An Introduction to the .com Phenomenon


A. An Introduction to the .com Phenomenon
 

The late 1990's were generally an unhappy time for bankruptcy attorneys. A strong economy and expanding financial markets greatly reduced the number of business bankruptcies filed. Chapter 11 business bankruptcy filings dropped from 13,379 cases in the year ending September 1994 to 7,953 cases during the year ending June 1999. This change coincides with an incredible expansion of the information technology (IT) industry, resulting, in large part, from the Internet's integration into U.S. society and business.

The Internet is a major component of the networks and non-networked applications generally referred to as "cyberspace." The term generally applies to "any interactive environment that is or can be outside of real time and real space." The term cyberspace references the network of computers that can be accessed over the Internet, and the information available on that network. The Internet is not as new as some might think. Its predecessor, ARPANET (the Advanced Research Projects Agency Network of the U.S. Department of Defense), was completed as far back as 1970. The current TCP/IP transmission protocol went into use in 1982. However, it was not until HTTP (hyper-text transfer protocol) was established (1991) and the Mosaic browser created (1993) that the Internet as we now know it began to emerge.

Still, at the end of 1994, when the author first started using the Internet, only 10,000 Web site servers were connected to the Internet. By August 1999, that number had increased to more than seven million. Today, HTTP allows the World Wide Web, which consists of millions of connected Web sites and is what most people think of when they think of the Internet. The Mosaic browser has gone through several transformations to become Netscape Communicator. Hundreds of millions now use it or similar Web browsers to surf the Internet.

Understanding the Internet''s impact on future bankruptcy practice requires examining how the Internet has changed technology use in U.S. business. After all, the computer industry is not a new industry, technology-oriented bankruptcies are not new, and businesses have used computers since the 1940's. The difference is that the Internet raises the stakes. Businesses using tools made available by the Internet gain such an advantage that they can't afford not to use them. Law practice provides a convenient example. Three years ago many major law firms had neither e-mail nor Web sites, and not all attorneys used personal computers. Today, almost all major firms realize that they must integrate computing into their practices in order to remain competitive. Without e-mail, attorneys don't have the ability to communicate with clients in the manner clients require. Without a Web site, firms can't project a world-class image. The software required to work collaboratively with clients and other firms does not run on older DOS based computers, nor will the software needed to access the Internet, so firms are forced to upgrade their computer systems.

Today any major corporation has a Web site, and probably uses it to sell goods, automate its supply function, or otherwise operate its business. Software systems, especially database management programs (like Oracle) and enterprise communication tools (like Lotus Notes or SAP) form the backbone of most corporations. Without these technology systems, the businesses cannot exist. Domain names are valuable property and companies will pay six or even seven figure sums to obtain the rights to their domain name.

Technology issues will play a greater role in future bankruptcy cases partly because technology, and new forms of technology, are now more pervasive in industry. Moreover, the acceleration in the U.S. economy is information technology based. The winners in the stock market are not the brick and mortar companies, but the software companies, the computer companies, and the .com start-ups. These are the companies that now are on the cutting edge and are most likely to fail as the business cycle next turns downward. When they do, technology related issues will play a major role in their bankruptcy cases. The same is true for the non-technology companies that rely on technology-related assets to sustain business operations.

The increased importance of information technology in U.S. industry has another effect. The concepts of information technology property law are now more important, and have a higher profile, than before. Attorneys and legislatures are focusing more on intellectual property law, software licensing, privacy law, and electronic signatures and documents. New statutes, such as the Uniform Electronic Transactions Act (UETA), the Uniform Computer Information Transactions Act (UCITA), the Electronic Signatures in Global and National Commerce Act (E-SIGN), and revised UCC Article 9 are changing the legal landscape and focusing attention on e-commerce issues.

