Lending Law Report : Corporate Finance Lawyer & Attorney : Reed Smith Law Firm : Lending Transactions, Secured Investments

This post was written by Svetlana Attestatova, a member of Reed Smith's financial industry practice group, addressing several intellectual property issues that have come up in our deals recently.  

Sometimes we get rather technical questions, and this post responds to one of those: if the collateral for your loan includes patents, trademarks or copyrights ("IP"), read on.

Searches.  In addition to regular lien searches, you may want to run specific IP searches on your borrower and guarantors, especially if valuable IP is part of your collateral.  A search will confirm who the owner of the IP is, and will reveal the existence of other liens.  If IP is central to your deal, beware of the timing gap issues discussed below and consider running some additional post-filing searches after the applicable time period lapses.

Disclosure Schedules.  Accurate schedules listing the IP are important -- and sometimes difficult to obtain.  The underlying representations in the credit and security agreements will determine what should be disclosed on the schedules.  Sometimes the list is limited to registered U.S. IP; other times, it is limited to material IP.  The schedules and your search results should be reconciled.

How to Perfect.  The steps required to perfect your security interest in IP vary for different types of IP.  We will spare you the extensive legal explanation here and just say that the preferred practice is to file a UCC-1 financing statement (as you typically would for most other collateral) and also to file a short-form security agreement with the U.S. Patent and Trademark Office for patents and trademarks, and with the U.S. Copyright Office for registered copyrights.  The short-form agreement is prepared solely for the purpose of making these filings and does not include the covenants and other detailed terms that would appear in the more comprehensive security agreement for the deal.  Even though a PTO filing may not be absolutely required for perfection of patents or trademarks, it is advisable in order to help protect your interests against a good faith purchaser of a patent or trademark.  However, please note that unlike patents and trademarks, a Copyright Office filing is required for perfection of your interest in registered copyrights.  As always, it is critical to get the collateral description, the IP identifying marks and other necessary  information right on these filings.

Timing Gap Issues. One potential timing gap issue arises when there is a discrepancy between the closing date and the date through which the searches have been run.  This is purely an issue of the PTO and Copyright Office records being up to date.  A longer gap in time here increases the likelihood of things being missing from the search results.  A second timing gap issue is the grace period provided by both the PTO and Copyright Office that permits an assignment that was signed before your security agreement filing but unrecorded at the timing of your filing to trump priority of your recorded filing, as long as the competing assignment is recorded within the grace period (even if recorded after your filing). This grace period is three months for patents and trademarks and one month for copyrights.  To help with this issue, the lender would usually receive representations from the borrower that  no competing assignments have been granted.  Post-closing searches should reveal the existence of any of these filings.

Other IP; Special Cases. “Intent-to-use” trademarks deserve a special mention.  Although a security interest can be taken in this type of IP, you should be aware that foreclosure may be problematic until the mark has been put to use in commerce and there is goodwill associated with it.  If the collateral includes mask works, you'll want to make both Copyright Office and UCC filings.  For trade secrets, UCC filings are advisable.  And, generally, if you have other unusual (and valuable) IP collateral -- for a company that develops software, or where software is embedded into machinery with accompanying accounts receivable, for example -- consult with counsel to be sure you are properly perfected.

After-Acquired IP. The credit or security agreement will usually require the borrower to deliver periodic updates listing any newly acquired or registered IP (including a requirement to inform the lender as soon as an unregistered copyright became registered).  UCC-1 filings can be structured to effectively cover after-acquired assets in the initial filing, but new filings with the PTO or the Copyright Office will be needed to cover each additional IP item.

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By now many of you will have heard about the recent decisions in the TOUSA (pdf) bankruptcy case.  There are several other write-ups out there that cover the many important elements of this case in detail, but here I wanted to just say a few words about one issue of significance to senior secured lenders.  The question of whether subsidiaries can properly guarantee a loan made to the parent company (without it being a fraudulent conveyance) sometimes comes up in loan transactions, and having an understanding of the issues here can be really helpful. 

You'll recall that the TOUSA case is about fraudulent conveyances.  As explained in our last post, in simple terms, a bankruptcy court can void (and claw back) payments made if the debtor was insolvent at the time of the transaction and if it received less than "reasonably equivalent value" for what it gave up in the deal.  Setting aside the question of solvency, then, here's our issue:

QUESTION:  If a subsidiary of the borrower guarantees the loan (and/or provides a lien or other support), do you have to show that the subsidiary received some of the proceeds of the loan in order to demonstrate that it got "reasonably equivalent value" in the transaction? 

SHORT ANSWER:  No.  Reasonably equivalent value can be received through intangible and indirect benefits as well as by direct benefits such as cash proceeds.  

The court in the TOUSA case explained that you can take a relatively broad view of what constitutes "value."   In TOUSA, the company's subsidiaries became co-borrowers on the loan and provided liens on their assets.  The loan proceeds were used to pay off a significant liability.  The court found that the subsidiaries had received value in exchange for this because they had received "indirect economic benefits" from the loan.  The benefits were, among other things, "the opportunity to avoid default, to facilitate the enterprise's rehabilitation, and to avoid bankruptcy, even if it proved to be short lived" (here, the companies ended up in bankruptcy anyway).  The court clarified that it is not just cash, but all kinds of interests in property -- including intangible things like "promises to act or forbear to act" and indirect or contingent benefits -- that can be considered.  

But was the value "reasonably equivalent" to the property rights that were transferred?  In this case, yes.  A "legitimate and reasonable" expectation that default could be avoided and the enterprise strengthened by the transaction can be enough value.  For the TOUSA subsidiaries, absent the loan transaction, there was a realistic risk that the companies would not have been able to continue to survive.  The value to the companies was their ongoing existence, and the court found that this met the standard for being reasonably equivalent to what they gave up in the deal.  It was not necessary to quantify the benefits and determine a precise dollar valuation in order to come to this conclusion. 

Of course, as with all things legal, the analysis can get rather complex and the conclusions will vary depending on the facts at hand (full disclaimers, no promises, your results may vary, don't try this at home, etc.).  A takeaway from the TOUSA case is that you can look at a lot of different things when considering if there was value received -- and showing that there was "reasonably equivalent value" may not be quite as difficult as it sometimes seems.

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