May 23, 2000 | Legal Times

Perfecting Security Interests in Intellectual Property

9 min

Those "Burn, Baby, Burn" dot-coms have run into an asbestos wall. With the recent Nasdaq crash, the once unthinkable is becoming a reality - dot-coms folding, declaring bankruptcy, or in need of workouts. Investors and lenders are beginning to think about stemming losses and mitigating damages rather than adding new wings onto their homes.

Yet even when dot-coms crash and burn, they still retain some valuable assets, and a scramble will begin shortly to claim them. Most of the assets will take the form of intellectual property. The failing company's copyrights, trademarks, patents, and URLs will be fought over in the event of the company's collapse and subsequent default on its obligations. The question becomes, who will get first crack at obtaining ownership of the remaining valuable IP assets?

To answer that question, dot-com executives, lenders, and investors are pulling out their various loan documents and investment agreements and reading the fine print. Particular attention is being given to sections that were barely glanced at in the heat of the moment when the initial investments or loans were made. The answer to who has "first dibs" may lie in the very pedestrian issue of who perfected their security interest.

In the rush of funding experienced by many dot-coms and in the post-funding euphoria, the follow-up required to perfect a security interest could easily have been overlooked. The proverbial dotting of the i's and crossing of the t's may not have occurred. There is no single IP perfection mechanism. Perfecting security interest in copyrights, trademarks, patents, and URLs are all separate and distinct, and their requirements are all different. To complicate matters, there are inconsistencies in court rulings, regular changes in the applicable law, and, as with URLs, brand new areas in which to figure out how one does in fact perfect an interest.

Often the only way a high-tech company, particularly a start-up, can arrange for financing is by pledging its IP assets as security for a loan. Any lender who invests in a technology company needs to be certain that it has properly perfected the security interest that it seeks in the debtor's intellectual property. If the lender ever wishes to foreclose on the collateral and to pursue its priority position if the debtor declares bankruptcy, doing it right is of paramount importance. Under bankruptcy law, a trustee or debtor in possession may circumvent a security interest if it is unperfected at the time of a bankruptcy filing. If the security interest in the collateral is not properly perfected, the lender is relegated to the status of unsecured creditor.

In the Beginning

Any discussion that deals with security interests must begin with Article 9 of the Uniform Commercial Code. Normally a lender simply files a UCC-1 form with the appropriate state entity and its interest is perfected. However, Article 9, Section 3 states that where a federal statute provides for another method of registration, the UCC "steps back" and will not be effective.

Federal patent, copyright, and trademark statutes all have provisions that deal with registrations of property interest in their respective subject matter. These statutes and conflicting court cases muddy the water and make it difficult for a lender who is seeking to perfect its security interest from feeling secure. When you have a new form of property, the URL, the water goes from muddy to opaque.

Trademarks. Trademark rights are a multifaceted bundle of rights. They are governed by both state and federal law. There are federal trademark statutes and state trademark laws in every jurisdiction in the United States. There are common law trademarks and statutory trademarks. There are important rights that go hand in hand with trademarks - good will, royalties, licensing rights, etc.

Section 10 of the Lanham Act (federal trademark law) provides that "assignments of trademarks" are void against subsequent purchases for value without notice unless they are recorded in the U.S. Patent and Trademark Office. The term assignment is not defined. Questions were raised as to whether granting a security interest was an assignment that needed to be registered at the PTO.

Case law in the past few years seems to indicate that a security interest is not the type of assignment contemplated by the act and that the correct method for perfecting a security interest in the trademark would be through the appropriate state's commercial code provisions. Generally, perfection is accomplished by recording the interest where the debtor is found. There are still a good number of practitioners who wear belts and suspenders and continue to record their security interests in both with the PTO and in the appropriate states.

Patents. The federal Patent Act also covers the registration of instruments that, "grant, assign or convey a Patent or Patent application." The statute provides that without a registration with the PTO, a conveyance or grant is void against subsequent purchasers or mortgagees for value. Case law generally determined that the Patent Act does not govern consensual liens. Courts were required to make this determination, as the act did not define assignment.

Some of the early cases indicated that a state UCC filing alone might not provide sufficient protection for secured creditors. Earlier cases raised the specter that subsequent assignees competing with secured creditors who had in fact made a PTO filing might obtain some type of preference. Cases also left ambiguous the issue of whether PTO filings would be able to defeat a trustee in bankruptcy. Most recent cases, however, seem to indicate clearly that PTO filings are not in fact necessary to perfect a security interest in a patent. However, the belt and suspender bar still feels it's prudent to file both with the PTO and the state.

