The Rooker-Feldman doctrine[1] is a legal precept invoked by defendants to strip federal district and bankruptcy courts of their subject matter jurisdiction over suits that can be characterized as appeals or reconsideration of state court judgments. This article discusses the nature of the Rooker-Feldman doctrine and its limitations under the Bankruptcy Code when asserted as a defense to the prosecution of avoidance actions.
Under the Bankruptcy Code, avoidance actions consist of the prosecution of preference claims and fraudulent transfers claims. Avoidance actions permit a trustee, a debtor in possession, or the representative of a debtor’s estate to recover assets that were transferred out of the debtor’s estate prior to the commencement of a bankruptcy case for the benefit of the debtor’s creditors. The avoidance powers under the Bankruptcy Code promote the “prime bankruptcy policy of equality of distribution among creditors by ensuring that all creditors of the same class will receive the same pro rata share of the debtor’s estate.”[2] The right to avoid such transfers protects the interests of the debtor’s general body of creditors by maximizing the assets available for distribution to such creditors, thus placing creditors in a more favorable position to recover on their claims against the debtor.
The policy underlying the Rooker-Feldman doctrine is based on the concept that a litigant should not be able to challenge state court orders in federal courts as a means of relitigating matters that already have been considered and decided by a court of competent jurisdiction. The Rooker-Feldman doctrine also applies where a lower federal court is asked to conduct a review of a state court judgment for errors in construing federal law or constitutional claims that are inextricably intertwined with, or impacts the validity of, the state court judgment.[3] The litmus test that a federal court must apply is whether the relief requested in the federal action would effectively reverse the state court decision or void its ruling.
In bankruptcy cases, the Rooker-Feldman doctrine has been applied in cases involving, by way of example, the estimation of a judgment creditor’s claim that arose from a pre-petition state court judgment against a debtor;[4] attacking a state court judgment for lack of procedural due process;[5] dismissing an adversary proceeding challenging a foreclosure judgment; [6] a marital dispute concerning exempt property and discharge in the face of a state court judgment;[7] and a state court’s adjudication of the automatic stay.[8] In these cases, the doctrine was invoked to maintain the separation of federal and state courts and to protect and enforce state court judgments.
However, application of the Rooker-Feldman doctrine is subject to limitations. In Exxon Mobil Corp. v. Saudi Basic Indus. Corp.,[9] the Supreme Court recognized that the Rooker-Feldman doctrine is a narrow jurisdictional bar to litigation where the losing party “repairs to federal court to undo the [state court] judgment in its favor.”[10] The Supreme Court cautioned that “Rooker-Feldman does not otherwise override or supplant preclusion doctrine or augment the circumscribed doctrines that allow federal courts to stay or dismiss proceedings in deference to state-court actions.”[11] The Supreme Court noted that, “[i]f a federal plaintiff ‘present[s] some independent claim, albeit one that denies a legal conclusion that a state court has reached in a case to which he was a party . . . , then there is jurisdiction and state law determines whether the defendant prevails under principles of preclusion.”[12] An important factor in Exxon Mobil is that the plaintiff was not seeking to overturn the state court.
A number of courts examining the reach of the Rooker-Feldman doctrine in bankruptcy cases have concluded that it has little or no application in the context of avoidance actions, which are independent claims under the Bankruptcy Code.[13] Recently, the Third Circuit adopted this position in its decision in the Philadelphia Entertainment[14] bankruptcy case in which the court limited the application of the Rooker-Feldman doctrine to an avoidance action under sections 544 and 548 of the Bankruptcy Code.
In Philadelphia Entertainment, the debtor, which owned a gaming business, was awarded a state license to operate slot machines. Prior to the debtor’s commencement of its chapter 11 case, the state gaming authority revoked the gaming license for the debtor’s failure to comply with its past orders and demonstrate financial suitability. The debtor appealed the revocation order to the state court and lost.
After the confirmation of the debtor’s chapter 11 plan, the litigation trustee commenced an adversary proceeding before the bankruptcy court to avoid the revocation of the license as a constructively fraudulent transfer. Specifically, the debtor claimed that the revocation of the license was a transfer for which the debtor received no value from the state. The bankruptcy court invoked the Rooker-Feldman doctrine to dismiss the trustee’s lawsuit, finding that the doctrine divested the court of subject matter to consider the avoidance claim. The district court affirmed, adopting the bankruptcy court’s Rooker-Feldman conclusions.
The Third Circuit reversed the lower courts concluding that the bankruptcy court erred when it held that the Rooker-Feldman doctrine barred its review of the fraudulent transfer claims. The court noted that the doctrine applies when four requirements are met: (1) the federal plaintiff lost in state court, (2) the plaintiff complains of injuries caused by the state court judgment, (3) that judgment issued before the federal suit was filed, and (4) the plaintiff invites the district court to review and reject the state court judgment. The Third Circuit found that the fourth requirement was not met. Relying on Exxon Mobile, the Third Circuit ruled that so long as federal court litigation does not concern “the bona fides of the prior judgment,” the federal court “is not conducting appellate review, regardless of whether compliance with the second judgment would make it impossible to comply with the first judgment.”[15]
The court further noted that the bankruptcy court applied the Rooker–Feldman doctrine too broadly in finding that the fraudulent transfer claims required the federal courts to void the state court order. In particular, the court found that the litigation trustee was not complaining of an injury caused by the state court judgment and thus was not seeking a review and rejection of that judgment. In particular, the trustee’s fraudulent transfer claims did not require the bankruptcy court to conduct an appellate review of the order revoking the gaming license. An important consideration for the Third Circuit was that “a federal court can address the same issue ‘and reach[] a conclusion contrary to a judgment by the first court,’ as long as the federal court does not reconsider the legal conclusion reached by the state court.”[16] In other words, the Rooker-Feldman doctrine should not apply when a federal statute, in this case the avoidance statutes under the Bankruptcy Code, specifically authorizes a lower court to vitiate a state court judgment.
The exception for avoidance actions under the Rooker-Feldman doctrine is important for debtors in possession and trustees in bankruptcy cases because the prosecution of these claims can be highly valuable for creditor recoveries. As noted, one of the key policy objectives of bankruptcy is the maximization of creditor recoveries, which is often achieved through the prosecution of avoidance actions. Although the Rooker-Feldman doctrine operates to protect the integrity of state court judgments attacked in federal courts, the doctrine does not survive this policy objective under the Bankruptcy Code.
[1] The Rooker-Feldman doctrine derives its name from two U.S. Supreme Court cases, Rooker v. Fidelity Trust Co., 263 U.S. 413 (1923), and District of Columbia Court of Appeals v. Feldman, 460 U.S. 462 (1983). The Ninth Circuit decision in In re Gruntz, 202 F.3d 1074 (9th Cir. 2000), contains an extensive discussion of the origins of the doctrine and its intersection with title 28 of the United States Code.
In a recent decision from Minnesota, a limited partnership was ordered to be dissolved in an action brought by the assignees of the limited partners. Storeland v. Nordic Townhomes Limited Partnership, A18-1564, 2019 WL 1983500 (Minn. Ct. App. May 6, 2019).
Nordic Townhomes was originally organized with three limited partners and three general partners. With the passage of time, all of the original limited partners died. No new limited partners were admitted, and the heirs of the various limited partners became transferees of their respective interests in the partnership. The partnership agreement of Nordic Townhomes and the present situation were summarized by the court as:
[O]nce Nordic did not have any limited partners, the partnership was to dissolve, liquidate, and cease doing business. Despite the fact that Nordic does not have any limited partners, it continued to exist as an entity and conduct business.
The plaintiffs, they being some of the transferees of now deceased limited partners, filed a complaint seeking that Nordic Townhomes wind up its business, satisfy its debts and obligations, and distribute the net proceeds to those holding the economic rights in the partnership. The limited partnership responded by claiming that the plaintiffs did not have standing to seek either judicial or nonjudicial dissolution of the partnership on the basis that they were neither limited or general partners. The trial court granted the plaintiffs’ summary judgment, in effect finding that they could enforce the provision of the limited partnership agreement with respect to the partnership’s dissolution. This appeal followed.
Applying an “injury-in-fact” paradigm, the Minnesota Court of Appeals found that the assignees of the limited partners had standing to enforce that provision of the limited partnership agreement directing that the partnership be dissolved upon having no limited partners:
Here, respondents suffered an injury-in-fact sufficient to give them standing to ask the district court to enforce the partnership agreement. The partnership agreement is clear: Nordic was to be dissolved when there were no longer any limited partners. That process involves liquidating assets, and respondents are entitled to their share of any profits remaining once partnership obligations are resolved. See Minn. Stat. § 321.0702(b)(2) (2018) (stating that “upon the dissolution and winding up of the limited partnership’s activities [a transferee is entitled to] the net amount otherwise distributable to the transferor”). Because respondents are entitled to their share of that money, and because Nordic refused to take steps to dissolve the partnership and liquidate assets, respondents suffered an injury-in-fact sufficient to confer standing.
Further rejecting the claim that the court was allowing a nonpartner to move for judicial dissolution, the court observed that, “respondents’ action is more properly characterized as seeking enforcement of the partnership agreement rather than seeking judicial dissolution of the partnership. And because we conclude that respondents have standing because they suffered an injury-in-fact, respondents do not need a statutory basis to have standing.” Still on that same point, the court wrote:
[T]he partnership agreement clearly states that Nordic was to be dissolved when there were no limited partners. Accordingly, as transferees, respondents had standing to ask the district court to enforce the partnership agreement and the district court correctly required Nordic to follow the partnership agreement’s mandate of dissolution and liquidation.
Finally, although our opinion rests on our application of the law, we observe that adopting Nordic’s position could effectively result in no one having standing to seek enforcement of the partnership agreement. We do not discern the Minnesota law leaves transferees like respondents without redress in cases where remaining general partners fail to abide by the partnership agreement.
I find this decision somewhat troubling. Yes, all the court is doing is enforcing the agreement, but it is enforcing the agreement on behalf of persons who are not parties to it. As transferees of economic interests in the limited partnership, the plaintiffs in this action have no right to participate in the limited partnership’s management. Although the original limited partners would have been parties to the limited partnership agreement and in that role had the capacity to bring an action for its enforcement, that right did not devolve to the transferees upon the deaths of the limited partners. They are not parties to the limited partnership agreement, and for that reason an “injury-in-fact” paradigm fails; the failure of strict compliance with the limited partnership agreement gave no rise to an injury in the transferees because they were never parties to that agreement to begin with. In effect, the court is allowing nonparties to an agreement to insist upon its enforcement. What about the requirement of privity before bringing an action for enforcement? What about the provision of the Minnesota Limited Partnership Act (Minn. Code § 321.0702(a)(3)) that provides a transferee has no right to participate in the partnership’s management?
