Traditional intellectual property assets, i.e., those capable of registration with a central governmental authority such as patents, trademarks and copyrights, are particularly valuable because they enable companies to create and hold monopoly power on unique products and services. Key intellectual property rights can provide owners with significant business advantages by allowing, for example, the creation of specialized goods that are capable of generating high profit margins. In fact, the driving force behind many of the mergers and acquisitions completed during the past decade has been the acquirer's desire to obtain the target's intellectual property assets. Now more than ever, the full financial potential of intellectual property is being realized as an additional source of funding to facilitate research and development, acquisitions and other commercial transactions. Companies seeking additional sources of capital, lenders, venture capitalists and other members of the investment community are increasingly looking beyond a company's traditional, nationally registered intellectual property rights and recognizing the growing value in trade secrets, know-how and other non-registrable intangible rights. As secured transactions continue to player a greater role in extracting additional value from intellectual property rights, securitization of trade secrets has become a more widely recognized and necessary practice.
Since the United States Supreme Court case of Kewanee Oil., Co.2 established that neither the U.S. Constitution nor federal patent law could preempt trade secret protection afforded by state law, reliance on state trade secret law has progressively increased.3 In Ruckelshaus v. Monsanto, the Supreme Court further solidified the critical role trade secrets play by holding that trade secrets are indeed a form of "property" capable of being assigned or otherwise exploited for commercial gain so long as the owner takes reasonable steps to secure their confidentiality.4 Following these important decisions, many states5 adopted the Uniform Trade Secrets Act in order to codify the basic principles of common law trade secret protection and preserve its essential distinctions from patent law.6 The Uniform Trade Secrets Act provides an expansive definition of a trade secret, namely:
Information, including a formula, patterns, compilation, program, device, method, technique, or process that:
- derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and;
- is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.7
Another widely accepted definition of a "trade secret" can be found in the Restatement of the Law, Third, Unfair Competition, which states:
A trade secret is any information that can be used in the operation of a business or other enterprise and that is sufficient valuable and secret to afford an actual or potential economic advantage over others.
At the most basic level, the protection of trade secrets advances several interests, including the articulation of standards for fair competition and the imposition of liability for misappropriation.8 More recently, however, the protection of trade secrets has been viewed as an untapped asset for obtaining capital.9
The system of protection for trade secrets differs greatly from registration-based intellectual property rights such as patents, trademarks and copyrights in that trade secret law is designed to limit the misappropriation of trade secrets by third parties and is based upon rights and duties arising under principles of state contract and trust law.10 So long as a trade secret is kept confidential, it could conceivably exist in perpetuity. Towards that end, it is critical for all parties to maintain the confidentiality of the trade secret in the context of granting a security interest therein. Unlike other IP rights that derive benefits from disclosing the intangible rights seeking protection, this fundamental principle of maintaining secrecy suggests the need to proceed with extreme caution when negotiating, creating and perfecting security interests in trade secrets.11
For quite some time, the law was unsettled as to whether trade secrets were a form of property in which a lender may take a security interest.12 Since Ruckelshaus, the law across the fifty states with respect to the creation of a security interest in trade secrets is fairly uniform under the Uniform Commercial Code (U.C.C.). This must be distinguished from the quite unsettled state of the law surrounding the perfection of security interests in many forms of intellectual property, which remains quite misunderstood.13 Companies who offer their intellectual property as collateral, and, in particular, lenders and other secured parties and their counsel, should be wary of the potential pitfalls which currently exist in the intellectual property securitization process. Unlike traditional IP rights, however, the most significant risk with respect to securitization of trade secrets is the unintentional disclosure of the trade secret, as opposed to the proper creation and perfection of such security interest.
