Texas Attorney General Privacy Is Not for Sale

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Oct 2000

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When a dot-com company seeks to liquidate under the Bankruptcy Code, there is usually little in tangible
assets to sell compared to its brick-and-mortar counterparts. Frequently, among the most valuable assets
a dot-com company holds is information regarding its customers. The information an online retailer
(e-tailer) collects from a consumer in order to customize the individual's online shopping experience (its
customer list) is often more sensitive than the customer's name, address and telephone number. It may also
include credit card numbers, personal shopping habits, even children's names and ages, and family health
data.

To acquire this sensitive information, many e-tailers make privacy guarantees promising the customer
never to disclose to a third party the information they have collected. However, when pressed by hungry
creditors, it is this expressly guaranteed privacy that dot-com debtors and their creditors argue should
become expendable. Such was the case with the recent filing of online toy company Toysmart.com.<a href="#2" name="2a">2</a>
Forced into a chapter 11 bankruptcy case by creditors on June 26, 2000, the Waltham, Mass., toymaker
quickly sought to sell substantially all of its assets, including its customer list, pursuant to <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §§105</a>
and 363(b). The debtor proposed to sell its entire database, including its customer list and related
information, notwithstanding its online privacy promise: "Personal information voluntarily submitted by
visitors to our site, such as name, address, billing information and shopping preferences, is never shared
with a third party. All information obtained by Toysmart.com is used only to personalize your online
experience (emphasis added)."<a href="#3" name="3a">3</a>

Texas Attorney General John Cornyn objected to the proposed sale on the grounds that it violated state
deceptive trade practice laws.<a href="#4" name="4a">4</a> More than 40 other states, including Massachusetts and New York,
subsequently joined in the challenge. The fundamental question raised by the Toysmart.com case is
whether a customer list with an attached privacy promise to keep such information confidential is an asset
of the bankruptcy estate that may be sold without restrictions.

Section 541(c)(1)<a href="#5" name="5a">5</a> of the Bankruptcy Code defines the universe of property that is included in an estate.
However, this section does not create the scope or value of a debtor's interest in property. <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Amer. Freight
Sys. Inc., 179 B.R. 952, 960 (Bankr. D. Kan. 1995)</a>. As the U.S. Supreme Court has held:
<blockquote>
Property interests are created and defined by state law. Unless some federal interest requires a
different result, there is no reason why such interests should be analyzed differently simply because
an interested party is involved in a bankruptcy proceeding. Uniform treatment of property interests
by both state and federal courts within a state serves to reduce uncertainty, to discourage forum
shopping and to prevent a party from receiving "a windfall merely by reason of the happenstance
of bankruptcy."
</blockquote>

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. U.S., 440 U.S., 48, 55, 99 S.Ct. 914, 918, 59 L.Ed.2d 136 (1979)</a>(citations and internal quotations
omitted.).

Section 541(c)(1) does not increase a debtor's property interests, but merely preserves them.<a href="#6" name="6a">6</a> When a
dot-com moves to sell its customer list in bankruptcy, it can only sell that interest—subject to any and all
restrictions—it maintained under state law prior to the bankruptcy filing.<a href="#7" name="7a">7</a>

The Texas A.G. has taken the position that privacy agreements, such as Toysmart.com's, deny debtors
the authority to unilaterally terminate or limit the privacy protection guaranteed in such agreements. "As a
former judge," said John Cornyn, "I would expect to see the bankruptcy courts balance the important privacy
rights of consumers with the business interests of creditors seeking to recover on their claims, but in such
instances as Toysmart.com, I believe never means never and would hope to see courts honor these privacy
agreements."

While the customer list a bankrupt dot-com holds is an asset, it is nonetheless burdened by the privacy
guarantees the company made to customers to attract their business. It should not be sold "free and clear
of interests" as other assets are pursuant to §363 without strict compliance with the contractual or statutory
restrictions placed on the sale or transfer of the asset.<a href="#8" name="8a">8</a> If the online privacy policy places the authority with
the consumer to alter, amend, edit or delete personal information, then it is the customer, and only the
customer, who should be entitled to determine whether such personal information may be disclosed or sold
to third parties. As the Texas A.G. observed, "Consumers have a right to decide who they wish to do
business with on the Internet and they should decide what happens to personal information they reveal, not
creditors and not the government."

