The Case of the Broken Checklist

Good lending practice depends on checklists ' in fact, a checklist of checklists.

Consider:

• The bankers have to review all the mandatory due diligence, and analyze the prospective borrower's financials and business.
• The asset valuations must show collateral meeting the loan-to-value ratios.
• The lending lawyers must make sure that the loans have been approved with all required corporate formalities, and that the bank's liens have been properly created and recorded.

“Safety in lending” starts with simply making sure that everything on the list has been done, and that no corners have been cut.

The same concerns apply, not surprisingly, to a merger and acquisition (M&A) transaction. The buyer wants to make sure that it has acquired not only everything that the seller wants to sell, but also everything that it might need to operate the business, including rights that may not appear on an asset list in an appraisal. If those two lists are different, then the parties should discuss why some assets may not be in the deal during negotiations, rather than after closing, when the price of the omitted assets certainly will have increased. (In fact, the lender should take the approach of an M&A buyer, because the lender may be in the position of an M&A seller if it has to foreclose and wants to maximize the sale value of the assets.)

Get It Right the First Time

But what if the checklists themselves are wrong, and missing a critical step ' such as the borrower's IP assets, which often aren't on a balance sheet? In fact, perhaps that step has always been missing (or at least was overlooked often enough to give bankers sleepless nights, with them up, wide-eyed and worrying about whether their collateral will be there when they go to foreclose on it).

While “making a list and checking it twice” may work for Santa Claus, it can't work for a lender if the original checklist itself is defective, because it lacks critical assets of the borrower that may not make it into the collateral package.

A recent case with which I am familiar suggests that the “IP checklist” may still be missing from some lenders' form documents. This is a particular concern today, because intellectual property rights, such as a domain name, and trademarks and copyrights, can far outweigh an e-commerce enterprise's (and other types of businesses') tangible assets in value ' and must be covered in the checklists that loan officers and outside counsel review to complete the loan documentation.

Consider, for example, what appeared to be a traditional real estate loan, secured by business-related personal property and by personal guarantees of the owners. Such loans have been the sweet spot of middle-market lenders for as long as there have been such lenders and, indeed, a middle market.

In this case, however, a critical asset necessary to generate revenue from the real estate was the name under which the business (a regional theater) was operated. Even worse, that name was not owned by the corporate borrower, but rather by the individual guarantor. While lenders' counsel asks about business names for Uniform Commercial Code (UCC) filing purposes, the names themselves are not what bankers and businessmen traditionally think of as collateral and, in this particular case, were not in the list of assets in which a security interest was granted in the security agreement.

As a result, when the lender began to market the real property after foreclosure, it found that it could not sell the right to continue to operate the theater under “Famous Name Theater,” under which it had operated for many years; instead, the now-adversarial borrower/guarantor still controlled that right. The lender and its foreclosure buyer would be forced to use “New Unknown Name Theater” and, worse, be at risk of competition by the former owner, who still controlled “Famous Name Theater.” The lender's counsel could not register a “new” trademark in “Famous Name Theater” because the lender had not acquired that right from the borrower and, even if it had, it could not show its own use (as required by trademark law). Certainly, the name issue didn't affect the real estate, per se, or restrict the lender's right to sell it. A buyer who wanted to tear down the theater and build a shopping center probably would not care (unless it wanted to name the shopping center after the failed theater).

But a buyer who wanted to continue the existing operation, with its decades of goodwill, could not do so without buying the name rights separately from the guarantor ' who was naturally a bit aggrieved after losing the business and real property. If the lender's security agreement had included a grant of a security interest in “all assets” of the borrower, then the lender would have had a claim to a lien on the critical IP assets.

In the theater case, even if the individual guarantor who owned the name right had not signed the security agreement, the lender could argue that a license to use the name granted from the guarantor and owner of the name rights to the borrower and theater operator was subject to the lender's lien, and the lender, therefore, could control that right to use the name. If the loan officer had focused specifically on what she would need to resell the theater after a foreclosure, then documentation for the right to use the name could have been created and collaterally assigned to the lender, to avoid any potential issues on foreclosure.

