Intellectual property – commercial drivers
Intellectual property (IP) rights protect a person's ideas and products of their creativity from unauthorised use by another person. IP includes registered rights such as patents and trademarks, and unregistered rights such as copyright and design rights. It has often been classified as a chose in action. However, unlike normal choses which are enforceable against a single debtor, IP consists of absolute rights which may be asserted against anyone.
Lenders wish to take security over the most valuable assets held by the borrower. Traditionally, these assets have been tangible, e.g. machinery or land. However, within the last few decades there has been a shift in lenders' acceptance towards using intangible assets to form the basis of security, or as part of a package. The IP portfolio of many companies, especially start-up technology companies, forms an important part of their assets. The World Intellectual Property Office has estimated that global commerce in the IP asset class is worth US $300 billion worldwide annually, and 80% of corporate value is now represented by intangible assets. Digital service providers such as Google, marketplace operators such as Amazon and eBay and other social networking providers hold no significant real assets, but have shown dramatic value creation over time, due to their intangible assets.
Although IP is becoming increasingly valuable, it is an intangible asset. Particular challenges are therefore presented regarding the security package. In transactions where the IP is of significant value, careful consideration is required as to what; where; when; and how security interests are to be created.
Forms of IP
Patents
Patents protect a person's inventions. They are registered rights and are governed by the Patents Act 1977 (PA 1977). In order to be patentable, inventions must:
- be new (not already publicly available)
- involve an inventive step (the invention cannot be obvious to a person skilled in the art, taking into account other inventions and products on the market)
- be capable of industrial application
- not be excluded (exclusions are listed in the PA 1977).
Patents can be used to protect either a product or a process. They provide the owner with 20 years of protection (subject to annual renewal), during which time nobody else can produce the product or make use of the process that is protected.
A patent must be registered to be valid. The inventor (or company if the invention was generated in the course of an employee's employment) will apply for the patent to be registered in their name.
Due to the registered nature of patents and the length of protection they grant the owner, patents can be highly valuable. It is therefore common to take security over them.
Trademarks
Trademarks are another form of registered IP right. Trademarks may be registered over logos, words, numerals, colours, letters, shapes, packaging and even sounds and smells. They are governed by the Trade Marks Act 1994 (TMA 1994).
Registration under the TMA 1994 gives the owner of the relevant trademark an indefinite monopoly on its use (subject to renewal every 10 years). However, registration of trademarks is not mandatory. Unregistered trademark rights are inextricably linked with goodwill. However, in the UK unregistered trademarks can only be enforced and protected under the common law tort of passing-off.
A downside of using trademarks as security is that their value will be utterly dependent on the borrower's business value.
Copyright and design rights
Copyright is an unregistered IP right and rests in original works (e.g. music; art; books; articles; computer programmes) arising on creation of the work.
Copyright gives the relevant author a monopoly on the substantial copying of that work, and can generate royalties for the owner on exploitation e.g. by way of licence.
Design rights protect the appearance of a product, and can include the 3D shape as well as the 2D surface decoration. They can be registered or unregistered. The latter in the UK is a species of copyright.
Exploitation of IP
To increase the value of IP and generate revenue, the owner of IP has various options. It can:
- license the IP: this gives the licensee the right to use the owner's IP. Licences can be exclusive or non-exclusive; perpetual or limited; for a one-off fee rather than a royalty stream
- sell/assign the IP: this will transfer the ownership of the IP to the buyer, usually for a fee
- use the IP as security: if of sufficient value, it could be used as security for a loan.
Due diligence
At the initial stage of a transaction, the lender must satisfy itself that the borrower's IP portfolio constitutes a viable asset on which a loan can be secured. It will therefore require the borrower to produce a detailed schedule of its IP assets.
At the same time, the lender will also carry out an independent IP audit, to verify the assets owned by the borrower; and, if any, the assets licensed by the borrower. It can be a useful starting point to conduct searches of IP databases to see what rights are registered, e.g. the UK IPO for trademarks and design rights; Espacenet/EPO for patents; and the EUIPO register for EU registered rights (also known as OHIM). For unregistered IP rights, such as copyright, the verification process is more difficult. The lender's best bet may be to take representations from the borrower in the loan agreement concerning its ownership of unregistered rights.
All relevant registrations will need to be checked to ensure that they are up-to-date.
A prudent lender should also determine whether there are any infringement claims or actions affecting the value of IP. Some of the most valuable forms of IP, such as patents, may be most likely to be those subject to infringement proceedings.
