Practical Problems for secured creditors and dealing with Intellectual Property Assets in Administrations and Receiver/Manager appointed scenarios

Intellectual property is amongst the most valuable asset that a business possesses - particularly if one examines the key assets of some of the worlds most profitable companies such as Microsoft Inc. However, financers are reluctant to advance funds on intellectual property assets due to problems in realising the assets. Why is this the case? This question is perhaps best answered by an analysis of the following sub-questions:

1. What are intellectual property assets?
2. What security is available?
3. How is such security enforced?
4. What are the problems? and
5. What possible solutions are available.

We will now review each of these questions in turn.

The main forms of intellectual property that will be encountered by an Administrator or Receiver/Manager are:

1. Copyright;
2. Trade marks;
3. Patents;
4. Domain Names; and
5. Confidential Information.

Copyright is personal property¹⁾ and protects the copyright owner’s exclusive right to exploit²⁾ copyright works and non-works³⁾; If arises when the work or non-work is reduced to material form and in Australia is not registration based.

The Copyright Act⁴⁾ allows for total or limited assignment of copyright ownership provided that the assignment is in writing and signed by or on behalf of the assignor. Therefore, copyright is easily assignable but there are a number of aspects which make the sale and use of such rights difficult. These include:

1. Whether or not the rights themselves have commercial value;
2. Whether or not the owner of the rights can establish a chain of title⁵⁾;
3. Whether or not use of the asset is subject to a third party claim. This could include for instance a patent infringement suit;⁶⁾
4. Whether or not licences which impact upon the commercial value of the asset have been granted to third parties; and
5. Whether or not the rights granted to the owner provide sufficient flexibility for the proposed use.

The chain of title is probably the most difficult aspect for a receiver/manager to master and requires a good understanding of the law and access to relevant documents.

In relation to works under the Copyright Act 1968 (Cth) this includes establishing that the works were either written by the employees within the scope of their employment or was assigned by virtue of Section 196(3) of the Copyright Act. A recent decision in relation to whether or not an employee wrote software within the scope of his or her employment is Redrock Holdings Pty Ltd v Hinkley & ors⁷⁾. In that case His Honour Justice Harper applied section 35(6) of the Copyright to find that the employer was the owner of various computer programs written by an employee⁸⁾.

This problem also arose in the case Tracker Software International Inc v Tracker Software Australia Pty Ltd⁹⁾ in which the sale of the intellectual property rights to various computer programs by a liquidator (who was at the time an administrator) were disputed by another company who unsuccessfully sought an application for an interlocutory injunction on the basis that it was the owner by virtue of its employee writing some code. However, the Court found that this assertion was not made out on the evidence.

Another problem - that of whether or not the rights are sufficiently wide can arise in unexpected situations. Recent amendments to the Copyright Act¹⁰⁾ introduced moral rights into the Australian copyright regime. Moral rights protect amongst other things the right of integrity, attribution and he right not to have the work used in a derogatory way.

The author’s moral rights continue despite the fact that they are no longer the copyright owner. For instance, an author's right of integrity of authorship in respect of a cinematograph film continues in force until the author dies. An author's right of integrity of authorship in respect of a work other than a cinematograph film continues in force until copyright ceases to subsist in the work. An author's moral rights (other than the right of integrity of authorship) in respect of a work continue in force until copyright ceases to subsist in the work¹¹⁾.

Further, Receiver’s and Managers cannot exercise rights to which the entity over which they have been appointed does not have. Therefore any sale needs to ensure that no representation is made that any asset is fit for purpose or can be used in any particular way.

For instance, litigation has been commenced in the United States in relation to a film company which has been providing films to the public which have profanity and violence removed which would in the author’s view clearly infringe various moral rights owned by the copyright owners of the films concerned.

Further dealing with licensed assets is often not simple - If the company is a licensee, the terms of the licence will often restrict the possibility for the licence to be on-sold and may even include terms that deem the licence to be terminated upon an act of insolvency, that may include the appointment of an Administrator or Receiver/Manager.

Obviously a critical review of all copyrights and licences should be undertaken by the Receiver/Manager as soon as possible after appointment.

Trade marks are used to identify the source of goods and services. Trade marks may be both registered and unregistered.

The Trade Marks Act 1995 defines a trade mark as:

a sign used, or intended to be used, to be distinguish goods or services dealt with or provided in the course of trade by a person from goods or services so dealt with or provided by any other person¹²⁾.

Registration provides the owner with an evidentiary advantage in litigation in that there is no need to prove reputation within Australia.

Unregistered trade marks are protected at common law and in some cases may be seen to be part of a business’s goodwill.

