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Articles

Security Interests in Intellectual Property

October 2003

Hornick, John F.

Article

Authored by John F. Hornick

I. Introduction 

Intellectual property owners seeking loans may find that their most valuable property for use as collateral is their trademarks, copyrights, or patents. In fact, a bank that provides capital or credit to an I.P. owner will most likely require that the I.P. owner's intellectual property assets be pledged as collateral. Most banks will insist on obtaining a security interest in the I.P. owner's trademarks, copyrights, and patents using a security agreement that greatly favors the bank and may severely restrict the I.P. owner's ability to alienate any of its intellectual property assets in the normal course of business.

For a lender to obtain priority over other parties who might have interests in the I.P. owner's trademarks, copyrights, and patents, the lender must perfect its interest in the intellectual property. One perfects a security interest by filing the right documents in the right place. The perfection of security interests generally is governed by the Uniform Commercial Code (U.C.C.) as adopted by the states. However, the ownership of trademarks, copyrights, and patents generally is governed by federal law. As a result, uncertainty has arisen as to which body of law—federal or state—governs the perfection of security interests in trademarks, copyrights, and patents. This article first examines the two bodies of law and then recommends procedures and considerations for perfecting security interests in intellectual property and drafting security agreements.

II. Rights and Requirements Under the U.C.C.

The Uniform Commercial Code is a cohesive body of law governing commercial transactions. The U.C.C. has been enacted as law by all of the states except Louisiana, as well as by the District of Columbia. However, Louisiana has enacted selected provisions of the U.C.C., including Article 9, which is the focus of this article.1

Article 9 "sets out a comprehensive scheme for the regulation of security interests in personal property."2 Almost all transactions that attempt to create a security interest in personal property are governed by Article 9. Article 9 attempts to protect secured parties, while simplifying and standardizing the system of securing interests and prioritizing different interests in secured property.

The main purpose of Article 9 is to protect the secured party "against purchasers from and creditors of the debtor."3 The concern is that other purchasers and creditors of the debtor may stake claim to the property in which a security interest has already been granted. Article 9 therefore provides that the secured party may protect itself by "perfecting" its security interest. Perfection affects the rights of creditors and others to the secured property of the defaulted debtor.

Specifically, perfection has the effect of putting subsequent purchasers and creditors on constructive notice that a prior interest has been granted in the property of the debtor, and of subordinating such subsequent interests to earlier-perfected interests. Article 9 provides that an unperfected security interest is subordinate to the rights of a lien creditor and to the rights of a person who purchases the collateral without knowledge of the security interest.4 Article 9 further instructs that when there are two security interests in the same collateral, generally the one perfected first has priority.5 When neither security interest is perfected, however, priority is awarded to the first to attach.6

Under Article 9, perfection generally requires the filing of a financing statement with the Secretary of State of the state where the debtor is located.7 Unlike the federal statutes discussed infra, Article 9 only requires that a financing statement contain a description of the type of collateral and other basic information about the parties.8 Filing a copy of the transaction document creating the security interest is not necessary under Article 9.9 However, whether the filing of a financing statement on the state level is sufficient to perfect a security interest depends upon whether Article 9 applies to the particular type of collateral at issue.

Article 9 governs transactions that are intended to create a security interest in personal property, which includes general intangibles.10 General tangibles "means 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, letters of credit, money, and oil, gas, or other minerals before extraction."11 Examples of general intangibles are goodwill, literary rights, rights to performance, trademarks, copyrights, and patents.12 In fact, the former Official Comment to old section 9-106 recognizes that trademarks, copyrights, and patents can be used as commercial security and were covered by old Article 9, "except to the extent that they may be excluded by [old] section 9-104(a)."

Old Article 9, section 9-104, sets forth several types of interests and transactions that were exempt from old Article 9. Most relevant for this discussion is old section 9-104(a), which provided that old Article 9 did not apply to a security interest subject to a federal statute "to the extent that such statute governs the rights of parties to and third parties affected by transactions in particular types of property." New section 9-109(a), which correlates to old section 9-104, provides that Article 9 does not apply to a security interest subject to a federal statute "to the extent that a statute, regulation, or treaty of the United States preempts this article." Trademarks, copyrights, and patents are arguably the subjects of such statutes and, as such, arguably could be exempt from Article 9. However, former Official Comment 1 to old section 9-104 indicates otherwise. This comment points out that the now repealed Copyright Acct of 1909, although containing provisions permitting the mortgage of a copyright and for the recording of an assignment of a copyright, does not seem to contain sufficient provisions regulating the security interest rights of the parties to exclude security interests in copyrights from old Article 9.13 The comment also references the Patent Act, indicating that security interests in patents similarly are governed by old Article 9.14

Even if intellectual property is governed generally by Article 9, new section 9-311 follows old section 9-302, limiting the types of security interests for which filing a financing statement is necessary to perfect the security interest. Specifically, old section 9-302(3)(a) provided that the filing of a financing statement was not required to perfect a security interest in property subject to a federal statute which provides for a national registration or specifies a place of filing of the security interest. Similar to the language of old section 9-302(a)(3), new section 9-311 provides that the filing of a financing statement is not required to perfect a security interest in property subject to "a statute, regulation, or treaty of the United States whose requirements for a security interest's obtaining priority over the rights of a lien creditor with respect to the property preempt section 9-310(a)." Thus, Article 9 still exempts transactions from the requisite U.C.C. filing if the transaction is subject to a system of filing established under federal law provisions.15 Compliance with such a federal statute is equivalent to the filing of a financing statement, and a security interest in property subject to the federal statute can be perfected only by compliance with the federal statute.16

Some of the comments in old Article 9 discuss the applicability of old sections 9-302(3) and (4) (which correlate to new section 9-311) to intellectual property. While  former Official Comment 1 to old section 9-104 indicates that security interests in copyrights and patents were subject to old Article 9 generally, the former comment references old sections 9-302(3) and (4) and provides that the filing provisions of the copyright and patent acts were equivalent to filing under old Article 9. Additionally, former Official Comment 8 of old section 9-302 includes the Copyright Act as an example of a federal statute that exempts an Article 9 filing under old section 9-302(3)(a).

