IP as Collateral

Advances in science and technology, as well as business innovations have transformed the economy, making way for new industries and modern ways of doing business. As a result of new technologies, and a rapid increase in innovation and creativity, intellectual capital has emerged as valuable assets for businesses. Intellectual Property such as patents, trademarks, brand value, copyright, etc have become foundational assets for several businesses, seeking greater importance and attention. While securities created over tangible assets still holds prominence in lending activities in India, intangible assets like Intellectual Property Rights are also increasingly being given importance for asset-based lending activities. Businesses are turning towards their intangible assets, specifically their IP to finance their growth and further innovation.

Pledging IP as collateral in a loan agreement is one of the many ways of IP-backed financing. In such cases, the secured creditor/lending institution can seize the IP if the debtor becomes insolvent or defaults on the loan. A report on “IP Backed Financing – Overview of Trends” by Relecura shows that companies like General Motors, Avago, Alcatel Lucent, Kodak, Freescale, and Seagate have raised significant financing as collateral. JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Wilmington Trust, and Deutsche Bank have been top financing entities advancing loans to companies with IP as collateral. Non-banking entities such as GE Capital, Jefferies Finance, CPPIB Credit Investments, Venture Lending & Leasing, and Highbridge Principal Strategies have also advanced IP backed loans to various companies. Government institutions like the U.S. Treasury and the UAW Retiree Medical Benefits Trust have also advanced IP backed loans.

In a report by CII and Duff & Phelps on “Using IP as Collateral” it was found that large transactions in which IP is used as collateral have been executed by companies in distress or under the threat of bankruptcy. It has been seen that such transactions for raising loans are used when companies run out of options to pledge tangible assets. This is attributable to the high amount of risk associated with pledging IP assets. The risks include unauthorised use and infringement, technological obsolescence, and the marketable nature of IP as collateral. Instances of companies using IP as collateral during times of distress are as follows:

• Xerox pledged its Patents as collateral due to problems faced concerning financial fraud and certain distress in 2002.
• General Motors pledged its “Green Technology” patents for a period of 2 years when it faced bankruptcy in 2009.
• Eastman Kodak pledged many of its patents, notably the one which consisted of a method for enabling persistent recognition of individuals in images. This was done during 2012-2015 when it faced bankruptcy.
• LSI faced financial distress in 2014 due to cost escalation. As a result of which it pledged many of its patents as collateral.

IP Financing Policies in Asia

Governments around the world have undertaken various initiatives to strengthen their IP-financing infrastructure because of the increasing importance of IP in the global economy. Almost all major economies of Asia have come up with policy and regulatory measures to incentivize IP-financing.

India

The Government of India has made constant efforts towards commercialization of IP by undertaking various policy initiatives. The Department for Promotion of Industry & Internal Trade (Formerly, Department of Industrial Policy & Promotion) which is the nodal department of IPR, introduced a National IPR Policy in 2016. The Policy is the first of its kind in India to specifically aim at securitization of IP rights by using them as collateral to raise funds for commercial development. Objective 5.11.1 of the Policy states – “Enabling valuation of IP rights as intangible assets by application of appropriate methodologies and guidelines; facilitating securitization of IP rights and their use as collateral by creation of enabling legislative administrative and market framework.”

The DPIIT also set up a professional body, Cell for IPR Promotion and Management (CIPAM) for specifically addressing issues of related to IPR. In addition to furthering IPR enforcement and commercialization, the body also works on simplifying and streamlining different IP processes.

The National IPR Policy specifies the tasks to be undertaken by the CIPAM for IP Commercialization and Monetization through:

• Setting appropriate guidelines for IP valuation.
• Facilitating investment in IP and IP driven businesses.
• Providing support and spreading awareness among less empowered groups of IP owners such as farmers, artisans, craftsmen, etc.
• Providing incentives to financial institutes like banks for development and commercialisation of IP.

The National IPR Policy of 2016 has resulted in increasing IP registration since its inception. The pendency in IP registration applications have also decreased. Several other government initiatives like Make in India, Digital India, and Startup India have also furthered the work of building a robust IPR system in India. Under the new schemes and policies, MSMEs and Startups have been given several incentives for developing, managing and monetising their IP.

