Bankruptcy Judge Puts Off Toysmart Decision

BOSTON (07/26/2000) - U.S. Bankruptcy Court Judge Carol Kenner today tabled Inc.'s controversial plan to sell its customer information until she holds a hearing on a proposed settlement deal announced Friday by the defunct online toy retailer and the U.S. Federal Trade Commission (FTC) -- a deal that Kenner said she's likely to reject.

At a hearing on Toysmart's request for approval to go ahead with a sell-off of its remaining assets, Kenner said she would have to schedule a separate hearing to consider the agreement reached by the Waltham, Mass.-based company and the FTC. The agreement, which would settle a lawsuit filed by the FTC over the planned sale, would allow Toysmart to transfer its customer list and related information to another company only under limited circumstances.

Kenner didn't set a date for the hearing on the proposed settlement. But the judge -- while vowing to keep an open mind on the issue -- said she's unlikely to approve the deal in part because of objections to both the proposed customer-data sale and the settlement agreement that were filed by the attorneys general of 41 states.

A group of attorneys general representing 39 of the states yesterday had vowed to proceed with its efforts to block any sale of Toysmart's customer list despite the FTC's settlement. In court today, those states were joined by officials from New York and Texas, who also objected to the proposed sale and the settlement.

The deal reached with Toysmart by the FTC would only allow the sale of the customer data to a "successor" family-friendly company that agreed to step in and buy the company's entire Web site. Harold Murphy, Toysmart's Boston-based attorney, today told Kenner that the settlement "balances the needs of Toysmart's creditors with the needs of its customers."

But the states said they believe the FTC's proposal should include notification to consumers who provided personal data to Toysmart, as well as a process under which the company's customers could decide whether they want their information to be sold to a third party. The privacy policy posted on Toysmart's Web site assured customers that their data wouldn't be shared with other companies.

"The FTC's settlement goes a long way to addressing our concerns," said Massachusetts Assistant Attorney General Pamela Kogut. "But it [still] constitutes a sale to a third party. The only way to do it is for [Toysmart] to notify consumers and allow them to agree to the sale of their information."

Truste, a San Jose-based organization that awards a seal of approval to companies that promise to adhere to a set of online privacy guidelines it developed, also filed an objection to Toysmart's plans with the bankruptcy court. Toysmart was one of the companies given a seal by Truste, which also said that it opposes the proposed settlement with the FTC.

At today's hearing, meanwhile, Toysmart declined to accept either of the two bids on its customer list -- $50,000 from The Walt Disney Co., which owns a 60% stake in Toysmart, and $15,495 from Digital Research Inc. (DRI) in Kennebunk, Maine. Murphy said Disney "has the opportunity to end this right now" by raising its offer, but Disney's attorney refused.

Disney said it would destroy the list to protect the privacy of consumers who provided information to Toysmart.

DRI, a marketing research firm, plans to use the information but pledged to keep it out of the hands of other companies. DRI also said it would seek to sell Toysmart's Web site and share the proceeds with Toysmart.

Larren Nashelsky, a bankruptcy attorney at Morrison & Foerster in New York, said after the hearing that he's concerned about the effects the Toysmart case may have on creditors' rights in the future.

"The goal of the bankruptcy code is to maximize the value of the fallen company for the benefit of its creditors and shareholders," Nashelsky said. "One issue that has been overlooked is that the bankruptcy code allows for contracts entered into by the bankrupt company to be assigned to others, regardless of prior agreements to the contrary, in order to maximize the value of the company in bankruptcy."

But Nashelsky added that the FTC's claims that Toysmart engaged in deceptive practices by proposing the sale of information it had promised to keep private "may force the judge to find that, in this case, privacy interests trump the bankruptcy code."

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