While these former comments are instructive, they are not dispositive. In fact, the federal statutes governing trademarks, copyrights, and patents do not explicitly address security interests. An examination of the relevant provisions of these statutes reveals why there is uncertainty as to where security interests in trademarks, copyrights, and patents need to be filed in order to be deemed perfected.

III. Rights and Requirements of the Federal Recording Systems

The federal statutes covering trademarks (15 U.S.C. § 1051 et. seq.), copyrights (17 U.S.C. § 101 et. seq.) and patents (35 U.S.C. § 101 et. seq.) include provisions for recording certain interest in intellectual property. Each recording system differs, and the rights protected in trademarks, copyrights, and patents by proper recordation also differ.

In order to understand these statutes, it is important to distinguish between an assignment and a security interest. An assignment is an absolute transfer of the entire right, title, and interest to the intellectual property being assigned.17 A security interest, in contrast, is merely a device to secure an indebtedness and does not result in an absolute transfer of the intellectual property used as collateral.

A. Trademarks
The federal statute governing trademarks is known as the Lanham Act. Section 10 of the Lanham Act18 provides a means for recording transfers of ownership of trademark applications and registrations with the United States Patent and Trademark Office (PTO), and dictates the effect of such filing. Specifically, section 10 states that "[a]n assignment shall be void against any assignment for valuable consideration without notice, unless the prescribed information reporting the assignment is recorded in the Patent and Trademark Office within 3 months after the date of the subsequent purchase or prior to the subsequent purchase."19 In other words, the recordation of an assignment with the PTO constitutes constructive notice to all subsequent purchasers, so actual notice is unnecessary.

The Lanham Act only provides for the recordation of assignments and is silent with respect to security interests. However, the regulations enacted by the PTO provide that other documents affecting title to trademark applications or registrations also may be recorded with the PTO.20 The PTO has further provided that such other documents may include security interests.21 Such documents may be recorded "in the public interest in order to give third parties notification of equitable interest or other matters relevant to the ownership of the mark."22 This statement, along with the fact that the federal statute provides that constructive notice results only from the recordation of assignments, seems to indicate that the recordation of security interests does not constitute constructive notice to subsequent purchasers. Thus, it would appear that the federal trademark laws do not govern the rights of parties holding security interests in trademarks.

B. Copyrights
Section 205 of the Copyright Act governs the recordation of transfers of copyright ownership and provides that any transfer of copyright ownership may be recorded in the Copyright Office. The Copyright Act defines a transfer of copyright ownership broadly as an "assignment, mortgage, exclusive license, or any other conveyance, alienation, or hypothecation of a copyright."23 Thus, section 205 covers considerably more types of transactions than section 10 of the Lanham Act and seemingly extends to security interests.

Proper recordation of a transfer of copyright ownership provides constructive notice of the transfer to all persons.24 In order for a recordation to constitute constructive notice, however, not only must documentation of the transfer be recorded, but the copyright also must be registered with the Copyright Office.25

Section 205(d) of the Copyright Act governs priorities among conflicting copyright transfers. Unlike Article 9, section 205(d) generally awards priority to the first executed transfer rather than the first recorded transfer. However, such priority is subject to the requirement that the transfer be recorded within one month after execution, or anytime before recordation of a later transfer. Otherwise, a later transfer will obtain priority if properly recorded first.

Because the recording system of the Copyright Office provides for the recordation of security interests and sets up a scheme for priority of such interests, filing with the Copyright Office alone arguably could be sufficient to perfect a security interest in a copyright.

C. Patents
The ownership of patent rights is governed primarily by 35 U.S.C. § 261. This section governs only patents and patent applications. Rights in an invention before a patent application is filed, to which a security interest may also extend, are treated as rights in a trade secret, and, as such, are not governed by the federal patent laws.

Section 261 provides that patents and patent applications shall have attributes of personal property. In addition, this section provides that patents, patent applications, or any interest therein, may be assigned in writing. Section 261 also provides that the timely recordation of an "assignment, grant or conveyance" with the PTO effectively constitutes constructive notice to the world of the transfer and is valid against a subsequent purchaser or mortgagee. A recordation is timely if it is filed within three months after the transfer or prior to the date of a subsequent purchase or mortgage.

Section 261 is similar to section 10 of the Lanham Act, discussed above, except that section 261, unlike section 10, is not limited to assignments, but also extends to "grants and conveyances." Although security interests might be described as grants or conveyances, section 261, like section 10, is silent as to security interests, and the federal patent laws nowhere indicate that a "grant or conveyance" includes security interests.

Additionally, the PTO regulations discussed above with respect to trademarks extend also to patents.26 However, similar to security interests in trademarks, it would appear that recording a security interest in a patent in the PTO will not serve as constructive notice. As will be discussed infra, the courts have not agreed on this interpretation.

IV. Judicial Interpretation of Which Filing System Should be Followed for Perfecting a Security Interest in Trademarks, Copyrights, and Patents

Few published cases have grappled with the issue of which system—federal or state—controls the filing requirements for security interests in intellectual property.

