Bar Journal - December 1, 2000
Security Interests in Intellectual Property: The Palpable Presence of E-Commerce Business in the Granite State
By: Paula M. Sicard
New Hampshire is leading the pack into the twenty*first century and those who believe they will be unaffected by the high*stakes world of e*commerce financing and venture capital investing are flat wrong. New Hampshire currently boasts more than 1,000 software and Internet companies1 and is the Nation’s second ranked state in its concentration of high*tech jobs.2 In 1999, the Granite State’s electronic exports totaled $867 million or 45% of the total exports for the state.3 Between 1993 and 1998, 7,618 high*tech jobs were added — a 22% growth rate, bringing last year’s total number of high*tech workers to 41,682.4 Jobwise, New Hampshire is ranked 8th in defense electronics manufacturing with 5,600 workers and 12th in electronic components and accessories manufacturing with 9,800 jobs.5 The average high*tech employee in New Hampshire earns an annual wage of $54,754 or 76% more than an average private sector employee, bringing the high*tech payroll in this state to $2.3 billion in 1998 alone.6
Make no mistake about it, this is an unprecedented economic boom that will reach every citizen of the state in some way in the near future. The staggering figures on high*tech jobs are but one example. In 1997, research and development expenditures exceeded $790 million and in 1999, venture capital investments reached $233 million.7 Still skeptical? Consider that as of October 1, 2000, the New Hampshire Retirement System had 30 venture capital managers handling a total of $200 million and was seeking one to three additional venture capital managers to manage some $50 million more of the $5 billion Retirement Plan.8 It comes as no surprise then, that Governor Jeanne Shaheen sits on the National Governor’s Association Task Force on the New Economy.9 According to one legal activist and attorney, Tom Rath, New Hampshire now:
Indeed, New Hampshire is entering the 21st century with a virtually unlimited innovative capacity. Last year, in addition to the state’s top ranking in high*tech, computers and telecommunications jobs, the state ranked 8th in patents issued per 1,000 workers and in the top ten in workforce education, export focus and foreign investment.11 It should come as no surprise, then, that these intellectual property rights have become critical to the vast majority of e*commerce financing arrangements.
Historically banks have become reliant upon underlying collateral as a secondary repayment source. If the operating cash flow from the borrower was insufficient to repay the debt, assets held as collateral were sold to satisfy the debt. As a result, most traditional lenders have become reliant upon the valuation and liquidity of certain “hard assets” (such as inventory, machinery and equipment, and real estate) and even certain intangible ones, such as accounts receivables, individual trading quotas (ITQs)12 or FCC licenses.13 However, New Hampshire’s high*tech revolution poses an increasing problem for the financial community, as intangible assets, including various types of intellectual property, have become some of the most valuable assets that entities hold. As the above figures demonstrate, New Hampshire’s innovative entrepreneurs and companies of all sizes are aggressively seeking financing to develop, market and sell these intangible assets, but traditional bank financing has been difficult to obtain.14
Usually, venture capital strategies provide a capital investment so that the assets can actually be put into market use, since many entrepreneurs and innovators lack the financial resources necessary to develop their ideas. When debt, as opposed to equity, is part of the funding process, the financiers usually require collateral, which often means that personal property, such as intellectual property rights, is offered to secure the loans.15 This process is not new to market financing and most practitioners have routinely handled secured transactions under Article 9 of the Uniform Commercial Code.
As New Hampshire consistently demonstrates its position as torchbearer for the powerful high*tech world market and information age electronic system, the need for financing continues to grow exponentially, and with it, the unavoidable problems of perfecting security interests in intellectual property. These problems arise, for the most part, because intellectual property rights, each of which carry their own governing federal statutes, inevitable collide with other related federal statutory schemes such as the Bankruptcy Code, and state legal regimes – specifically, the Uniform Commercial Code secured transaction requirements as embodied in Article 9.16
This high tech progress is not without its pitfalls. Stock market volatility affects the degree to which high tech companies can obtain money from venture capitalists or through initial public offerings. With this growth comes an inevitable decline that results in cash*starved companies that cannot obtain financing or find a buyer and are forced into bankruptcy. Dot.coms nationally have faced difficult financial times during the past year, resulting in bankruptcies, shutdowns, layoffs, fire sales of their assets and withdrawal of their IPOs.17 Internet mergers and acquisitions were up 700% in the first half of this year and buyers spent more than $230 billion to buy more than 500 Web destinations.18 A study published by a San Francisco group in the “Webmergers Watch List” revealed that of the 238 Internet startups it monitored, almost 30 have been sold and 41 shut down.19 In addition, 83 of the monitored companies have withdrawn their IPO plans and almost 15% of those that withdrew their plans have been acquired. Between Jan. 1 and Aug. 8, 200, 98 of those 238 companies had layoffs.
The list of troubled Dot.coms is growing daily, illustrating a trend in which layoffs are massive while the companies struggle for viable business models and achieve profitability. Bankruptcy filings are also increasing exponentially, some of which are motivated by the desire to seek Chapter 11 shelter from copyright infringement and other lawsuits.20 Thus, it is inevitable that important intellectual property rights in New Hampshire will be at issue in any number of transactional and litigation scenarios in the upcoming year. Practitioners will be called on to handle valuation and sales, mergers and acquisitions, perfection of security interests and bankruptcies and other lawsuits. For many of the new e*commerce companies and enterprising individuals, these intellectual property rights often represent their most, or only, valuable assets. Transactional lawyers may find themselves defending clients who own assets leased or licensed to the debtor in bankruptcy court.21
It is ironic then, that while the demands to create and perfect security interests in intellectual property continue to grow, almost no other emerging issue can so paralyze practitioners and generate wildly divergent professional and judicial opinions of the correct processes required. And undoubtedly, the issue will become increasingly critical as the multitude of e*commerce companies, which were originally founded upon equity investments from venture capitalists, seek more traditional forms of capitalization in order to maintain their viability and maximize their potential for growth in the present volatile and high*stakes world markets. The venture capitalists and investment “angels” purchasing equity stakes in these software and Internet companies also need to be assured that the assets upon which their investments depend have not been previously encumbered. The Internet has already inspired “an expanding universe of angels and other venture investors” who will play a significant role in the increasing economy and development in this state.22
In response to the obvious confusion, courts throughout the country are actively debating how a creditor may perfect a security interest in intellectual property and are attempting to address federal and state law conformity issues.23 Given the present state of disarray in this area, what follows is a brief glimpse of the various types of intellectual property, the jurisdictional problems applicable to each as they relate to perfection issues, and the compelling arguments for a centralized, integrated system by which lenders could easily and comprehensively determine what security interests encumber intellectual property assets at both the state and federal levels.
