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Granting or Recording a Security Interest in a Patent at the USPTO Does Not Deprive the Patent Owner of the Ability to Enforce the Patent

October 6, 2020

LES Insights

By John C. Paul ; D. Brian Kacedon ; Anthony D. Del Monaco; Umber Aggarwal

A patentee did not lose the ability to bring a patent infringement lawsuit when it entered into a security interest agreement covering all of its intellectual property and the agreement was recorded at the USPTO

Raffel, a manufacturer of electronic controls for the seating, bedding and industrial marketplaces, entered into an “Intellectual Property Security Agreement” with two different banks granting the banks a security interest in all of its intellectual property. The banks filed notices of their security interests with the USPTO. Shortly thereafter, Raffel sued Man Wah for patent infringement and other causes of actions. In response, Man Wah moved to dismiss Raffel’s patent infringement claims arguing that Raffel lacked the right to sue for infringement because the security agreements transferred title of Raffel’s intellectual property to the banks.

Trial Court’s Decision

Lenders take security interests in a debtor’s intellectual property and other assets to protect themselves if the debtor defaults on a loan. In some instances, the lender demands that the security agreement transfer the ownership in the intellectual property until the loan is repaid.

The trial court found the act of granting a security interest in intellectual property and recording that security interest at the USPTO did not transfer title of the patents from Raffel to the banks, and, therefore, Raffel retained the right to enforce the patents.

To have the ability or “standing” to sue for patent infringement, an entity must satisfy the requirements of the U.S. constitution as well as the patent statute. To have constitutional standing, a plaintiff must possess exclusionary rights in the patent such as the right to prevent others from making, using, selling, or offering to sell the patented invention. Statutory standing further requires that the plaintiff have “all substantial rights” to the asserted patents through being the original patentee, an assignee, or an exclusive licensee of all such rights.  If an entity has “exclusionary rights” in the patent but lacks “all substantial rights,” it typically must join the owner of the patent in any infringement suit.

Man Wah argued that Raffel’s grant of a security interest and the subsequent recording of that security interest transferred title to the banks and thus, deprived Raffel of “standing” to sue.  In support, Man Wah relied on a Supreme Court case from 1891,   Waterman v. Mackenzie , which supported the principle that recording a security interest in patents was equivalent to transferring title.  The court noted, however, that   Waterman   was decided prior to the enactment of the Uniform Commercial Code (“UCC”) in 1952, which fundamentally changed the way a security interest is perfected. After the enactment of the UCC in 1952, transfer of title was unnecessary to perfect a security interest.

Man Wah asserted that state UCC laws provide only one way for a party to perfect security interests and are preempted by the Patent Act and   Waterman   when they conflict. Specifically, Man Wah argued that, under the Patent Act and   Waterman , a security interest is created through transfer of the patent when it is recorded at the USPTO. Man Wah asserted that this preempts perfecting a security interest through the UCC which does not transfer title. The court rejected the preemption argument citing numerous cases showing the Patent Act does not address perfection in security interests, but only assignments of title, and, thus, does not preempt state regulation of security interests in patents.

In looking at the actual agreements with the banks, the court confirmed that “[n]othing in the Intellectual Property Security Agreements states that Raffel is assigning title of the patents to the banks; rather, the agreements specifically state that Raffel is granting a ‘security interest’ in its intellectual property.” Thus, Raffel never transferred title and maintained standing. The court, therefore, denied the motion to dismiss.

Strategy and Conclusion

A party receiving a security interest in a patent may record the security agreement with the USPTO to protect itself against and give notice to subsequent bona fide purchasers or mortgagees. Standard security agreements that do not include language assigning title of the patents, however, will not prevent a patentee from bringing a patent infringement lawsuit. This case demonstrates the value of drafting the security agreement in a way that does not transfer ownership of intellectual property to the lender while the loan is pending. 

The   Raffel   decision can be found   here .

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The IP Law Blog

How to perfect a security interest in intellectual property (copyrights, trademarks and patents).

When a creditor provides a loan to a debtor, the debtor will often grant to the creditor a security interest in the debtor’s collateral, including the debtor’s intellectual property. A creditor who receives a security interest in the debtor’s intellectual property, usually by a security agreement, must perfect the security interest so that subsequent purchasers and creditors are on notice of the creditor’s security interest in the collateral. Rules relating to the creation, attachment, perfection and priority of security interests in personal property, including “general intangibles” which include intellectual property, are governed by Division 9 (Secured Transactions) of the California Uniform Commercial Code (“Article 9”), unless federal law preempts Article 9. In order to determine where to perfect a security interest for each type of intellectual property, and since copyrights, trademarks, and patents are all governed by different statutes and case law, it is important to review and analyze not only Article 9 but also the Copyright Act of 1976, 17 U.S.C. § 101 et. seq. (the “Copyright Act”), the Lanham Trademark Act of 1946, 15 § 1051 et. seq. (the “Lanham Act”), and the Patent Act of 1952, 35 U.S.C. § 101 et. seq . (the “Patent Act”).

1.   Article 9 (Secured Transactions – California Uniform Commercial Code)

Article 9, which provides a comprehensive scheme for the regulation of security interests in personal property and fixtures, applies to “a transaction, regardless of its form, that creates a security interest in personal property or fixtures by contract.” California Uniform Commercial Code (“U.C.C.”) §§ 9109(a)(1), 9101 cmt. 1. However, Article 9 does not apply to the extent that a statute, regulation, or treaty of the United States preempts it. Id . § 9109(c)(1). Also, the filing of a financing statement is “not necessary or effective” to perfect a security interest in personal property subject to a “statute, regulation, or treaty of the United States” which provides a national filing system for the perfection of security interests. U.C.C. §§ 9310(b)(3), 9311(a)(1), 9311 cmt. 2. Before analyzing whether the Copyright Act, the Lanham Act, or the Patent Act preempt Article 9 with respect to perfecting a security interest in a copyright, trademark or a patent, as the case may be, it is necessary to review the provisions contained in Article 9 for the creation, attachment, perfection and prioritization of security interests.

• Creation of Security Interest.