Singapore

Singapore is known for having strong regulatory policies for the protection and monetization of IP. The Intellectual Property Office of Singapore launched an IP Financing Scheme (IPFS) in 2014. The Scheme has been crucial for facilitating IP based financing as it has provided a much needed impetus to the intangible asset based marketplace in the country. Under the scheme, Participating Financing Institutions (PFIs) are allowed to advance loan to companies using IP as collateral. The risk of such IP backed loans is shared by the Government with the PFIs. The Singapore government also offers valuation subsidies to defray the cost of IP valuation. A subsidy for 50% of the IP valuation cost, of up to SG$ 25,000 is also provided. The Scheme has benefited a number of businesses in Singapore by helping them raise capital during crucial junctures through pledging their IPs as collateral.

China

The Chinese National Intellectual Property Administration is responsible for setting parameters and administering IP based financing in the country. In 2019, the China Bank Insurance Regulatory Commission, the National Intellectual Property Administration, the National Intellectual Property Administration, and the National Trademark Administration jointly released an IP-Pledge Financing Framework. The framework aims at strengthening and setting new parameters for IP pledge loans from various banks. The objectives of the framework include:

• Optimizing pledging of IP by extending support to commercial banks and financial institutions that accept IP as collateral for loans.
• Strengthening pledging of IP by encouraging commercial banks to provide loans based on IP and widening the ambit by introducing new forms of IP-financing.
• Optimizing pledging of IP by introducing a risk management framework by way of bringing IP financing specialists, strengthening the management of collaterals, and closely monitoring the business of borrowers.

Korea

Korea has introduced a wide array of programs for IP related financing. The programs allow for risk sharing such as cost sharing for disputes relating to IP. The Korea Credit Guarantee Fund and the Korean Development Bank has advanced millions of dollars to IP rich companies.

Valuation of IP which is an important process for the purpose of collateralizing is subsidised by the Korean Intellectual Property Office. The subsidised valuation is done by government bodies like the Korea Invention Promotion Centre. As a result, Korea has been able to develop Asia’s first IP Investment and Monetization Company named Intellectual Discovery.

Malaysia

The Government of Malaysia came up with a 5 year roadmap in 2015 with the aim of turning the IP of IP rich businesses into sources of wealth. It launched an IP Financing Scheme to help encourage SMEs in expanding their business by using IP as collateral. Under the Scheme, 2% interest rate subsidy and 50% guarantee is provided by the Government for IP backed loans.

Trademark as Collateral in the US

In addition to registered trademarks at the USPTO, debtors can also pledge common law trademarks, which are trademarks not formally registered. As a part of the application, the creditor requires a list of the registered trademarks, trademark applications in process, and all common law trademarks. The creditor then determines what lien position it will have on the trademarks and whether there is prior lien recorded against the borrower’s trademarks. The creditor also searches for other potential security interests in the form of assignments.

Article 9 of the Uniform Commercial Code (UCC) governs security interests in trademarks. A standard lender security agreement and a UCC financing statement, along with a notice of the creditor’s security interest should be recorded in USPTO. For a common law trademark, notice of the lender’s security interest is not required to be recorded. The registration at USPTO is required to protect the creditor from bona fide purchasers and mortgages. A short-form trademark security agreement which avoids the disclosure of terms of the loan is also recommended while filing documents in the USPTO to protect the privacy of the debtor.

Patent as Collateral in the US

The first step for declaring a patent as collateral involves the valuation of the patent to determine its objective value. A third-party is engaged to assess factors like product demand, market condition, and potential patent infringement. The third-party translates its finding into financial figures.

If the patent is found valuable enough, the creditor proceeds with the loan. The creditor signs a security agreement with the patent owning debtor. The agreement lays down conditions for patent ownership in the event of default. The security agreement has to be registered with the USPTO.