SECURITY INTERESTS IN INTELLECTUAL PROPERTY
There are three substantial areas of law involved in any effort to use intellectual property assets as collateral; first, secured transactions under Article 9 of the Uniform Commercial Code as adopted by the individual states; second, federal and state intellectual property laws; and third, the Federal Bankruptcy Code. Banking institutions and other more traditional lenders that might otherwise be inclined to provide funding to information age businesses are currently discouraged from doing so because of significant problems in satisfying all aspects of all the implicated statu tory schemes. In its 1992 Preliminary Report on Security Interests in Intellectual Property, the American Bar Association Task Force unequivocally noted that:
The current state of the law governing security interests in intellectual property is unsatisfactory. There is uncertainty as to where and how to file, what constitutes notice of a security interest, who has priority, and what property is covered by a security interest. This area of the law is further complicated by the fact that both federal and state law impact on these issues.24
Perfection issues are also muddled by the fact that title to each of the three principal types of intellectual property, i.e. patents, trademarks and copyrights, is individually governed by it’s own unique federal statutory scheme, so that the rules vary depending on the type of intellectual property asset involved.25 And even when there is no question that the borrower has good title to the intellectual property asset or that the asset has a value, the convoluted and often contradictory steps to perfecting the right to liquidate the asset and realize the value can become a nightmare of Orwellian proportions. Further exacerbating the situation is the fact that many of the assets, such as software, may involve more than one species of intellectual property26 and that some types of intellectual property (such as trade secrets) may be subsequently transformed into another form of intellectual property (such as a patent).27
State Article Nine Security Interest Provisions
A security interest is, as the name suggests, “an interest that secures payment or performance of an obligation.”28 The state law on security interests in personal property, including intellectual property as a generic category, is Article 9 of the Uniform Commercial Code,29 which was designed as a model statutory framework to effectuate the granting of credit secured by personal property.30 A substantial revision to Article 9, which had last been revised in 1972, was completed in 1998 and since that time, many states have adopted Revised Article 9.31 Because of the extensive nature of the revisions, the sponsors recognized the potential problems inherent in the transition and suggested a uniform effective date of July 1, 2001.
As conceptualized by Article 9, a “security interest” is divorced from “title” and recorded by the filing of a simple one*page notice form known as a UCC*1 Financing Statement.32 Two basic steps are required for a creditor to become a secured party under Article 9. First, a security interest in the collateral must be created following the requirements of the Code. Once this has been done, the security interest is said to attach to the collateral and the process is referred to as attachment.33 Under this approach, the agreement documents that are used to create a security interest in the debtor’s intellectual property need not be recorded.34 The short financing statement merely notes the possible existence of a documented transaction and it can actually be filed before the agreement creating the interest.35 It can cover later agreements with the same debtor, as well as later advances made to, and later property acquired by, the same debtor.36 It is this “notice” based approach of the UCC that provides its great flexibility, but at the same time is in conflict with the fully descriptive “tract” system of the United States Patent and Trademark Office and United States Copyright Office.
Traditionally, the filing of the UCC*1 served to perfect the enforceable security interest in tangible goods including equipment and inventory, and establish the priority of the creditor over other creditors of the debtor.37 Once the UCC*1 was appropriately filed, subsequent creditors could examine the filings to determine if others had a prior claim on the collateral.38 However, this process has significant shortcomings if used for intellectual property assets, in large part, because of the uncertainty in application of federal intellectual property and bankruptcy laws. In addition to the choice of law issue, the problem is exacerbated by the chimera*like qualities of the various types of intellectual property as described earlier.39
When considering choice of law and preemption issues, it is also necessary to appreciate that the U.C.C. has its own “step*back” provisions where the U.C.C. does not apply.40 These step*back provisions are triggered when the parties’ substantive rights are governed by a federal statute or when a federal statute provides for a national system of registration or specifies a place of filing different than the U.C.C.41 For example, the Federal Aviation Administration Act requires that the Aircraft Registry at the Mike Monroney Aeronautical Center in Oklahoma City function as the central repository for information that determines the ownership of, the liens against, and the security interests in aircraft.42 These step*back provisions also form the basis of the Peregrine decision, discussed herein regarding copyrights and can be used to establish a centralized national registry for security interests in intellectual property.
Federal Laws and the Preemption Doctrine
A. Federal Preemption
In the majority of financing circumstances not involving intellectual property, one would normally look to an individual state’s statutory Article 9 requirements for creating or determining the validity or priority of a security interest in personal property. However, the issue of federal preemption must first be thoroughly examined if intellectual property is the proposed collateral involved. This is so because the “step*back” provisions of Article 9 and Revised Article 9 render them inapplicable to a “security interest subject to any statute of the United States, and to the extent that such statute governs the rights of parties to and third parties affected by transactions in particular types of property.”43 Thus, the first overriding consideration is which federal law(s) apply to each type of intellectual property interest. Secondly, it is necessary to determine the extent to which the federal law pertains to or governs any issues related to perfection of security interests.