Unfortunately, the “standard form” and checklist used by the lender did not address any of those issues to call attention to the question, and the loan officer did not have enough experience to realize that she should have asked counsel about rights to the borrower's intellectual property. In today's world of extremely tight legal budgets, lender's counsel worked only on what he was asked to do, and did not raise the question of what other potential collateral ' and documents ' might be needed.

Don't Overlook IP Rights

Of course, rights owners and their counsel can overlook IP rights just as easily ' especially when control of those rights sits outside themselves, but in an entity that they may not control.

That is what happened in several widely publicized cases of designers who used their own names as “brand names,” then lost the rights to use those assets when they were transferred in connection with the sale of their business assets. (In this context, the lack of focus on the effect of IP provisions in business agreements applies equally to M&A deals as to loans.)

What Happened to Nipon

For example, designer Albert Nipon sold a portfolio of trademarks and other rights built on his own name when his firm sold its business to Leslie Fay (see In re: The Leslie Fay Companies, Inc., 216 Bankr. 117 (S.D. NY 1997)).

When Leslie Fay, in turn, also sought bankruptcy protection, those rights were a valuable asset that remained with the debtor ' even after the debtor rejected the employment agreement it had with Nipon, individually.

When Nipon tried to create a new line of products, somewhat different from those he had made when he had his own firm but advertised as “Created by Albert Nipon,” the debtor quickly obtained a judgment that the designer's use of his own name infringed the rights his company had sold to Leslie Fay many years earlier.

The court was not persuaded by the designer's use of a disclaimer, “This garment is not licensed or under the authorization of the owner of the Albert Nipon registered trademarks.”

And Joseph Abboud

Similarly, designer Joseph Abboud found that he could not use his own name, or even derivations of it, after he had sold comprehensive rights to it. As in the Nipon case, Abboud did not try to use the exact name he had sold; he simply wanted to describe a new line, “JAZ,” as “a new composition by designer Joseph Abboud.” (See, e.g., http://fashionlawwiki.pbworks.com/w/page/11611214/JA-Apparel-Corp–v–Joseph-Abboud; 2010 WL 102299 (S.D. NY 2010).) Instead, the court found that even though the original sale did not transfer “all commercial rights,” it still specified detailed conditions on Abboud's future use of his own name.

In particular, he was barred from using it as a “trademark, service mark, trade name or brand name,” and required to use his own name only “descriptively,” and in conjunction with his own different, non-infringing trademark.

A Designer Closer to Home

In a similar context, in my office, a designer who sold her eponymous brand to one of our clients negotiated to retain rights to use her name, but only for products outside the line of business purchased by our client. When the deal did not work out as planned, and the buyer shut down the business (frustrating the seller's right to make earnout payments on future sales), the seller's desire to reacquire rights to use her own name became the critical negotiating point to obtain a settlement and release from future obligations.

The Case of Annie Leibovitz

A final case of what can go wrong, from a borrower's perspective, occurred to noted photographer Annie Leibovitz, who had pledged her portfolio of photography copyrights to secure loans to support real estate investments.

When her other ventures became challenged by a difficult economy, or just bad business decisions, using IP assets as collateral must have seemed very attractive ' it was not needed immediately, and was so valuable that it solved other financial problems. Of course, eventually the loan must be repaid, and the risk that the IP would be lost became a real one (the same risk faced by anyone who has mortgaged a house to support a business dream). Fortunately for Leibovitz, a marketing firm “bailed her out” for the right to help her market her images.

Look Carefully, All Around

Once a lender recognizes the importance of thinking about IP assets just as it does about inventory or receivables, or about real estate, it must still look at its collateral base from a “backward” perspective, to decide whether it would be sufficient for the foreclosure purchaser.

Just as some trademarks have no legal existence apart from the goodwill of the business associated with them, IP assets rarely have an intrinsic value (except perhaps to someone stockpiling rights for infringement claims, or as a speculative investment, such as in domain names).

Instead, they must be valued in conjunction with that business. In other words, do the IP assets increase the collateral value of the tangible assets if they can be sold as a package following foreclosure?