In the United States, patents, trademarks and copyrights, are often viewed as creatures of federal law, while state law typically governs trade secret law.14 However, the creation (as opposed to perfection) of a security interest in all forms of intellectual property in the United States is governed by state law. Article 9 of the U.C.C. explicitly provides that it applies to any transaction, regardless of its form, that creates a security interest in personal property.15
More specifically, Article 9 of the U.C.C. governs security interests in "general intangibles"16 and general intangibles are considered personal property for purposes of U.C.C. interpretation.17 While reference to patents, trademarks, copyrights and trade secrets are not mentioned specifically in Section 9-102, the Official Comment uses the catch-all term "intellectual property" as an example of a general intangible18 and it is well-settled that patents, trademarks, copyrights and trade secrets fall within most common definitions of intellectual property and the phrase "intellectual property" is commonly used to refer to a variety of intangible rights, including trade secrets. In fact, the phrase "trade secret" is specifically mentioned within the definition of intellectual property under the U.S. bankruptcy code, which is relevant in the context of a foreclosure action to enforce the terms of a security interest.19
In the United States, most aspects of patent, trademark and copyright law are governed by federal law. Although the creation of a security interest in IP is exclusively governed by state law, depending upon the type of IP concerned, perfection could take place at either the state or federal level. For example, proper perfection of a registered copyright takes place at the U.S. Copyright Office20 while proper perfection of a registered trademark takes place at the state and/or local level.21 Generally, in order to perfect a security interest, the secured party must provide public notice of the existence of the encumbrance by filing a notice with the applicable local, state or federal agency. As stated above, the applicable jurisdiction and law depends upon the type of intellectual property involved, but is particularly worrisome in the area of trade secrets.
In order to perfect a security interest in trade secrets, it is necessary to file what is known as a "financing statement" at the state level.22 It is here that difficulties can be encountered that solely exist with respect to trade secrets as opposed to other IP rights. This is due, in part, because any U.C.C. financing statement must adequately describe the collateral that is the subject of a lien.23 If only certain intellectual property is serving as collateral, then that collateral must be separately identified.24 If, however, all general intangibles are to serve as collateral, there is no strict requirement under the U.C.C. that they be separately identified.25 Language to the effect of "all general intangibles now owned or hereinafter acquired by the debtor" is generally considered a sufficient statement.26
Although limited, there is case law to suggest that a general description of collateral is not sufficient. For example, in the case of In re 199Z, Inc., a California bankruptcy court held that where the description of collateral merely referred to "general intangibles", such description was wholly insufficient and the security interest was not properly perfected.27 Unfortunately, for the defendant/creditor in this case, their attempt to perfect with the USPTO was also deemed insufficient and they were relegated to unsecured creditor status.28 Although this case concerned trademarks, not trade secrets, the careful practitioner should bear this case in mind when drafting their UCC description. It has also been suggested that the trade secret be held in escrow for the benefit of the secured party.29
Multinational companies with substantial worldwide intellectual property portfolios are offering not only their domestic intellectual property rights as collateral, but increasingly, their international rights as well. Although today most major countries recognize the concept of trade secret protection, not all countries recognize the creation of security interests in intellectual property and, at the same time, offer a mechanism for perfection.
In today's rapidly changing global economy, intellectual property been cast in a new and dynamic role in commercial lending transactions. Trade secrets represent valuable intangible rights that are not only capable of enhancing a company's bottom line, but also function in a new capacity as a source of collateral and revenue.
Footnotes
1. Scott J. Lebson, a partner in the New York office of the intellectual property law firm Ladas & Parry LLP, has written and lectured extensively on intellectual property issues. Mr. Lebson can be reached at slebson@ladas.com. For more information on intellectual property law or Ladas & Parry LLP, please visit www.LADAS.com. Copyright © 2008 by Scott J. Lebson. All Rights Reserved
2. See Kewanee Oil Co. v. Cicron Corp., 416 U.S. 470 (1974). See also Aronson v. Quick Point Pencil Co., 440 U.S. 257 (1979) (holding that federal patent law is not a barrier to a contract to which someone agrees to pay a continuing royalty in exchange of the disclosure of trade secrets concerning a product).
3. See Thomas M. Ward, Intellectual Property in Commerce, §1:11, p14., West Group, 2003.
4. See Ruckelshaus V. Monsanto Co., 467 U.S. 986 (1984).
5. The Uniform Trade Secrets Act or other trade secret statutes of general applicability are currently in effect in forty-one states and the District of Colombia.