A. Trademarks
Although there has been only a handful of cases addressing the perfection of a security interest in a trademark, the courts have consistently reached the conclusion that state filing alone is sufficient. The main rationale advanced by the courts is that the Lanham Act governs only the recordation of assignments and if Congress had intended the Lanham Act to preempt the U.C.C., it would have specifically addressed security interests in trademarks.

For example, in In re TR-3 Industries,27 a bank took a security interest in the trademark of a debtor and filed a financing statement with the California Secretary of State. The debtor subsequently filed a voluntary petition for relief under Chapter 11 of the bankruptcy law. Other creditors of the debtor argued that the bank failed to perfect the security interest in the trademark because it did not record the security interest with the PTO, but the court held that the U.C.C. filing was sufficient.

Similar circumstances existed in In re Roman Cleanser.28 The court reasoned that a grant of a security interest is not an assignment, and that the Trademark Act only specifies a place of filing for assignments. The court went on to explain that the PTO's regulations for the recordation of security interests in trademarks could not be interpreted to expand section 10 to include security interests since the regulations promulgated by the PTO are subject to the limitations imposed by the Lanham Act. Thus, the court concluded that the Trademark Act is not a federal statute "which specifies a place of filing different from that specified" in Article 9 for the filing of a security interest.

Interestingly, the court also relied on the failure of the drafters of the U.C.C. to include the Lanham Act in the Official comment to section 9-104. The court reasoned that since the Comment specifically recognized that the filing provisions of the Copyright Act and the Patent Act are the equivalent to filing under Article 9, the drafters must not have intended the filing provisions of the Lanham Act to be equally sufficient. While this argument may have some merit, it is important to note that not all courts have followed the Comment's suggestions, at least with respect to the sufficiency of the Patent Act's filing provisions.

Although the consensus is that a federal filing is not required to perfect a security interest in a trademark, the question still remains as to whether a federal filing without a state filing is sufficient to perfect such an interest. This issue was addressed in both In re 199Z,29 Inc. and In re Together Development Corp.30 

In 199Z, the defendants recorded a security interest in a trademark in the PTO in April 1990, filed a U.C.C. financing statement for the security interest with the California Secretary of State in June 1990, then filed an amended financing statement in November 1990. The defendants sought to establish that the security interest was perfected before the November 1990 amendment. They argued that the security interest should be deemed perfected through their filing in the PTO. The court rejected this argument. Relying on the rationale in Roman Cleanser, the court held that, where a trademark is used as collateral, the recordation of a security interest in the PTO is insufficient to perfect the security interest. A security interest in a trademark is only deemed perfected if there is a U.C.C. filing.

A similar conclusion was reached in Together Development Corp.31 After the court ordered the debtor to sell all of its assets, including its trademark, to Horace Trimarchi, an evidentiary hearing was set to determine the validity and perfection of Trimarchi's security interests. Trimarchi, who had received the debtor's trademark as security on two promissory notes, did not file a financing statement with the appropriate Secretary of State. Instead, Trimarchi filed by mail with the PTO.

Trimarchi argued that because there is a national filing requirement for security interests in copyrights, a similar requirement should exist for trademarks. The court rejected this argument, concluding that Trimarchi's filing with the PTO failed to perfect a security interest in the trademark. The court reasoned that the filing with the PTO was insufficient because the Lanham Act fails to specify a place of filing different from that specified in Article 9 for filing of a security interest. The Lanham Act fails in this respect because it does not provide for a national recording system of security interests. Provisions for assignments of trademarks were insufficient, the court noted, because the grant of a security interest cannot be characterized as an assignment under the Lanham Act.

On appeal, the district court affirmed the bankruptcy court, holding that (1) the Lanham Act does not preempt the U.C.C.'s filing requirements, and (2) that the perfection of a security interest in a trademark is governed by Article 9.32 Couching the issue in terms of policy considerations, the district court further observed that Trimarchi's proposal would cause lenders to be more reluctant to extend credit, because the Lanham Act fails to provide a reliable means of verifying the status of collateral.

B. Copyrights
The courts have reached the opposite conclusion with respect to security interests in copyrights. The seminal case on this issue is In re Peregrine Entertainment, Ltd.33 In Peregrine, a creditor secured a line of credit by a film library, which included the copyrights in the films. The creditor filed financing statements in California, Colorado, and Utah, but did not record the security interest with the Copyright Office. The debtor later filed a voluntary petition for bankruptcy, and the debtor and creditor disputed whether the creditor had a valid security interest in the copyrights.

The court began its analysis by recognizing that the Copyright Act provides a means for recording a security interest, pointing out that the terms "mortgage" and "hypothecation" appearing in the statutory definition of a "transfer of copyright ownership," 17 U.S.C. § 101, include "a pledge of property as security or collateral for a debt."34 Since proper recordation in the Copyright Office provides all persons constructive notice, such recordation is sufficient to perfect a security interest in a copyright.

However, the court was faced with the question of whether the U.C.C. provides a parallel method of perfecting a security interest in copyrights. The court reasoned that competing recordation schemes would lessen the utility of each since potential creditors would have to conduct several searches to be certain that property is not encumbered. The court also pointed out the differences in the priority schemes of the U.C.C. and the Copyright Act, explaining that the availability of filing under the U.C.C. would undermine the priority scheme of the Copyright Act. Thus, the court concluded that a security interest in a copyright could only be perfected by recordation of the transfer in the Copyright Office.

The court found that the language of the U.C.C. supported this conclusion. Specifically, the court looked to the exception of old section 9-104 and found that the Copyright Act is a statute which provides for a national registration. The court also focused on the drafters' identification of the Copyright Act as such a statute in the former Official Comment to old sections 9-302(3) and (4).