At its April meeting, the Advisory Committee on Civil Rules approved a proposed amendment to Federal Rule of Civil Procedure 7.01 that, if adopted, will require that each party to a lawsuit in federal court where jurisdiction is conditioned upon diversity jurisdiction (28 U.S.C. § 1332) file a statement setting forth the information necessary to determine each parties’ citizenship.
For purposes of federal diversity jurisdiction, no plaintiff may have the same citizenship as any defendant. See, e.g., OnePoint Solutions, LLC v. Borchert, 486 F.3d 342, 346 (8th Cir. 2007) (complete diversity “exists where no defendant holds citizenship in the same state where any plaintiff holds citizenship.”). In the case of a natural person, one is a citizen of the state in which one is domiciled. Although there can be disputes as to a person’s domicile (see, e.g., Art Van Furniture LLC v. Zimmer, 2019 WL 2433245 (E.D. Mich. June 11, 2019)), seldom will that occur. A corporation (private, nonprofit, professional service, etc.) is a citizen of its jurisdiction of incorporation and a citizen of the state in which it maintains its principal place of business (see 28 U.S.C. 1332(c)(1)), the latter determined under the “nerve center” test. See Hertz Corp. v. Friend, 559 U.S. 77, 130 S. Ct. 1181 (2010) (decision adopting and explaining the “nerve center” test). Although there may be more dispute as to the location of a corporation’s principle place of business than the domicile of an individual, the dispute and confusion is, again, unlikely.
Things become more complicated for other business organizations, including partnerships, limited partnerships, LLCs, and business trusts. In each of those instances, the organization itself has no citizenship. Indeed, the state of organization and location of the principal place of business play no role in determining the citizenship of these organizations. See, e.g., Citizens Bank v. Plasticware, LLC, 2011 WL 5598883 (E.D. Ky 2011); Hale v. MasterSoft Int’l Pty. Ltd., 93 F.Supp.3d 1108 (D. Colo. 2000). Rather, the organization’s citizenship is the citizenship of each of its “members.” In the case of a partnership or limited partnership, the members are, for these purposes, every general partner and every limited partner. See Carden v. Arkoma Assoc., 494 U.S. 185 (1990). In the case of a limited liability company, it will be deemed to have the citizenship of every one of its members. See, e.g., Cosgrove v. Bartoletta, 150 F.3d 729 (7th Cir. 1998). A business trust will have the citizenship of every one of its beneficial owners. See Conagra Foods, Inc. v. Americold Logistics, LLC, 136 S. Ct. 1012 (2016). Whether it will as well have the citizenship of any trustee who is not also a beneficial owner is something of an open question. See Thomas E. Rutledge & Christopher E. Schaefer, The Trust as an Entity and Diversity Jurisdiction: Is Navarro Applicable to the Modern Business Trust?, 48 Real Property, Trust & Estate L. J. 83 (Spring 2013). This means that an unincorporated business organization may be a citizen of numerous states, perhaps even every state if its membership is large enough. See, e.g., Reisman v. KPMG Peat Marwick LLP, 965 F.Supp. 165 (D. Mass. 1997 (noting that the then-“Big Six” accounting firms are “effectively immunized” from being subject to diversity jurisdiction).
The proposed amendments to Rule 7.01, if adopted, would require unincorporated business organizations to file with the court information as to the citizenship of each of its partners/members/beneficial owners. Recall that in many instances business organizations are in turn owned by other business organizations. For example, consider an LLC in which one of the members is a limited partnership. It will now be necessary that the LLC, in order to satisfy the proposed rule, list the partners, both general and limited, of that limited partnership. Ultimately, that LLC (or other unincorporated organization) must drill down through all of its layers of ownership until it reaches natural persons (who have their own citizenship), corporations (again, who have a recognized citizenship), and other structures, an example being a decedent’s estate, that, again, have their own citizenship. See, e.g., Delay v. Rosenthal Collins Group, LLC, 585 F.3d 1003, 1005 (6th Cir. 2009) (“When diversity jurisdiction is invoked in a case in which a limited liability company is a party, the court needs to know the citizenship of each member of the company. And because a member of a limited liability company may itself have multiple members—and thus may itself have multiple citizenships—the federal court needs to know the citizenship of each ‘sub-member’ as well.”).
Although this may seem burdensome at first blush, this proposed rule (and at this juncture it is only a proposal) would require nothing more than is already required; the parties to the dispute and the court have an obligation to confirm that diversity jurisdiction exists. Thus, at some juncture (and that juncture should be early) there must be scrutiny of the parties’ citizenship. See, e.g., Four Winds Distrib., LLC v. Cincinnati Ins. Co., 2019 WL 3940936 (D. Colo. Aug. 20, 2019) (“delay in addressing the issue only compounds the problem if, despite much time and expense having been dedicated to the case, a lack of jurisdiction causes it to be dismissed.”). Parties (particularly their attorneys) fail to engage in this analysis at their peril. See, e.g., Belleville Catering Co. v. Champaign Marketplace, LLC, 350 F.3d 691 (7th Cir. 2003) (case then on appeal on the merits to the Seventh Circuit Court of Appeals remanded to state court where diversity jurisdiction was in fact not present, depriving federal courts of jurisdiction; counsel ordered to relitigate dispute in state court pro bono on behalf of clients as sanction for this “doomed foray into federal court”). The proposed amendment to Rule 7.01, if adopted, will streamline the process, requiring each party to make a declaration to the court rather than leaving the determination of citizenship to the discovery process. Moreover, this proposed rule change may eliminate oft-seen gamesmanship as to the availability of diversity jurisdiction, particularly with respect to facial attacks. See, e.g., Lincoln Benefit Life Co. v. AEI Life, LLC, 800 F.3d 99 (3d Cir. Sept. 2, 2015) (court ordered jurisdictional discovery when defendant asserted a facial attack on the plaintiff’s position that diversity jurisdiction existed, trying to defeat the jurisdictional statement while denying information as to its citizenship, which was not publicly available).
This change (again assuming its adoption) will perhaps reduce the initial burden on a plaintiff filing in or a defendant removing to federal court. It is rare that the membership of an unincorporated entity available in the public record. This objective fact has necessitated allegations of diversity based upon “information and belief.” See, e.g., Wright, Federal Practice & Procedure § 1224 (pleading diversity jurisdiction on the basis of “information and belief” is a “practical necessity.”). There are, however, a number courts that have rejected allegations of diversity based on information and belief. See, e.g., Pharmerica Corp. v. Crestwood Care, LLC, 2015 WL 1006683 (N.D. Ill. Mar. 2, 2015); Principal Solutions LLC v. Feed.Ing BV, 2013 WL 2458630 (E.D. Wisc. June 5, 2013). Assuming that the party bringing the action to federal court has a good-faith basis for the assertion that diversity exists, and as that assertion will be quickly tested against the other parties’ citizenship disclosure, perhaps any bar against information and belief pleading should be reduced.
Haben Girma shows what an attorney with a disability can accomplish. She’s both deaf and blind, and her new memoir, Haben: The Deafblind Woman Who Conquered Harvard Law, has many stories about her facing challenges, and showing the world that her challenges didn’t limit her. As she writes in the introduction, “This book takes readers on a quest for connection across the world, including building a school under the scorching Malian sun, climbing icebergs in Alaska, training with a guide dog in New Jersey, studying law at Harvard, and sharing a magical moment with President Obama at the White House.”
Haben Girma is the daughter of parents from two different African countries; her father is from Ethiopia, and her mother is from Eritrea. Although Haben herself was born and grew up in California, that perspective influences how she takes on the world. The memoir opens with a harrowing story of her father being taken off an airplane by Ethiopian soldiers during her childhood. In reference to her background, this memoir discusses the complicated and historic relationship between the people of Ethiopia and Eritrea.
She also discusses the reality of growing up as a child with a disability in the United States and going to a mainstream school. She shows that these challenges can be confronted head-on and handled with attention and care (as well as reasonable accommodations), not by ignoring them and pretending they don’t exist. A theme running through the memoir is the importance of independence and obliterating misconceptions about what people with disabilities can and cannot do. The data clearly shows that the vast majority of disabilities are invisible and people often hide a key aspect of him or herself.
Like many children with disabilities, she challenges her parents to allow her to do things, such as travel. She also faces colleagues and mentors who underestimate and look down on her. Throughout the story, she endeavors to break down the myths of what she unable to accomplish, while never falling into the untrue and damaging myth of “overcoming” disability. As research shows, disability inclusion provides an advantage for those organizations that work to include people with disabilities, such as Accenture, Microsoft, and Sidley Austin (all three have been recognized by the ABA for including attorneys with disabilities).
In Haben’s case, she is a Harvard Law School graduate with international experience. She writes that society treats “people with disabilities as incapable of contributing, and yet these kids [in Eritrea] treat me like someone with gifts to share and lessons to teach.” In her discussion of her experience at Harvard Law School, she explained that she used communication devices to interact with other students, professors, and people at networking events. In particular, she discussed using her Braille computer to network. (“Tactical sign language is our backup plan” was decided during a strategy meeting.)
Dancing salsa allows her to use her sense of touch to manage her lack of vision and lack of hearing a beat. She describes using the skills she has to manage the senses she doesn’t have. For example,she also describes using her sense of touch to volunteer to build houses in Mali. Building houses helped prove that she could still make a worthwhile contribution and have a disability at the same time. Her disability allows her to perceive problems that others don’t even notice.
The memoir also makes clear that a disability rights legal practice also provides her with great legal training. For example, she discussed an attorney with a disability that was the best litigator she’s ever witnessed: “Disability Rights hero Daniel Goldstein grips the court’s attention. He stands at the lectern before Judge William K. Sessions, III, in the district court for the district of Vermont.”
As a Skadden fellow after law school, she operated a disability rights practice. As discussed above, the disability rights legal practice helped develop her legal skills and gave her front line access to top lawyers.
“As a public service lawyer, my salary is far below what a Harvard Law graduate would typically make, but still exceeds the average income for blind Americans, 70 percent of whom struggle with unemployment,” writes Haben. The memoir then explains that disability rights are civil rights, and she shows that the ADA is federal legislation that offers protections that help businesses reach a “giant” market.
In conclusion, this is a worthwhile book that you should read to better understand the challenges of the disabled. Haben gives concrete examples of her youth, her perspective, and the excellent legal training she received. The book discusses the value for business organizations and law firms to include people with disabilities; her unique voice brings us just a glimpse into how disabilities can be an asset to businesses. The memoir shows the level of talent and size of the potential market that businesses could reach by including persons with disabilities.
