"To promote the progress of science and useful arts": a role for federal regulation of intellectual property as collateral.

• Author: Baldwin, Shawn K.

INTRODUCTION

The practice of using intellectual property(1) as collateral to secure financing is over a century old: in the late 1880s Thomas Edison used his patent to the incandescent electric light as collateral to borrow money to start his own company.(2) That business would eventually become the General Electric Company.(3) Similarly, the problems associated with trying to obtain financing on the basis of intellectual property are not new. Lenders, seeking to minimize their exposure to risk, have historically been hesitant to lend money on the security of intellectual property, instead preferring more traditional, tangible collateral such as land, buildings, and equipment.(4)

Recently, however, commercial lenders, already reluctant to lend on the basis of intellectual property, are being further deterred by the confusion surrounding the proper method of perfecting(5) a security interest(6) in intellectual property. Parties who wish to use intellectual property as collateral are faced with a host of questions to which the answers are unclear: To perfect a security interest, must a lender record according to state law, federal law, or both? How is priority among competing creditors determined? Does a lender who takes a security interest in intellectual property expose itself to infringement liability? Can a lender take and perfect a security interest in the debtor's after-acquired property? The current state of the law does not answer these questions with the clarity and certainty needed to foster growth of investment in information and technological assets.

Foremost among these problems is whether federal or state law governs the parties' rights. Both the Uniform Commercial Code (UCC or the Code)(7) and the relevant federal statutes(8) arguably control the creation of security interests in patents,(9) copyrights,(10) and trademarks.(11) It is presently unclear, however, to what extent federal regulations preempt the UCC in a particular secured transaction.

A number of recent judicial decisions attempt to clarify these issues and establish a system of perfection,(12) but many significant questions remain unanswered. Creditors fear that the current legal framework will not consistently recognize their efforts to safeguard security interests in intellectual property as collateral. This uncertainty must be resolved to enhance the utilization of intellectual property as collateral in financing transactions.

This Comment argues that federal law should govern security interests in intellectual property. It will become clear that a single, uniform law will best meet the goals of both commercial credit and intellectual property law. It is important, however, to bear in mind that the question of which law should govern is a separate question from what that law should look like. Thus, this Comment will also argue that federal law should be improved, so that the uniform law being applied will also be the optimal substantive law.

This Comment begins, in Part I, with an exploration of the value of intellectual property and the events that have led to the increased recognition and use of intellectual property as collateral in financing transactions. Part II contains a review of the relevant state and federal statutes and the judicial decisions interpreting those statutes. It concludes with an analysis of how the current practice of dual filing at both the state and federal levels, established in response to these judicial decisions, is both diminishing the value of intellectual property in financing transactions and deterring lenders from accepting intellectual property as collateral.

Part III provides an in-depth analysis and criticism of the "mixed perfection" approach that is currently advocated as the best method of reform. Part IV proposes that a wholly federal system of perfection is a preferable approach because such a system is more consistent with the nature of intellectual property and recognizes federal interests that are not adequately addressed by either a wholly state or mixed perfection approach. This Comment concludes by exploring the optimal substantive law which should be adopted under a uniform federal system.

1. THE INCREASING RECOGNITION OF INTELLECTUAL PROPERTY AS A VALUABLE

   ASSET

   Intellectual property used to be the tail that failed to wag the dog in

   commercial transactions. Now it is the dog itself.(13)

   The value of intellectual property has risen substantially in recent years, to the point where, in many instances, a company's intellectual property is now far more valuable than its real property. As a result, intellectual property has earned recognition as the dominant factor behind many recent commercial transactions.(14)

   As the value of intellectual property has risen, so has the value of having intellectual property available for financing purposes. In a small, emerging growth corporation, for example, trademarks may represent as much as eighty percent of a company's value.(15) In such corporations, the availability of intellectual property for use as collateral may represent the only means by which that company can obtain financing for the promotion and development of new ideas and products.

   The stakes for large corporations are also extremely high. The value of intellectual property for large corporations with established, name-recognizable products can run into the billions of dollars. Consider the Marlboro cigarette. One in four cigarettes sold in the United States is a Marlboro cigarette, and the estimated worth of the Marlboro trademark is $40 billion worldwide.(16) The ability to tap such a resource for financing purposes is extraordinarily valuable.

   Modern companies are well aware of the importance and value of their intellectual property. The 1991 Annual Report of the Campbell Soup Company reveals the significance that modern businesses place on their intellectual property:

   Campbell owns a mighty array of proven brands--brands like "Pepperidge Farm," "UG," "Franco-American," "Vlasic," "Swanson" ...and "Campbell's" itself. They provide an asset bank to fund global expansion.... In the coming years we will launch brand line extensions and new products and expand into new distribution channels and new geography.(17)

   The recognition of intellectual property as an extremely valuable asset is the result of several recent, concurrent developments. Intellectual property law has changed radically since the inception of the Court of Appeals for the Federal Circuit(18) (CAFC) on October 1, 1982. The CAFC was established primarily to settle the law in dozens of areas where various adjudications in regional appellate courts had created a morass of conflicting standards.(19) The CAFC has consistently resolved these disputes in favor of the patent owner,(20) which has made the patent a much more stable and valuable business asset.(21) Financiers, in turn, are increasingly willing to consider a patent as collateral for funds they desire to lend.(22)

   Another development leading to the recent increase in recognition of the value of intellectual property is the unprecedented mergers and acquisitions activity of the 1980s. This activity contributed greatly to a heightened awareness of the need to value accurately a corporation's intellectual property assets. "Intellectual property is fast becoming the most important asset possessed by corporations. Various forms of intellectual property are the foundation of market dominance and continuing profitability for many companies. Very often they are the prized target in mergers and acquisitions."(23)

   An example is the acquisition of the Pillsbury Company by Grand Metropolitan of Great Britain for $5.7 billion. In obtaining Pillsbury, Grand Metropolitan's primary purpose was to acquire such powerful brands as Burger King, Green Giant, and Haagen-Dazs.(24) Similarly, Nestle paid $4.5 billion to obtain the Rowntree corporation(25) and acquire brands such as Rollo, Kit Kat, and After Eight.(26) Such deals heightened awareness throughout the business community of the value of intellectual property.

   The extremely high failure rate of new brands, coupled with the exorbitant costs of introducing them into the marketplace, has also enhanced perceptions of the value of established trademarks. The domestic introduction of a new brand of soap, for example, costs approximately $100 million.(27) With ten thousand new products introduced annually, eighty percent of them destined to fail and fewer than one percent ever obtaining annual sales of $15 million,(28) it is easy to recognize why established brands are extremely valuable.(29)

   The importance for companies to have intellectual property available for use as collateral in financing transactions has grown in conjunction with the increased value and recognition of intellectual property. The current state of the law, however, diminishes the value of intellectual property and deters lenders from accepting it as collateral.

2. THE PRESENT SYSTEM OF LAW DETERS THE USE OF INTELLECTUAL PROPERTY AS

   COLLATERAL

   To create an unassailable security interest in the borrower's intellectual property, the lender and its counsel are advised to follow four basic steps: (1) exercise "due diligence" by searching the appropriate federal and state offices to determine the title, ownership, and status of the intellectual property; (2) negotiate a separate security agreement for the intellectual property serving as collateral for the loan and include clauses regarding the representations, warranties, and other terms relating to intellectual property; (3) obtain a letter of opinion from the borrower's intellectual property counsel regarding the status of the intellectual property collateral, thereby supporting the borrower's representations and warranties; and (4) perfect the security interest by recording it in the appropriate government office or offices.(30)

   It is the fourth step which currently presents the most difficulty. The...