A “security interest”—which is an interest in personal property or fixtures which secures payment or performance of an obligation—is created by a “security agreement.” U.C.C. §§ 1201(b)(35), 9102(a)(73). The parties need not draft a separate document entitled “security agreement.” See Komas v. Future Systems , 71 Cal.App.3d 809, 814, 816 (1977). A security agreement is effective according to its terms between the parties, against purchasers of the collateral, and against creditors. U.C.C. § 9201(a). A “security interest” can be created in any “collateral,” which is defined as the property subject to a security interest, including the proceeds to which a security interest attaches. Id . § 9102(a)(12). “General intangibles” is a type of collateral and means any personal property, including things in action, other than types of collateral specifically exempted. Id . § 9202(a)(42). General intangibles include “various categories of intellectual property.” U.C.C. § 9102 Assem. Comm. cmt 5(d).

The security agreement which creates a security interest must sufficiently describe the collateral subject to the security interest, for evidentiary reasons. U.C.C. §§ 9108, 9203, 9108 Assem. Comm. cmt 1. A description of personal or real property in a security agreement is sufficient, whether or not it is specific, if it “reasonably identifies what is described.” U.C.C. § 9108(a). A description of collateral reasonably identifies the collateral if it identifies the collateral by any of the following: (1) specific listing; (2) category; (3) by type of collateral defined throughout the U.C.C., such as general intangibles; (4) quantity; (5) computational or allocational formula or procedure; or (6) any other method, so long as the identity of the collateral is “objectively determinable,” and the description of collateral does not merely state “all the debtor’s assets” or “all the debtor’s personal property.” Id . § 9108(b)-(e). The description of the collateral must “make possible the identification of the collateral described.” Id . §§ 9108, 9108 Assem. Comm. cmt. 2. A security agreement may also create or provide for a security interest in “after-acquired collateral” without requiring the creditor to take any further action—i.e., a “continuing general lien” or “floating lien.” U.C.C. §§ 9204(a), § 9204 cmt. 2.

• Attachment of Security Interest

In order to perfect a security interest in a collateral, the security interest must first attach to the collateral. U.C.C. § 9308(a). A security interest attaches to collateral when it becomes “enforceable against the debtor with respect to the collateral.” Id . § 9203(a). A security interest is enforceable against the debtor and third parties with respect to the collateral only if: (1) value has been given; (2) the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party, and, (3) the debtor has authenticated (i.e., executed) a security agreement that sufficiently provides a description of the collateral. Id . §§ 9203(b), 9102(a)(7).

• Perfection of Security Interest

Under Article 9, the law of the jurisdiction of the debtor’s location governs the perfection of security interests in both tangible and intangible collateral, whether perfected by filing, automatically (through attachment), possession, or otherwise. U.C.C. §§ 9301, 9301 cmt. 4. A debtor who is an individual is located at the individual’s principal residence. Id . § 9307(b)(1). A registered organization, such as a corporation or a limited liability company, is located in the state under whose law it was organized. Id . §§ 9307(e), 9101 cmt. 4(c). A security interest is perfected if it has attached and if other requirements are met, including the possible filing of a financing statement. Id . §§ 9308(a), 9310(a). However, a financing statement does not need to be filed for security interests that are automatically perfected upon attachment, such as a purchase money security interest in consumer goods, or a sale of a promissory note. Id . §§ 9310(a)(1), 9309(1),(4). Further, a creditor may perfect a security interest in tangible negotiable documents, goods, instruments, money, or tangible chattel paper by taking possession. Id . §§ 9313(a), 9310(a)(6). In fact, a security interest in money may be perfected only by taking possession. Id . § 9312(b)(3). More importantly to this article, the filing of a financing statement is “not necessary or effective” to perfect a security interest in personal property subject to a “statute, regulation, or treaty of the United States whose requirements for a security interest’s obtaining priority over the rights of a lien creditor with respect to the property preempt” the filing provisions contained in Article 9 (i.e., because the federal law provides a national filing system). U.C.C. §§ 9310(b)(3), 9311(a)(1), 9311 cmt. 2. If federal law preempts Article 9 with respect to perfection of a security interest, then a financing statement would not be filed and the creditor would need to record the security interest with the appropriate federal office—i.e., the United States Copyright Office (“Copyright Office”) for filings related to copyrights, and the United States Patent and Trademark Office (“USPTO”) for filings related to patents and trademarks. Case law analyzing whether any of the federal statutes preempts Article 9 with respect to perfection of a security interest in a particular intellectual property is discussed below.

i.               Financing Statement

If federal law does not preempt Article 9 with re spect to perfecting a security interest in a particular intellectual property, a financing statement must be filed in the office of the Secretary of State, unless the collateral is real-estate-related, in which case a filing should generally be made with the county recorder’s office. U.C.C. § 9501. A financing statement must: (1) provide the name of the debtor; (2) provide the name of the secured party or a representative of the secured party; and (3) indicate the collateral covered by the financing statement. Id . § 9502(a)(1)-(3). The financing statement need not be signed by the debtor. Id . § 9502, cmt. 3. A financing statement sufficiently indicates the collateral that it covers if it provides either (1) a description of the collateral similar to that found in the security agreement as set forth above, or (2) an indication that the financing statement “covers all assets or all personal property.” Id . § 9504. A financing statement is effective for a period of 5 years after the date of filing, unless its effectiveness is continued or terminated. Id . §§ 9513, 9515(a). 

ii.              Priority  

When more than one perfected security interest exists, the security interests rank according to priority in time of filing or perfection. U.C.C. § 9322(a)(1). A perfected security interest has priority over an unperfected security interest. Id . § 9322(a)(2). With respect to unperfected security interests, the first security interest to attach has priority. Id . § 9322(a)(3).

2.  Perfecting a Security Interest in Intellectual Property

As a preliminary matter, it should be noted that most courts which have analyzed the proper place to record and perfect a security interest with respect to various types of intellectual property have conducted their analysis under (1) former U.C.C. § 9-104(a) (whether the federal statute governed the rights of parties affected by transactions) and (2) former U.C.C. § 9-302(3)(a) (whether the federal statute provided for national registration or specified a place of filing for a security interest different from that in the former U.C.C.). Under the revised Article 9, the analysis turns to whether the relevant federal statute (1) preempts Article 9 with respect to perfecting a security interest, as set forth in U.C.C. § 9109(c)(1), and (2) provides a national filing system for perfecting security interests, as set forth in U.C.C. § 9311(a)(1)—similar though not entirely the same analysis as was done in the former Article 9. Nonetheless, cases that have been published after the revised Article 9 went into effect have for the most part mirrored their analysis to the former Article 9 standards, and many of the cases have conflated the two issues set forth above into one issue or just analyzed both issues at the same time.