Another fundamental question to be asked is whether bankruptcy courts should allow debtors to undo
contracts steeped in privacy concerns simply to benefit creditors. At a hearing on the Toysmart.com sale
motion, the debtor withdrew the portions of the motion containing the web site database and the customer list,
alleging that the offers to purchase were too low. Subsequently, the bankruptcy court denied, as premature,
the debtor's motion to enter a compromise agreement to settle a lawsuit brought by the Federal Trade
Commission.<a href="#9" name="9a">9</a> This agreement was proposed to establish parameters under which the debtor could sell its
customer list in the future.<a href="#10" name="10a">10</a> The bankruptcy court's denial of the debtor's authority to enter into the
settlement agreement leaves unresolved the question of whether a dot-com debtor may sell its customer list
and under what circumstances.<a href="#11" name="11a">11</a>

One solution proposed by the state attorney generals in Toysmart.com was to allow debtors to sell their
customer lists encumbered by privacy guarantees on e-mail notice to all potentially affected customers and
effective consent by such customers, i.e., on an "opt-in" basis. E-mail notice, in a form approved by the
bankruptcy court, would not only provide each customer with information regarding a change in circumstance
or a change in the original contract it entered with the dot-com, but would also comport with due process
requirements that notice be given to any party having an interest in property being sold under §363. E-mail
consent by consumers on an opt-in basis allows the customer to assent to the sale and to enter a new contract
at their choosing with the debtor or its successor.<a href="#12" name="12a">12</a> Despite the simplicity of this approach, this concept has
to date not been embraced by Toysmart.com or its creditors. As more and more dot-coms seek bankruptcy
relief, the issues raised in Toysmart.com will undoubtedly resurface.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> The views and opinions expressed herein are solely those of the authors and do not necessarily reflect those views and opinions of the
Office of the Attorney General of Texas. <a href="#1a">Return to article</a>

<a name="2">2</a> In re Toysmart.Com L.L.C., case no. 00-1395-CJK, U.S. Bankruptcy Court, District of Massachusetts, Eastern Division.
The case attracted significant attention. See, e.g., Brick, Michael, "Judge Overturns Deal on Sale of Online Customer Database," N.Y.
Times.com/TheStreet.com, Aug. 18, 2000; "Judge Shelves Plan for Sale of Online Customer Database," New York Times, Aug. 17,
2000 at C2; "Judge: No Conditions on Toysmart Data Sale," USA Today Tech Report; Shapiro, Keith J., "Don't Ban All Data
Sales," USA Today Opinion, Aug. 5, 2000; "Privacy Goes to Top Bidder," EXCITE.NEWS, July 26, 2000; "FTC Favors
Plan for Toysmart Sell Customer List—WSJ," YAHOO!.FINANCE, July 21, 2000; Perine, Keith, "FTC Tries to Stop Sale of Toysmart
Customer Lists," THE STANDARD.COM, July 10, 2000. <a href="#2a">Return to article</a>

<a name="3">3</a> The Toysmart.com web site is located at <a href="http://www.toysmart.com/toysmart/ts_cs_privacypolicy.asp">http://www.to…; (Sept. 1999). <a href="#3a">Return to article</a>

<a name="4">4</a> "Texas Deceptive Trade Practices—Consumer Protection Act," Tex. Bus. & Com. Code §§1741 et seq. The Texas Attorney General
was authorized by the state of Texas to act on behalf of consumers in Texas to enforce the Texas Deceptive Trade Practice—Consumer Protection
Act to protect against false, misleading and deceptive business practices, unconscionable actions and breaches of warranty. Tex. Bus & Com.
Code §17.45-47. <a href="#4a">Return to article</a>

<a name="5">5</a> <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §541(c)(1)</a> provides:
<blockquote>
Except as provided in paragraph (2) of this subsection, an interest of the debtor in property becomes property of the estate under
subsection (a)(1), (a)(2), or (a)(5) of this section notwithstanding any provision in an agreement, transfer instrument,
or applicable non-bankruptcy law—
<blockquote>
(A) that restricts or conditions transfer of such interest by the debtor; or
 (B) that is conditioned on the insolvency or financial condition of the debtor, on the commencement of a case under this
title, or on appointment of or taking possession by a trustee in a case under this title or a custodian before such
commencement, and that effects or gives an option to effect a forfeiture, modification or termination of the debtor's interest
in property. <a href="#5a">Return to article</a>
</blockquote>
</blockquote>
<a name="6">6</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Transcon Lines, 58 F.3d 1432, 1438 (9th Cir.1995)</a> (noting that "non-bankruptcy law defines the nature,
scope and extent of the property rights that come into the hands of the bankruptcy estate...only those property rights which are owned by
the debtor become the bankruptcy estate"), cert. denied sub nom., <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Sterling Press Inc., 516 U.S. 1146 (1996)</a>;