This preemption doctrine has historically been most often encountered in situations involving valuable and highly mobile tangible assets such as aircraft, by virtue of the Federal Aviation Act44 and ships, through the Ship Mortgage Act45 and it’s successor, the Commercial Instruments and Liens Act.46 More recently, the issue has arisen within the context of location of space objects.47 As evidence of the emergence of 21st century technology and innovation, some lenders have been willing to take space collateral as security in some jurisdictions with debtor*based security filing systems.48 However, the pervasive problems with the ability of lenders to record any security interests in satellites in an appropriate registry, together with the lack of recognition of such security interests in other jurisdictions proves prohibitive to many lenders.49 Preemption does not necessarily trump state perfection laws, but may instead, compliment the state UCC laws under certain circumstances. For instance, the Federal Aviation Act mandates a central recording system for lender liens in aircraft.50 While the Act preempts Article 9’s filing rules, it does not generally preempt other provisions of Article 9, since state law governs the determination of an aircraft’s lien’s validity.51 Thus, in most jurisdictions, both the priorities provisions and remedies provisions of Article 9 apply to aircraft.52
Likewise, both the Ship Mortgage Act and the Commercial Instruments and Maritimes Liens Act preempt Article 9’s filing and perfection provisions for vessels which are registered as “vessels of the United States.”53 Liens on such vessels must be recorded at the vessel’s port of documentation to be valid against third parties who do not have actual notice of the liens.54 Notwithstanding the above, however, the priorities created under Article 9 still apply to these liens so long as they do not conflict with the federal law provisions regarding “preferred mortgages” and “preferred maritime liens.”55 In addition, if the vessel is unregistered, Article 9 perfection provisions apply, but if the vessel is subsequently registered, the UCC filing becomes ineffective.56
The preemption issue arises in the intellectual property arena through the Patent Act,57 state58 and federal59 trademark laws, and the Copyright Act of 1976.60 These federal statutes stand above the state notice*based filing system of Article Nine insofar as they purport to control the transfer and recording of rights in federal copyrights, patents and trademarks. Each federal statute has its own separate history and separate enforcement bureaucracy, and its own documentation, recordation and priority provisions.61 Unfortunately, since each type of intellectual property at issue is governed by a different set of laws, there is little consistency from which one seeking to perfect a security interest can take much comfort or assurance. Nor is there presently a central or integrated registry for intellectual property security interests where one could search for all potential notices of encumbrances filed at both the state and federal levels.62
Because there is no central or integrated registry for intellectual property security interests as there are for aircraft and ships, such interests are caught between the non*title notice filing system recognized as appropriate for all personal property under Article Nine, and the single transaction “title” assumptions which underlie the federal ownership and recording rules dealing with patents, trademarks and copyrights. Furthermore, ownership and title questions, as distinguished from metes and bounds definitional questions, have historically received less administrative attention at the federal level.63 Notwithstanding this lack of an effective federal structure for security interests, there is respectable authority that federal law controls all, or at least many, of the issues surrounding security interests in some forms of intellectual property born of federal law.64
B. Intellectual Property Generally
Intellectual property can be broadly defined as any product of the mind in which one can assert some “ownership” rights. Therefore, such a characterization could include such diverse areas of the law as the right of publicity or trade secrets. Although significant types of intellectual property are created and defined under state tort or property law, the most valuable forms of intellectual property are patents, trademarks and copyrights which are defined and protected by their own separate federal statutory schemes. These schemes share a common title*centered concern for the owner of the intellectual property and are designed to delineate the exact boundaries of that owner’s rights. The principle function of “recording” such rights at the federal level, then, is to establish “title,” namely, the carefully defined exclusive rights, and to provide a recorded chronology of the ownership and transfer of those rights. These federal recordings may be searched by assignor or assignee name as part of the ownership tracking. However, this “title” purpose must be distinguished from a creditor’s aim to establish priority and perfect a security interest in intellectual property, and therein lies the rub.
The federal statutes do not prohibit a creditor from filing a document that purports to establish a security interest in a particular piece of intellectual property. But, the statutes were originally designed to work like tract record ing processes for real estate.65 Patent and copyright “mortgages” and “conditional assignments” are frequently used as the instruments for secured transactions involving federal patents and copyrights. In fact, a “security interest” may be recorded in the trademark and patent files as a discretionary document. However, the recording is not actually intended to be a true assignment of the title of the underlying title patent or trademark by the lender filing the discretionary document.66
Patents generally protect the novel and unobvious functional aspects of useful products or processes. A patent is a grant by the government to an inventor that gives the inventor the right to exclude others from making, using, or selling his or her invention for 20 years. It does not matter if a subsequent user of the patented product or process independently comes up with the patented product or process, or is totally unaware of the prior patent. The patent holder will still be able to stop the subsequent “inventor” from using the invention.
Patents are solely within the power of the Federal government67 in that the U.S. Patent and Trademark Office (USPTO) has exclusive authority to prevent other from making, using or selling the patented invention for a specified amount of time throughout the United States.68 There is no state patent system. It is relatively easy to identify and track a patent since it cannot exist until the Federal government issues the certificate and each patent is duly numbered. A patent owner may assign the entire patent right, and any lesser interest, to another party, and written assignments may be recordable with the USPTO.69
Several bankruptcy courts have considered the issue of whether a creditor is required to perfect a security interest in a patent by recording with the USPTO or whether perfection under state U.C.C. Article 9 requirements will suffice.70 The courts have drawn a distinction between an “assignment” voluntarily filed with the USPTO and a U.C.C.*1 recorded with the state, and generally concluded that federal patent law does not preempt state Article 9 requirements.71 For example, in a case involving a security interest in patents where the creditor filed under the UCC but did not record a notice of its interest in the USPTO, the appellate court reversed the bankruptcy court and held that the U.C.C. filing was sufficient, but not with regard to subsequent purchasers. According to In re Transportation Design and Technology, Inc., a lender cannot perfect a security interest against a subsequent purchaser under the UCC because anything involving the title to a patent is regulated by the Patent Act and requires a filing at the U.S. Patent and Trademark Office.72 But at the same time, the lender cannot perfect lien*type security interests under the Patent Act because the Patent Act has no provision for them. This proposition was recently reaffirmed by the Bankruptcy Appellate Panel in In re Cybernetic Services, Inc., noting that the Patent Office records security interests on a discretionary basis which does not provide constructive notice and, therefore, is insufficient to provide the sole method of perfecting a security interest in a patent.73 Nonetheless, some legal commentators advise recording in multiple places to avoid bankruptcy trustees’ claims to the property.74
A copyright protects the creator of original works of authorship. A copyright owner has the right to exclude others from doing any of the following five activities in connection with the copyrighted work: (1) reproduction; (2) adaptation; (3) distribution to the public; (4) performance in public; or (5) display in public.75 These legal rights of an author, artist, composer or other creator of intellectual property to control the use of his or her work by others may be transferred and owned separately. In contrast to a patent, a copyright comes into existence as soon as the creator fixes the work in a “tangible medium of expression”. No registration is required, although there is a system of registration available through the Copyright Office. Like patents, copyrights are now exclusively governed by federal statute.76 But unlike patents, independent “creation” will not infringe upon another’s copyright, even if the creations are identical. Copying or the legal equivalent of copying is required. Because not all copyrights are registered, identification and tracking of copyrights can be much more difficult than patents.
