Silicon Secrets

02/01/2001

© 2001 - Haynes and Boone, LLP

Unlike more conventional debtors, technology based entities bring to the liquidation and reorganization process their own set of issues, many of which are yet unresolved. The assets of many of these prospective debtors consist of no more than a few computers, licence agreements and customer relationships, which can disappear overnight. From time to time, a domain name (1) or a web site can add to the value of the enterprise. Often the only valuable assets consist of trade secrets, copyrights, trademarks or patents which must be liquidated or utilized in connection with a reorganization of the debtor.

The recent furor in the United States over the attempt by Toysmart.com and others to auction customer information in connection with Chapter 11 reorganization cases highlights the tension between privacy issues and the maximization of payment to creditors of financially troubled companies engaged in Internet activities and other commerce. Many consumer advocates, and others, believe that information regarding the personal shopping and purchasing habits of Internet customers should remain private, particularly if the Internet company has a stated policy of not divulging personal information about its customers. This concern was recently addressed when Toysmart.com applied to the United States Bankruptcy Court for permission to sell its customer data in its Chapter 11 reorganization case.

Whenever you "surf the 'net", you leave a trail of where you were, what you saw and what you did there. Netsurfing creates electronic footprints which can be captured and manipulated by e-tailers (2) and others and which may constitute a valuable asset of a debtor.

Formerly, information was gathered from sales slips, the addresses on customers' checks or from information provided in connection with frequent flier and other affinity programs. This information, provided by the customers, was intrinsically valuable and provided extra revenue when it was sold to other merchants.

Simply surfing the 'net and buying on-line enables the e-tailer's computer (its www site), to identify you, determine which computer server you came through and where to send you e-mail. If the e-tailer uses "cookies" to "personalize your shopping experience," you make the tracking process even easier because your own computer tracks what you looked at, even if you never buy anything. (3) You can, however, check the "cookies" settings of your Internet browser and change the settings to accept only cookies from sites you choose to visit or to tell the computer to prompt you before accepting any cookies.

In its bankruptcy case, Toysmart.com proposed to sell its customer lists and information even though the company's "privacy policy" provided that it would not share customer information. The debtor and its creditors argued that the "agreement" between the debtor and its customers was no more sacred than the obligation of the debtor to pay its creditors and that the customer information should be sold to finance the reorganization. They also pointed out that the agreement between the customer and the debtor could be construed as a contract and that the Bankruptcy Code permits the debtor to abrogate contracts.

Privacy mavens argued the sanctity of the right of privacy and the attorney generals from forty states filed papers opposing the sale of the information. Initially, the United States Federal Trade Commission agreed with Toysmart to certain restrictions on the sale of the customer information, including a provision that the assets be sold to a "family friendly" purchaser which agreed to abide by the debtor's stated privacy policy and the deletion of approximately 2000 records allegedly collected in violation of the Children's Online Privacy Protection Act of 1998. (4) This agreement was opposed by the attorney generals who proposed that notice be provided to all customers and that each customer be afforded the opportunity to have his file deleted from the data base. The Bankruptcy Court rejected the agreement as "premature."

Subsequently, in the Living.com bankruptcy case in Texas, an agreement was reached which allowed the trustee for the debtor to sell certain customer information. Notice is to be provided to all customers by e-mail and the customers will be given the opportunity to have their names deleted from the data base. In addition, certain sensitive information, such as bank account numbers, credit card numbers and social security numbers will be destroyed. This arrangement will allow the trustee to sell the remaining information and realize value for the creditors of the debtor. Other potential solutions which would alleviate the need for a sale of the customer information could involve the debtor maintaining the data base while providing a service to third parties by transmitting advertising or other information to the customers in its data base for a fee.

Lost in the debate is the fact that customer lists and other information provided by customers have been bought and sold for decades. Where were these issues before the Internet became such a vehicle of commerce? Should a bankruptcy trustee be prohibited from selling this extremely important asset? Consumer advocates argue that the sale of such information would, in many circumstances, violate consumer protection laws that apply to the debtor or a trustee.

The United States Congress is now considering legislation (SB 2857) which would remove from property of a bankrupt debtor the type of customer information at issue in the Toysmart.com case and legislation (HR 4814) which would make it a violation of the Federal Trade Commission Act (5) to sell Internet information in violation of a privacy pledge. If this legislation is enacted, secured creditors might argue that attempts to seize the customer information did not violate the automatic stay provisions of §362 since the customer information was not property of the estate.

Clearly, there are two competing interests on their way to repeated "head on collisions" as more "dot.com's" find their way into bankruptcy. These issues become more complicated when the debtor is engaged in international operations. If the data is stored on computers outside of the United States, creditors may be able to seize and sell the customer information notwithstanding the policies of the United States. In addition, directors may be faced with the choice of seeking judicial protection in countries other than the United States, or transferring the data to servers or subsidiaries outside of the United States, in order to comply with their fiduciary duties to creditors and shareholders. It is conceivable that certain countries will become "data havens" where data is stored in a forum that is free at least some of the restrictions of other countries. Until the issues are sorted out by legislation and the courts, financially distressed Internet companies and their creditors will have some very difficult decisions to make.

Endnotes

  • The extent of a party's rights to a domain name was recently discussed in Network Solutions, Inc v. Umbro International, Inc., 2000 WL 29449 (Va. April 21, 2000).
  • This article is limited to legitimate actions. Nefariously gathering of information (including hacking, wire-tapping and other activities) is an entirely separate issue.
  • Toysmart.com's www site required you to permit cookies on your computer to even access its site. This is somewhat of a conflict with a strict privacy statement since you must give them access to your computer to shop on-line.
  • An Internet company's failure to comply with its stated privacy policy may constitute a violation of the Federal Trade Commission Act if the action constitutes a deceptive business practice.
  • It would be an "unfair practice."
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