Avoiding the Pitfalls in
using Intellectual Property as security
Craig Subocz - Solicitor
INTRODUCTION
Small and
medium enterprises (“SMEs”) are becoming attuned to
the notion that their intellectual property (“IP”) is
valuable. Therefore, there is a growing trend of IP being
offered as security in exchange for finance.
To better
secure the SME’s repayment obligation, the lending
institution should maximise its capacity to control future
dealings with the security. However, the lending
institution and the SME must be aware of the novel issues in
using IP as security.. This article outlines a checklist of
important issues when dealing with IP as security.
BACKGROUND
The term
“intellectual property” encompasses a broad range of
rights. Typically, copyright, designs, trade marks and
patents are the rights most often used as security.
Copyright is granted automatically to creators of
sufficiently original works. Statutory rights in trade
marks, patents and designs are granted upon their
registration. The exclusive statutory rights are the
owner’s personal property and may be licensed, assigned and
encumbered.
VALUATION
OF IP
A key
consideration in determining whether to accept IP as
security is the value of the IP.
There are
numerous methods for valuing IP, and to explore each method
is beyond the scope of this article. However, it should be
borne in mind when valuing the offered IP is whether there
is a market for the IP should the lending institution
exercise its rights and appoint an administrator to deal
with the IP in the event of default in repayment.
For example,
the SME may hold a patent in relation to a particular
invention, but the SME’s competitors may prefer another
method of achieving the same result. Similarly, copyright
protects only a particular expression of an idea. One SME’s
software may not be as useful as another SME’s software
which achieves the same outcome. Therefore, the value of
the IP to the market may be less than the value to the SME.
On the other
hand, for example, if the trade marks used as security
represent a popular or well-known brand of products offered
by the SME to the market, other traders may be keen to
acquire some or all of the trade marks to exploit their
distinctiveness.
Security Rights in
IP
Using IP as
security is permitted under the respective statutes.
Nevertheless, when taking intellectual property as security,
the lending institution must be careful that the
documentation evidencing that security covers essential
criteria.
Type of security
An important
decision is the type of security that must be provided by
the SME.
For example,
the statutes permitted assignments of the IP. Therefore,
the lending institution may accept an absolute assignment
from the SME with a licence-back of the necessary rights and
a provision for reassignment upon completion of the
repayment obligations. However, the lending institution may
be directly involved in claims of infringement of third
party rights. To overcome this, the lending institution may
instead obtain an equitable assignment of the IP, with the
capacity to provide notice to the SME to perfect the
assignment.
Alternatively, the lending institution may require a fixed
and/or floating charge over the IP. However, a fixed charge
may not be suitable for security over IP, as the fixed
charge prevents the SME from dealing with the secured assets
without the consent of the lending institution. Given that
the SME uses the IP in the ordinary course of its business,
granting a fixed charge over the IP may limit its capacity
to properly conduct its business activities.
In all
situations, the lending institution must be cognisant of the
rules in the relevant legislation on priorities of interests
in IP.
Copyright as security
Unlike
patents, designs and trade marks, copyright subsists
automatically in a sufficiently original work under the
Copyright Act 1968 (Cth). The Copyright Act 1968
(Cth) permits assignments of future works, so a mortgage
consisting of an assignment may specify that security is
granted over the SME’s future works.
The lending
institution should consider the following issues:
-
In Australia, copyright is not subject to
registration. Therefore, due diligence should be undertaken to verify the
nature of the copyright work, its author(s) and whether the SME has previously
dealt with the copyright work in a manner which may prejudice the lending
institution’s rights under the security (including licences and previous
encumbrances).
-
Were the author(s) employee(s) of the SME? If not,
does the SME hold written and signed assignments of the copyright from the
author to the SME?
-
The
Copyright Act 1968 (Cth) recognises
that authors hold so-called “moral rights” in the work,
which cannot be assigned. These rights are separate from copyright. These rights include the right to attribution of
authorship, the right not to have authorship falsely attributed, and the right
to integrity. Unless the lending institution obtains from the SME evidence that
the authors have consented to acts that would otherwise infringe these moral
rights, the lending institution’s capacity to deal with the work may be
compromised.
-
The lending institution must insist that any
licence of the copyright granted by the SME is subject to termination upon
insolvency.
