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E-business

Lots of legal challenges when dot-coms die

Among issues are status of domain names,
plus right to sell client lists, other data


MICHAEL GEIST

Friday, March 30, 2001

In the late 1990s, dot-com companies became synonymous with high-flying stock prices and the free flow of venture capital. In recent months, the landscape has changed, with headlines chronicling layoffs and Web-site closings.

Currently, only a small percentage of failed tech ventures end up in bankruptcy court. For venture capitalists or investors, such proceedings are a very public acknowledgement of a bad investment.

Moreover, the dot-com's limited asset base and the fact that the major creditors are usually also the major investors leave little incentive for bankruptcy proceedings.

Rather than undergo the public scrutiny that accompanies a bankruptcy proceeding or attract unwanted media attention, dot-coms probably will search for a buyer or simply liquidate their assets.

As the dot-com sector grows and matures, however, bankruptcies will affect more than just venture-capital investors. Dot-coms that actually do business with the public for several months or even years before failing leave a wide range of creditors, not all of whom are sophisticated investors who calculate the risks beforehand.

When Canadian bankruptcy law bumps into the e-commerce economy, a number of critical issues are raised, including the status and sale of domain names as well as the right to sell customer lists and other private data.

Domain names are often a dot-com's most obvious asset. The rights of a domain-name owner are defined to a significant extent by its contract with the domain-name registrar. Although domain names are regularly bought, sold and transferred, their precise legal status has not yet been fully defined.

Moreover, the transfer of domain names raises issues relevant to the disposal of such names as assets in a bankruptcy. Both trademark law and registration rules can limit who may hold certain domain names. A domain name that does not infringe a trademark when used by a bankrupt company may become an infringing use if transferred to a third party. For example, if a dry cleaner that hypothetically owns and uses "ford.ca" declared bankruptcy and the domain name were sold to a car-leasing company, the new use might infringe on the trademark of Ford Motor Co.

Limitations on the ownership of dot-ca names further complicate matters because ownership of a dot-ca domain currently is restricted to those who meet Canadian-presence requirements. On liquidation, the highest bidder may not meet those requirements.

Private data create perhaps the most complex legal challenge to dot-com bankruptcies. For many dot-coms, their customer database (which frequently contains detailed financial and behavioural profiles) is a key asset. In the event of bankruptcy, limitations on the use or transfer of that information reduces the compensation to creditors.

It also must be recognized that people who provide their personal information while doing business have a legitimate expectation of privacy. This is enhanced when the company collecting the information maintains a policy that pledges to protect user privacy.

Last summer, the bankruptcy of Toysmart.com, a major on-line toy retailer, illustrated the public concern over privacy of personal information collected on-line and the conflict that may arise between maximizing creditor recovery and protecting consumer privacy. To satisfy creditors, the receivers attempted to sell Toysmart's customer database. Much of the information contained in the database was related to children and was collected under a privacy policy that promised the information would "never" be shared with a third party.

Both the U.S. Federal Trade Commission and TRUSTe, an on-line organization that awards a seal to Web sites that adhere to established privacy principles, opposed the attempted sale. The matter was finally resolved earlier this year when Walt Disney Co., a major Toysmart.com shareholder, agreed to buy and destroy the customer list.

Unfortunately, Canadian legislation provides little guidance on the status of personal data in the event of bankruptcy. The Bankruptcy Act does not touch on the issue, and the effect of new federal privacy legislation is unclear.

Despite legislative uncertainty, the case of Josephine V. Wilson Family Trust v. Swartz -- a 1993 Ontario bankruptcy case involving a bankrupt dentist and his patient files -- provides some guidance on how a Canadian court might address the issue.

The plaintiff, who sought to seize the property of the dentist, including the records and charts of his patients, was a secured creditor of the dentist. The court found that although the physical records were indeed the property of the dentist, the information contained in the records was impressed with a trust that made it exempt from seizure under the security agreement.

The court acknowledged that its decision to protect the public interest in preserving the confidentiality of patient records might have adverse effects on the ability of health-related business to secure financing. However, it maintained that any transfer of patient information would require the prior consent of the patient.

Although Canada has not yet felt the full brunt of e-commerce bankruptcies, the number of such bankruptcies may well increase in the months ahead. The challenges created by uncertain assets must be addressed so investors know the bankruptcy system will offer some protection should their dot-com die.
Michael Geist is a professor at the University of Ottawa Law School and director of e-commerce law at Goodmans LLP. He can be reached by email at mgeist@uottawa.ca.



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