Under the Copyright Act, “copyright protection subsists . . . in original works of authorship fixed in any tangible medium of expression, ” including literary works, musical works, dramatic works, motion pictures and sound recordings. 17 U.S.C. § 102(a). The Copyright Act confers upon copyright owners the exclusive rights to reproduce the copyrighted work, prepare derivative works based upon the copyrighted work and distribute copies of the copyrighted work to the public by sale or other transfer of ownership. Id . § 106(1)-(3).

The Copyright Act provides that any “ transfer of copyright ownership or other document pertaining to a copyright” may be recorded in the Copyright Office, and further defines a “transfer of copyright ownership” as “an assignment, mortgage, exclusive license, or any other conveyance, alienation, or hypothecation of a copyright or of any of the exclusive rights comprised in a copyright.” 17 U.S.C. §§ 101, 205(a) (emphasis added). A “hypothecation” means the “‘pledging of something as security without delivery of title or possession.’” Moldo v. Matsco, Inc. ( In re Cybernetic Servs., Inc. ), 252 F.3d 1039, 1056 (9th Cir. 2001), cert. denied , 534 U.S. 1130 (2002) ( quoting Black’s Law Dictionary 747 (7 th ed. 1999)).

Because 17 U.S.C. § 205(a) covers assignments and hypothecations of copyrights (i.e., security interests), it establishes a uniform method for recording security interests in copyrights and preempts Article 9 with respect to perfecting security interests in registered copyrights. Nat’l Peregrine, Inc. v. Capitol Fed. Sav. & Loan ( In re Peregrine Entm’t, Ltd .), 116 B.R. 194, 200-204 (C.D. Cal. 1990). Accordingly, the proper method for perfecting a security interest in a registered copyright is recording the security interest with the Copyright Office in order to give “all persons constructive notice of the facts stated in the recorded document,” rather than filing a financing statement under Article 9. Id . (quoting 17 U.S.C. § 205(c)); see also Aerocon Eng’g, Inc. v. Silicon Valley Bank ( In re World Auxiliary Power Co. ), 303 F.3d 1120, 1128 (9 th Cir. 2002); Morgan Creek Prods., Inc. v. Franchise Pictures LLC ( In re Franchise Pictures LLC ), 389 B.R. 131, 142 (Bankr. C.D. Cal. 2008); In re Avalon Software Inc. , 209 B.R. 517 (Bankr. D. Ariz. 1997). However, the perfection of an unregistered copyright must be done by filing a financing statement with the Secretary of State pursuant to Article 9—not by recording the security interest in the unregistered copyright with the Copyright Office. In re: World Auxiliary Power Company , 303 F.3d at 1128.

The Lanham Act defines a trademark to mean “any word, name, symbol, or device or any combination thereof” used by any person “to identify and distinguish his or her goods . . . from those manufactured or sold by others and to indicate the source of the goods.” 15 U.S.C. § 1127. The Lanham Act also provides registered trademark owners protection against any person who, without the trademark holder’s consent, uses the mark in connection with the sale, distribution or advertising of any goods or services, where such use is likely to cause confusion, mistake, or deception. Id . §§ 1125(a), 1141(1).

The Lanham Act provides that an “assignment shall be void against any subsequent purchaser for valuable consideration without notice, unless the prescribed information reporting the assignment is recorded in the United States Patent and Trademark Office within 3 months after the date of the assignment or prior to the subsequent purchase.” 15 U.S.C. § 1060(a)(4). Unlike the Copyright Act—which governs filings both with respect to assignments and transfer of security interests—the Lanham Act provides only for the recording of an assignment of a trademark with the USPTO, which does not include pledges, mortgages or hypothecation of trademarks. Joseph v. Valencia, Inc. ( In re 199Z, Inc .), 137 B.R. 778, 782 (Bankr. C.D. Cal. 1992) ; 15 U.S.C. § 1060(a)(4).

Trademark cases distinguish between security interests and assignments. Roman Cleanser Co. v. Nat’l Acceptance Co. of Am. ( In re Roman Cleanser Co .), 43 B.R. 940, 944 (Bankr. E.D. Mich. 1984), aff’d , 802 F.2d 207 (6th Cir. 1986) . While a trademark assignment is an absolute transfer of the entire right, title and interest in and to the trademark, the grant of a security interest is not such a transfer. Id . Rather, the grant of a security interest is merely “a device to secure an indebtedness,” or “a mere agreement to assign in the event of a default by the debtor.” Id . Given that the Lanham Act only covers assignments of trademarks and the fact that a security interest in a trademark is not equivalent to an assignment, the filing of a security interest is not covered by the Lanham Act. Id . Thus, the Lanham Act does not preempt Article 9 and the manner of perfecting a security interest in trademarks is governed by Article 9, which means that the secured creditor must file a financing statement with the Secretary of State to perfect the security interest in the trademark. E.g., In re Roman Cleanser Co ., 43 B.R. at 944; In re 199Z, Inc., 137 B.R. at 782 (holding that secured party cannot perfect security interest in trademark by recording with the USTPO); Trimarchi v. Together Dev. Corp ., 255 B.R. 606, 610-11 (D. Mass. 2000) (holding that the Lanham Act does not preempt Article 9); In re Together Dev. Corp ., 227 B.R. 439 (holding that filing of security interest with the USPTO failed to perfect security interest); I n re Chattanooga Choo-Choo Co., 98 B.R. 792 (Bankr. E.D. Tenn. 1989) (holding that the U.C.C., not the Lanham Act, governs recordation of security interests in trademarks); Creditors’ Comm. of TR-3 Indus., Inc. v. Capital Bank ( In re TR-3 Indus .), 41 B.R. 128 (Bankr. C.D. Cal. 1984) . Arguably, if Congress intended to provide a means for recording security interests in registered trademarks—in addition to recording assignments of trademarks—it would have done so, as it did in the Copyright Act with respect to recording security interests in registered copyrights . In re Roman Cleanser Co ., 43 B.R. at 944; In re 199Z, Inc., 137 B.R. at 782.