A year later, the same conclusion was reached in In re AEG Acquisition Corp.35 In AEG, the creditor obtained a security interest in three motion pictures, two of which were foreign films. The creditor filed a U.C.C. financing statement with appropriate states and recorded a copyright mortgage for each of the films with the Copyright Office. The creditor also obtained a certificate of copyright registration for the domestic film but not for the two foreign films. After filing for bankruptcy, the debtor challenged the creditor's security interest in the copyrights.

Citing Peregrine, the court first ruled that a security interest in a copyright is perfected only under the Copyright Act, not the U.C.C. Therefore, the creditor's state filings were insufficient to perfect its security interest in the films.

Looking next to perfection under the Copyright Act, the court noted that such perfection requires both recordation of the security interesting the Copyright Office and registration of the copyright. Thus, the court found that the creditor perfected its interest in the domestic film, but not in the two foreign works.

With respect to the foreign films, the court rejected the creditor's argument that the foreign works were exempt from registration pursuant to the Berne Convention Implementation Act ("BCIA").36 Noting that section 205 of the Copyright Act did not distinguish between domestic and foreign works, the court held that even a work which falls under the BCIA must be registered if one wishes to perfect a security in it.

The holdings of Peregrine and AEG, which suggest that a U.C.C. filing is insufficient to perfect a security interest in copyright, were later adopted in In re Avalon Software Inc.37 In Avalon, a bank had attempted to perfect its security interests in a debtor's copyrighted and copyrightable property by filing a UCC-1 financing statement with the Arizona Secretary of State. The bank never filed with the Copyright Office. Citing AEG, the court held that a security interest in a copyright is only perfected when filed with the Copyright Office. The court also stated that after filing with the Copyright Office, ultimate perfection depended on registration of the product. Accordingly, the court concluded that the bank's filing with the Secretary of State failed to perfect its security interests. In reaching its conclusion, the court noted that had the bank recorded its security interests in the Copyright Office and then registered the after-acquired property, it would have perfected its security interests.

According to Peregrine, AEG, and Avalon, therefore, a secured creditor need only record with the Copyright Office to have his interests in copyrights protected. While this statement of law seems to hold true today for registered copyrights, the Ninth Circuit Court of Appeals in In re World Auxiliary Power Co.38 rejected the proposition to the extent that it extends to unregistered copyrights.

In World Auxiliary Power, a bank, which had received unregistered copyrights as a security interest from the owner debtors, filed UCC-1 financing statements with the California Secretary of State. The copyrights remain unregistered, and the bank did not file the transfer of security with the Copyright Office. After the debtor companies filed for bankruptcy, a dispute arose as to whether the bank had perfected its security interest in the unregistered copyrights. A subsequent purchaser of the unregistered copyrights brought an adversary proceeding against a bank, seeking to recover the value of the copyrights. The court denied the subsequent purchaser's claim, concluding that the bank perfected its security interests in the unregistered copyrights by filing with the Secretary of State pursuant to California's version of Article 9 of the Uniform Commercial Code.

The court's decision was based in part upon Peregrine, agreeing that security interests in registered copyrights can only be perfected by filing with the Copyright Office. The court, however, refused to go farther and extend the holding of Peregrine to unregistered copyrights. Instead, the court further held that "[o]nly the U.C.C. creates a filing system applicable to unregistered copyrights." To hold otherwise, the court stated, would "make registration of copyrights a necessary prerequisite for perfecting a security interest in a copyright." The court was unprepared to send such a message because it would imply that unregistered copyrights were useless as collateral. 

According to World Auxiliary Power, perfection of a registered copyright is governed by federal law and perfection of an unregistered copyright is governed by state law. Thus, a U.C.C. filing is not insufficient to perfect a security interest in a copyright unless the security at issue pertains to a registered copyright. To the extent that AEG and Avalon held that security interests in unregistered copyrights may not be perfected under the U.C.C., the Ninth Circuit has expressly rejected these opinions.

C. Patents
The case law concerning patents is not definitive as to which system governs security interests in patents. In 1973, a district court recognized that a security interest in a patent is not equivalent to an assignment.39 In Holt v. United States, a lender alleged that its security interest in a patent was superior to the United States' subsequent lien on the property.  The court explained that a security interest, unlike an assignment, does not pass title and therefore section 261 of the patent law is not applicable to security interests. The court thus held that the lender's security interest in the patent was perfected when the financing statement was filed with the Secretary of State.

A similar conclusion was reached in In re Transportation Design & Technology, Inc.40 In Transportation Design, a lender took a security interest in a borrower's patent, recorded a financing statement with the California Secretary of State, but did not record an assignment with the PTO. The debtor subsequently filed for reorganization under Chapter 11 of the Bankruptcy Law. The lender claimed priority in the patent over the bankruptcy trustee. The question for the bankruptcy court was whether the lender was required to record with the PTO in order to perfect its security interest in the patent.

In deciding in favor of the lender, the court held that the U.C.C. filing was sufficient to protect the secured creditor against the trustee, who was in the position of a hypothetical lien creditor rather than a subsequent purchaser.41 The court made what might be an artificial distinction between two different groups protected by security interests: (1) subsequent lien creditors, and (2) subsequent purchasers and mortgagees. Ordinarily the U.C.C. protects against subsequent claims by both groups. But according to the court, since the federal patent law governs the interest of one of the groups—subsequent purchasers and mortgagees—the patent law preempts the U.C.C. for protecting against claims by this group. The court went on to conclude that the patent law does not protect against subsequent lien creditors, and therefore that U.C.C. filing is necessary for protection against this group. Thus, according to the Transportation Design court, for complete protection a secured creditor must file under both the federal and state filing systems when patents are the collateral. The court's distinction may be artificial, however, because at least some lien creditors are mortgagees.

