December 2001
Vol. 31, No. 12, pp 56–58.
Legal Insights

Table of Contents

Eric S. Slater

Intellectual property and failed dot-coms: A new type of law practice

Throughout history, technological advances have generated growth in various sectors of the economy. All during the 20th century, new industries were born and developed—many jobs were created, information was disseminated rapidly through new media, and novel and creative forms of entertainment were introduced. The telecommunications industries arguably led the way in terms of economic growth. From a broad perspective, electronic media (broadcasting, cable, satellites, telephony, and computers) were responsible for most of this growth.

Rapid expansion in the computer and Internet industries has made a major impact on the way we communicate, and people who invested early made a lot of money. Much of this growth took place without viable business models in place. For example, Web sites that relied on banner ads for revenue frequently found themselves short of funds. This led to some chaotic times for the technology sector. Many Internet technology firms have gone out of business, and some investors have lost a lot of money.

What happens to the assets and property of a dot-com company when it goes bankrupt? Office equipment and furniture can be sold, auctioned off, or included in the sale of the business. But what about the intellectual property—patents, trademarks, or copyrighted material? A new specialty is emerging in the practice of law—a mix of bankruptcy, corporate, and intellectual property law. Its main goal is valuing the intellectual property of Internet firms that are preparing to cease operations.

The present dot-com landscape
One only needs to look at the daily newspaper headlines and business pages to see what’s going on. Companies are announcing massive layoffs and reorganizations, and the Nasdaq stock exchange is slumping. The Washington Post’s Washtech.com Web site has a “Layoffs Watch”—a listing resembling a baseball box score—that keeps track of the number of tech jobs lost in the Washington, DC, area (1). This downturn has been aggravated by the terrorist attacks on September 11. Even Internet-era stalwarts such as Yahoo! (2), Cisco (3), and America Online (4) have not been immune to the technology slump. All have seen drops in their stock prices and have offered new services to try to drum up new business, revamped their internal structures, or cut jobs. Even The Industry Standard, the highly regarded weekly Internet magazine, has suspended publication (5).

Adding fuel to the fire are reports issued in late August that consumer confidence has further tumbled because of the weakening job market (6) and the announcement in early September that Hewlett-Packard is buying Compaq (7)—a merger that may lead to more job cuts overseas (8). Some egregious errors have been made. For example, the now-bankrupt company PSINet spent millions of dollars for the naming rights to the Baltimore Ravens’ football stadium.

Some defunct Web sites seem better known for their advertising than for what they actually offered in services. Who could forget the Pets.com sock puppet dog? Even though this company no longer exists, the puppet remains as a reminder of what might have been. I recently visited the FAO Schwartz toy store in Tysons Corner, VA, with my 3-year-old daughter, and the famous toy was still on the shelves and for sale. Interestingly, items such as the sock puppet have become collectors’ items for those who are nostalgic for the Internet’s “good old days”—ironically, less than a decade ago (9).

The anatomy of a dot-com’s assets
A common misconception about Internet companies is that if they fail, there is nothing to sell for the benefit of creditors. Unlike those of the typical “brick and mortar” company, Internet company assets can be described as “virtual”, consisting mainly of intangible property (10). Sock puppets are one thing, but what happens to the intangible assets when a dot-com firm goes belly-up? Existing law firms have added technology groups to their practices, and new firms that specialize in technology have been formed to assist the failed dot-coms in selling their intangibles. Intellectual property is an intangible asset that must be considered when liquidating the assets of a bankrupt company (see box, “Intellectual property and the law”).

Intellectual property is generally defined as patents, trademarks, and copyrights. In the Internet world, intellectual property includes patents (issued or pending), domain names (including those that have been claimed but not used), targeted customer lists, customer information databases, trade secrets, trademarks, claimed and unclaimed copyrights, online content, and back-end systems—virtually anything that has spilled out of an inventor’s head (16).

For the most part, patents, copyrights, and trademarks are all incorporated into the fabric of a Web site. The tricky part is determining how much it’s all worth. This can become further complicated when dealing with customer information. The patent aspect could incorporate methods in which customers receive online ads and methods of secure online credit card payments. The trademarks could incorporate the domain name in some way, or be something akin to logos that describe the product or service. Copyright includes any text, computer software, or music. Adding to the difficulty are trade secrets, which include half-finished programs and lists of data and customers.