Choose the Correct Document

Of course, once a lender or buyer understands that intellectual property rights are a critical asset in a deal, it still must create the appropriate legal documents to work with those rights.

As described in the story about the theater, the language in traditional form real-estate lending documents did not reach assets necessary to operate the property as a theater. For example, as seen in the designer cases described above, rights to use an individual's name, image and persona must be explicitly granted, and made assignable.

The ubiquitous publicity release signed whenever a photo will be used illustrates the types of situations in which a lender and its foreclosure purchaser may need to use IP rights concerning an individual (particularly if the foreclosure purchaser may be a competitor or rival of the borrower).

'Other' Considerations

Also, beyond simply making sure that IP is, in fact, “in the deal,” people whose deals involve IP collateral or assets should think about other considerations not typically found in business loans. Foremost, of course, is the risk of loss of control of the property and rights. While an artist or designer may have specific views about how a work should be marketed, and through what channels, a firm seeking to recover a loan or to get the benefit of an investment may want to pursue a “monetization” plan that focuses more on volume than on quality control. (Of course, the value of IP may just be a red herring if the real value to a lender lies in traditional assets that are also part of the collateral.)

Just as any seller of a business may not like what the buyer chooses to do with it, once IP is transferred, whether as collateral or in a sale, the rights owner has lost control (see “Punk Rock and the Sale of Your e-Business: Should You Stay or Should You Go? It's Not Always An Easy Decision,” in the January 2007 edition of e-Commerce Law & Strategy, at www.lawjournalnewsletters.com/issues/ljn_ecommerce/23_9/news/147939-1.html).

It's possible to negotiate restrictions on a buyer's IP rights use, but that's harder to do in a loan, where the potential buyer won't be identified until a loan foreclosure. (A lender would be unlikely to restrict its resale rights to protect its borrower's views on how to use the IP collateral ' not only will the lender be interested only in getting back its principal, from any buyer, but ultimately the one paying cash in exchange for it will dictate the terms, not the transferor.)

Escrow As Collateral

Another concern related to control of IP as collateral is the use of an escrow. Certainly, lenders are familiar with the concept of an escrow agent who acts as an intermediary to ensure that property is not withheld from the lender but that does not pass between parties until all agreed-upon steps have occurred.

IP escrows, in contrast, exist to preserve the IP assets from deterioration, at one level and, more important, to ensure that they can be transferred at an unspecified time in the future. Just as real-estate title-insurance agents have developed a niche in providing specialized title-escrow services to lenders, an industry of IP-escrow agents has developed as well for the same purpose. From the borrower's and from the lender's perspective, while the use of a specialty technology escrow firm can give comfort that the lender will get what it believed it was getting at the time the loan was made, the introduction of a third party into the process will also add cost and time. Compared with an escrow held directly by the lender, moreover, it can delay foreclosure proceedings for the time necessary to follow the protocols of the escrow arrangement.

Don't Forget About Domain Names

Another area of specialized IP concern is the borrower's domain names. Just as in taking real estate as collateral, the borrower's domain name and related assets can be a boon, even if the business conducted through them is not (see “When Real Estate Isn't Real: Real Estate e-Commerce Still Needs the Real World,” in the October 2007 edition of e-Commerce Law & Strategy, at www.lawjournalnewsletters.com/issues/ljn_ecommerce/24_6/news/149455-1.html; also, see, “Protecting IP Rights in a New gTLD World,” page 1).

In this area, in particular, courts are struggling to determine the legal treatment of what remains at its heart a contract right between a borrower and a name registrar (albeit one heavily infused with aspects of trademark law). From a transactional perspective, however, the decision is much simpler: Rather than try to anticipate how the law of domain names will develop, lenders should instead take contractual control of the name, subject to the terms of a control agreement with the borrower. (This “account control agreement” concept should be very familiar to all parties, because it is used with many types of deposit and securities accounts to maintain the “control” required for perfection of a lien under the Uniform Commercial Code.) While in theory a three-way agreement among the borrower, lender and registrar is possible, the registrar is not in the business of lending, and will likely have no interest in devoting time or expense to such an effort; instead, the lender becomes the contact person of record with the registrar, subject to the terms of its contract with the borrower.