The Transportation Design reasoning was followed a few years later in City Bank & Trust Co. v. Otto Fabric, Inc.42 In Otto Fabric, a trustee similarly argued that perfection of a security interest in a patent requires filing with the PTO. The Otto Fabric court agreed with the Transportation Design court's reasoning and held that a federal filing was not necessary.

The Otto Fabric court also pointed out a practical—though logically flawed—reason for not requiring federal filing to protect a security interest in a patent against subsequent creditors. The court explained that a federal filing is considered an absolute assignment, so requiring security interests to be perfected by a federal filing would reduce the flexibility of patents as collateral in secured transactions.43 Specifically, if a security interest in a patent were filed with the PTO, the lender would obtain title in the patent and the original owner could no longer grant licenses for the patented technology.  Moreover, the patentee could not sue for infringement without joining the lender as a party. Therefore, the court concluded, recordation with the PTO is not necessarily more rational or convenient. This reasoning is probably flawed because the court seemed to assume that all grants of security interests in patents are structured as assignments conditioned on the payment of money.44 Under the Otto Fabric court's interpretation of Waterman v. Mackenzie, such conditional assignments are treated as absolute assignments if recorded. But the grant of a security interest need not be structured in this way, so the recording of a security agreement need not, in itself, convert a grant of less than all rights into an absolute assignment.

This issue was again addressed in Chesapeake Fibre Packaging Corp. v. Sebro Packaging Corp.45 In Chesapeake, the defendant challenged a security interest in a patent, claiming to be a subsequent purchaser. This claim was based on the fact that the defendant paid the fees of the attorneys that prepared the application for the patent owner and the attorneys then submitted a statement to the PTO swearing that the defendant owned the patent. The defendant claimed that its status as a subsequent purchaser entitled it to ownership of the patent under section 261 since the security interest was not filed with the PTO. The court rejected the defendant's claim. It held that the defendant could not be a subsequent purchaser since the attorneys never owned the patent and the patent therefore was not theirs to sell. While not specifically addressing the failure to file the security interest with the PTO, the court did state that the security interest was valid.

None of these cases, then, involved claims by subsequent purchasers or mortgagees, who are mentioned in 35 U.S.C. § 261. In fact, the Transportation Design court expressly stated that protection against such claims required perfection by filing with the PTO. Similarly, the Otto Fabric court limited its holding to claims by trustees in bankruptcy, who (according to the court) are akin to lien creditors. To protect against claims by both subsequent purchasers/mortgagees and lien creditors, according to both the Otto Fabric and Transportation Design courts, one must file under both Article 9 and the federal patent laws. Yet once one does so, at least according to the flawed reasoning of the Otto Fabric court, filing with the PTO divests the patent owner of its right to license and sue for infringement.

The holdings of these cases seem inconsistent with one of the policy arguments raised in Peregrine, the case involving security interests in copyrights. Specifically, Peregrine emphasized the importance of having only one filing system so that subsequent creditors and purchasers can easily determine whether a particular interest has been transferred or encumbered. Yet Otto Fabric, Transportation Design, and even World Auxiliary Power encourage just the opposite—requiring filing under two separate systems. Such a requirement could, in the words of the Peregrine court, "hinder the purchase and sale" of intellectual property.46

Additionally, the Peregrine court, in dicta, expressly rejected the reasoning of Otto Fabric and Transportation Design. The Peregrine court opined that these cases misconstrued the plain language of former U.C.C. section 9-104 and reasoned:

[W]hen a federal statute provides for a national system of recordation or specifies a place of filing different from that in Article Nine, the methods of perfection specified in Article Nine are supplanted by that national system; compliance with a national system of recordation is equivalent to the filing of a financing statement under Article Nine. U.C.C. § 9-302(4).  Whether the federal statute also provides a priority scheme different from that in Article Nine is a separate issue, addressed below. Compliance with a national registration scheme is necessary for perfection regardless of whether federal law governs priorities.47

Despite the Peregrine court's treatment of Transportation Design and Otto Fabric, the Ninth Circuit Court of Appeals, in In re Cybernetic Services, Inc.,48 recently affirmed the holding of these cases to the extent that a state filing under the U.C.C. is sufficient to perfect a security interest in a patent as against a subsequent lien creditor. Although the court in Cybernetic never expressly stated that the holder of a security interest in a patent can only perfect its interest against a subsequent lien creditor by recording with the appropriate Secretary of State, it seemed to imply as much. 

In Cybernetic, a trustee of a bankruptcy estate opposed a creditor's foreclosure of a security interest in a patent, arguing that the creditor failed to perfect its interest in the patent because it was not recorded with the PTO. Rather than filing with the PTO, the creditor had filed its security interest with the California Secretary of State, under Article 9 of the U.C.C. Therefore, the issue before the court in Cybernetic was whether 35 U.S.C. § 261 of the Patent Act or Article 9 of the U.C.C. "requires the holder of a security interest in a patent to record that interest with the federal Patent and Trademark Office (PTO) in order to perfect the interest as against a subsequent lien creditor." Finding for the creditor, the court held that neither the Patent Act nor Article 9 requires the holder of a security interest in a patent to record that interest with the PTO in order to perfect the interest as against a subsequent lien creditor.   

In reaching its conclusion, the Ninth Circuit followed precedent distinguishing a subsequent lien creditor from a subsequent purchaser and mortgagee. The trustee, the court noted, was not a subsequent mortgagee or purchaser, but a hypothetical lien creditor. In order for the trustee to be classified otherwise, title in the patent would have had to been conveyed to the trustee. Such an event, the court recognized, never occurred. This distinction was significant because the court interpreted § 261 of the Patent Act to be concerned only with providing constructive notice to subsequent parties taking an ownership interest in a patent. Because the trust held no title in the patent, recordation of the security interest with the PTO was not required. In addition, the court further concluded that because § 261 only concerns ownership interests in patents, the Patent Act does not preempt Article 9.

