Bermuda: Domain Names As Security - A Solution

A South Korean bank was recently reported by the BBC news service as offering mortgages using domain names as security. Loans of up to 30% of the assessed value with a maximum of US$25600 were obtainable. Furthermore, there is now an ‘Association of Certified Domain Name Appraisers’ who purport to regulate those individuals offering domain name valuation services. An objective observer reading these items would believe that a domain name must be a form of property in which rights may be bought and sold. As this is not legally correct, questions are raised as to whether a mortgage is the right means of obtaining security over a domain name.

Much has been written about domain names and their relationship with trademarks. There are obvious similarities. The value of a good domain name has been recognised for some time, which is the reason that trade mark owners get so exercised when they see others making use of, directly or indirectly, their valuable intellectual property. The future does not appear to offer any hope of relief from this conflict between the two. The rise in the number of dispute resolution initiatives is evidence of that, whilst offering the intellectual property judges the faint hope that they won’t have to work during their summer recess! At the same time as these initiatives are rolled out, the Internet keeps growing and the finite number of names available for use is dwindling. Toes will inevitably be trampled upon, either intentionally or not.

This is the age of ‘intellectual capital’. Companies that safeguard this most ephemeral of assets can reap huge rewards. However, on their way to becoming the next Internet success story they may wish to borrow some money. Lenders are considered to be a conservative body. Lending money to an organisation that exists only virtually taxes this conservatism to its limit. If one of the main assets of a virtual company is a domain name, how is a lender to react?

Whilst it is not proposed to repeat the basics regarding domain names in this article, it would be useful to remind ourselves of the most salient points.

• A domain name can only be registered once for each top-level domain.
• Generic domain names are the most valuable - .com, .org and .net.
• The usefulness of a good domain name increases as the Internet grows. Whilst search engines do as good a job as possible given the limitations of the technology, a good domain name will mean that a user will come straight to you and not get side-tracked into a large number of competitors sites.

A business seeking to raise finance usually has to provide some security in the form of property. This is not always as simple as it seems. A software company for example may have no tangible assets to speak of. Its computers, premises, desks, cars, etc. may all be leased. The sole asset of any worth could well be the software itself. Having regard to the software industry’s poor record of choosing distinctive trademarks this could well be true! How does a lender protect itself? Securing against the personal assets of the directors is one route, and securing the source code in escrow is another. Whilst not straightforward, the issues here are surmountable.

The issues facing web-based businesses are slightly different. Their assets include the site content, which is readily accessible, and the business idea, which is often self-evident. With business to consumer sites in particular such sites will rely heavily on their domain name for their popularity. Whilst content is vital thereafter, it is primarily this domain name that will enable people to identify the site. How many people go to ‘amazon.com’ because it is the first name that comes to mind and is easier to type than ‘barnesandnoble.com’?

A domain name is not source code however, the property rights in which have long been recognised. Neither is it like a telephone number provided by a telephone service provider. Whilst a number can identify you as an individual from millions of other telephone users, you cannot sell it on as being your property. A domain name similarly identifies you from millions of users and yet once registered you can sell it onto anyone you wish. Where does the difference lie?

When a domain name is acquired from a registration authority you enter into a contract. That contract states the terms of registration including the length of time that you, as registrant, can use that name. It is effectively a licence. Any future transactions regarding that domain name must be notified to the registration authority and they will deal with that transaction subject to their stated terms and conditions.

The fact that there is a mechanism for the transfer of a domain name from one organisation to another indicates that they have some of the attributes of ‘property’. That is the right of ownership; the exclusive rights to possess, enjoy, and dispose of an object of value. The system of registered land in the UK in that sense is similar. Land may be bought and sold but you must notify the Land Registry that this has occurred in order to perfect your title. The similarities end there. The Land Registry does not have any rights with regard to the transaction between the vendor and purchaser. Furthermore, any third party interest to the land is clearly marked on the documents of title. A purchaser can therefore check to see if it is mortgaged.

