Securing Copyrightable Collateral A Lenders Perspective

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Jul/Aug 2000

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As a follow-up to the March 2000 Practice and Procedure article "Intellectual Property in Today's
Financing Market," one narrow, poignant issue needs further attention from a lender's perspective. That
issue is whether a secured creditor must record its security interest in unregistered copyrightable materials
in the U.S. Copyright Office, or whether the traditional recording under applicable state UCC law is
sufficient.

Federal pre-emption doctrines would appear to dictate that the Copyright Act pre-empts state law. On
the other hand, one must consider the practical issues created by attempting to record where no registration
exists. A close examination of the scant case law reveals, however, that no affirmative answer exists.

<h3>The Copyright Act</h3>

The Copyright Act establishes a priority scheme for interests in registered copyrights. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §205</a>.
Creators and owners of copyrightable materials, however, are not required to register those materials with
the Copyright Office to receive the benefits of copyright protection. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §408(a)</a>. Specifically,
§408(a) states that the owner of copyrightable materials, or of any exclusive right in such materials, may
obtain registration thereof by delivering to the Copyright Office the specified deposit. Section 408 further
states that such registration is not a condition of copyright protection.

Due to the discretionary nature of §408, owners of copyrightable materials such as computer codes and
programs often choose not to register their works in order to protect trade secrets, as well as the need for
frequent refiling or new registrations due to constant enhancements and modifications. In fact, the
Copyright Act requires a copyright owner to register copyrightable materials only if it wants to pursue an
infringement action and statutory damages thereunder. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §§411, 412</a>.

The discretionary use of the Copyright Act, and the conditional nature of its recording provisions, is
further demonstrated in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §205</a>, which provides the recording procedure and schematic for
copyrightable material. Specifically, the relevant portion of §205 states:

<blockquote>
(a) Conditions for Recordation—Any transfer of copyright ownership or other document pertaining
to a copyright may be recorded in the Copyright Office...
 (c) Recordation as Constructive Notice—Recordation of a document in the Copyright Office gives
all persons constructive notice of the facts stated in the recorded document, but only if—

</blockquote>

<blockquote><blockquote>
<hr>
<big><center>
Due to the discretionary nature of §408, owners of copyrightable materials...often choose not to
register their works in order to protect trade secrets...
</center></big>
<hr>
</blockquote></blockquote>

<blockquote>
<blockquote>
(1) the document, or material attached to it, specifically identifies the work to which it
pertains so that, after the document is indexed by the Register of Copyrights, it would be
revealed by a reasonable search under the title or registration number of the work; and

(2) registration has been made for the work.

</blockquote>

(d) Priority Between Conflicting Transfers—As between two conflicting transfers, the one executed
first prevails if it is recorded in the manner required to give constructive notice under subsection
(c)...(emphasis added)
</blockquote>

Due to this discretionary language, it seems only logical that when copyrightable materials are not
registered, §205 does not apply and no procedure for recording a security interest in unregistered
copyrightable materials exists. Thus, the only method for a secured creditor to perfect its security interest
is pursuant to applicable state UCC law, as it is impossible to perfect a security interest in unregistered
copyrightable materials by recording a financing statement with the Copyright Office. Such a filing, where
there is no file, is the equivalent of a fixture filing in a county where the subject real property is not located.

Consequently, although <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §301</a> expressly pre-empts other laws that might otherwise interfere
with a copyright owner's rights under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §106</a>, such as the right to reproduce, copy or distribute
copyrighted materials, no section of the Copyright Act expressly pre-empts state law application to the
recording of a security interest in unregistered copyrightable materials. Certain courts, however, have held
that perfection of a security interest in unregistered copyrightable materials occurs only by recording in the
Copyright Office. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Peregrine Entertainment Ltd., 116 B.R. 194, 198-99 (C.D. Cal. 1990)</a>.

<h3>Peregrine and Its Progeny</h3>

In Peregrine, the court stated that the Copyright Act established a uniform method of recording security
interests in copyrights and, therefore, state law methods of perfection are supplanted. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 116 B.R.
at 203</a>. Accordingly, the court held that due to the failure to record a security interest in the Copyright
Office, such interests are avoidable and may be preserved for the bankruptcy estate. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 207</a>.