A new California law related to the processing of personal data will go into effect in July 2020. The California Consumer Privacy Act (CCPA) (California Civil Code §§ 1798.100 to 1798.199) is currently the most comprehensive privacy legislation in the United States, with extensive new compliance requirements and liabilities. Although the law was drafted with threshold requirements for application, it will have significant reach given California’s undeniably large global economic impact. If you are a for-profit business doing business in California or you are collecting California consumers’ personal information, this is one law you cannot ignore.
In short, the CCPA grants California residents new rights with respect to the collection of their personal information, including, among other things, the right to be forgotten (deletion of information), the right to opt-out of the sale of their personal information, and the right to know what information a business collects about them. All of this creates new operational challenges for businesses that must be addressed in advance of the law taking effect. To further complicate matters, there are several open questions about the law, including the application of several amendments recently passed by the California state legislature, and whether preemptive federal legislation may be passed. In the meantime, companies should prepare themselves for the most monumental shift in domestic privacy legislation in decades.
Background of the Passage of the CCPA
General elections in California often include voting on legislative ballot initiatives, some of which are drafted and proposed by California citizens. Prior to the passage of the CCPA, real estate developer Alastair Mactaggart set out to place an initiative on the ballot regulating the collection of personal information by businesses. The idea quickly gained steam, and within a few months a consumer-friendly privacy initiative co-drafted and funded by Mactaggart gathered what appeared to be more preliminary signatures than necessary to qualify for the November 2018 statewide ballot. Initiatives that pass via the ballot process are notoriously more difficult to amend, modify, or repeal, typically requiring another initiative or a 70-percent majority in the California legislature. In order to avoid the passage of a law that would have been immensely difficult to change, the California legislature brokered a deal with Mactaggart and his team and hastily passed Assembly Bill 375, now known as the CCPA. The proposed legislation, although in the works for some time, reportedly received only a few days of debate and virtually no input from industry before it was passed and signed into law. As a result of the deal and signed legislation, Mactaggart agreed to withdraw his ballot initiative only hours before the final deadline to withdraw.
Not surprisingly, this unusually swift process resulted in drafting errors, inconsistencies, ambiguities, and confusion as to the law’s potential reach and application. Indeed, several weeks after its initial passage, the legislature amended the new law with the passage of SB 1121. Intended to correct certain drafting errors and clarify certain provisions, the amendment still left several glaring inconsistencies and ambiguities. Several additional amendments have passed through the legislature and are currently pending before Governor Newsom. It is anticipated that there may be additional amendments proposed after the CCPA takes effect in 2020.
Threshold Application of the CCPA
The CCPA applies generally to for-profit businesses and sets threshold requirements for its application. The CCPA will apply to businesses around the world if they exceed one of the following thresholds:
annual gross revenues of $25 million;
annually buy, sell, receive, or share for commercial purposes the personal information of 50,000 or more consumers, households, or devices; or
derive 50 percent or more of its annual revenues from selling consumers’ personal information.
Notably, parent companies and subsidiaries sharing the same branding must also comply even if they themselves do not exceed the applicable thresholds.
At this point, there are some ambiguities as to how the thresholds can be met. For example, a common question is whether the $25 million limit for annual gross revenues is met with California revenue alone or if it is met with global revenue. The answer to this question is unclear and may or may not be resolved before the law goes into effect, meaning that, ultimately, the courts may be the ones to resolve this issue.
Who Is Affected and What Is Protected?
Under the CCPA, consumers can exercise their rights with respect to any information that relates to them and that is held by a business. The term “consumer” is broadly defined to include any California resident (see Cal. Civ. Code § 1798.140(g) (defining “consumer” as any “natural person who is a California resident”)). An amendment known as AB 25 currently on the governor’s desk would redefine “consumers” to omit employee personal information to the extent the person’s personal information is collected and used only by the business in that context. The provision will sunset after one year.
A consumer’s “personal information” is broadly defined to include information that identifies, relates to, describes, or could reasonably be linked, directly or indirectly to a particular consumer or household. As the law exists currently, personal information includes, but is not limited to, the following:
identifiers such as a real name, alias, postal address, unique personal identifier, online identifier, internet protocol address, e-mail address, account name, Social Security number, driver’s license number, passport number, or other similar identifiers;
characteristics of protected classifications under California or federal law;
commercial information, including records of personal property; products or services purchased, obtained, or considered; or other purchasing or consuming histories or tendencies;
biometric information;
internet or other electronic network activity information, including, but not limited to, browsing history, search history, and information regarding a consumer’s interaction with an internet web site, application, or advertisement;
geolocation data;
audio, electronic, visual, thermal, olfactory, or similar information;
professional or employment-related information;
education information;
inferences drawn from any of the information collected to create a profile about a consumer reflecting the consumer’s preferences, characteristics, psychological trends, preferences, predispositions, behavior, attitudes, intelligence, abilities, and aptitudes.
Specifically excluded from the definition of “personal information” is any information publicly available, meaning any information that is lawfully made available from state, federal, or local government records. “Publicly available” does not mean biometric information collected by a business about a consumer without the consumer’s knowledge.
How Will the CCPA Be Enforced?
Under the CCPA, the California attorney general can bring civil actions for injunctions or civil penalties of $2,500 per violation under the statute and up to $7,500 for any intentional violation. A business is in violation of the statute if it fails to cure an alleged violation within 30 days after being notified of alleged noncompliance.
The CCPA also includes a limited private right of action for consumers for violations of the statute’s data security requirements. Specifically, a consumer can institute a civil action if nonencrypted or nonredacted personal information (as defined under California’s data breach notification statute, California Civil Code, § 1798.81.5(d)(1)) is subject to unauthorized access and exfiltration, theft, or disclosure as a result of a business’s failure to maintain reasonable security procedures.
The security provision refers to a business’s “duty to implement and maintain reasonable security procedures and practices.” Although “reasonable security” is not defined in the statute, it is worth noting that in February 2016 the California attorney general released the California Data Breach Report, which makes five recommendations regarding data security, including an explicit endorsement of the Center for Internet Security’s Critical Security Controls as a minimum threshold for reasonable security. It is also worth noting that the CCPA’s security provision does include a proportionality element providing that it is the duty of the business to maintain reasonable security procedures and practices “appropriate to the nature of the information.”
In an interesting twist, another proposed amendment to the CCPA, SB 561, which would expand the private right of action to any violation of the CCPA and remove the ability to cure within 30 days of notification, was killed during the recent legislative session. The bill had the backing of Attorney General Xavier Becerra, but on April 29, 2019, the California Senate Appropriations Committee placed this bill on the “suspense file,” which is a way to consider the fiscal impact of the bill to the state. Shortly thereafter, the bill was taken under submission, which means it was blocked and is effectively dead. Given that the legislative session in California has ended, it appears that there will not be an expansion of the private right of action this year. California has a two-year legislative session, however, so this bill can be raised again next year without the need to be reintroduced.
How Does the CCPA Compare to the GDPR?
You may have heard of Europe’s General Data Protection Regulation (GDPR) and wonder how it compares to the CCPA. Notably, it is difficult to make generalities about the differences or similarities between the laws because some provisions in the laws closely align, whereas others do not.
Both laws are generally intended to provide privacy protections to individuals by granting them control and access to their personal information. Additionally, both the GDPR and CCPA focus on transparency obligations. To achieve their objectives, each requires contracts between businesses and service providers, detailed privacy notices, and similar grants to individuals with respect to the control over their information. The devil, as they say, is in the details in that each law sets out different compliance and applicability requirements.
Fundamentally, the GDPR and CCPA also differ in many aspects, including that the GDPR anchors itself with the concept that a business must have a “legal basis” to process personal information, otherwise the processing is not permitted. The CCPA has no such requirement and instead creates a mechanism for consumers to opt-out of the sale and disclosure of their information or to request deletion.
The CCPA also explicitly excludes from its scope certain broad categories of personal information altogether, including medical information covered by the Confidentiality of Medical Information Act and the Health Insurance Portability and Accountability Act and personal information under the Gramm-Leach-Bliley Act. The GDPR excludes no specific categories of information from its scope.
What Must Your Business Do Now?
Review Your Data Privacy Practices. It is always a good starting point to take stock of your data. Determine what data (including personal information and sensitive or confidential information) your business is collecting, what you are doing with the data (including with whom it is being shared), and where the data resides. The CCPA gives consumers new rights over their information and, as a result, organizations must be prepared to comply with requests that may come from consumers beginning January 1, 2020. The new rights include the right to request from a business:
categories and specific pieces of personal information collected;
categories of sources from which the personal information is collected;
the business or commercial purpose for collecting or selling the personal information;
categories of third parties with whom the business shares personal information; and
deletion of personal information about the consumer that the business has collected, subject to some important exceptions.
The information must be delivered free of charge to the consumer, in a format that is portable, and typically within 45 days. The first step to complying with any requests from consumers is understanding your current data practices.
Review Your Policies. If you have a privacy policy in place, it will likely need updating before January 1, 2020, even if you prepared for the GDPR. The CCPA provides for new disclosure requirements that must be included in a privacy policy or notice. At or before the time of collection, a business must disclose the categories of personal information to be collected and the purpose for which the information is used. The notice must also separately list the categories of personal information collected, sold, or disclosed for a business purpose in the preceding year and explicitly state if the personal information has not been sold or disclosed. The new disclosures can be made part of an existing privacy policy, or a separate policy can be maintained for California residents.
Businesses should also analyze whether they are “selling” personal information to third parties. Where a consumer’s personal information is sold as defined by the statute, the consumer has the right to opt-out of the sale of their personal information. A clear and conspicuous link on the business’s internet homepage, titled “Do Not Sell My Personal Information,” must be made available, and the link must enable consumers to opt-out of the sale of their personal information. The business must wait at least 12 months before requesting to sell the personal information of any consumer who has opted out.
Review Third-Party Agreements. Take the time to identify vendors or third parties that receive personal information from your business. Once identified, consider adding appropriate contract terms to address the CCPA, including terms regarding the use or disclosure of personal information received from your business, to clarify that you are not “selling” personal information to vendors, or to increase transparency with regard to the privacy and data security practices of your vendors.
Conclusion
Business leaders can anticipate that the CCPA will continue to evolve over the coming year, and that this will not be the end of data privacy regulation in California or the United States. Indeed, several states are currently considering their own privacy regulations. Given that regulatory change in this area will be ongoing for some time, it is best to build a flexible, dynamic privacy program that can adapt to changes as they occur.
In Mission Product Holdings, Inc. v. Tempnology, LLC, 139 S. Ct. 1652 (2019), the U.S. Supreme Court answered what has been called the most important unresolved question in trademark licensing and resolved a decades-long division among the lower courts on a foundational question of bankruptcy law. Specifically, Mission held that when the licensor of a trademark files for bankruptcy, its “rejection” of the trademark license agreement under section 365 of the Bankruptcy Code does not terminate the licensee’s rights in the mark.