B. Recognition of Electronic Documents and Signatures

Three new statutes will enable the use of electronic forms of documents and signatures in both consumer and commercial transactions. These statutes--revised Article 9 to the Uniform Commercial Code, the Uniform Electronic Transactions Act (UETA), and the Electronic Signatures in Global and National Commerce Act (E-SIGN)--will result in new forms of transactions that, while functionally equivalent to familiar forms, will look very different. This will require bankruptcy attorneys to rethink how they examine the effect and validity of commercial instruments. For example, imagine possible treatment of negotiable instruments that do not exist in paper form.

  1. Revisions to UCC Article 9

    The current revision to UCC Article 9 was approved and recommended for enactment at the annual meeting of Uniform Law Commissioners on July 30, 1998, and approved by the American Law Institute in 1999. Revised Article 9 eliminates the writing and signature requirements contained in the current Article 9 and instead recognizes electronic means of authenticating documents. The concepts of "writing" and "sign" are replaced with the concepts of "record" and "authenticate." The term "record" is defined as "information that is inscribed on a tangible medium or which is stored in an electronic or other medium and is retrievable in perceivable form." This definition encompasses the definition of "writing," that remains unchanged as part of Article 1, but will also include electronic information. The term "record" will include documents created using computer applications, such as Word documents, data designed for use with EDI systems, and digitized writings.

    A person can "authenticate" a record by "signing" it, or by executing or adopting a symbol, or encrypting a record in whole or in part with "present intent to: (i) identify the authenticating party; and (ii) adopt, accept, or establish the authenticity of a record or term." This definition of authenticate is designed to allow a party to create enforceable electronic documents. The terms "authenticate" and "record" have replaced the terms "writing" and "sign" throughout most of the revised Article 9, including Section 9-203, which governs enforceability of security agreements. Under the revised Article 9, a security agreement is enforceable if authenticated. It no longer needs to be in writing.

    The Article 9 revisions also allow for the creation of security interests in electronic documents and other intangible assets. The revised Article 9 recognizes that while a payment obligation may exist in electronic form, it may still possess qualities of general intangibles because of the lack of a writing. For example, the possession requirement for certain types of instruments becomes difficult to satisfy with an electronic document. The revision defines monetary obligations in intangible form as "payment intangibles" and includes them in the definition of general intangibles. Consequently, perfection can be accomplished by filing a financing statement.

    One type of secured transaction significantly impacted by the Internet is transactions involving chattel paper. Chattel paper is a form of agreement, common in both consumer and business transactions that evidences both a monetary obligation and a security agreement in or lease of identified goods. If one or more documents is used to document the financing transaction, the group of documents taken together constitutes the chattel paper. The rules governing security interests in chattel paper contained in the UCC are necessary to simplify transactions involving the sale or lease of goods or equipment with financing terms. Traditionally, the documents used in the transaction must be in writing and signed by the borrower to qualify as chattel paper.

    With the advent of electronic business transactions, including electronic commerce conducted over the Internet, chattel paper can be created as a result of transactions that do not create paper documents. For example, assume a business purchases a computer system over the Internet. The purchaser fills out an electronic form and "agrees" to pay for the computer through installment payments and grant the seller a lien against the computer by attaching a digital signature to the form. Assuming that this creates an enforceable contract and security interest, the seller needs a mechanism to finance its extension of credit. It does this by either selling the resulting chattel paper to a finance company, or by borrowing funds using the chattel paper as collateral. The chattel paper, consisting of the data record created by the transaction and the record of the purchaser's digital signature, is electronic. If the UCC definition of chattel paper excludes electronic records, the seller can not obtain financing, and can not sell goods over the Internet on credit.

    The Article 9 revisions address this problem by defining categories of tangible and intangible chattel paper. The requirement that chattel paper be in "writing" is eliminated, and replaced by a requirement that chattel paper consist of a record or records. When the record or records that evidence the chattel paper are written or otherwise inscribed in tangible form, the chattel paper is referred to as "tangible chattel paper."When the records are stored in an electronic medium, the chattel paper is referred to as "electronic chattel paper."

