Protecting Interests if Another Company Files for Bankruptcy Protection

In light of the current economic tsunami, which is certain to throw a few entertainment companies into bankruptcy, this article provides a basic overview of the common issues that arise in connection with such bankruptcies. The most important reason to understand bankruptcy is to protect oneself from the draconian results that can result from a bankruptcy of the other party to a transaction. The U.S. Bankruptcy Code is written so perversely in favor of the bankrupt party that a bankruptcy upsets all reasonable expectations of anyone doing business with that party. Film rights can be lost, payment obligations can be canceled and other contractual obligations can be left in limbo for years. The havoc is so great that it is necessary to plan in advance for the tragic event: “What if the other side goes bankrupt?” For consistency, this article refers to the entity in bankruptcy as the “debtor” and the other party to a contract with the debtor as the “non-debtor.”

Almost every important asset of an entertainment company relates to the ownership or exploitation of copyrights, including film and television rights, film libraries, licenses and receivables. Thus, understanding the nature of copyright is critical to analyzing almost all entertainment bankruptcy issues.

U.S. Copyrights

United States copyright law is governed by the current federal copyright statute, the Copyright Revision Act of 1976, 17 U.S. Secs. 101-914, as amended. Under the Copyright Act, copyright protection exists for “original works of authorship” as soon as they are “fixed in any tangible medium of expression, now known or later developed, from which they can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device.” Thus, an original screenplay is deemed to be an original copyrighted work from the moment it is “fixed” in a writing. Copyright protection for a motion picture arises as each frame is shot and therefore becomes fixed in a tangible medium. A motion picture is viewed as a single and separate work, although it may embody other copyrightable contributions, such as the screenplay and the music soundtrack.

Under the Copyright Act, an exclusive license is treated as a transfer of the licensed rights to the licensee. Thus, the licensee owns a property interest in the licensed rights, which is referred to in the statute as ownership of “an interest in the Copyright.” Under the Copyright Act, a non-exclusive license is not treated as a transfer of the licensed rights to the licensee. Thus, the licensee under a non-exclusive license does not own any property interest in the licensed rights.

Foreign Copyrights

The word “copyright” is shorthand for the protections afforded by a country for a copyrighted work. Copyright laws protect exploitation of a work. This right exists on a country-by-country basis, and the rights and remedies of the copyright holder vary from country to country. Under the Berne Convention ' the copyright treaty entered into among most countries, including the U.S. ' publication in any country will trigger copyright protection in all the other signatory countries. However, the Berne Convention does not create one worldwide “copyright.” The copyright holder actually owns separate property in each country.

The copyright laws of any one country are irrelevant in determining the ownership of the copyright in another country, so the United States does not have subject matter jurisdiction to determine the ownership of copyright in another country. See, Danjaq v. MGM/UA Communications Co., 773 F.Supp. 194 (C.D. Cal. 1991); DeBardossy v. Puski, 763 F.Supp. 1239 (S.D.N.Y. 1991); Zenger-Mill Inc. v. Training Team GmbH, 757 F.Supp. 1062 (N.D. Cal. 1991); Subafilms Ltd. v. MGM-Pathe Communications Co., 24 F.3d 1088 (9th Cir. 1994); and Yount v. Acuff Rose-Opryland, 103 F.3d 830 (9th Cir. 1996).

Some foreign countries have a copyright system that is similar to the U.S. model, in that an exclusive license is treated as a transfer of ownership of the licensed rights to the licensee and there is a recording system. But many countries do not follow the U.S. model and do not treat the licensee under an exclusive license as owning the licensed rights as property.

Throughout this article, the right to exploit a copyright in the U.S. is referred to as a “U.S. Copyright,” and the right to exploit a copyright outside of the U.S. is referred to as a “Foreign Copyright.”

Security Interests in U.S. Copyrights

This section summarizes the manner in which a security interest must be perfected in a U.S. Copyright and in related licenses, receivables, prints and negatives.