Of course, once it takes responsibility to maintain the domain name in force, the lender must perform its duties in this area flawlessly, lest the borrower lose its online presence. A simple failure to file a renewal on time can lead to a cybersquatter swooping in to register an expired domain name ' literally within minutes in one case in which I was involved ' and an expense to buy the domain name back from the party that buys it. In theory, the domain name dispute resolution policies would allow a formal procedure to reacquire control of the right, but in practice the time to do so is so great that paying the price of the squatter is a preferred way to get a business back online as quickly as possible. For lenders, the relatively nominal expense of multi-year registrations can help defer and ultimately avoid this risk.

Pay Attention to Particular Transfer Rules

Yet another legal formality affecting IP assets is the particular rules about how transfers must be performed, even in a foreclosure context. Frequently, the transfer made through the loan-foreclosure process is not enough; just as a sheriff's deed must be recorded to reflect a foreclosure sale of real estate, follow-up filings may be needed in the U.S. Copyright Office, or with the U.S. Patent and Trademark Office (see, for example, Sky Technologies v. SAP AG, 576 F.3d 1374 (Fed. Cir. 2009), cert. den. 130 S.Ct. 2343 (2010) (upholding transfer of title to a patent by operation of law in a foreclosure, rather than through an assignment)). Just as lenders' counsel anticipates future needs to transfer collateral after a default through documents signed at a loan closing, such as stock powers signed in blank to allow transfer of pledged shares, or deeds in lieu of foreclosure held in escrow, the presence of critical IP assets may also require similar pre-funding planning to ensure the lender's ability to obtain control of the borrower's IP should circumstances require it to do so.

Similarly, if the collateral includes copyrights, does the borrower have assignable rights from everyone involved in the copyrighted materials' creation? While works created by employees in the scope of their employment generally remain under the employer's control, transferees ' whether lenders or buyers ' should ask for more from works created by independent contractors, or independent contractors working for those independent contractors. The work-made-for-hire rules may require getting rights from many persons in the chain of creation or, more likely, a comprehensive and strong indemnification from the borrower, should any of those persons later claim infringement by the foreclosure purchaser of rights pledged by the borrower.

Perhaps the most important “unusual” concern with IP collateral, however, is one that should be very familiar to any reader of this publication: Everything changes regularly online. Just as I have urged lenders and their counsel to review their checklists to account for the importance of IP assets in today's economy, I also urge them to periodically review the checklists they use, because the law of cyberspace is itself in constant flux. Developments in technology law may make today's good checklist not only obsolete but wrong, and much more quickly than loan officers unfamiliar with the e-conomy would expect. A routine search on concepts discussed in this article will reveal how much the legal rules on many points I've discussed have changed over the last decade as courts and businesses have adjusted to the way business is conducted now, when an online presence is mandatory for most firms.

Conclusion

While there certainly have been important changes to the Uniform Commercial Code law of security in personal property transactions (particularly when the system was updated nationally 10 years ago), the basic rules of creating and recording security interests have remained essentially unchanged for decades, if not centuries for real estate law. Laws relating to online business, in contrast, have developed over the last decade as rapidly as the latest decisions and technologies have been employed.

Lenders and their counsel who do not think critically about what legal rights they need from their borrowers when a loan is made, especially IP rights, may instead be reminded of the 1980s hit song of Mike and the Mechanics when they try to foreclose: “All I need is a miracle; all I need is you.”

Unfortunately, however, miracles rarely are granted to lenders, especially those who have to explain why their collateral resale value can't recover the loan principal.

Stanley P. Jaskiewicz, a business lawyer, helps clients solve e-commerce, corporate, contract and technology-law problems, and is a member of e-Commerce Law & Strategy's Board of Editors. Reach him at the Philadelphia law firm of Spector Gadon & Rosen, P.C., at [email protected], or 215-241-8866. He thanks his firm's summer associate, Joshua Goldenberg, for research assistance in the preparation of this article.

