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Intellectual Property as Collateral

Abhishek Kumar (abhishek1888@gmail.com) is a student at the National Law University, Delhi.

The scope of using intellectual property as collateral is discussed. Through examples, it is shown here that, owing to its volatile and dynamic nature, IP is not a reliable collateral. There is a pressing need for proper methods of valuation and registration so that confidence in IP as collateral is enhanced.

The question of whether intellectual property (hereafter IP) could be used as collateral for a bank loan is a recent and a controversial one. Cash-strapped entrepreneurs may have the idea, yet at the same time, could lack the money to condense it into reality. To bridge this gap, it would be worth considering whether and under what circumstances—their very idea ­itself should be deemed sufficient for successfully securing a loan.

While such a situation would be ideal for entrepreneurs, when this question is considered from the perspective of a bank; a natural apprehension that comes to mind, pertaining to the use of IP as collateral for a loan, has to do with the fundamental nature of IP itself—in that it is intangible, might not retain its value unlike gold or real estate, and would therefore pose a high amount of risk to any bank accepting it as a valid collateral for a loan.

However, the World Intellectual Pro­perty Organization (WIPO) has observed that there is an emerging trend regarding the collateralisation and securitisation of IP, especially in internet start-ups, the music industry and in high technology sectors (WIPO 2018). Hence, the emerging importance of studying the mainstreaming of IP coll­ateralisation cannot be understated.

Among some insightful works delving into this question—Kenan Patrick Jarboe and Ian Ellis (2010) have, in their paper ­titled “Intangible Assets: Innovative Fina­n­cing for Innovation” examined the usage of IP backed financing as well as the reasons why lenders and investors feel uncomfort­able with regard to IP. Among other reasons for this aversion to IP—they observe that IP is highly erratic showing no set pattern regarding its market behaviour, a characteristic absent in other assets.

In “Secured Financing of Intellectual Property Assets and the Reform of English Personal Property Security Law,” Iwan Davies (2006) too considers the inherent difficulties associated with using IP as economic assets.

In India, the National Intellectual Property Rights (IPR) Policy, released in 2016 proposed the securitisation and collateralisation of IPR (Chitravanshi 2015). In the Indian context, however, there remains a dearth of literature exploring this question.

Against this backdrop, this article will seek to examine the following: (i) the nature of IP vis-à-vis the regular array of properties pledged as collateral to banks, (ii) instances wherein IP has been pled­ged as collateral for a loan, and (iii) the viability of and hurdles to collateralising IP in India.

Routine Forms of Collateral

One need only look as far as acquisition drives to realise that intangible assets, such as customer relations and brand loyalty, are increasingly viewed as an ­integral aspect of a company’s value. In other words, a company’s skill and intell­ectual capital may in fact be the driving force behind its acquisition (King 2005).

Despite the increasing importance of IP, it remains underutilised as collateral. The primary reason behind the prevai­ling aversion to IP as collateral is because IP tends to be highly erratic, showing no set pattern regarding its market beha­viour—much unlike tangible assets (Jarboe and Ellis 2010).

Additionally, the prevailing perception is that intangible assets are “unsuitable,” especially due to their suspect valuation and the accompanying risk involved. The suitability of an asset as collateral depends on various different factors: valuation, asset recognition, transferability, risk and liquidity (Jarboe and ­Ellis 2010). Financial markets require that an asset be capable of having its ­behaviour calculable, that is, it should be discernible how that asset acts over time in the market. Certain predictable patterns of performance need to emerge over time in order for an asset to be perceived as a secure and dependable security. The ­asset ideally must be capable of replicating its past performance as markets need a degree of predictability in order to be able to evaluate an asset.

The perceptions of risk associated with intangible assets have also posed a major hurdle towards the use of intangible ­assets such as IPR in capital markets. The pre-existing thinness of the market and the accompanying paucity of information contribute towards increasing uncertainty and feeding the perception of higher risk (Jarboe and Ellis 2010). Inve­stors and lenders therefore tend to overestimate the risk of default on securities (Jarboe and Ellis 2010).

Some of these perceptions pose a real risk. In fact, it is estimated that in cases of loan default, it may take twice as long to liquidate IP. “Toys R Us”—an American toy retail chain which went insolvent, is a prime example of this (Ellis 2009).

