The Growing Popularity and Complexity of IP Financing Transactions in the USA

Recently, the combination of both a challenging capital markets environment and rising interest rates has caused companies to start thinking outside the box when looking to meet their liquidity needs. A phenomenon which has grown in popularity is the leveraging of intellectual property and other intangible assets as collateral in asset-backed financings, secured notes offerings and other securitisations (each, an “IP Financing Transaction”).

IP Financing Transactions are now being utilised in a wide variety of industries beyond royalty securitisations deployed in the music and pharmaceutical industries where the structure has historically found favour. The intangible assets used to secure these IP Financing Transactions are equally varied, with companies leveraging not only traditional registered intellectual property, but also unregistered intellectual property, such as proprietary technology, software, trade secrets and databases. This is because, unlike tangible assets, intangible assets are non-rivalrous and highly divisible, which facilitates greater flexibility and creativity when structuring an IP Financing Transaction and creates opportunities for companies to unlock value.

The balance that must be struck in any IP Financing Transaction is preserving sufficient flexibility for the company looking to obtain financing to be able to continue exploiting the intangible assets (which are often a key value driver for its business) while providing the secured parties with adequate assurances that their collateral interest and the value of the intangible assets will be protected up to and, importantly, after any default by the company.

Clearly, IP Financing Transactions vary in complexity, from traditional secured asset-backed loans to highly bespoke structures such as those deployed by US airlines during the height of the COVID-19 pandemic, which leveraged their customer loyalty programmes to raise much-needed funds to help them confront an industry-wide liquidity crisis as air travel ground to a halt.

Parties to IP Financing Transactions often seek to establish a “mutually assured destruction” scenario to ensure that all parties will act rationally and not seek to circumvent the structure. This tension can be created in a variety of ways given the malleable nature of intangible assets. 

One emerging paradigm involves a structure where the company pledging its rights to intangible assets transfers those assets into one or more special purpose vehicles, whose shares are also pledged as collateral. These special purpose vehicles serve as the grantors of the security interest and license the intangible assets back to the company on an exclusive basis.

By virtue of the exclusive licensing back, the company is kept in largely the same position; meanwhile, depositing the intangible assets in the special purpose vehicles provides the secured parties with an enhanced ability to protect and foreclose on the collateral in the event of default, especially if the special purpose vehicles, through their respective jurisdictions of incorporation and organisational documents, are designed with bankruptcy remoteness features.

Alternatively, where a special purpose vehicle-type structure is not feasible, whether due to administrative burden, cost, tax concerns or otherwise, a leaner form of deal technology can be deployed where the key design feature of the collateral package is an exclusive licence granted directly to the collateral agent under the company’s valuable intellectual property assets.

The collateral agent in turn sublicenses the intellectual property back to the company, and any default by the company could give rise to a termination by the secured parties of the sublicence and result in the company’s loss of its freedom to operate its business. Additionally, a fee may be payable by the company under this licence, which may be sized to cover debt service under the financing.

The exclusive licence to the collateral agent provides the secured parties with valuable rights that survive bankruptcy, much like the bankruptcy remoteness in the special purpose vehicle structure. This is because most forms of intellectual property licences are afforded the protection of Section 365(n) of the US Bankruptcy Code notwithstanding the executory nature of those contracts. The fact that the collateral agent can make an election to retain its exclusive rights under the licence provides the secured parties with considerable leverage if the the trustee or debtor-in-possession in a bankruptcy scenario ever sought to reject the licence.

Designing these IP Financing Transactions requires a deep understanding of the intersection of intellectual property and bankruptcy law and ensuring that the dominoes all fall in the manner the parties to the transaction intend.

Beyond the mechanics of perfecting a secured party’s interest in the intangible assets, among other things, the parties need to contend with certain bankruptcy considerations, including in the US bankruptcy context:

There are design features that attempt to overcome, or at least mitigate, these obstacles to ensure that the secured parties are not frustrated in their efforts to exercise their remedies.

With all their complexity, designing IP Financing Transactions is never a one size fits all approach. However, if structured thoughtfully, the deal architecture will result in incentivising all parties to continue to respect the structure when default, bankruptcy or other disruption arises. While careful structuring of deal mechanics is necessary to make these arrangements function, leveraging intangible assets as collateral has the potential for significant upside for all parties to the transaction.

Understanding how to balance these objectives and make these structures work requires each of the finance, restructuring, capital markets, tax and intellectual property teams on the legal side, together with the company and the financial advisers to the transaction, to all work together collaboratively to achieve this outcome.