The 21st Century has seen
India transforming itself to a land of young entrepreneurs and startup
ventures. Securing funds for a startup is
one of the toughest challenges an Entrepreneur faces while starting a new
business. In this new dawn of Startups, the Government of India itself has come
forward supporting them under various schemes like Startup India and Stand Up India.
Banks have donned the new role of handholding these startup ventures by offering
them a wide range of credit facilities including term loans or working capital or
asset backed loans based on their requirements. Banks like SIDBI are
offering special schemes for the startups which can be used for marketing, brand
building, creation of distribution network, technical know-how, R&D
and software purchase.
The Government has brought in amendments to the Intellectual
Property legal framework in India providing for a liberal fee structure for
registering Patents under the Scheme for Facilitating Start-ups IntellectualProperty Protection (SIPP) thereby encouraging the startups to secure
protection of the intellectual property created by them under their R&D. In a knowledge-based
economy, physical assets such as property, plant and equipment dwindle in
importance relative to Intellectual Property assets, which provide access to
the latest and most innovative forms of technology and act as barriers to entry
by competitors. The Banks can explore to secure their credit
facilities by creating enforceable security interest over this intellectual
property. However recent decision of the Supreme Court in Canara
Bank v N G Subbaraya Setty has created apprehensions amongst the
Banks as to the enforceability of security interest created over the intangible
property of the borrowers.
Intellectual Property (IP) rights comprise
of the underlying intangible rights such as patents, copyrights or trademarks, through
which a set of exclusive rights is given to the right holder/s under which they
may use the work in an unrestricted manner while others can do so only upon the
permission of the right holder/s.[1]
A business enterprise may have both identifiable and unidentifiable intangible
assets.[2]
For instance the Patents, Trademarks, Copyright, designs etc can be generally considered
as identifiable intangible assets which enjoy protection as the Intellectual
Property of the enterprise. The good will of the business enterprise may also
contribute towards the value creation for the company but the same does not
count as a protected intellectual property and may not be often quantified or
identifiable.
While offering an IP right owned by a
business enterprise as a collateral security, a security interest is created in
favour of the Creditor over the receivables including future receivables
generated from the intellectual property asset/s. Such receivables may include
future royalty payments that are likely to be received through the licensing of
a patent or a trademark, various rights in the music industry, such as recording
rights, the future income from copyrights, distribution rights, etc.[3]
Whether An Enforceable Security Under Indian Legal
Framework?
The Banking Regulation Act, 1956, allows the Banks
in India to acquire, hold and generally deal with any property or any right, title or
interest in any such property forming the security or part of the security for
any loans or advances. Banks can manage, sell or realise any such property that
has come into its possession as a security in full or part satisfaction of any
of its claims.[4] By
virtue of this provision there is no bar on the Banks for accepting an
intangible asset of a borrower like patent rights or trademarks for securing
the credit facilities offered to the borrower. A security interest so created
over an IP right can be enforced by the Banks under provisions of the SARFAESI
Act or under the Insolvency and Bankruptcy Code (IBC).
By virtue of the provisions of the
SARFAESI Act, a secured creditor can enforce any security interest created by
the borrower in its favour, by way of a mortgage or an assignment. The Act has
defined security interest to include any right, title and interest of any kind
upon ‘property’ and the term property has been defined to include know-how, patent, copyright,
trade mark, licence, franchise or any other business or commercial right of
similar nature.
Similarly the intangible assets of a
person, including any company has also been brought under the ambit of the IBC.
The scope of IBC covers every description of property situated in India or
outside and every description of interest including present or future or vested
or contingent interest arising out of, or incidental to, property. IBC also
provides for a similar but wider definition for security interest. As per the
Code, security interest means right, title or interest or a claim to property,
created in favour of, or provided for a secured creditor by a transaction which
secures payment or performance of an obligation and includes mortgage, charge,
hypothecation, assignment and encumbrance or any other agreement or arrangement
securing payment or performance of any obligation of any person[5].
IBC provides for the Resolution
professional to take control of the intangible assets including intellectual
property of the Corporate Debtor (CD) during the Resolution process.[6]
It has been further provided that the intellectual property of the CD shall
also form part of the liquidation estate if the CD goes into liquidation[7].
I.
Patents
For securing the credit
facilities offered by a lender, the proprietor of a patent can create a valid
mortgage of his right or assign the patent in favour of the Lender as per the
provisions of the Indian Patent Act. In a mortgage of patents, the patent
rights are wholly or partly transferred to assignee in return for a sum of
money. Under such an assignment the creditor may require the proprietor of the
Patent to assign the whole or part of the royalties and other receivables,
including future receivables to the creditor by cross licensing or by other
means. The lending banks may examine accepting of licensing agreements or
royalty streams as either standalone collateral or as part of an asset package
to secure a loan.
As per the provisions of
the Indian Patents Act, an assignment of a patent or of a share in a patent, a
mortgage, licence or the creation of any other interest in a patent shall not
be valid unless the same were in writing and the agreement between the parties
concerned is reduced to the form of a document embodying all the terms and
conditions governing their rights and obligations and duly executed.