Case Studies

• The Technology Sector is an IP intensive industry where IP assets are frequently used to generate revenues. However, due to the rapid development in technology and extensive R&D undertaken in the sector, the return on investment of technology related IP has always been uncertain. However, since IP assets form a substantial portion of the total book value of the businesses in the Industry, considering these intangible assets as collateral for financing is of utmost interest for them.One such example is of Cambridge Display Technologies (CDT) which raised US$ 15 million from a British retail and Commercial bank in 2004 using its fundamental patents central to their next-generation technology of flat panel display.  The amount raised was crucial in funding research and development for Polymer-based Organic Light Emitting Diode (PLED) Technology. CDT was also able to break away from the equity owners and became a self sustaining business entity in the process.
• The pharmaceutical industry has a rich store of IP relating to novel combinations of compounds, dosage forms of therapeutics, production technologies and delivery mechanism. Due to the strict enforcement of IPRs the businesses in the industry can leverage their IP assets to secure funding.
  In 2005 a US-based pharmaceutical company engaged in the production of ophthalmic pharmaceuticals, pledged 32 pharmaceutical patents as collateral at the Bank of New York and raised around US$ 6 million for clinical trials and future applications for their new products.
• The telecom industry is one such sector that relies heavily on debt-funding with most businesses pledging their towers and spectrum licenses as their collateral assets. In 2012, Alcatel, a telecommunications equipment company as acquired for 16.6 bn USD by Nokia. Subsequent to the acquisition, the business was able to tackle its financial crisis by way of raising a loan of 2.1 bn USD from major financial institutions. The loan was secured by keeping around 29,000 patents relating to voice recognition and video conferencing technology as collateral.
• Masai is an international player in the footwear industry engaged in designing, marketing, and distributing shoes. In 2008, the company secured a patent for creating a “physiological footwear” which stimulates the body’s supporting system. The shoes became very popular and the rising popularity was followed by an increase in supply of low priced counterfeit shoes. This counterfeits affected the company’s sales and almost led the business to bankruptcy. The business was finally taken over by a Singaporean footwear business.
  In 2016, Masai Group International was advanced a seven-figure loan for keeping its patented technology for physiological footwear as collateral. It was the first company in Singapore to secure an IP backed loan under the IP Financing Scheme of Singapore(discussed above). The company which was facing bankruptcy was able to revive its business due to the financial assistance received by way of the loan. They were able to invest in IP protection, research and development, and advertising.
• In 2014, SITO Mobile, a leading mobile data technology company, was able to raise US$ 10 million from an Investment Management Group by keeping several of its registered patents related to mobile technologies as collateral. The amount raised helped them fuel their growth by making selective acquisitions and deepen the reserves for their IP monetisation initiative.
• In 2018, one of the largest manufacturers of pharmaceutical, chemical, and botanical products in India was extended a loan by a private listed Indian bank. The loan was advanced against a portfolio of brands of a number of drugs and consumer products. The bank carried out an extensive research with respect to competitor profiling and growth of the brand performance in order to value the IP. In addition to assessing the value of the brand, the bank also looked into the credibility of the borrower. This is an example of how companies with a good market standing and brand image can use their brand portfolio to raise funds.
• In 2019, a company engaged in the manufacture of hair care, cosmetics, and baby care products availed credit facility from a private listed Indian Bank. The primarily collateral in the loan deal was the brand of hair care of the Company. The hair care brand generated more that 90% of the company’s revenue and was one of the well known brands of hair care products in India. Due to the brand’s steady stream of revenue in addition to its stable market share, the loan was successfully secured.
• In 2012, Kodak, one of the leading digital imaging companies worldwide was facing a decline in sales and was forced to file for bankruptcy. In order to save the business from winding up, the company sold around 1,100 of its digital imaging and processing patents to raise around 525 mn USD. The amount raised was crucial for repaying a substantial amount of the loans it had taken earlier. Furthermore, with the amount raised the company positioned its digital imaging business for further expansion and development. Although, due to the transaction the company had to sell of a chunk of its major businesses, it was able to come out of bankruptcy a year later.
• Due to increasing competition in the toy industry and the increasing dominance of e-commerce marketplaces, a leading toy retailer in the US was on the verge of bankruptcy in 2017. The retailer carrying business under the renowned brand “Toys R Us” decided to auction off its IP assets including its brand names, websites, and brand mascots. However, later they abandoned the auction and tried to revive the business.

Scenario in India

Using IP as collateral is riddled with systematic obstacles. There are also uncertainties with respect to the laws that govern securitisation of IPs.

In a 2018 decision, the Supreme Court held that using assignment of trademark as security for loan is against the Trademark Act and the Banking Regulation Act. The Defendant NG Subbaraya Setty owed dues of an outstanding loan to Canara Bank. As a way to repay the debt, the parties made an assignment deed, assigning the trademark “EENADU” (used for incense sticks) of Setty to the Bank. The Bank later went on to cancel the assignment deed stating that engaging in any business other than banking would be a violation of the Banking Regulation Act. The Court noted that the assignment deed was not registered and for that reason could not be received as evidence by the Court as per Section 45(2) of the Trademark Act. The Court also agreed to the Bank’s contention that it was not allowed to carry any business other than banking as per Ss. 6 and 8 r/w S. 46(4) of the Banking Regulation Act.  The Apex Court held that a Bank cannot step outside the banking business and can sell goods only to realise security held by it.

