2 July 2020
Download - July 2020 – 3 of 7 Insights
Traditionally, lenders have taken security over the tangible assets (such as machinery or land) of borrowers. However, within the last few decades lenders have begun to recognise that intangible assets (such as IP rights) have realisable value and so potential to be used as part of a package – or even the basis – of security. While taking security over IP rights is now an established process, where the IP is of significant value, careful consideration is required as to the rights to be secured and the type of security to be granted.
Under the law of England and Wales, it is possible to grant security over both registered and unregistered IP rights including patents, trade marks, design rights, copyright, database rights, domain names and confidential information.
The types of IP right that generally form a good basis for security on their own are those for which there is a ready market and realisable value separate from the business of the borrower. The lender will want to ensure that it can quickly and easily realise the value of the IP should the borrower default on the loan and enforcement be necessary. Patents and copyright usually fall within this description, with rights such as patents for pharmaceutical and electronic products and copyright in films and bespoke computer software commonly secured.
Other types of IP right often do not have sufficient standalone value to form the basis of security on their own although there are exceptions. For example, trade marks that are particularly renowned (such as those in the fashion industry) and registered designs for the appearance of successful products can form a good basis for security. Where security is being granted over a package of assets, relevant IP is usually included so that the lender can realise the full value of those assets on enforcement.
It is also possible to grant security over a licence or sub-licence of a patent, provided that it is in writing and signed by the borrower and is not prohibited by the terms of the licence. Opinion is divided over whether it is possible to take security over a licence of other rights such as trade marks and copyright. Security can also be taken over applications for IP rights although these rights usually have limited value until registered.
It goes without saying that borrowers should think carefully before granting security over any valuable IP rights and consider the potential impact of losing any such rights in the event it defaults on the loan.
Since IP is intangible it is not possible to take a pledge over it - possession of the asset in question being required for a pledge. However, a pledge can sometimes be taken where IP is embodied in a physical item such as a master copy of a film. More commonly, a mortgage or charge is taken over IP rights.
A legal mortgage is generally the safest form of security. This is because legal title to the IP is assigned to the lender. This is usually achieved through an assignment by way of security. Simultaneously, the borrower retains a beneficial equitable interest in the mortgaged IP called the equity of redemption. The borrower will be entitled to the re-assignment of the legal title to the IP upon the full discharge of its debt.
A licence will usually be granted back to the borrower to allow it to use the IP. The licence-back should generally be exclusive, royalty-free, limited, and the lender should have the power to terminate the licence if the borrower defaults on the loan.
The main advantages of a legal mortgage are that it protects the lender from disposal of the IP rights secured by the borrower and makes enforcement by the lender easier in the event of default. However, lenders can be reluctant to take a legal mortgage over IP rights since owning legal title to those rights comes with various administrative and other obligations. In particular, the lender will have to maintain the rights, record the assignment (as well as the grant of security) at the relevant IP registries and be a named party in any infringement and other proceedings. The grant of a legal mortgage also requires more complex documentation.
A fixed charge involves the creation of an encumbrance over the IP rights in question. Provisions are generally included to ensure that legal title to the IP rights can be transferred to the lender in the event of default by the borrower. One way of achieving this is for an executed but undated assignment of the IP to be entered into, which is held in escrow by the lender, to be used if the borrower defaults.
Alternatively, the lender can be given a power of attorney from the borrower to enable it to enter into an assignment of the IP and otherwise to enforce the security if the borrower defaults.
One of the key elements to establishing a valid fixed charge is demonstrating that the lender has control over the asset. For registered IP, as well as relevant provisions in the security document, this is assisted by noting security on the relevant IP register. Absent control, the security will be considered a floating charge.
Fixed charges are generally quicker to put in place and administratively easier to manage than mortgages as the lender does not take legal title over the IP. Nonetheless, since the lender retains control over the IP, it should be able to realise its value relatively easily if necessary. The downside of a fixed charge is that the borrower (as legal owner of the IP) has greater scope to transfer or encumber the secured rights (often in breach of the security document) without giving notice to the lender.
Under the law of England and Wales, any acquirer of an interest in IP takes subject to any security and other interests if it has knowledge of the existence of those interests (and is a purchaser in good faith and for valuable consideration). This knowledge is imputed if the security interest is recorded against the relevant IP at the UKIPO (see below). While this might provide some comfort to the lender, it will not want third parties having rights in or taking ownership of the IP secured. Given that recordal is not possible for unregistered rights, a legal mortgage might be preferable if unregistered rights form a key part of the security package.
A floating charge will be relevant if the IP assets of the borrower can only be identified as a group, not as individual assets. The advantages of a floating charge include that the lender does not have any maintenance requirements over the IP and the borrower usually has greater freedom to deal with the IP in the ordinary course of its business. In addition, most floating charges permit the lender to appoint an administrator to the borrower. Conversely, the lender will rank behind fixed charge holders in the order of priority on an insolvency and the borrower has greater scope to transfer or encumber the secured IP without notice to the lender (although, again, this can be partly mitigated, at least for registered rights in the UK, by recordal at the UKIPO).