An early decision by a California court attempting to navigate the requirements of the UCC and the federal copyright statute has produced volumes of academic criticism and has inspired the introduction of at least one bill in Congress designed to obviate the necessity of such a questionable decision in the future. That case, Peregrine Entertainment, Ltd. V. Capitol Savings and Loan Association, involved security interests in the copyrights of a film library.77 The preemption issues were complicated by the fact that the film library was property of the estate of a bankrupt entertainment company that had received a sizable loan from a lender. In that case, the court held that security interests in copyrights need to be filed federally (namely with the Copyright Office in Washington, DC) in order to be effective. The court also noted that inasmuch as the current federal system for recording such security interests was cumbersome (although not totally “unworkable” in the courts’ words) it was for Congress to implement “more adequate procedures”.78
More recently, an Arizona bankruptcy court in In re Avalon Software 79 ruled that certain general intangibles and accounts receivables associated with copyrights were considered copyright proceeds. That decision was critical to a creditor who had attempted to perfect a security interest by complying with Arizona’s Article 9 filing requirements against the debtor’s general intangibles and accounts. The court held such an effort was insufficient to achieve perfection and, like in Peregrine, held that section 205 of the Copyright Act perfection rules controlled.80
Because “title” in a copyrighted work exists from the moment the creative work is fixed in a tangible medium, there exists the potential problem of how to perfect a security interest in copyright assets that are not registered with the Copyright Office. The confusion engendered by the analysis contained in the Peregrine case has caused at least one subsequent court to require different perfection schemes for unregistered and registered copyright assets. In In re World Auxiliary Co. (“Aerocon”), the Bankruptcy Court for the Northern District of California ruled that a lender could perfect a security interest in an unregistered copyright by filing a U.C.C. 1 financing statement in compliance with state requirements, and was not required to file its lien in the Copyright Office.81 The decision was based upon the reasoning that the Copyright Act did not specifically articulate a manner in which a creditor could prefect a security interest in an unregistered copyright and, therefore, federal preemption was not an issue.82 The Aerocon court did note that Peregrine would apply in situations regarding registered copyrights and, in fact, recommended that a lender would be well advised to record a security interest at the Copyright Office as well as with the state pursuant to Article 9.83
A trademark includes any word, phrase, symbol, color, or design, or any combination thereof, which identifies and distinguishes the source of goods or services of one party from those of others. Trademarks can be traced back to the common law, and both federal and state systems exist.84 Like copyrights, registration is not required but federal registration gives substantive nationwide rights. A common law trademark can be created by adoption and use of the mark on, or in connection with the sale products or services on which it is used. It is important to note that a trademark does not exist independently of the “goodwill” of the underlying goods or services.
If an owner chooses to register a trademark with the USPTO, the Trademark Act of 1946 (the “Lanham Act”), allows an owner to prevent others from using similar marks if any confusion, mistake or deception would occur as a result.85 Similarly, the Lanham Act describes the manner in which a trademark can be assigned. But the Lanham Act offers no guidance on how a creditor can perfect a security interest in a trademark; thus, most creditors opt to prefect under state Article 9 laws.
In that regard, courts have consistently held that perfecting a security interest under Article 9 is sufficient.86 The creditor is not required to record its interest with the USPTO. However, the failure to perfect under state law exposes a creditor to the strong*arm powers of a bankruptcy trustee who can avoid such interest and claim it as property of the estate.87 For example, in contrast to Peregrine, a different California bankruptcy court two years later in In re 199Z Co.88 held, in a case involving an asset purchase agreement under which the purchaser pledged trademark assets as collateral, that the trademarks were “general intangibles” and perfection of a security interest in them would have to be done in conformance with the Uniform Commercial Code.
IV. TRADE SECRETS
While not defined and protected by federal law, nonetheless, trade secrets bear brief mention, as they are a prime example of state statutory or common law intellectual property.89 The most commonly accepted definition of a trade secret is found in the Comment to section 757 of the Restatement of Torts:
As opposed to patents, trademarks and copyrights, trade secrets do not carry the exclusive right to use the property.90 The relative spheres of trade secret law and federal patent law were delineated in Kewanee Oil v. Bicron, where the United States Supreme Court held that state trade secret protection was not preempted by federal patent law.91 While creditors are not required to comply with any federal laws regarding perfection of security interests, state Article 9 perfection laws apply. However, it is important to note that trade secrets are included within the federal definition of “intellectual property” for purposes of the rules in subsection 365(n) of the Bankruptcy Code.92 Customer lists, business and marketing secrets as well as technological confidences comprise a vast stock of intangible assets that are useful as collateral.93 A “right of publicity” has been recognized under state law outside the boundaries of the federal statutes.94
State law notions of intangible property can be created around the use of data necessary to obtain a federal entitlement, even if that data is not protected under the federal law defining the entitlement.95 The state law right recognized in Kalitta was not preempted by the federal Copyright Act because it protected against improper use of compiled data and information, not just against improper copy ing.96 Perfection of security interests in trade secrets is accomplished under the notice*based U.C.C. system and, in fact, one could hardly envision any title*based system that could function effectively for this type of intellectual property asset.97
Federal Bankruptcy Code
The bankruptcy law system is primarily a federal one, governed by the Federal Bankruptcy Code.98 As such, it may also have preemptive effect, particularly since the Code provides a method for determining which of the debtor’s assets can go to satisfy the allowed claims of the debtor’s collective creditors. This reliable bankruptcy framework becomes essential to a fair and efficient distribution of estate assets but it also has significant preemptive effect in a variety of ways. First, once the bankruptcy petition is filed, an “automatic stay” is created which absolutely prohibits all creditors from taking any action against the debtor or the assets without the express authorization of the court.99 The practical implication of this provision is evident in situations where, because the perfection methods for intellectual property are so unclear, a creditor may discover it is unsecured after the bankruptcy has been filed. At that point, the creditor is barred from taking any further action absent court authorization.100
Secondly, the Bankruptcy Code provides for a determination of which of the debtor’s assets constitute “property of the estate” for purposes of liquidation or reorganization.101 The Code’s definition of “intellectual property” includes trade secrets, invention, process design, or plant protected under title 35 (Patent Act), patent application, plant variety, work of authorship under title 17 (Copyright Act).102 Not surprisingly, some courts have held that intellectual property held by a debtor at the time the bankruptcy petition was filed is property of the estate.103 Further, the definition of “property of the estate” extends to “[p]roceeds, product, offspring, rents or profits of or from property of the estate.”104 However, trademarks are not enumerated and therefore, licenses may not be entitled to the Bankruptcy Court’s protection. In such an ironic scenario, a licensee could continue to use software, but not the trademark that validates it.105 Therefore, in many instances, it is necessary to engage in formal bankruptcy proceedings in order to elicit a ruling on whether an intellectual property interest is actually “property of the estate” for bankruptcy purposes.