Although businesses may seek to include the value of trade marks as a separate item in their balance sheet, there is no provision in the Trade Marks Act¹³⁾ to register a charge over the asset. While there is little impediment in dealing with an unregistered trade mark, registered trade marks are registered for specific classes of goods and services. There is also the possibility of removal of a registered trade mark from the register for non-use¹⁴⁾ thus a trade mark does not have the character of real property.

If the owner had no bona fide intention of using the mark when the registration was applied for and there had been no use of the mark up to a month before the application for removal was made¹⁵⁾ or if there has been no bona fide use of the mark for a continuous period of at least three years up to a month before the application for removal was made, the trade make may be removed from the register.

An Administrator or Receiver/Manager should promptly audit the trade mark portfolio to determine the past and present usage of the marks to ensure the possibility of removal for non-use is minimised or that trade marks, which are not being used in all or some of the classes for which they are registered are either sold or licensed for use by an authorised user¹⁶⁾ to maintain the trade mark portfolio’s value.

If the Administrator or Receiver/Manager decide to discontinue the supply of certain goods or services or to sell off parts of the business the trade marks relevant to those areas of business should be sold, noting that it is possible to assign the trade mark ownership for a subset of the total number of classes of goods and services for which it is registered.

To maintain the value of the trade mark portfolio that is retained for use by the business, the Administrator or Receiver/Manager must ensure that the trade marks are only used as trade marks and not in a way in which may lead to the trade mark becoming descriptive of the goods or services for which they are used. For instance Sony failed in their attempt to register the trade mark “Betamovie” for use in the sale of their “Beta” video cameras and video tape recorders as “Beta” had become a generic term for such goods¹⁷⁾.

It is important for registered trade marks that the Administrator or Receiver/Manager keeps the contact details up to date with IP Australia. If the registration renewal fees are not paid the trade mark registration will lapse.

Patents are registered monopoly right to exploit various inventions which can be ascertained by searching the patent register in each relevant jurisdiction. They can be transferred by an assignment signed in writing by the assignor and assignee¹⁸⁾.

To be valid patents must be:

1. a manner of manufacture within the meaning of section 6 of the Statute of Monopolies; and
2. when compared with the prior art base as it existed before the priority date of that claim:
   1. novel; and
   2. involve an inventive step; and
3. useful; and
4. not secretly used in the patent area before the priority date of that claim by, or on behalf of, or with the authority of, the patentee or nominated person or the patentee’s or nominated person’s predecessor in title to the invention.¹⁹⁾

If the Receiver/Manager becomes aware of such assets he or she should immediately seek appropriate advice to protect those assets.

It is arguable that domain names (which are an exclusive licence issued by various Registrars) should be considered as a new form of intellectual property. Domain names perform a similar function to trade marks, but they are not limited in the same way that trade marks are to specific classes of goods and services. A domain name can be used only by one party and so affords exclusive rights of use to the owner.

A domain name is a mnemonic string of characters that is mapped onto a numeric Internet Protocol (“IP”) address. For instance it is easier to remember www.computerlaw.com.au rather than the IP address 139.130.50.38 . A similar system is used for telephone numbers where the telephone number is given as a word, the letters of which map back to the number keys on a telephone keypad. For example in the United States of America Holiday Ins, Inc operate a “vanity number” of 1-800 465 4329 that corresponds to 1-800 HOLIDAY²⁰⁾.

Like a telephone number, only one party can use each domain name. There is a potential for an Administrator or Receiver/Manager to be liable for trade mark infringements on a world wide basis if the continued use of the domain name is not supported by evidence of commercial use and reputation.

It has been a contentious question whether a domain name is a form of property. For example the use Australian “.com.au” domain name addresses is permitted by way of a licensing agreement²¹⁾. Before an Administrator or Receiver/Manager attempts to sell a domain name, the terms of the relevant licensing agreement must be reviewed to determine whether the domain name may be on-sold. In some cases, including for “.com.au” domain names, the transfer of a domain name may only be done by the simultaneous lodgement of a surrender of the existing licence an application for a new licence. The Administrator or Receiver/Manager must ensure that all the contact details for the administration of domain names is up to date. If the licence fees are not paid at the end of a licence period, the domain name registration will lapse and the domain name will then be made available to the general public.

Often an obligation of confidence will arise pursuant to either the circumstances of the disclosure, contract or the nature of the relationship enjoyed by the parties eg. employer/employee, solicitor/client. Ownership of confidential information gives rise to the ability to seek relief to restrain use and disclosure.

Confidential information may be known by multiple people and may exist in written form or merely as ideas. As such, it is difficult to transfer confidential information. The Administrator or Receiver/Manager should ensure that as few people as possible gain access to the confidential information and that all persons with access to the confidential information have executed confidentiality undertakings. What security is available?

