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Leveraging Knowledge Assets

3.1              The Problem

The law relating to security interests federal IPRs is radically uncertain. Though all the federal IP Acts establish ownership registries of one form or another, they were not intended to facilitate the use of the IPRs as collateral. None of the six existing federal intellectual property statutes expressly addresses the secured financing aspects of intellectual property law. Their application to security interests arises purely by implication from the federal provisions that provide for the assignment or transfer of the relevant kind of intellectual property right, and for the establishment of federal intellectual property registries to record ownership of the right and its transfer.⁴⁴ The impact of the federal assignment and registry provisions on security has been extensively analyzed, but these analyses do not allow any firm conclusions to be drawn.⁴⁵ On the contrary, there is a general, indeed universal, consensus that there is fundamental uncertainty with respect to essentially all of the basic questions regarding the effect of the federal provisions on security and the relationship between the federal and provincial systems.

The first step any creditor relying on IP collateral must take is to identify the existence, nature and extent of the debtor’s IPRs. This may seem like a straightforward matter in view of the existence of federal registries for recording the assignment and transfer of all six categories of federal IPRS. In fact, the federal acts as currently drafted mean that the federal registry is not a reliable indicator of the debtor’s clear title to the relevant IPR. In the first place, under three of the federal IP Acts (including the Trade-marks Act ), registration is not a pre-requisite to the validity and effectiveness of a transfer against third parties taking from or under the transferor. It follows that a secured creditor cannot rely on the results of a registry search as a guarantee against the risk that the debtor, though apparently the owner or assignee of record, has previously disposed of the relevant IPR. As long as the prior unregistered assignment complies with the requirements for a valid transfer under the relevant federal statute, the title acquired by the intervening unregistered transferee would prevail.⁴⁶ Existing practice in respect of “registration” of security interests compounds the confusion. The Registrar of Trade-marks will make an annotation on the record indicating that it has received a security agreement purporting to affect the trade-mark in question, but this practice is not sanctioned by the legislation and its effect is unclear. Whether it might constitute constructive notice and whether failure to register a security agreement in this way might be considered a fraud on subsequent parties, is unclear.⁴⁷ A fortiori, the priorities between a provincially registered security interest in a registered trade-mark and one which is registered federally according to this practice of the trade-mark office is so obscure as to almost be beyond speculation.

The other three federal IP Acts, including the Patent Act and the Copyright Act, provide somewhat greater protection against the risks posed by unregistered prior assignments. Under these Acts, an unregistered assignment is void against a subsequent assignee without notice who registers first. Consequently, if the assignment under which the debtor acquired title is registered, and assuming an unbroken chain of title from the original owner, a secured creditor can generally rely on the registry record as a reliable indicator of the debtor/assignee’s title. But registration does not absolutely guarantee priority over a prior unregistered assignee. The first-registered assignee must be without actual notice of any prior unregistered assignment.⁴⁸ The actual notice qualification creates some residual uncertainty since its application depends on the subjective state of knowledge of the debtor/assignee.

Moreover, registration under these Acts does not necessarily guarantee that the registered assignee’s title will prevail against a subsequent assignee from the same assignor. It has been held judicially that registration has negative priority effect only.⁴⁹ It prevents a prior unregistered assignee from prevailing against an innocent subsequent assignee who registers. But it does not create a positive first-to-register rule of priority so as to preclude a subsequent assignee from relying on any exception to first-in-time priority created by otherwise applicable general property law principles. It follows that a secured creditor faces the legal risk that a debtor’s federally registered title may be defeated by a subsequent assignment to a different assignee by operation of other law.

Further, it is not clear whether “assignment” includes transactions creating a security interest. And if the registration provisions do apply to apply to transactions creating a security interest, it is likely (but not certain) that the form of the transaction is important, and that only to those security agreements which in the form involve a transfer of title are registrable federally.⁵⁰ For many common forms of security agreement it may be difficult to determine whether a transfer of title is involved and so whether the agreement is registrable federally.⁵¹ Priorities as between federally and provincially registered security interests are also unclear. It is unclear whether the provincial security Acts would apply at all, and there may be some variation between provinces on this point.⁵² If the provincial Acts did apply, the outcome of priority contests would probably depend on the form of the security agreement.⁵³

Apart from this profound legal uncertainty, there are many uncertainties associated with current registry practices. Patent, copyright and trade-marks databases are currently accessible on-line, but the on-line source is not adequate for due diligence searching in respect of financing. None of the on-line databases are guaranteed to disclose all relevant information and such information as is disclosed may be several weeks out of date.⁵⁴ Security agreement information does not appear at all in the on-line patent database.⁵⁵ As Knopf notes “Such uncertainty does not exist and would not be considered acceptable in other Canadian registration regimes, such as those for real estate or PPSA filings.”⁵⁶

3.2              The Need for Reform

It is little exaggeration to say that the law relating to security interests in federal IPRs could not be moire uncertain. The question is, what, if anything, should be done about it.

