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A graduate in Law from University of Mysore. Post graduate in Business Laws from National Law School of India University, Bangalore. Advocate on the Bar Council of India.
Intellectual Property is an intangible asset. We have heard people keeping their tangible assets like land, house and gold as security for the debts. Since few years, there has been an increasing trend in the foreign countries to keep intangible assets like intellectual property as security. In my project paper, I am going to introduce the trends in securitisation of Intellectual Property (IP), methods of valuation of IP and its legal implications.
· Intellectual property - refers to creations of the mind: inventions, literary and artistic works, and symbols, names, images, and designs used in commerce.
· Securitise - convert (an asset, especially a loan) into marketable securities, typically for the purpose of raising cash by selling them to other investors. To convert assets to negotiable securities for relase in the financial market, allowing the issuing financial institution to remove assets from its books, to improve its capital ratio & equity while making new loans with security proceeds.
Why IP assets have value:
Today's economy can be called as 'Knowledge Economy'. Any existing technology can become useless with any new emerging technology. Take the example of how digital cameras have replaced the traditional cameras running on films. Same is with the mobile phone industry where each company is trying to offer the latest technology to its customer.
How do these companies offer the latest technologies to its customers? Every company can offer a technology only if it has the “know how” to manufacture a particular feature in a product or a product itself. This “know how” is the intellectual property. Apple companies shares went up when it came out with its innovative I-phone product.
Intellectual properties do have value, especially in the technology, media and pharmaceutical field. Intellectual property can be identified, registered and hence legally protected. It can create ongoing benefits. Hence, securitisation of Intellectual Property is a good idea for large industries, small and medium enterprises and the economy.
It is good for large industries because, the IP assets of large industries have really good brand value and it can serve as a good source of capital. For small and medium enterprises, IP assets help to raise capital for their big ventures. It is good for the economy because the asset is not kept stale and it accelerates some sort economic activity indirectly. For example, a small enterprise with the capital raised by its research and development can plan for an expansion in its business and promotion of its products in a bigger way, thereby facilitating economic growth.
IP Valuation for financing:
Having known that IP assets have value, the next challenge is to make the valuation of IP for the purpose of financing. Some of the practices of valuation are -
1. Market Approach – this method is similar to the valuation land situated in a particular area. Same way, we can compare the price of similar IP in the market. But this method is difficult when the IP in question is a totally new innovation. Moreover, the price of the various IP is usually not disclosed by the parties.
2. Income approach – various factors like the economic benefits of the IP, duration of benefits, secondary revenue by way of licensing, increasing or decreasing benefits are considered to make the valuation.
3. Cost Approach – this method makes use of the balance sheet data or any other data which shows the amount of money invested on the Research & Development (R & D) of the IP.
All the three methods have their own merits and demerits. A combination of all the above methods along with other factors have to be considered in arriving at a valuation. The process of valuation cannot be done in a mechanical way, but rather in an intelligent way by considering all the related factors.
One problem with the valuation of IP is that the value is highly dynamic. Technology in mobile industry changes fast. And with changing technology, the value may diminish. Same applies to media industry where the future royalties will depend on the popularity of a performer. But the IP in the pharmaceutical industry always has high value, because of the slow change in the technology development.
Securitisation of IP:
Securitisation can be done in two ways. One, by assigning the IP to the lender as security for getting a loan. For example, Michael Jackson is reported to have raised US $ 200 million from Sony Corporation using the Beatles’ catalogue as collateral.
Two, by assigning the IP rights to a an entity (securitisation company or a special purpose vehicle), and this entity issues securities to capital market investors. For example, singer David Bowie issued a ten year asset-backed bonds on the basis of future royalties on publishing rights and master recordings, and raised US$55 million.
Many times, scientists have their inventions patented. Further research will require funds. Selling away the patent title just for the want of funds will be painful for the inventor. In such a case, IP securitisation will be of great help. Securitisation will be useful even for creative persons like singers, musicians and writers.
A borrower is cash-poor but asset-rich. The borrower can use IP assets to raise funds to promote his brand. The process of R & D takes a long time, even investment on R & D will be high. Hence, there will be a necessity for recovering these expenses. The borrower (owner of IP assets) has to decide whether security is taken over IP rights or the revenue streams generated by IP.
Good brands have good chances of getting a higher value. The track record of the brand will always matter. The most important aspect is whether the borrower wishes to mortgage the IP asset. By making a mortgage, the ability to control the IP asset will reside with the lender. Such a mortgage will affect the balance sheets of the borrower and also affects the shareholders of the company.