Although the Supreme Court took a negative stance on IP Securitization, it did not put a blanket ban on securing IP backed loans. It is important to note that in the instant case trademark was not part of security/collateral to secure loan. It was chosen as a way to repay the debt of an outstanding loan.

Another classic example of using IP as collateral is the case of the Kingfisher trademark. In 2009, State Bank of India advanced a loan of over Rs. 2,000 Crore, keeping the airline brand as collateral. This included nine trademarks including Fly Kingfisher, Flying Models, Funliner, Fly the Good Times, Kingfisher, and Flying Bird Device. In April 2014, after Kingfisher defaulted, the Bank put up the trademarks of the Airliner for sale but it failed to receive any serious bids.

In order to pledge IP as collateral a proper valuation is the first and foremost need. In order to create security over IP certain formalities have to be followed:

• Stamp Duty: The applicable stamp duty on documents has to be paid in accordance with the Stamp Act. The duty varies from state to state.
• Filing with Registrar of Companies: The debtor/security provider has to file a form recording creation of security interest with the ROC. It must also obtain a certificate of charge.
• Filing with the CERSAI (Central Registry of Securitisation Asset Reconstruction & Security Interest of India): A charge over IPR has to be filed with the CERSAI. The registration must be done by the person/entity in whose favour the security interest has been created.
• Filing with IPR office: The security creation must be filed with the concerned IPR office. Assignments of IPRs have to be mandatorily registered at the respective IPR office (except for copyrights)
• Release Deeds: On the successful repayment of the loan release deeds have to be executed. The release deeds have to be mandatorily filed with the relevant IP office to terminate the security interest created over the IP.

Relevant laws for governing IP backed Financing in India are as follows:

• Companies Act, 2013: Section 77 of the Act allows a company to create a charge on intangible assets. Schedule III of the Act classifies intangible assets and includes all Intellectual Properties.
• SARFAESI Act, 2002: The Act includes intangible assets, being know-how, patent, copyright, trade mark, license, franchise, or any other business or commercial right of any nature, under the definition of “property” given in Section 2(1)(t)(v).
• Patents Act, 1970: Section 68 of the Act provides that a patent or a share in a patent, a mortgage, license, or the creation of any other interest in a patent shall not be valid unless the same were in writing and the agreement between the parties concerned is reduced in the form of a document.
• Trade Marks Act, 1999: Section 37 of the Act allows a proprietor of a registered or unregistered trade mark to assign his rights in said trade mark, either with or without the goodwill associated with such trade mark.
• Designs Act, 2000: Section 30(2) of the Act provides for security interest created by way of mortgage, license or other interest apart from assignment to be recorded.

Although IP backed loans are valid in India, banks are generally hesitant and reluctant to advance such loans as there is an apparent lack of clarity regarding IP valuation, laws, procedure and know-hows. Despite the National IPR Policy, companies have limited themselves to traditional tangible asset backed financing. Although there is great potential for IP collateral, lack of IP infrastructure and inconsistencies in IP valuation sets a deterrence for businesses.

Author: Aparthiba Debray, a 5th Year student of B.A. LL.B. (Hons.) of Institute of Law (Nirma University),  an intern at Khurana & Khurana, Advocates and IP Attorneys.  In case of any queries please contact/write back to us at [email protected].

References:

1. Ian Ellis, Maximizing Intellectual Property & Intangible Assets, Working Paper #7, Athena Alliance, available at https://core.ac.uk/download/pdf/71342793.pdf
2. Varun Gupta, Aviral Jain, and Umakanta Panigrahi, IP-Backed Financing: Using Intellectual Property as Collateral, Duff & Phelps, available at https://www.duffandphelps.com/insights/publications/valuation/ip-backed-financing-intellectual-property-collateral
3. IP Backed Financing – Overview of Trends, Relecura IP Intelligence Report, 2015
4. Jayant Kumar, Intellectual Property Securitization: How Far Possible and Effective, Journal of Intellectual Property Rights, Vol. 11, March 2006.