Using IP assets as security

The Indian economy, like those of many other developing nations, is increasingly driven by intangibles, with many companies listing intellectual property as their key asset. The financial sector has innovated over the years by advancing loans with IP as their sole or partial security. The lender and the borrower have to go through many pre- and post-transactional exercises, including due diligence, recording of security agreements, maintenance of IP and the measures to be taken should there be a default on the money advanced.

Due diligence

It is vital for comprehensive due diligence to be conducted to ascertain exact ownership, validity, conflicting rights and valuation of the IP, and the nature of the loan to be created.

Trademarks in India are protected under common law and statute law. A simple trademark search of the register may not reveal the accurate ownership, given backlogs at the Trade Marks Registry, lack of mandate to record the assignment of registered trademarks, etc. The due diligence would have to be done not only on the title of the trademark; it is also necessary to evaluate the distinctiveness, use and registrability of the trademark.

In India a copyright need not be registered to be protected and may be protected when the author and the first owner separate in cases of work that has been commissioned or was created when the author was  employed. Further, even when works are assigned, they may revert back to the author by operation of contract or law. Patents and industrial designs are solely protected under statute, so details of ownership, assignments, licences and validity can be ascertained relatively easily.

However, other forms of IP such as confidential information, trade secrets and know-how are protected only under common law, with no mandates or obligations to register before any authority, the contractual agreements between parties dealing or conveying them.

No matter the type of IP asset, the lender advancing money against it should rely on its own intelligence through inspections, investigations and due diligence.

Valuation of the IP

Valuation of IP assets is more an art than a science. The oft-ignored but essential factors would be to monitor the competitive landscape, including the levels of infringements and competing patents, and the actions taken by the IP owner, which could easily eradicate the bottom line of an IP asset or, in fact, the entire portfolio surrounding it.

Also to be considered are the expenditure on research and development, marketing, present and projected revenue, through direct sales or through licensees, both present and prospective.

Nature of loan, security agreement

The traditional form of securing a loan is a mortgage or fixed or floating charge, without transferring the title of the IP asset but with the lender acquiring a simple equitable interest thereon. A guarantee on the part of the borrower to transfer the full title in case of default or to have a pre-executed assignment agreement, which could recorded in case of default, is recommended.

A second option would be to let the lender have the right to sell the secured IP, either by executing a power of attorney in favour of the lender or by way of a receiver with or without the need to institute formal court proceedings.

"due diligence would have to be done not only on the title of the trademark; it is also necessary to evaluate the distinctiveness, use and registrability of the trademark."

There could be restrictions on any future third-party rights to be created on the IP assets on which the security has been created by the borrowing IP owner, especially by way of further security interest or alienation by way of sale or assignment. Licensing of the said IP assets could be considered only with the prior approval of the lender with a first charge on the licence fees/royalties.

Special purpose vehicle

In recent times, the more popular system is to create a special purpose vehicle (SPV), which is normally an entity especially created to take over all the IP assets on which the security is to be created, including surrounding rights such as the licences granted to third parties, the right to collect royalties on such IP assets, etc. The creation of the SPV would not only not affect the ownership of the secured IP but also retain first and sole charge over the IP assets even if the borrower becomes bankrupt.

The structure, lifespan and other mandates of the SPV are to be tailored by the lender and the borrower to include provisions in case of default or repayment of the loan.

Post-transactional mandates: recording of security interests

With the signing of a security agreement, charges on the IP assets have to be recorded before the appropriate authorities, to ensure notice to potential or subsequent purchasers, assignees or licensees without which devastating consequences of conflicting interest may be created.

While the Indian patent and design statutes provide specifically for registration of a mortgage, licence or other instrument to any interest apart from an assignment, no such specific provision is available under the Trade Marks Act. One could possibly address a letter citing the loan as a limitation.

Repayment and defaults

The whole structure of arrangement chosen would be put to a real test only upon default on the part of the lender, which would automatically trigger sale of the secured IP assets, as contemplated, either to proceed through a liquidator in a bankruptcy proceeding or taking over the SPV and satisfying the claims by sale of the SPV, or the IP assets held by the SPV.

Multi-jurisdictional considerations

IP assets being invariably multi-jurisdictional, it is necessary to carefully consider the laws in each jurisdiction regarding the scope and nature of the IP asset, the nature of loan which can be created over each asset, the ability and requirement to record such security interest, and the cost of each recorded asset and of enforcement of the securities created in case of default.

Given the likely surge in dependence on intangible assets and its capitalisation, it is time that there were fresh laws or amendments to existing ones to facilitate, govern, administer and enforce the securitisation of IP assets, balancing the interests of the IP owners and the lenders.

M S Bharath is a partner at Anand and Anand. He can be contacted at: bharath@anandandanand.com