Can your ideas secure your loan?

The problem
Your company is growing. You have a great product, an excellent rapport with your customers and a steady stream of sales. Your brand name is gaining reputation and you may have sought to register your trademark. You may even have acquired patents for your innovative products.

The problem is cash flow. Your receivables are in good shape, but the rent is due first. Worst of all, payday is fast approaching and your employees are already counting their change. You need a loan, which you could repay within a reasonable time as your sales are growing and your customers will be settling their accounts with you shortly. However, no financial institution will lend your company money without adequate security. So what will you tender as collateral?

The solution
You can use your intellectual property. Intellectual property includes intangible assets such as patents, trademarks, copyright, industrial designs, trade secrets and know-how. For example, if you are a software developer, you already possess copyright in your object code and source code, even if you have never registered that right. Alternatively, you may have developed the ideal recipe for chicken soup and consider it a trade secret, or your company’s brand name may be covered by a registered trademark.

Your intellectual property may be your only asset of sufficient value to cover your loan. A lender may accept and even require your company’s intellectual property as security for the loan. Even your application for the registration of an IP right (eg, a patent application) may be given as security.

However, by giving your intellectual property as security, you agree in advance that your lender may exercise certain rights over it should you default on the loan. Once you have agreed on the type of property to secure your loan and have negotiated terms acceptable to you and your lender, a security agreement (or a deed of hypothec in Quebec) must be entered into. In addition to the main security agreement, certain additional agreements may be required by the lender – for example, an escrow agreement whereby your source codes will be held in escrow by a trust company.

The type of security agreement
In general, the purpose of a security agreement is to allow the creditor (ie, the lender) certain rights, such as the right to take ownership and possession of the secured property upon the default of the debtor (ie, the borrower). Consequently, where a patent is given as security and the borrower defaults, the secured creditor may, upon the exercise of certain rights, become the owner of the patent in question, and therefore enjoy all the rights afforded to a patent owner. This includes the right to: 

  • exploit the patent; 
  • license it; or 
  • assign it to third parties.

Transfer of ownership in intellectual property is carried out by an assignment in favour of the new owner. In the common law provinces, an efficient method of ensuring this assignment is to draft the security agreement as a conditional assignment – that is, the agreement would specify that upon the fulfilment of certain conditions (one of which is the debtor’s default), the secured intellectual property is to be assigned to the creditor.

By drafting the agreement in this form, the creditor is assured that it will be able to assert ownership over the secured intellectual property without necessarily seeking the execution of additional documents in the event that the relationship turns sour and the parties become uncooperative. However, if the transaction is governed by the laws of the province of Quebec, the appropriate method of taking security over intellectual property is by way of a hypothec.

Where to file your security agreement
A security agreement must be registered at the appropriate provincial registry office in order to alert third parties to the existence of the security and to rank the creditor in the event of the debtor’s default. This will normally be the province in which the person granting the security is located at the time the contract is signed, although this varies from province to province.

Furthermore, since an IP right extends to the whole of Canada, in order to notify third parties of rights affecting your intangibles, it is also advisable to register the security agreement in the appropriate federal registry office. For example, if a patent has been given as security for a loan, the security agreement should be filed at the (Canadian) Patent Office, as well as at the appropriate provincial registry.

Similarly, both the Copyright Office and the Trademarks Office will accept the filing of a security document if the affected copyright or trademark already appears on the register. However, it is uncertain whether the federal filing of a security agreement affects the rank of the secured creditor. Thus, in order to perfect the security interest, the security agreement should always be filed at the provincial level, even if it is also filed federally.

You need to keep your house in order! You may have rights of which you are unaware and which you need to identify. If you own intellectual property, carry out a detailed survey and an audit of your intangible assets so that they can be used when the time is right.

This is an Insight article, written by a selected partner as part of IAM's co-published content. Read more on Insight

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