Of course, privacy issues can arise when it comes to distributing data about people. After Toysmart.com went bankrupt, under a settlement agreement with the Federal Trade Commission, it offered to sell its customer records along with its other assets only if the purchasing company abided by the same privacy policy that Toysmart had instituted. That policy was a statement that personal information would not be shared with third parties. The bankruptcy court handling the case refused to accept this settlement, instead waiting to see if there were any potential buyers. Ultimately Toysmart was sold, and under a new settlement, the customer database was destroyed (17). This kind of situation was probably not considered when the Internet first took off.

User’s guides for valuing and buying assets
As discussed earlier, new technology not only spawns growth, but also leads to declines in growth and businesses as the technology sorts itself out. This generates new areas that the law must address. This is not to say that these new areas of legal practice follow the “ambulance chaser” model, in which unscrupulous attorneys take advantage of injured parties. The legal principles found in areas such as bankruptcy and corporation law must be applied to the nuances and quirks inherent in new technology. Contract and commercial law play a large role as well. It always takes some time for law to catch up to technology; and this is the case now, especially considering that several practice types have to be merged and sorted out.

How are assets such as intellectual property valued? Although a dot-com may have accounts receivable, fixtures, and other physical property, intellectual property is its principal asset and investment. This intellectual property, however, is hardly a liquid asset; it is gained through a long, methodical process that eventually creates value for the company (18). The assets are intangible, and therein lies the difficulty in assigning a value to them. Some factors to consider include the number of hours people worked and their hourly pay rates, other costs of the investment, the number of years of development, the further cost of finishing the product, and the patent expiration dates, all adjusted for the perceived risk (19). Additional factors include how much a buyer might have to spend to get the product ready for market or how much the buyer might save by buying instead of developing its own product (11). These factors reflect primarily the patent component found in the failing company’s assets.

Recent buyouts in this industry demonstrate the wide range of values assigned to intellectual property.

  • KB Toys’ purchase of bankrupt eToys’ intellectual property assets, including eToys’ trademark, logo, and Web address for $3.4 million (20);
  • Web service company Bright Station’s buyout of British fashion site Boo.com’s pricey, cutting-edge commerce transaction system and Web site (later bought by FashionMall.com) for just $375,000 (10, 19, 21, 22);
  • Consumer Review’s purchase of product buying guides from defunct sites Mercata and Geargoddess.com as an alternative to creating its own costly original content (19).

Essentially, valuing the intellectual property assets boils down to pure haggling, according to technology attorney Joseph Siino of Brobeck, Phleger, and Harrison (San Francisco): An old-world technique meets the new technology (11). The seller wants to sell, so it can pay off its creditors; the buyer wants the best possible price. Siino says a company has a better chance of getting a good price if it acts to find buyers for its technology before it shuts down. Even though this area of law is relatively new, several “how to” articles have appeared, their goal to give potential buyers some clue as to how to go about purchasing the assets of a failed company. These include “How to Buy the Assets of a Failed Dot-Com” (23), “How To Purchase the Assets of Failed Dot-Coms Without Getting Burned” (24), and “Yes, It’s Brain Surgery…Venture Capitalists Are Dissecting Intellectual Property Assets and Strategies Like Never Before” (25).

When looking into the possibility of purchasing a bankrupt or almost-bankrupt dot-com, it is natural to think of the Web site as the most coveted of the seller’s assets. Obtaining legal and complete ownership of the Web site and all its underlying components should be a top priority. It is essential to have accurate information about the seller’s ownership of any text, images, and software with regard to underlying copyrights and warranties (24). For example, it is important to know if there are any third-party agreements to consider. Was the Web site developed in-house or under a work-for-hire agreement, or was the development contracted out? This is key information to have to avoid the risk of a patent or copyright infringement lawsuit. It is wise to obtain legal counsel to ensure a thorough investigation, preferably from an attorney with a background in intellectual property as well as in e-commerce issues.

Picking up the pieces
The Internet industry burst upon the scene so quickly and in such a seemingly chaotic fashion that many entrepreneurs failed to formulate solid business plans. I’m speculating on why some companies succeeded and others failed: It appears that not much thought was given to intangible assets such as intellectual property. Many of the entrepreneurs were young, inexperienced, or perhaps a bit naïve; many venture capitalists handed out large sums of cash in hopes of getting rich quickly; many people were simply unaware of intellectual property law. With the number of companies going under, people are not as quick as they were as recently as 2 years ago to rush into investing in the Internet without knowing all the facts. A company with a business model consisting of generating revenue using pop-up ads will not pass muster today. More people than ever before are aware of intellectual property, as is exemplified by highly publicized court cases involving music copyrights and payments to freelance writers.

