Commercial Lending and Intellectual Property

January 21st, 2013 by Meliha Waddell

This is a two part blog on the use of intellectual property in the commercial lending context. This blog will concentrate mostly from the lender’s perspective. The next blog will review some key considerations from the perspective of borrowers and businesses looking to obtain financing using their portfolio of intellectual property as security.

The knowledge economy provides both opportunities and threats in the commercial lending context. Opportunities abound as “gazelle companies”[1] require a suite of financial institution products and services and, as relative newcomers, are generally free from brand loyalty to a particular lender.

Threats exist in that the nature of the collateral, in the form of copyright, trademarks and patents, create underwriting and enforcement issues. The issues are not insurmountable. However, they require lenders interested in lending to intellectual property concerns to conduct a different type of due diligence from traditional bricks and mortar lending. This post concentrates primarily on enforcement issues relevant to lenders; the next blog will deal with underwriting business and legal issues of corporations with intellectual property assets seeking financing.

The most basic legal issue facing lenders is jurisdictional. The registration of security falls under the provincial sphere while the registration of intellectual property falls under the federal sphere.

This jurisdictional issue is not merely academic. The particular language of the Patent Act[2] and Copyright Act[3] can be read as requiring lenders to register their interests in patents and copyrights; the Trade-marks Act is not as direct in such a requirement.

Given there is no federal equivalent of a personal property registrar should the lender require the borrower to assign the intellectual property to the lender as a condition of financing? Obvious business reasons alone dictate against this condition. From a risk management perspective, the lender would then be potentially liable for intellectual property infringement claims or be obligated to defend the intellectual property. As such, lenders should avoid such drastic measures.

Unfortunately, at the date of writing, there has been no resolution on how to resolve the jurisdictional issues between the requirements of federal statutes to register interest and the provincial personal property regime.

Instead, various best practices have developed to ensure the lender has sufficient security in intellectual property as part of a financing. Well-drafted loan and security agreement may include the following:

  1. 1. Representations and warranties on the following:
      a. Identification of applicable copyright, trademarks and patents
      b. Confirmation of ownership
      c. No infringement over the intellectual property
  2. 2. Covenants
      a. Enforce intellectual property rights against infringers
      b. Keep the intellectual property current and registered
      c. Not encumber intellectual property
      d. Provide power of attorney to lenders to assist in keeping intellectual property current
  3. 3. Reporting requirements:
      a. Up to date list of intellectual property
      b. List of licenses granted over intellectual property (many lenders also require consents to any licensing by the borrower)
      c. Royalty revenue by each intellectual property

In instances where the borrower is in special loans, lenders may demand that any royalty or licensing fees be subject to a lock box agreement.

Intellectual Property

As the above shows, “conventional” lending documentation will need to be amended where the collateral is primarily intellectual property. Commercial lenders should avoid the customary “check the box” due diligence and understand both the nature of the collateral. Borrowers who are borrowing on intellectual property assets should be prepared to answer questions from lenders about the nature of their collateral. Regardless, both lenders and borrowers dealing with intellectual property should be advised to seek qualified legal advice.

If you have any questions regarding commercial lending or intellectual property, please do not hesitate to contact the Commercial Lending department at Devry Smith Frank LLP. We have been assisting our clients grow and prosper since 1964.

[1]Conventionally defined in the entrepreneurial community as a business with at least $1 million in revenue with a growth rate of at least 20% in the last four years.

[2]Section 51

[3]Section 57(3)

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