delay, and administrative burden or in, some situations, have had to forego otherwise attractive financing opportunities altogether.

For many reasons that are elaborated in my written testimony, CFA strongly believes that the current law governing the perfection of security interests and copyrights badly needs reworking. CFA welcomes the opportunity to work with the groups present here today and others to devise a comprehensive Federal filing system for all intellectual property.

However, as today's testimony reveals, there is still no agreement on how to create such a filing system nor when such a filing system could become fully functional. In the meantime, lenders and borrowers are left struggling with the current cumbersome system, which the Copyright Office in its March 18 memo to the chairman of this subcommittee, described as causing, quote, "significant problems with the financing of copyrighted materials.'

In the interim, CFA believes that it would be very beneficial to borrowers and lenders for Congress to pass a narrowly-focused, narrowly-targeted legislation which could provide immediate relief for borrowers and lenders alike.

The Copyright Office would appear to agree with CFA's approach not only in their March 18 memo, but I believe earlier today in the Honorable Ms. Peters' remarks, she mentioned that it might make sense to recognize the perfection of a security interest in copyrights at the State level for the purpose of allocating rights among lien creditors.

The CFA draft bill that has been submitted to the subcommittee would accomplish this limited goal through an amendment to the Copyright Act. It would allow a lender, through a UCC filing, to perfect a security interest in both copyrighted and copyrightable material. Only the rights of a holder of a security interest and lien creditors would be affected. It would not affect the rights of an outright transferee of a copyright or the interest in a copyright such as a bona fide purchaser or exclusive licensee. These persons would continue to take free and clear of any security interest filed only at the State level under the UCC.

It is important to stress that CFA's proposal would not require third parties to conduct a 50-State search to ascertain whether there is a security interest that exists in a copyright. If a third party were to be a bona fide purchaser or licensee, it would need only to look for filing at the Copyright Office, for a security interest in a copyright is not registered-if it is not registered there, that person would take free and clear of the security interest. If a third party did elect to conduct a search under the UCC for a recorded security interest, they would only need to look in one State, that namely being the State where the debtor is located.

In the end, the CFA bill would simply allow a secured lender who has loaned money to a business secured by copyrighted or copyrightable material or assets of the business to establish a priority over a bankruptcy trustee through the filing under the UCC. The same can be done with patents and trademarks. In this way, in the unfortunate event that a business borrower seeks bankruptcy protection and the copyright assets are sold, the lender who supported the business by extending it credit would be paid ahead of the bankruptcy trustee, as intended by commercial and bank

ruptcy law. On behalf of CFA, I would like to thank the chairman for holding this important hearing.

Mr. COBLE. I thank you, Mr. Johnson.

[The prepared statement of Mr. Johnson follows:]

PREPARED STATEMENT OF CHARLES G. JOHNSON, PRESIDENT AND CEO, ALLSTATE FINANCIAL CORPORATION, ON BEHALF OF COMMERCIAL FINANCE ASSOCIATION

INTRODUCTION

Chairman Coble, members of the Subcommittee, my name is Charlie Johnson. I am the President and CEO of Allstate Financial Corporation. Allstate Financial, which is located in Virginia, provides asset-based commercial lending products and financial services to a variety of businesses. I am present today in my capacity as First Vice President of the Commercial Finance Association or CFA, the trade group for the asset-based financial services industry. On behalf of all CFA members, I appreciate this opportunity to present to the Subcommittee the CFA's views on the problems and difficulties that have arisen in the area of secured financing involving copyrights as a result of recent judicial decisions in the Ninth Circuit. These cases, most notably In re Peregrine Entertainment and In re Avalon Software Inc., have held that the Copyright Act pre-empts the Uniform Commercial Code with respect to the perfection of security interests in both copyrighted works and copyrightable material which has not yet been registered in the Copyright Office.1

CFA also appreciates the opportunity to address legislative approaches, one from the Commercial Finance Association and another from the American Bar Association, that have been offered to the Subcommittee to address the problems resulting from Peregrine and Avalon. I also want emphasize that in addition to addressing the current difficulties faced by lenders and borrowers engaged in secured financing transactions involving valuable copyrights, both the comprehensive ABA bill and the narrowly targeted copyright specific CFA bill have an equally important goal. This goal is to bring the law regarding the treatment of security interests in copyrights in bankruptcy proceedings into harmony with similar laws governing security interests in patents and trademarks.