Interestingly, the court in Cybernetic did not address whether recording a security interest with a Secretary of State is sufficient to perfect an interest in a patent as against a subsequent purchaser. Rather than addressing how a security interest should be recorded, as against a bona fide purchaser, the court dismissed the question because the trustee did not argue at the Bankruptcy Appellate Panel ("BAP") that he was a subsequent purchaser. The BAP, however, did state that it held Waterman to stand for the proposition that a bona fide purchaser of a patent who records that transfer of title in the PTO will defeat the interests of a secured creditor who fails to record the security interest with the PTO. 

So the question remains as to where a creditor should record a security interest when patents are pledged as collateral. While Peregrine is not controlling law with respect to patents, courts addressing the issue may find the Peregrine rationale persuasive. However, the current state of the law seems to be that to be completely protected against all claimants, both subsequent purchasers/mortgagees and lien creditors (if this is a distinction with a difference), one must file under both the U.C.C. and in the PTO.

V. Lessons Learned from the Case Law

The case law is scant in the area of perfecting security interests in intellectual property. As a result, no hard and fast rules have been developed, but certain valuable lessons can be gleaned from the cases that the creditor should follow to preclude the possibility of taking collateral that is encumbered and to ensure that a court will recognize its secured interest in the collateral over other creditors and third parties.

A. Trademarks

1. Priority
Courts have recognized that a U.C.C. filing of a security interest in a trademark perfects such interest. Thus, the state records should be searched for prior-recorded security interests that have priority over a subsequent security interest granted in the same mark.

A creditor who anticipates accepting a trademark or service mark as collateral should also search the PTO records for other encumbrances on the mark. A creditor's failure to discover a prior recorded assignment in the PTO records will result in that assignment having priority over the creditor's security interest.49 

Nevertheless, a creditor who checks the PTO records and does not find any recorded documents may yet be surprised. As previously discussed, the Lanham Act provides that an assignment is entitled to priority so long as it is recorded within three months after execution or before a bona fide subsequent purchase.50 Therefore, an assignee who records within the three-month period will have priority over a creditor who takes a security interest after execution of the assignment. Yet the creditor has no way of ascertaining whether such an assignment exists. Moreover, it is very difficult for the creditor to guard against the problem. Holding funds until three or more months after closing is an impractical solution. Perhaps the best solution is to obtain a warranty from the borrower that it has granted and will grant no conflicting interests in the trademark collateral.

After ensuring that the mark is unencumbered, the creditor should file evidence of its security interest, both with the PTO and with the Secretary of State in the state where the debtor is located. Even though PTO recordation probably does not perfect a security interest in a trademark, the creditor would be wise to record with the PTO after execution of the security agreement.51

2. Execution
Aside from adequate perfection of a security interest by proper filing, the creditor must also ensure that the security documents are properly drawn. Trademark law provides that a registered trademark "shall be assignable with the goodwill of the business in which the mark is used."52 Thus, the creditor must ensure that a security interest that provides for assignment of a trademark upon the debtor's default transfers not only the trademark, but also the "goodwill" of the debtor's business. An assignment of the trademark without the goodwill is called an assignment in gross and is generally invalid or may affect the value of the mark.

For example, in Haymaker Sports, Inc. v. Turian,53 a security agreement between a law firm and its client provided that upon default the client's trademark was to be assigned to escrowees as collateral security for payment of attorney fees. When the client defaulted, legal title passed to the escrowees and the "assignment" was recorded in the PTO. The court found that the escrowees never played an active role in the debtor's business, never used the mark themselves, and never acquired any tangible assets or goodwill of the debtor. Therefore, the court held that the assignment was invalid because it was actually an assignment in gross.

Another case involving a security interest in a trademark raised this issue.54 In Roman Cleanser, a lender took a security interest in goods, equipment, and general intangibles, including the debtor's trademarks, formulas and customer lists. Prior to the debtor filing for bankruptcy, the lender released its security interest in the goods and equipment, keeping only its interest in the intangibles. The trustee in bankruptcy challenged the lender's security interest in the trademark, arguing that the lender was being assigned a trademark without obtaining the goodwill of the debtor.

The court rejected the trustee's argument, explaining that the purpose of the statute's requirement that goodwill be transferred with a trademark was to protect consumers against deception by the assignee using the trademark on goods different from the goods on which the debtor used the mark. The court found that formulas and customer lists that the debtor passed with the trademarks provided the assignee sufficient knowledge about how to produce the goods at quality levels previously enjoyed by the debtor's customers. The court concluded that requiring equipment and machinery to be transferred would not provide the consumers with any additional protection. Therefore, the court held that the transfer of the trademark to the lender was valid.

To avoid the problem encountered in Haymaker, the security agreement may be structured as a grant of a security interest, not an assignment. The secured creditor may be granted a power of attorney, exercisable only upon default, to transfer the trademark with the goodwill of the debtor's business (i.e., whatever the assignee needs to step into the debtor's shoes with respect to use of the trademark) to an ongoing business that will actually use the mark substantially as the debtor used it.

B. Copyrights
The most recent case concerning perfection of security interests in copyrights holds that the federal filing system preempts state law with respect to perfection of security interests in registered copyrights, but not unregistered copyrights. For unregistered copyrights, the U.C.C. filing system controls. Thus, filing in the Copyright Office is not the only method to perfect a security interest in a copyright.55   

Whereas a creditor who anticipates accepting a registered copyright as collateral should check the Copyright Office records for encumbrances of the copyright, one who anticipates accepting an unregistered copyright as collateral should search state records. If the creditor does not know if the copyrighted collateral is registered, a complete search for encumbrances requires examination of both the Copyright Office records and state U.C.C. filings.

