Uncertainty About Perfection Of Security Interest in a Copyright Or: Better Safe Than Sorry
Perfection of Security Interests Under the UCC
Article 9 of the UCC, as adopted and modified by each state, generally governs the perfection of security interests in personal property. Among other things, the UCC provides that the proper place to file in order to perfect a security interest in general intangibles (which include copyrights) is with the applicable office of the Secretary of State. However, section 9-104 of the UCC specifically excludes from its scope any security interest subject to a federal statute regulating the rights of parties with respect to the collateral. This exclusion is commonly referred to as the "step back" provision. Further, under section 9-302 of the UCC, the filing requirements under the UCC do not apply if federal or state law establishes a system for filing and perfecting security interests outside the scope of the UCC. (A security interest governed by a federal statute under the step back provision is excluded from coverage by the UCC entirely, whereas a security interest covered by the carveout in section 9-302 is excluded only from the UCC filing requirements.) The applicability of these two exclusions are the crux of the issue of what law governs the perfection of a security interest in a copyright.
The World Auxiliary Power Company Case In World
Auxiliary, before the commencement of the debtors' chapter 7 cases, the debtors designed, manufactured, and sold certain aircraft-related products. Although they held a copyright to their designs, they did not register the copyright with the Copyright Office. The debtors granted a security interest in their copyright to Silicon Valley Bank to secure the debtors' obligations under loan and guaranty agreements. The debtors executed UCC-1 filing statements that the bank filed with the California Secretary of State; however, the bank did not record the security agreement or the UCC-1 statements at the Copyright Office.
After the debtors filed under the Bankruptcy Code and their cases were converted to chapter 7, the debtors' successor-in-interest sought to avoid the bank's security interest in the copyright pursuant to section 544(a)(1) of the Bankruptcy Code, which permits a trustee or debtor in possession to avoid any unperfected prepetition security interests granted by the debtor. The debtor's successor argued that the bank's security interest was unperfected because it had not been recorded at the Copyright Office.
Rejecting this argument, the court concluded that because the copyright had not been registered with the Copyright Office, a security interest in the unregistered copyright could be perfected by filing a UCC-1 financing statement with the Secretary of State. Accordingly, the court held that the bank's security interested was properly perfected and could not be avoided. The court noted, however, that a security interest in an unregistered copyright, properly perfected by filing a UCC-1 with the Secretary of State, may be vulnerable if the copyright is subsequently registered and a competing security interest had previously been recorded in the Copyright Office.
In stark contrast to the decision in World Auxiliary, in In re Avalon Software, Inc., a bankruptcy court in the District of Arizona observed that a product which is entitled to be registered at the Copyright Office does not change its character and, with it, the requirement for filing a security interest at the Copyright Office, simply because its creator did not register it at the Copyright Office. The Avalon court concluded that it is "immaterial whether the debtor has registered its [copyrightable] material." Where an unregistered copyright is at issue, the court concluded that a creditor has the burden of properly perfecting a security interest in the copyright by ensuring that the copyright is registered and notice of the security interest is filed with the Copyright Office. The court noted that registering a copyright with the Copyright Office is easily achieved, and the secured creditor can register the copyright if the debtor has not already done so.
Similarly, in National Peregrine, Inc. v. Capitol Federal Savings & Loan Association (In re Peregrine Entertainment, Ltd.), without any reference as to whether the copyright at issue was registered or unregistered, a district court in the Central District of California held that a security interest in a copyright can be perfected only by recording it with the Copyright Office. The court noted, however, that in order for recordation at the Copyright Office to be effective against third parties, the copyrighted work must also have been registered in accordance with the requirements of the United States Copyright Act ("USCA").
In Official Unsecured Creditors' Committee v. Zenith Productions, Ltd. (In re AEG Acquisition Corp.), a bankruptcy court in the Central District of California also concluded that perfection of a security interest in a copyright requires both registration of the copyright and filing notice of the security interest with the Copyright Office. The court compared the recordation requirements under the USCA to real property recording acts and noted that a mortgage on real property is not effective if it is recorded outside the chain of title. Based on this comparison, the court questioned but did not answer whether a security interest in a copyright would be properly perfected if notice of the security interest were filed before the copyright was registered.
Intersection of UCC Article 9 And the United States Copyright Act
In reaching their conclusions, each of these courts analyzed the provisions of Article 9 of the UCC and the USCA. The court in World Auxiliary concluded that neither the step back provision in section 9-104 nor the carveout in section 9-302 of the UCC excludes unregistered copyrights from the filing requirements under the UCC. As a result, according to the court in World Auxiliary, the UCC regulates the perfection of security interests in unregistered copyrights, whereas the USCA regulates the perfection of security interests in registered copyrights. In contrast, the courts in Peregrine Entertainment and Avalon Software concluded that both the step back provision in section 9-104 and the carveout in section 9-302 exclude copyrights from the purview of the UCC. Similarly, the court in AEG Acquisition relied on the decision in Peregrine Entertainment in concluding that the USCA preempts the UCC.
It should be noted that The American Law Institute and the National Conference of Commissioners on Uniform State Laws have approved and recommended substantial revisions to Article 9 of the UCC, which are scheduled to become effective July 1, 2001; however, it is uncertain whether Revised Article 9 will be adopted in all fifty states. Under Revised Article 9, the step back provision in section 9-104 and the carveout in section 9-302 have been replaced. Instead, sections 9-109 and 9-311 of Revised Article 9 provide that Article 9 does not apply to a security interest if a federal statute regulating the security interest preempts application of Article 9.
However, the determination as to whether the USCA falls within the exclusion apparently will remain a question of judicial interpretation. Thus, interestingly, this modification would not have altered the outcome in Peregrine Entertainment, where the court held that the USCA preempts the UCC, or in World Auxiliary, where the court held that the USCA does not preempt the UCC, because under the USCA, the owner of a copyright, although permitted to register the copyright with the Copyright Office, is not compelled to do so.
As noted by the court in Peregrine Entertainment, the purpose of establishing a recording system is to enable a third party to determine with ease whether an interest has been transferred or encumbered. However, the decision in World Auxiliary increases the uncertainty. It contemplates that a lien search will be a two-step process. If the copyright is registered, the search is complete, and only the Copyright Office records need be examined. If the copyright at issue is unregistered, then the records of any applicable Secretary of State must be searched. The additional costs associated with a two-step process and the uncertainty inherent in not following such procedure could hinder the encumbrance and transfer of interests in copyrights. In contrast, if a security interest in a copyright can be perfected only by recording with the Copyright Office, then an interested party would have to check only one set of records. Since the decision in World Auxiliary has been appealed, it remains to be seen whether it will be upheld. Nonetheless, until this issue is resolved by a higher court or by Congress, a secured creditor is better safe than sorry and ought to record its security interest in a copyright with the Copyright Office and all applicable offices of the Secretary of State.
National Peregrine, Inc. v. Capitol Fed. Sav. & Loan Ass'n (In re Peregrine Entertainment, Ltd.), 116 B.R. 194 (C.D. Cal. 1990).
World Aerotechnology Corp. v. Silicon Valley Bank (In re World Auxiliary Power Co.), 244 B.R. 149 (Bankr. N.D. Cal. 1999).
In re Avalon Software, Inc., 209 B.R. 517 (Bankr. D. Ariz. 1997).
Official Unsecured Creditors' Comm. v. Zenith Prods., Ltd. (In re AEG Acquisition Corp.), 127 B.R. 34 (Bankr. C.D. Cal. 1991).