The U.S. Bankruptcy Court for the Northern District of California recently held in Atlantic Recording Corp. v. Chin-Liang Chan, 325 B.R. 432 (Bkrtcy. N.D. Cal. 2005) that a creditor of a company found liable of copyright infringement may have that obligation declared nondischargeable against the company’s CEO as a willful and malicious injury.

On June 7, 2000, the plaintiff, Atlantic Recording Corporation (“Atlantic”) filed a lawsuit in the U.S. District Court alleging that Media Group, Inc., (“Media Group”) willfully infringed their copyrights in over 1,500 sound recordings.  Media Group’s business consisted of replicating and providing services to replicate compact discs (“CDs”), and at the time of the alleged infringement, Chin-Liang Chan (“Chan”) served as the CEO of Media Group.  The District Court granted Atlantic’s motion for summary judgment and awarded damages in excess of $136 million against Media Group, Chan and other defendants.  Subsequently, Chan filed a voluntary Chapter 7 bankruptcy petition.  In response, Atlantic filed an adversarial proceeding in Chan’s bankruptcy case requesting that the District Court’s judgment be excepted from discharge under 11 U.S.C. Section 523(a)(6).

Under Section 523(a)(6), a Chapter 7 discharge does not discharge an individual debtor from a debt for “willful and malicious injury by the debtor to another entity or to the property of another entity.”  The Bankruptcy Court adopted the Ninth Circuit’s definition of “willfulness,” which encompasses acts performed intentionally with knowledge that an injury was substantially certain to occur.  Id. p. 406. The Court also noted that a defendant’s act is “malicious” if their conduct was (1) wrongful, (2) intentional, (3) necessarily caused injury, and (4) was done without just cause or excuse.  Id.  With these tests in mind, the Court set out to determine if collateral estoppel should apply with respect to the District Court judgment.

The Court found that each of seven causes of actions (i.e. direct copyright infringement, contributory copyright infringement, vicarious copyright infringement, conspiracy to infringe copyright, violation of Cal. Civ. Code § 980, violation of Cal. Bus. & Prof. Code § 17220 and conversion) that made up the underlying District Court judgment were deficient to support the application of collateral estoppel for the establishment of nondischargeability under Section 523(a)(b).  However, Atlantic in addition argued that summary judgment was warranted based on the undisputed evidence submitted to the Court.  Based on a thorough analysis of the evidence, the Court agreed.

Atlantic’s evidence showed that the Recording Industry Association of America (“RIAA”) provided Media Group with three separate employee training seminars to help screen customer orders for verification of copyrights, a toll-free number to check copyright ownership of questionable recording requests, and warnings that indemnification agreements were insufficient evidence of copyright ownership.  RIAA also informed Media Group of past infringing activities and gave instructions on how Media Group could prevent any future infringing activities.  Yet, based on employee testimonies, Media Group failed to implement any of RIAA’s suggested procedures.

During discovery, Chan admitted he “was in a position to control Media Group’s operations, and actually exercised control,” and “believed” that the copies were made under the appropriate licenses. Even though Chan did not attend any of RIAA’s training seminars, nor take customer orders or produce the CDs, the Court ruled that as the person in control of Media Group’s operations, his failure to take any of the suggested remedial steps established “willful conduct” on the part of Chan.  The Court rejected Chan’s claims of mere negligence, and found that Chan’s conduct undoubtedly was substantially certain to cause injury to Atlantic.  It is noteworthy that Chan failed to submit any opposing evidence to Atlantic’s motion and then one week before the hearing filed an opposing declaration.

The Court quickly established that Chan’s conduct was also malicious.  The Court found that Media Group acted intentionally in replicating the CDs, it was wrong to do so and the replication caused injury to Atlantic.  The Court again reasoned that since Chan was responsible for Media Group’s conduct and that there was no just cause or excuse for replicating copyrighted sound records, the requisite element of malice was established.  Therefore, based on the evidence, Atlantic was entitled to summary judgment and that judgment should be excepted from discharge under Section 523(a)(6).

Chin-Liang Chan is one of the first cases to be decided in California’s Northern District addressing nondischargeability of a debt under Section 523(a)(6) based on a copyright infringement claim.  Only a handful of other courts have previously addressed this issue.  See, e.g.,Sophos v. Hibbs, 161 B.R. 259, (Bkrtcy. C.D. Cal. 1993) fn. 1, and most recently, in Star’s Eagle, Inc. v Braun, Adv. Pro. No. 04-3333 DM, 2005 Bankr. LEXIS 1446 (N.D. Cal. July 26, 2005).

This case also highlights opportunities and pitfalls for creditors and debtors.  On one hand, creditors now have an additional type of claim, beyond the traditional intentional tort claim, for pursuing corporate insiders for nondischargeability.  Given the nature of the claim and the large amount of the judgment in a case like Chin-Liang Chan, this can be particularly advantageous for a creditor.  As for debtors, special care must be taken in the oversight of remedial activities or personal liability may well attach to the unwary insider.  And on a procedural note, even though summary judgment is sought based on collateral estoppel, as a back-up, it is prudent to also submit supporting evidence as well.  In the Chin-Liang Chan case, that was the eventual difference.

*Xochitl Marquez (JD Candidate 2007, University of California, Hastings College of the Law) assisted in the preparation of this Alert.

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