    Tangible chattel paper is treated substantially as it was under the original UCC. A security interest can be perfected by filing a financing statement or by possession. Filing can also perfect a security interest in electronic chattel paper. The concept of possession is difficult to apply to electronic documents because of the ease with which they can be duplicated. To solve this problem, the revised UCC uses the concept of "control." Under the revised UCC Article 9 obtaining "control" of the chattel paper can perfect a security interest in intangible chattel paper. The security interest remains perfected from the date the secured party establishes control and continues as long as the secured party retains control.

    A new section describes how a creditor obtains control over electronic chattel paper.

    "A secured party has control of electronic chattel paper if the record or records comprising the chattel paper are created, stored, and assigned in such a manner that:

    (1) a single authoritative copy of the record or records exists which is unique, identifiable and, except as otherwise provided in paragraphs (4), (5) and (6), unalterable;

    (2) the authoritative copy identifies the secured party as the assignee of the record or records;

    (3) the authoritative copy is communicated to and maintained by the secured party or its designated custodian;

    (4) copies or revisions that add or change an identified assignee of the authoritative copy can be made only with the consent of the secured party;

    (5) each copy of the authoritative copy and any copy of a copy is readily identifiable as a copy that is not the authoritative copy; and

    (6) any revision of the authoritative copy is readily identifiable as an authorized or unauthorized revision."

  2. The Uniform Electronic Transactions Act

    The National Conference of Commissioners on Uniform State Laws (NCCUSL) adopted the UETA on July 29, 1999. The UETA's purpose is to provide a uniform national framework governing use and application of electronic transactions. First enacted in California, the UETA had been enacted by ten states by April 24, 2000, and fifteen other jurisdictions had legislation pending.

    The act defines the terms "record," "electronic record," and "electronic signature" and provides as a general rule that electronic records and signatures satisfy legal requirements that a record be in writing or signed. The UETA also applies only to transactions between parties when each has agreed to conduct transactions by electronic means. Some types of transactions will be exempt. Although the UETA is intended to have broad application, laws governing the creation and execution of wills, codicils, or testamentary trusts and, if desired by the enacting state, transactions governed by the Uniform Commercial Code (UCC) or the Uniform Computer Information Transactions Act (UCITA) will be excluded from the statute's affect.

    The UETA contains provisions governing provision or transmission of information in electronic form, attribution of electronic records and signatures, distributing risk of error in electronic transmissions, and retention of "original" electronic records. Other provisions govern automated electronic transactions or the use of so-called electronic "agents" and acceptance of electronic records and signatures by governmental agencies.

    The UETA also creates a form of electronic negotiable instrument, called a "transferable record." As long as an entity has "control" of the transferable record, it is a holder of the record as defined by UCC § 1-201(20) and has the same rights and defenses as a holder of a negotiable instrument or document under UCC Articles 3, 7 and 9. The requirements of delivery, possession and endorsement are eliminated. A person has "control" over the record if "a system employed for evidencing the transfer of interests in the transferable record reliably established that person as the person to which the transferable records was issued or transferred." This requirement can be met by a system that creates, stores, and assigns the transferable record in a manner that satisfies six specific conditions enumerated in the UETA.

    The UETA will affect the rules governing creation of enforceable contracts or instruments. Transactions existing or signed electronically, that might be unenforceable under traditional principals of law, may become enforceable when taking into account the UETA's provisions. Some commentators have also opined that the UETA could affect application of UCC Article 9's priority rules to accounts. Put simply, under UCC Article 9 a security interest in an account is perfected by filing. However, a security interest in an instrument is perfected only by possession. The UETA § 16(a) creates the concept of "transferable record," essentially an electronic record that can qualify as a note under UCC Article 3. The point is to allow electronic forms of negotiable instruments. Theoretically, an electronic communication related to an account might satisfy the rules under the UETA defining "transferable record," and thus, pursuant to the UETA § 16(d), a person having control of the communication would have the rights of a holder of a negotiable instrument under the UCC. These rights include having priority over the holder of a security interest perfected solely by filing. Thus, possession of the "transferable record" would be required to properly perfect a security interest in the "account."

