The internet bankruptcy: what happens when the bell tolls for the eCommerce industry?

• Jurisdiction: United States
• Date: 01 January 2002
• Author: Agin, Warren E.
• Published date: 01 January 2002
• Author: Agin, Warren E.

AN INTRODUCTION TO E-COMMERCE AND INSOLVENCY ISSUES

Not long ago most business and intellectual property lawyers representing Internet start-ups thought they had no need for knowledge of the bankruptcy world. Bankruptcy attorneys knew no better, thinking that Internet companies never really failed--at worst they just closed their doors quietly while the VC paid any creditors. Both sides of the fence know better now and are learning that the technologies that revolutionized intellectual property law, tort law, and business have the potential to also revolutionize bankruptcy and commercial law. The last two years saw a trickle of eCommerce and telecommunication bankruptcies turn into a flood and, along the way, found several books and articles published by the people on the front lines. (1) This article summarizes some of the relevant and emerging issues.

The .com Phenomenon

The late 1990's were generally an unhappy time for bankruptcy attorneys. A strong economy and expanding financial markets greatly reduced the number of business bankruptcies filed. Chapter 11 business bankruptcy filings dropped from 13,379 cases in the year ending September 1994 to 7,953 cases during the year ending June 1999. (2) This change coincides with an incredible expansion of the information technology (IT) industry, resulting, in large part, from the Internet's integration into U.S. society and business.

The Internet is a major component of the networks and non-networked applications generally referred to as "cyberspace." The term generally applies to "any interactive environment that is or can be outside of real time and real space." (3) The term cyberspace references the network of computers that can be accessed over the Internet, and the information available on that network. (4) The Internet is not as new as some might think. Its predecessor, ARPANET (the Advanced Research Projects Agency Network of the U.S. Department of Defense), was completed as far back as 1970. The current TCP/IP transmission protocol went into use in 1982. However, it was not until HTTP (hyper text transfer protocol) was established in 1991 and the Mosaic browser created in 1993 that the Internet as we now know it began to emerge. (5)

Still, at the end of 1994 only 10,000 Web site servers were connected to the Internet. By August 1999, that number had increased to more than seven million. (6) Today, HTTP allows the World Wide Web, which consists of millions of connected Web sites and is what most people think of when they think of the Internet. The Mosaic browser has gone through several transformations to become Netscape Communicator. Hundreds of millions now use it or similar Web browsers to surf the Internet.

Understanding the Internet's impact on future bankruptcy practice requires examining how the Internet has changed technology use in U.S. business. After all, the computer industry is not a new industry, technology-oriented bankruptcies are not new, and businesses have used computers since the 1940's. The difference is that the Internet raises the stakes. Businesses using tools made available by the Internet gain such an advantage that they can't afford not to use them. Law practice provides a convenient example. Three years ago many major law firms had neither e-mail nor Web sites, and not all attorneys used personal computers. Today, almost all major firms realize that they must integrate computing into their practices in order to remain competitive. Without e-mail, attorneys don't have the ability to communicate with clients in the manner clients require. Without a Web site, firms can't project a world-class image. The software required to work collaboratively with clients and other firms does not run on older DOS based computers, nor will the software needed to access the Internet, so firms are forced to upgrade their computer systems.

Today any major corporation has a Web site and probably uses it to sell goods, automate its supply function, or otherwise operate its business. Software systems, especially database management programs (like Oracle) and enterprise communication tools (like Lotus Notes or SAP) form the backbone of most corporations. Without these technology systems, the businesses cannot exist. Domain names are valuable property and companies will pay six or even seven figure sums to obtain the rights to their domain name.

Technology issues play a greater role in present bankruptcy cases partly because technology, and new forms of technology, are now more pervasive in industry. Moreover, the acceleration in the U.S. economy was information technology based. The winners in the stock market were not the brick-and-mortar companies, but the software companies, the computer companies, and the .com start-ups. These companies on the cutting edge were the first to fail when the business cycle turned downward. (7) Technology related issues play a major role in their bankruptcy cases. The same is true for the non-technology companies that rely on technology-related assets to sustain business operations.