Perfection of security interests in registered copyrights by federal filing, as mandated by World Auxiliary Power, raises several logistical problems. The Copyright Act grants priority to the first executed of two or more conflicting transfers if it is recorded within one-month after execution in the U.S., or any time before recordation of a later transfer.56 Thus, an earlier assignment and an earlier security interest will take priority over a later security interest if it is recorded within one month after execution. As with trademarks, perhaps the best way for the secured party to guard against this problem is to require the debtor to warrant that no conflicting interests have been or will be granted in the copyright, and the secured party should record its interest in the Copyright Office within one month after the security agreement is signed.

Another timing problem a potential secured party may face is that the searchable Copyright Office records are usually months behind the most recent filing date. Thus, a search may not reveal an earlier security interest that has in fact been filed.

Yet another logistical problem arises from the requirement of a copyright registration. To register a copyright, a copy of the work must be deposited in the Copyright Office. Thus, a copyright in a future work cannot be registered, and therefore security interests in future copyrighted works (which may be granted in the same document in which security interests in registered and unregistered copyrights are granted) must be perfected by state U.C.C. filings.

Another problem with perfection by federal recordation is that the federal recording system, unlike the state recording system, does not recognize a floating lien.57 Thus, the creditor securing an interest in registered copyrights is required to update its filings continually as the copyrighted material comprising the collateral changes. In this regard, the creditor should include a clause in the security agreement requiring the debtor to notify the creditor whenever the registered copyrighted material comprising the collateral changes, so that the creditor can update its filings.

There is also the possibility that other federal courts will disagree with the World Auxiliary Power court and hold that security interests in copyrights may be perfected only by state U.C.C. filings. In jurisdictions that do not recognize (or have not ruled upon) the supremacy of the federal system with regard to registered copyrights, the state U.C.C. records should be searched to discover prior recorded security interests.

After ensuring that the copyright is unencumbered, the secured creditor should file both with the Copyright Office and with the Secretary of State in the state where the debtor is located. Because the perfection of the security interest or priority could be addressed by any federal court with personal jurisdiction over the parties, recording in the Copyright Office and on the state level should be done to ensure perfection in case the court refuses to follow World Auxiliary Power.

The creditor should file with the Copyright Office within one month after execution of the security agreement to obtain full protection from subsequent creditors.58 Such filing serves as constructive notice provided (1) registration has been made for the work, and (2) the document specifically identifies the work so that, after it is indexed, it would be revealed by a reasonable search under the title or registration number.59

Another logistical problem arises if the copyright in the work is registered concurrently with recordation. Constructive notice requires registration and the ability to locate the document by a search under the title or registration number. Even if the security agreement is recorded within one month after execution, constructive notice may not attach and priority may not vest until the document is indexed against the registration number and title, which—because of the Copyright Office backlog—may not occur until quite some time after the document is filed for recordation. It may be possible to avoid this problem by requesting "Special Handling" when the application is filed. Special Handling results in expedited issuance of a registration certificate, but the pre-approved circumstances under which Special Handling will be granted do not include the perfection of security interests. Thus, in this instance the creditor should also file with the Secretary of State where the debtor is located to perfect a security interest in the unregistered copyright.

C. Patents
Because the cases seem to hold that U.C.C. filings perfect security interests in patents vis-à-vis subsequent lien creditors and PTO filings perfect security interests vis-à-vis subsequent purchasers and mortgagees, a creditor who anticipates accepting a patent as collateral should search both state U.C.C. records and the PTO records for encumbrances on the patent. Failure to discover a prior recorded assignment, grant or conveyance in the PTO records will result in a prior recordation having priority over a subsequent purchaser or mortgagee.60

However, the patent statute (like the Lanham Act) allows a three-month grace period for recording the transfer once it is executed.61 Under Transportation Design and Otto Fabric, a creditor who records with the PTO within the three-month period will have priority over a bona fide subsequent purchaser or mortgagee who takes an interest during that period. Moreover, an assignment recorded during the grace period may even supersede a previously perfected state U.C.C. filing vis-à-vis subsequent lien holders. As with trademarks and copyrights, perhaps the best way for the creditor to guard against this problem is to require the borrower to warrant that no conflicting interests in the patent have been or will be granted.

The creditor should file with both the PTO and the Secretary of State in the state where the debtor is located. The PTO filing should be made within three months after execution of the security agreement. Double filing ensures that the security interest will be perfected against all subsequent encumbrances, regardless of the case law of the jurisdiction.

VI. Conclusion

As the foregoing discussion makes clear, there is no certainty as to which law or system—federal or state—governs the perfection of security interests in trademarks, copyrights, and patents. However, since both systems permit filing of security interests in intellectual property, the prudent lender will not only search both systems for prior encumbrances of the pledged collateral, but will also be sure to perfect its security interest by filing under both systems. Perhaps most important for the I.P. owner, after the loan has been paid off the I.P. owner should insist that a release of the security interest be filed wherever the security agreement was perfected or recorded.

Endnotes
1 Unless otherwise indicated, all references to Article 9 refer to revised Article 9.  Although the official commentary to Article 9 is superseded by the new commentary, discussion of the former commentary "remains useful in understanding the background and general conceptual approach" of revised Article 9.  Article 9 U.C.C. § 9-101 cmt. 1 (2001).