Mission is a critically important decision for trademark licensing, and practitioners in that area have welcomed it, because it makes clear that a licensee’s rights will not evaporate if the licensor files for bankruptcy and rejects the parties’ license agreement. That greater certainty will affect the negotiation and terms of trademark licenses because it makes trademark rights more valuable to the licensee (and, as a corollary, makes licenses more profitable for the licensor). It is also a highly significant decision for the bankruptcy bench and bar because it clarifies long-standing confusion regarding one of the Bankruptcy Code’s central concepts: the concept of rejection.
By way of background, section 365 of the Bankruptcy Code permits a trustee or debtor-in-possession in bankruptcy to “assume or reject any executory contract”—that is, any contract the debtor entered before bankruptcy in which each party still owes a duty of performance to the other. 11 U.S.C. §365(a). Briefly, section 365 permits the bankruptcy estate to assume an executory contract and perform the debtor’s future obligations under that contract if doing so will be profitable for the estate, and to reject the contract if performing would not be profitable. Mission, 139 S. Ct. at 1658. The Bankruptcy Code provides that rejection “constitutes a breach” of the rejected contract that is deemed to have occurred before bankruptcy, 11 U.S.C. §365(g), entitling the counterparty to a claim in the bankruptcy case (which will typically be paid at cents on the dollar) for damages stemming from the debtor’s failure to perform. However, courts have not always agreed on the precise consequences of rejection. Is rejection merely the equivalent of a breach of contract outside bankruptcy, or does it terminate all the counterparty’s rights? That was the core question in Mission.
The seeds for Mission were sown in 1985 when the Fourth Circuit addressed the same question in the context of a patent license. Lubrizol Enters. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985). Lubrizol held that the debtor-licensor’s rejection of the license agreement enabled the estate to take back the patent rights the debtor had granted to the licensee before bankruptcy and sell or license those rights to a third party. See id. at 1047-48. In response, Congress amended section 365 by adding a new provision governing rejection of licenses of “intellectual property,” which provided that licensees could choose either to treat such licenses as terminated or to retain their rights (and obligations) under the licenses. 11 U.S.C. §365(n). Congress defined “intellectual property” to include patents, copyrights, and trade secrets, id. §101(35A), but omitted trademarks, meaning that section 365(n), by its terms, does not apply to trademark licenses. After section 365(n) was enacted, courts divided over whether Lubrizol was still good law for trademark licenses. Some lower courts concluded that the omission of trademark licenses from section 365(n) meant that Congress had implicitly endorsed Lubrizol’s reasoning in the trademark licensing context. In 2012, however, the Seventh Circuit held to the contrary, reasoning that under section 365, rejection is simply a breach and, like a breach outside bankruptcy, cannot take away the licensee’s rights in the mark. See Sunbeam Prods., Inc. v. Chicago Am. Mfg., LLC, 686 F.3d 372 (7th Cir. 2012).
That was where matters stood when the Mission case originated. Tempnology had developed a patented technology for cooling fabric to be used in sportswear, towels, and the like, marketed under the COOLCORE trademark. In 2012, it licensed its patents and trademark to Mission, granting Mission the exclusive right to distribute certain COOLCORE products in the United States. In 2014, Tempnology filed a Chapter 11 petition and rejected the license agreement with Mission, contending that rejection terminated Mission’s right to use the trademark. Ultimately, the First Circuit agreed with Tempnology and split with the Seventh Circuit’s decision in Sunbeam, reasoning that allowing Mission to continue using the mark would be too burdensome for Tempnology and could impair its ability to reorganize. The Supreme Court granted Mission’s petition for certiorari to resolve the circuit split. Mission, 139 S. Ct. at 1658-60.
After rejecting Tempnology’s argument that the case was moot, see id. at 1660-61, the Court turned to the fundamental question presented: “What is the effect of a debtor’s . . . rejection of a contract under Section 365 of the Bankruptcy Code?” Id. at 1661. The Court’s answer was unequivocal: “Rejection of a contract—any contract—in bankruptcy operates not as a rescission but as a breach.” Id. Accordingly, rejection “leave[s] intact the rights the counterparty has received under the contract.” Id. “Both Section 365’s text and fundamental principles of bankruptcy law command [that] approach.” Id.
Beginning with the text, the Court observed that section 365 provides that rejection “‘constitutes a breach’” of the rejected contract. Id. Outside bankruptcy, one party’s breach of contract does not terminate the other party’s rights. The Court used the example of a contract in which a dealer leases a photocopier to a law firm and agrees to service the copier monthly. If the dealer stops servicing the machine, materially breaching the contract, the law firm may choose to terminate the contract, but the dealer cannot do so. “The contract gave the law firm continuing rights in the copier, which the dealer cannot unilaterally revoke.” Id. at 1662. Rejection in bankruptcy works the same way, for a trademark license as well as a photocopier lease: “The debtor can stop performing its remaining obligations under the agreement. But the debtor cannot rescind the license already conveyed. So the licensee can continue to do whatever the license authorizes.” Id. at 1662-63. That reading of section 365, the Court explained, “reflects a general bankruptcy rule: The estate cannot possess anything more than the debtor itself did outside bankruptcy,” at least absent a successful preference or fraudulent conveyance action by the trustee. Id. at 1663.
The Court found Tempnology’s contrary arguments unpersuasive. Tempnology had contended that because section 365(n) specifies that counterparties may retain their rights after rejection, one should draw the negative inference that “the ordinary consequence of rejection” is termination of those rights. Id. at 1663. After examining the history and context of section 365(n), however, the Court concluded that “no negative inference arises.” Id. at 1665. “Congress did nothing in adding Section 365(n) to alter the natural reading of Section 365(g)—that rejection and breach have the same results.” Id. Rather, section 365(g) could be read to “reinforce or clarify the general rule that contractual rights survive rejection.” Id. at 1664.
Finally, the Court dismissed Tempnology’s contention that if trademark licensees retained their rights after rejection, the debtor’s ability to reorganize would be impeded because the debtor would need to continue to exercise quality control over the goods bearing the mark or else risk losing the mark. See id. at 1665. As an initial matter, the Court noted that there was no support in the text of the Bankruptcy Code for a trademark-specific rule of rejection. Id. Moreover, Tempnology’s argument proved too much: The Code “aims to make reorganizations possible,” “[b]ut it does not permit anything and everything that might advance that goal.” Id.
The Mission decision has many significant aspects, three of which are noted here. First, as the Court expressly stated, its holding—that rejection has the same consequences as breach—is not limited to trademark licenses, but applies to all executory contracts. Mission thus has the potential to simplify what has become an extraordinarily complex and confused area of the law. Courts often conduct lengthy analyses of whether a particular contract is executory, at times seemingly doing so to avoid the draconian consequences that rejection would have if it terminated the counterparty’s rights. See, e.g., In re Exide Technologies, 607 F.3d 957 (3d Cir. 2010) (holding that trademark license agreement was not executory, and licensor therefore could not reject it and terminate licensee’s right to use the mark); id. at 967-68 (Ambro, J., concurring) (noting the inequity of using rejection “to let a licensor take back trademark rights it bargained away”); see generally Michael T. Andrews, Executory Contracts in Bankruptcy: Understanding ‘Rejection,’ 59 U. Colo. L. Rev. 845 (1988). Once rejection is correctly understood as the bankruptcy analogue of breach, and not as a special power to terminate the other party’s rights under a contract, courts should no longer need to rely on the highly malleable test for executoriness to ensure a just result.
Second, Mission reaffirms that in deciding any question arising under the Bankruptcy Code, the Code’s language comes first, but Mission approaches that language contextually. As the Court observed, section 365’s statement that rejection “constitutes a breach” “does much of the work” in the Court’s analysis. Mission, 139 S. Ct. at 1661. That is not surprising. As Justice Kagan, who wrote the Court’s opinion, said in another context, “We’re all textualists now.” SeeThe Scalia Lecture: A Dialogue with Justice Elena Kagan on the Reading of Statutes (Nov. 17, 2015). Significantly, however, the Court did not limit its inquiry to the text of section 365 considered in isolation, as it has at times in past bankruptcy cases. See, e.g., RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 566 U.S. 639, 645-49 (2012). Rather, it also relied on the “fundamental principle[]” that the estate has no greater rights in property than the debtor had before bankruptcy—a principle reflected in the overarching structure of the Code and its various provisions governing the estate and its property—to confirm its interpretation. Mission, 139 S. Ct. at 1661; see id. at 1663. That willingness to grapple with the overall architecture of the Code—also reflected in the Court’s decision two years ago in Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017)—is a promising sign for the Court’s bankruptcy jurisprudence.
Finally, Mission once again confirms that to understand the workings of the Bankruptcy Code, one must start with the parties’ rights and obligations outside bankruptcy. To be sure, the Code can and sometimes does alter those rights and obligations, but the Court will not be quick to jump to the conclusion that Congress intended such an alteration unless the Code clearly indicates it. Likewise, the interpretation of the Code that best promotes reorganization will not always be the correct interpretation; the Code carefully balances the interests of different constituencies, and courts must respect the balance Congress struck. In short, as the Court has now held repeatedly in various contexts, the Bankruptcy Code gives debtors specific tools that can be used to maximize the value of the estate, but it does not grant either the debtor or the bankruptcy court any general power to alter the parties’ background entitlements in the service of reorganization or of an equitable resolution more broadly. See, e.g., Czyzewski, 137 S. Ct. 973 (when dismissing a Chapter 11 case, bankruptcy courts lack the power to order a distribution of estate assets that would violate the priority scheme applicable to a Chapter 11 plan). Although the Court’s view of the bankruptcy power as tied closely to the provisions of the Code may be more constrained than some bankruptcy practitioners would prefer, the Court has now made that view inescapably clear.
This article explores certain potential effects on a letter of credit transaction of the applicant for the credit becoming the subject of a bankruptcy proceeding under the United States Bankruptcy Code (Title 11 of the United States Code). [1]
What Is a Letter of Credit?
A letter of credit (LC) is an undertaking by an issuer, typically a bank (Issuer), at the request or for the account of its customer (Applicant) or, in rare cases, for itself, to a beneficiary (Beneficiary), to pay or otherwise honor a documentary presentation made by the Beneficiary (Uniform Commercial Code (UCC) § 5-102(a)(10)). A classic use of an LC is for a buyer of goods to pay the purchase price for the goods by arranging for its bank to issue an LC to the seller, payable against the seller’s presentation to the bank of a copy of the seller’s invoice for the goods and an original or copy of the transport document covering the shipment of the goods to the buyer. In this example, the buyer would be the Applicant, the bank would be the Issuer, and the seller would be the Beneficiary. Another common use of an LC is as a standby in case of a default in payment or performance of an obligation, such as an LC payable against the Beneficiary’s statement that the Applicant has defaulted in performing a specified obligation to the Beneficiary.