Before taking a mortgage or fixed charge over IP, 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 and to answer questions about those assets. At the same time, the lender will also carry out an independent IP audit to verify the extent and value of the assets. This will usually entail conducting searches of IP databases (for registered rights) and online. The sorts of issues the lender will want to determine include:
Following due diligence, the value of the IP must be ascertained to determine whether it will be a good basis for providing security. Factors relevant to the value of any particular IP right will include the type of right, its strength, the number and value of similar products on the market, the cost of maintaining and policing the right, and the potential to license or sell the right to others in the market. These factors will need to be flushed out for key IP rights as part of the due diligence process. It is worth remembering that a considerable gap often exists between the value of IP assets examined for a collateralisation or internal evaluation and the value of IP assets if they have to be sold or licensed.
The documents required and their scope will depend on the type of security being granted and the type and value of the IP rights in question. The lender will usually want the borrower to give various warranties and representations about the IP being secured, including around ownership, validity, infringement, and renewals. These will be particularly important for unregistered rights against which fewer searches are possible. The borrower will want to resist certain warranties (such as that the IP rights are valid) or qualify them by knowledge. The scope of the warranties will be subject to negotiation and there might be disclosure against them in the normal way.
In addition, the borrower will usually have to agree to various other provisions regarding the IP rights, including not to grant any further security over them (a negative pledge), to use, maintain and actively police them, not to do anything which might negatively affect their value, to notify the lender of any suspected infringements and for any proceedings concerning the rights to be at the borrower's expense but lender's discretion.
Where security is granted over copyright, the lender will normally also want a waiver of moral rights and to ensure that security is taken over any future versions of the work. This is particularly important in the case of computer software which is often updated. A lender who is taking security over copyright in software should ensure that the source code is placed in escrow (to be released by the escrow agent in the event of default and enforcement) so that it has a saleable asset.
The UKIPO operates a straightforward and cost-effective recordal system. A recordal should be made in respect of the grant of any security interest over a registered IP right (and over a licence or sub-licence of any such right) and any assignment and licence-back of a registered IP right forming part of the transaction. Recordal must be made within six months from the date of the underlying transaction to ensure that the lender takes priority against others claiming an interest in the IP right in question and that actions for infringement and the full range of remedies are available. The cost of recordal is low and is charged per owner as opposed to per IP right.
The system for recording registrable transactions at the EUIPO is also straightforward and cost-effective. The rules in other jurisdictions differ and local advice should be sought. In some jurisdictions, there is no facility to record security interests against IP rights, which can weaken the value of any security.
Any security created by a company or LLP registered in England and Wales (with certain exceptions) should also be registered at Companies House within 21 days of its creation. Failure to meet the 21 day time limit means the charge will be void against a liquidator, administrator and any creditor of the company or LLP in question.
At the end of the Brexit transition period, each registered EUTM and Registered Community Design (RCD) will automatically give rise to a comparable UK trade mark or design registration (as appropriate). References to EUTMs and RCDs in security documents are to be read as including the comparable UK registration which derives from it. The same is true of licences of such rights, if they relate to the UK.
However, recordals of security interests and licences against EUTM and RCD applications and registrations will not be ported across from the EUIPO register (or International register) to the UKIPO register. It will, therefore, be necessary to record any registrable transactions (such as security interests and licences) at the UKIPO against the newly-created comparable UK rights. Lenders should ensure that this is done within the prescribed time frame.
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 an English law security agreement, a number of issues can arise. In particular, some jurisdictions do not recognise the concept of a charge and others do not have facility for security to be registered (a particular problem in those countries that do not recognise equitable rights). This can weaken the value of any security taken. Others require assignments and powers of attorney to be in a prescribed form. In addition, the cost of recording security interests in a number of jurisdictions can be expensive. If non-UK IP rights are key, specialist advice should be sought at the outset.
If the security documentation has been properly drafted, the lender will usually be given ample warning of a potential default on the part of the borrower. Normally, the lender will want to explore a number of options before deciding to enforce the security since enforcement may not result in the lender being repaid in full. Much will depend on the borrower's financial position, the relationship between the parties and market conditions.
One option is for the lender to waive the event of default. Any waiver should be documented formally (even if there is a "no waiver" clause since these clauses are not always effective). Another option is for the lender to agree an amendment to the terms of the loan. Again, this will need to be formally documented. Where the borrower's financial position is more serious, lenders and creditors might be asked to enter into a debt restructuring to help improve the borrower's financial standing.
As a last resort, the lender may have to enforce its security or rely on it in an insolvency process. The options for enforcement will vary depending on type of security granted, the terms of the security (and any related) documentation and the type of IP right in question.
While the lender will usually have power (in the security document) to sell, license, and otherwise dispose of or use the IP rights, it will rarely wish to exercise these powers itself. The holders of mortgages and fixed charges may appoint a receiver to deal with the secured IP. No court involvement or formal insolvency proceedings are required, but there must be express power in the security document for a receiver to be appointed. The powers of the receiver should be expressly specified in the security document as its statutory powers are relatively limited. Preferably, the receiver will act as agent for the borrower and have the power to deal with and sell the secured IP so that the lender can realise the value of the IP without incurring any liability.
In the case of floating charges, the lender usually has the power to appoint an administrator or (for floating charges taken prior to 15 September 2003) administrative receiver.
by Multiple authors
by Simon Jupp
by Marie Keup