In today's stream of commerce in the capital markets, intellectual property plays a prominent role. Intellectual property may take many forms but generally includes (i) patent rights, (ii) copyright rights and (iii) trademark and servicemark rights. Intellectual property is a creation of federal law and covers a wide range of matters from inventions to writings and may be a valuable asset from both a debtor and creditor point of view.
Patented technology, copyrighted media and trademarked brand names are significant components of both the U.S. and global hi-tech economies. The financial impact of such individual creativity generates important revenue streams for the parties involved. Fortunately, an owner of intellectual property has various protected rights under federal law and federal law generally preempts local law in this area.1
One of the main avenues that allow parties to leverage the financial import of intellectual property is the license agreement. The licensor or owner of intellectual property may enter into licensing agreements with third party licensees that will mutually benefit (hopefully) both the licensor and licensee in their respective businesses. The licensor may receive royalties and other income from its license of its intellectual property and the licensee will seek to enhance its business and product by the use of the intellectual property under the terms and conditions of the license agreement. In certain industries, the licensing of intellectual property may comprise a substantial portion of a licensor/licensee's balance sheet. Licenses usually take the form of either "exclusive" or "non-exclusive." The purpose of this article is to discuss intellectual property licensing issues and the role of secured commercial finance.
Under Article 9 of the Uniform Commercial Code ("UCC"), both exclusive and non-exclusive licenses appear to be forms of personal property in which a debtor has rights, even if limited, sufficient enough for a security interest to attach.2 It is well accepted that a non-exclusive license is a "personal right."3 So where does this personal right fit in regarding secured financing?
An intellectual property right is viewed as a "general intangible" under the UCC.4 To a lender or other financial institution, a general intangible is a collateral category of comfort by virtue of the UCC whereas the concept of intellectual property collateral in its pure form may not be as familiar. Lenders, specifically asset-based lenders, look primarily to a collateral base during the underwriting or approval process. If a borrower's intellectual property (licensed or otherwise) can be properly appraised and given a value, a lender is generally willing to lend on such collateral within certain parameters - specifically, its ability to perfect a security interest therein.
The Borrower As A Licensee
As mentioned earlier, the focus of this article will be geared toward the license issue and not the underlying intellectual property vis--vis the UCC. If the borrower is a licensee, the licensor is viewed as an "account debtor" under the UCC. UCC 9-102(a)(3) refers to an account debtor as a person obligated on an account, chattel paper or general intangible. The obligations of the licensor in this scenario is one of performance rather than monetary. The licensor is generally not obligated on any financial level under the license agreement but is expected to perform under the terms therein and make available its intellectual property to the licensee.
Naturally, most intellectual property licenses will contain covenants with respect to what the licensee may and may not be able to do regarding the underlying intellectual property. One of the more likely covenants will be the prohibition against the transfer or assignment of the license or the pledge of the license to a third person as security for a loan or other financial accommodation. As opposed to the general practice of filing a security agreement with the Patent and Trademark Office or Copyright Office, the federal statutes do not require a license to be filed so there are potential pitfalls for a prospective lender in this area.
It should first be noted that there is a difference between an "assignment" of intellectual property and a "transfer." A transfer that is not an absolute sale constitutes a license.5 The lender is therefore presented with an interesting set of circumstances. What rights, if any, would a lender have in a borrower/ licensee secured lending transaction and how do the rights of the licensor come into play?
UCC 9-408(a) provides that a term in a promissory note or in an agreement between an account debtor and a debtor which relates to a health-care insurance receivable or general intangible including a contract, permit, license, or franchise, and which term prohibits, restricts or requires the consent of the person obligated on the promissory note or the account debtor to, the assignment or transfer of, or creation, attachment, or perfection of a security interest in, the promissory note, health-care insurance receivable, or general intangible, is ineffective to the extent that the term (1) would impair the creation, attachment, or perfection of a security interest or (2) provides that the assignment or transfer or the creation, attachment, or perfection of the security interest may give rise to a default, breach under the general intangible. This section is the so-called "anti-assignment" provision of the UCC. Under this section, a lender would be able to obtain an effective security interest in the general intangible despite the likely conflicting terms contained in the license agreement.