The increased importance of information technology in U.S. industry has another effect. The concepts of information technology property law are now more important, and have a higher profile, than before. Attorneys and legislatures are focusing more on intellectual property law, software licensing, privacy law, and electronic signatures and documents. New statutes, such as the Uniform Electronic Transactions Act (UETA), the Uniform Computer Information Transactions Act (UCITA), the Electronic Signatures in Global and National Commerce Act (E-SIGN), and revised U.C.C. Article 9 are changing the legal landscape and focusing attention on e-commerce issues.

RECOGNITION OF ELECTRONIC DOCUMENTS AND SIGNATURES

Three new statutes will enable the use of electronic forms of documents and signatures in both consumer and commercial transactions. These statutes--revised Article 9 to the Uniform Commercial Code, the Uniform Electronic Transactions Act (UETA), and the Electronic Signatures in Global and National Commerce Act (E-SIGN)--will result in new forms of transactions that, while functionally equivalent to familiar forms, will look very different. This will require bankruptcy attorneys to rethink how they examine the effect and validity of commercial instruments. For example, imagine possible treatment of negotiable instruments that do not exist in paper form.

Revisions to U.C.C. Article 9

The current revision to U.C.C. Article 9 was approved and recommended for enactment at the annual meeting of Uniform Law Commissioners on July 30, 1998, approved by the American Law Institute in 1999, and uniformly enacted into law in all fifty states effective July 1, 2001. Revised Article 9 eliminates the writing and signature requirements contained in the current Article 9 (8) and instead recognizes electronic means of authenticating documents. The concepts of "writing" and "sign" are replaced with the concepts of "record" and "authenticate." The term "record" is defined as "information that is inscribed on a tangible medium or which is stored in an electronic or other medium and is retrievable in perceivable form." (9) This definition encompasses the definition of "writing," that remains unchanged as part of Article 1, but will also include electronic information. The term "record" will include documents created using computer applications, such as Word documents, data designed for use with EDI systems, and digitized writings.

A person can "authenticate" a record by "signing" it, (10) or by executing or adopting a symbol, or encrypting a record in whole or in part with "present intent to: (i) identify the authenticating party; and (ii) adopt, accept, or establish the authenticity of a record or term." (11) This definition of authenticate is designed to allow a party to create enforceable electronic documents. The terms "authenticate" and "record" have replaced the terms "writing" and "sign" throughout most of the revised Article 9, including Section 9-203, which governs enforceability of security agreements. Under the revised Article 9, a security agreement is enforceable if authenticated. It no longer needs to be in writing. (12)

The Article 9 revisions also allow for the creation of security interests in electronic documents and other intangible assets. The revised Article 9 recognizes that while a payment obligation may exist in electronic form, it may still possess qualities of general intangibles because of the lack of a writing. For example, the possession requirement for certain types of instruments becomes difficult to satisfy with an electronic document. The revision defines monetary obligations in intangible form as "payment intangibles" (13) and includes them in the definition of general intangibles. (14) Consequently, perfection can be accomplished by filing a financing statement. (15)

One type of secured transaction significantly impacted by the Internet is transactions involving chattel paper. Chattel paper is a form of agreement, common in both consumer and business transactions that evidences both a monetary obligation and a security agreement in or lease of identified goods. (16) If one or more documents is used to document the financing transaction, the group of documents taken together constitutes the chattel paper. (17) The rules governing security interests in chattel paper contained in the U.C.C. are necessary to simplify transactions involving the sale or lease of goods or equipment with financing terms. Traditionally, the documents used in the transaction must be in writing and signed by the borrower to qualify as chattel paper. (18)

With the advent of electronic business transactions, including electronic commerce conducted over the Internet, chattel paper can be created as a result of transactions that do not create paper documents. For example, assume a business purchases a computer system over the Internet. The...