Copyrights. Just when it seemed the law covering perfection of security interests in copyrights was finally settled, it was turned on its head. The Copyright Act seemed to be less ambiguous than the patent and trademark statutes. The Copyright Act provides that "any transfer of copyright ownership or other document pertaining to a copyright may be recorded in the copyright office." The act goes on to define a transfer of ownership to include an "assignment, mortgage, exclusive license, or other conveyance, alienation, hypothecation of a copyright."

On its face, it would seem to cover the granting of a security interest. Courts have tended to follow that interpretation. Federal copyright law has pre-empted all state copyright measures. For the past 25 years, there have been no state or common-law copyrights. A copyright is created when the expression that is to be protected is fixed in a tangible form. Registration is not a requirement to obtaining a copyright. Registration provides additional benefits, such as a presumption of ownership, the right to file suit against infringers, the right to recover attorney fees, and the right to obtain statutory damages in lieu of actual damages. These extra benefits are all carrots being provided to the public to encourage them to record their copyrights with the Library of Congress. As such, we have two types of copyrights, registered and unregistered.

Up until very recently, the only issue seemed to be whether or not the registration of the underlying copyright was a prerequisite to the filing of the necessary document with the Copyright Office in order to perfect a security interest. Courts were split on the issue. Prudent lenders simply required their prospective borrower to first register the copyright and then the accompanying security interest documents as a condition to receiving a loan. That small level of ambiguity and uncertainty has just greatly expanded. A recent case in California held that the copyright requirements applied only to works already registered and that unregistered copyrights were to be recorded with a UCC-1 form in the appropriate state office in order to effect perfection.

Thus, the seemingly uniform system created under copyright law is now in question. What the recent court case did not address is what happens to an unregistered copyright perfected by filing a UCC-1 in a state if the copyright is subsequently registered. It would seem that the Copyright Act would then take effect and, under this court ruling, the parties would then have to refile with the Copyright Office of the Library of Congress in order to continue the perfection.

This dual registration scenario is not an abstraction, but will probably be the norm. While most copyrights initially might not be registered, if they have any value (which they must have if they are collateral), surely the parties will want to obtain the additional protections afforded under the Copyright Act by registration. The case is currently under appeal.

For unregistered copyrights, the best course of action is to register the copyright and file the appropriate documents with Copyright Office. For the unregistered copyrights, at this time it would seem prudent to file with both the Library of Congress and with the state.

URLs. For many dot-coms, their URLs are by far and away their most valuable asset, especially those in difficulty because of a failing business plan. If the perfection of security interests in intellectual property, a concept with which we have had hundreds of years of experience, is still not settled, what can we expect from a new form of IP, the URL? Total chaos, of course.

Certainly, the overwhelming majority of IP lawyers, if asked to define a URL, would persuasively propose that it is intangible personal property or some form of license. It would appear, however, that the Supreme Court of Virginia disagrees.

The court is very important in this area, as Network Solutions Inc., the largest registrar of domain names is located in Virginia. In a case just decided, the Supreme Court of Virginia has ruled that a URL is, in fact, a service contract and thus not subject to garnishment. The court dodged the exact issue as to whether or not a URL is property by stating that it did not need to reach that specific question in the case. However, if one cannot garnish the URL, the writing is certainly on the wall as to foreclosing on it.

The issue in this case dealt with whether a judgment creditor was allowed to serve a writ of garnishment on NSI in order to have the defendants' URLs sold at a sheriff's auction to satisfy a judgment. NSI successfully argued that the garnishment was impermissible. The court looked to a body of case law dealing with phone numbers and their disposition in the bankruptcy courts. It seems that the circuits are fairly split as to whether one acquires a property interest in a telephone number and whether it becomes part of the debtor's estate. In the circuits where phone numbers are held to be a series of numbers attached to a service contract with the phone company, they are outside the reach of the trustee in bankruptcy. The court in Virginia found that the URLs are nothing more than a series of numbers attached to services provided by NSI.

It would seem that the only certain way to protect the lender's interest in a URL put up as collateral is to take possession of it. One could file UCC-1s in Virginia (or where the specific registrar is located) as well as in the jurisdiction of the debtor's principal place of business. It probably would also be prudent to file one where the server that contains the Web site is located.

For a lender, it would be simpler and safer just to get an assignment of the URL to be held in the lender's name, in trust, until the loan is paid off. We're sure that the owners of URLs will be delighted at the prospect of assigning their most valuable and visible asset to their lenders.

As the dot-com fire sale scramble for assets begins in the e-commerce world, those who paid attention to the details and nuances regarding protecting their investments in IP assets may end up the only winners!