Nonetheless, although cases uniformly suggest that a security interest in a trademark must be perfected by filing a financing statement with the Secretary of State of the state in which the debtor is located, it is recommended that a recording or filing also be made with the USPTO, especially since the USPTO has no authority to refuse to record a filed document on the ground that it is not a valid assignment. In re Ellison Publications, Inc. , 182 U.S.P.Q. 498, 1974 WL 19944 (Comm’r Pat. & Trademarks 1974). Filing a financing statement with the Secretary of State and recording the security interest with the USPTO will ensure that lien creditors and subsequent lenders and purchasers are all on notice of the security interests.

On a related note, when recording an assignment of a trademark in the USPTO, a creditor should make sure that the trademark is assigned together “with the goodwill of the business in which the mark is used.” 15 U.S.C. § 1060. Because a trademark is merely a symbol of goodwill and it has no independent significance apart from the goodwill it symbolizes, it cannot be sold or assigned apart from the goodwill it symbolizes. Marshak v. Green, 746 F.2d 927 (2d Cir. 1984). A sale of a trademark without its goodwill is an “assignment in gross” and is not a valid assignment. 1 J.

Thomas McCarthy, McCarthy on Trademarks and Unfair Competition , § 18:3 (4th ed. 1996).

The Patent Act grants inventors and discoverers of “any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof” the right to obtain a patent, which must be novel and nonobvious. 35 U.S.C. §§ 101-103. The Patent Act protects the inventor or discoverer of the patent who applies for and pursues the patent from infringers who use or sell the patented invention without authority. 35 U.S.C. § 271(a).

The Patent Act provides that an “assignment, grant or conveyance shall be void as against any subsequent purchaser or mortgagee for a valuable consideration, without notice, unless it is recorded in the Patent and Trademark Office within three months from its date or prior to the date of such subsequent purchase or mortgage.” 35 U.S.C. § 261. The Ninth Circuit has held that the terms “assignment, grant or conveyance” refer to ownership interests only, and a security interest in a patent that does not involve a transfer of the rights of ownership is a “mere license” and not an “assignment, grant or conveyance” within the meaning of 35 U.S.C. § 261. In re Cybernetic Servs., Inc. , 252 F.3d at 1052. Since 35 U.S.C. § 261 provides that only an “assignment, grant or conveyance shall be void” as against subsequent purchasers and mortgagees, only transfers of ownership interests need to be recorded with the USPTO. Id.  Unlike the Copyright Act, which refers to a transfer of ownership, which is further defined to include any “hypothecation” (i.e., the pledging of something as security without delivery of title or possession), the Patent Act does not refer to hypothecation, or to any security interests. Id . at 1056. The Patent Act does not preempt Article 9 with respect to filing security interests in patents, and a transaction that grants a creditor a security interest in a patent but does not effect a transfer of title or ownership is not the type of “assignment, grant or conveyance” that is referred to in 35 U.S.C. § 261. Id . at 1058. Accordingly, the proper method to perfect a security interest in a patent against subsequent lien creditors is to file a financing statement with the Secretary of State, in accordance with Article 9, rather than to record the interest with the USPTO. Id ; Pasteurized Eggs Corp. v. Bon Dente Joint Venture ( In re Pasteurized Eggs Corp .), 296 B.R. 283, 291-292 (D.N.H. 2003); In re Transportation Design and Technology, Inc ., 48 B.R. 635, 638-639 (Bankr. S.D. Cal. 1985); City Bank and Trust Co. v. Otto Fabric, Inc ., 83 B.R. 780 (D. Kan. 1988); Chesapeake Fiber Packaging Corp. v. Sebro Packaging Corp ., 143 B.R. 360, 369 (D. Md.) 1992). However, such a filing pursuant to Article 9 does not perfect security interests in patents against subsequent bona fide purchasers . In re Transportation Design and Technology, Inc ., 48 B.R. 635, 638-639 (Bankr. S.D. Cal. 1985). In order to properly perfect a security interest in patents against both future lien creditors and subsequent purchasers or mortgagees for value, it is best to file a financing statement with the Secretary of State, and to record the security interest with the USPTO. See Rhone-Poulence Agro, S.A. v. DeKalb Genetics Corp ., 284 F.3d 1323 (Fed. Cir. 2002) (noting that a secured creditor should record the security interest with the USPTO to perfect the security interest against a bona fide purchaser or mortgagee).

In summary, after reviewing Article 9, along with the Copyright Act, the Lanham Act and the Patent Act, and the case law interpreting those statutes, here’s what appears to be the consensus: (1) to perfect a security interest in a registered copyright, the secured creditor must record the security interest with the Copyright Office (2) to perfect a security interest in an unregistered copyright, the secured creditor must file a financing statement with the Secretary of State of the state where the debtor is located, (3) to perfect a security interest in trademark (whether registered or not), the secured creditor must file a financing statement with the Secretary of State of the state where the debtor is located, (4) to perfect a security interest in a patent against subsequent lien creditors , the secured creditor must file a UCC financing statement with the Secretary of State of the state where the debtor is located, and (5) to perfect a security interest in a patent against subsequent bona fide purchasers , the secured creditor must record the security interest with the USPTO. Nonetheless, due to the fact that some of the cases were decided under the former Article 9, and to ensure that the secured creditor is completely protected against subsequent lien creditors and bona fide purchasers, it is recommended that when perfecting a security interest in a copyright, trademark or a patent, that the secured creditor file both a financing statement with the Secretary of State of the state where the debtor is located, and to record the security interest with the Copyright Office (for copyrights) or with the USPTO (for patents and trademarks).

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Perfecting Security Interest in Patents

As the economy continues to evolve away from traditional manufacturing to knowledge and services, so has the focus of enterprise capital investment.  Historically, enterprise investment was focused on the tangible assets and infrastructure needed to maintain and grow operations.  Today, however, investment is focused on technology, innovation, and knowledge-based assets; and this intellectual property (IP) investment plays a fundamental role in the creation of corporate value.  IP is a dynamic corporate asset, acting as a driver of revenue, a signal to investors, and collateral for businesses seeking to borrow money.

At of the date of this article, the United States Patent & Trademark Office (USPTO) had recorded more than 62,464 patent assignments where patents were pledged as debt collateral.  Moreover, looking as far back as 2013, more than 40% of firms with patents outstanding had, at some time, pledged their patents as collateral.