Attachment and Perfection

The “attachment” of a security interest is made by a written agreement signed by the debtor granting the secured party a security interest in the U.S. Copyright to secure a specific obligation of the debtor. The “perfection” of a security interest in a U.S. Copyright is discussed below. The importance of perfection is that: a) it gives constructive notice to the world of the security interest and thus trumps any subsequent security interests or transfers; and b) most importantly, only perfected security interests survive a bankruptcy of the debtor, while all unperfected security interests are voided in a bankruptcy.

UCC vs. Copyright Act

Several cases have held that the only proper method to perfect a security interest in a U.S. Copyright is by recording the security interest in the U.S. Copyright Office. (The original copyright in a work is “registered” in the Copyright Office, while subsequent transfers, including the grant of a security interest, are “recorded” there.) The courts in In re Peregrine Entertainment Ltd., 116 B.R. 194 (Bankr. C.D. Cal. 1990), In re AEG Acquisition Corp., 127 B.R. 34 (Bankr. C.D. Cal. 1991), aff'd, 161 B.R. 50 (9th Cir. BAP 1993), and In re Avalon Software Inc., 209 B.R. 517 (Bankr. D. Ariz 1997), held that the Copyright Act overrides the creation and perfection provisions of the Uniform Commercial Code (UCC) under the doctrine of federal preemption applying the test used by the U.S. Supreme Court in Hillsborough County v. Automated Medical Labs. Inc., 471 U.S. 707, 713 (1985). Hillsborough County held that in the absence of express preempting language, a federal statute will preempt state law if the federal interest is so dominant that the federal system will be assumed to preclude enforcement of state laws on the subject.

In particular, the courts found that the Copyright Act's recording system covered the same matters as the UCC's, and that if there were no preemption, a secured creditor would not know in which jurisdiction to search the records. Moreover, the two recording systems have different rules for priority conflicts between competing security interests.

These courts explicitly applied the federal preemption doctrine not only to security interests in copyrights, but also to related licenses, accounts receivable and proceeds on the rationale that they are integral to the copyright. In re AEG Acquisition went even further and applied the preemption doctrine to prints and negatives on the same rationale. These holdings are somewhat questionable, as these other assets were not themselves copyrights. A license and related receivable seem analogous to an installment note for the sale of land. A security interest in such an installment note would be perfected under the UCC, not under a real property recording statute. (Following this rationale, at least two later decisions held that a security interest in licenses and receivables is not perfected by a copyright filing. See, MCEG Sterling, Inc. v. Phillips Nizer, 646 N.Y.S.2d 778 (NY Sup. Ct. 1996) (U.C.C. filing required for perfection); and Broadcast Music Inc. v. Hirsch and Staenberg, 104 F.3d 1163 (9th Cir. 1997) (holding that assignment of receivable did not require any filing for perfection under New York law).)

The one anomaly under this line of cases is that recordings of transfers (including security interests) in the Copyright Office are ineffective until the work has been registered. See, 17 U.S.C. Sec. 205(c)(2). Thus, if the work has not been registered, it is impossible to perfect a security interest in the work under this line of cases. The Copyright Act permits third parties (such as a secured party) to register the underlying work, so the impediment to perfection of an unregistered work can be overcome by the secured party, but in the absence of registration a security interest would not be perfected under these cases. Because of this problem, the Ninth Court, in World Auxiliary Power Company v. Silicon Valley Bank, 303 F.3d 1120 (9th Cir. 2002), held that a UCC-1 filing was valid to perfect a security interest in a copyright that had not been registered in the Copyright Office.

The solution adopted in practice to deal with these conflicting cases is to use the belt-and-suspenders approach of perfecting a security interest both by filing a UCC-1 with the appropriate Secretary of State, and by recording the security interest in the U.S. Copyright Office and making sure the work is registered there. That way, the secured party is perfected under all the cases as to the work itself and as to receivables, contracts and prints. In addition, a U.S. court may treat a UCC-1 filing as the proper manner of perfecting a security interest in a Foreign Copyright, even though that conclusion is not logically correct, as discussed below.

Registration of Work and Chain of Title

The Copyright Office records can be searched by title of the work as well as by registration number or grantor. In this respect, the copyright recording system is different than the real property recording systems of many states (including California), which can be searched only through a grantor/grantee index. Therefore, it should not matter if the U.S. Copyright is registered: a) after the security interest is recorded (since a U.S. Copyright can be registered at any time); or b) by a party other than the debtor. For the same reason, the security interest should be validly perfected as against the debtor even if the debtor's rights are outside the recorded chain of title, as when the license from the registered owner to the debtor is not recorded.