THE COMMERCIAL FINANCE ASSOCIATION AND ASSET-BASED LENDING

The Commercial Finance Association is the trade group for the asset-based lending and factoring industries. Our association consists of more than 300 members, including money center banks, regional banks, independent finance companies, and commercial lenders that are publicly held or owned by industrial companies and foreign banks. Some of our larger members are Citigroup, Nationsbank/Bank of America, GE Capital, and Fleet Capital. Our member institutions are located nationwide and around the world.

CFA members provide asset-based commercial financing and factoring products and services to small and medium-sized businesses at the local, regional, national, and international level. In 1997, CFA members extended approximately $205 billion in credit to small and medium-sized businesses throughout the United States. These funds supported more than $2 trillion in economic activity and millions of jobs.

1In re Peregrine Entertainment Ltd. 116 B.R. 194 (C.D. Cal. 1990). In Peregrine, a film distributor granted a lender a security interest in its inventory, which included film copyrights. The lender filed financing statements with the state under the Uniform Commercial Code. After the borrower filed for bankruptcy, the trustee challenged the perfection of the security interest. The California bankruptcy court held that the Copyright Act of 1976 establishes a comprehensive national system for recording transfers of copyright interests, and, therefore that federal law broadly pre-empts state law regarding the manner of perfection of security interests in copyrights themselves and any proceeds thereof, including accounts receivable generated through licenses of copyrights. Since the lender had not filed its interest with the Copyright Office, it lost its security interest in the films and the licensing revenues they generated.

In re Avalon Software, Inc. 209 B.R. 517 (Bankr. D.Ariz. 1997). In Avalon, a lender obtained a security interest in all the assets of a software developer, including copyrighted software and software in process of development. The lender filed financing statements with the state under the UCC. In bankruptcy, the trustee challenged the perfection of the security interest. The Arizona bankruptcy court, building on Peregrine, re-affirmed that the only method for perfecting a security interest in a copyrighted work was to file at the Copyright Office, and then extended this requirement to copyrightable works. The Court found that a work entitled to be registered with the Copyright Office does not become something different because it is not registered. Thus, a security interest filing with the Copyright Office is still required to perfect a security interest in such work, and such security interest cannot be filed until the work has been registered.

Many small businesses depend on asset-based financing for working capital, and for some businesses, such financing is their only available option.

Asset-based loans are lines of credit that generally are secured by a "floating lien" on the borrower's assets. A floating lien usually covers all the borrower's assets including inventory, equipment, accounts receivables, general intangibles (which include intellectual property), after-acquired property and other valuable personal and real property.

In substantially all cases not involving collateral in the form of copyrights or copyrightable material, a security interest in a borrower's assets becomes perfected when notice of the security interest is properly filed under the Uniform Commercial Code. With respect to intangible assets, such as patents, trademarks, and accounts receivable, this involves filing a UCC-1 financing statement, describing the collateral, with the designated filing office(s) in the state where the borrower is located.

When a lender's security interest in the collateral of a borrower is perfected, the lender's interest is valid against the claims of third parties, as well as against the debtor. It is important to point out that the majority of priority contests occur in the context of bankruptcy proceedings where the priority contest pits a security interest holder against the debtor's trustee in bankruptcy or other security interest or lien holder.

It almost goes without saying that the more certain and predictable a lender's security interest in the borrower's collateral, the better the loan terms the borrower can obtain. Conversely, risks and uncertainties with respect to a lender's security interest will increase the costs to the borrower, or in some cases, even make credit unavailable.

THE PEREGRINE/AVALON PROBLEM

On a subject so fundamental and integral to the asset-based lending community such as the perfection of security interests, I must admit I find it a bit strange that I am addressing the Courts and Intellectual Property Subcommittee and not the Commercial Law Subcommittee or a Banking Subcommittee. Nonetheless, as the impetus for today's hearing has shown, Peregrine and Avalon have forced bankers to act like copyright lawyers, and it has forced the U.S. Copyright Office into the business of secured financing. Unfortunately, these are unfamiliar and inefficient roles that neither the banking industry or the Copyright Office desired, or, under current law, is well-suited to fulfill.

As an example of this inefficiency, in a March 18 memo from the U.S. Copyright Office to the Subcommittee on today's topic, the Copyright Office stated that "while recordation [of a security interest in a copyright] under the UCC takes place in about two days, recordation in the Copyright Office can take several months. Much of the difference in time is attributable to the fundamentally different nature of the two systems." This means that anyonee-a lender, a purchaser, or licensee - about to acquire an interest in a copyright will be forced to take added measures to try to determine if a security interest in that particular copyright already exists.

