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Can US Bankruptcy Law Extend to Virtual Reality Entities?

Article

The Business Advisor

Summer 2016

Some of the technology sector’s biggest names – Facebook’s Mark Zuckerberg, Amazon’s Jeff Bezos, and serial entrepreneur Elon Musk – have lately increased their attention (and investment dollars) on virtual reality (“VR”). To date, retail consumer VR applications primarily focus on entertainment and gaming; for instance, using VR, a person could “vacation” in Hawaii without leaving her couch. VR’s ultimate potential, however, increasingly appears almost limitless. Basic commercial uses already include flight and combat simulators for pilots and soldiers and training modules for surgeons. Mr. Musk and others hail VR’s “transformative” prospects, including the potential for “billions of simulations” and entire virtual worlds. Given the advertising industry’s appetite for personalized consumer data, the value from “billions” of cheap, simulated trials in a virtual world that mimics our own is obvious. Or, a startup company wooing investors might utilize simulations to support its future cash flow projections. Such VR simulations, or “worlds,” have been described as “intermediate environments: the first settlements in the vast, uncharted territory that lies between humans and their machines.” 1

As VR worlds come into existence, if they are like our own, wholly virtual commerce will follow, with the usual winners and losers in its wake. Indeed, this is already occurring in a virtual world known as “Second Life,” where nearly one million active users per month contribute to a virtual economy with an annual gross domestic product (“GDP”) over $500 million.2 It has been estimated that total VR users across all platforms will exceed 100 million by 2030.3 In the “real world,” insolvency law offers economic losers a chance for a fresh start. In the United States, the historical dynamism of our economy has been greatly assisted by the bankruptcy system, which makes it relatively easy for an entrepreneur to go from a failed business to attempting a new startup. But what about an entity that exists only in a VR world? Where could it turn for legal protection in a distressed situation? The answer is not clear. Yet, if our future activities are to be increasingly conducted in VR, it seems prudent to provide such an entity – and, by extension, the entire virtual economy in which it exists – with an equally sophisticated and modern insolvency regime. Moreover, what about the potential for overlap between the “real world” and VR worlds – will a VR entity also have “real world” creditors? If so, how can such creditors protect themselves?

Consider a wholly virtual business entity. It has no “real world” presence or property. It operates solely in VR world, using virtual currency, and virtual employees and equipment. It was created, however, by a human being who exists in the “real” world. Moreover, its activities in the virtual world generate profits and property, including intellectual property rights, that could be converted into real world assets; Second Life, for example, uses a virtual currency that is pegged to, and may be freely exchanged for, US dollars, among other currencies. If the VR entity becomes insolvent, can it, on its own and not as an asset or extension of its human principal,4 seek bankruptcy protection under the Bankruptcy Code?

The Bankruptcy Code provides for global jurisdiction over a debtor’s assets, “wherever located and by whomever held.” 11 U.S.C. § 541(a). This includes foreign property and intangibles. Likewise, the automatic stay against collection activities applies to all of a debtor’s property. 11 U.S.C. § 362(a). However, to become a debtor in the first place, one must: (i) be a “person,” a defined term that includes business entities; and (ii) either reside in, be domiciled in, have a place of business in, or hold property located in the United States. 11 U.S.C. § 109(a). The question, then, is whether our VR entity is “in the United States” by one of more of those measures. If it is not, it cannot file a petition for relief under the Bankruptcy Code.

Today, millions of businesses operate only on the internet, without a physical “brick & mortar” presence. No one doubts that such entities are eligible to be “debtors” under Section 109(a). So why is a VR business different from an ordinary online business? For one, even if a business operates solely online, it will still have some basic footholds offline; i.e. a registered business entity, an office, a bank account,5 etc. A VR entity, on the other hand, could operate without any of those things, and, thus, have no way to qualify as a “debtor” under Section 109(a).