Foreclosure

The mechanics for foreclosure are governed by UCC Sec. 9-504, which requires advance notice to the debtor and requires that the sale be conducted in a “commercially reasonable manner.” A problem in conducting any foreclosure occurs when the obligation being foreclosed upon is not fixed. For example, if a debtor has breached its obligation to pay contingent royalties to a licensor and has thus breached the license, a licensor foreclosing on a security interest in the licensed rights is foreclosing not upon just the actual royalties due, but also upon the licensee's future royalty obligations. In this situation, the licensor should make an estimate of the value of the future royalties (or other obligation of the debtor) and should state this value as the amount of the claim for purposes of the foreclosure. Thus, the licensor can bid in the amount of this claim against the licensed rights and, if the licensor is outbid by third parties, the licensor will at least receive the full amount of its stated claim, subject to subsequent litigation with the debtor over the reasonableness of the claim.

Security Interests in Foreign Copyrights

Choice of Law

This section summarizes the manner in which a security interest must be perfected in a Foreign Copyright and related licenses, receivables, prints and negatives. A Foreign Copyright exists only to the extent recognized under the laws of each country, so the laws of each country should govern the issue of whether a security interest in a Foreign Copyright is properly perfected there applying the doctrine of lex loci rei sitae (the law of the jurisdiction where the property is located governs). For example, security interests in real property are regulated by the law of the situs of the property.

This conclusion is buttressed by the Berne Convention, which states that: “ownership of copyright in a cinematographic work shall be a matter for legislation in the country where protection is claimed.” Berne Convention, Article XIV(2)(a). Since a security interest is a contingent claim of ownership and certainly relates to ownership if foreclosed upon, this provision makes clear that the law of each country where the rights are exploited should apply for determining the validity of ownership, including security interests, in those rights.

The analysis is similar with respect to a security interest in foreign licenses and foreign receivables. The same choice-of-law analysis should apply to the foreign licenses and foreign receivables in that these ancillary rights are an integral part of ' and stem from ' the Foreign Copyrights. See, In re Peregrine Entertainment Ltd., 116 B.R. at 199 (federal copyright law preempts state UCC with respect to perfection of security interests in not only copyrights but in related accounts receivable as well). Furthermore, even if a license or receivable is treated as a separate asset from the copyright, it should be subject to the same choice-of-law analysis. The case is even stronger for prints and negatives in foreign countries, which are tangible property, and thus would be directly covered by those cases applying the lex loci rei sitae doctrine. In addition, following AEG Acquisition, prints and negatives associated with a foreign license should be treated as integral parts of the Foreign Copyrights and should thus be subject to the same choice-of-law rule.

Therefore, a bankruptcy court should apply foreign law to determine whether a security interest in Foreign Copyrights and related licenses, receivables, prints and negatives is perfected.

Status of Security Interest if
Foreign Law Controls

The law of each foreign jurisdiction controls the determination of whether a secured creditor has a perfected security interest with respect to exploitation rights within that country.

Several countries have created public registers for grants of motion picture rights to avoid the confusion that might result from multiple grants in works that are intended to be exploited throughout the world. Some of these registers expressly provide for the registration of a security interest. Under this type of a foreign recordation law, a security interest would be unperfected unless it is recorded with the appropriate government register. In addition to copyright recording systems, many foreign countries also have security recording systems analogous to the UCC.

Approximately 90% of the total value of foreign rights for a film is attributable to the following 10 countries: Australia, Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Spain and the UK. Of these 10 countries, the following have a copyright recording system: Canada, France, Japan and Spain.

Of the remaining five countries, Australia and the UK have a UCC-type recording system that can apply to films. Thus, for the following countries, no steps are needed to perfect a security interest beyond entering into a security agreement: Belgium, Germany, Italy and the Netherlands

Part Two of this article will discuss executory contracts in bankruptcies, automatic stays, voidable preferences and post-petition property.