Another unique aspect of the Bankruptcy Code is a provision allowing a bankruptcy trustee or debtor*in*possession (i.e., the party who is charged with the duty to marshal the debtor’s assets and distribute them to the creditors) to avoid certain unperfected security interests.106 The compelling reason for such an avoidance effort through the “strong*arm” powers is to obtain the value of assets, which are otherwise unavailable, since, if the security interest is perfected, it is not subject to liquidation and distribution to the unsecured creditors. The interests recovered become property of the estate. Under this scenario, one could readily understand how critical intellectual property assets might be to a Chapter 11 successful reorganization or a larger distribution to creditors under a Chapter 7 liquidation scenario.
Where the methods of perfecting security interests in the various types of intellectual property remain uncertain, these assets take on greater value in that they may be subject to rulings that the creditor’s interests are unperfected and thus become property of the estate. Creditors who, outside of the bankruptcy forum, would possibly obtain a favorable ruling that their security interests were perfected face significant uncertainty when the debtor filed for bankruptcy protections because of the application of these preemptive federal bankruptcy provisions.107 Unfortunately, what this often means in practical terms is that traditional creditors are wary of financing new enterprises.
Venture capitalists step in to provide the start*up funding, but ongoing capital needs cause the debtor to seek capitalization in more traditional forms that generally require collateral. If faced with the choice of lending to a debtor whose business is in shaky financial straits or lending to a debtor who has already filed for bankruptcy, many lenders will choose the latter course. The choice, however contradictory it may initially seem, is based on the fact that a lender can loan money to a bankruptcy debtor and obtain a ruling from the court that the lender has super*priority status with regard to that particular debt.108 If that same lender had provided financing prior to the bankruptcy filing, that lender would be threatened by the hypothetical lien creditor powers of the bankruptcy trustee. Thus, at present, lenders may have a vested interest in refraining from financing a needy enterprise until after it seeks bankruptcy protection.109 This issue is predominant in commercial bankruptcies, where the assets are mainly comprised of intellectual property, because the uncertainty surrounding a lender’s priority with regarding to collateral consisting of intellectual property can be lowered, or even eliminated, if they are able to obtain super*priority status.
Arguments for a Central Registry of Security Interests
The chaos depicted above has an obvious chilling effect on creditors who might otherwise provide critical financing to new entrepreneurs who possess valuable intellectual property assets. At present, the processes for perfecting security interests in intellectual property are cumbersome, convoluted and riddled with unforeseen and potentially fatal obstacles. Additionally, significant costs are associated with intellectual property transactions due to the uncertainty of the currently utilized processes for perfection. Thus, more lawyers must struggle with a variety of issues when advising and representing their clients. The representation may take the form of opinion letters sought to provide assurances that if certain steps are taken, a client’s security interest will be properly perfected. The inherent liability risks of offering a professional opinion given the current uncertainty of the laws regarding securitization of intellectual property interests are obvious. This is particularly true in light of the conflicting judicial opinions which, to date, have done little to resolve these problems. For those reasons, many practitioners continue to subscribe to the belief that a secured party should prophylactically register its interest with the designated federal agency and comply with state Article 9 requirements.
A central registry for security interests in intellectual property would allow practitioners, creditors and other interested parties to conduct a single, comprehensive search to uncover prior recorded interests and make a determination of a creditor’s secured status. The need for a central registry is not a new or novel idea. In fact, the idea was proposed in New Hampshire in 1998 through Senate Concurrent Resolution 6, which urged Congress to establish a central registry for security interests in intellectual property in New Hampshire.110 A central registry would not supplant the substantive federal or state laws, but would rather compliment them by offering a central information forum which would be available to any one seeking security interest information on intellectual property. Indeed, a central registry of security interests would work equally well for in intellectual property, space equipment, individual trading quotas or any other 21st century intangible asset, as it would ensure that good faith efforts to file an interest in such property or to discover the presence of a secured creditor’s claim are efficient, reliable and most importantly, uniform.
Franklin Pierce Law Center is currently engaged in a cooperative research project with the Patent and Trademark Office to develop a model for an integrated central federal registry for security interests in intellectual property. The Project, under the direction of Professor William J. Murphy is assessing and defining the technical, economic and legal requirements associated with a centralized registry for security interests in intellectual property. The Project is founded upon the fact that the dispute over where to file a security interest is not just mechanical, but rather touches on the substantive nature of any security interest in intellectual property. It is hoped that the proposals generated by the Project will ultimately encourage innovation and make the patent and trademark registration system more effective and useful. However, in the meantime, practitioners are left with no option but to recognize the inconsistencies in the present system and make their best efforts to engage in all potentially necessary steps to ensure that their clients’ security interests in intellectual property rights are properly perfected.