Good lending practice depends on checklists ' in fact, a checklist of checklists.

Consider:

• The bankers have to review all the mandatory due diligence, and analyze the prospective borrower's financials and business.
• The asset valuations must show collateral meeting the loan-to-value ratios.
• The lending lawyers must make sure that the loans have been approved with all required corporate formalities, and that the bank's liens have been properly created and recorded.

“Safety in lending” starts with simply making sure that everything on the list has been done, and that no corners have been cut.

The same concerns apply, not surprisingly, to a merger and acquisition (M&A) transaction. The buyer wants to make sure that it has acquired not only everything that the seller wants to sell, but also everything that it might need to operate the business, including rights that may not appear on an asset list in an appraisal. If those two lists are different, then the parties should discuss why some assets may not be in the deal during negotiations, rather than after closing, when the price of the omitted assets certainly will have increased. (In fact, the lender should take the approach of an M&A buyer, because the lender may be in the position of an M&A seller if it has to foreclose and wants to maximize the sale value of the assets.)

Get It Right the First Time

But what if the checklists themselves are wrong, and missing a critical step ' such as the borrower's IP assets, which often aren't on a balance sheet? In fact, perhaps that step has always been missing (or at least was overlooked often enough to give bankers sleepless nights, with them up, wide-eyed and worrying about whether their collateral will be there when they go to foreclose on it).

While “making a list and checking it twice” may work for Santa Claus, it can't work for a lender if the original checklist itself is defective, because it lacks critical assets of the borrower that may not make it into the collateral package.

A recent case with which I am familiar suggests that the “IP checklist” may still be missing from some lenders' form documents. This is a particular concern today, because intellectual property rights, such as a domain name, and trademarks and copyrights, can far outweigh an e-commerce enterprise's (and other types of businesses') tangible assets in value ' and must be covered in the checklists that loan officers and outside counsel review to complete the loan documentation.

Consider, for example, what appeared to be a traditional real estate loan, secured by business-related personal property and by personal guarantees of the owners. Such loans have been the sweet spot of middle-market lenders for as long as there have been such lenders and, indeed, a middle market.

In this case, however, a critical asset necessary to generate revenue from the real estate was the name under which the business (a regional theater) was operated. Even worse, that name was not owned by the corporate borrower, but rather by the individual guarantor. While lenders' counsel asks about business names for Uniform Commercial Code (UCC) filing purposes, the names themselves are not what bankers and businessmen traditionally think of as collateral and, in this particular case, were not in the list of assets in which a security interest was granted in the security agreement.

As a result, when the lender began to market the real property after foreclosure, it found that it could not sell the right to continue to operate the theater under “Famous Name Theater,” under which it had operated for many years; instead, the now-adversarial borrower/guarantor still controlled that right. The lender and its foreclosure buyer would be forced to use “New Unknown Name Theater” and, worse, be at risk of competition by the former owner, who still controlled “Famous Name Theater.” The lender's counsel could not register a “new” trademark in “Famous Name Theater” because the lender had not acquired that right from the borrower and, even if it had, it could not show its own use (as required by trademark law). Certainly, the name issue didn't affect the real estate, per se, or restrict the lender's right to sell it. A buyer who wanted to tear down the theater and build a shopping center probably would not care (unless it wanted to name the shopping center after the failed theater).

But a buyer who wanted to continue the existing operation, with its decades of goodwill, could not do so without buying the name rights separately from the guarantor ' who was naturally a bit aggrieved after losing the business and real property. If the lender's security agreement had included a grant of a security interest in “all assets” of the borrower, then the lender would have had a claim to a lien on the critical IP assets.

In the theater case, even if the individual guarantor who owned the name right had not signed the security agreement, the lender could argue that a license to use the name granted from the guarantor and owner of the name rights to the borrower and theater operator was subject to the lender's lien, and the lender, therefore, could control that right to use the name. If the loan officer had focused specifically on what she would need to resell the theater after a foreclosure, then documentation for the right to use the name could have been created and collaterally assigned to the lender, to avoid any potential issues on foreclosure.