There is no clear-cut method for valuing the intellectual property found in a failing company. It is a somewhat complicated and cumbersome task requiring painstaking research. Values hinge on the particular assets from a specific company; thus, they must be considered on a case-by-case basis. Market conditions play a large role, as well as how quickly a seller wants to sell or a buyer wants to buy. Readers beware: There are many factors to consider when a dot-com goes out of business and a new party enters the fray to purchase its assets.

Acknowledgments
I thank Michael Block for the opportunity to contribute to Chemical Innovation over the past several months. I enjoyed working with the staff as well and wish them all the best.

References

  1. www.washtech.com/specialreports/layoffs_bydate.html.
  2. Yahoo! Adds New GeoCities Services, The Associated Press, Aug 28, 2001 (retrieved from Lexis-Nexis).
  3. Gaither, C. Amid Slump, Cisco Announces a Revamping. The New York Times; http://nytimes.com/2001/08/24/technology/24CISC.html, Aug 24, 2001. (Free registration is required to access this site.)
  4. Klein, A.; Joyce, A. AOL Says Ad Slump Led to Cuts. The Washington Post; www.washtech.com/news/media/12008-1.html, Aug 22, 2001.
  5. Johnson, C. The Industry Standard Suspends Publication. The Industry Standard; www.thestandard.com/article/0,1902,28744,00.html, Aug 16, 2001.
  6. Finley, R. Consumer Confidence Tumbled Again in August. Reuters, Aug 28, 2001.
  7. Bergstein, B. Hewlett-Packard Is Buying Compaq. The Associated Press, Sept 4, 2001 (retrieved from Lexis-Nexis).
  8. PC Merger Could Mean More Overseas Layoffs. Reuters, Sept 4, 2001 (retrieved from Lexis-Nexis).
  9. Tedeschi, B. Dot-Coms Already Collector’s Items. The New York Times; www.nytimes.com/2001/08/13/technology/ebusiness/13ECOM.html, Aug 13, 2001. (Free registration is required to access this site.)
  10. Chertok, M.; Agin, W. E. Restart.com: Identifying, Securing and Maximizing the Liquidation Value of Cyber-Assets in Bankruptcy Proceedings. American Bankruptcy Institute Law Review, Winter 2000, 8, 261–262.
  11. U.S. Code, Section 154, Title 35, 2000.
  12. Trademark Act of 1946, 60 Stat. 427, codified as U.S. Code, Section 1051, Title 15, 2000.
  13. U.S. Code, Section 102(b), Title 17, 2000.
  14. U.S. Constitution, Article I, Section 8, Clause 8.
  15. U.S. Constitution, Commerce Clause, Article I, Section 8, Clause 3.
  16. Grimes, A. After Dot-coms Unload All Their Tangible Stuff, There Still May Be Lots of Value Left in the Company. Enter Joseph K. Siino. The Wall Street Journal; http://www.wsj.com/, July 16, 2001.
  17. Hopper, D. I. Settlement Made in Toysmart Case to Protect Customer Names. The Associated Press, Jan 10, 2001 (retrieved from Lexis-Nexis).
  18. Davidoff, B. The New New Bankruptcy. The Daily Deal, June 19, 2001.
  19. Hua, V. Ideas for Sale or Rent—What Happens to the Intellectual Property When a Company Closes. San Francisco Chronicle; www.sfgate.com/cgi-bin/article.cgi?file=/chronicle/archive/2001/05/29/BU175213.DTL&type=business, May 29, 2001.
  20. E-Retail Bytes. KB Toys Bought Bankrupt eToys Intellectual Property Assets. Chain Store Age Executive with Shopping Center Age 2001, 77 (7), 80.
  21. Regan, K.; Macaluso, N. Boo.com Saga Ends with Asset Sale. E-Commerce Times; www.ecommercetimes.com/perl/story/3428.html, May 30, 2000.
  22. Regan, K. Boo.com Rises from Dot-Com Graveyard. E-Commerce Times; www.ecommercetimes.com/perl/story/4482.html, Oct 6, 2000.
  23. Hollander, J. How to Buy the Assets of a Failed Dot-Com. www.gigalaw.co/, June 14, 2001.
  24. Berk, J. L. How to Purchase the Assets of Failed Dot-Coms Without Getting Burned. The Internet Newsletter including legal.online, 2001, 5 (12), 1.
  25. Siino, J.; Kapoor, R. Yes, It’s Brain Surgery . . . Venture Capitalists Are Dissecting Intellectual Property Assets and Strategies Like Never Before. www.brobeck.com/. Reprinted from Corporate Counsel, May, 2001.


Eric S. Slater is the copyright administrator for the ACS Publications Division (1155 16th St., NW, Washington, DC 20036; 202-872-4367; copyright@acs.org).

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