Reaping Tangible Benefits From Intangible Assets: Financing Intellectual Property

Friday, June 1, 2007 - 01:00

The transition from an industrial-based economy to a service-based economy presents new challenges and opportunities for lenders. Traditionally, borrowers sought to monetize inventory and receivables for working capital needs and to finance the acquisition and development of property, plant and equipment. Lenders and borrowers have become familiar with using tangible assets to finance working capital and other business needs, and our legal system protects and promotes such financing arrangements.

Today, potential borrowers often do not own tangible assets at previous levels. Instead, many borrowers sell service products, and their assets consist of processes, formulas, databases, information services, brand names and related patents, trade secrets, copyrights and trademarks.

Firms still need working capital to sustain growth. Consequently, the need to use intangible assets for credit support is growing, and such use is increasingly accepted as a viable alternative for handling businesses' day to day financial needs. Financing arrangements that put a borrower's intellectual property to work are not without risk, but for lenders and borrowers willing to work hard and think flexibly, new opportunities are available.

Financing intellectual property raises unique issues. For example, one significant challenge to the lender is properly valuing intellectual property. Intangible assets might have intrinsic value standing alone, or their value may be based on cash flow from royalties generated from licensing out the right to use the asset. The life of the asset should be determined. Recently, in KSR International Co. v. Teleflex Inc. et al (decided April 30, 2007), the United States Supreme Court made it harder to obtain a patent based on elements of existing inventions, which may encourage re-examination of existing patents. Additionally, understanding the "bundle of sticks" comprising usage rights, and whether such rights may be transferred, are important issues. The licensee of a trademark may only have a nonexclusive personal right to use the trademark, with limited rights of assignment. In the event of the licensee's bankruptcy, a debtor-in-possession, as successor to the licensee, may not be able to assume the right to use the trademark. If the trademark is a borrower's primary asset, the business may no longer be viable and the prospects of loan repayment jeopardized. In sum, it is usually more difficult for a lender to determine "what it has" and "what it's worth" when dealing with intellectual property.

Still many lenders are pleasantly surprised to find that "boot" collateral comprised of intellectual property can provide, albeit inadvertently, a full or partial way out of distressed financing arrangements. Other lenders are successfully lending directly on their customers' intellectual property.

Determining that there is value to support debt is only the first step. Obtaining an enforceable security interest is the next one. With careful and thorough due diligence, a security interest can be obtained by a lender. In most cases, that interest can be perfected and ultimately enforced. The rules relating to security interests in intellectual property often appear confusing and unclear, but Revised Article 9 of the Uniform Commercial Code (UCC), along with federal and state law, provide the legal framework.

It is generally settled that under Article 9, a security interest in a patent or trademark is perfected by filing an appropriate UCC-1 financing statement, and the foreclosure procedures, in many instances, are governed completely by Article 9. A prudent Lender, however, will also file with the United States Patent and Trademark office to prevent unwarranted transfers or avoidance claims in bankruptcy. In certain cases, lenders may wish to take additional steps to protect their collateral. For example, if a trademark is used as part of the address for a borrower's website, a lender may want to take the precaution of notifying the domain host of the security interest and having the domain host acknowledge the security interest and agree to comply with a Lender's instruction after a default.

The financial community has grown increasingly aware of the necessity and opportunity of employing intellectual property as credit support and has developed sophisticated new methods to finance such assets. Fortunately, the UCC and related state and federal laws continue to evolve to facilitate the process.

Christopher G. Dorman is a Partner with New York State law firm Phillips Lytle LLP. He concentrates his practice in the areas of banking and commercial law. He can be reached in the New York City office at (212) 508-0427.

Please email the author at cdorman@phillipslytle.com with questions about this article.