Whenever any mortgage or
license in a patent is being created, either the mortgagee/licensee or the
mortgagor/licensor has to apply in writing in the manner prescribed under the
Patent Act for the registration of his title or, as the case may be of
notice of his interest in the Register of Patents. Once the mortgagor/assignor
repays the sum to the mortgagee/assignee, the patent rights are restored to patentee.
The person in whose favour a mortgage is made is not entitled to have his name
entered in the register as the proprietor, however he can get his name entered
in the register of Patents as the mortgagee. The rights of a mortgagor and a mortgagee
of a patent are no different from that of the mortgagor and mortgagee with
respect to an immovable property[8].
II.
Trademarks
Reading the ratio in Subbaraya Setty in toto, it can be said that the Court
has not barred the acceptance of trademark as a security. As it was rightly
pointed out in the Judgement, unless the assignment of trademark has been made
part of the loan documentation and has been registered with the Registrar of
trademarks, such document/instrument evidencing the assignment will not be
admissible in evidence by any Court in proof of title to the trade mark by
assignment.[9]
While creating the assignment as a security it must be explored and suitably defined
under the instrument as to what are the receivables related to the Trademark which
may be used for timely service of the credit facility availed and what shall be
the right of the Lender in case of any default.
III.
Copyright
No assignment of the copyright in any work shall be valid
unless it is in writing and signed by the assignor or by his duly authorised
agent. The assignment of copyright should identify such work, and must specify
the rights assigned and the duration of such assignment. If the period of
assignment is not stated, it shall be deemed to be five years from the date of
assignment. Under Section 18 of the Copyright Act, even the copyright in a
future work can be assigned in accordance with Section 19, however, such
assignment shall come into effect only upon date of creation of the work. It
has now been added by the Amendment that no assignment shall be applied to any
medium or mode of exploitation of the work, which did not exist or was not in
commercial use at the time when the assignment was made, unless the assignment
specifically referred to such medium or mode of exploitation of the work. For
instance if any financial institution proposes to provide credit facility for
production of a cinematograph film, the copy right over the future work and the
receivables can be assigned as a security if the same has been specifically
mentioned therein under the Deed of assignment.
Further if the borrower is a Company, it shall be
required under the Companies Act, 2013 to duly create and register the said
charge over its IP assets under the ROC records.
Underlying Challenges For Lenders
a) Due Diligence and Valuation: Performing due diligence and
appraising the IP assets have all along considered to be time consuming and
difficult. The first step in due diligence is to ascertain the ownership and
gauge the likelihood of future ownership challenges. For instance, in the case
of Information Technology sector, the only protection available for the source
code is under copyright law. The absence of the requirement of registration of
copyrights in India makes it extremely difficult to ascertain prior instances
of the work in question, which might potentially be lawsuits for copyright
infringement.
The major drawback associated with
trademarks is that that they are closely associated with the goodwill enjoyed
by the organization that continues to hold those intangible assets. A decline
in the value of the brand would also have a corresponding negative impact on
the value of the trademarks associated with that brand. A classic example in
this regard is the case of Kingfisher Airlines. The proportionate security
cushion that was available to the lenders based on the value of the Brand was
substantially eroded to the extent that the value of the brand, being an
operating asset, has declined in the market[10].
The rapid technological advancements quite
often render several patents obsolete and thereby the licenses that flow from
them redundant. Drawing an example from the entertainment industry, the use of
cassettes/diskettes as a conventional medium of distribution was totally made
obsolete with the advent of digital distribution. Such risks are more in the
case of software and semiconductor industries as new versions are being
released within a very short span of time, drastically reducing the shelf time
of the patents in this field. Such risks will have to be foreseen by the
Lenders and should be accounted for at the time of valuation. At the time of
valuation the future marketability and commercial potential of the IP assets
also have to be considered, by assessing their values as a going-concern and
also under liquidation scenario. The IP assets are generally considered as
passive assets, where the owner of the IP uses its exclusionary rights to
prevent unauthorised competition[11].
While valuing IP assets as collateral, it is important and always advisable to engage
an independent third-party expert to ensure the fairness of the valuation and
in assessing the future returns. [12]
In the international banking
scenario, the Banks have begun to move away from a purely balance-sheet analysis
into looking at the cash flow generating capability of the business and to
ascertain whether there is adequate, stable cash flow from the business owning
the IP asset to service and repay the loan within the stipulated time period[13].
b) Ensuring Continuing validity: If accepted
as collateral, the lender will be creating a “security interest” over the IP
asset, which can be seized and sold in the event of a default. During the
tenure of the loan the lender will have to ensure that the Borrower has timely
renewed the ownership and that he has taken necessary precautions to ensure the
continuation
of valid IP ownership. As per the legal framework in India the duration of
validity of a Patent is Twenty Years and that of the Trademark is Ten years
from the date of application. In the case of any default resulting in the
Lender/s may end up managing and monitoring potential infringements,
defending them from charges of infringement and administering royalty
payments. This includes payment of the renewal fees periodically till the
liabilities are liquidated.
[11] See Jacqueline
Lipton, “ Intellectual Property in the Information Age and Secured Finance
Practice” EIPR, 2002, 358, 364