6. See Uniform Trade Secrets Acts (with 1985) Amendments, National Conference of Commissioners on Uniform State Laws, Prefatory Note and Comments.
7. See Uniform Trade Secrets Acts (with 1985) Amendments, National Conference of Commissioners on Uniform State Laws.
8. See Restatement of the Law, Third, Unfair Competition, §39, Comment.
9. See Jeffrey D. Dunn & Paul F. Seiler, Trade Secrets and Non-Traditional Categories of Intellectual Property as Collateral, UNCITRAL, Second International Colloquium on Secured Transactions: Security Interests in Intellectual Property Rights, Vienna, Austria, Jan. 18-19, 2007.
10. See Thomas M. Ward, Intellectual Property in Commerce, §1:11, p14., West Group, 2003.
11. Certain private companies offer services in the nature of evaluating and "registering" company trade secrets. See e.g., The Trade Secret Office, Inc., www.thetso.com.
12. See Claire Philpott and Susan Jahnke, Intellectual Property: A New Form of Collateral", Puget Sound Business Journal, March 7, 2005.
13. The U.C.C. is in effect in all 50 States and the District of Columbia and has undergone several revisions. In New York and several other States, the most recent revisions to Article 9 became effective on July 1, 2001. The term "perfection" is a term of art used to describe the process of making a public filing to serve as constructive notice to third parties of the existence of the lien.
14. It should be noted, however, that the Economic Espionage Act of 1996 made it a federal crime to misappropriate trade secrets related to a product that is offered for sale in interstate or foreign commerce. See 18 U.S.C. §1832.
15. See U.C.C 9-109(a)(1), providing "except as otherwise provided in Subsection (c) and (d), this Article applies to: (1) a transaction, regardless of its form, that creates a security interest in personal property or fixtures by contract...".
16. See U.C.C. 9-102(42).
17. See Section 9-102(42) of the U.C.C. defines "general intangibles" as: "any personal property, including things in action, other than accounts, chattel paper, commercial tort claims, deposit accounts, documents, goods, instruments, investment property, letter of credit rights, money and oil, gas, or other minerals before extraction. The terms include payment intangibles and software."
18. See Official Comment, 9-102(d) providing that "General intangible is the residual category of personal property, including things in action, that is not included in the other defined types of collateral. Examples are various categories of intellectual property and the right to payment of a loan that is not evidenced by chattel paper or an instrument. As used in the definition of "general intangible" "things in action" includes rights that arise under a license of intellectual property, including the right to exploit the intellectual property without liability for infringement.
19. See 11 U.S.C. §101(35A) (A).
20. See 17 U.S.C. §205 stating "Any transfer of copyright ownership or other document pertaining to a copyright may be recorded in the Copyright Office...]". A "transfer" is further defined as "an assignment, mortgage, exclusive license, or any other conveyance, alienation, or hypothecation of a copyright or of any of the exclusive rights comprised in a copyright". See 17 U.S.C. §101.
21. It should be noted, however, that security interests in registered trademarks are very often recorded at the USPTO in order to give third parties constructive notice of the existence of the encumbrance.
22. See U.C.C. 9-310(a).
23. See U.C.C. 9-502(a)(3). See also Baila H. Celedonia, Intellectual Property in Secured Transactions, Trademarks in Business Transactions Forum, at 109, 2002.
24. See Baila H. Celedonia, at 109.
25. See id at 109.
26. See id.
27. See In re 199Z, Inc. v. Valencia, Inc., 137 B.R. 778 (C.D. Cal. 1992).
28. See id. As discussed later herein, trademarks are not properly perfected at the USPTO, although there may be benefits to such recordal.
29. See Jeffrey D. Dunn & Paul F. Seiler, Trade Secrets and Non-Traditional Categories of Intellectual Property as Collateral, UNCITRAL, Second International Colloquium on Secured Transactions: Security Interests in Intellectual Property Rights, Vienna, Austria, Jan. 18-19, 2007.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.