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The Domain Name as Collateral: Considerations for Creditors Seeking to Use a Domain Name as a Security Interest or as a Source of Payment on a Judgment

assignment in grossFor many firms, on-line property, such as their domain names and the interactive software that they permits users to access, constitutes the vast majority of the value of their business. Firms such as Amazon.com and eBay heavily market their domain names, with the result that their domain names have become their primary trademarks and are worth billions of dollars. Lenders would naturally like to have the ability to obtain security interests in these valuable assets for loans to these businesses. Creditors also would like to be able to seize these assets to satisfy unpaid debts. However, there are significant hurdles in both state and federal law to both of these uses of domain names.

The following is a survey of some of the issues faced when attempting to use a domain name as collateral, along with suggestions of methods for dealing with these problems.

The “assignment in gross” problem

To the extent that a domain name constitutes a trademark, it is subject to what is call “the anti-assignment in gross” rule. This rule is based on the notion that a trademark is really the embodiment of the goodwill relating to a business. As such, it cannot be transferred apart from this goodwill. If a trademark could be assigned and used for a different product or business, it could result in fraud on consumers, who would assume that the trademark signified that the same nature and quality of goods were present as when it was used in the original business. See McCarthy on Trademarks § 18:2-3.

I am aware of no cases dealing with domain names that directly address this issue. However, cases dealing with assignments of trademarks in general hold that if a lender wants to take a security interest in a trademark, it should obtain a security interest in the goodwill of the business associated with the trademark as well. See Marshak v. Green, 746 F.2d 927 (2d. Cir. 1984). What this means is that a lender wishing to obtain a security interest in a domain name should obtain a security interest in the goodwill of the business associated with the domain name.

Anti-assignment clauses

Domain name registrants assume that they can transfer their domain names to third parties at will — via sale or use as collateral. Indeed, there has long been a well-developed market for domain names. Ian Ballon’s treatise on internet law contains a list of hundreds of such sales over the past few years, with sale prices ranging into the many millions of dollars.See Ian Ballon, E-Commerce and Internet Law, §7.23[3].

Most domain name registrants have obtained their domain names via a contract with a domain name registrar. While many domain name registrars have procedures that permit the transfer of domain names, they often do not permit direct assignments. See Warren E. Agin, I’m a Domain Name. What Am I? Making Sense of Kremen v. Cohen, 14 Journal of Bankruptcy Law and Practice 3:73, 79 (2005). This would present a problem for parties wishing to use a domain name as a security interest, were it not for a special provision in the Uniform Commercial Code (UCC) that trumps such anti-assignment provisions. Section 9-408 of the UCC provides that a security interest may be granted in a general intangible, even if assignment is prohibited under by the contract relating to the intangible. See UCC § 9-408, comment 5. Most legal scholars believe that an Internet domain name qualifies as a general intangible under the UCC. See, e.g., McCarthy on Trademarks, § 18:7. As such, a lender should be able to obtain a security interest in a domain name, despite the presence of an anti-assignment clause in the borrower’s contract with the registrar.

Now for the bad news. While a lender may obtain a security interest in a domain name subject to an anti-assignment clause, UCC Section 9-408(d)(6) prohibits the lender from enforcing such a security interest. So now the lender has a security interest in collateral that it can’t seize or sell.

One way around this problem is to put the debtor in bankruptcy. The Bankruptcy Code provides that a bankruptcy trustee generally may assume and then assign (e.g., sell) a debtor’s contracts, despite the presence of an anti-assignment clause. 11 U.S.C. § 365(f)(1). A creditor’s security interest in collateral attaches to the proceeds of the collateral, as well as the collateral itself. UCC § 9-315(a)(2). This means that if the bankruptcy trustee assumes and then sells a domain name contract (something that a bankruptcy trustee would normally be expected to do), a creditor with a security interest in the domain name should be able to claim the proceeds from the sale. See Straffi v. State of New Jersey (In re Chris Don, Inc.), 308 B.R. 214 (D.N.J. 2004) (creditor with lien on debtor’s liquor license entitled to proceeds from bankruptcy trustee’s sale of the license).

Another way around this problem may be for the lender to sue the borrower and obtain a judgment. As discussed below, at least under California law, it appears that a judgment creditor may levy a writ of execution and then obtain a sale of a domain name.

State laws prohibiting turnover of domain names

Some state courts have limited the judgment enforcement mechanisms that may be used for domain names. In 2000, the Virginia Supreme Court held that a judgment creditor could not use a state law procedure called “garnishment,” under which a third party who holds the debtor’s property is ordered to turn that property over to the county sheriff for sale. Network Solutions, Inc. v. Umbro Int’l, Inc., 529 S.E.2d 80 (2000).

In June 2009, a California Court of Appeal similarly ruled that a judgment creditor was not entitled to an order requiring the debtor to turn over a domain name to the creditor for sale to satisfy the judgment. The case was Palacio Del Mar Homeowners Assn., Inc. v. McMahon, 174 Cal.App.4th 1386 (2009). In 2008, Palacio obtained a $40,000 judgment against McMahon. Palacio then attempted to collect on this judgment. It first obtained a writ of execution against McMahon, but was unable to satisfy its judgment. It then conducted a judgment debtor exam of McMahon. During the exam, Palacio discovered that McMahon had possession of the domain name www.ahrc.com. Palacio then asked the court to order McMahon to turn the domain name over to it.

The trial court granted Palacio’s motion, but the Court of Appeal reversed. The Court of Appeal first held that California’s turnover statute does not authorize a court to require a debtor to hand property directly over to a creditor. Id. at 1391. Rather, California law requires property taken from a debtor to be sold and the proceeds distributed to judgment creditors. Moreover, under California law, a turnover order is limited to “tangible property that can be levied upon by taking it into custody.” California Code of Civil Procedure Section 699.040. Even if a domain name constitutes property, “it cannot be taken into custody.” Palacio, 174 Cal.App.4th at 1391. As such, no turnover order can be issued for it.

So what can a judgment creditor in this position to do? While a turnover order cannot be obtained, California law does appear to permit a judgment creditor to use normal writ of execution procedures for intangible property, such as domain names. These procedures permit a judgment creditor to obtain a lien on the domain name by levy of a writ of execution. California Code of Civil Procedure §§ 699.080. Once a “general intangible” has been levied, the judgment creditor can then file a motion with the court to have it sold. Id. at 701.510, 701.520. If the court grants this motion, the property can sold and the proceeds distributed to all of the debtor’s creditors, including the judgment creditor, under a statutory priority scheme. Id.at 701.810.

Of course, for domain names that involve trademark rights, sale still might be hindered by such things as the assignment in gross rule.

A final option

If worse comes to worse for a judgment creditor, a number of bankruptcy court decisions have found that a domain name constitutes part of the property of a bankrupt debtor’s estate. In re Paige, 2009 WL 2591335 (D. Utah 2009); Koenig v. McLear, 2004 WL 3244582 (Bnkr. M.D. La. 2004) * 7. As such, if a debtor winds up in bankruptcy, its domain name can be sold and the proceeds used to satisfy either secured or unsecured debts.

Conclusion

Because of the central role a domain name plays in a business, the law appropriately does not make it easy for creditors to get access to it as either security for loans or to satisfy judgments. If you have questions about accomplishing either of these objectives, please feel free to contact me at the address below.

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