The lender should beware of external contractors and consultants being used by the borrower to create e.g. software. Unless their work is expressly assigned to the borrower, they may be the owner of any copyright.
A lender should confirm that there are no earlier security interests registered against the assets, or any licences (particularly exclusive licences). This would significantly impact on the resale value of the IP should the lender's security need to be realised.
Lenders must also be wary of collaboration agreements (where multiple businesses work together to create new IP). There is often confusion over who owns the IP in the deliverables created by the collaboration, and who therefore has the right to grant security over it.
Considerations following due diligence
If the borrower is a licensee of various valuable IP rights, it would be prudent for the lender to consider entering into a tripartite agreement between themselves, the borrower and the licensor (owner) of the IP. This guarantees that the owner has provided express consent for the borrower to use the IP as security.
Certain valuable rights may need to be registered, and these registrations will also need to be maintained. If IP is assigned to the lender as part of the security package (see below), this may fall to the lender. If the borrower remains responsible for maintaining the relevant IP registrations, this can increase the risk to the lender, as the borrower may not renew IP and its value may reduce.
Taking security over IP: difficulties
As the value and potential of IP grows, lenders are beginning to be more confident with taking security over this asset class. However, there are many general issues and considerations which must be taken into account when determining whether a lender should seek to take security over a borrower's IP.
Valuation
Firstly, the value of the IP must be ascertained to determine whether it will be a good basis for providing security. This is difficult as IP can have a different value to different entities; a lender may not have the skills/expertise to use IP if they need to enforce it. IP specific to a particular industry may be enormously valuable to the borrower but of little value to a lender who does not trade within that industry.
We also note that a considerable gap exists between the value of IP assets examined for a collateralisation or internal evaluation and the value attached to IP assets in an actual transaction. Low creditor confidence in intellectual property as security and the lack of standards in the valuation of IP assets are two major impediments to the continued growth of IP financing.
Maintenance
Maintaining IP rights requires constant vigilance. Trademarks and patent registrations will lapse permanently if not renewed. Unregistered trademarks and copyright will become worthless if a third party successfully claims that its rights have been infringed. A failure to defend valuable IP by taking legal action against bootleggers and piracy may lead to the same outcome.
International considerations
Companies operating in a global market will often have a multi-jurisdictional IP portfolio. While security can be taken over the entirety of the portfolio by a single English law security agreement, there are a number of issues that will arise:
- some jurisdictions do not recognise the concept of a charge. Under Norwegian law, security may only be taken over IP registered in the jurisdiction by way of a mortgage or as part of a floating charge over the borrower's assets
- recording the lender's security interest may not be possible in all jurisdictions, even those where the concept of a charge is recognised
- the cost of recording security interests in a number of jurisdictions can be prohibitively expensive
- there is no concept of 'equity' in civil law jurisdictions. In countries such as Spain where it may not be possible to record the lender's security interest, while this will be recognised as a contractual right as between lender and borrower, enforcing the security against third parties (even those with prior knowledge of the transaction) will not be possible.
Types of Security
Mortgage
A mortgage is generally the preferred route, and if the IP right is unregistered, a legal mortgage is desirable. This is effected by way of an assignment by way of security. The assignment should include warranties that the borrower owns the IP, there are no claims for infringement against the borrower or prior security interests, and all renewals are up-to-date. Legal title to the IP will be transferred to the lender, while simultaneously the borrower will retain a beneficial equitable interest in the mortgaged IP (the equity of redemption). The borrower will be entitled to the re-conveyance of the legal title upon the full discharge of its debt. At the same time, a licence will be granted back to the borrower, to allow it to use the IP. Licence-back should be an exclusive or sole licence, which is royalty-free, limited, and revocable. It should contain an obligation on the borrower not to do anything which may damage or reduce the value of goodwill in the IP. The lender should also be permitted to terminate the licence if the borrower defaults on the loan.
The benefits of taking a mortgage include: preserving priority for the lender; lender protection from disposal of the IP right by the borrower; lender ease in enforcing any default by the borrower by selling or licensing the IP without the need for borrower consent.
The disadvantages of taking a mortgage include: higher maintenance costs (although an agent can be appointed to manage the IP portfolio); the lender being required to be a named party in infringement proceedings; the mortgage not applying to future IP; and complex documentation will be involved, which will be costly and cause the process to be longer.
As patents and trademarks are registered IP rights, and can have a high value, a mortgage should be taken over these. Equally, lenders seeking to take security over unregistered IP of commercial value (for example, copyright in the computer programmes developed by an IT company) should do so by way of a legal mortgage.
