Know What You're Getting - Five Handy Tips on Using IP Assets as Collateral

by Terry Church, J. D. - Morgan Miller Blair

As we progress further into the Information Age, the value paradigm is changing.  Businesses are more and more building value based on their intellectual property assets.  Such intangible assets have immense value and can offer a ready source of collateral for loans and other debts.  It is to the advantage of all parties to a credit transaction to understand some facts about using intellectual property assets as collateral.  An owner of such assets may not be aware that she holds an asset she can turn into cash.  And for the creditor, what may at first blush seem solid backing for a financial obligation may turn out to be so much vapor when it comes time to collect.  Following are five things to should take into consideration when evaluating IP assets as collateral.  Our purpose is to provide a primer to the various types of intellectual property assets that may be considered as candidates, and offer a few points to take into consideration in deciding whether to take the plunge.

  1. Consider where the value lies. 
    A prospective borrower will want to maximize the perceived value of his assets, and a creditor will want to know that if foreclosure becomes necessary he can realize sufficient value to get his money back.  The commercial or competitive value of an asset often differs from its potential to generate a cash return.  For example, patents derive their value several different ways.  A patent owner derives a valuable competitive advantage from his ability to prevent a competitor from practicing the patented invention.  But this intrinsic value is of little practical use to a creditor who has no interest or ability to invest in the skill set and know-how to exploit the patented investment to yield a return.  The patent holder makes a much better case if he can explain to the creditor the value that can come from licenses and royalties. A creditor foreclosing on a security interest in a patent may exploit the patent by granting licenses under it or being the beneficial owner of a royalty stream.  It is vital that the security agreement provides for the creditor to exercise these rights to grant licenses and/or collect royalties.  The creditor must also be aware of what other licenses have already been granted.  This can be especially important in a bankruptcy situation.

  2. Know your competition.
    A security interest in a patent will be profoundly affected by existing licenses and joint owners.  A patent doesn’t entitle the patent holder to practice the patent. It only allows her to prevent others from practicing the patented invention.  So if there are other owners who can grant that permission, the right to prevent loses much of its value.  Any joint owner of a patent can grant rights under the patent, and it will be necessary to ensure that the joint owner agrees to certain rights restrictions in order to protect the interests of the secured party.  Also, if the patent is subject to licenses that allow for sublicenses, the value of the patent can be rapidly diluted.  Ownership interests, including assignments and security interests, should be registered with the United States Patent and Trademark Office (USPTO.gov). You may have to dig to discover the licensees and their rights.  If you are a creditor getting the security interest, be sure to register it with the USPTO.  Like copyrights, patent are governed under federal law and state registration alone may not be sufficient to protect the rights of creditors against good faith claims under federal registration.

  3. Copyrights make good collateral, but be careful with the paperwork.
    Copyright rights arise upon the creation of the work, but they are not enforceable until they are registered with the United States Copyright Office (copyright.gov).  Copyrights can only be transferred by written assignment that is registered with the Copyright Office, so perfection of a security interest must also be registered.  Since copyrights are a federal right, copyright registration in the Copyright Office will trump state Article 9 filings.  It is a good idea to include a power of attorney in the security agreement to ensure that if the debtor is unable or unwilling to file the assignment at foreclosure, the secured party may do so in his stead.

  4. Careful what you ask for … or give.
    Trademarks do not make good security, although rights in a trademark may provide leverage against a reluctant debtor.  A trademark designates the source or origin of a service or product and is closely associated with the goodwill of the owner.  Foreclosing on a security interest in a trademark would likely do little more than cripple its debtor owner.  To a business owner, a trademark may be his most powerful marketing tool.  Losing the right to use the mark with your business could have a devastating consequence that would benefit no one. From the creditor’s point of view, a trademark without the goods or services it represents is worth very little. How valuable would McDonalds® be without hamburgers or Starbucks® without coffee?

  5. Trade secrets are extremely valuable … until they’re not.
    Trade secrets are without a doubt the most commonly used form of intellectual property protection.  But they are also the most volatile. A necessary attribute of a trade secret is secrecy.  Once it is revealed to the public, even inadvertently, its legal protection is lost, along with much of its commercial value.  By its nature, a trade secret is constantly exposed to risk of disclosure by its users, a risk over which a secured party has little control.  So a security interest in a trade secret requires two rather conflicting elements: a clear description of the secret(s) subject to the security interest, and robust and monitored procedures in place to protect its confidentiality, not only in the hands of the security holder, but most importantly in the hands of the users of the secret.  A creditor should check to see that the trade secret owner has confidentiality agreements in place with his employees and contractors who may have access.  Moreover, it is impossible to register a security interest in a specific trade secret asset because identifying it in a public record would destroy the trade secret.  Intellectual Property has become a major component of business assets in this Information Age.  Businesses are seeking to extract value from these assets in new and different ways, and are increasingly offering them as collateral for debt.  But the laws governing intellectual property are complex and often technical.  Anyone seeking to use intellectual property assets for collateral for a loan or other debt obligation should seek the advice of a knowledgeable and experienced intellectual property attorney.

Terence N. Church, J.D., Principal, Business & Technology GroupMorgan Miller Blair 
Direct: (925) 979-3388 •
[email protected]
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