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When Worlds Collide: Perfection of Intellectual Property Security Interests and Bankruptcy Law

Norton Journal of Bankruptcy Law and Practice
January 2012, Ryan M. Murphy

The impact of intellectual property in the increasingly techno-centric global economy runs the gamut from microchips to blockbuster movies. Intellectual property's status as a property interest is flexible and may be summarized as the recognition of the exclusive right to the embodiment of an idea.  Given the intangible nature of intellectual property, it is unsurprising that it persists as an area of uncertainty for bankruptcy practitioners.  A particularly vexing issue in Chapter 11 cases is the dueling mechanisms for perfection of security interests in intellectual property between the state and federal recordation systems.

Pledging intellectual property to secure credit has developed into a staple of asset-based financing. The nuances associated with perfecting and preserving security interests in such collateral however remains a source of unease for lenders. Intellectual property presents risks both in terms of the stability of valuation and increased monitoring. Federal intellectual property recordation systems often impose burdens concerning guarding against infringement of a debtor's title or interference with a lender's priority. Further, conflict often arises in terms of whether the federal or state recording system is the proper mechanism for perfection of such security interests. The increased costs of policing collateral and the attendant risk creates uncertainty for lenders extending credit to businesses centered on intellectual property.

The risks associated with security interests in intellectual property are more pronounced in the bankruptcy context. The issues over perfection and priority of a senior lender's security interest are critical and can impact the trajectory of an entire Chapter 11 case. The avoiding powers created by sections 544 and 547 of the Bankruptcy Code may provide leverage to debtors in challenging purported security interests in intellectual property. Creditors committees and subordinate creditors obviously have a strong interest in “kicking the tires” on existing security interests in an effort to topple a senior lender's priority in intellectual property collateral. Against this backdrop, Chapter 11 can be a veritable minefield for a lender secured by intellectual property who is seeking to avoid being relegated to unsecured status.

This article provides a summary of the rules for perfecting a security interest in intellectual property, more specifically patents, copyrights and trademarks, under both the Uniform Commercial Code (UCC) and the respective federal systems. It then examines bankruptcy cases which have attempted to resolve some of the uncertainty in which system is the proper avenue for perfecting such security interests. The void created by these conflicting regimes suggests collective action among Congress and the states is necessary to mesh the existing systems in order to provide greater predictability to lenders and borrowers in order to foster innovative growth.

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