There is a separation of interests in land that enables the use of mortgages as a vehicle for lenders. These legal and equitable interests enable the borrower to keep possession whilst the lender has legal rights of redress. A possessory form of security would not be either practicable or appropriate. What vehicle can lenders use with domain names and what other practical issues should they consider?

The most practical issue to consider is the value of the domain name. How one values a name is beyond the scope of this article and, the writer suggests, is an art that cannot currently be defined with any great accuracy. Whilst the value of land can fluctuate, it still looks as secure as Fort Knox compared to that of domain names. Lenders must consider not only what a domain name is worth now but what it might or might not be worth in the future. In order to make a valid estimate an assessment of potential conflicts with established trademarks should be made in all potential markets. As the Internet is an international medium this alone shows the potential problems involved. The lender should keep abreast of domain name developments. The issuing of a whole new series of TLD’s could have a dramatic effect upon prices. Furthermore, what is the likely market in the future? Is it a long-term proposition or a short-term money-maker. The latter would include event-related sites or the latest children’s ‘craze’. It is arguable that these issues would have to be addressed if you use trademarks as security but that ignores the fluidity in the e-commerce marketplace. Trademarks tend to have developed goodwill that will not normally vanish overnight, although there are some notable exceptions. The mark ‘Aids’ in the UK was used for a slimming product just prior to the media interest in the disease of the same name. Goodwill here counted for very little.

Another practical issue is geographical location. Domain names can be relocated quite easily in a part of the world the lender does not deal in. Consideration should be given to this and to the contractual jurisdiction and law clause.

As a mortgage would appear inappropriate, then a form of security by way of contract might be considered. Here the problem noted above arises with regard to a record of prior interests. As there is no record of such interests there is no guarantee that the value of the security is maintained for the lender. Whilst it would be possible to obtain some form of guarantee that the borrower would not create any other interest in the domain name, it is unlikely that any prudent lender would consider this satisfactory.

Consideration should also be given to how control over the domain name will be taken. Will it be direct by way of a receiver, or indirectly through the registration authority? With the latter there may be a transfer to the lender itself or to a third party of its choice. Consideration should be given to any restrictions that the local registration authorities may have. Bermuda, for example, will only allow residents to register a ‘.bm’ TLD. There are also strict requirements on the ownership of companies in Bermuda that may affect the rights of the lender. With such a transfer there is also the possibility that the lender could lose its interest to a bona fide purchaser who has acquired the domain without notice of the lenders interest.

Another possible means of security is the use of a trusted third party to hold the domain name for the duration of the loan. Whilst this solves the problem with regard to multiple interests this could not be used in jurisdictions that require the domain name to be directly derived from the registrants’ name. The lender should also consider the value of that name if there are problems with the borrower. Who will want to purchase a domain name and business from a company that has failed? It would have to be a good name to hold its value.

A lender could require that the domain name be held by the holding company of the borrower and licensed back to the trading entity. The lender could charge the shares of the holding company and secure its interest that way. This still suffers from the risk of the domain name being transferred to a bona fide purchaser without notice.

The simplest option would be for the lender to take a charge over all the borrower’s assets and include the right to appoint an administrator or receiver. This administrator or receiver will be able to take control of the company. This overcomes the problem with regard to jurisdictions that require that the domain name be derived from the company name. This option has many advantages. Whilst using a domain name the borrower should also secure its rights to the name by registering a trade mark or at the very least by building up goodwill in the domain name by using it as a mark. The lender should ensure that when it takes its security over the domain name it also does so over such marks be they registered or unregistered.

The Internet is such a dynamic medium that it is both difficult and foolish to make hard and fast judgements as to the usefulness of domain names as security. Whilst they obviously have value and whilst there is a ‘gold-rush’ mentality in the marketplace, it is only natural that organisations wish to be part of that. Pressures from shareholders seeing the potential rewards will ensure that institutions such as banks etc. will dip their toe in the market. No doubt some will lose money. This should not put them off investing in this area, as it is possible for lenders to obtain a reasonable level of security if care is taken.