Historically, patents were pledged alongside other assets, but the tide has shifted and lenders’ perspectives on the benefits of taking patents as collateral have improved dramatically.  This change in perspective is due to several factors.  First, and foremost, is the evolution of the U.S. economy.  Over the last fifty years, the US economy has shifted from a manufacturing economy to a knowledge-based economy.  In a knowledge-based economy, value creation and competitive advantage is driven by technological innovation.  In a knowledge-based economy, IP is a company’s most valuable asset and tangible assets take the back seat. The growing contribution of IP to corporate value is clear.  As shown below, the value of intangible assets as a percent of market value has grown from 17% in 1975 to 90% in 2020.

In addition to the growth in value attributable to IP and patents, there has been a broad increase in the number of IP and patent transactions.  These transactions, cross-licenses, and acquisitions by patent aggregators and non-practicing entities (NPE) are indicators of asset liquidity, and this liquidity has stimulated lender interest in IP and patents as collateral.

The combination of increasing liquidity and value to corporate borrowers has been key to the growing acceptance of IP and patents as collateral.   As discussed by Henry, S., Ferraro, H. and Keeton, H. “Securing a Loan with Patents, Trademarks, and Copyrights is Best for Lenders,” in Pratt’s Journal of Bankruptcy Law, Issue 1, January 2010, pp. 50-64, in a typical agreement, a third-party lender takes an interest in the patent or application to secure payment on a loan. The lender, as a secured creditor, has preferential rights in the disposition of the asset upon any default. Thus, legal ownership does not change unless and until the borrower defaults and the lender forecloses on and seizes the patent or application.

Not every patent is suitable as collateral.  Patents are suitable collateral for loans when they are valuable assets that can be sold or licensed to generate income. However, there are risks associated with using patents as collateral, as the value of a patent can be uncertain and may depend on a number of factors, such as the strength of the patent, the market demand for the technology, and the availability of competing technologies.  Failure to understand the value of a patent or patent portfolio may result in a significant shortage of collateral.

Perfecting a security interest in a patent means taking certain steps to protect your rights as a lender or creditor in the event that the borrower defaults on their loan or other obligation. Perfecting a security interest allows you to have a legal claim to the patent as collateral in the event that the borrower fails to meet their obligations.

The process of perfecting a security interest involves identifying the patent or patents being used as collateral, executing a written security agreement, and filing a financing statement with the relevant patent office. By following these steps, you are creating a public record of your security interest, which helps to establish your priority over other creditors in the event that the borrower defaults.

To perfect a security interest in a patent, you must take certain steps to protect your rights in the event that the borrower defaults on their loan or other obligation.

In the United States, the process for perfecting a security interest in a patent involves:

• Identifying the collateral: You must accurately identify the patent or patents that are being used as collateral. This may include the patent number, the title of the invention, and the date of issuance.
• Executing a security agreement: You and the borrower should execute a written security agreement that specifies the terms of the loan or other obligation and the patent or patents being used as collateral. The security agreement should be signed by both parties and should be witnessed by a third party.
• Filing a financing statement: To perfect your security interest in the patent, you must file a financing statement with the relevant patent office. In the United States, this is done through the United States Patent and Trademark Office (USPTO). The financing statement should include the names and addresses of the parties involved, the patent number and title, and a description of the security interest being perfected.
• Searching for other security interests: It is important to search for any other security interests that may have been filed against the patent to ensure that your security interest is properly perfected and that you have priority over any other creditors.

Perfecting a security interest is critical to protecting your rights as a lender or creditor and ensures that you are able to recover your investment if the borrower fails to meet their obligations. Without a perfected security interest, you may have difficulty enforcing your rights and recovering your investment in the event of default.

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Perfecting A Security Interest in Intellectual Property

Periodically, we field questions concerning perfection of security interests in intellectual property assets (including patents, copyrights, and trademarks, collectively, "Intellectual Property"). There seems to be growing interest in this area, which we attribute to several factors (e.g., increased lending by financial institutions (8.3% increase Q1 from 2013 to 2014)); increased bankruptcy activity (4414 business filing in South Carolina by Sept. 30, 2014 compared to 4490 for the entire year of 2013), and the continued increase in the creation of Intellectual Property (the number of patents issued to South Carolina inventors and companies continues to rise as do patent grants nationwide).

With increased interest and activity come a heightened risk of error on the part of the creditor - particularly with respect to required financing statements. This risk is due in large part to the level of detail required for perfecting a security interest and uncertainty as to the place and manner of registration as a result of federal preemption issues.

THE NEED FOR ACCURATE AND COMPLETE OWNER NAME

With regard to the issue of detail, one need only recall In re Tyringham Holding, Inc., 354 B.R. (E.D. Va. 2006), in which the Court held that the creditor failed to perfect its security interest due to the mere omission of "Inc." from the debtor's name in the financing statement; this oversight allowed $311,000 of inventory to be sold at auction over the protest of the creditor. Although the collateral at issue in the In re Tyringham Holding, Inc. case was not Intellectual Property, the importance of thoroughness and attention to detail equally applies when a creditor accepts Intellectual Property to secure the debtor's commitment to repay. Not only can an incorrect or partial entity name cause a financing statement to be ineffective (and relegate an otherwise secured creditor to the status of unsecured creditor), a trademark application containing an incorrect entity name is cause for the application to be voided. Further, where copyright infringement is alleged, the defendant may raise as a complete defense against infringement the existence of an error in the name of the owner on the registration. Accordingly, it is critical to ensure the complete and correct name of the owner of the Intellectual Property is used in registration of the federal rights, as well as on the financing statement and the supporting security agreement.

PERFECTION OF SECURITY INTERESTS IN INTELLECTUAL PROPERTY

Perfection of a security interest under the UCC is used to protect secured parties "against purchasers from and creditors of the debtor." U.C.C. § 9-101. Article 9 governs perfection of security interests in personal property, including Intellectual Property. The UCC provides that a party must perfect its security interest by filing a financing statement with the Secretary of State where the debtor is located. U.C.C. §§ 9-310 & 9-307. The foregoing general rule does not apply to property which is subject to a statute, regulation, or treaty of the United States, where the federal law preempts state financing statement requirements. U.C.C. § 9-311(a).