It is important to note two key features of LCs. First, although an LC can serve the same purpose as an ordinary guaranty in assuring a Beneficiary of payment, an LC is not a secondary obligation like a guaranty or other suretyship undertaking. It is an independent obligation of the Issuer to the Beneficiary separate from the arrangements relating to it, such as the reimbursement arrangement between the Applicant and the Issuer and the underlying purchase and sale transaction between the Applicant and Beneficiary (UCC § 5-103(d)). Second, an LC is a documentary undertaking. The Issuer’s obligation to honor is triggered by the presentation of one or more documents that appear on their face strictly to comply with the terms and conditions of the LC (UCC § 5-108(a)). In our first example above, the Issuer’s payment obligation would be triggered by the Beneficiary’s presentation of its invoice and the requisite transport document; payment would not be triggered by the fact that the Beneficiary had shipped the goods to the Applicant. The Issuer checks the presented documents, not whether the Beneficiary actually shipped the goods; neither is the Issuer responsible for any breach of contract by the Beneficiary (UCC § 5-108(f)).
Applicant’s Bankruptcy
U.S. courts have overwhelmingly held that an LC and its proceeds are not property of the Applicant’s bankruptcy estate within the meaning of 11 U.S.C. § 541. Thus, neither the Beneficiary’s presentation of drawing documents under the LC nor the Issuer’s payment of the LC would violate the automatic stay under 11 U.S.C. § 362 that prohibits, among other things, taking the property of or enforcing claims against the bankrupt. E.g., Elegant Merch., Inc. v. Republic Natl. Bank (In re Elegant Merch., Inc.), 41 B.R. 398, 399 (Bankr. S.D.N.Y. 1984). An LC is an independent undertaking running from the Issuer to the Beneficiary; the payment of the LC is by the Issuer, not by the bankrupt Applicant.
Practice tip: If the Beneficiary wants to make sure it can draw on the LC in the event of the Applicant’s bankruptcy, the LC should avoid specifying any drawing conditions that require taking action against the bankrupt or its property (e.g., do not require presentation of a statement that the Beneficiary has demanded payment from the bankrupt).
While the Applicant’s bankruptcy will not, in and of itself, prevent the Beneficiary from drawing on the LC and being paid in the first instance, will the Beneficiary be entitled to keep the LC payment? In most cases, the Beneficiary will be entitled to keep the LC payment, and whether or not the Applicant reimburses the Issuer will be the Issuer’s problem. However, there are bankruptcy scenarios in which the Beneficiary will not be allowed to keep the LC proceeds. These scenarios typically involve LCs supporting an antecedent debt owed to the Beneficiary by the Applicant, and the Issuer’s issuing the LC to the Beneficiary within the 90-day (one year in the case of an insider) bankruptcy preference period (see 11 U.S.C. § 547(b)). The following are two leading cases in which payment of an LC was seen as a preference and could be recovered by the bankruptcy estate from the Beneficiary:
Kellogg v. Blue Quail Energy, Inc. (In re Compton Corp.), 831 F.2d 586 (5th Cir. 1987), modified, 835 F.2d 584 (5th Cir. 1988) (LC issued just prior to bankruptcy to support unsecured antecedent debt of Applicant to Beneficiary, where Issuer had long ago perfected a security interest in Applicant’s assets to secure future advances; court viewed Beneficiary as an indirect transferee of that security interest granted by Applicant to Issuer and, arguably, in effect transferred to Beneficiary when Issuer issued the LC; indirect preference may be recovered from Beneficiary).
Bank v. Leasing Servs. Corp. (In re Air Conditioning, Inc. of Stuart), 845 F.2d 293, 298 (11th Cir. 1988) (Beneficiary can be subject to preference “clawback” where Applicant granted a security interest to Issuer contemporaneously with issuance of an LC to support antecedent debt of Applicant to Beneficiary).
The Beneficiary is not the only party worried about whether it can keep a payment when the Applicant becomes bankrupt. An Issuer would want to know whether it can be reimbursed and keep the reimbursement if the Applicant becomes bankrupt. In this regard, an Issuer that has paid an LC drawing is much like a lender that has made a loan to the Applicant and wants to be repaid—if the Issuer was unsecured or undersecured, and then reimbursed by the Applicant during the preference period, that reimbursement may be a preference. Similarly, if the Issuer issued an LC and later (non-contemporaneously) obtained collateral from the Applicant during the preference period, that transfer may be a preference. See, e.g., Luring v. Miami Citizens Nat’l Bank (In re Val Decker Packing Co.), 61 B.R. 831, 841-43 (Bankr. S.D. Ohio 1986).
Novices to this area often assume that the Beneficiary is better off if the Applicant pays its debts to the Beneficiary rather than defaults; however, that is not always the case. As the court said in Comm. of Unsecured Creditors v. Koch Oil Co. (In re Powerine Oil Co.), “Can an unsecured creditor be better off when the debtor defaults rather than paying off the debt? Yes. Law can be stranger than fiction in the Preference Zone.” 59 F.3d 969, 971 (9th Cir. 1995) (Payment by Applicant to Beneficiary could be preferential even though Beneficiary would have been able to draw on the LC and be paid in full had Applicant failed to pay Beneficiary.)
Practice tip: There are at least two ways for the Beneficiary to structure its transaction to avoid the Powerine trap of being unable to draw on its LC: (i) use a direct-draw or direct-pay LC (where drawing on the LC is the intended payment mechanism rather than the LC standing by to be drawn on only if the Applicant defaults), or (ii) use a standby LC that permits a drawing if the Applicant becomes bankrupt within 90 days (one year in the case of an insider) after making a payment to Beneficiary (but this can be a costly option, as it requires keeping the LC outstanding for a longer period after the date on which payment is due from the Applicant to the Beneficiary).
This brief article is only an introduction to a complicated subject. If you find the subject interesting and want to learn more, feel free to check out the American Bar Association Business Law Section’s March 29, 2019, CLE Program “Letters of Credit & Applicant Bankruptcy: U.S. & Canadian Bankruptcy Provisions and Cases for Beneficiaries, Issuers, Applicants & Others,” presented by Michael Evan Avidon (Moses & Singer LLP), Mark N. Parry (Moses & Singer LLP), Patricia A. Redmond (Stearns Weaver Miller Weissler Alhadeff & Sitterson P.A.), and Natalie E. Levine (Cassels Brock & Blackwell LLP).
With the proliferation of YouTube TV, Apple TV, and Amazon Prime Video, one might think competition in the streaming television market is flourishing. However, the major television networks continue to block competition, and legal barriers to entry have stifled competition among would-be market players not sponsored by the world’s largest multimedia companies—companies that already have millions of eyeballs before they launch television services. The outdated and uncertain legal landscape forces courts to determine the legality of many innovative services. But the high costs associated with such litigation can be prohibitive, particularly for emerging technology companies. The net result of outdated law governing constantly evolving technology is a reduction in competition and fewer choices for consumers, who are also essentially forced to pay higher fees as companies pass on legal costs.
The Copyright Act
The legal architecture that governs the delivery of broadcast television in particular is sorely out of date and goes back more than four decades to the last major overhaul of the Copyright Act in 1976. At that time, “community antennas”—large hilltop antennas connecting rural communities by dedicated physical cables and wires—were new and disruptive technology. With the 1976 amendment, Congress created a statutory license for certain secondary transmissions made by “cable systems.”
In drafting the 1976 Act, Congress recognized that “technical advances have generated new industries and new methods for the reproduction and dissemination of copyrighted works” and that there are “promises [of] even greater changes in the future.”[1] For this reason, Congress attempted to use technology-neutral language and defined the term “cable system” to allow for future advancements in the delivery of broadcast television, regardless of whether the system uses “wires, cables, microwave, or other communications channels[.]”[2]
In the 43 years since the Act’s last general update, television delivery methods have expanded to include cable, microwave, satellite, and now the internet. Typically, in response to court rulings, Congress has enacted limited updates to address specific technologies. For example, in 1988 Congress created a separate license for satellite providers.[3] And in 1994, Congress amended the definition of a “cable system” in the Copyright Act to expressly include “microwave” transmissions, another early form of wireless transmission.[4]
But none of these “band-aids” provides a comprehensive framework for market competition of constantly evolving technology. Since 1994, Congress has not modified the Copyright Act’s statutory definition of a cable system. As a result, the task of interpreting outdated statutes and regulations has been left to the courts, which do not offer an efficient solution.
The Courts
In 2014, the U.S. Supreme Court issued its decision in American Broad. Cos. v. Aereo, Inc.,[5] finding it engaged in public performance. At the time, certain amici argued Aereo met the Act’s definition of cable system. Although Aereo declined to pursue that argument, the Court seemed to embrace its logic, reasoning that Aereo is “substantially similar to” and “is for all practical purposes a traditional cable system[.]”[6]
In 2016, FilmOn X, LLC v. Fox Television Stations, Inc.[7] (FilmOn) was argued before the D.C. Federal Circuit Court of Appeals. FilmOn urged the court to find that companies providing film and television content over the internet (over-the-top or OTT) were within the Act’s definition of a “cable system.” The FilmOn case settled shortly after the two-hour argument, and another opportunity for the courts update the interpretation of outdated legislation passed.
On July 31, 2019, the major broadcast networks filed a copyright infringement lawsuit in the Southern District of New York[8] to shut down yet another new streaming service, “Locast.” Locast asserts that it fits within another statutory license for nonprofits that provide a public service by retransmitting broadcast television for free or at cost and without any commercial purpose.[9] Although the outcome of the Locast litigation is uncertain, it is certain that Locast must now bear the heavy expense of defending its model in court based on severely outdated law.
Conclusion
Unlike the Apples and Googles of the world, smaller emerging technology companies lack the established consumer bases and market power necessary to leverage their own content deals in the context of today’s outdated law. In the absence of legislative action, and in today’s chilled regulatory environment, the courts are left to interpret existing law in a fair, technologically neutral fashion. The right government action will provide consumers more choice, as well as more control over the content they receive and how they receive it.
The legal industry is getting with the program, so to speak. Like many industries before it—including technology, financial services, and manufacturing—a large part of the legal industry now recognizes that data is a strategic asset. Further, modern law firms are now striving to build data-driven cultures enabled by emerging and innovative technologies like artificial intelligence (AI), cloud computing, and blockchain.