1 Venture Capital; For Most Venture Capitalists, N.H. is Still an Adventure, BOSTON GLOBE, C5 (Sept. 18, 2000).
2 New Hampshire had 83 out of every 1000 private sector workers employed in the high*tech industry and is outranked only by Colorado. New Hampshire Slips to Nation’s Second Ranked State in Concentration of High*Tech Jobs; Colorado Now Claims Highest Concentration in High*Tech Jobs, BUSINESS WIRE, May 17, 2000.
3 Cyberstates 4.0, data are for 1998 unless otherwise noted. Published by the American Electronics Association (www.aeanet.org).
8 PENSIONS AND INVESTMENTS (News Briefs), pg. 4, June 26, 2000.
9 NH Capital Program Praised, THE UNION LEADER (Manchester NH) May 16, 2000
10 New Hampshire Becoming More Representative Of Nation, THE BULLETIN’S FRONTRUNNER, October 29, 1999
11 New Hampshire Ranks Seventh in PPI ‘State New Economy Index, U.S. NEWSWIRE, (July 22, 1999); see also, NH is Seen Positioned for Future, NEW HAMPSHIRE SUNDAY NEWS (Aug. 1, 1999).
12 See, e.g., Nelson, Receivables Financing to Mexican Borrowers: Perfection of Articles 9 Security Interests in Cross*Border Accounts, 29 U. MIAMI INTER*AM. L. REV. 525, (Spring/Summer 1998) (generally the only acceptable collateral is dollar*denominated accounts receivables generated from export sales to U. S. customers; see also, Collons, ITG’s as Collateral Rightly Understood: Preserving Commerce and Conserving Fisheries, 14 UCLA J. ENVTL. L. & POL’Y 285 (1995/1996) (The importance of Individual Trading Quotas for Fish (ITQs) as collateral serves both the economic needs of the fishing industry and important conservation policies.)
13 Hutton, Lenders Seeking to Take a Security Interest in FCC Licenses Obtain Only Limited Protection by Structuring Loans Through Subsidiaries That Will Hold the Licenses, THE NATIONAL LAW JOURNAL, B5 (Monday, January 26, 1998).
14 E.g., Sylva, Bowie Bonds Sold for Far More than a Song: The Securitization of Intellectual Property as a Super*charged Vehicle for High Technology Financing, 15 COMPUTER & HIGH TECH. L. J. 195 (1999) (In 1997, singer David Bowie pioneered the issuance of music sound recording and publishing royalties as privately sold bonds.) See also Dickerson, Symposium: From Jeans to Genes: The Evolving Nature of Property of the Estate, 15 BANKR. DEV. J. 285 (Spring 1999).
16 New Hampshire presently adheres to Article 9 through RSA § 382*A:9*101 et seq. However, both current Article 9 and Revised Article 9 are treated herein.
17 Homan, Attorneys and Wall Street Deal with the Dot*Com Downturn, NEW YORK LAW JOURNAL, p. 5 (Aug. 29, 2000).
19 See Webmergers.com (Webmergers Watch List).
20 Richtel, Music and Movies Web Site in Bankruptcy*Law Filing, THE NEW YORK TIMES, B4 (Saturday, Oct. 14, 2000).
21 Deger, Is a Bankruptcy Bonanza Looming?, The NAT’L LAW J., B5 (Monday, Aug. 8, 2000).
22 MerchantBanc Draws Industry Leaders to Board of Directors, BUSINESS WIRE, September 6, 2000
23 Task Force on Security Interests in Intellectual Property, Business Law Section, American Bar Association, Preliminary Report 1 (June 1, 1992). As of March 1, 1999, the Task Force had drafted a piece of consolidated federal legislation entitled the “Federal Intellectual Property Security Act.”
24 See generally, Haemmerli, ARTICLE: Insecurity Interests: Where Intellectual Property and Commercial Law Collide, 96 COLUM. L. REV. 1645 (Nov. 1996).
25 For example, it is highly likely that retail software involves trademark, copyright, patent and trade secret protection.
26 A typical example would be where a company is secretly developing a process to produce a new drug and is using state trade secret law as its primary means of protection. At this point, the production process would be a trade secret. However, the company could subsequently apply for a process patent to protect the method of production under the federal patent statute and the intellectual property would be transformed into a patent.
27 U.C.C. §1*201(37).
28 The mechanics of filing vary from state to state since some require the filing to be made at the county level while others require the filing to be made at both the town and county levels. In New Hampshire the former dual filing system, where a UCC 1 had to be filed both at the Secretary of State’s office and at the appropriate town clerk’s office, is being replaced with a single filing system.
29 See e.g., NCCUSL – Introduction & Adoptions of Uniform Acts, found at http://www.nccusl.org/uniformact_factsheets. Prior to the adoption of Article 9, a variety of methods were used by creditors to help guarantee the debtor’s promise to repay a debt, such as chattel mortgages, conditional sales contracts, assignment of accounts, and trust receipts. The introduction of the U.C.C. in late 1940’s and early 1950’s significantly simplified the creation and perfection of security interests in personal property and fixtures.
30 Id. Article 9 underwent three revisions from 1953 until 1998. The first revision addressed minor problems, while the second and third revisions, in 1977 and 1994, respectively, responded to changes in the securities industry. In 1990, the American Law Institute and the National Conference of Commissioners on Uniform State Laws created a study committee and began an eight*year process which culminated in the approval of a substantial revision and reorganization of Article 9.Various state legislatures have begun enacting Revised Article 9 into law and, as of June, 2000, 23 states have introduced the new Article 9 into the legislative process, with an additional 16 states already enacting the revision into law with a subsequent effective date. The 23 states are: Alaska, Colorado, Delaware, District of Columbia, Florida, Hawaii, Idaho, Illinois, Iowa, Kansas, Louisiana, Michigan, Mississippi, Missouri, New Hampshire, New Mexico, Oklahoma, New York, Rhode Island, South Carolina, Tennessee, Vermont, and Wyoming. The 16 states in which the revision is already enacted into law are Arizona, California, Indiana, Kentucky, Maine, Maryland, Minnesota, Montana, Nebraska, Nevada, South Dakota, Texas, Utah, Virginia, Washington, and West Virginia. See, e.g., McElroy, Perfection of Security Interests, THE JOURNAL OF LENDING & CREDIT RISK MANAGEMENT, June 1, 2000.
