In re Avalon Software Inc.
209 B.R. 517 (Bkcy D. Ariz. 1997)
FACTS
[Avalon Software, Inc., an Arizona corporation, was in the business of developing, for businesses, computer software for inventory control, from purchasing through manufacture to sale, and collection and accounting. Avalon borrowed money from Imperial Bank. At the time Avalon filed its Chapter 11 bankruptcy, Avalon owed Imperial Bank $1,483,662. To secure the loan Imperial Bank had taken a security interest in Avalon's personal property, including accounts, general intangibles, equipment, inventory, and proceeds, existing and after-acquired. Imperial Bank filed a UCC-1 financing statement with the Arizona Secretary of State. Imperial Bank never filed a financing statement, its security agreement, or any other document evidencing its security interest with the United States Office of Copyright. Avalon registered its copyrights on its intellectual property between 1986 and 1991. Thereafter, Avalon did not register copyrights on its newly developed products, or modifications to its previous versions.]
LEGAL ISSUES
1. Is the bank's security interest perfected in Avalon's copyrighted software and its proceeds?
2. Is the bank's security interest perfected in Avalon's updates, modifications amendments, or enhancements to Avalon's copyrighted software and its proceeds?
3. Is the bank's security interest perfected in Avalon's non-copyrighted software and its proceeds?
4. Is the bank's security interest perfected in Avalon's updates, modifications, amendments, or enhancements to Avalon's non-copyrighted software and its proceeds?
5. Is the bank's security interest perfected in Avalon's accounts receivable derived from service and maintenance agreements.
6. Is the bank's security interest perfected in Avalon's equipment and inventory?
DISCUSSION
Copyrights, Security Interests and Bankruptcy
A. Copyright Law
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Copyright protection exists and subsists in tangible, expressed works of authorship. 17 U.S.C. § 102(a); [case citations omitted.] A computer program is a work of authorship subject to copyright. [Citations omitted.] In order for an author or creator to be entitled to obtain the protection of a copyright, no registration is necessary for it to exist for a term of years. 17 U.S.C. § 302. However, in order to enforce an infringement claim against another, registration is a prerequisite. 17 U.S.C. §§ 410, 411. Such registration is not, however, a condition of copyright protection. 17 U.S.C. § 408(a). Once a copyright is applied for, a deposit is made, and the Register of Copyrights has issued a certificate, an action for infringement may be made. 17 U.S.C. § 411.
B. Security Interests Under Copyright Law
If a creditor undertakes to obtain a security interest in a copyrighted work, it must comply with both the Uniform Commercial Code and federal copyright law. That is, in order for a security interest to attach, there must be value given, the debtor must have rights in the collateral, and there must be an agreement signed by the debtor. Ariz.Rev.Stat. § 47-9203(A). Under federal copyright law, the grant of a security interest is defined as a "transfer of copyright ownership," because within copyright law that term includes mortgages or other forms of hypothecation. 17 U.S.C. § 205. If the copyright has been registered, and if the document adequately identifies the property in which the security interest is taken, the recordation of the security interest serves to impart constructive notice to the world of the existence of the security interest. 17 U.S.C. § 205(c).
C. Security Interests Under Arizona Law
[As to most security interests in business assets, filing with the Secretary of State's Office will suffice to perfect.]
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But, the usual perfection requirements are different if the property is subject to either a state or federal statute which requires central filing in another registry or location. Ariz.Rev.Stat. § 47-9302(C)(1). The most typical example of this exception in Arizona is the Motor Vehicle Department's central registration of liens on motor vehicles. See Ariz.Rev.Stat. § 28-325; § 47-9302(C)(2). Arizona's Uniform Commercial Code filing location requirements are inapplicable "[t]o a security interest subject to any statute of the United States...." Ariz.Rev.Stat. § 47- 9104(1). In other words, if another statutory means of filing is covered by another state or federal statute, then the usual UCC methods are superceded, and, in the case of federal statutes, preempted.
D. Bankruptcy of the Debtor
If a security interest is not properly perfected, it becomes subordinate to the rights of a bankruptcy trustee (or debtor-in-possession) whose principal purpose is to maximize a debtor's estate for the benefit of the unsecured creditors. Ariz. Rev.Stat. § 47-9301(A)(2); § 47-9301(C); 11 U.S.C. § 544; Nattional Peregrine, Inc. v. Capitol Federal Savings and Loan Association of Denver, (In re Peregrine, Entertainment, Ltd. 116 B.R. 194 (C.D.Cal.1990)).
