This article is written by Ashwene Vij, pursuing a Diploma in Intellectual Property, Media and Entertainment Laws from LawSikho.com.
Intellectual property (IP) exists as a non- monetary asset which is identifiable without physical substance. IP assets come into existence by operation of law and actually differ from other intangible assets. It stands in opposition to tangible assets. Companies are nowadays lacking a steady source of financing and use of traditional avenues for source funding which can also become critical at times. IP comes as a readymade gift which unlocks the “hidden value” found in intangible IP assets. IP backed financing in simple terms means “where money issues meet IP rights”. It further means that companies leverage their IP assets in exchange for finance and lending institutions extend their business by providing loans on the basis of IP. Intangible IP assets and its rights increases a company’s asset value and hence by valuing and understanding these assets, companies make careful investment and marketing decisions.
IP as collateral allows a company to further invest in building larger revenue streams as compared to the existing ones and when such financial considerations are integrated by the company in its business, the companies then strategically value its intangible assets and earn commercial benefit from such investments. for eg:- Pension led funding, a lessor known option for IP backed finances, wherein the pension which is held by business owners or directors etc is used as a means of providing cash injection into a business via IP of the business. IP assets of business are purchased and subsequent licencing-back is taken from the pension fund to the company or a loan is secured against IP assets themselves.
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Benefits of IP Backed Finance
The structuring of IP- Backed Finance is innovative. One of the major advantages using IP as collateral is that there is a positive correlation in terms of experience with respect to reduction of borrower constraints, company’s innovation and growth and loan performance. It is important because IP is a driver of cash flow and creator of competitive differentiation. Due to its intangible characteristics, costs which are associated with the borrower’s companies/firms are reduced significantly.
Favourable credit rating can be received by the companies looking for finances by putting their IP assets securitised to its projected revenues like royalties, in a special purpose vehicle and hence can eliminate the risk of IP assets being held by the lending institutions. This will help the Company/SME/firms in obtaining more favourable funding conditions. The Company/SME/firms etc. can give direct collateral to the lender by pleading IP as collateral in a loan agreement to help the company to gain finances easily as the revenue derived from licensing agreement can be secured against loan and even if they later default or become insolvent the lender can seize it. Compared to tangible assets, the value of intangible assets of the firm or IP assets increases over time and also indicates Company/SME/firms capacity to generate value in the future.
To honour the borrowers’ stronger repayment commitments, and where intangibles assets are core to business activity, lenders provide a powerful incentive for borrowers. For technology based companies IP collateralization appears to be a key mechanism for decreasing credit rationing as Intellectual Property portfolio is a sign that acts like a signal of firm’s quality. The leveraging enhancement tools through IP collateralization/securitization not only increase profit achieving, higher credit rating but also the firm’s move forward in terms of growth and succeed as there are no consistent expenses.
The wider pool of assets, wider the finances. Patents, copyrights and trademarks are the most important key elements which not only represents the actual value of firms portfolio but also its market value consequently and in turn to obtain more finances based on such aspects the companies are adopting and enhancing transparency and reliability in the IP markets as they are providing information and disclosure requirements through the means of reporting regime which is managed by IP offices. For e.g. In 2013, Singapore government encouraged IP rights holders to divulge or communicate and disclose ownership, transfer and licensing information to make the country a ‘Global Hub for IP which is a part of a wider ranging program of that country.
The use of IP as a financial/ investment tool is an off-balance-sheet way of financing as it does not affect the credit reputation of the borrower but only increases the multiplication in the funding sources and increases the welfare of the capital market.
Challenges and Issues of IP Backed Finance
IP is a part of a growing share of commerce which revolves around IP assets and nowadays it has not been dominated by industrial age physical commodities. It is a source of commerce in its own right which also has led to an increasing component in respect of traditional merchandise i.e from patented drugs to trademarked fashion. In India since the launch of National IPR Policy in 2016, interest has been shown for IPR commercialization but at the same time, profound challenges has been risen which lead to relatively slow place IP finance in the country that include, no uniformity in valuation of IP, insufficient IP infrastructure which leads to lack of transparency and reliability, unwillingness to treat IP as a business asset to name a few.