Fixed charge
General charging wording in a security document will usually be enough to cover IP where security is taken over a number of assets of the borrower, which will include the IP. The usual wording includes a charge over present and future IP rights in respect of the portfolio of the borrower's IP rights.
If the borrower's IP is the main or only asset over which security is taken, any charging provisions should be revised so they are specific to the IP that security is being taken over. The same applies to the warranties and representations in the security documentation e.g. covenants requiring the borrower to maintain the IP, and a warranty that no other parties have any claims over or security interests in the IP.
If a fixed charge is being taken, the charging provisions must contain information in relation to how the lender will control the IP. If these arrangements are absent, the security will be considered to be a floating charge. The lender should consider taking an assignment of the IP, which agreement would be held in escrow by the lender, to be used if the borrower defaults and enforcement is required. Alternatively, the lender could obtain a power of attorney from the borrower to enable it to enforce security should the need arise. By way of example in relation to software being charged, sometimes the lender and the borrower enter into an escrow arrangement whereby an escrow agent agrees to hold the software in escrow and to release it to the lender in the case of enforcement. This process can be costly and an administrative burden since it needs to be maintained during the life of the security. However, it can be beneficial for borrowers sensitive to disclosing their software to any third parties. Lenders will also require a copy of the software to be given to them (and further copies, each time such software is updated) along with copies of relevant user guides. This would ensure that any receiver would have a copy of the software. Whether this is appropriate would depend on how sensitive a borrower is to allowing such information to remain in the possession of the lender.
The benefits of a fixed charge include: no maintenance requirements for the lender as the lender does not own the IP; priority over other lenders; simpler and quicker to put into place; applies to future rights; the lender retains control of the secured IP and can sell the IP, appoint a receiver, or receive royalties.
However, one major disadvantage of taking a fixed charge over IP is that the borrower could sell the IP to an assignee without notice.
Floating charge
A floating charge will only be relevant if the IP assets of the borrower can only be identified as a group, not as an individual asset.
For example, the borrowers 'brand' could be secured by way of a floating charge. This would include unregistered trademarks, and copyright in the logo, domain name, or website. The lender will not have any maintenance requirements over the IP. However, the borrower could sell the IP without notice, and the lender will fall lower in the order of priority.
Perfection and registration of security
If a lender takes an assignment, licence or security interest in a registered IP right this will need to be registered at the appropriate registry as soon as possible after the transaction.
Security should also be registered with the Registrar of Companies. If the lender takes an assignment of a patent or trade mark as part of its security package, a lender that fails to register the assignment six months from the date of the underlying transaction would not be able to claim damages for infringements occurring whilst the assignment is unregistered. This lender will only be able to claim damages or an account of profits in respect of infringement as from the date its ownership is recorded.
Further, if not recorded in a register, relevant documents may not be useful as evidence of title in a court of law. Registration may assist in fending off a third party purchaser.
Enforcement
A lender taking security over IP must be aware of enforcement routes, should it need to enforce following a default by the borrower.
If the lender has taken a mortgage over IP it will own the IP, and will therefore be able to sell the IP, grant a licence to a third party and terminate the licence to the borrower, or exploit the IP itself.
If a fixed charge has been taken, the lender will take ownership of the IP by dating the assignment it is holding in escrow, or the lender can exercise the power of attorney it has been granted, to assign the IP. Once the IP has been assigned the lender can sell it, grant a licence over it, or exploit the IP itself. Alternatively, the lender could appoint a receiver to take possession of the IP or sell the IP and this may be a convenient route if the security covers other assets of the business. Without an express power of sale, the lender will have to apply to court for an order of sale or the appointment of a receiver.
If a floating charge has been taken, the lender will only be able to exercise their right to appoint an administrator, who would likely sell the borrower's business and use the sale proceeds towards repayment of the debt.
Conclusion
IP rights are a commercially valuable asset to any business that derives goodwill from its brand or associated IP interests, and so too may it be to a lender. Because IP is intangible, it poses particular challenges for a lender wishing to take security over it. IP specific to a particular industry may be valuable to the borrower but of little value to a lender who does not trade within that industry. Consequently, it is often of indeterminate resale value and therefore, as discussed in this article, before taking a security interest over IP (be that by mortgage, fixed charge, or floating charge) the lender should explore how it would exploit that IP if it had to enforce its interest, and be mindful of the practical steps needed to make good that security, such as registration formalities (both at Companies House and the UK/EU Intellectual Property Office). Nevertheless, when presented with an IP-rich borrower, taking security over IP should be a key consideration when acting for either borrower or lender.