The lender has to first make sure that there are no pending litigation relating to the ownership of the IP. The IP should be registered. For example, an unregistered trade mark will not be protected absolutely without registration. Registered IP assets should be relied on.
Legal Mortgage of IP asset should be preferred. Legal Mortgage will assign the title of the IP to the lender and the lender will again assign the borrower some rights through license. After the debt is paid back by the borrower, the lender releases the mortgage. This type of mortgage is best because, it provides the total control over the IP to the lender in case of default.
Sometimes, situations may arise where an IP asset contains confidential information. This poses a challenge to both the parties on how to proceed. The borrower may not be ready to give up the trade secret. For example, Mac Donald's consider their recipe unique and maintain secrecy. Even Coca-Cola have some trade secrets which they do not reveal. In such cases, the lender can expect warranties and indemnity. This will protect the lender from any losses arising out of the non-disclosure of confidential information in a patent.
Rights of a Lender:
These are the usual rights expected by a lender -
· Right to sell the IP asset in case of default.
· Right to restrict dealing of the IP asset by the borrower in a way which diminishes the value of the IP.
· Right to audit to examine if the IP rights are being used by the borrower as per the terms.
· Right to approve before licensing to the third parties.
· Right to collect payments from licensing.
· Right to enforce the rights of the IP asset in case the borrower is not in a position to fight a legal battle.
The aspects of IP assets being collateral security have the basis in The Indian Contract Act, 1872. The Securitisation and Reconstruction of Financial Assests and Enforcement of Security Interest Act, 2002 does not specifically deal with the intellectual property. It only makes a mention in Section 2 (t) where it lays down that “property” means intangible assets, being know-how, patent, copyright, trade mark, licence, franchise or any other business or commercial right of similar nature.
This Act is made mainly for regulating Non-performing assets. If the interest or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan, then that account is considered as a non-performing asset. Hence, this Act cannot be relied on completely.
The United Nations Commission on International Trade Law established a Working Group on Intangible Assets. It opined that most of the countries do not have proper legal framework to necessitate the process of IP securitisation. In the absense of a legal framework, most of the IP asset holders do not feel comfortable to proceed with IP securitisation.
I make the following suggestions -
1. The Government should come out with a new legislation which deals exclusively with IP securitisation and guidelines for valuation of Intellectual Property.
2. A professional body consisting of the members of Institute of Chartered Accountants of India, Reserve Bank Of India, Leading Bankers should be constituted to make more realistic IP Valuation. Such a step would ensure fairness both to lender and borrower.
3. Establishment of a National Level IP security registry which maintains the details of IP assets, valuation and their securitisation details.
4. Suitable amendments should be made to the Patents Act, 1972; Copyright Act, 1957 and other IP legislation providing for entering the details of IP securitisation details in the respective IP organisations like Patent Office etc.
5. Special provisions while are to be enacted for valuating the IP of individuals like scientists, artists, performers and musicians so that they have a good bargaining power. Established companies will be in a better position to get their IP valued because of their brand value, corporate identity and market value of their products. But individuals and small firms do not have good market value. The economic and market factors do influence the valuation of IP assets. Hence, there is a need to have organised bodies scientists, musicians, writers who can collectively bargain for their rights in a better way.
6. Tax laws relating to securitisation should be made in a market friendly and in a simple manner which has to benefit both the borrower and lender. This will go a long way in influencing the IP asset owners to go for securitization.
The second world war was influenced by the “know how” of preparing a nuclear bomb. Today, we live in a “knowledge society” and our economy is also highly dependent on the knowledge – knowledge of our citizens. Other countries are already making IP securitisation in a big way. The Government should provide a legal basis for the emerging field of IP securitisation, so that we are not jeopardised in any way vis-à-vis other countries.
Index of Authorities
· Christina Demetriades (Ed.), Intellectual Property issues in Commercial transactions, Sweet and Maxwell (2008)
· Russel Par, Pricing Intangible Assets: Methods of Valuation of Intellectual Property AUS Consultants, Valuation Services, Moorestown, New Jersey (United States)
· What is intellectual property? Available at http://www.wipo.int/about-ip/en/ (Last visited on September 6, 2010)
· Intellectual Property Financing – An introduction, available at http://www.wipo.int/wipo_magazine/en/2008/05/article_0001.html (Last visited on September 6, 2010)
# Oxford English Dictionary
# Black's Law Dictionary, (7th edition,1999)
# Russel Par, Pricing Intangible Assets: Methods of Valuation of Intellectual Property AUS Consultants, Valuation Services, Moorestown, New Jersey (United States)
# Intellectual Property Financing – An introduction, available at http://www.wipo.int/wipo_magazine/en/2008/05/article_0001.html
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