Another significant problem facing lenders and borrowers in the copyright field is directly traceable to the Avalon decision which held that under federal law copyrightable material (as distinguished from already copyrighted material) must first be registered in the Copyright Office before a security interest in such material can be perfected. This has greatly increased the risks, and thus costs, in using creative works in process as collateral for loans, and is a particularly worrisome problem for lenders who finance software developers. It also complicates film industry financings where a film is not typically registered in the Copyright Office until the film is ready for release. As a leading commentator on secured transactions, Barkley Clark, has noted, "This is a big problem with the federal copyright statute, it does not appear to allow after acquired property clauses. In this respect, it is much less flexible than Article 9 of the UCC."2

There are also other fundamental differences between the state UCC filing system and the federal Copyright Office system that impede efficient and cost-effective commercial financing when copyrights comprise the collateral. In contrast to UCC filings against intangibles, which are typically recorded in one location under the name of the debtor, a filing with the Copyright Office is made under the name or registration number of the copyrighted work. Consequently, searches in the Copyright Office for existing filings require that the searching party know the name or number of the registered work, and separate filings must be made for each individual work pledged as collateral.

2 Clark, "The Law of Secured Transactions under the UCC (1998 Cumulative Supplement No. 2, Sec. 1.08 (1) (e), page SI-29.

Furthermore, the Copyright Office rules for establishing the priority of competing security interests in copyrights are much less certain than those found in the UCC. It is essential that lenders know, based upon public records, their relative priority in collateral at the time a transaction closes. The UCC priority rule is simple-the first to file (or otherwise perfect) has priority. Under this first to file system, a lender can be certain that its loan will be secured and prior to others by properly filing a UCC-1 form and then searching to see that no other party is senior.

No such certainty exists under the Copyright Act's first to sign rule. Section 205(c) provides that the first to sign a security interest has priority, provided it is recorded within thirty days if signed within the U.S., or within 60 days if signed outside of the U.S. Thus, a lender who filed first with the Copyright Office could still lose priority to a lender that obtained an earlier signed document.

In addition, another problem exists concerning the enforcement of security interests in copyrights. Peregrine focused entirely on the filing issue without addressing the extent to which the UCC may nevertheless govern other aspects of security interests, such as enforcement. Earlier case law held that the federal statute had no role to play in foreclosures of security interests in copyrights.3 Thus the foreclosure rules of the UCC should still govern in this important area.

Presently, for a lender to ensure perfection under federal law, the lender must take the following steps. (1) conduct a thorough audit of all the borrower's copyrights and copyrightable material, (2) require the borrower to register any copyrightable material, (3) enter into a security agreement that identifies each of the copyrights by title or registration number, (4) record the security agreement with the Copyright Office, (5) establish a reporting and monitoring process with respect to the borrower's existing and after-acquired copyrights, (6) require the borrower to register all after-acquired copyrights, and (7) record any additional security interests with the Copyright Office as additional copyrights (including derivative works, enhancements and modifications, are added to the collateral.

ADDRESSING THE CURRENT LEGAL SITUATION

CFA strongly believes that the current law governing the perfection of security interests in copyrights is negatively impacting secured financing and badly needs reworking. Recording security interests in the Copyright Office does not facilitate financial transactions. As loans and business acquisitions are often made on very tight timetable, timely access to filing information about security interests and liens is vital to the free flow of commercial loans. A search of UCC filings can be performed quickly while a search at the U.S. Copyright Office can be time-consuming and costly, and fail to reveal security interests filed months previously. Nonetheless, CFA does not disagree with the Peregrine holding that federal law could pre-empt state law with respect to recording security interests in copyrights. In fact, the reasoning of Peregrine seems to highlight the need for a comprehensive federal recording statute governing all types of intellectual property including copyrights, patents

and trademarks.

However, as the witnesses at today's hearing have indicated, and CFA representatives have ascertained from various meetings and consultations with members of the lending and copyright communities, and related federal agencies, there is no common agreement on how to devise and facilitate such a federal system. More so, there is no real indication when and if such a system could become functional. Unfortunately, until such a system can be constructed, we are left struggling with the current cumbersome situation regarding the perfection of security interests in copyrights-a situation that the Copyright Office, again in its March 18 memo to the Chairman of this Subcommittee, described as causing "significant problems with the financing of copyrighted material

THE CFA AND ABA PROPOSALS

CFA welcomes the opportunity to work with the groups present here today and others to formulate a comprehensive federal filing system. However, in the interim, CFA believes that it would be highly beneficial to borrowers and lenders, especially in software related industries, for Congress to pass narrowly targeted copyright specific legislation which would provide immediate relief to the lending community while at the same time having a negligible effect on the copyright community. The Copyright Office would appear to agree with this approach. In the Copyright Office's above-mentioned March 18 memo to the Subcommittee on this subject, the memo concluded with the statement; “Before taking on comprehensive reform, solving the

3 See Republic Pictures Corp. v. Security-First National Bank of Los Angeles, 197 F2d 767 (9th Cir. 1952).

immediate needs of the financing community by allowing the perfection of a security interest in copyrighted material through a UCC filing seems desirable."