Accounting for this high level of risk, bankers tend to offer such loans with high interest rates. However, such an ­approach undervalues potential cash flows (Patrick and Ellis 2010). IP with only future implied value tends to be placed at a 10% loan to value ratio as opposed to IP with a positive cash flow, which tends to be placed at a 40% loan to value ratio. This signifies that IP with only future value is treated very cautiously as collateral.

Another important aspect which must be considered here is liquidity. Assets that can easily be liquefied are prefe­rred by lenders. Markets for the sale and lease of IP, although up and running, need to be regularised and brought into the mainstream still (Jarboe and Ellis 2010).

Given the high interest rates and low loan to value ratios, currently, even if loans backed by IP are allowed—they ­remain highly prohibitive in nature as a result of the high cost for borrowers. Since the estimated recapture rates of IP assets are usually low (ranging from 10% to 40%) (Jarboe and Ellis 2010), they appeal to only risk tolerant investors. Moreover, IP, even in the rare ins­tances where it is accepted as collateral by lenders, these instances are one-off, individualised events where different methods have to be employed in order to reach a valuation of the IP assets. This in turn contributes towards increased tran­saction costs (Jarboe and Ellis 2010).

While lenders at present rarely rely on IP-based collateral, in ignoring the same, they altogether exclude a valuable asset from being called upon in the case of a default—owing to their own inability to understand or valuate the intangible asset. However, there have been instances wherein lenders have relied on IP as collateral, which need to be engaged with.

Real-world Instances

Despite the manifold problems associated with furnishing IP as collateral, there are real-world instances involving its usage (albeit not always successful). One of the earliest examples is that of Lewis Waterman, founder of the famed Waterman pens company, who started his business after borrowing a sum of $5,000 backed by his iconic fountain pen patent.

More recently, “Toys R Us”—an Ameri­can toy retail chain, had secured a loan on the basis of its IP and had some debt backed by real estate as collateral. As it went insolvent, its debt backed by real estate was estimated to be 70% to 90% recoverable while its debt backed by IP was listed as less than 10% recoverable (Ellis 2009)! Incidents like these only serve to reinforce the perception that the use of intangible assets as collateral comes at a high risk.

An innovative use of IP as an asset was witnessed in the 1990s when David Bowie along with his financial manager Bill Zysblat, and banker David Pullman issued “Bowie bonds” in order to collect cash from Bowie’s extensive body of work. These “Bowie bonds” essentially bestowed upon investors a share in ­Bowie’s future royalties for a per­iod of 10 years.

They were purchased by Prudential Financial, an insurance company based in the United States, at a price of $55 m (Espiner 2016). However, while the arr­angement was lucrative for Bowie, the same could not be said for the investors. Moody’s, a prominent rating agency, eventually had to downgrade its rating of the “Bowie bond” from the investment grade rating that it had originally assigned (subject to a low risk of default) to just one level above “junk status” (Chen 2020). This was principally due to the advent of Napster and the rise of ­online music sharing services, and as the industry witnessed a paradigm shift, the investment soured as a consequence (Boulden 2016).

Tranlin Paper, an eco-friendly paper manufacturer based in Shandong, China, in 2014 borrowed over $1 billion from the China Development Bank, providing its IP portfolio as collateral. In 2018, however, around 21 suits were filed against the company as it defaulted on its repayments on a separate grant. As of now, Tranlin’s financial health appears weak and observers are so far unconvinced that the China Development Bank will be able to successfully recoup the loan amount from the IP it received as collateral (Schindler 2018).

In India, Vijay Mallya’s trademark “Kingfisher” airline brand was offered as collateral in 2009, in a first, to State Bank of India for a loan amounting to over `2,000 crore (Dasgupta and Vyas 2016). However, when the trademark was sought to be auctioned by the bank, it was unsuccessful—as by that time the brand had suffered a huge hit. It no longer commanded a stellar goodwill, altho­ugh still possessed a significant “brand recall” value.

While these instances show that IP has in the past and continues to be used as collateral, the fact that lenders are unable to recover their loan through such IP collateral is discomforting to say the least. A major problem remains one of valuation of IP, especially given its volatile and dynamic nature.

