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Perfecting Security Interests in Copyrights The Confusion Continues

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The recent In re Avalon[1] case demonstrates once again the uneasy fit between copyright law and Article 9. In that case, the bank filed only a UCC-1 to perfect its security interest in collateral for a software company. The court found that the copyrights as well as the accounts receivables from the licensing and sale of software were not perfected. Avalon made its money through the distribution and maintenance of its own software. Avalon had registered the copyrights in its software between 1986 and 1991, but it had not registered any copyrights in the more recent versions of its software. The bank did not record its security interest in the copyright in the existing registrations and did not register copyrights in the more recent versions of the software, nor record its security interest in such versions in the Copyright Office.

Code to Code This case is consistent with the other cases relating to perfections of security interests in copyrights, i.e.,In re Peregrine[2] and In re AEG.[3] Copyrights protect "works of authorship" fixed in a tangible form of expression. They protect films, software, art work, music, books and similar items. Copyright law provides the owner the exclusive right to reproduce, distribute, publicly perform, publicly display and modify the copyrightable work.

The issue of where to file to perfect a security interest in copyright and its associated receivables arises from the interaction between §§9-106 and 9-104(a). Section 9-106 states that copyrights, trademarks and patents fall under the category of "general intangibles" except to the extent that they may be excluded by §9-104(a). The issue then becomes whether or not the federal filing system in the Copyright Office is adequate for purposes of Article 9. Unfortunately, this issue is the subject of conflicting statements in the Official Comments. The issue is further complicated because these comments were about the Copyright Act of 1909 (the "1909 Copyright Act"), which is no longer in effect. The current copyright law, the Copyright Act of 1976 (the "1976 Copyright Act"),[4] has a very different filing system. The Official Comments for §9-104 state that the 1909 Copyright Act "would not seem" to provide for sufficient regulation of security interests to preempt Article 9. Yet later in the same paragraph, the Official Comment compares the 1909 Copyright Act and the Patent Act to the Federal Aviation Act (FAA) as examples of federal statutes whose filing systems preempt Article 9's state filing system. Furthermore, the Official Comment 8 to §9-302 states that the 1909 Copyright Act is sufficiently detailed to preempt Article 9 state filings. This confusion becomes less relevant when you consider that the 1976 Copyright Act, which governs all transactions after January 1, 1978, has a filing system that is at least as comprehensive as those provided by the FAA and the Ship Mortgage Act.

The initial question of where to file was resolved in the In re Peregrine decision in 1990. There, Judge Kozinski, sitting as a district court judge, reversed the bankruptcy court's holding and found that security interests in copyrights could only be perfected through registration of the copyright in the Copyright Office and recordation of the security interest against such copyright. More importantly, he also found, with little additional reasoning, that accounts receivables "generated" from copyrights could similarly only be perfected in that manner. These results were confirmed in a second case regarding films, In re AEG.

These cases left open a number of important issues, particularly the application of these principles to software. Unlike films, computer software is constantly being modified. These modifications are separately copyrightable as "derivative works." Each new version or revision of the software is protected by a separate copyright. Consequently, a computer software program is like a layer cake, with a series of individual copyrights each piled one on top of the other. In addition, computer software can be protected by other intangible rights such as trademarks, trade secrets and patents. Security interests in such forms of intellectual property may be perfected simply by filing a UCC-1 financing statement.[5]

Consequently, the Avalon case had the opportunity to deal with three important questions relating to software: (1) Does the lender have to register each new copyright in a revision and record his security interest against it in order to have a perfected security interest in the whole computer software program, or may he use some form of an after-acquired property clause? (2) If the security interest in the copyright of a computer program is not properly perfected, but a security interest in other rights protecting the computer program such as trademarks, patents and trade secrets is perfected, will the court allocate the accountsreceivable between the value of the unperfected copyrights and the perfected trademarks, trade secrets and patents? (3) What is the scope of accounts receivables "generated from a copyright" that must be perfected by a filing in the Copyright Office? For example, do these accounts receivable include (a) fees from sales of the software, (b) fees from licenses to third parties for further distribution, and (c) fees relating to maintenance?

Unfortunately, the Avalon case answers few of these questions clearly. The case is confusing regarding the perfection of copyrights and enhancements. Although at one point the court suggests that an "after-acquired property" clause will protect the bank if initially it properly recorded a security interest at the Copyright Office, but at another point it states that to perfect security interests in copyrights for enhancements: "[if bank had made sure that] the after-acquired property had been registered, it would have been found to be perfected." Ultimately, then, the court takes the position held by most commentators that each new copyright needs to be registered separately and the security interest recorded against it in order to perfect a security interest in the copyright in the revision to the computer program.

The court did not reach the question of allocation because it held that the trademarks, service marks, know-how, unpatented inventions and all trade secrets relating to the Avalon software as well as the copyrights were not perfected. This decision relating to trade secrets, trademarks and know-how is contrary to all other court decisions in this area. They have consistently found that a filing of a UCC-1 will perfect a security interest in patents, trademarks (both federally registered and common law) and trade secrets. The court does suggest, however, that allocation might be appropriate: It states that the only revenues from value added reseller (i.e., distributor) agreements which were not perfected were those that arose from "calculable and measurable additions of Avalon software."

On the issue of the scope of accounts receivables "generated from" copyrights, the court provided good news for lenders. The court found that accounts receivable derived from maintenance agreements were perfected by the filing of the UCC-1 financing statement. Maintenance agreements generally are a mix of services that may include telephone support, correction of errors and sometimes, provision of new releases of the software. It is not clear from the opinion whether the maintenance agreements for Avalon provided new releases of the software as part of the maintenance services. If so, the court may have decided that the value of such new releases as part of the maintenance contracts was relatively minor. Since many software companies derive as much as 30 percent of their revenue from maintenance contracts, these amounts can be significant.

A legislative solution to this problem is almost complete. An American Bar Association task force has been working on the problem created by the inconsistencies between the Article 9 and the federal intellectual property laws. The task force has completed its drafting of the proposed amendments and is making final changes in these drafts. It is expected to propose its amendments to federal intellectual property laws in the next six to eight months.

Avalon demonstrates once again the critical importance of identifying the intangible rights and related accounts receivable that are part of collateral. Failure to do so can lead to problems which arose in this case as most of the borrower's accounts receivable were found to be unperfected because of the failure to make the appropriate filings.


Footnotes

[1]In re Avalon, 1997 Bankr. Lexis 806 (Bankr. D. Ariz., June 6, 1997).[RETURN TO TEXT]

[2]In re Peregrine, 116 B.R. 194 (C.D. Cal 1990).[RETURN TO TEXT]

[3]In re AEG, 127 Bankr. 34 (Bankr. C.D. Cal 1991) aff'd 161 Bankr. 50 (BAP 1993).[RETURN TO TEXT]

[4] 17 U.S.C. 101 (1976).[RETURN TO TEXT]

[5]In re Transportation Design and Technology Inc., 48 B.R. 635 (Bankr. S.D. Cal 1985) (patents); In re Roman Cleanser, 802 F.2d 207 (6th Cir 1986) (trademarks); United States v. Antenna Systems Inc., 251 F. Supp. 1013 (D.N.H., 1966) (trade secrets).[RETURN TO TEXT]

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Wednesday, October 1, 1997

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