IP as a means of securing a loan under German law
A shift is required in the finance and banking sectors’ approach to the use of intangible capital assets as collateral, says Marco Stief of Maiwald
Intellectual property can be utilised commercially in many ways. In addition to the traditional forms – such as the granting of licences, selling, and the judicial enforcement of cease-and-desist orders and claims for damages – IP can also be used as collateral for loans.
Companies take out loans for expansion and construction planning, in order to achieve growth targets or for restructuring. Collateral plays a crucial role in the granting of such loans. The collateral provided has a significant influence on the conditions and especially on the amount of interest payable on a loan.
However, collateral is often largely concentrated on tangible assets – in particular, real estate – or the company's plant and machinery. So-called intangible assets are rarely accepted as collateral. Indeed, the percentage of corporate loans secured by intangible assets is less than 5% (Zimmermann, “Immaterielle Vermögenswerte als Sicherheiten bei der Kreditvergabe” (“Intangible assets as collateral in lending activities”), Mittelstands- und Strukturpolitik No. 39, p. 107).
On the one hand, this is because it is difficult to put a monetary valuation on IP. However, it is also partly due to a widespread lack of experience and to a still insufficiently considered handling of IP, especially in the finance and banking sectors.
If one considers that capital assets increasingly take the form of intangible capital assets for a growing number of companies, this attitude is no longer in keeping with the times and ultimately inhibits technologically and economically sensible investments, as well as research and development (R&D) projects.
The changing face of collateral
The importance of intangible assets as a corporate value or production factor has steadily increased over recent decades (Braunberger, “Die unsichtbare Macht hinter der Finanzrevolution” (“The invisible power behind the financial revolution”), Frankfurter Allgemeine Zeitung), while traditional types of collateral are declining. For instance, the share of IP in the overall corporate value, especially as a hidden reserve, has risen to over 80% in some knowledge- and technology-intensive industries (Zimmermann, p. 85). For young companies such as those pursuing R&D projects and companies that are of a certain size and/or are based in the new Länder (federal states as designated under German law), the likelihood of securing a loan through IP is increasing (Zimmermann, p. 108).
Despite its hesitant development, the opportunity to make more IP rights the basis for collateral and thus support the operational running of a business depends on the difficulty in putting a value on the collateral provided. While IP greatly influences the corporate value of a company, banks still have difficulty in accepting IP as collateral and in valuing it for this purpose. Such valuations are regularly carried out using the risk-adjusted licence analogy method.
There is uncertainty on the part of companies and banks, and a lack of the necessary expertise to handle this process.
Pledging IP as collateral has, in normal contractual arrangements, no influence on the day-to-day utilisation of the IP for business purposes. The company can continue to use the rights transferred or pledged as collateral, and/or can license them to other companies. Also, the autonomous decision on whether to relinquish or transfer particular rights to third parties, in the ordinary course of business or within certain threshold values, remains with the company. By the same token, also after pledging or transfer of the collateral, the collateral provider remains obliged to maintain the IP right, or even, often, to defend the IP right at its own expense.
Where a pledge is made, the collateral provider may not transfer the IP right. In the case of a transfer by way of security, which is the most common form of transfer, it depends on the contractual arrangement, which usually permits use until the occurrence of the collateral event for the collateral provider, but not for the collateral taker.
The contractual purpose of a transfer by way of security is most likely to be achieved if the collateral taker retains an unrestricted right of use and the possibility of taking action on the economic side, while preserving the value of the collateral. Also, in the case of a pledge (in this case, however, regulated by law), the collateral provider is not entitled to a right of use (sections 1273 and 1204, German Civil Code).
Patents, trademarks, and copyrights as collateral
Patents and trademarks, including European patents and community rights, are among the IP rights that are suitable as collateral without any substantial regulatory or financial formalities.
In certain cases, the inclusion of foreign IP rights can entail special formal or registration requirements and thus corresponding adjustments to the contractual provisions, but these are generally also easy to deal with.
