that since the Copyright Act does not provide a means by which a security interest in an unregistered copyright may be perfected, it does not conflict with or preempt the U.C.C. filing system with respect to perfection of security interests in unregistered copyrights. In the Court's words, 'there aren't two competing filing systems for unregistered copyrights. The Copyright Act doesn't create one. Only the U.C.C. creates a filing system applicable to unregistered copyrights.'
Relying in large part on the text and purposes of the Copyright Act, the Court rejected the decisions of two lower courts which, following Peregrine, had held that security interests in unregistered copyrights may not be perfected under the U.C.C. The Ninth Circuit concluded that there is no justification for requiring registration as a condition of perfection because it would imply that 'Congress intended to make unregistered copyrights practically useless as collateral' and would wrongly 'amount to a presumption in favor of federal preemption.' The Court also concluded that its decision to allow secured lenders to perfect their security interests by filing U.C.C. financing statements does not frustrate federal copyright policy; rather, it preserves the collateral value of unregistered copyrights.
Problems Still Remain for the Lender
The Court accepted that there may be situations where a devious debtor that had obtained financing based on unregistered copyrights may then register the copyrights and obtain additional financing from another secured lender who, by recording its interests with the Copyright Office, would obtain priority over an original lender who had only perfected its security interests under the U.C.C. However, the Court never addressed the more probable situation in which even a good-faith borrower may need to register valuable copyright collateral (for example, to sue for infringement or register the copyright with Customs), thus inadvertently taking this valuable collateral 'out of perfection.' The Court assumed that prudent lenders would take the necessary steps to protect themselves.
Avoiding Perfection Problems After Aerocon
Aerocon provides some new comfort to lenders who wish to extend credit to borrowers whose assets include valuable unregistered copyrights. Indeed, if Aerocon is followed, lenders now have the ability to perfect security interests in unregistered copyrights, making it easier to finance, for example, a software developer.
At the same time, Aerocon also introduces additional uncertainty to such secured transactions. Of course, it is impossible to forecast whether courts in other circuits will follow Aerocon, although its reasoning appears sound. Hopefully, the commercial finance and intellectual property bars will again go to Congress to seek a solution based on a more workable, unified filing system. If Aerocon remains good law, Lenders must continue to include appropriate covenants and warranties in their loan documents, such as requiring the borrower to promptly notify the lender when the borrower registers previously unregistered copyrights and being more vigilant in enforcing such provisions. In addition, an internal program at the lender must be in place, so that the lien is immediately recorded in the Copyright Office against each copyright that is registered.
Our firm has extensive experience with respect to security interests in intellectual property. If your company needs assistance in securing and perfecting its intellectual property security interests, or if your company wants advice on how to institute policies and procedures properly to maintain such interests, please contact us.
| Baila H. Celedonia | (212) 790-9203 |
| Joel K. Schmidt | (212) 790-9244 |
This article was published in the November 4, 2002, issue of Banking Report, Vol. 79, No. 17.
Copyright 2002
Cowan, Liebowitz & Latman, P.C.