The first question is whether reform is needed at all. Legal practitioners are clearly not satisfied with the current uncertainty, but lenders are generally advised to use a “belt and suspenders” approach, in which all interests are registered both federally and provincially. If the only additional cost of the uncertainty is this dual filing, it might be argued, then reform is not essential, particularly since the provincial filing would often be required in any event as part of a general security agreement. Prior research has tended to focus on the sources of current legal uncertainty, accepting that the case for reform is self-evident.⁵⁷ Certainly no attempt has been made to quantify the impact of this uncertainty on the cost of lending.

With that said, we can at least identify the general nature of the excess costs of the current regime.

Registering valid security against intellectual property is plagued with uncertainty and unique issues due to the interaction and potential conflict between provincial and federal law. The result at present is that borrowers who use their intellectual property as collateral can expect higher than usual borrowing transaction costs and increased reporting requirements. Lenders can likewise expect increased administrative burden in monitoring borrowers and somewhat less certainty respecting the quality of the security obtained from the borrower.⁵⁸

It may also be that the savings achieved by reform will increase as IP-based secured lending becomes a more significant source of financing for information based firms. As Knopf observes,

It may be that the pressures for or against revision are somewhat or even very time-sensitive and situation-specific. Anecdotal evidence suggests that asset based lending was not extremely important in the very bullish equity markets that fuelled the rise of the “dot com” businesses in the late 1990s. This contrasts with the earlier 1990s which were driven by recession and the need to raise money based upon whatever assets were at hand, since there was little interest in equity financing at that time. Perhaps not surprisingly, this was the period at which demand for legislative reform in these areas last peaked.

Consequently, it would appear that demand for improvement of the legal framework in this area will increase if the economy worsens and asset based financing makes a resurgence. Moreover, the related questions arising in bankruptcy and insolvency will become more important if there are hard times ahead, especially in the high tech sector which is so dependent on licensing.⁵⁹

The current recession in technology industries is unlikely to be permanent, nor is the “dot com” frenzy likely to re-occur. This suggests that as the sector recovers the demand for secured debt will also increase. Though satisfaction of this demand may be retarded by legal uncertainty, some secured lending based on IPRs will take place. As it does, the uncertainties that were historically unimportant will eventually be resolved through litigation. This will be expensive in itself. And as uncertainties are resolved, some proportion of lenders will find that their assumptions have been wrong and there will be additional expense as the lending community adjusts to the results which will be at least partially unanticipated.

Although the benefits of a reformed system for security in IPRs are difficult to quantify, we believe that the current level of inefficiency and uncertainty is unacceptable in what is destined to become a major area of secured lending. This view reflects a widespread consensus that reform is necessary.

3.3              Generic Federal Registry Reforms

Many of the reforms which are needed to implement an effective system for security in IPRs are dependent on the approach taken to the division of responsibilities between the federal and provincial spheres. The next several chapters of the report are concerned with these aspects of reform. But there are some reforms to the federal registry system which are needed no matter what approach is adopted.

We will see below⁶⁰ that the federal ownership registries are an integral part of the provincial approach to security interests in IPRs, since chain of title searching through the federal ownership registry is necessary to establishing good security in IPRs even under that approach. A fortiori modernized federal registries are needed if a federal approach is to be adopted.

Though considerable progress has been made in making federal IPR database information available on-line, these efforts have been aimed primarily at substantive searching for e.g. patent prior art, or similar trade-marks, and the systems remain inadequate for chain of title searching. Some basic technological changes will be are needed to the federal IPR ownership registries if the provincial system is to be effectively implemented. In particular, legally reliable, up to date, on-line searching of the federal ownership registries, including full chain of title for all IPRs (that is, grantor/grantee searching), is important. Otherwise it will not be possible to take a fully protected security interest in a debtor’s federal IPR without the cost and delay of a search at the CIPO offices in any case where the debtor is not the original owner of any of its IPRs.

Legal change is also desirable. As we have seen, at present the form of the security agreement is important with respect to registration in the federal system. A reformed system would adopt the substance over form approach which is used in the provincial systems. This should not be controversial. Further, debtor name rules should be specified to improve search reliability.

We recommend repeal of the existing qualification based on actual knowledge of a prior assignment by the first registered assignee in favour of an unqualified first to register rule. This recommendation is in line with contemporary legal policy for both land and movables registries. Allowing priority based on actual notice can prevent sharp dealing in some circumstances, but it can lead to increased litigation by undermining the completeness of the registry.⁶¹

Finally, we recommend that all licences which are in substance (partial) assignments of the rights in the IPRs should be subject to the federal ownership registration regime. The usual view, which we adopt, is that it is exclusive licences which are functionally equivalent to (partial) assignments and so should be subject to the ownership registration regime.

⁴⁴Copyright Act, ss. 27(1), 57; Patent Act, ss. 50(1), 51; Trade-marks Act s. 48(1); Industrial Design Act, s. 13(1); Plant Breeders’ Rights Act, s. 31(1); Integrated Circuit Topography Act, s. 7(1), s.21.