Progress has been made on this front, but it is still early in the new technology adoption curve for the legal industry. Despite the fact that law firms possess significant amounts and types of data, it is often fragmented by lawyer or practice silos.
Siloed data makes it impossible to derive the necessary insights and collaborate effectively. In addition, most of the centralized systems and processes that do exist are legacy systems, e.g., spreadsheets, generic , and SharePoint, that are incompatible with the rest of the firm’s technology and workflow processes. The result is missed business opportunities as the complexity of engagements continues to increase and lost market share to competitors that take a more modern approach to data. This dynamic has become a major issue facing law firms in the client-empowered era that exists today with more discerning, price-sensitive clients and leaner margins.
Although the top one percent of global firms will be insulated from profitability concerns for the foreseeable future, the other 99 percent must take action based on data-driven decisions in collaboration with institutional knowledge.
The CMO’s Dilemma
Although the scenario above applies to all functional areas of a law firm, the problem is particularly acute with marketing.
Rather than delivering proactive client insights that inform new business opportunities, many law firm marketing departments remain mired in administrative work due to the heavy responsibility of manual data gathering. In a 2018 Bloomberg Law study, legal marketeers cited “lack of time” as their primary challenge.
Eliminating the manual data gathering tasks to free up time for strategic consultation is critical. CMOs in particular cannot discuss strategy with lawyers and identify new business opportunities without the necessary insights that come from client data and relationship knowledge.
The Modern Law Firm and Technology Innovation Are Inextricably Connected
When people ask me what being a “modern” law firm entails, I tell them it means employing strategies, initiatives, and investments that enable the firm to keep pace with rapidly changing client demands, market conditions, and new technologies. These modernization initiatives typically involve unifying people, processes, and data.
The most successful firms are those that transition their organizations from a reactive to an insights-based posture. Making this transition accelerates a firm’s ability to win business with both new and existing clients. The key is unifying data across the entire client lifecycle so the people who need it are able to easily access it. Data that flows with limited friction throughout a firm—where and when it is needed—delivers insight and value.
So how do these modern firms make the transition? The highest-impact move is to replace legacy systems with a robust, full client lifecycle platform that facilitates key client planning (the “80-20 rule,” where 80 percent of an organization’s profits come from 20 percent of its customers, is just as true in the legal industry) to better positioning themselves for growth.
Specific to marketing, a unified system powered by modern technologies like AI and cloud computing eliminates “random acts of marketing” and allows CMOs to spend more time, energy, and discipline on enhancing the client experience.
By the same token, lawyers can use the best possible and most up-to-date data to make decisions, increasing their chances of exceeding client expectations and keeping retention rates high.
The net-net: by making the move to a modern, unified platform, firms gain the ability to use their data to seize nearly every opportunity for growth as opposed to not having the data they need and missing opportunities.
Data may or may not be the “new oil,” as the (now clichéd) maxim goes, but it’s pretty clear that every business operates in what is now a data economy. Thus, it’s not surprising that, armed with the right data at the right time in the hands of the right people, law firms can extract insights that drive better decision-making, and better decisions are every firm’s best fuel source for revenue growth and continued profitability.
Wyoming has taken the lead in updating its version of Article 9 of the Uniform Commercial Code to provide new commercial law for blockchain technology and virtual currency. Wyoming’s approach offers benefits to market participants looking to perfect a security interest in assets created through blockchain technology, but its revisions are far from comprehensive and do not integrate into existing commercial law norms with respect to the perfection and priority of security interests. This article will provide a brief overview and analysis of the amendments to Article 9 of the Wyoming Uniform Commercial Code with respect to perfection and priority and will highlight issues market participants may wish to consider prior to taking advantage of the Wyoming amendments.
In February 2019, the Wyoming legislature passed Senate File No. SF0125 (SF0125). Effective July 1, 2019, SF0125 amended Article 9 of the Wyoming Uniform Commercial Code (WY-UCC) to: (1) define digital assets that utilize blockchain and distributed ledger technology (such assets Blockchain Assets, and such technology Blockchain Technology); (2) classify Blockchain Assets under the perfection and priority regime; (3) establish special rules for perfection and priority with respect to such Blockchain Assets; and (4) provide a framework for banks to act as custodians with respect to Blockchain Assets (Blockchain Custodians).[2]
The Wyoming legislature has recognized the importance of Blockchain Technology and the need to adapt existing commercial law to these new technological developments. Blockchain Technology is revolutionizing the financial services industry in many ways, affecting the issuance and exchange of digital securities and the transfer and maintenance of virtual currency, as well as recording evidences of indebtedness and the use of electronic documents of title. Wyoming is not alone in embracing new developments in Blockchain Technology; for example, Delaware and Maryland have recently amended both their general corporation laws and limited liability company laws to provide for the creation and maintenance of corporate and company records with respect to equity interests using Blockchain Technology, and financial institutions have begun negotiating and syndicating loans using Blockchain Technology.[3] Wyoming is leading the way, however, in addressing Blockchain Technology’s impact on the attachment, perfection, and priority rules of Article 9 of the Official Text of the Uniform Commercial Code (UCC).[4]
Overview of SF0125 with Respect to WY-UCC Article 9
SFR0125 amends the WY-UCC to provide four key elements: (1) a baseline set of definitions for Blockchain Assets; (2) classifications of Blockchain Assets as property under the WY-UCC; (3) rules outlining how perfection and priority of security interests under WY-UCC Articles 8 and 9 apply to Blockchain Assets; and (4) rules treating Blockchain Custodians as securities intermediaries under WY-UCC Article 8.[5]
(a) Baseline Definitions with Respect to Blockchain Assets
SFR0125 creates a new defined term for Blockchain Assets called “digital assets,”[6] which term is further divided into three subtypes: “digital security,” “virtual currency,” and “digital consumer asset.” “Digital security” means a digital asset which constitutes a security under Wyoming Statute section 17-4-102(a)(xxviii),[7] but excludes virtual currencies and digital consumer assets.[8] “Virtual currency” means a digital asset that is (1) used as a medium of exchange, unit of account, or store of value, and (2) not recognized as legal tender by the U.S. government.[9] “Digital consumer asset” is a catch-all provision that includes a digital asset that is used or bought primarily for consumptive, personal, or household purposes and includes Blockchain Assets that would be “an open blockchain token constituting personal property” and any other digital asset that is not a digital security or a virtual currency.[10] SFR0125 further provides that the terms “digital consumer asset,” “digital security,” and “virtual currency” are mutually exclusive.[11]
(b) Classifications of Blockchain Assets as Property with Respect to WY-UCC
After providing baseline definitions for Blockchain Assets, SF0125 § 29-102(b) provides the general rule as to how the different types of Blockchain Assets are to be treated under WY-UCC Articles 8 and 9:
(1) Virtual currencies are considered money, notwithstanding the definition of “money” under WY-UCC Article 1, but only for the purposes of WY-UCC Article 9.
(2) Digital consumer assets are considered “general intangibles” under WY-UCC Article 9, but only for the purposes of WY-UCC Article 9.
(3) Digital securities are considered “securities” as defined in WY-UCC Article 8 and “investment property” as defined in WY-UCC Article 9, but only for purposes of WY-UCC Articles 8 and 9. [12]
Section 29-102(b) then provides for an opt-in provision (Opt-In) for financial asset treatment under WY-UCC Article 8 with respect to Blockchain Assets under the WY-UCC.[13] A Blockchain Asset (note that this can be a digital consumer asset, a virtual currency or a digital security) may be treated as a “financial asset” as defined under Article 8 of the WY-UCC pursuant to a written agreement with the owner of the Blockchain Asset. If treated as a financial asset, the Blockchain Asset shall remain an “intangible personal property.”[14]
In addition, SF0125 provides that a Blockchain Custodian meeting the requirements of section 29-104 is considered to be a “securities intermediary” as defined in WY-UCC Article 8.[15]
(c) Perfection and Priority Rules with Respect to Blockchain Assets
In addition to providing property classifications for Blockchain Assets, SF0125 creates an overlay to the existing perfection and priority scheme under WY-UCC Article 9 with respect to Blockchain Assets, including, among others, the following provisions:
(1) Perfection of a security interest in a Blockchain Asset may be achieved through a new form of control pursuant to section 29-103(e)(i). A security interest in a Blockchain Asset perfected by control has priority over a security interest that is not perfected by control.[16]
(2) Before a secured party may take control of a digital asset, it shall enter into a control agreement with the debtor.[17]
(3) A secured party may file a financing statement with the secretary of state to perfect a security interest in a Blockchain Asset, including to perfect a security interest in proceeds from such Blockchain Asset pursuant to WY-UCC § 9-315(d) (continuation of perfection in proceeds).[18]
(4) With respect to a security interest in Blockchain Assets perfected by a method other than control, a transferee takes a Blockchain Asset free of such security interest two years after such transferee takes the asset for value and does not have actual notice of an adverse claim during the two-year window.[19]
(5) Pursuant to section 29-103(e)(i), “control” of a Blockchain Asset means:
(a) a secured party, agent, custodian, fiduciary, or trustee of the party has the exclusive legal authority to conduct a transaction relating to a Blockchain Asset including by means of a private key or the use of a multi-signature arrangement authorized by the secured party; or[20]
(b) a smart contract[21] created by a secured party which has the exclusive authority to conduct a transaction relating to a Blockchain Asset.