  3. The Electronic Signatures in Global and National Commerce Act

    In 2000, President Clinton signed The Electronic Signatures in Global and National Commerce Act (E-SIGN). The act has two purposes; first, to make valid those contracts executed by electronic signature, and second, to protect consumers by requiring that they provide adequate consent to performing transactions electronically.

    Under E-SIGN, all signatures, contracts, or other records of transaction executed in electronic form can be valid and enforceable. This means that, by itself, the fact that a signature or contract exists electronically is insufficient grounds for denial of legal effect. However, E-SIGN does not require an individual to accept or use electronic records and signatures.

    In addition to its coverage of signatures and contracts, the act also governs "transferable records." Transferable records are electronic promises to pay money that, in paper form, would qualify as a negotiable instrument under UCC Article 3, and which are related to a loan secured by real property. In short, E-SIGN allows electronic mortgage notes. E-SIGN's provisions governing transferable records are almost identical to those contained in Section 16 of the UETA. E-SIGN's provisions, unlike those of the UETA, are limited to Article 3 negotiable instruments secured by real property.

    A state statute or regulation can modify or supersede the act if it meets one of a few conditions. Most significantly, E-SIGN's section 101 can be modified, limited or superseded by any state statute that constitutes an enactment of the Uniform Electronic Transactions Act (UETA) in the form approved and recommended by the National Conference of Commissioners on Uniform State Laws. Any exception to the scope of the UETA included in the state statute, however, must be consistent with E-SIGN. A state statue can also suggest alternative procedures and requirements for the use or acceptance of electronic signatures or records. As long as the procedures outlined do not violate any terms of E-SIGN, and do not accord greater legal status to one specific technology relating to the transmitting or authenticating of electronic signatures, E-SIGN does not preempt the state statute.

    In addition, E-SIGN does not apply to a contract to the extent that it is governed by a law governing probate or family law matters, a record governed by the UCC (other than sections 1-107 and 1-206 and Articles 2 and 2A), official court documents, a Federal or state regulatory agency's right to require that records in paper form be kept if there exists a compelling governmental interest in doing so, and certain consumer notices.

  4. Electronic Transactions and the Bankruptcy Code

    Electronic forms of documents and signatures are now used regularly in commerce, even in situations where a firm statutory foundation for their enforceability does not exist. This trend will accelerate with the adoption of revised UCC Article 9 and UETA, and enactment of E-SIGN. In some areas, the bankruptcy code dictates different treatment for written and oral records, or requires that a document be signed. This has the potential to require different treatment for electronic records and paper records in inappropriate situations. Three sections in particular refer to written or signed documents in circumstances where electronic records or signatures are encountered.

    • Section 523 (a)(2)(B) - A debt for money, etc., to the extent obtained by use of a materially false statement regarding the debtor's or an insider's financial condition is only non-dischargeable if, inter alia, the statement is in "writing."
    • Section 546(c)(1), (d)(1) - The trustee's rights under certain provisions of the Code are subject to certain reclamation rights (such as those provided under the UCC) but only if, inter alia, the seller makes a reclamation demand in "writing" within specified time limits.
    • Section 547 (c)(3)(A)(1) - A transfer that creates a security interest in property acquired by a debtor is not an avoidable preference to the extent it secures new value that was, inter alia, given at or after the "signing" of a security agreement that contains a description of such property as collateral.

These provisions create a danger if the terms "writing" and "signed" contained within them are interpreted to exclude electronic forms of writing or signing. Electronic forms of documents, created in most cases before the commencement of the bankruptcy case, may, outside of the bankruptcy process, be valid and enforceable. However, when viewed in light of the related bankruptcy code provisions, the efficacy of the documents in electronic form becomes subject to question.