Limitations On Remedies
It is clear that a licensee/debtor may grant a security interest to a secured party under the UCC. However, what will the secured party be able to proceed against in a default/enforcement action? A secured party will be limited in its ability to enforce the security interest in the debtor's interest in an intellectual property license for a variety of reasons. First, the licensor, which is not a party to the arrangement between the secured party and debtor, may ignore such security interest. Second, the secured party will not have a lien on the underlying intellectual property which gives rise to the license agreement. Third, the security interest imposes no duty on the licensor and is not enforceable against the licensor.6
From an equitable point of view, it would appear that short of some type of infringement on the intellectual property by the licensee, the licensor should not be able to stymie the licensee's legitimate business interest in the license or for that matter, in the licensee's ability to leverage that interest for its own benefit in the credit markets. The reality is that as long as there is no default under the credit relationship between the licensee and lender, the issue does not actually come to a boil. Moreover, these intellectual property relationships provide impetus for the credit markets and the drafters of the UCC appear to have attempted in UCC 9-408(d), to strike some type of balance between the secured party and licensor in allowing such security interests to exist while protecting the licensor's proprietary interest in the intellectual property from a foreclosing secured party.
The bankruptcy of a licensee creates an interesting situation. Like all bankruptcy filings, the end-game seems to be a weeding out process among the secured and unsecured creditors. Most importantly, Section 552 of the U.S. Bankruptcy Code invalidates security interests in property acquired after a bankruptcy petition is filed except to the extent the post-petition property constitutes proceeds of pre-petition collateral. By properly perfecting its security interest in the general intangible of the licensee, the lender should fall under the "secured creditor" status which is paramount in a bankruptcy and should prevail against a trustee or other creditors on the proceeds or any other disposition of the licensee's interest.7
While the concept of intellectual property licenses as collateral may play an important role in commercial finance, lenders need to be aware of the limitations that may be available to them under default scenarios concerning a licensee and in particular, the rights of the licensor. However, consideration should be given not only to the lender's status as a secured creditor in a bankruptcy proceeding, but also with respect to the non-bankruptcy or liquidation situation involving a licensee and the potential sale or other disposition of the licensee or its assets. As stated earlier, UCC 9-408(d) provides the licensor with "anti-secured party" protection but the secured party, with a security interest in the proceeds of a licensee's collateral, may be in a position to use this status in potential negotiations with the licensor. The possibilities that may play out under this scenario, including the licensor agreeing to a lender's use of the license to produce a good or asset on behalf of the defaulting licensee, would be intriguing. Generally, the bottom line for all creditors, including a licensor, is to maximize the value of the disposition of assets of a debtor and the lender's status as a secured party may aid that goal notwithstanding UCC 9-408(d).1 Art. VI of the U.S. Constitution provides that: "This Constitution, and the Laws of the United States which shall be made in pursuance thereof. . . shall be the supreme law of the land. . ."
2 Official Comment No. 6 to UCC 9-203.
3 Unarco Indus., Inc. v. Kelley Co., Inc., 465 F.2d 1303 (7th Cir. 1972).
4 Official Comment 5(d) to UCC 9-102.
5 Waterman v. Mackenzie, 138 U.S. 252 (1891).
6 UCC 9-408(d).
7 Official Comments Nos. 7 and 8 to UCC 9-408.
James A. Dempsey is Of Counsel to Sills Cummis & Gross P.C.'s Banking and Finance Practice Group and is resident in the Firm's Princeton, New Jersey office. The views and opinions expressed in this article are those of the author and do not necessarily reflect those of Sills Cummis & Gross P.C.