Accordingly, the CFA bill submitted to the Subcommittee would accomplish this limited, yet very beneficial, goal. It would amend the Copyright Act to allow a lender, through a UCC filing, to perfect a security interest in both copyrighted and copyrightable material, thereby enabling the secured lender to prevail over a trustee in bankruptcy or other lien creditor. Such a narrow amendment would only affect the rights of holders of security interests and lien creditors; it would not affect the rights of an outright transferee of a copyright or an interest in a copyright, such as a bona fide purchaser or licensee, who would continue to take free and clear of any security interest filed only at the state level under the UCC.

This limited approach to the application of the UCC is also a fundamental component of the ABA draft legislation which would apply it to all intellectual property. While CFA believes the copyright specific problems of Peregrine and Avalon can be addressed with a copyright specific solution, CFA applauds the ABA proposal for recognizing that to promote financing and development of intellectual property, the UCC should govern the creation, attachment, perfection, priority and enforcement of security interests, while federal law should govern the rights of a person other than a secured party or lien creditor who acquires any other right or interest in intellectual property. A person the ABA bill defines as a "transferee."

CFA can clearly see the merits of the comprehensive filing system which the ABA suggests will better accommodate the filing of security interests when they are recorded at the federal level against transferees. But for CFA members who on a daily basis are being forced to deal with the realities of Peregrine and Avalon, such comprehensive relief may be more than is needed for a workable interim solution to their problems. Most challenges to secured loan documentation come from trustees in bankruptcy, and it is in such situations where relief is needed now. Accordingly, in response to this limited need, the primary thrust of the CFA bill is to change the confusing and inefficient current law in the context of bankruptcy proceedings. As to the merits of the limited CFA bill, the Copyright Office, in the March 18 memo to the Subcommittee, commented; "The draft proposal makes minimal changes to existing provisions in Title 17 regarding recordation of transfers and other documents that would not require the Copyright Office to change any of its existing procedures. . . The Office believes a minimal approach at this time has considerable advantages. It would give financial institutions immediate relief; it would allow the Copyright Office, which is just beginning to consider efficiencies for recordation of documents such as an electronic system to continue using its existing system, and it would not preclude subsequent consideration of more comprehensive reform.'

Such a limited amendment will also result in copyrighted and copyrightable material receiving the same legal treatment afforded patents and trademarks under existing law. Under a substantial majority of the cased decided with respect to other types of intellectual property, it is clear that a secured lender which is properly perfected under the UCC will obtain priority over non-consensual creditors, such as a bankruptcy trustee and lien creditors.

Patents and trademarks are treated differently from copyrights under existing case law. While federal recordation remains necessary to protect security interests in patents and trademarks against bona fide purchasers, such recordation is not required to give the secured creditor priority over the patent or trademark owner's trustee in bankruptcy. There is no good reason for treating security interests in copyrights differently from those in patents or trademarks. Accordingly, the CFA bill will harmonize the law as it applies to these common forms of intellectual property.

Finally, it is important to stress, that the enacting the CFA's legislative proposal would not require subsequent buyers, licensees, lenders, or other lien creditors to conduct a 50 state search to ascertain whether a security interest exists in a copy

4 For cases dealing with patents, see, In re Transportation Design and Technology, Inc., 48 B.R. 635 (Bankr. S.D. Cal. 1985) (holding that a lender's security interest in patents filed only with the secretary of state under the UCČ, and not with the U.S. Patent and Trademark Office, prevails against the claim of the debtor's trustee in bankruptcy) and City Bank & Trust Co. v. Otto Fabric, Inc., 83 B.R. 780 (D. Kan. 1988) (holding that no federal filing is required to protect a security interest in patents against a trustee in bankruptcy). For cases dealing with trademarks, see, In re TR-3 Indus., 41 B.R. 128 (Bankr. C.D. Cal. 1984) (holding that a bank's security interest in a trademark, filed with the secretary of state, prevailed over a trustee in bankruptcy's claim because the Lanham Act does not preempt state law) and In re Roman Cleanser, 43 B.R. 940 (Bankr. E.D. Mich. 1984) (holding that filing under the UCC is sufficient to perfect an interest in a trademark since the Lanham Act only contemplates federal registration of outright assignments, not collateral assignments (i.e., security interests)).