The decision of the Court of Appeals for the Tenth Circuit in Bellco First Federal Credit Union v. Kaspar illustrates this phenomenon. In that case, a credit card issuer interviewed a customer and obtained financial data over the telephone. The issuer's employee entered the financial data obtained into a computer database maintained by the credit card issuer. When the customer filed a bankruptcy petition, the issuer discovered the financial data provided was incorrect and filed a complaint seeking to determine the debt owed by the customer non-dischargeable pursuant to 11 U.S.C. § 523(a)(2)(B). The issuer claimed the computer database record created from the telephone comment was a "statement in writing1/4 that the debtor caused to be made1/4 with intent to deceive." The court held that the electronic data record could not constitute a "writing" for purposes of 11 U.S.C. § 523(a)(2)(B). The court's focus on the issue of whether the computer record could be a "writing," and its statement that it was not, demonstrate that the use of the term "writing" in the Code may be held to refer only to paper documents and exclude electronic documents.

The ABA's Electronic Transactions in Bankruptcy Subcommittee of the Business Bankruptcy Committee has proposed a legislative solution in the form of the "Electronic Commerce in Bankruptcy Recognition Act." This legislation would amend Code section 102 to provide that the use of the terms "writing" and "signed" within the Code shall not limit the effect of electronic records or signatures where enforceable under applicable non-bankruptcy law.

C. Perfection of Security Interests in Copyrights

One goal of commercial law is to provide lenders ease and certainty in perfecting security interests in property. Uniform Commercial Code, Article 9 ("Article 9") accomplishes this goal by allowing perfection against most assets by filing a simple document with a centralized registry. Easily obtained security interests simplify lending and open capital sources. The Bankruptcy Code is designed to recognize secured creditor's rights when they comply with the applicable rules, and balance those rights against the needs of the debtor and other creditors.

The carefully constructed rules cease working when applied to security interests in copyrights because of a provision in the US Copyright Act and a California District Court decision, In re Peregrine Entertainment, Ltd. The US District Court for the Central District of California addressed a creditor's claim that it had properly perfected its lien on a film library by filing a UCC-1 financing statement in accordance with the provisions of Article 9. The court held that the US Copyright Act preempted the Article 9 perfection provisions and therefore filing with the Copyright Office was required to perfect a security interest in a copyright.

The court's conclusion flows naturally from provisions of the Copyright Act and Article 9. Section 205(a) of the Copyright Act provides that "any transfer of copyright ownership or other document pertaining to a copyright may be recorded in the Copyright Office.." and Section 205(c) provides that recording any such document in connection with a registered copyright gives all persons constructive notice of the facts stated in the recorded document. The Copyright Act defines the term "transfer of copyright ownership" to include "an assignment, mortgage, exclusive license, or any other conveyance, alienation, or hypothecation of a copyright." This definition clearly encompasses security interests in copyrights.

The UCC, because it is enacted as a state statute, is subject to preemption by Federal statutes. UCC, § 9-104(a) provides that Article 9 does not apply to a security interest subject to a Federal statute "to the extent that such statute governs the rights of parties to and third parties affected by transactions in particular types of property." Section 9-302(3)(a) states that a UCC-1 Financing Statement is not necessary to perfect a security interest in property subject to any statute or treaty of the United States which provides for national or international registration or which specifies a place for filing a security interest. The provisions of Section 205 of the Copyright Act appear to satisfy the requirements for federal preemption of Article 9.

The decision in Peregrine, and the later, but similar, decision in In re AEG Acquisition Corp., applied to security interests in registered copyrights. Thus, their direct impact was limited to intellectual property assets that are easily defined and determined. Registered copyrights are relatively easy to identify through the US Copyright Office's records and due diligence. Further, in the context of the entertainment industry (the subject of Peregrine) lenders want to secure with respect to a specific asset, usually a film or other artistic work, without regard to ownership. The perfection structure dictated by Peregrine serves this need. Copyrights in these works are always registered and the US Copyright Office provides a central filing location.

The Peregrine structure does not work when applied to the software industry, as demonstrated by the US Bankruptcy Court for the District of Arizona's decision in In re Avalon Software, Inc. That court held a creditor does not have a perfected security interest in property subject to protection under the Copyright Act, unless (1) the debtor has registered its copyright in the property, and (2) the creditor files its security interest with the U.S. Copyright Office. Thus, the Avalon decision extends the Peregrine decision to unregistered copyrights.