Section 9-311 has caused some uncertainty for lenders seeking to perfect a security interest in a borrower's trademarks. Though the Lanham Act does not specifically preempt Article 9 of the UCC, it does provide a system for recording trademark assignments in the United States Patent and Trademark Office ("USPTO"), which constitutes constructive notice to all subsequent purchasers. See 15 U.S.C. § 1060 (2014). The USPTO, however, has stated that other documents affecting title to trademark applications or registrations-including security interests-may also be recorded using this same system. See 37 C.F.R. § 3.11; TMEP § 503.02.

The few courts that have addressed this issue have found that because the Lanham Act does not expressly provide for the registration of a security interest, a UCC filing in the jurisdiction in which the debtor is located is sufficient to perfect security interests in trademarks. See In re Roman Cleanser, 43 Bankr. 940, 225 U.S.P.Q. 140 (Bankr. E.D. Mich. 1984). Though the limited case law suggests that perfection of security interests in trademarks does not require a filing with the USPTO, it is nonetheless advisable for the lender to both file a UCC financing statement, and record its security interest with the USPTO.

While case law suggests perfection through the USPTO is unnecessary for trademark and service marks, patent law is clear that 35 U.S.C. § 261 (Ownership; Assignment) preempts state law priority rules for purchasers. See, e.g., Rhone-Poulence Agro, S.A. v. DeKalb Genetics Corp., 284 F.3d 1323 (Fed. Cir. 2002) (indicating that a secured creditor should record its security interests in patents in the USPTO to perfect against a bona fide purchaser); In re Transp. Design & Tech., Inc., 48 B.R. 635, 639 (Bankr. C.D. Cal. 1985) (holding that a bona fide purchaser who recorded his transfer of title with the USPTO will defeat a secured party's interests who has not filed notice of his/her security interest with the USPTO).

In light of the preemption by patent laws, a creditor taking trademarks or services marks as collateral runs the risk of a court, one day, using patent precedents to establish guidelines for trademark securitization. Therefore, if a party is trying to contend that failure to file the USPTO for a trademark or service mark results in ineffective perfection, that party may argue its position by analogy, citing patent cases. The argument may look something like: (1) the relevant sections of the Patent Act and the Lanham (Trademark) Act are virtually identical; (2) case law addressing this issue in the trademark arena simply does not exist; and (3) since the Patent and Trademark Office processes both patent and trademark documents, the internal operation of this administrative body are the same. The party would then conclude that patent cases should control, rendering ineffective a trademark-related security interest that is not filed with the USPTO. Fortunately, avoiding the potential risk is accomplished by filing with the USPTO for trademark and services mark.

The Patent Act states that an "assignment, grant or conveyance shall be void as against any subsequent purchaser or mortgagee for a valuable consideration, without notice, unless it is recorded in the [USPTO] within three months from its date or prior to the date of such subsequent purchase or mortgage." 35 U.S.C. § 261. Further, the Federal Circuit has stated in dicta that a secured creditor should record the security interest with the USPTO to perfect the security interest against a bona fide purchaser or mortgagee. See Rhone-Poulence Agro, S.A. v. DeKalb Genetics Corp., 284 F.3d 1323 (Fed. Cir. 2002). With patents, the security interest should be filed with the USPTO.

The Copyright Act preempts Article 9 of the UCC and therefore controls the perfection of security interest in registered copyrights and pending copyright applications. In order to perfect a security interest in registered copyrights and pending copyright applications, a security agreement must be filed with the United States Copyright Office. It should be noted that the US copyright laws generally rely upon the first executed transfer and not necessarily the first recorded transfer.

As for unregistered copyrights, the traditional methods of state filing of security interests is adequate.

THE SECURITY INTEREST

In order to file security agreements acceptable to the appropriate federal office, it is advisable to use properly prepared IP short forms. The McNair IP Team can provide the appropriate form and guidance regarding its use. Such forms can be included in closing documents as Exhibits and provide language such as, "'Intellectual Property Security Agreements' means the short-form Patent Security Agreement, short-form Trademark Security Agreement, and short-form Copyright Security Agreement, each substantially in the form attached hereto as Exhibits III, IV and V, respectively."

Using attention to detail along with the foregoing procedures should help the creditor avoid the unhappy discovery that its security interest in Intellectual Property was not perfected.

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Patents as debt collateral: perfecting security interests.

June 16, 2023 by Gregory Campanella Categories: Ocean Tomo , Ocean Tomo Debt and Equity Capital , Ocean Tomo Insights , Ocean Tomo Intellectual Property Valuation , Ocean Tomo Investment Banking , Ocean Tomo Team Tags: Assets , Borrower , Collateral , Debt Collateral , Financing , Financing Statement , Intellectual Property , IP , Licensing , Loan , Loan Default , Patent Assignments , Patents , Perfecting Security Interests , Security Interest

There will be many lessons to learn and conclusions to be made over the Silicon Valley Bank (SVB) fallout, but what we know is that SVB rapidly grew during the pandemic. In 2021 SVB’s deposits grew from $62 billion to $124 billion, in part due to the fact that SVB offered higher rates on deposits than many of its larger rivals.

To help fund these higher rates, SVB kept lower levels of deposits than other banks on hand and invested significant capital in startup company loans and higher-yield bonds. But that strategy failed when the Fed began hiking rates, and the venture capital market began to experience instability. This combination of higher rates and a slowdown in tech was a one- two punch for SVB.

The value of the bank’s investments shrank, and previously cash-heavy depositors started withdrawing cash deposits to fund operations.

SVB played an important role in the startup ecosystem. Without it, financing for startups is likely to become more difficult and more expensive; and this may lead to further instability in venture capital markets, an increase in loan defaults, and further declines in the value of SVB’s investments. In the event of default, the proper securitization of intellectual property (IP) pledged as collateral will be critical to the recovery of portfolio value.

The failure of SVB is a cautionary tale and a good segue into a discussion of patents as debt collateral and the importance of perfecting security interests.

As the economy continues to evolve away from traditional manufacturing to knowledge and services, so has the focus of enterprise capital investment. Historically, enterprise investment was focused on the tangible assets and infrastructure needed to maintain and grow operations. Today, however, investment is focused on technology, innovation, and knowledge-based assets; and this IP investment plays a fundamental role in the creation of corporate value. IP is a dynamic corporate asset, acting as a driver of revenue, a signal to investors, and collateral for businesses seeking to borrow money.