Indian Scenario and Drawbacks

The Indian Patents Act, 1970 and the ­Designs Act, 2000 both allow for the cre­ation of mortgage or other security inte­rests on patents and registered designs by means of executing an agreement in writing between the parties seeking the same.

Similarly, the Trade Marks Act, 1999 and the Copyright Act, 1957 each allow for a trademark and a copyright respectively, to be assigned by the owner through the execution of an assignment agreement in writing. A security on a trademark can also be created through the execution of a deed of hypothecation.

In Canara Bank v N G Subbaraya Setty and Anr, the assignment of the trademark “EENADU” for the manufacture of incense sticks was held to be impermissible in light of the Banking Regulation Act, as it was not a part of the agreement when taking up the debt. The Supreme Court held, reading Sections 6(1)(f) and (g) of the Banking Regulation Act, 1949, which permit the sale of goods under trademark, and earning a royalty from a sub-assignment respectively, that a trademark could not be assigned to a bank by a borrower, after the borrower had defaulted on the loan.

This was unlike the Kingfisher scenario discussed previously, where the trademark had been offered at the time of agreement and therefore did form a part of the security under Section 6 of the Banking Regulation Act.

The Court went on to observe that the bank could not be permitted to sell ­incense sticks and collect a royalty from a trademark by way of a third party, given that banks are prohibited from moving beyond the banking business. At most it could sell goods in order to rea­lise the security with it.

Notably, Section 2(1)(t) of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security ­Interest Act, 2002 (SARFAESI Act) defines “property” to include even intangible ­assets such as trademark, copyright, ­licence or franchise.

In addition, Section 2(1)(zf) of the act defines “security interest” as a right, title or interest of any kind upon property created in favour of secured creditor and includes such right title or interest in inta­ngible assets. Additionally, Section 2(zd) mentions that the bank which is accepting the assignment of a trademark as the security for such an outstanding loan would become the secured creditor. Therefore, the bank would possess a ­security interest over the trademark and would be permitted to further sell or ­assign the trademark for a royalty and recover the defaulted loan.

It follows that the aforesaid decision needs to be reviewed in light of the ­SARFAESI Act, in order to facilitate the usage of IP as collateral even if not a part of the initial agreement, as a set-off (Umarji 2018).

Again, the nature of the IP in question is also of importance, given that each type of IP, that is, patents, copyrights, trademarks, trade secrets—all prop up new hurdles when it comes to valuation. In the case of a copyright, if someone were to offer a copyrighted work as collateral, given that in India there is no requirement of registering a copyright, this would pose a roadblock towards determining whether or not there already ­existed conflicting copies of the work in question, which in turn may result in a future lawsuit for copyright infringement. If such a lawsuit were to turn out to be successful for the plaintiff, the ­value of the item pledged as collateral would fall to naught, as there would no longer be vested in it an IP right.

Patents too pose a high risk, given that they might not retain their value in the future. Hence, if securitised, a concern would be to exploit the patent and ­extract the maximum possible from it within a given period of time. Trade ­secrets on the other hand, owing to their very nature are unlikely to be disclosed in the first place.

There are considerable drawbacks when we look at trademarks as well. Trademarks are closely associated with the value of the brand in question. Therefore, should the goodwill of the company or the brand take a hit in the future, it is likely that the trademark too would lose its value as a consequence, as was the case with Kingfisher.

Conclusions

Much more needs to be done to promote the usage of IP as collateral in India. ­Recently, an entire marketplace dedicated towards IP assets and their auctions was established by Internet Content ­Adaptation Protocol Ocean Tomo. The emergence of such web-based marketplaces can greatly bolster the transfer of technology and aid businesses that seek to sell or licence their IP; upfront cash can be generated by company by means of it selling or auctioning its IP, licensing on the other hand leads to the creation of a future revenue stream (Jarboe and Ellis 2010). India, in its recent National IPR Policy, explores what may be done to promote the commercialisation of IPR and mentions this as a potential option as well, as there is a need for a platform to connect inventors with potential users and buyers.

An impediment that needs to be rectified is the decision of the Supreme Court in Canara Bank v N G Subbaraya Setty and Anr, which is problematic to say the least. It needs to be revised with reference to the SARFAESI Act, in order to ­facilitate lending against IP.