Professor Sykes states the general concept of a security as being “a transaction whereby a person to whom an obligation is owed by another person called the “debtor” is afforded, in addition to the personal promise of the debtor to discharge the obligation, rights exercisable against some property of the debtor in order to enforce discharge of the obligation”²²⁾. Although securities are not as commonly sought over intellectual property as compared to real property, an Administrator or Receiver/Manager must still be aware that this is a possibility, particularly with companies in which intellectual property is recorded as the major asset.

A financier will normally seek to take a legal mortgage over an asset, but if a legal mortgage is not available, they may consider taking an equitable mortgage or a charge. Lessor forms of security may be re-enforced by an escrow arrangement. An Administrator or Receiver/Manager must carefully investigate the extent to which a secured creditor may deal with an intellectual property asset over which the security is held.

A mortgage over an intellectual property asset owned by a company may be created by an absolute assignment of the asset with a provision for reassignment on payment of the debt. An Administrator or Receiver/Manager must ensure that an inquiry is conducted to ensure who is the legal owner of each of the intellectual property assets before any assets are dealt with by the company. A claim of intellectual property infringement may be made against the Administrator or Receiver/Manager if they deal with the company’s assets in a way that is inconsistent with the mortgagee’s rights.

In the case of trade marks, an equity of redemption may be registered under s113²³⁾ as may any other unregistered interest or right in a registered trade mark. However, if the ownership of a registered trade mark is transferred, the mortgagee must ensure a formal arrangement is in place to allow the mortgagor’s continued authorised use, to prevent the possibility of the trade mark being removed from the register for non-use.

A fixed charge over an asset creates an equitable interest in the asset. In some cases an equitable interest may be defeated by a subsequent legal interest. For example, a fixed charge over land will lose priority to a later registered mortgage over the same land. A fixed charge over land must be protected by lodging a caveat on the title to ensure protection against a subsequent legal interest.²⁴⁾ However, with intellectual property assets (except trade marks), there is no equivalent method to protect an equitable interest and so the Administrator or Receiver/Manager must ensure that a secured creditor does not gain priority over assets to which another party holds a superior claim and that the assets are not dealt with by the company in a way that is inconsistent with the fixed charge.

A fixed charge prevents the chargor from dealing with the secured assets, without the consent of the chargee. In the case of intellectual property rights, it is questionable whether a fixed charge could be held over assets such as copyright works which are licensed in the ordinary course of business.

A floating charge is an equitable charge on the assets at any given time and allows the company to deal with the asset in the ordinary course of business, without needing the chargee’s consent.

A floating charge essentially remains dormant until the company defaults, at which time the floating charge “crystallises” and becomes a fixed charge over all assets of held by the company at that time.

The difficulty with this type of security is the point of crystallisation. The charge must be drafted to ensure that any attempt to transfer the rights crystallises the charge.

One of the problems which faces any Receiver/Manager in this area is that of insufficient information. For instance, in Hall v Sherman [2001] NSWSC 810 (14 September 2001) a dispute involving the One.Tel Group the Receiver unsuccessfully sought orders to, amongst other things, inspect documents. Relief was denied as, amongst other things, the powers of the Receiver and Manager did not extend to documents outside the rights granted by the Corporations Law²⁵⁾ or outside the charge itself. Accordingly, it seems appropriate for the security holder to ensure on its own account that it has all relevant documents in its possession and control.

Where a security is held over an intellectual property asset, escrow may be used to ensure that the documents (including source code and other relevant materials) are accessible in a form that is realisable by the financier. For example, a security held over the copyright subsisting in a computer program, will not be readily on sold unless the financier has access to the source code, as the source code enables a future purchaser to continue the development of the program, where as the commonly supplied object code only enables the use of the program. An escrow arrangement whereby the relevant documents are held by a third party subject to various triggers for release may alleviate this problem. However difficulties may arise in ensuring the code kept in escrow is complete and up to date.

An assignment of copyright must be in writing and this should be obtained at the time the security is created. A creditor would be advised to conduct a due diligence investigation to verify the ownership of a copyright work, particularly when a work has been created by many contributors. As stated earlier, it is important that the company holds, amongst other proof of ownership, written assignments from all parties who contributed to the work, where those parties were not employees of the company during the time their contribution to the work was created. If this is not the case then the rights are most likely unenforceable against third parties.

It is important to note that “a licence granted in respect of a copyright by the owner of the copyright binds every successor in title to the interest in the copyright of the grantor of the licence to the same extent as the licence was binding on the grantor”²⁶⁾. If the creditor obtains a mortgage over the copyright work and licences back the use of same to the company, there should be terms in the licensing agreement that state that the licence is terminated upon an act of insolvency. If such a provision is not made, the value of the copyright work may be diminished if the licence is on-sold by the Administrator or Receiver/Manager to a third party. The same problem will be encountered with third parties who already have a licensing agreement in place prior to the security being created. The number of licences and the terms of the licensing agreements should be carefully examined when the creditor is deciding what value to place on the copyright work.