Unfortunately, the “standard form” and checklist used by the lender did not address any of those issues to call attention to the question, and the loan officer did not have enough experience to realize that she should have asked counsel about rights to the borrower's intellectual property. In today's world of extremely tight legal budgets, lender's counsel worked only on what he was asked to do, and did not raise the question of what other potential collateral ' and documents ' might be needed.

Don't Overlook IP Rights

Of course, rights owners and their counsel can overlook IP rights just as easily ' especially when control of those rights sits outside themselves, but in an entity that they may not control.

That is what happened in several widely publicized cases of designers who used their own names as “brand names,” then lost the rights to use those assets when they were transferred in connection with the sale of their business assets. (In this context, the lack of focus on the effect of IP provisions in business agreements applies equally to M&A deals as to loans.)

What Happened to Nipon

For example, designer Albert Nipon sold a portfolio of trademarks and other rights built on his own name when his firm sold its business to Leslie Fay (see In re: The Leslie Fay Companies, Inc., 216 Bankr. 117 (S.D. NY 1997)).

When Leslie Fay, in turn, also sought bankruptcy protection, those rights were a valuable asset that remained with the debtor ' even after the debtor rejected the employment agreement it had with Nipon, individually.

When Nipon tried to create a new line of products, somewhat different from those he had made when he had his own firm but advertised as “Created by Albert Nipon,” the debtor quickly obtained a judgment that the designer's use of his own name infringed the rights his company had sold to Leslie Fay many years earlier.

The court was not persuaded by the designer's use of a disclaimer, “This garment is not licensed or under the authorization of the owner of the Albert Nipon registered trademarks.”

And Joseph Abboud

Similarly, designer Joseph Abboud found that he could not use his own name, or even derivations of it, after he had sold comprehensive rights to it. As in the Nipon case, Abboud did not try to use the exact name he had sold; he simply wanted to describe a new line, “JAZ,” as “a new composition by designer Joseph Abboud.” (See, e.g., http://fashionlawwiki.pbworks.com/w/page/11611214/JA-Apparel-Corp–v–Joseph-Abboud; 2010 WL 102299 (S.D. NY 2010).) Instead, the court found that even though the original sale did not transfer “all commercial rights,” it still specified detailed conditions on Abboud's future use of his own name.

In particular, he was barred from using it as a “trademark, service mark, trade name or brand name,” and required to use his own name only “descriptively,” and in conjunction with his own different, non-infringing trademark.

A Designer Closer to Home

In a similar context, in my office, a designer who sold her eponymous brand to one of our clients negotiated to retain rights to use her name, but only for products outside the line of business purchased by our client. When the deal did not work out as planned, and the buyer shut down the business (frustrating the seller's right to make earnout payments on future sales), the seller's desire to reacquire rights to use her own name became the critical negotiating point to obtain a settlement and release from future obligations.

The Case of Annie Leibovitz

A final case of what can go wrong, from a borrower's perspective, occurred to noted photographer Annie Leibovitz, who had pledged her portfolio of photography copyrights to secure loans to support real estate investments.

When her other ventures became challenged by a difficult economy, or just bad business decisions, using IP assets as collateral must have seemed very attractive ' it was not needed immediately, and was so valuable that it solved other financial problems. Of course, eventually the loan must be repaid, and the risk that the IP would be lost became a real one (the same risk faced by anyone who has mortgaged a house to support a business dream). Fortunately for Leibovitz, a marketing firm “bailed her out” for the right to help her market her images.

Look Carefully, All Around

Once a lender recognizes the importance of thinking about IP assets just as it does about inventory or receivables, or about real estate, it must still look at its collateral base from a “backward” perspective, to decide whether it would be sufficient for the foreclosure purchaser.

Just as some trademarks have no legal existence apart from the goodwill of the business associated with them, IP assets rarely have an intrinsic value (except perhaps to someone stockpiling rights for infringement claims, or as a speculative investment, such as in domain names).

Instead, they must be valued in conjunction with that business. In other words, do the IP assets increase the collateral value of the tangible assets if they can be sold as a package following foreclosure?