<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Sanders, 969 F.2d 591, 593 (7th Cir.1992)</a> ("[A] bankruptcy trustee succeeds only to the title and rights in
property that the debtor had at the time she filed the bankruptcy petition"). <a href="#6a">Return to article</a>

<a name="7">7</a> See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… re Bishop College, 151 B.R. 394, 398 (Bankr. N.D. Tex. 1993)</a> (a bankrupt's estate receives trust assets
"subject to any restrictions imposed by state law, pre-petition"); see, also, <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Solutions Inc. v. Service Support Specialists
Inc., 124 F.3d 487, 492-93 (3rd Cir. 1997)</a> (noting "...without explicit federal pre-emption, the trustee does not
have greater rights in the property of the estate than the debtor had before filing for bankruptcy"). <a href="#7a">Return to article</a>

<a name="8">8</a> While <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §363</a> defines the permissible use, sale or lease of estate property, it does not authorize a debtor to sell
property in violation of state law transfer restrictions. It merely provides the debtor with the authority to dispose of property if the debtor
would have the same right under state law. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Solutions Inc. v. Service Support Specialists Inc., 124 F.3d at 493</a>,
<a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…; <a href="#8a">Return to article</a>

<a name="9">9</a> Federal Trade Commission v. Toysmart.Com L.L.C. and Toysmart.Com Inc., Civil Action No. 00-11341-RGS, filed in the
U.S. District Court, District of Massachusetts. The FTC's lawsuit was brought under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… U.S.C. §45</a> to prevent Toysmart.com from
allegedly engaging in, inter alia, deceptive trade practices regarding the proposed sale of its customer list. <a href="#9a">Return to article</a>

<a href="#10" name="10a">10</a> See Debtor's Motion to Approve Stipulation with Federal Trade Commission and for Authority to Enter into Consent Agreement, In re
Toysmart.Com L.L.C., case no. 00-13995-CJK, U.S. Bankruptcy Court, District of Massachusetts, Eastern Division (Docket
No. 113). The FTC took the position that the list could be sold under certain restrictions, including sale to an entity engaged in
a family market. The state attorneys general advocated more privacy rights for consumers. <a href="#10a">Return to article</a>

<a name="11">11</a> Other questions surround the sale of a dot.com debtor's customer list when personal customer information has been obtained under promises
of confidentiality. For, example, if a bankruptcy court grants a dot.com debtor the right to sell such a customer list, will the sale
and arguable breach of contract to customers give rise to 50 separate state law deceptive trade practices actions against the debtor by state
attorneys general across the country? Will damages arising post-petition under those suits constitute administrative expenses? Will individual
customers file separate or class-action suits to enjoin the dissemination of their personal information or recover damages for the loss? Will
the federal government file actions under the <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Trade Commission Act, 15 U.S.C. §45</a>, or the <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Online Privacy Protection
Act of 1998, 15 U.S.C. §6501</a>, for violations thereunder? Will online watchdog groups such as TRUSTe.org seek damages against
the debtor for allegedly dishonoring the privacy guarantees not only promised by the debtor but also by the watchdog group because of its "seal
of approval" stamped on the web site? If a debtor spends five times as much as it receives in sale proceeds to defend and pay damages
arising from lawsuits by states, individuals, the federal government and watchdog groups, what net benefit inures to creditors of the estate? <a href="#11a">Return to article</a>

<a name="12">12</a> Notice and consent requirements are not novel ideas with respect to estate assets. In <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… v. Catapault Entertainment Inc. (In
re Catapult Entertainment Inc.), 165 F.3d 747 (9th Cir. 1998)</a>, the Ninth Circuit Court of Appeals precluded the debtor's
assumption of patent licenses, pursuant to §365 of the Code, over the licensor's objection to assumption as applicable non-bankruptcy law
barred assignment of the personal and non-delegable licenses to a hypothetical third party without the licensor's consent. <a href="#12a">Return to article</a>

Journal Authors

Flora A. Fearon

Hal F. Morris

Journal Date

Sunday, October 1, 2000 - 12:00