Given the high interest rates and low loan to value ratios, currently, even if loans backed by IP are allowed, they ­remain highly prohibitive in nature as a result of the high cost for borrowers. Since the estimated recapture rates of IP assets are usually low—they attract only risk tolerant investors. These risks, however, tend to be overestimated on account of the small market and general lack of information.

While the concept of IP as collateral or security is legally permitted, it is yet to pick up in practice. IP is very difficult to valuate owing to its volatility and dyna­mic nature, which in turn renders it an unattractive back-up for banks and lenders. The need of the hour remains the introduction of an appropriate method for valuation and registration which would boost confidence in IP as collateral.

The National IPR Policy, recognising this drawback, seeks to alleviate it by prescribing appropriate methodologies and guidelines for valuation. It further seeks to facilitate the securitisation and collateralisation of IPR by pushing for a conducive administrative, legislative and market framework. The policy, however, remains silent on how it will go about the same.

References

Boulden, Jim (2016): “David Bowie Made Financial History with Music Bond,” CNN Money, viewed on 29 October 2019, https://money.cnn.com /2016/01/11/media/bowie-bonds-royalties/.

Canara Bank vs NG Subbaraya Setty & Anr (2018): “Civil Appeal 4233 of 2018, Supreme Court,” Judgment dated 20 April, https://indiankanoon.org/doc/163696803/.

Chen, James (2020): “Bowie Bond,” Investopedia, 6 March, https://www.investopedia.com/terms/ b/bowie-bond.asp.

Chitravanshi, Ruchika (2015): “National Policy Suggests Use of Intellectual Property Rights as ­Collateral to Raise Funds,” Economic Times, 16 December, viewed on 18 September 2019, https://economictimes.indiatimes.com/news/economy/policy/national-policy... =mdr.

Dasgupta, Pritha Mitra and Maulik Vyas (2016): “Kingfisher Trademark High on Brand Recall But Low on Brand Valuation,” Economic Times, viewed on 6 November 2019, https://econo­mictimes.indiatimes.com/news/company/corporate-trends/kingfisher-trademark-high-on-brand-recall-but-low-on-brand-valuation/articleshow/51366949.cms?from=mdr.

Davies, Iwan (2006): “Secured Financing of Intellectual Property Assets and the Reform of English Personal Property Security Law,” Oxford Journal of Legal Studies, Vol 26, No 3, pp 559–83, https://academic.oup.com/ojls/articleabstract/26/3/559/1452016?Redirecte... PDF.

Ellis, Ian (2009): “Maximising Intellectual Property and Intangible Assets: Case Studies in Intangible Asset Finance,” Case Studies in Intangible Asset Finance, Working Paper 07, November, Washington, DC: Athena Alliance.

Espiner, Tom (2016): “Bowie’s Bonds: The Singer’s Financial Innovation,” BBC News, viewed on 29 October 2019, https://www.bbc.com/news /business-35280945.

Jarboe, Kenan Patrick and Ian Ellis (2010): “Intangible Assets: Innovative Financing for Inno­vation,” Issues in Science and Technology, Vol XXVI, No 2, Winter, https://issues.org/jarboe -2/.

King, Kelvin (2005): “The Value of Intellectual Property, Intangible Assets and Goodwill,” World Intellectual Property Organization, viewed on 31 October 2019, https://www. wipo.int/export/sites/www/meetings/en/ 2005/smes_qtc/presentations/wipo_smes_qtc _05_king.pdf.

Schindler, Jacob (2018): “Chinese Company Which Raised $1.3 Billion in IP-backed Financing Has Virginia Factory Site Foreclosed,” Lexology, 22 May, viewed on 2 November 2019, https://www.lexology.com/library/detail.aspx?g= a48706aa-b6a6-4d44-9142-799a4eb3cc62.

Umarji, M (2018): “Why Intellectual Property Rights as Security for Loans Is Correct in Legal Terms,” Economic Times, viewed on 17 December 2019, https://economictimes.indiatimes.com/news/economy/finance/why-intellectu....

WIPO (2018): “The Securitisation of Intellectual Property Assets—A New Trend,” World Intellectual Property Organization, 11 November, viewed on 18 September 2019, https://web.archive.org/web/20181111142818/http://www.wipo.int/sme/en/ip....

 

Updated On : 3rd Aug, 2020

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