Choose the Correct Document

Of course, once a lender or buyer understands that intellectual property rights are a critical asset in a deal, it still must create the appropriate legal documents to work with those rights.

As described in the story about the theater, the language in traditional form real-estate lending documents did not reach assets necessary to operate the property as a theater. For example, as seen in the designer cases described above, rights to use an individual's name, image and persona must be explicitly granted, and made assignable.

The ubiquitous publicity release signed whenever a photo will be used illustrates the types of situations in which a lender and its foreclosure purchaser may need to use IP rights concerning an individual (particularly if the foreclosure purchaser may be a competitor or rival of the borrower).

'Other' Considerations

Also, beyond simply making sure that IP is, in fact, “in the deal,” people whose deals involve IP collateral or assets should think about other considerations not typically found in business loans. Foremost, of course, is the risk of loss of control of the property and rights. While an artist or designer may have specific views about how a work should be marketed, and through what channels, a firm seeking to recover a loan or to get the benefit of an investment may want to pursue a “monetization” plan that focuses more on volume than on quality control. (Of course, the value of IP may just be a red herring if the real value to a lender lies in traditional assets that are also part of the collateral.)

Just as any seller of a business may not like what the buyer chooses to do with it, once IP is transferred, whether as collateral or in a sale, the rights owner has lost control (see “Punk Rock and the Sale of Your e-Business: Should You Stay or Should You Go? It's Not Always An Easy Decision,” in the January 2007 edition of e-Commerce Law & Strategy, at www.lawjournalnewsletters.com/issues/ljn_ecommerce/23_9/news/147939-1.html).

It's possible to negotiate restrictions on a buyer's IP rights use, but that's harder to do in a loan, where the potential buyer won't be identified until a loan foreclosure. (A lender would be unlikely to restrict its resale rights to protect its borrower's views on how to use the IP collateral ' not only will the lender be interested only in getting back its principal, from any buyer, but ultimately the one paying cash in exchange for it will dictate the terms, not the transferor.)

Escrow As Collateral

Another concern related to control of IP as collateral is the use of an escrow. Certainly, lenders are familiar with the concept of an escrow agent who acts as an intermediary to ensure that property is not withheld from the lender but that does not pass between parties until all agreed-upon steps have occurred.

IP escrows, in contrast, exist to preserve the IP assets from deterioration, at one level and, more important, to ensure that they can be transferred at an unspecified time in the future. Just as real-estate title-insurance agents have developed a niche in providing specialized title-escrow services to lenders, an industry of IP-escrow agents has developed as well for the same purpose. From the borrower's and from the lender's perspective, while the use of a specialty technology escrow firm can give comfort that the lender will get what it believed it was getting at the time the loan was made, the introduction of a third party into the process will also add cost and time. Compared with an escrow held directly by the lender, moreover, it can delay foreclosure proceedings for the time necessary to follow the protocols of the escrow arrangement.

Don't Forget About Domain Names

Another area of specialized IP concern is the borrower's domain names. Just as in taking real estate as collateral, the borrower's domain name and related assets can be a boon, even if the business conducted through them is not (see “When Real Estate Isn't Real: Real Estate e-Commerce Still Needs the Real World,” in the October 2007 edition of e-Commerce Law & Strategy, at www.lawjournalnewsletters.com/issues/ljn_ecommerce/24_6/news/149455-1.html; also, see, “Protecting IP Rights in a New gTLD World,” page 1).

In this area, in particular, courts are struggling to determine the legal treatment of what remains at its heart a contract right between a borrower and a name registrar (albeit one heavily infused with aspects of trademark law). From a transactional perspective, however, the decision is much simpler: Rather than try to anticipate how the law of domain names will develop, lenders should instead take contractual control of the name, subject to the terms of a control agreement with the borrower. (This “account control agreement” concept should be very familiar to all parties, because it is used with many types of deposit and securities accounts to maintain the “control” required for perfection of a lien under the Uniform Commercial Code.) While in theory a three-way agreement among the borrower, lender and registrar is possible, the registrar is not in the business of lending, and will likely have no interest in devoting time or expense to such an effort; instead, the lender becomes the contact person of record with the registrar, subject to the terms of its contract with the borrower.