In light of the current economic tsunami, which is certain to throw a few entertainment companies into bankruptcy, this article provides a basic overview of the common issues that arise in connection with such bankruptcies. The most important reason to understand bankruptcy is to protect oneself from the draconian results that can result from a bankruptcy of the other party to a transaction. The U.S. Bankruptcy Code is written so perversely in favor of the bankrupt party that a bankruptcy upsets all reasonable expectations of anyone doing business with that party. Film rights can be lost, payment obligations can be canceled and other contractual obligations can be left in limbo for years. The havoc is so great that it is necessary to plan in advance for the tragic event: “What if the other side goes bankrupt?” For consistency, this article refers to the entity in bankruptcy as the “debtor” and the other party to a contract with the debtor as the “non-debtor.”

Almost every important asset of an entertainment company relates to the ownership or exploitation of copyrights, including film and television rights, film libraries, licenses and receivables. Thus, understanding the nature of copyright is critical to analyzing almost all entertainment bankruptcy issues.

U.S. Copyrights

United States copyright law is governed by the current federal copyright statute, the Copyright Revision Act of 1976, 17 U.S. Secs. 101-914, as amended. Under the Copyright Act, copyright protection exists for “original works of authorship” as soon as they are “fixed in any tangible medium of expression, now known or later developed, from which they can be perceived, reproduced, or otherwise communicated, either directly or with the aid of a machine or device.” Thus, an original screenplay is deemed to be an original copyrighted work from the moment it is “fixed” in a writing. Copyright protection for a motion picture arises as each frame is shot and therefore becomes fixed in a tangible medium. A motion picture is viewed as a single and separate work, although it may embody other copyrightable contributions, such as the screenplay and the music soundtrack.

Under the Copyright Act, an exclusive license is treated as a transfer of the licensed rights to the licensee. Thus, the licensee owns a property interest in the licensed rights, which is referred to in the statute as ownership of “an interest in the Copyright.” Under the Copyright Act, a non-exclusive license is not treated as a transfer of the licensed rights to the licensee. Thus, the licensee under a non-exclusive license does not own any property interest in the licensed rights.

Foreign Copyrights

The word “copyright” is shorthand for the protections afforded by a country for a copyrighted work. Copyright laws protect exploitation of a work. This right exists on a country-by-country basis, and the rights and remedies of the copyright holder vary from country to country. Under the Berne Convention ' the copyright treaty entered into among most countries, including the U.S. ' publication in any country will trigger copyright protection in all the other signatory countries. However, the Berne Convention does not create one worldwide “copyright.” The copyright holder actually owns separate property in each country.

The copyright laws of any one country are irrelevant in determining the ownership of the copyright in another country, so the United States does not have subject matter jurisdiction to determine the ownership of copyright in another country. See , Danjaq v. MGM/UA Communications Co. , 773 F.Supp. 194 (C.D. Cal. 1991); DeBardossy v. Puski , 763 F.Supp. 1239 (S.D.N.Y. 1991); Zenger-Mill Inc. v. Training Team GmbH , 757 F.Supp. 1062 (N.D. Cal. 1991); Subafilms Ltd. v. MGM-Pathe Communications Co. , 24 F.3d 1088 (9th Cir. 1994); and Yount v. Acuff Rose-Opryland , 103 F.3d 830 (9th Cir. 1996).

Some foreign countries have a copyright system that is similar to the U.S. model, in that an exclusive license is treated as a transfer of ownership of the licensed rights to the licensee and there is a recording system. But many countries do not follow the U.S. model and do not treat the licensee under an exclusive license as owning the licensed rights as property.

Throughout this article, the right to exploit a copyright in the U.S. is referred to as a “U.S. Copyright,” and the right to exploit a copyright outside of the U.S. is referred to as a “Foreign Copyright.”

Security Interests in U.S. Copyrights

This section summarizes the manner in which a security interest must be perfected in a U.S. Copyright and in related licenses, receivables, prints and negatives.