The creditor will need an assignment from the trade mark owner to the creditor. The Trade Marks Act²⁷⁾ requires that an assignment be in an approved form and be submitted with any prescribed documents²⁸⁾. Normally a deed of assignment is used and this should have been obtained by the creditor at the time the security was created along with the certificates of registration.

The problem with completing the assignment is that the creditor will probably not trade in the relevant goods or services and unless the security is covering other assets of the company that allow the creditor to continue to trade in the company’s place, the creditor will be at risk of an application being made to have the trade mark removed for non-use, however, it may appoint the debtor as a user of the mark on behalf of the creditor. It is important that the creditor have regard to potential purchasers of the trade mark, should the security have to be realised.

A security over a trade mark should be protected both during the application process²⁹⁾ and once the trade mark has been accepted for registration³⁰⁾.

The position with unregistered trade marks is less clear. It has been held that a common law mark is not a distinct piece of property that may transferred³¹⁾. In order to obtain security over a common law trade mark, it would be best to obtain a floating charge over the trade mark and associated goodwill. But it may be difficult to realise such an asset without being able to sell the company’s business as an on-going concern.

Australian “.com.au” domain names and many others are used pursuant to a licensing agreement. As stated in the auDA domain name eligibility and allocation policy rules for open second level domains³²⁾, “there are no proprietary rights in the domain name system. … [A] registrant holds a licence to use a domain name, for a specified period of time and under certain terms and conditions”. In order for a domain name to be disposed of, a creditor will need to have a signed surrender of the domain name which will be lodged simultaneously with an application for use of the same domain name. Despite recent changes to the Australian domain name system, which means that there is no longer a requirement to have a business or company name that contains the characters used in the domain name in the same order, there is still a requirement that the owner have some connection to the domain name, such as a registered trade mark, goods or services that the registrant sells or the profession which the registrant practices. If the creditor or the party to whom the domain name is being subsequently registered by cannot satisfy this requirement, the domain name licence will not be able to be transferred.

Perhaps the safest security to take over a domain name is a floating charge which includes other assets necessary to sell the business as a going concern.

The Corporations Act³³⁾ requires that a charge on goodwill, on a patent or licence under a patent, on a trade mark or service mark or a licence to use a trade mark or service mark, on a copyright or a licence under a copyright or on a registered design or a licence to use a registered design be registered³⁴⁾, but states that the normal rules of priority with respect to charges³⁵⁾ do not affect the operation of³⁶⁾ the Copyright Act³⁷⁾ or the Trade Marks Act³⁸⁾. This places a creditor holding a security over intellectual property at an advantage over other creditors and it is important that an Administrator or Receiver/Manager does not deal with such assets until their ownership has been carefully investigated.

Although the Trade Marks Act³⁹⁾ contains registration and priority provisions that potentially conflict with the Corporations Act⁴⁰⁾ there are no such provisions in the Copyright Act⁴¹⁾. So a search for registered charges should alert an Administrator or Receiver/Manager or a creditor as to charges held over copyright assets which will have the protection of the priority provisions of the Corporations Act⁴²⁾.

Administrators or Receiver/Managers and creditors need to bear in mind that copyright has a finite duration and before any copyright asserts are dealt with, the expiry date of the copyright should be checked to assist in valuing the asset.

The value of confidential information will be diminished upon disclosure of the information that reduces its confidential nature. This is particularly important if the confidential information is to be used as the basis for a patent application. As it is hard to control the knowledge of people to whom the confidential information has already been released, this asset will be difficult to control and realise in isolation. It would be easier for a creditor to access the potential value of confidential information by registering a general floating charge that covers the business’s know-how strengthened by obtaining confidentiality undertakings from all parties who have knowledge of the confidential information.

One possibility for creditors seeking to obtain security over intellectual property assets is for a separate company to be registered to whom all the intellectual property is transferred⁴³⁾ and then the use of same is licensed to the company seeking credit. The creditor would hold the shares in the new company or register a mortgage or charge over the shares.⁴⁴⁾

This could greatly assist the creditor in isolating the assets from the trading company and providing a vehicle to sell the intellectual property portfolio as a going concern. This is currently occurring in the Coogi administration.

Effective security for intellectual property assets is available but it requires a degree of due diligence and understanding to reduce potential problems. It would appear at this stage that such financing will remain in the realm of specialists financial organisations such as venture capitalists who understand and are prepared to undertake the provision of such facilities in conjunction with an equity position.

Insolvency practitioners need to take all appropriate steps to ensure that all intellectual property assets are properly realised.

STEVE WHITE
WHITE SW COMPUTER LAW
JUNE 2002

www.computerlaw.com.au

© White SW Computer Law 2002

This article is a guide only and should not be used as a substitute for proper legal advice, readers should make their own enquiries and seek appropriate legal advice.