In 1994, Avalon Software, Inc, a computer software developer, obtained a loan from Imperial Bank. Avalon granted Imperial a security interest in all its assets, then or after acquired, including accounts, general intangibles, equipment, inventory and proceeds. Imperial filed a UCC-1 financing statement with the Arizona Secretary of State, thus satisfying the perfection requirements of Article 9 as enacted in Arizona. At that time, Avalon had registered with the Copyright Office copyrights in software developed between 1989 and 1991. However, after 1991, Avalon did not register copyrights in its software. Imperial did not file any documents providing notice of its security interest with the Copyright Office. After 1994, Avalon continued to produce new software programs. It also created updates, modifications, amendments and enhancements to its existing software programs. Avalon did not register a copyright in any of these works. Avalon subsequently filed a chapter 11 petition and substantially all of its assets were sold, with court approval, to a third party. Imperial's lien attached to the sale proceeds.

The debtor and the creditor's committee sought to avoid Imperial's lien against the proceeds from the sale of Avalon's software and software licenses. Judge Marlar, following the Peregrine and AEG Acquisition decisions, held that Imperial's failure to file its security interest with the U.S. Copyright Officer meant its lien was unperfected as against all Avalon's software related assets, including the proceeds from selling those assets. A product susceptible to copyright protection acquires its character as "copyrightable" when the intellectual work is created. A work can receive copyright protection even if the copyright is not registered. Thus, the court concluded, regardless of whether the copyright in the work is registered, a lien in the copyright can only be perfected by filing a security agreement with the Copyright Office. Based on this argument, the bankruptcy court judge held in Avalon that Imperial's lien was unperfected against Avalon's software, even the copyrightable software that had not been registered with the Copyright Office. The lack of perfection extended to software that was a modification, enhancement or offshoot of the existing programs, and also extended to Avalon's rights under licenses of the software rights.

Avalon took rules that worked when applied to the entertainment industry and applied them to a software company. In the entertainment industry, copyrights in finished works are always registered. Lending is project based, not entity based. In the software industry, copyright registration is less often used, especially since copyright registration of software code is inconsistent with the concept of using trade secret laws to protect source code. Also, copyright protection is available for a broad variety of assets, for which registered copyright protection is not sought. Marketing materials, brochures, instruction manuals, internal correspondence, accounting and business records, white papers, advertising copy and graphics, logos, artwork, and even buildings are all examples of common business assets subject to copyright protection. As a business matter, registering a copyright in all such assets is impractical and expensive. Further, registering a copyright in some types of copyrightable assets, such as intellectual property works in progress, is not possible, because registering a copyright requires making a deposit of the work. Imagine filing as a public record a copy of a Web site for a product that is not yet launched.

The Avalon decision also creates a problem with respect to after-acquired property. Maintaining the security interest against after-acquired or derivative works becomes more difficult because the security agreement filed with the Copyright Office must reference each individual copyright registration. Thus, as new works are created and old works are revised, the lender and borrower must file a continuous stream of copyright registrations and security agreements.

Perhaps the Avalon decision's greatest problem is its failure to recognize that while a debtor can have a copyright in a work, the copyright is not the work. For example, software consists of tangible media, trade secret rights, license rights, trademark rights, and patent rights. Even if the court held that Imperial's lien against Avalon's copyrights in its software was unperfected, that is not the same as holding that Imperial's lien against the software was unperfected. Even following the decisions of the courts in Peregrine and AEG Aqcuisitions, courts need to develop methods for determining the value that is attributable to the copyright in a work, and the value of the work attributable to other factors. This calculation will differ on a case by case basis. The approach taken by the court in Avalon, determining that the lender's failure to perfect its lien in copyrights in the software obviated any lien it had in the software itself, simply misapplies copyright law, confusing a personal right in an aspect of a property asset with the property asset itself. A subsequent case out of the US Bankruptcy Court for the Northern District of California, Aerocon Engineering, Inc. v. Silicon Valley Bank, approached the problem with a more limited approach. The court in Aerocon limited the Peregrine preemption principal to copyrights registered under the US Copyright Act, thus reaching a more commercially reasonable result.

