Fortifying Innovation: Leveraging Intellectual Property as a Valuable Collateral Asset K.SETHURATINAM GOVT LAW COLLEGE, MADURAI, TAMIL NADU, INDIA IPR Mon, Feb 26, 2024, at ,12:10 AM INTRODUCTIONIntellectual property (IP) assets, including patents, trademarks, copyrights, and trade secrets, have become increasingly important in today's knowledge-based economy. As a result, there is a growing need for IP owners to use their IP assets as collateral to secure financing or investment. However, the process of creating a security interest, mortgage, or collateral interest on IP assets is complex and raises a number of legal and financial issues. This paper will provide an overview of the key issues and challenges involved in creating security interests, mortgages, or collateral interests on IP assets.BackgroundIP assets are intangible assets that are created through human innovation and creativity. They can take various forms, including patents, trademarks, copyrights, trade secrets, and domain names. IP assets are valuable because they provide a competitive advantage to their owners, and they can generate significant revenue through licensing, franchising, and other means.However, IP assets are also inherently intangible and difficult to value. This makes it challenging to use them as collateral for loans or investments. Unlike tangible assets, such as real estate or equipment, IP assets are not easily susceptible to seizure or foreclosure in the event of default. Moreover, IP assets are often difficult to value, which makes it challenging to determine the appropriate level of collateralization.Methods for Creating Security Interests, Mortgages, or Collateral InterestsThere are several methods for creating security interests, mortgages, or collateral interests on IP assets. One common method is to use a security agreement, which is a contract between the IP owner and the lender or investor that grants the lender or investor a security interest in the IP assets. The security agreement should clearly define the IP assets that are being used as collateral, as well as the terms and conditions of the security interest.Another method is to use a mortgage or deed of trust, which is a legal document that grants the lender or investor a mortgage or lien on the IP assets. The mortgage or deed of trust should clearly describe the IP assets that are being used as collateral, as well as the terms and conditions of the mortgage or lien.A third method is to use a collateral assignment agreement, which is a contract between the IP owner and the lender or investor that assigns the IP assets to the lender or investor as collateral for the loan or investment. The collateral assignment agreement should clearly describe the IP assets that are being assigned, as well as the terms and conditions of the assignment.Legal IssuesThe creation of security interests, mortgages, or collateral interests on IP assets raises a number of legal issues. One of the main issues is the need to ensure that the IP assets are properly transferred and assigned to the lender or investor. This requires a thorough understanding of the legal requirements for creating and perfecting security interests in IP assets.Another legal issue is the need to ensure that the IP assets are free from any existing encumbrances or liens. This requires a thorough search of public records and databases to identify any existing claims on the IP assets. Additionally, it is important to ensure that the IP assets are not subject to any licensing agreements or other contractual obligations that may limit their use or transfer.Commercial Acts Companies Act: Section 77 of the Companies Act 2013 inter alia provides that a company can create a charge on its property or assets or any of its undertakings situated in India or outside, whether the same are tangible or otherwise provided such charge is registered with the Registrar of Companies. Banking Regulation Act, 1949 (“Banking Act”): Section 6 of the Banking Act inter alia allows banks to do the business of borrowing, raising, taking up, lending or advancing of money either upon or without security as well as acquiring, holding and generally dealing with any property or any right, title or interest thereof, which may form the security or part thereof, for any loans or advances or which may be connected with any such security. The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 (“SARFAESI Act”): Section 2 (1) (zf) of the SARFAESI Act empowers a secured creditor to enforce any security interest created by the borrower in its favour, by way of a mortgage or an assignment. At this juncture, it is pertinent to point out that there are certain exemptions to the same under section 31 of the SARFAESI Act but IP assets do not find a mention as part of such exemptions. Foreign Exchange Management Act, 1999 (“FEMA Act”): While Section 2 (za) of FEMA Act which inter alia defines ‘security’, does not expressly include IP as a security, FEMA Act does not expressly disallow IP to be included within the purview of the definition of security. Transfer is defined under Section 2 (ze) of the FEMA Act to include sale, purchase, exchange, mortgage, pledge, gift, loan or any other