As of the date of this article, the United States Patent & Trademark Office (USPTO) has recorded more than 62,000 patent assignments where patents were pledged as debt collateral. Moreover, looking as far back as 2013, more than 40% of firms with patents outstanding had, at some time, pledged their patents as collateral. Historically, patents were pledged alongside other assets, but the tide has shifted, and lenders’ perspectives on the benefits of taking patents as collateral have improved dramatically. This change in perspective is due to several factors. First and foremost is the evolution of the U.S. economy. Over the last fifty years, the US economy has shifted from a manufacturing economy to a knowledge-based economy. In a knowledge-based economy, value creation and competitive advantage are driven by technological innovation. In a knowledge-based economy, IP is a company’s most valuable asset, and tangible assets take the back seat. The growing contribution of IP to corporate value is clear. As shown below, the value of intangible assets as a percent of market value has grown from 17% in 1975 to 90% in 2020.

In addition to the growth in value attributable to IP and patents, there has been a broad increase in the number of IP and patent transactions. These transactions, cross-licenses, and acquisitions by patent aggregators and non-practicing entities (NPE) are indicators of asset liquidity, and this liquidity has stimulated lender interest in IP and patents as collateral.

The combination of increasing liquidity and value to corporate borrowers has been key to the growing acceptance of IP and patents as collateral. As discussed by Henry, S., Ferraro, H. and Keeton, H. “Securing a Loan with Patents, Trademarks, and Copyrights is Best for Lenders,” in Pratt’s Journal of Bankruptcy Law, Issue 1, January 2010, pp. 50-64, in a typical agreement, a third-party lender takes an interest in the patent or application to secure payment on a loan. The lender, as a secured creditor, has preferential rights in the disposition of the asset upon any default. Thus, legal ownership does not change unless and until the borrower defaults and the lender forecloses on and seizes the patent or application.

Not every patent is suitable as collateral. Patents are suitable collateral for loans when they are valuable assets that can be sold or licensed to generate income. However, there are risks associated with using patents as collateral, as the value of a patent can be uncertain and may depend on a number of factors, such as the strength of the patent, the market demand for the technology, and the availability of competing technologies. Failure to understand the value of a patent or patent portfolio may result in a significant shortage of collateral.

Perfecting a security interest in a patent means taking certain steps to protect your rights as a lender or creditor in the event that the borrower defaults on their loan or other obligation. Perfecting a security interest allows you to have a legal claim to the patent as collateral in the event that the borrower fails to meet their obligations.

The process of perfecting a security interest involves identifying the patent or patents being used as collateral, executing a written security agreement, and filing a financing statement with the relevant public office. By following these steps, you are creating a public record of your security interest, which establishes your priority over other creditors in the event that the borrower defaults.

In the United States, the process for perfecting a security interest in a patent involves:

Identifying the collateral: You must accurately identify the patent or patents that are being used as collateral. This may include the patent number, the title of the invention, and the date of issuance.

Executing a security agreement: You and the borrower must execute a written security agreement that specifies the terms of the loan or obligation and provides a description of the collateral. The UCC states that a sufficient description “reasonably identifies what is described.” The security agreement must be authenticated or signed by the debtor.

Filing a financing statement: To perfect your security interest in the patent, you must file a financing statement with the relevant office. In the United States, this is done through a public office, generally the Secretary of State. The financing statement must include the name of the debtor, the name of the secured party, and an indication of the collateral. Ideally, patent number and title will be included in the indication, but generic descriptions, for example, “all assets of the debtor now owned or hereafter acquired or arising,” are sufficient.

Filing evidence of the security interest with the USPTO. According to the statutory notice requirements under 35 U.S. Code § 261, An interest that constitutes an assignment, grant, or conveyance shall be void as against any subsequent purchaser or mortgagee for valuable consideration, without notice, unless it is recorded in the Patent and Trademark Office within three months from its date or prior to the date of such subsequent purchase or mortgage.

Searching for other security interests: It is important to search for any other security interests that may have been filed against the patent to ensure that your security interest is properly perfected and that you have priority over any other creditors.

Perfecting a security interest is critical to protecting your rights as a lender or creditor and ensures that you are able to recover your investment if the borrower fails to meet their obligations. Without a perfected security interest, you may have difficulty enforcing your rights and recovering your investment in the event of default.

Gregory Campanella, CLP is a Senior Managing Director and joined J.S. Held in March of 2022 as part of J.S. Held's acquisition of Ocean Tomo. He is responsible for leading the Management Consulting & Valuation practice of Ocean Tomo, a part of J.S. Held. His work has focused on strategic advisory and the valuation of intangible assets and intellectual property for acquisitions and divestitures, bankruptcy and restructuring, establishment of monetization strategies including licensing, mergers, joint venture / partnership formations, litigation support, and tax matters. He is skilled in the creation of models to both evaluate the economics of alternative spin-out strategies and to establish the value of IP to be contributed in a joint venture.

Greg can be reached at [email protected] or +1 415 946 2605

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Due Diligence on Startups: Patent Assignments and Inventorship Issues

Assignments are recorded at the USPTO and are available to the public. On the USPTO website[1], a search for the company or inventor will show assignments as they are recorded. This website will show that an assignment exists and the parties to the assignment, but to get an actual copy of the assignment someone needs to visit the USPTO in person. There are third party services that will get the USPTO copies for a fee.

One of the flexible things about assignments is that different rights to a patent can be assigned to different people. For example, a patent can be assigned to a third party but can grant the previous owner a paid up, royalty-free license to use the technology. These provisions are only shown in the documents available at the USPTO and not online.

For due diligence, the owners of the patents should provide all of the assignments in a chain of title. The chain of title always starts with the inventor and will progress to the current owner. If there are any license agreements relating to the patents, each of the previous owners of the patents should provide copies of the agreements.

Startups typically use assignments that come from their patent attorneys. Normally, these are ok, but often these assignments were written years ago and have been reused for decades since the patent attorney started practicing.

One of the items most often omitted is the right to “causes of action”, which include the rights to sue for past damages. This is not important when the invention is created, because there is no past infringement, but it is important when patents are transferred later on.

Another thing to look for in the chain of title are any security interests in the assets. Just like a mechanic’s lien on real estate, the patents may be put up as collateral for a bank or some other institution. This typically does not happen in startups, but these will appear from time to time.