D. Personal Information as an Asset: Treatment in the Bankruptcy Process

A key asset generated by e-commerce is customer information. This information takes several forms. At one end of the spectrum is non-personally identifiable information collected about how people use a company's Internet Web site. A company can track what Web sites visitors come from (sort of like knowing what store in the Mall people visited before coming to your store), what Web sites they visit next, and how they travel through the on-line store or Internet portal. This information, generally maintained as a trade secret, can have significant value because it helps businesses understand their customers. At the other end of the spectrum is customer data. This can go beyond just names and addresses, but can include large amounts of information about personal interests and buying habits obtained from tracking a visitor's use of the Web site.

How collected personal data passes through the bankruptcy process will become an issue for future cases. Currently, few rights attach to corporate use of personal data, and what rights do exist are provided solely by statute. A business that collects data can use the data how it likes. In the traditional framework, a company in bankruptcy can use customer data without restriction. It also can sell the data freely, either as part of the entire business, or separately. In some cases, the customer data is one of the most valuable assets.

Companies, by using privacy policies, theoretically limit their rights to customer information. This became very clear in the In re Toysmart.com, LLC Chapter 11 case. Toysmart operated an on-line toy store that ran into financial trouble and ceased operations in May 2000. After its creditors filed an involuntary Chapter 11 case against it, Toysmart filed a motion to conduct a public auction of several assets, including its customer data. Toysmart had, in 1999, adopted a privacy policy and became a licensee of TRUSTe. On learning about the proposed sale of personal information, TRUSTe complained to the Federal Trade Commission (FTC) that the proposed sale would violate Toysmart's privacy policy. The FTC sued Toysmart in Federal District Court alleging that the sale of data was an unfair or deceptive business practice violating the FTC Act, and requesting that the court enjoin the sale. While Toysmart settled its issues with the FTC, several states' attorneys generals filed objections to the sale with the bankruptcy court. The controversy limited Toysmart's ability to obtain significant bids and, in the face of the objections Toysmart withdrew the customer data from auction.

The Toysmart case raises the question of what exactly is a privacy policy. A privacy policy might be considered a contract between the customer and the company. In this case, would the contact be treated as executory? Whether a privacy statement is executory or non-executory will depend on its terms, primarily whether it places continuing material obligations on the customer. The company will always have a continuing obligation to use and maintain data according to the policy's terms. Assuming the privacy policy is executory, a company desiring to retain customer data would have to assume the privacy policy and continue to abide by its terms. Could a company that files a bankruptcy petition breach the use restrictions by transferring the data in violation of the contract, reject the contract, and leave individuals with general unsecured claims? Most likely, a debtor rejecting a privacy policy would have to relinquish rights to data collected under the policy.

A non-executory privacy policy would grant customers fewer rights. A debtor could breach the non-executory policy, and the customer's rights could be limited to a general unsecured claim. Possibly, a court might grant the customer the right to equitable relief against the debtor to prevent misuse of the provided information.

However, a privacy policy might not even qualify as an enforceable contract. One court has already stated that an on-line contract is not enforceable unless its terms are obvious and apparent, and that making the contract accessible only through a link at the bottom of a Web page does not qualify. Under this test, most privacy policies do not rise to the level of mutually enforceable contracts. In most cases, companies do not conspicuously display their privacy policy. A customer wanting to view the privacy policy must find and click on a small link at the bottom of a Web page.

Customers might enforce a non-contractual privacy policy based on the doctrine of unjust enrichment. Another option is to claim that use of the information in violation of the privacy policy constitutes an unfair or deceptive business practice. Many states have statutes, known as "little-FTC Acts," which give consumers a private cause of action to enjoin unfair or deceptive business practices. A privacy regime would give a third option, giving the individual a statutory or judicially created right to control personal data. This right would be similar to the rights granted a patent or copyright holder. Privacy rights in personal data would give individuals significant control over the data - businesses could only use what rights they contract for, and these rights probably will not be transferable in bankruptcy without the individual's affirmative consent.