31 U.C.C. §9*202; §9*101*102, §9*203, §9* 402(1)&(2). Accord Revised Article 9. Secured Transactions §9*202, §9*502, §9*503 & §9*504.
32 U.C.C. §9*203.
33 A copy of the actual document of the transaction can be filed, however. U.C.C. §9*402(1).
3 Id.. Accord U.C.C. [Revised] §9*502(d).
34 U.C.C. §9*204.
35 Larsen & Heilbock, Unidroit Project on Security Interests: How the Protect Affects Space Objects, 64 AIR L. & COM. 703 (Summer 1999).
36 Id. 3 Supra, Note 17.
40 U.C.C. §9*104.
41 U.C.C. §9*104(a): “This article does not apply . . . (a) to a security interest subject to any statute of the United States, to the extent that such statute governs the rights of parties to and third parties affected by transactions in particular types of property.” As explained in §9*104, Cmt 1., the UCC recognizes that federal preemption under the Supremacy Clause of the United States Constitution directs that where “a federal statute regulates the incidents of security interests in particular types of property, those security interests are of course governed by the federal statutes and excluded from this Article.”
42 49 U.S.C. §1403 et seq.. See also, Aircraft Registration Issues, BUSINESS & COMMERCIAL AVIATION, December, 1999. The FAA Aircraft Registry in Oklahoma City registers aircraft and records aircraft security interests. The Registry is currently transitioning into an ‘’Electronic Document Management System’’ designed to streamline the filing and searching processes. Id.
Vol. 85, No. 6; Pg. 106
43 UCC 9*104(a).
44 49 U.S.C. 1301 et seq.
45 46 U.S.C. 911 et seq.
46 See 46 U.S.C. 30101, 31301*31309, 31321*31330, 31341*31343 (1988).
47 See supra Note 33.
49 Id. Already under consideration are the difficulties the international legal society will have in establishing a uniform international security interest in space objects, which are internationally registerable.
50 49 U.S.C. 1403 et seq. supra, Note 38; see also In re Holiday Airlines Corp., 620 F.2d 731 (9th Cir.), cert. denied Danning v. Pacific Propeller, Inc., 449 U.S. 900 (1980).
51 49 U.S.C. 1406 (1976).
52 See e.g., Bank of Oklahoma City Plaza v. Martin, 744 P.2d 218 (Okla. Ct. App. 1987); Cessna Fin. Corp. v. Skyways Enters., Inc., 508 S.W. 2d 491 (KY 1979). But see, Dowell v. Beech Acceptance Corp., 3 Cal. 3d 544, 91 Cal. Rptr. 1, 476 P.2d 401(1970), cert. denied, 404 US 823 (1971).
53 46 U.S.C. 911 et. seq.
54 See 46 U.S.C. 1321 (a)(2).
55 E.g. Chemical Bank v. United States Lines (S.A.)(In re McLean Indus.,) 132 B..R. 271 (Bankr. S.D. N.Y. 1991); Security Bank of Oregon v. Levens, 257 Or. 630, 480 P.2d 706 (1971).
56 E.g. McCorkle v. First Pennsylvania Banking & Trust Co., 321 F. Supp. 149 (D. Md. 1970), vacated on other grounds, 459 F.2d 243 (4th Cir. 1972).
57 35 U.S.C 1 et. seq.
58 See e.g. the Model State Trademark Bill.
59 15 U.S.C. 1060.
60 17 U.S.C. §204 & §205 (1994).
61 17 U.S.C. §204 & §205 (1994); 35 U.S.C. §261 (1994); 15 U.S.C. §1060 (1994). In many ways, the these federal recording provisions have more in common with real estate counterparts than with other statutes dealing with rights in personal property. As Judge Nott observed more than 100 years ago:
Though the most intangible form of property, it still, in many characteristics, is closer in analogy to real than to personal estate. Unlike personal property, it cannot be lost or found; it is not liable to casualty or destruction; it cannot pass by manual delivery. Like real property, it may be disposed of, territorially, by metes or bounds; it has its system of conveyancing by deed and registration; estates may be created in it, such as for years and in remainder; and the statutory action for infringement bears a much closer relation to an action of trespass than to an action in trover and replevin. It has, too, what the law of real property has, a system of user by license.
Solomons v. United States, 21 Ct. Cl. 479, 483 (1886), aff’d, 137 U.S. 342 (1890).
62 See Collons, supra, Note 12.
63 Changes in Patent & Trademark Assignment Practice * Discussion of Specific Sections To Be Changed or Added, 57 Fed. Reg. 29634, 29635 (1992)(The pre*1992 system was based on assignment cards stored in various location that made searching of older documents very difficult.)
64 In re Peregrin Entertainment, Ltd., 116 B.R. 194 (C.D. Cal. 1990). In re Otto Fabric, Inc., 55 B.R. 654 (Bankr. D. Kan. 1985), rev’d, City Bank and Trust Co. v. Otto Fabric, Inc., 83 B.R. 780 (D. Kan. 1988).
65 Weinberg & Woodward, ARTICLE: Easing Transfer and Security Interest Transactions in Intellectual Property: An Agenda for Reform, 79 Ky. L. J. 61, 75 (1991).
66 35 U.S.C. 261 (1994).
67 35 U.S.C. §§1, et. seq. The Federal government’s power over patents (and copyrights but not trademarks) is derived from the U.S. Constitution. Art. I, Sec. 8, Cl.8
68 See, Dickerson, Symposium, supra., Note 17.
69 35 U.S.C. 261 (1994)
70 For bankruptcy purposes, this conclusion means that a trustee cannot avoid a security interest properly perfected under U.C.C. Article 9.
71 See, e.g., City Bank & Trust Co. v. Otto Fabric, Inc., 83 B.R. 780 (Bankr.D.Kan. 1988); In re Transportation Design & Technology, Inc., 48 B.R. 635 (Bankr. S.D.Cal. 1988).
72 48 B.R. 635 (Bankr. S.D. Cal. 1985).