IP carries valuable Know-how, therefore transactions become difficult to redeploy and hence can affect the IP value very largely. Brand being intangible assets can be adhered to rapid changes in value “depending on the fortunes of the companies that own them.” The fixed assessments costs are increased due to operating at a small scale.There are complications when recognizing the assets for accounting which occur due to lack of total transparency. Intangibles are included in the balance sheet only if they are purchased. In case of external acquisition and otherwise they are excluded. Cost with respect to securitization leads to question whether such scheme shall be adopted or not as realisation of costs to be incurred includes the payments made to accounting firm, law firm etc. and such that asset must be of a reasonable size so that cost of securitization can be realised from it.
There is uncertainty in liquidation value which arises from information imbalance and low redeploys ability and hence, asset class as new collateral becomes low. The assessment of potential revenues tends to become incorrect if the investors overestimate the risk as they tend to escalate the default risk of loans collateralized by IP and therefore adds to additional complexity and risk related to IP transactions.
Transferability of IP itself presents with inherent problems. In practice IP does not truly be separated from the firms itself as both parties sign side agreements with respect to knowledge transfer even to the simplest licensing agreements resulting in a difficult transfer to the lender due to imperfect risk decoupling.
The secondary markets of IP are immature and they are too undeveloped for guaranteeing a low cost and quick resale of assets. Lenders often don’t show enough confidence in managing the particular risk profiles associated with these assets. There lacks a system, recognised standards for intangible asset value management, training or familiarisation. To secutrize IP assets, lenders, financial institutions have to understand the potential value, its functions and cash flow relationships.
Examples of IP backed Finance in India
IP used as collateral for obtaining a loan is a great option but it is covered with systematic obstacles and such unconventional form of security creates inconsistency between the laws that protect IP and the valuation of the company as a whole. There is great uncertainty with respect to the prevailing laws that govern securitisation of IP. In the case of Canara Bank vs NG Subbaraya Setty, the Supreme Court held that using the assignment of trademark as security for the loan is against the Trademarks Act, 1999 and the Banking Regulation Act, 1949. “The Supreme Court took the view that the trademark cannot be said to be property which has come into possession of the bank in satisfaction of any of the claims of the bank. Trademarks are not part of any securities for loans or advances.”
However parties to litigation did not mention or viewed the matter with respect to Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act, 2002) which clearly includes intangibles assets and defines the expression property under Section 2(1)(t) of the said act and section 2(1)(zf) of the SARFAESI, 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. And hence within the provisions mentioned hereinabove, the bank can sell or assign intangible assets or trademark in this context of default the lender has the right to recover the defaulted loan by selling the property.
Another classic example where IP was used as collateral but no outcome was observed which is seen in the case of Kingfisher Trademark and one liner tag “Fly with good times”. Along with the logo, the label marks, device mark etc. were put on auction by the Indian Bank SBI, but failed to monetize IP as no bidders were found in spite of IP collateralized debt as suggested by the National IPR Policy.
IP against Loan is very much valid in India, though banks prefer not to grant loans against IP as certain technical issues like Valuation, Know how, procedure and clarity on laws still have to fill up the Gap. Certain documents like Stamp duty, Filings with ROC in view of recording creation of security, obtaining charge certificates, Filing with CERSAI and Filing with IPR office are required in order for creation of security over IP.
Conclusion/ the way forward
IP backed financing exists as a tool to ease access to credit and is literally boosting. But still a part of IP backed financing has to be realised by the companies and firms as there lacks infrastructure for IP, inconsistencies in valuations and lack of international framework. Though having great potential to use as collateral and securitised, firms and companies are not totally accepting radical change toward non-traditional forms of asset backed securitization. The only way forward is to create transparency in the market place so that strong relationships between enterprises with well-built IP portfolios and financing entities for IP backed financing are utilised to its full possible extent. Companies and firms need to scrutinize their R&D, create brand awareness which is considered to be crucial as it will help in aiding transformation of business models of established organisations. Policies for visibility and value understanding for intangibles shall be reinforced to have an effect. In India despite National IPR policy in place, companies and firms need to rethink and consider seriously monetizing their IP.
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