-
The lending institution may insist that the
SME deposits a copy of the secured work into escrow. For example, where the
work is a piece of software, the SME may be required to deposit a complete
working copy of the software, with commented source code and all necessary
documentation, and developments from time to time.
Registered IP as security
Whenever the
lending institution considers taking security over a form of
registered IP (such as patents, designs or trademarks), the lending institution should consider the
following matters:
The statutory rights and the
characterisation of the IP as personal property do not apply
until the rights have been granted upon registration.
Further, until registration, the
applications are vulnerable to being rejected on
examination. If the application is rejected and the
rejection is not overcome, the IP is effectively worthless.
A common tactic when defending a threat
of infringement is to counterclaim for revocation of the
registered IP. If the revocation claim is successful, the
lending institution loses its security.
To minimise this risk, the lending
institution may require an independent opinion as to the
validity of the patent, or evidence of actual use of the
trade mark within the preceding three year period before
agreeing to accept the IP as security.
A registered design may not be enforced
until it is examined by the Designs Office for compliance
with the requirements of the Designs Act 2003 (Cth).
The registration of IP can be for a fixed
time. For example, the registration of a trade mark lasts
for ten years from the date of filing, but may be renewed
upon payment of the renewal fee. Designs, on the other
hand, last for a maximum of ten years from the date of
filing. The term of a standard patent is 20 years from the
date of the patent, while the term of an innovation patent
is 10 years from the date of the patent. A contract for the
lease of, or a licence to exploit, a patented invention may
be terminated on three months written notice at any time
after the patent by which the invention was protected
expired.
Similarly, copyright’s term is limited,
depending on whether the work has been published or not.
When establishing the repayment
obligations with the SME, the lending institution should be
cognisant of the finite life of the IP.
Recording interests in
registered IP
The Trade
Marks Act 1995 (Cth), Designs Act 2003 (Cth) and
the Patents Act 1990 (Cth) all make provision for the
recordal of interests in registered IP. Therefore, the
lending institution must, at a minimum, require the SME to
register the lending institution’s interest in the
registered IP on the appropriate Register and the Register
of Company Charges, maintained under the Corporations Act
2001 (Cth).
However, the
statutes do not make recordal of such interests mandatory,
and they generally permit the registered owner of the IP to
deal with the IP as the absolute owner, subject to any
recorded interests. This raises the complex issue of
priorities between competing interests. For example, the
SME may assign the granted patent to A. This assignment is
not registered. Some time later, the SME assigns the patent
to B. Under the Patents Act 1990 (Cth), the SME is
entitled to assign to B. If B’s assignment is registered,
it prevails over A’s assignment. However, if A’s assignment
is registered before B’s assignment, A’s assignment prevails
under the Patents Act 1990 (Cth). If A then assigns
to C, and C registers before B, C’s assignment prevails.
Finally, the
SME may grant an equitable mortgage to A, who fails to
register the interest. The SME then assigns the patent to
B, who also fails to register. A eventually registers its
interest, followed by B. Under the Patents Act 1990
(Cth), B’s assignment prevails over A’s equitable mortgage,
because A is not the patentee and cannot deal with the
patent as absolute owner, whereas the SME remains the
patentee and can deal with it as absolute owner.
The position
becomes more complicated if the holder of the latter
interest is aware of the earlier interest granted by the
patentee. The Patents Act 1990 (Cth) does not
protect a person who dealt with a patentee otherwise than as
a purchaser in good faith for value without notice of any
fraud on the part of the patentee.
The point to
be made is that the lending institution must as soon as
possible register its interest in the IP on the appropriate
Register. It should also register its interest in the
Register of Company Charges, pursuant to the Corporations
Act 2001 (Cth). While this is not an ironclad guarantee
that the lending institution has perfected its interest in
the security, it will assist the lending institution in any
challenge to the priority of the interest.
Conclusion
SMEs are
beginning to see the monetary value in intangible assets,
particularly intellectual property. While some SMEs will
choose to finance their growth through capital raisings,
others may prefer obtaining finance from lending
institutions and rely upon the value of the intellectual
property to secure the finance. Lending institutions, for
their part, are becoming aware that intellectual property is
capable of being used to secure finance. However, while
security over intellectual property may provide a valuable
alternative to taking security over other assets of the
mortgagor, the security holder must ensure that its rights
are protected as far as possible.
For further information,
please contact Craig on +61 3 9609 1646 or email
csubocz@rk.com.au
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