Peregrine, however, did not state whether the copyrightable materials in issue were registered or
unregistered and also failed to analyze the applicability of recording a security interest in unregistered
copyrightable materials. Similarly, in <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re AEG Acquisition Corp., 161 B.R. 50 (9th Cir. BAP 1993)</a>, a
secured creditor failed to record its interest in foreign films, which the Berne Convention for the Protection
of Literary and Artistic Works exempts from registration. Despite the registration exemption, however, the
BAP summarily stated that no other exemption exists, and therefore, an unrecorded interest in foreign films
is avoidable. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Acquisition, 161 B.R. at 57</a>.

AEG Acquisition, however, did not analyze the affect of state law recording where a secured creditor
failed to record in the Copyright Office. Thus, both Peregrine and AEG Acquisition are an incomplete
analysis of whether a security interest in unregistered copyrightable materials must be recorded under the
Copyright Act or applicable state law.

However, the Bankruptcy Court for the District of Arizona has held that the Copyright Act pre-empts state
law, thereby requiring recordation with the Copyright Office to perfect a security interest in copyrightable
materials, whether registered or unregistered. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Avalon Software Inc., 209 B.R. 517 (Bankr. D. Ariz. 1997)</a>.
In Avalon, as opposed to Peregrine and AEG Acquisition, the facts clearly set forth that the secured creditor
took a security interest in unregistered copyrightable materials (software) and recorded its security interest
under state law, but not under the Copyright Act.

Thus, the Avalon court held that when a creditor obtains a security interest in copyrightable materials,
it must comply with both applicable state law and the Copyright Act. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 209 B.R. at 520</a>. Avalon,
however, failed to recognize the discretionary language of <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §408</a>. This discretionary language
was recognized by another court, thereby creating a split of authority as to unregistered copyrightable
materials. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re World Auxiliary Power Co., 244 B.R. 149 (Bankr. N.D. Cal. 1999)</a>.

<h3>The Sound Reasoning of World Auxiliary Power</h3>

In World Auxiliary Power, the court held that Peregrine's analysis only works if the copyrightable
materials are registered. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Auxiliary Power, 244 B.R. at 152</a>. Further, the court held that Congress did
not clearly indicate an intention to occupy the field of a secured creditor's rights with respect to a copyright,
and therefore, the Copyright Act does not expressly pre-empt state law. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 155</a>. Thus, the court held that
the failure to record a security interest under the Copyright Act does not create an avoidable security
interest. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;

Additionally, World Auxiliary Power set forth an analysis that goes to the heart of a trustee's
avoidance powers. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 152-53</a>. Specifically, the court pointed out that a hypothetical judicial lien
creditor's recording of its lien in the Copyright Office does not give priority over an unperfected security
interest under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §205(d)</a>. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; at 152.</a> Section 205(d), in fact, sets forth priorities of interests
recorded in the manner sufficient to give constructive notice to third parties, and constructive notice is
given only if the copyright is registered. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…;, citing <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §205(c)</a>.

Further, since unregistered copyrightable materials are by nature unregistered, no such filing could
ever give any third party constructive notice. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §205(c)</a>. Since no constructive notice could be
made, a trustee, who does not have the rights of a bona fide purchaser, could never attach a lien with
priority over a creditor's security interest.<a href="#1" name="1a">1</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Auxiliary Power, 244 B.R. at 152-53</a>; see, also,
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 116 B.R. at 206-07</a>, but, see <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; 209 B.R. at 521-22</a> (which again failed to fully address
all pertinent issues). Thus, a secured creditor's priority in unregistered copyrightable materials must
derive from state law, as the Copyright Act provides no such priority of interests. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Auxiliary Power
Co., 244 B.R. at 154</a>.

<h3>Conclusion</h3>

World Auxiliary Power is currently on appeal. The result of the World Auxiliary Power appeal could
end or further compound the current split of authority. While the outcome of the appeal is uncertain, the
result may very well change the practice of securing financial obligations using copyrightable materials.

Further, all of the cases cited herein derive from Ninth Circuit courts, resulting in a lack of mandatory
authority for other circuits, who may apply their own analysis. Accordingly, practitioners should carefully
examine such issues and consider the implications thereof, as the split of authority may very well surprise
many a lender who thought its security interest was perfected and unavoidable.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Pursuant to <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §544</a>, after all, a trustee receives only the rights of a hypothetical judicial lien creditor, not the
benefit of a bona fide purchaser's rights. <a href="#1a">Return to article</a>

Journal Authors

Bruce H. White

William L. Medford

Journal Date

Saturday, July 1, 2000 - 12:00