(6) Pursuant to section 29-103(f), “control” of a Blockchain Asset is equivalent to the term “possession” of a tangible asset and, pursuant to section 29-103(f), perfection of a Blockchain Asset by control creates a possessory security interest and does not require physical possession.[22]
(7) A Blockchain Asset is located in Wyoming if the asset is held by a Wyoming custodian, the debtor or secured party is physically located in Wyoming, or the debtor or secured party is incorporated or organized in Wyoming.[23]
Analysis of SF0125 with Respect to Perfection and Priority Rules under WY-UCC Article 9
SF0125 provides generally that a secured party may perfect its security interest in a Blockchain Asset by properly filing a financing statement or by control. Control is achieved by the debtor and secured party entering into a control agreement (Blockchain Control Agreement), and the secured party then taking control of the Blockchain Asset pursuant to section 29-103(e)(i) (Blockchain Control).[24] A secured party perfected by Blockchain Control has priority over a secured party that does not have Blockchain Control, and the secured party perfected by Blockchain Control is deemed to have a possessory security interest. A Blockchain Asset subject to a security interest perfected by filing (but not control) is “taken free” of any security interest in such Blockchain Asset by a transferee (a Blockchain Transferee) after two years if such Blockchain Transferee does not have actual, as opposed to constructive, notice of an adverse claim during such two-year window (Two-Year Rule). Additionally, a Blockchain Asset may be treated as a “financial asset” under WY-UCC Article 8 pursuant to an agreement between the owner of the Blockchain Asset and a securities intermediary, at which point the perfection and priority rules governing security entitlements in a securities account would apply (without reference to the new rules regarding Blockchain Assets) and perfection may be achieved through a traditional tri-party control agreement.[25]
(a) Perfection in Blockchain Assets as “Digital Assets”
SF0125 implicitly contemplates the default UCC rule that a secured party may perfect its security interest in most types of personal property, including those types of which Blockchain Assets are comprised, by filing a financing statement, although it contains no special discussion of financing statement rules related to Blockchain Assets. The treatment of digital consumer assets as general intangibles and digital securities as securities under WY-UCC Article 8 (which are categorized as investment property under WY-UCC Article 9) leads to the interpretive conclusion that perfection may be achieved by properly filing a financing statement.[26] One of the benefits of the perfection by filing system is that secured parties can rely on a filing regime to put third parties on notice of their secured claims without having to monitor subsequent transfers of a debtor’s assets.[27] Under the Two-Year Rule, however, a Blockchain Transferee needs actual notice, as opposed to constructive notice (by UCC filing or otherwise), to avoid the two-year filing priority lapse. Therefore, if a secured party perfected solely by filing is unaware that a Blockchain Asset subject to its security interest has been subsequently transferred, then it runs the risk of becoming second in priority or even losing its security interest in such Blockchain Asset entirely. The Two-Year Rule is a new facet to the WY-UCC that has no analog elsewhere in Article 9 of the UCC, and the harshness of this rule incentivizes secured parties to perfect by control in order to protect against third-party claims to Blockchain Assets.
As discussed above, a secured party may perfect its security interest in Blockchain Assets by Blockchain Control. Section 29-103(f) provides that Blockchain Control creates a possessory security interest in a Blockchain Asset.[28] Although SF0125 does not explicitly so state, it is reasonable to conclude that the intent of SF0125 is to provide that a security interest in Blockchain Assets perfected by Blockchain Control is to be governed by the sections of WY-UCC Article 9 that pertain to possessory security interests. As such, a secured party perfected by Blockchain Control:
(2) is perfected if a person, other than the secured party, has Blockchain Control and that person authenticates a record acknowledging that it holds the Blockchain Asset for the secured party’s benefit;[30]
(3) remains unaffected by a buyer of such Blockchain Asset purchased in the ordinary course of business, so long as Blockchain Control is maintained by the secured party or its agent;[31]
(4) may be governed by consignment rules of section 9-319;[32] and
(5) is governed by the law where the collateral is located with respect to perfection, the effect of perfection or nonperfection, and the priority of such collateral.[33]
Pursuant to WY-UCC § 9-207, a secured party perfected by Blockchain Control will also be required to exercise reasonable care with respect to such Blockchain Asset (among other duties as specified in WY-UCC § 9-207).[34]
As stated previously, the Two-Year Rule incentivizes secured parties to perfect their security interests in Blockchain Assets by Blockchain Control. However, because Blockchain Control creates duties of reasonable care on the part of a secured party exercising Blockchain Control, which could impose additional liability on a secured party, secured parties may want to take the additional step of utilizing a Blockchain Custodian to achieve Blockchain Control. A bank meeting the Blockchain Custodian requirements of WY-UCC § 29-104 will also meet the requirements of the definition of a securities intermediary, thereby gaining the benefits afforded to a securities intermediary under WY-UCC Article 8.[35] A bank, excluding national banks, having a place of business in Wyoming and offering custodial services under WY-UCC § 29-104, is subject to specified custodial requirements with respect to maintaining Blockchain Assets.[36] Those custodial requirements include obligations to accounting and internal control standards in accordance with applicable state or federal law; an obligation to maintain best practices relating to Blockchain Assets; and obligations to comply with anti-money laundering and beneficial ownership requirements.[37] In addition, a bank acting as a Blockchain Custodian is required to submit to independent audits conforming to 17 C.F.R. § 275.206(4) regarding the Blockchain Assets in its custody and to maintain control over such Blockchain Assets while in its custody as a bailment.[38] Therefore, a secured party that has perfected its security interest through a Blockchain Custodian would have the benefit of a regulatory framework that both provides technological standards a Blockchain Custodian is required to maintain and clarifies the legal relationship between a Blockchain Custodian and the owner of such Blockchain Assets.
(b) Opt-In
Pursuant to SF0125 § 29-102(b), and consistent with UCC norms, parties may agree to treat a Blockchain Asset as a financial asset as defined in WY-UCC Article 8 (Opt-In).[39] This section is most likely intended to preserve the existing UCC constraint that allows debtors and secured parties to opt into the securities intermediation regime under WY-UCC Article 8, Part 5, whereby the debtor would be the entitlement holder of a security entitlement maintained in a securities account by a securities intermediary.
Perfection of security interest in a security entitlement may be achieved by filing or control pursuant to WY-UCC §§ 9-312(a) and 9-106, respectively.[40] Perfection by control under WY-UCC § 9-106 is in turn governed by WY-UCC § 8-106, pursuant to which the financial asset is treated as an indirectly held security entitlement in a securities account through a securities account control agreement.[41] If a secured party perfects by control, then its security interest has priority over security interests perfected by filing, and the collateral is taken clear of any adverse claims without notice.[42] So long as the owner of the Blockchain Asset agrees, the Opt-In would apply to all Blockchain Assets, including digital securities, digital consumer assets and virtual currencies, effectively collapsing the three subtypes of Blockchain Assets into the single term “financial asset,” as well as removing the requirement for a separate Blockchain Control Agreement.[43]
However, the unamended WY-UCC and UCC already allow for secured parties to opt-in to security entitlement treatment. The securities intermediary concept is well established under UCC Article 8 and is functionally similar to a deposit account bank. A debtor credits its financial asset to a securities account maintained with a securities intermediary, and the debtor and the secured party enter into a securities account control agreement whereby the securities intermediary agrees to comply with the entitlement orders of the secured party without further consent of the debtor.[44] When the debtor credits its financial assets to a securities account with a securities intermediary, the financial assets become “security entitlements” and the debtor an “entitlement holder.”[45] The securities intermediary concept reflects the commercial realities that financial assets are often held not by the owners themselves, but by intermediaries and clearing entities in order to reduce administrative burdens and create liquidity by increasing the efficiency of transfers in such assets.[46] Like money held in a deposit account, the security entitlement is not the property right in specific financial assets, but rather the rights in the account of fungible assets maintained by the securities intermediary. As such, if the Blockchain Asset is a security entitlement, then control is achieved pursuant to the rules set forth in WY-UCC § 8-106(d)—the same rules that apply to any other financial asset that is a security entitlement.[47] As outlined above, because debtors and secured parties can rely upon an existing control regime under the WY-UCC in place prior to SF0125, and because the rules governing Blockchain Custodians refer back to that same regime, the Opt-In provision appears unnecessary.
(c) Choice-of-Law Considerations for Secured Parties
SF0125 § 29-105 provides that the courts of Wyoming shall have jurisdiction to hear claims in both law and equity relating to Blockchain Assets, including those arising from the WY-UCC.[48] Further, section 29-103(f) provides that a Blockchain Asset is located in Wyoming if the Blockchain Asset “is held by a Wyoming custodian, the debtor or secured party is physically located in Wyoming or the debtor or secured party is incorporated or organized in Wyoming.”[49] These two provisions offer a jurisdictional hook in which secured parties may avail themselves of the WY-UCC, as amended by SF0125. If the Blockchain Asset is held by a custodian located in Wyoming, or either the secured party or the debtor is located or organized in Wyoming, then a secured party could avail itself of the benefits of the WY-UCC (as amended by SF0125) in a Wyoming court. However, regardless of the jurisdictional provisions in SF0125, courts, located in Wyoming or otherwise, may be unwilling to apply the WY-UCC as amended by SF0125 when adjudicating claims because of the choice of law rules found in the WY-UCC and UCC.[50] For example, a judge in another state such as New York would begin a choice of law analysis by opening the New York version of the UCC, not the Wyoming version of the UCC. Further, a court may be subject to the mandatory choice of law rules in the UCC designed to protect third-party interests. As a result, secured parties may find their security interests in Blockchain Assets unperfected if a court does not apply Wyoming law.
The UCC, including the WY-UCC, has its own intricate choice-of-law rules, and the presence of a non-uniform provision in one jurisdiction does not require courts to recognize or defer to it. Section 9-301 of the UCC and WY-UCC provides that “except as otherwise provided in this section, while a debtor is located in a jurisdiction, the local law of that jurisdiction governs perfection, the effect of perfection or nonperfection, and the priority of a security interest in collateral.”[51] When determining the location of a debtor, the UCC provides that:
(1) a debtor that is organized under the law of a state is located in that state (e.g., a Delaware limited liability company is located in Delaware);[52]
(2) a debtor that is an individual is located at its principal place of residence; and
(3) a debtor that is an organization that is not registered is located at its place of business or, if it has more than one place of business, its chief executive office.[53]
Therefore, when adjudicating a claim involving a debtor located in Delaware, for example, a court would look to the UCC in effect in Delaware, and not the WY-UCC.[54] In applying the Delaware version of the UCC, a court would not apply the SF0125 provisions governing Blockchain Assets because no such provisions exist. If the secured party did not file a financing statement, then its security interest may be unperfected.[55] A secured party located in Wyoming may argue that Blockchain Control (either its own or through a Wyoming Blockchain Custodian) creates a possessory security interest, and that UCC § 9-301(2), which provides that the law where the collateral is located governs, would apply. However, if the debtor is not located in Wyoming, then courts may find such argument unpersuasive pursuant to section 9-301(1).[56] If the secured party has Opted-In with a properly executed securities account control agreement, and the security intermediary is located in Wyoming, then the WY-UCC may govern pursuant to section 9-305(a)(3),[57] but as discussed above, secured parties can already opt-in to UCC Article 8 with respect to security entitlements under UCC Article 8.
Conclusion
The Wyoming legislature correctly recognizes the revolutionary aspects of Blockchain Technology and is a first-mover in modernizing commercial law for Blockchain Assets. Although Wyoming deserves praise for addressing transactions dealing with Blockchain Assets, in many ways their amendments fall short. SF0125 deviates from UCC norms with respect to control and perfection-by-filing, and highlights unresolved policy considerations with respect to the application of commercial law to Blockchain Assets. Ambiguities in the control-related provisions of SF0125 raise questions of how much “control” a secured party must have over a Blockchain Asset to call its security interest perfected. The Two-Year Rule attempts to balance the rights of a Blockchain Transferee and a secured party, but strips the effectiveness of a financing statement in ways that will trouble a typical commercial law practitioner. The end result of SF0125 is a Blockchain Asset overlay that may create ambiguities within the existing UCC perfection and priority regime. Further, because the Wyoming legislature has enacted a non-uniform UCC, there are legitimate questions as to whether other jurisdictions will recognize any Wyoming claims or even apply the WY-UCC when determining perfection and priority. As a result, rather than creating a forward-looking system, the Wyoming legislature has created a perfection and priority scheme in which secured parties may prefer to rely on the oldest form of perfection—a possessory pledge—or the very institutions that blockchain advocates seek to eliminate—intermediaries.