Further, such a VR entity might even be created and managed by an artificial intelligence (“AI”) system, with no human involvement whatsoever! What then? Do creditors look behind the AI system to find a human creator in cases of fraud or other potential veil-piercing scenarios?6 What if the AI system is “autonomous,” or was itself created by an earlier AI system? The complexity of the problems associated with extending our existing bankruptcy regime to VR worlds is obvious. Indeed, to call it an “issue of first impression” seems woefully inadequate.

Yet some basic solutions already exist within the Bankruptcy Code, and minor revisions to the statute could add greater clarity. First, and perhaps most simply, a VR business could establish a “real world” footprint by registering itself as a domestic business entity in the United States (assuming compliance with associated state law requirements is possible) or by obtaining property in the United States. In these scenarios, the VR business is akin to a foreign corporation seeking refuge from its creditors under chapter 11. Alternatively, Congress could amend Section 109(a) to specifically cover VR entities with some relationship to the United States (e.g., a principal or corporate parent that would otherwise qualify as a debtor under the Code). This would have the added benefit of allowing real world creditors to file an involuntary petition against the VR entity.

In any event, the problem remains that, even though chapter 11, in theory, protects a debtor’s assets “wherever located,” creditors in other countries (or VR worlds) may not recognize a United States Bankruptcy Court’s jurisdiction over assets not located in the United States. See, e.g., In re McLean Indus., Inc., 68 B.R. 690 (Bankr. S.D.N.Y. 1986) (bankruptcy court entered order enjoining continuance of any action against the debtor’s foreign property, which was widely ignored by foreign creditors, who seized the debtor’s assets and commenced foreign insolvency proceedings in several different jurisdictions). One suspects creditors in a VR world would be no less aggressive in attacking virtual (or foreign, real world) assets.

Alternatively, a VR entity could attempt to commence an “ancillary” bankruptcy case in the United States pursuant to 11 U.S.C. §§ 1504 and 1515, which permit the recognition of “foreign proceedings.” This option, however, presumes that (i) courts will interpret “country” as used in Section 1502 to extend to VR worlds; and (ii) that the VR world itself has an insolvency regime where a foreign proceeding could first be commenced. Again, Congress could amend chapter 15’s pertinent provisions to make clear that VR proceedings qualify for ancillary treatment.

Ultimately, the risk of operating in a VR world is unpredictable. Some VR worlds may develop sophisticated legal systems that seamlessly interact with our real world systems – and perhaps systems in other VR worlds – observing principles of comity that underlie the existing real world global economy. Some VR worlds may even develop insolvency regimes that improve on the Bankruptcy Code. Yet others will probably lack any legal systems at all. Bankruptcy practitioners should be prepared to effectively advise would-be VR entrepreneurs and their creditors on the coming VR revolution.


1 See EDWARD CASTRONOVA, SYNTHETIC WORLDS: THE BUSINESS AND CULTURE OF ONLINE GAMES 9 (2005).

2 http://www.businessinsider.com/second-life-is-still-around-and-getting-ready-to-conquer-virtual-reality-2015-3.

3 See CASTRONOVA, supra note 1, at 65-67.

4 If we treat the VR business as “property” of a human principal or a “real world” corporate parent, then it seems clear that the business could become property of a bankruptcy estate, pursuant to Section 541(a), in a case commenced by the principal or parent. However, if the VR business was created to take advantage of the limited liability inherent in distinct business entities, then a bankruptcy filing by an otherwise solvent principal or parent will not be an attractive option.

5 Although, with the advent of Bitcoin and other virtual currencies, this may no longer be necessary.

6 In the case of a lawsuit involving the Second Life virtual world, one district court briefly grappled with the problem of exercising personal jurisdiction over the company’s CEO based on his conduct inside the virtual world, before ultimately finding it had jurisdiction based on the CEO’s real world marketing efforts. See Bragg v. Linden Research, Inc., 487 F. Supp. 2d 593 (E.D. Pa. 2007).