LENDERS MUST PERFECT THEIR SECURITY INTEREST WHEN MAKING LOANS SECURED BY INTELLECTUAL PROPERTY

You make a $50,000 bridge loan to a fledgling movie production company. The purpose of the loan is to pay for certain pre-production costs for a film project. The loan is to be repaid by the borrower from the permanent financing being arranged through a large lender. A Promissory Note evidences the bridge loan and the borrower has given you a personal property security agreement that purportedly encumbers the primary asset of the borrower, a movie script. Six months pass without the borrower obtaining permanent financing and then, unexpectedly, it files for Chapter 7 Bankruptcy.

Initially, the bankruptcy proceeding is classified as a “no asset” case. Somewhat surprisingly, a few months after the bankruptcy filing, the Bankruptcy Trustee receives court approval to sell the script (the primary bankruptcy estate asset) to a third party for $25,000.

Throughout all of the foregoing, you believed that your interest in the bankruptcy estate is protected in that as a secured creditor you will get priority in the distribution of assets of the estate. While $25,000 is only half of what you loaned the borrower, at least it is not a complete loss.

As the bankruptcy proceeds, you learn that the Bankruptcy Trustee has elected to treat you as an unsecured creditor because your security interest was not “perfected” until just before the filing of the bankruptcy. The net result: Instead of receiving nearly all of the proceeds from the sale of the script after the payment of administrative costs, you are lumped with other unsecured creditors and entitled only to your proportionate share of the net assets of the bankruptcy estate. Consequently, nearly two years after the filing of the bankruptcy, instead of receiving all or nearly all of the $25,000 in cash assets held by the Trustee, you only receive about $2,000—small consolation after making a $50,000 loan!

What went wrong? What should you have done to perfect your security interest in the script?

This blog post will discuss the anomalies created by the intersection of state law with the federal system governing intellectual property and provides recommendations for documenting and perfecting security interests in intellectual property. It is not intended as a complete discussion of the issues in this complicated field of law but, instead, is an attempt to identify the matters that must be considered. You should contact a well-qualified business attorney or intellectual property (IP) attorney to make sure that you have completed all of the steps necessary for protection of your interests.

Dual Systems

UCC Protection

The Uniform Commercial Code has been enacted by every state (except Louisiana) and the District of Columbia. Among other things, it provides a comprehensive scheme for regulation of security interests in personal property by standardizing the creation of interests in secured property. Article 9 of the UCC allows the secured party to “perfect” its security interest by the filing of “financing statements,” which provides priority over and protection from later attempts to lien the personal property.

One of the types of personal property in which a lender may obtain a security interest under Article 9 is “general intangibles.” Examples of general intangibles include trademarks, copyrights and patents. However, Article 9 does not apply to a security interest that is subject to a federal statute “to the extent that a statute, regulation or treaty of the United States preempts this article.” Moreover, Article 9 exempts trademarks, copyrights and patents from UCC filings transactions that are subject to a system of filing under federal law.

Notwithstanding the UCC exemption, the federal law provisions governing trademarks, copyrights and patents do not directly address security interests, thereby creating doubt as to whether the security interest in intellectual property must be perfected under the UCC or by a filing with the appropriate federal agency.

Trademarks

The federal statute governing trademarks is known as the Lanham Act, which provides a system for recording ownership and transfers of ownership of trademarks. While the statute is silent with respect to security interests, the regulations of the U.S. Patent and Trademark Office (“TPO”) provide that documents affecting title to the trademark may also be recorded, however, there is significant doubt as to whether the Lanham Act was intended to provide constructive notice of security interests held by lenders. That is, it seems likely that the Lanham Act has not preempted the UCC with respect to perfection of security interests in trademark. The few courts that have considered this issue have generally concluded that the recording of a security interest under the Lanham Act does not fall within the UCC’s filing exemption.

Copyright

Unlike the Lanham Act, the Copyright Act broadly covers the “assignment, mortgage, exclusive license, or any other conveyance, alienation, or hypothecation of a copyright” if (1) the transfer is recorded with the Copyright Office and (2) the copyright is registered with the Copyright Office. The statute also sets up a scheme for establishing priority of transfers. Arguably, filing a notice of the security interest with the Copyright Office may be sufficient to perfect a security interest in a copyright. However, for unregistered copyrights, a UCC filing is mandatory.

Patents

Patent rights are primarily established under 35 U.S.C. section 261. While the assignment of rights may be recorded and the regulations of the TPO permit recordation of security interests, the language of the statutes, which is similar to those governing trademarks, suggests that federal law does not preempt the perfection provisions of the UCC. Case law, however, suggests just the opposite (i.e., that to be completely protected, a lender must file an appropriate notice under both the UCC and with the TPO).

Recommendations

Essentially, state and federal law for perfection of security interests in intellectual property is a muddle. Prudence therefore dictates that:

1. A lender that is making a loan to be secured by a trademark, copyright or a patent carefully research the existence of prior liens or assignments with both the Secretary of State in the state in which the borrower is located with the TPO and/or Copyright Office.

2. In the loan documents the borrower should warrant that there has been no prior assignment or lien granted. Further, make sure the borrower is prohibited from assigning the intellectual property to a third party without (a) lender’s consent and (b) the assignee’s agreement to be bound by the terms of the Note and Security Agreement. It is also important that the security instrument clearly and specifically identify the intellectual property that is being used as security for the loan.

3. The lender must file a notice with both the Secretary of State and the TPO or Copyright Office as soon as possible to avoid any intervening assignments and to reduce the risk a subsequent bankruptcy filing will invalidate the attempt to perfect the security interest.

Conclusion

Following the suggested procedure will make it less likely that you will be unpleasantly surprised by the loss of your security interest, however, there are countless other circumstances that could adversley impact your loan transaction. As always, you must conduct your due diligence concerning the borrower to make sure it is credit worthy. Such due diligence would include checking its track record and legal status. It is recommended that you consult with a well qualified attorney to concerning these and other issues that could affect your security interest.

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