form of transfer of right, title, possession, or lien. Though transfer of security is allowed under FEMA Act, IP may or may not form part of the definition of security. Hence, creating security interest or collateral on the IP will depend on a case-to-case basis as well as the authorized dealer bank. Reserve Bank of India, 1934 (“RBI Act”): Section 19 of the RBI Act lays down certain business which bank cannot transact. Though this list does not restrict granting loans and advance against IP specifically, it may act as an impediment for the banks to accepting IP as security or collateral. IP Acts Patents Act, 1970: Section 68 read with section 69 of the Patent Act, 1970 allows creation of a security interest in a patent by the way of assignment or mortgage or license of a patent either wholly or in part. However, the creation of such a security interest on patent must be captured in writing and registered with the Controller General of Patents in a prescribed manner for it to be valid. Trade Mark Act, 1999: While the Trade Mark Act, 1999 is silent on the creation of security interest over trademarks, it provides for assignment of a trademark either with or without goodwill. However, at this juncture it is pertinent to mention that while trademark(s) can form security or collateral for a loan, if it is not part of the collateral or security while procuring the loan it cannot be used by a defaulting borrower to repay the said loan. Thus, a trademark cannot be assigned to a bank by a borrower who has defaulted on the loan. Copyright Act: Since Copyright is a right that automatically vests in the creator irrespective of registration, it is not a preferred security or collateral. While the provisions of Section 18 and 19 of the Copyright Act allow for assignment of an underlying copyright in a work, the Copyright Act in itself is silent with regard to creation of mortgages or securities for loans. In day to day business banks may consider accepting registered copyright as collateral or security, however, unregistered copyrights, may not be considered as valuable collateral. Designs Act, 2000: Section 30(2) of the Designs Act, 2000, akin to the Patent Act, 1970 specifically allows the creation of a mortgage, license or security interest in a registered design by making an application to the Controller to register the title who shall issue cause notice of the interest in the prescribed manner in the register of designs for creating such interest. Thus, a brief analysis of the IP Acts prima facie shows that while some legislations specifically mention that charges or liens that can be placed on the IP assets, a majority of them are silent on it. The banks and/or other financial institutions face various practical obstacles and may abstain in accepting IP assets as collateral or security.Financial IssuesThe creation of security interests, mortgages, or collateral interests on IP assets also raises a number of financial issues. One of the main issues is the difficulty in valuing IP assets. Unlike tangible assets, which can be easily valued based on market prices or depreciation schedules, IP assets are often difficult to value due to their intangible nature.Another financial issue is the need to ensure that the IP assets generate sufficient cash flow to service the debt or investment. This requires a thorough analysis of the IP assets' revenue-generating potential, as well as the potential risks and liabilities associated with their use.Challenges faced for creation of security interest or mortgage or collateral on IP assets Lack of Tangibility: One of the major challenges in creating security interests or mortgages on intellectual property (IP) assets is the inherent lack of tangibility. Unlike traditional collateral such as real estate or physical assets, IP assets are intangible and can be difficult to value and enforce in case of default. This poses challenges in establishing a clear and enforceable security interest. Complex Ownership Rights: IP assets often involve complex ownership rights, especially in cases where multiple parties contribute to the creation or development of the asset. Determining the rights and interests of each party and establishing a valid security interest can be challenging, particularly when there are disputes or uncertainties regarding ownership. Registration and Public Notice: In many jurisdictions, the creation of a security interest or mortgage requires registration or public notice to establish priority rights. However, the registration process for IP assets can be complex and fragmented, particularly when dealing with different types of IP such as patents, trademarks, copyrights, or trade secrets. Navigating the registration requirements and ensuring proper public notice can be a challenge. Valuation and Evaluation: Valuing IP assets for the purpose of creating a security interest can be subjective and challenging. Unlike physical assets with established market values, IP assets often require specialized expertise to determine their worth. Accurately evaluating the potential risks and rewards associated with IP collateral is crucial for lenders, but it can be a complex task. Enforcement and Liquidation: