February 7, 2018
For many businesses, a domain name is among its most valuable assets. Lenders routinely seek to use domain names as collateral. However, perfecting a security interest in a domain name is only the first step because conflicting laws and the realities of technology create hurdles to foreclosing on this collateral after a default.
Perfecting a Security Interest
Practitioners and scholars disagree on the legal nature of a domain name. Some argue that a domain name represents only a conditional contractual right for the term of registration. Others compare a domain name to an intangible property, like a telephone number. In the absence of definitive law to the contrary, courts generally consider domain names to be “general intangibles” under the Uniform Commercial Code.
A security interest in any property (including general intangibles) attaches only to whatever rights a debtor has in that property and only if that property is properly described in the security agreement. Lenders must take care to determine who owns and controls any domain name intended to be collateral, and that entity must be party to the security agreement. To cover domain names, the collateral description in a security agreement should include “general intangibles”; for additional clarity, that collateral description also could include “domain names” (including a list of specific domain names) and any associated trademarks and goodwill.
To perfect a security interest in general intangibles, a lender must file a proper financing statement in the UCC filing office in the state where the debtor is deemed to be located under the UCC (typically, the state where the debtor is organized).
Obstacles to Enforcement
A properly perfected security interest in a domain name does not guarantee success in taking control of that domain name after a default. Domain name registrars often require the approval of the domain name holder before making any transfer. A registrar risks violating its registration agreement with the owner by transferring the domain without the owner’s permission, and is therefore unlikely to circumvent the owner’s wishes without a court order. Furthermore, under the UCC a registrar has no duty to cooperate with a creditor.
Even if a buyer is willing to agree to the transfer, the domain name registrar must cooperate as well. Many registration agreements include non-assignment provisions, which could render any domain registration void if transferred without the consent of the registrar. Lenders might seek an agreement with the registrar to acknowledge the security interest and effect a transfer on notice of default, but a registrar has little or no incentive to make such an agreement.
Lenders might address these limitations in other ways. The debtor could deliver a power of attorney or escrowed instruction letter empowering the lender to take any action on behalf of the debtor to maintain or transfer the domain name. For that approach to be effective, the domain name registrar would need to recognize the validity of that document and cooperate with the lender. The debtor also might transfer the domain name to the lender or a third-party escrow agent for the duration of the loan, which would enable the lender to control the domain name but need not affect the debtor’s continued use of the domain name prior to a default. If these challenges are not properly contemplated at the deal phase, a lender’s only option is to file suit.
Even if a lender successfully secures a domain as collateral, it may be impossible to monetize if it violates a third party’s trademark. The Anticybersquatting Consumer Protection Act creates a cause of action against an individual for registering or using a domain name diluting or infringing on a trademark. Congress created the law to prevent “cybersquatters” from purchasing domain names infringing on valuable brands with the plan to sell these domain names back to the trademark holder. Therefore, if the domain name is sold, the buyer may be infringing on the trademark rights of a third party — or even the original owner. At a minimum, the transfer of the domain must include a transfer of the owner’s associated goodwill in that name.
Careful planning is needed prior to the closing and funding of a loan to mitigate or avoid pitfalls to enforcing a security interest in a domain name.
The private equity practice group at McGuireWoods is dedicated to keeping clients advised of new legislative and business developments as they occur. If you have any questions regarding these issues, please feel free to contact Donald A. Ensing (+1 312 849 8111), Bryan P. Bylica (+1 312 750 3617), Clayton J. Stallbaumer (+1 312 641 2096) or your primary attorney at McGuireWoods.