[1] The views expressed in this article are exclusively those of the author and do not necessarily reflect those of Sidley Austin LLP and its partners. This article has been prepared for informational purposes only and does not constitute legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this without seeking advice from professional advisers. The author thanks Teresa Harmon, T.J. Gordon, and Lilya Tessler of Sidley Austin LLP for their review and comments. The author also thanks Carter Isham for her help proofing and many read-throughs.
[4] This article will primarily focus on the amendments to WY-UCC Article 9. At times it will be beneficial to compare the WY-UCC to the Official Text of the Uniform Commercial Code. When referring to the Official Text of the Uniform Commercial Code, this article will use the designation “UCC”.
[5] SF0125 § 29-102(c). SF0125 provides extensive definitional language for what constitutes a Blockchain Asset and Blockchain Technology in general. This article will focus on the implications of amendments to the Article 9 perfection and priority regime. The definitional language with respect to Blockchain Technology will be addressed in a separate article at a later time.
[6] SF0125 § 29-101(a): “‘Digital Asset’ means a representation of economic, proprietary or access rights that is stored in a computer readable format, and includes digital consumer assets, digital securities and virtual currency.” The definitional and classification scheme of SF0125 leverages defined terms from different statutory regimes (e.g., the Wyoming Uniform Securities Act as discussed below) that do not readily fit into WY-UCC Articles 8 and 9. The definitional and classification scheme of SF0125 also raises statutory interpretation questions (e.g., whether the use of “includes” in the definition of digital asset should be read to mean that digital securities, virtual currencies, and digital consumer assets are the exclusive subcategories of digital assets or is meant to be exemplary).
[7]See Wyo. Stat. § 17-4-102(a)(xxviii) (Wyoming Uniform Securities Act) (definition of “security” includes, among other things, certificated and uncertificated securities, evidence of indebtedness, “investment contracts,” or “an interest or instrument commonly known as a ‘security’”, but pursuant to the recently passed Wyoming Utility Token Act (H.B. Wyo. Leg. No. 0062 (Feb. 2019) (Wyoming Utility Token Act)), effective July 1, 2019, does not include utility tokens (tokens maintained on an open blockchain whose predominant purpose is consumptive and not marketed to initial buyers as a financial investment)).
[9]Id. § 29-101(a)(iv) (emphasis added). Note that WY-UCC Article 9 and UCC Article 9 define money as “a medium of exchange currently authorized or adopted by a domestic or foreign government. The term includes a monetary unit of account established by an intergovernmental organization or by agreement between two or more countries.” See WY-UCC § 9-102(24) and U.C.C. § 9-102(24).
[12]Id. § 29-102(a). A token that is a security under the Wyoming Uniform Securities Act may not necessarily be a security under WY-UCC Article 8 (see WY-UCC §§ 8-102(15)(ii) & (iii)). Given that the definition of “security” under Article 8 is not co-extensive with the definition found in the Wyoming Uniform Securities Act, there is a potential gap of how to treat digital securities that are not “securities” under WY-UCC Article 8. SF0125 § 29-103(a)(ii) bridges this gap by providing that digital securities that are “securities” under the Wyoming Uniform Securities Act are classified as a “security” under WY-UCC Article 8 and “investment property” as defined in WY-UCC Article 9 “only for purposes of Articles 8 and 9 of the [WY-UCC]” (emphasis added).
[13] As discussed in more detail below, U.C.C. § 8-102(a)(9) (and the WY-UCC) already allows for debtors and secured parties to opt into Article 8 financial asset treatment without having to rely on the amendments provided for in SF0125.
[14] SF0125 § 29-102(b). Since “intangible personal property” is not a definition in the UCC, the term is presumably meant to conform to terminology used in the Wyoming Utility Token Act to make clear that digital consumer assets that are conducted on an open blockchain are non-physical personal property and not securities as defined in the Wyoming Uniform Securities Act.
[17]Id. § 29-103. A control agreement may include terms under which a secured party may pledge its security interest in the Blockchain Asset as collateral for another transaction. Note that the language contemplates a bilateral control arrangement between the secured party and the debtor. Control arrangements in deposit accounts and security entitlements contemplate tripartite agreements (see U.C.C. §§ 9-104, 9-106).
[20] Note that SF0125 § 29-103(e)(i) is missing a conjunction between subclauses (A) and (B). Thus, it is unclear if a smart contract is a necessary and sufficient factor or merely a necessary factor in establishing control. Judging from context, it is reasonable to conclude that SF0125 intended control to be attainable through “exclusive authority” or a smart contract.
[21]See SF0125, which also provides definitions with respect to a “smart contract,” “multi-signature arrangement,” and “private key,” an analysis of which is beyond the scope of this article.
[24] The bilateral control agreement concept is a departure from previous UCC Article 8 and 9 securities and account control agreements which contemplate a tri-party agreement involving the debtor, secured party and an intermediary with respect to assets held in an account. See U.C.C. §§ 9-104(a)(2) and 8-106(d)(2).
[25] As discussed below, this is most likely meant to clarify that WY-UCC Article 8, Part 5, which in part covers indirectly held intermediated securities and financial assets, may be applied to Blockchain Assets.
[26]See WY-UCC §§ 9-312(B)(3), 9-313. This issue is discussed further below. Omitting any specific guidance for perfection-by-filing leaves the status of virtual currency in doubt, given that particular digital asset is treated as money under Article 9, which may mean that perfection can only be achieved by possession.
[27] Note that purchasers of chattel paper and other instruments may have priority over secured parties perfected by filing pursuant to section 9-330 of the UCC. (See U.C.C. § 9-330.)
[31]Id. § 9-320(e). An example of a purchaser of Blockchain Assets who would not have Blockchain Control would be a seller who executes a bill of sale for assets outside of the blockchain system to a purchaser.
[32]Id. § 9-319. To the extent that a Blockchain Asset becomes characterized as a “good.”
[34]Id. §§ 9-207(a), (b) (e.g., the secured party shall keep collateral identifiable).
[35] SF0125 § 9-102(c). For example, section 8-509(b) provides that: “to the extent that specific standards for the performance of the duties of a securities intermediary or the exercise of the rights of an entitlement holder are not specified by other statute, regulation, or rule or by agreement between the securities intermediary and entitlement holder, the securities intermediary shall perform its duties and the entitlement holder shall exercise its rights in a commercially reasonable manner.”
[36]Id. §§ 9-104(a), (b). Pursuant to section 9-104(p), “‘Bank’ has the meaning ascribed to it in W.S. 13-1-101(a)(i). W.S. 13-1-101(a)(i) (Banks, Banking and Finance) in turn provides that a “‘Bank’ means any corporation, excluding national banks, having a place of business within this state which engages in banking business.”
[37] SF0125 § 9-104(b). While SF0125 § 29-102(b) references the entire definition of “financial asset,” it is reasonable to conclude that Opt-In treatment means Blockchain Assets would be treated as security entitlements pursuant to section 8-102(9)(iii) of the WY-UCC. See WY-UCC § 8-102(a)(9)(iii): “any property that is held by a securities intermediary for another person in a securities account if the securities intermediary has expressly agreed with the other person that the property is to be treated as a financial asset under this Article [8].”
[39] Such agreement, even though it only requires that the owner of the Blockchain Asset be a party, would, for practical reasons, be a tripartite arrangement between the debtor, the secured party, and a securities intermediary.
[40] Sections 9-312(a) & 9-106 govern rules for investment property, which includes securities entitlements and securities accounts. See WY-UCC § 9-102(a)(49). “Investment Property” means security entitlement and securities account.
[41] WY-UCC § 9-106(a): “a person has control of a . . . security entitlement as provided in Section 8-106.”
[43] A security agreement granting a security interest in such Blockchain Asset and a securities account control agreement will still be required.
[44]See WY-UCC § 8-106(d) (“the securities intermediary has agreed that it will comply with entitlement orders originated by the purchaser without further consent by the entitlement holder”).
[45]See U.C.C. § 8-102 cmt. 17 (“A securities entitlement means the rights and property interest of a person who holds securities or other financial assets through a securities intermediary”) and § 8-102 cmt. 7 (an entitlement holder is the person who holds the security entitlement).
[49]See id. § 29-103(f). “Wyoming custodian” is not defined, but it is not unreasonable to conclude that it would include both Blockchain Custodians and Wyoming entities that have not opted into the Blockchain Custodian framework provided by SF0125.
[50] A court may be unwilling to apply the WY-UCC for public policy reasons as well.
[54]See Arrow Oil & Gas, Inc. v. J. Aron & Co. (In re SemCrude L.P.), 864 F.3d 280, 291–92 (3d Cir. 2017) (determining that, under UCC § 9-301(1), because debtors were organized in Delaware and Oklahoma, the UCC in effect in Delaware and Oklahoma applied and therefore the security interest in the collateral at issue was unperfected, notwithstanding automatic perfection provisions under Texas and Kansas versions of the UCC).
A secured party and debtor may agree by contract in the security agreement to have the WY-UCC be the governing law; however, such agreement does not insulate them from third-party claims that the laws of a different jurisdiction would apply.
[55] A Blockchain Asset would most likely be characterized as a general intangible, the catch-all definition under UCC Article 9. See U.C.C. § 9-102(a)(42).
[56] Despite the qualifying lead-in language “except as otherwise provided in this section” found in UCC § 9-301(1), unless a court is already using the WY-UCC to conduct its choice of law analysis, such court with a non-Wyoming debtor may conclude that the UCC in effect in the debtor’s location would apply, and not the WY-UCC. As discussed above, the Blockchain Asset definitions and related possessory security interests rules governing Blockchain Assets provided in the WY-UCC (as amended by SF0125) currently only exist in the WY-UCC. A court using the UCC of any other state would most likely categorize a Blockchain Asset as a “general intangible” for which perfection is achieved only by filing and not by possession. Accordingly, UCC § 9-301(1) (location of debtor) and not UCC § 9-301(2) (location of collateral) would govern the choice of law analysis of a court. See In re SemCrude, 864 F.3d at 291-292.
[57]See U.C.C. § 9-305(a)(3) (providing that the local laws of the securities intermediary’s jurisdiction govern perfection and priority of a security interest in a security entitlement or securities account).
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