Enforcing a security interest on IP assets can be difficult due to the intangible nature of the collateral. Unlike physical assets that can be easily seized or sold, IP assets require specialized knowledge and processes for enforcement and liquidation. This can involve legal proceedings, licensing agreements, or other mechanisms to realize the value of the collateral. Changing and Evolving IP Rights: IP laws and regulations are subject to constant change and evolution. New technologies, international agreements, and court decisions can significantly impact the value and enforceability of IP assets. Staying updated with these changes and ensuring that security interests or mortgages on IP assets remain valid and enforceable can be a challenge for lenders and borrowers. Cross-Border Considerations: IP assets often have international reach, and creating security interests or mortgages that span across multiple jurisdictions can be complex. Different legal systems, varying registration requirements, and conflicting laws can pose challenges for lenders seeking to establish and enforce security interests on IP assets in different countries. Lack of Uniform Standards: Unlike traditional collateral, there is a lack of uniform standards and practices for creating security interests on IP assets. Different jurisdictions may have different legal frameworks and requirements, leading to inconsistencies and complexities when dealing with cross-border transactions involving IP collateral. Risk of Infringement or Obsolescence: IP assets are subject to risks such as infringement by third parties or becoming obsolete due to technological advancements. Lenders must assess these risks and ensure that appropriate measures are in place to protect the value of the collateral. However, accurately evaluating and mitigating these risks can be challenging, particularly in rapidly evolving industries. Limited Secondary Market: Unlike some traditional collateral, there is a limited secondary market for trading IP assets. This can make it difficult for lenders to sell or transfer IP collateral in case of default, potentially impacting the recovery of their investment. The lack of a well-established secondary market adds another layer of complexity to creating security interests on IP assets. Benefits of creation of security interest or mortgage or collateral on IP assets: Enhanced Access to Financing: Creating security interests or mortgages on IP assets can open up new avenues of financing for businesses. By using their IP assets as collateral, companies can provide additional security for loans. This increased security can give lenders the confidence to provide financing that may not be available through traditional means. It's like unlocking a hidden treasure chest of funding opportunities! Diversification of Collateral: Traditionally, businesses have relied on tangible assets like real estate or equipment as collateral for loans. However, by creating security interests or mortgages on IP assets, companies can diversify their collateral options. This means they don't have to solely depend on physical assets to secure financing. It's like adding more colors to their canvas of collateral! Leveraging Intangible Assets: Intellectual property, such as patents, trademarks, copyrights, and trade secrets, can hold immense value for businesses. By creating security interests or mortgages on these intangible assets, companies can leverage their IP portfolios to access funding. This is especially beneficial for businesses that have invested time and resources in building a strong IP portfolio. It's like turning their creative genius into a valuable financial resource! Flexibility in Capital Use: When a business creates security interests or mortgages on IP assets, it retains ownership of the intellectual property. This means that while using IP assets as collateral, companies can still utilize and exploit their IP assets for their business operations. It provides them with the freedom to continue using their valuable intangible assets to generate revenue and drive innovation. It's like having your cake and eating it too! Competitive Advantage: Having a robust IP portfolio can give businesses a competitive edge in the marketplace. By creating security interests or mortgages on IP assets, companies can showcase their intellectual property as valuable assets. This not only adds credibility but also demonstrates the company's innovative capabilities to potential investors and partners. It's like flaunting a shiny medal of creativity and innovation! Case study:I. Bowie Bonds:The first known of IP financing relates backs in 1997, wherein singer David Bowie who paved his innovative way of raising finance by converting his future royalties from his record sales into securities and converted them to a private bond worth $55 million.II. Utilizing Patents as Collateral in Indian Businesses:Firms in India are finally recognizing the value of patents, and are using them as collateral for loan funding. This trend demonstrates the rising relevance of intellectual property rights in the corporate world. This growing usage of intellectual property as collateral may be an excellent way for businesses