Attachment and Perfection

The “attachment” of a security interest is made by a written agreement signed by the debtor granting the secured party a security interest in the U.S. Copyright to secure a specific obligation of the debtor. The “perfection” of a security interest in a U.S. Copyright is discussed below. The importance of perfection is that: a) it gives constructive notice to the world of the security interest and thus trumps any subsequent security interests or transfers; and b) most importantly, only perfected security interests survive a bankruptcy of the debtor, while all unperfected security interests are voided in a bankruptcy.

UCC vs. Copyright Act

Several cases have held that the only proper method to perfect a security interest in a U.S. Copyright is by recording the security interest in the U.S. Copyright Office. (The original copyright in a work is “registered” in the Copyright Office, while subsequent transfers, including the grant of a security interest, are “recorded” there.) The courts in In re Peregrine Entertainment Ltd., 116 B.R. 194 (Bankr. C.D. Cal. 1990), In re AEG Acquisition Corp., 127 B.R. 34 (Bankr. C.D. Cal. 1991), aff'd , 161 B.R. 50 (9th Cir. BAP 1993), and In re Avalon Software Inc. , 209 B.R. 517 (Bankr. D. Ariz 1997), held that the Copyright Act overrides the creation and perfection provisions of the Uniform Commercial Code (UCC) under the doctrine of federal preemption applying the test used by the U.S. Supreme Court in Hillsborough County v. Automated Medical Labs. Inc. , 471 U.S. 707, 713 (1985). Hillsborough County held that in the absence of express preempting language, a federal statute will preempt state law if the federal interest is so dominant that the federal system will be assumed to preclude enforcement of state laws on the subject.

In particular, the courts found that the Copyright Act's recording system covered the same matters as the UCC's, and that if there were no preemption, a secured creditor would not know in which jurisdiction to search the records. Moreover, the two recording systems have different rules for priority conflicts between competing security interests.

These courts explicitly applied the federal preemption doctrine not only to security interests in copyrights, but also to related licenses, accounts receivable and proceeds on the rationale that they are integral to the copyright. In re AEG Acquisition went even further and applied the preemption doctrine to prints and negatives on the same rationale. These holdings are somewhat questionable, as these other assets were not themselves copyrights. A license and related receivable seem analogous to an installment note for the sale of land. A security interest in such an installment note would be perfected under the UCC, not under a real property recording statute. (Following this rationale, at least two later decisions held that a security interest in licenses and receivables is not perfected by a copyright filing. See , MCEG Sterling, Inc. v. Phillips Nizer , 646 N.Y.S.2d 778 (NY Sup. Ct. 1996) (U.C.C. filing required for perfection); and Broadcast Music Inc. v. Hirsch and Staenberg , 104 F.3d 1163 (9th Cir. 1997) (holding that assignment of receivable did not require any filing for perfection under New York law).)

The one anomaly under this line of cases is that recordings of transfers (including security interests) in the Copyright Office are ineffective until the work has been registered. See, 17 U.S.C. Sec. 205(c)(2). Thus, if the work has not been registered, it is impossible to perfect a security interest in the work under this line of cases. The Copyright Act permits third parties (such as a secured party) to register the underlying work, so the impediment to perfection of an unregistered work can be overcome by the secured party, but in the absence of registration a security interest would not be perfected under these cases. Because of this problem, the Ninth Court, in World Auxiliary Power Company v. Silicon Valley Bank , 303 F.3d 1120 (9th Cir. 2002), held that a UCC-1 filing was valid to perfect a security interest in a copyright that had not been registered in the Copyright Office.

The solution adopted in practice to deal with these conflicting cases is to use the belt-and-suspenders approach of perfecting a security interest both by filing a UCC-1 with the appropriate Secretary of State, and by recording the security interest in the U.S. Copyright Office and making sure the work is registered there. That way, the secured party is perfected under all the cases as to the work itself and as to receivables, contracts and prints. In addition, a U.S. court may treat a UCC-1 filing as the proper manner of perfecting a security interest in a Foreign Copyright, even though that conclusion is not logically correct, as discussed below.

Registration of Work and Chain of Title

The Copyright Office records can be searched by title of the work as well as by registration number or grantor. In this respect, the copyright recording system is different than the real property recording systems of many states (including California), which can be searched only through a grantor/grantee index. Therefore, it should not matter if the U.S. Copyright is registered: a) after the security interest is recorded (since a U.S. Copyright can be registered at any time); or b) by a party other than the debtor. For the same reason, the security interest should be validly perfected as against the debtor even if the debtor's rights are outside the recorded chain of title, as when the license from the registered owner to the debtor is not recorded.