In most cases, a quick look at the USPTO assignments database will show the provenance of the asset. The inventor, patent attorney, or company should have the signed assignments for review.

What If There Are No Assignments?

For young startups or first time inventors, there may be no assignments at all. When this problem is encountered, no investment should be made for three months .

This means that there is a possibility that the patents were assigned to someone else in the last three months, and that person has not yet filed the assignment with the USPTO.

When there are no assignments recorded and the patent application has been around for a long time, the assignee must file an assignment, then wait three months to see if any other assignments are filed. If the three months pass without incident, the assignment is valid.

There are all sorts of scenarios where an entrepreneur, hungry for money, assigns their patents to someone for cash. They might not even know that it happened, as it could have been in a stack of papers or even a paragraph in some deal they signed.

The company needs to have solid chain of title to the assets. Until that is set in stone, stay away from the investment.

Inventorship Issues

Inventorship issues are one quick way to sink a patent. One of the worst things that someone can uncover is that there are problems with who was listed on the patent.

When patents get litigated, the patents can be attacked on the merits by arguing that the patent was issued incorrectly or that the patent examiner did not interpret the prior art correctly. This is long and tedious.

One of the easiest ways to kill the patent completely is to argue that the inventors were incorrectly listed. If there was any impropriety, the patent can be completely invalidated without ever arguing whether or not it was properly granted.[2]

These problems come in two forms: people who are listed as inventors but should not have been, and people who are left off.

Having Too Many Inventors

Courtesy in Asia is that an inventor will always list their boss on a patent. This can happen in startups, too, where the CEO might not have anything to do with the invention, even though their name was listed first. When looking at a patent portfolio, especially with a long list of inventors, investigate who all the inventors are and what their area of expertise is.[3]

Here is a typical scenario where everything falls apart: Let’s assume that the names of a six-person startup team are all listed as inventors on a patent. The CEO (or the patent attorney) is too cowardly to tell one of the people that they did not contribute, so the CEO magnanimously adds everybody to the patent. What actually happens is that the person who actually contributed the biggest portion of the ideas is quiet, but very resentful.

When the patent is being litigated, or when an acquiring company is doing due diligence before they buy the company, someone asks about all the people listed on the patent. By the time this happens, some of the people have left the company. The investigator calls all of the inventors, because they are listed on the face of the patent, and asks about how the invention took place.

Inevitably, the inventor who was scorned will go into a tirade about how so-and-so was included on the patent when they contributed nothing. Alternatively, the inventor may state that they had absolutely nothing to do with the invention but they were included for some reason.

All of a sudden, the patent can be completely invalidated with a simple affidavit from the scorned inventor. When that asset is a key to the entire acquisition deal, it can fall apart completely.

Having Not Enough Inventors

On the other side of the coin, what about leaving off an inventor?

These problems are less severe mostly because they are harder to uncover. We do not have a list of people on the face of the patent to call. However, there is one place where this happens quite frequently:

Patents that come from startup accelerator companies have half the value.

Within the patent valuation community, the value of a patent of any company in a startup accelerator must be cut in two. Why is that?

The problem is inventorship, and here’s the scenario:

A bunch of startups are put in a big room and put through their paces. They learn lean startup methods, they hone their pitch, they build a minimum viable product, they get some customer data, they hone their pitch some more, and they present to investors.

All of these companies work elbow-to-elbow with each other. A CTO from one startup might be standing by the water cooler struggling with their minimum viable product, and a CTO from a second company may be there, too. The first CTO explains the problem and the second CTO offers a suggestion. The light bulb goes off and they find the key that unlocks the product. The first CTO gets a patent on the invention, but the second CTO believes (rightly or wrongly) that they contributed to the invention.

The value of the patents for accelerator companies is cut in half because there is no way for the second CTO to be listed on the first CTO’s patent. If they do list both inventors, both companies would have rights to the patent. If they do not list both inventors, the second CTO can cause the patent to be invalid.

The value is discounted 50% because there is a very strong possibility that another person in another company believes (rightly or wrongly) that they should have been an inventor but they were left off the patent.

It really does not matter if that person should have legally been listed as an inventor or not; what matters is what that person believes . The mere fact that someone is out there making noise that they should have been an inventor is enough to scare buyers away for good.

Patents And Proprietary Information Agreements

Every person, including the original founder, must have a patents and proprietary information agreement in place with the company.

These agreements cause all of the inventions created by the person to be assigned to the company.[4]

Founders are notorious for not having these agreements in place. They will often have them with employees, but the solo founder often will not sign one with the company. As an investor, this must be in place with everyone – including the inventor/founder.

These agreements are essential because they cause the company to be the owner of the invention at the time the document is signed . Once the document is in place, it can be substituted as a regular assignment and sent to the USPTO as an assignment. This is incredibly helpful when there are problems down the road, such as when an inventor leaves the company or decides that they try to hold the patent hostage for some kind of bonus.

Note: This is an excerpt from “ Investing In Patents ” by Russ Krajec. Russ is the founder and CEO of BlueIron IP, and investment company that finances intellectual property for angel and venture backed startup companies.

_______________

[1] See http://assignment.uspto.gov .

[2] Note that this is a feature of US law. In the US, patents are granted to “inventors”, but every other country, patents are granted to “applicants”, which can be an inventor or a corporation. The recent patent law now allows the applicant to be a corporation, but only after the inventor assigned their rights to the corporation.

[3] The legal definition is that a joint inventor or co-inventor must contribute at least one limitation to at least one claim to be listed as an inventor. The key here is that inventors must contribute to something that is in the final version of the claims. Often claims are amended and the inventorship is supposed to be updated, but this rarely happens in practice.

Patents with even the hint of inventorship issues are severely discounted in the secondary market and have almost no value.

[4] See Stanford University v Roche Molecular Systems, Inc.   The key pint is that the agreement between the employee and employer must state that the employee “hereby assigns” their inventions, not “will assign” their inventions.

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One (not so minor) correction:

The statement “ Assignments are recorded at the USPTO and are available to the public. ”

should read instead:

Assignments may be recorded at the USPTO and may be available to the public.

Contrary to the perception created, there is no actual legal requirement that assignments must be recorded.

Is it “smart” or “best practice” to do so? Sure. Are there situations that lend themselves to not doing so? Also sure.

The caveat should always be included informing a client that the due diligence is limited by this fact.

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