2 U.C.C. § 9-101 Official Cmt. (2001).

3 U.C.C. § 9-101 Official Cmt.

4 U.C.C. §  9-317(a)-(b).

5 U.C.C. §  9-322(a).

6 Id.

7 See U.C.C. §§  9-307; 9-301(1); see also U.C.C. §§ 9-101 cmt. 4c, 9-301 cmt. 4.

8 U.C.C. § 9-502(a).

9 U.C.C. §  9-502(a) cmt. 2.

10 U.C.C. §  9-109(a); see also §§ 9-109 cmt. 4, 9-102(a)(42).

11 U.C.C. §  9-102(a)(42).

12 U.C.C. §  9-102 cmt. 5(d).

13 The provisions of the Copyright Act of 1976 that govern the transfer of ownership of copyrights are broader than those of the old Copyright Act of 1909.

14 The provision of the federal trademark law governing the recordation of assignments is very similar to that in the federal patent law. See infra discussion of federal statutes governing recordation of patents and trademarks. Thus, according to former Comment 1, Article 9 would probably govern trademarks as well as patents.

15 See U.C.C. § 9-311 cmt. 2. 

16 U.C.C. §  9-311(b).

17 See In re Roman Cleanser Co., 225 U.S.P.Q. 140, 142 (E.D. Mich. 1984).

18 15 U.S.C. § 1060.

19 Id.

20 37 C.F.R. § 3.11 (1994).

21 Trademark Manual of Examining Procedure § 503.02 (2002) [hereinafter T.M.E.P.].

22 Id.

23 17 U.S.C. § 101. See also 17 U.S.C. § 201(d), which provides that "ownership of copyright may be transferred…by any means of conveyance or by operation of law."

24 17 U.S.C. § 205(c).

25 Generally, registration of a work is not necessary to obtain federal protection, but it is required to obtain certain rights and remedies in an infringement action.

26 37 C.F.R. § 3.11, which defines documents that will be recorded with the PTO, extends to trademark and patent applications, patents, and trademark registrations. The Manual of Patent Examining Procedure (M.P.E.P.), like the T.M.E.P., allows for the recordation of security interests with the PTO. M.P.E.P. § 313 (5th ed. 1994).

27 In re TR-3 Indus., 41 Bankr. 128 (Bankr. C.D. Cal. 1984).

28 In re Roman Cleanser, 225 U.S.P.Q. 140 (Bankr. E.D. Mich. 1984), aff'd, 802 F.2d 207 (6th Cir. 1986); see also In re Chattanooga Co., 98 B.R. 792, 795 (Bankr. E.D. Tenn. 1989); In re C.C. & Co., 86 B.R. 485 (Bankr. E.D. Va. 1988).

29 In re 199Z, Inc., 137 B.R. 778 (Bankr. C.D. Cal. 1992).

30 In re Together Dev. Corp., 227 B.R. 439 (Bank. D. Mass. 1998).

31 Id

32 Trimarchi v. Together Development Corp., 255  B.R. 606 (D. Mass. 2000).

33 In re Peregrine Entm't, 16 U.S.P.Q.2d 1017 (C.D. Cal. 1990).

34 Id. at 1019.

35 In re AEG Acquisition Corp.,127 B.R. 34 (Bankr. C.D. Cal. 1991).

36 Under the Berne Convention, works from member countries outside the United States are entitled to certain benefits under the Copyright Act without complying with any formalities, including registration. However, registration is necessary to obtain certain other benefits of the Copyright Act.

37 In re Avalon Software Inc., 209 B.R. 517 (Bankr. D. Ariz. 1997).

38 In re World Auxiliary Power Co., 303 F.3d 1120 (9th Cir. 2002). 

39 Holt v. United States, 73-2 U.S.T.C. P9680 (D.D.C. 1973).

40 In re Transp. Design & Tech., Inc.,226 U.S.P.Q. 424 (Bankr. S.D. Cal. 1985).

41 Id. at 426. 

42 City Bank & Trust Co. v. Otto Fabric, Inc., 7 U.S.P.Q.2d 1719 (D. Kan. 1988).

43 Id. at 1722 (citing Waterman v. MacKenzie, 138 U.S. 252 (1891)).

44 Id. at 1721, 1722.

45 Chesapeake Fibre Packaging Corp. v. Sebro Packaging Corp., 23 U.S.P.Q.2d 1522 (D. Md. 1992).

46 Peregrine, 16 U.S.P.Q.2d at 1020.

47 Id. at 1023.

48 In re Cybernetic Servs., Inc., 252 F.3d 1039 (9th Cir. 2001), aff'd, 239 B.R. 917 (9th Cir. BAP 1999).

49 15 U.S.C. § 1060.

50 Id.

51 See 15 U.S.C. § 1060.

52 Id.

53 Haymaker Sports, Inc. v. Turian, 581 F.2d 257 (C.C.P.A. 1978).

54 In re Roman Cleanser, Co., 802 F.2d 207 (6th Cir. 1986).

55 In re World Auxiliary Power Co., 303 F.3d 1120 (9th Cir. 2002).

56 17 U.S.C. § 205(d).

57 Peregrine, 16 U.S.P.Q.2d at 1022 n.10 ("[A]s the contents of the film library changes, the lienholder will be required to [sic] make a separate filing for each work added to or deleted from the [film] library. By contrast, a UCC-1 filing can provide a continuing, floating lien on assets of a particular type owned by the debtor, without the need for periodic updates."). Compare old U.C.C. § 9-204(1) ("a security agreement may provide that any or all obligations covered by the security agreement are to be secured by after-acquired collateral.") with 17 U.S.C. § 205(c) ("the [recorded] document . . . specifically identifies the work to which it pertains . . . under the title or registration number.").

58 See 17 U.S.C. § 205(d).

59 17 U.S.C. § 205(c).

60 35 U.S.C. § 261.

61 Id.

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