Foreclosure

The mechanics for foreclosure are governed by UCC Sec. 9-504, which requires advance notice to the debtor and requires that the sale be conducted in a “commercially reasonable manner.” A problem in conducting any foreclosure occurs when the obligation being foreclosed upon is not fixed. For example, if a debtor has breached its obligation to pay contingent royalties to a licensor and has thus breached the license, a licensor foreclosing on a security interest in the licensed rights is foreclosing not upon just the actual royalties due, but also upon the licensee's future royalty obligations. In this situation, the licensor should make an estimate of the value of the future royalties (or other obligation of the debtor) and should state this value as the amount of the claim for purposes of the foreclosure. Thus, the licensor can bid in the amount of this claim against the licensed rights and, if the licensor is outbid by third parties, the licensor will at least receive the full amount of its stated claim, subject to subsequent litigation with the debtor over the reasonableness of the claim.

Security Interests in Foreign Copyrights

Choice of Law

This section summarizes the manner in which a security interest must be perfected in a Foreign Copyright and related licenses, receivables, prints and negatives. A Foreign Copyright exists only to the extent recognized under the laws of each country, so the laws of each country should govern the issue of whether a security interest in a Foreign Copyright is properly perfected there applying the doctrine of lex loci rei sitae (the law of the jurisdiction where the property is located governs). For example, security interests in real property are regulated by the law of the situs of the property.

This conclusion is buttressed by the Berne Convention, which states that: “ownership of copyright in a cinematographic work shall be a matter for legislation in the country where protection is claimed.” Berne Convention, Article XIV(2)(a). Since a security interest is a contingent claim of ownership and certainly relates to ownership if foreclosed upon, this provision makes clear that the law of each country where the rights are exploited should apply for determining the validity of ownership, including security interests, in those rights.

The analysis is similar with respect to a security interest in foreign licenses and foreign receivables. The same choice-of-law analysis should apply to the foreign licenses and foreign receivables in that these ancillary rights are an integral part of ' and stem from ' the Foreign Copyrights. See, In re Peregrine Entertainment Ltd., 116 B.R. at 199 (federal copyright law preempts state UCC with respect to perfection of security interests in not only copyrights but in related accounts receivable as well). Furthermore, even if a license or receivable is treated as a separate asset from the copyright, it should be subject to the same choice-of-law analysis. The case is even stronger for prints and negatives in foreign countries, which are tangible property, and thus would be directly covered by those cases applying the lex loci rei sitae doctrine. In addition, following AEG Acquisition, prints and negatives associated with a foreign license should be treated as integral parts of the Foreign Copyrights and should thus be subject to the same choice-of-law rule.

Therefore, a bankruptcy court should apply foreign law to determine whether a security interest in Foreign Copyrights and related licenses, receivables, prints and negatives is perfected.

Status of Security Interest if
Foreign Law Controls

The law of each foreign jurisdiction controls the determination of whether a secured creditor has a perfected security interest with respect to exploitation rights within that country.

Several countries have created public registers for grants of motion picture rights to avoid the confusion that might result from multiple grants in works that are intended to be exploited throughout the world. Some of these registers expressly provide for the registration of a security interest. Under this type of a foreign recordation law, a security interest would be unperfected unless it is recorded with the appropriate government register. In addition to copyright recording systems, many foreign countries also have security recording systems analogous to the UCC.

Approximately 90% of the total value of foreign rights for a film is attributable to the following 10 countries: Australia, Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Spain and the UK. Of these 10 countries, the following have a copyright recording system: Canada, France, Japan and Spain.

Of the remaining five countries, Australia and the UK have a UCC-type recording system that can apply to films. Thus, for the following countries, no steps are needed to perfect a security interest beyond entering into a security agreement: Belgium, Germany, Italy and the Netherlands

Part Two of this article will discuss executory contracts in bankruptcies, automatic stays, voidable preferences and post-petition property.