73 Moldo v. Matsco, Inc. (In re Cybernetic Services, Inc.), 1999 Daily Journal D.A.R. 11155 (Nov. 1, 1999).
74 Sereboff and Kogan, Recordation of Security Interests in IP Rights, INTELLECTUAL PROPERTY TODAY (May, 2000).
75 These activities are listed in the Copyright Act. 17 U.S.C. §106.
76 17 U.S.C. §§101*1101(1994) as amended by the Digital Millennium Copyright Act, Pub. L. No. 105*304, 122 Stat. 2860 (1998).
77 116 B.R. 194 (C.D. Cal. 1990).
78 One result of Peregrine has been a virtual avalanche of filings in the Copyright Office by lenders seeking to perfect their security interests.
79 209 B.R. 517 (Bankr. D. Ariz. 1997).
80 Id. While both applied the perfection requirements of section 205, Peregrine specifically applied that conclusion to copyright receivables while Avalon more broadly applied section 205 to any intellectual property that is “copyrightable” and therefore, the basis of proceeds. But see, Broadcast Music v. Hirsch, 104 F.3d 1163 (9th Cir. 1997)(in a non*bankruptcy context, an irrevocable assignment of an interest in copyright royalties not recorded pursuant to section 205 was nevertheless perfected under state law.)
81 Aerocon Eng’g, Inc. v. Silicon Valley Bank (In re World Aux. Power Co.), 244 B.R. 149 (Bankr. N.D. Cal. 1999).
83 Id. At Note 11.
84 The Federal system is governed by the Trademark Act of 1946, as amended, also known as the Lanham Act, 15 U.S.C. §1051, et seq.
85 15 U.S.C. 1051(1994).
86 E.g., In re Together Dev. Corp., 227 B.R. 439 (Bankr. D. Mass. 1998); Joseph v. 1200 Valencia Inc. (In re 199Z, Inc.), 137 B.R. 778 (Bankr. C.D. Cal. 1992); In re Chattanooga Choo*Choo Co., 98 B.R. 792 (Bankr. E.D. Tenn. 1989); In re C.C. & Co., Inc., 86 B.R. 485 (Bankr. E.D. Va. 1988); In re Roman Cleanser Co., 43 B.R. 940 (Bankr. E.D. Mich. 1984); In re TR*3 Industries, 41 B.R. 128 (Bankr. C.D. Cal. 1984).
87 11 U.S.C. 544 (1994).
88 137 B.R. 778 (Bankr. C.D. Cal. 1992).
89 Trade secrets are governed by the Uniform Trade Secrets Act (14 U.L.A. 433 (1985)) as adopted by the individual states.
90 Id. Cmt. 1.
91 416 U.S. 470 (1974).
92 See 11 U.S.C. §101(35A) (1994).
93 Bramson, Intellectual Property as Collateral * Patents, Trade Secrets, Trademarks and Copyrights, 36 Bus. Law. 1567, 1588*90 (1981).
94 Zacchini v. Scripps*Howard Broadcasting Co., 433 U.S. 562 (1977). See also, Restatement of the Law of Unfair Competition §46 (Tentative Draft No. 4, March 25, 1993).
95 See, e.g., G.S. Rasmussen & Assoc. v. Kalitta Flying Service, Inc., 958 F.2d 896 (9th Cir. 1992); cert. denied, Kalitta Flying Serv. V. G.S. Rasmussen & Assocs., 508 U.S. 959 (1993).
96 See Daboud v. Gibbons, 42 F.3d 285, 289 (5th Cir. 1994).
97 Babaian, Striving for Perfection: The Reform Proposals for Copyright*Secured Financing, 33 LOY. L. REV. 1099 (April 2000).
98 11 U.S.C.§101 et seq.
99 11 U.S.C. 362 (a)(1997) (The bankruptcy filing “operates as a stay, applicable to all entities, of –
(4) any act to create, perfect, or enforce any lien against property of the estate.)
100 A creditor may seek relief from the automatic stay by motion in order to foreclose on its collateral under non*bankruptcy law rights. However, relief from the automatic stay is generally allowed only if the debtor has no equity in the property subject to the security interest (implicating a variety of valuation of intellectual property issues not covered by this article) and if the property is not necessary to an effective reorganization. 11 U.S.C. 362(d)(2)(A) and (B) (1997).
101 11 U.S.C. 541 (1997).
102 11 U.S.C. 101(35)(A)(1997).
103 E.g. Chesapeake Fiber Pkg. v. Sebro Packaging Corp., 143 Bankr. 360, 363 (D. Md. 1992)(It is undisputed that the property of the debtor’s estate includes the debtor’s intellectual property, such as interests in patents, trademarks and copyrights.”) citing United States v. Inslaw, Inc., 932 F.2d 1467, 1471 (D.C. Cir. 1991); cert. denied INSLAW, Inc. v. United States, 502 U.S. 1048 (1992).
104 11 U.S.C. 541 (1997). But see In re Transportation Design & Technology, Inc., 48 B.R. 635 , 640 (S.D. Cal. 1985) in which a California federal court limited the definition of proceeds under the California Commercial Code to what arises when collateral is “sold or in some way disposed of.”
105 Internet Bankruptcies, VENTURE CAPITAL JOURNAL (Sept. 1, 2000).
106 11 U.S.C. 544(a)(1)(1997).
107 One example is presented by In re Szombathy, where the court ruled that the chapter 7 trustee did not have an interest in certain improvements and modifications to a patented machine as section 541(a)(6) “offspring” of the patent. The court noted that even if the improvements infringed the patent pre*petition, they remained assets of the debtor who made the improvements and not property of the bankruptcy estate. 1997 U.S. Dist. LEXIS 5168 (N.D. Ill. April 10, 1997).
108 11 U.S.C. 364 (c)(2)(1997).
109. See Internet Bankruptcies, supra Note 100.
110. THE UNION LEADER (Manchester, NH) April 10, 1998.
Paula M. Sicard is an attorney licensed to practice law in the state of Florida and is currently an Account Executive for Lexis Publishing responsible for Harvard Law School, Franklin Pierce Law Center and the University of Maine School of Law.