to get the finance they want to grow and thrive. Here is an example of an Indian company that has utilized patents as collateral effectively:Biocon Limited: Harnessing Biotechnology for Financial AdvancementIn an impressive demonstration of strategic financial management, Biocon Limited, a prominent biopharmaceutical company headquartered in Bangalore, has effectively leveraged its extensive patent portfolio to secure funding amounting to ₹1,125 crore. By utilizing its patents as collateral, Biocon has not only garnered substantial financial resources but has also accelerated its research and development endeavors in the field of biotechnology.III. IPR: Fueling the Success of India's Startup EcosystemThe pivotal role of Intellectual Property Rights (IPR) in driving the triumph of India's startup ecosystem cannot be overstated. A substantial number of Indian startups possess at least one IP asset, as per data from WIPO (2020). India has made remarkable strides in IP registrations, currently ranking 5th in trademark registration, 6th in patent registration, and 11th in industrial design registration globally.The growth in patent applications is particularly noteworthy, with numbers surging from 3,024 in 1980 to 53,627 in 2019, reflecting a compound annual growth rate (CAGR) of 7.7%. This progress can be attributed to heightened awareness of IPR across various sectors and the implementation of robust government policies. The registration of 'industrial design' has also witnessed significant growth, increasing from 1,033 in 1980 to 13,723 in 2019, at a CAGR of 6.9%. Likewise, trademark registrations have soared from 14,397 in 1980 to an impressive 367,764 in 2019 (Figure), highlighting the expanding scope and importance of IPR in India's entrepreneurial landscape.Figure IV. Exploring the Significance of IPR-Backed Debt Financing: A Literature ReviewThe global economy has experienced a remarkable transformation, shifting towards a knowledge-based economy, where intangible assets and intellectual property (IP) take center stage as the primary drivers of economic value, surpassing tangible assets. This shift is evident in the composition of the world's most valuable companies, such as Apple, Microsoft, Amazon, Alphabet (Google), and Facebook, which predominantly rely on intangible assets. As of March 31, 2021, these companies boasted market valuations of ₹150.8 trillion (USD 2,051 billion), ₹130.7 trillion (USD 1,778 billion), ₹114.5 trillion (USD 1,558 billion), ₹102.4 trillion (USD 1,393 billion), and ₹61.7 trillion (USD 839 billion) respectively.According to the Global Intangible Finance Tracker 2020, physical assets constitute only a minuscule portion of these companies' net worth. For instance, Amazon's physical assets account for a mere 4% of its total value, while the corresponding figures are 6% for Apple, 7% for Microsoft, 16% for Facebook, and 26% for Alphabet. Additionally, Brand Finance (2020) reveals that over 16% of the patented stock in the United States has been utilized as collateral at some point, underscoring the significant role of IP-backed debt financing.These trends highlight the growing importance of leveraging intellectual property as a valuable asset class in securing debt financing. This literature review seeks to delve deeper into the subject, examining the various dimensions and implications of IPR-backed debt financing and shedding light on its potential benefits and challenges.V. Examining Financing Challenges in the Indian Startup Sector: Insights from RBI's Pilot SurveyThe pilot survey on the Indian startup sector by the Reserve Bank of India (RBI) from November 2018 to April 2019, covering 1,246 startups from public/private limited companies, partnership firms, limited liabilities partnerships and others, has portrayed the financing difficulties faced by Indian startups, as only 36% of the participating startups availed loans from institutions including banks. Families & friends emerged as the largest source of funding (43%) for Indian startups (RBI, 2019).CONCLUSIONAlthough there is no express restriction under the law to create mortgage, lien, encumbrance, security interest or collateral on IP assets, in the absence of a regulatory framework it is completely at the discretion of the banks and/or financial institutions to accept IP assets as a security for financing.IP backed financing exists as a tool to ease access to credit. One of the most common ways of securing the lenders legal claim over the IP assets, is to provide public notice that the IP assets are being used as collateral for a loan.Another way forward to facilitate the use of IP assets as collateral or security will be to create transparency in the market place so that strong relationships between entities with well-built IP portfolios and financing entities for IP backed financing are utilised to its full possible extent.In conclusion, the creation of security interests or mortgages on IP assets brings several benefits to businesses. From enhanced access to financing and diversification of collateral to leveraging intangible assets and maintaining flexibility in capital use, this approach can unlock new opportunities for growth and success.