E. Perfection in a Copyright Against a Trustee
The proper method, then, for a secured creditor to obtain a perfected security interest in either copyrighted or copyrightable property is to register that security interest with the United States Copyright Office. 17 U.S.C. § 205. This protection also extends to the proceeds naturally derived from the copyrighted material. An additional requirement is that the copyright also be registered. 17 U.S.C. § 205(c).
Imperial Bank argues that if Avalon failed to register any of its copyrightable material or software, that it (or its Trustee) is not entitled to the "other central registry " exception of the UCC. The bank then maintains that, because of the failure actually to register a product which is capable of registration, it then becomes something else--perhaps a general intangible-- which was perfected and which could only be perfected by filing with Arizona's Secretary of State.
Importantly, registration "is not a condition of copyright protection." 17 U.S.C. § 408(a). Thus, a product which is entitled to be registered at the U.S. Copyright Office, but is not, does not carry a different "label" or become something different solely because it was not registered at the U.S. Copyright Office. [Citations omitted.] In other words, a security interest in such an item is unperfected if filed or recorded anywhere other than at the U.S. Copyright Office.
Attempting to call such product a "trade secret" does not change the requirement for security-interest filing at the Copyright Office. The burden to perfect properly is entirely on the secured creditor in such an instance. It is immaterial whether the debtor has registered its material. Perfection and constructive notice to the world is accomplished by the creditor's satisfaction of two requirements: (1) documenting the security interest with the U.S. Office of Copyright, and (2) insuring that a registration of the copyrighted product has also been made at the U.S. Copyright Office.
Therefore, as to all Avalon property which the bank was required to perfect at the U.S. Copyright Office, but which it did not, Imperial Bank is unperfected, and it is an unsecured creditor to the extent of that property interest and any sale proceeds.
F. Derivative or Offshoot Intellectual Property
The next issue raised by Imperial Bank may be addressed easily. The bank contends that intellectual property which is an enhancement, an offshoot, or a modification to an existing program does not rise to the level of a mature program. This distinction, however, is not material. Whether the new product is a completely new and mature program, or an accessory to an older, copyrighted or non-copyrighted program, any security interest therein must be filed with the U.S. Copyright Office in order to be perfected as against a bankruptcy trustee. An "after-acquired" clause would protect the bank if it had initially properly filed its security interest at the Copyright Office. All such subsequent, various versions are dependent upon each other in order to operate the software. Thus, there is no logical way to separate them into categories, some of which are required to be filed in Washington, D.C., and some in Phoenix, Arizona. Moreover, this argument is inconsistent with the intent of the Uniform Commercial Code, which is to require filing in logical, statutory places in order to give notice to the world of a claim or interest. See Peregrine, supra, 116 B.R. at 200. The bank's argument simply elevates form (labels) over substance (what the product does or is intended to do).
G. With Regard to the Debtor's Interest, Registration of The Copyright is Irrelevant
The bank confuses the protection available to a copyright owner who registers its interest with the perfection of a secured creditor's rights, which is obtained by filing in a specific location. However, as federal law mandates, in order to claim a perfected security interest, a creditor must file that interest with the U.S. Copyright Office. 17 U.S.C. § 205. Ultimate perfection may depend upon registration of the product, but this burden is one which is placed exclusively upon the creditor. If each step is not complied with, the creditor is denied the presumption of constructive notice. If a security interest is not so filed, the creditor is left unperfected and its claim to such property is subordinate to a trustee or debtor-in-possession who exercises the "strong arm" powers of § 544 of the Bankruptcy Code. 17 U.S.C. § 205; Peregrine, supra, 116 B.R. at 204-07.
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H. Maintenance and Consulting Agreements
[Maintenance agreements] covered a service only, and did not involve, require, or significantly include the sale or licensing of any tangible "intellectual property" other than the expertise of the personnel who carried out maintenance under such agreements. Accordingly, accounts or receivables created by the servicing and maintenance agreements were properly perfected by Imperial Bank.
I. The Bottom Line
Thus, it can be concluded that the bank is perfected and unperfected as follows:
[The security interests in the debtor's copyrighted and copyrightable software, derivatives, modifications, enhancements, licenses attributable to this software and proceeds of any type from the licensing and sale of this software are not perfected by the filing with the Secretary of State's Office in Arizona.
The security interests in the debtor's Equipment, Inventory (except that consisting of any of the software), and Accounts and General Intangibles (other than that which constitutes proceeds from the license or sale of copyrighted or copyrightable software) are perfected by the filing in the Secretary of State's Office in Arizona.]
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