Tech Lending: How To Register Security Interests In IP – Trademark … – Mondaq News Alerts

As discussed previously in this series, there are inherent
challenges in valuing intellectual property (IP) assets. Valuation
requires an understanding of the marketability and commercial
potential of the assets, as well as an awareness of the unique
risks associated with them. This entails a more exhaustive due
diligence process that can be time-intensive and challenging to
complete.

In addition to valuing IP, lenders must also understand the
process for registering a security interest in IP. There are
different systems for provincial, federal and U.S. registrations.
Each presents unique features.

Many forms of IP rights exist without any formal governmental
approval or registration of the IP. As previously addressed in this
series, virtually all companies in Canada have IP rights that are
not registered with the Canadian Intellectual Property Office
(CIPO). In particular, while some types of IP rights require
registration (such as patents and industrial designs), many types
do not. For example, Canadian law recognizes both registered and
unregistered trademarks and copyright. Trade secrets are not
registered at all.

Registering Security Interests in Ontario

In Ontario, security interests in personal property are governed
by the Personal Property Security Act  (PPSA).
Under the PPSA, personal property includes intangibles like IP. For
a security interest to be valid and enforceable under the PPSA, two
things are required: attachment and perfection.

A security interest attaches to collateral only when:

1. value is 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 signed a security agreement containing a
   description of the collateral which is sufficient to enable it to
   be identified.

While perfection of security in other classes of collateral is
achievable through registration, possession or control, perfection
of a security interest in an intangible such as IP can only be
achieved through registration. The law governing perfection over
tangible collateral is generally the law of the jurisdiction where
the collateral is located. However, for intangibles like IP, the
law of the location of the debtor at the time the security interest
attaches governs. Under the Ontario PPSA, location of the debtor is
determined as follows:

Registering a security interest under the PPSA can be done
through the Personal Property Security Registration (PPSR) system.
This is done by submitting a financing statement to the Business
and Personal Property Branch of the Ministry of Public and Business
Service Delivery, which can be completed and submitted
electronically. Under the PPSA, registration can be made even
before the relevant security agreement is entered into.

Using the PPSR establishes priorities between parties with
competing interests in the same personal property. It also ensures
that the non-possessory lien is enforceable against third parties
in the case of a claim for lien. Once registered under the PPSR
system, the information can be searched by potential lenders and
buyers to find out if a lien has been filed in Ontario. However,
PPSR registrations are not contained in a federal register. It is
therefore common for lenders, where possible, to register against
IP through both the PPSR and at CIPO.

Registering Security Interests Federally in Canada

Certain types of IP rights are governed by federal statutes
including: the Trademarks Act, the Patent
Act, the Copyright Act and
the Industrial Design Act. These federal statutes
permit secured lenders to register or record transfers or
assignments of applications for and registrations of patents,
trademarks, copyrights and industrial designs with CIPO.
Assignments may include assignments by way of security.

However, CIPO’s system can be clumsy when it comes to
recording security interests in IP. In particular, recording a
security interest with CIPO does not perfect that interest in the
same way that registration of the security interest under the PPSA
does. Rather, a note will simply be added to the applicable CIPO
database entry to indicate the existence of the security agreement
in respect of the particular type of registered or applied-for IP
(e.g., if a security interest is recorded in respect of a
particular patent, a note will appear in the entry for that patent
in CIPO’s Canadian Patent Database). Therefore, recording a
security interest with CIPO is typically used only as a means of
providing notice of that interest to future assignees.

To record a security interest with the CIPO, the IP must first
be filed with CIPO: there must be a pending application for
registration of the IP with CIPO or registration in good standing
with CIPO. CIPO cannot record security interests in respect of
unregistered or unfiled IP rights. As a practical matter, this
means that security interests cannot be recorded federally in
respect of many forms of IP (including common law trademarks and
unregistered copyright). Further, trade secrets are not registered
in Canada. While trade secrets are theoretically captured under the
PPSA as an intangible, “attachment” can be an issue.
Trade secrets may or may not be reduced to a written or other
recorded form. Some trade secrets are only held in the minds of
company personnel. If a business is in receivership and that
personnel leave, the trade secrets may not be preserved or remain
in a manner that is truly available for the lender.

Registering Security Interests in the U.S.

In the U.S. context, it is critical to register security
interests with the United States Patent and Trademarks Office as
well as under the Uniform Commercial Code (UCC). The UCC is a
uniformly adopted set of state laws that govern all commercial
transactions in the U.S., with Article 9 providing the framework
for secured transactions in personal property, including
intangibles. The PPSA is largely based on Article 9. State laws
must also be considered, as Article 9 of the UCC does not apply
where a U.S. statute, regulation or treaty pre-empts it.

Use of Third-Party Escrow Services to Secure Loans

Once a security interest in the IP is registered, it is
important to, where possible, set up a system that allows the
lenders to access the IP if need be. IP is often the most valuable
asset of many companies and, for some forms of IP (such as trade
secrets), maintaining confidentiality is critical. Companies can
thus be reluctant to share their IP with others in fear that it
will be misused. Third-party escrow services are commonly used to
secure certain types of IP, as it maintains protection of the IP
while still making it available to lenders under specific
circumstances.

For example, in the software space, the use of escrow services
is becoming increasingly common. As security for loans, a lender
can stipulate that source code be placed in a third-party escrow
account with an escrow agent. The source code will be held by the
escrow agent on behalf of the parties and the agent will ensure
unauthorized parties do not have access. The source code will be
released to the lender only in the event of default.

Placing the source code in escrow aims to ensure the
lender’s access to the software as security. However, source
code escrow is not a catchall solution and presents its own
limitations. The source code deposited is often outdated or
incomplete. Even if it is up to date, the lender may not be able to
verify it.

Additionally, the source code will be of little value to the
lender if it is not accessible to the employees who are familiar
with it or if the company itself is no longer operating, which is
often the case.

Lastly, the cost of source code escrow presents a challenging
barrier as setting up and maintaining the escrow arrangement can
involve substantial legal and administrative fees. While not
perfect, escrow services can be a useful tool for lenders to secure
their loans against tech companies.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.