Of course, once it takes responsibility to maintain the domain name in force, the lender must perform its duties in this area flawlessly, lest the borrower lose its online presence. A simple failure to file a renewal on time can lead to a cybersquatter swooping in to register an expired domain name ' literally within minutes in one case in which I was involved ' and an expense to buy the domain name back from the party that buys it. In theory, the domain name dispute resolution policies would allow a formal procedure to reacquire control of the right, but in practice the time to do so is so great that paying the price of the squatter is a preferred way to get a business back online as quickly as possible. For lenders, the relatively nominal expense of multi-year registrations can help defer and ultimately avoid this risk.

Pay Attention to Particular Transfer Rules

Yet another legal formality affecting IP assets is the particular rules about how transfers must be performed, even in a foreclosure context. Frequently, the transfer made through the loan-foreclosure process is not enough; just as a sheriff's deed must be recorded to reflect a foreclosure sale of real estate, follow-up filings may be needed in the U.S. Copyright Office, or with the U.S. Patent and Trademark Office ( see , for example , Sky Technologies v. SAP AG , 576 F.3d 1374 (Fed. Cir. 2009), cert. den. 130 S.Ct. 2343 (2010) (upholding transfer of title to a patent by operation of law in a foreclosure, rather than through an assignment)). Just as lenders' counsel anticipates future needs to transfer collateral after a default through documents signed at a loan closing, such as stock powers signed in blank to allow transfer of pledged shares, or deeds in lieu of foreclosure held in escrow, the presence of critical IP assets may also require similar pre-funding planning to ensure the lender's ability to obtain control of the borrower's IP should circumstances require it to do so.

Similarly, if the collateral includes copyrights, does the borrower have assignable rights from everyone involved in the copyrighted materials' creation? While works created by employees in the scope of their employment generally remain under the employer's control, transferees ' whether lenders or buyers ' should ask for more from works created by independent contractors, or independent contractors working for those independent contractors. The work-made-for-hire rules may require getting rights from many persons in the chain of creation or, more likely, a comprehensive and strong indemnification from the borrower, should any of those persons later claim infringement by the foreclosure purchaser of rights pledged by the borrower.

Perhaps the most important “unusual” concern with IP collateral, however, is one that should be very familiar to any reader of this publication: Everything changes regularly online. Just as I have urged lenders and their counsel to review their checklists to account for the importance of IP assets in today's economy, I also urge them to periodically review the checklists they use, because the law of cyberspace is itself in constant flux. Developments in technology law may make today's good checklist not only obsolete but wrong, and much more quickly than loan officers unfamiliar with the e-conomy would expect. A routine search on concepts discussed in this article will reveal how much the legal rules on many points I've discussed have changed over the last decade as courts and businesses have adjusted to the way business is conducted now, when an online presence is mandatory for most firms.

Conclusion

While there certainly have been important changes to the Uniform Commercial Code law of security in personal property transactions (particularly when the system was updated nationally 10 years ago), the basic rules of creating and recording security interests have remained essentially unchanged for decades, if not centuries for real estate law. Laws relating to online business, in contrast, have developed over the last decade as rapidly as the latest decisions and technologies have been employed.

Lenders and their counsel who do not think critically about what legal rights they need from their borrowers when a loan is made, especially IP rights, may instead be reminded of the 1980s hit song of Mike and the Mechanics when they try to foreclose: “All I need is a miracle; all I need is you.”

Unfortunately, however, miracles rarely are granted to lenders, especially those who have to explain why their collateral resale value can't recover the loan principal.

Stanley P. Jaskiewicz, a business lawyer, helps clients solve e-commerce, corporate, contract and technology-law problems, and is a member of e-Commerce Law & Strategy's Board of Editors. Reach him at the Philadelphia law firm of Spector Gadon & Rosen, P.C., at [email protected], or 215-241-8866. He thanks his firm's summer associate, Joshua Goldenberg, for research assistance in the preparation of this article.