Security Interests in Intellectual Property and Related Issues in Bankruptcy

Intellectual property (“IP”) can act as collateral to be pledged to secure an extension of credit.  For example, a company that borrows money from a bank can pledge its patents as collateral for the loan.  The bank (referred to as the “secured creditor”) in this case will of course want to make sure that its security interest in the IP can be enforced against the borrower if the borrower defaults on the loan.

What Happens to Your Security Interest in a Debtor’s Intellectual Property in Bankruptcy?

• It is Important to Hold a Perfected Security Interest in Bankruptcy

As we previously wrote, a secured creditor with a perfected security interest holds the highest priority position in a bankruptcy case (See If You Liked It Then You Shoulda Put a Lien on It — The Importance of Security for Creditors).  Thus, in bankruptcy, it becomes even more important that you have taken all steps necessary to ensure that there is attachment and perfection with regard to the granting of your security interest.  In bankruptcy, the debtor-in-possession (DIP) or the bankruptcy trustee has the “avoidance” powers to invalidate an unperfected lien or a lien that is not perfected sufficiently ahead of time before the bankruptcy.

• How to Perfect a Security Interest in Different Types of Intellectual Property

              ** Copyrights

A security interest in a registered copyright cannot be perfected simply by filing a UCC-1 financing statement with the Secretary of State.  The only way to perfect such a security interest is by filing with the U.S. Copyright Office.  If the lien is not filed with the Copyright Office, the lien can be wiped out in the debtor’s bankruptcy!

This rule applies to registered copyrights only.  You can only perfect a security interest in unregistered copyrights by filing a UCC-1 financing statement with the Secretary of State (because it is not possible to file a security interest in an unregistered copyright with the Copyright Office).

However, if you were to lend money to a debtor and take a security interest in the debtor’s unregistered copyright, the prudent course of action would be to require the debtor to register that copyright and file your lien with the Copyright Office.

Otherwise, if the debtor, before filing for bankruptcy, registers its copyright with the Copyright Office (without telling you) and files for bankruptcy, your security interest becomes unperfected, and you face the risk of having your security interest wiped out (causing you to become unsecured) in the debtor’s bankruptcy.

              ** Trademarks

Generally, to perfect a security interest in a trademark, you must file a UCC-1 financing statement with the Secretary of State.  Case law seems to suggest that this is sufficient to perfect a security interest in a trademark, without filing it with the U.S. Patent and Trademark Offices (PTO).  But it would never hurt to be cautious and file your lien with the PTO, too.

A trademark is not assignable without the goodwill of the underlying business in which the mark is used.  Taking a security interest in a trademark is not considered an assignment of the mark. However, if you try to foreclose the mark upon the debtor’s default pursuant to your security agreement, the prohibition against such an assignment may be triggered.  For this reason, taking a security interest in a trademark, standing alone, is not advisable.  You may want to take a lien on other, related assets associated with the products or services associated with the mark.  However, it is not necessary to take a lien against all goods and services provided by the debtor.

              ** Patents

Patent law is somewhat similar but a little distinct from trademark law.  The recent trend in the law is that the grant of a security interest in a patent is not considered an assignment under the meaning of the patent statute, and therefore, you do not need to file your lien with the PTO to perfect your security interest in a patent.  (The question of whether the grant of a security interest in a patent is treated as an assignment is important because, then, the patent statute preempts the UCC, and the filing of a UCC-1 is not the proper way to perfect a security interest in a patent.)  Earlier court cases (in the 1980s) held that the best method of perfecting a security interest in a patent was to file with the PTO.  Some of these cases are still good law.  Therefore, it is the better practice to file both with the PTO and the Secretary of State.

• How All of This Affects a Security Interest in the Proceeds of the IP

If the bankruptcy court finds that your lien on the debtor’s IP is unperfected because you have failed to file your lien with the appropriate federal office, and therefore your security interest is wiped out in the debtor’s bankruptcy, will you then not only lose your security interest in the underlying IP but also in royalties and accounts receivable (AR) deriving from the IP?

In the case of trademarks or patents, you will probably not lose your security interest in the proceeds if you perfected your security interest by filing a UCC-1 financing statement.

In the case of registered copyrights, there is at least one case that held that you lose your security interest in royalties and ARs from the registered copyright, as well as your security interest in the copyright itself if you fail to file your lien with the Copyright Office.

Perhaps one way around this is to take a security interest in specific streams of royalties and ARs and not just generally in the copyright and its product or proceeds.  (Even in this case, you still have to have filed your UCC-1 with the Secretary of State.)