Collateral that includes individually selected IP rights can be created, or future IP rights can be captured by the collateral.
There is no automatic extension to newly registered IP rights, although this can be contractually negotiated.
The basis for the creation of a security interest can be a transfer by way of security or a pledge (Fesenmair/Fels, “COVID-19 – sind Ihre IP-Rechte immun? Optionen und Gefahren – Verwertung, Kreditsicherheit und Lizenz” (“COVID-19 – are your IP rights immune? Options and risks – exploitation, collateral and licence), Bird & Bird). To this extent, the pledge does not cover surrogates. In the case of a transfer by way of security, however, royalties are also included, which is one reason why a transfer by way of security predominates in practice.
For trademarks and registered designs, pledgeability is positively regulated by law (Section 29, paragraph 1, No. 1, Trademark Act; Section 30, paragraph 1, No. 1, Design Act.); for patents and utility models, pledgeability arises from the transferability (Section 1274, German Civil Code). Trademarks are more often used as loan collateral because of their specific identification with a product or a company, which makes it more difficult for third parties to copy them.
However, the real value of a company often resides in the technical property rights. Thus, licences, which are to be regarded as receivables, are usually transferable. The only time they cannot be pledged as collateral is when they are, in exceptional cases, not transferable. This applies to an exclusive licence due to the close relationship of trust that usually exists between the parties, or to a non-exclusive licence that is to be interpreted restrictively and that leaves the holder of the IP with the possibility of granting further licences (no exclusive use clause or exclusive licence clause).
The use of copyrights as collateral is more difficult, because they are not transferable under sections 11 and 34 (1) of the Copyright Act. However, the transferable rights of use under sections 15 ff. of the Copyright Act may be pledged. As for rights in software, which are particularly important from a practical point of view, the special provisions of sections 69a of the Copyright Act, and 327–327u and 475a of the German Civil Code, articles 4 and 5 of the Software Directive, and the Computer Programs and Infosoc Directive apply.
Non-traditional types of collateral
In addition to the traditional types of collateral, internet domains or similar valuable assets can also be used as security, because it is generally sufficient for a transfer of ownership by way of security or a pledge that some kind of value can be assigned to the pledge object or the object of the transfer by way of security (Section 857, paragraph 1, Code of Civil Procedure; German Federal Court of Justice – VII ZR 288/17, DGVZ 2019, 60). For example, the value of an internet domain resides in the right that can be enforced against DENIC, the central registry and manager of all domain names on the internet with a country code ending .de, to maintain the registered domain.
Likewise, non-physical assets such as manufacturing know-how, and supplier and customer relationships can also be considered as collateral.
The principle of speciality of property law, on the other hand, precludes the pledging of operational know-how as a tangible or legal asset. However, by means of a corresponding escrow agreement, it is possible to pledge objects in which the confidential or proprietary information is contained (for example, customer lists), or through an agreement to make the know-how available when conditions for realisation of the collateral arise, which is particularly important in the area of software.
Third parties and disclosure
As general rule, the use of IP as collateral is not discernible to third parties, but is merely contained in a bilateral, usually strictly confidential contract between the collateral provider and the collateral taker.
Trademarks, patents, utility models, and designs used as collateral do not have to be recorded in the relevant registers. In some cases, it is not even possible to record their use as collateral. In the respective collateral agreement, the corresponding declarations are usually already made, and powers of attorney are granted so that when conditions for realisation of the collateral arise, the transfer can be arranged without the further involvement of the collateral provider.
Disclosure of the transfer to third parties can be, and usually is, contractually barred if the financial situation of the company providing the collateral has not (materially) deteriorated or the collateral event does not occur. It is possible to make contractual arrangements for all these matters; the secured asset, realisation of collateral, utilisation, and unwinding the collateral relationship.
In the case of pledging, provisions regarding inspection and audit rights, administration and utilisation, assurances by the pledgor, determination of notification, and registration obligations in favour of the pledgee and/or on collateral release are conceivable (Heuer, BKR 2020, 559, 561).