Feel secure? Security interests in patent sales transactions

Unlike a license, once a patent is sold the seller will not necessarily have significant leverage if the buyer fails to make good on its subsequent payment obligations

Traditionally, patent holders have used the licensing model to commercialize their patents. Patent licensing transactions can have many different bells and whistles, but at their core they usually contemplate a grant, to the licensee, of specified rights in the patents (e.g., to make, use and sell products covered by the patents) in return for a running royalty. In recent years, patent holders, particularly inventors and others who may own patents but do not have the financial wherewithal to aggressively enforce their patent rights, have been faced with a changing commercial environment, where patent assertion entities and others are taking advantage of a growing marketplace for patent assets by focusing on the outright purchase of patent portfolios.

In many instances, perhaps because patent owners are used to the licensing model, this trend has led to patent sales transactions where the purchase price is structured as an “earn-out,” meaning a payment of an agreed amount over a period of time. These types of transactions usually involve an assignment of the relevant patents in the first instance, in return for which the seller receives an agreed amount at the time the sale is consummated, then receives subsequent payments (sometimes, much like a running royalty, payments are made periodically based on a percentage of revenue earned by the buyer in the course of its post-closing efforts to commercialize the patents; sometimes fixed amounts paid in installments over time) until an agreed purchase price has been paid, or perhaps until an agreed end date for payments has been reached.

Regardless of the exact structure of these transactions, anytime a seller (as opposed to licensor) of patents agrees to receive its compensation over time, rather than being paid in full when title to the patent passes to the seller, the seller needs to take steps to protect its interest in ensuring that it is paid the full purchase price. If a licensee breaches its payment obligations, the licensor can simply terminate the license, grant a license to a third party and/or sue the former licensee for non-payment and (if it continues to sell products covered by the patent) patent infringement. The key point being that the licensor still controls the principal asset at issue, and has ways to further commercialize that asset. Unlike a license, however, once a patent is sold the seller will not necessarily have significant leverage if the buyer fails to make good on its subsequent payment obligations, regardless of the reason for that failure.

The seller cannot simply “terminate” the agreement and take its patent back, and if it simply sues for payment, there is no assurance the buyer will have the resources to pay a judgment if one is obtained. Accordingly, many inventors and other patent owners have to consider other ways to protect their rights; short of putting the entire purchase price in escrow, perhaps the best way to do so is for the seller to obtain a security interest in the patents being sold.  

Security interests are familiar to any business that uses its assets as collateral for loans, and businesses that have substantial patent portfolios routinely use those patents as collateral, but for individual inventors and other small businesses that do not necessarily have sophisticated banking arrangements, using patents as collateral can be an unfamiliar transactional tool. Like a mortgage on a house, obtaining a security interest in patents does not necessarily mean the original patent owner gets to “take back” its patents; rather, it only means that the original owner can compel a sale of the patents in order to get paid. Nevertheless, a security interest in patents it intends to sell is a critical tool if a seller wants to ensure that it will be paid amounts it is otherwise entitled to receive in a sale transaction.

Negotiating a security interest is always a tricky thing. The seller may want to use the patents as security for its own lending strategies (for example, it may contemplate using the patents as collateral to finance a litigation strategy), and regardless of the circumstances, the seller may understandably be reluctant to subject its newly acquired asset to a risk of forfeiture. The best way to minimize this tension is to ensure that, when a seller first proposes a sale contemplating an earn-out or other post-closing payments, the seller makes clear that it would require that the buyer use the acquired patents as collateral for, or otherwise guarantee, its post-closing payment obligations. 

Once the buyer has agreed in principle to grant a security interest in the patents being sold, it is critical for the seller to ensure that it properly perfects its security interest. In most states, security interests for most tangible personal property are subject to a process dictated by Article 9 of the Uniform Commercial Code (the UCC), which also contemplates including patents and other intellectual property, such as copyrights and trademarks, in the scope of the security interests governed by Section 9-101 of the UCC . While in most instances reliance on the UCC process alone to perfect a security interest is adequate, in the case of patents (and most other intellectual property), this is not necessarily the case; rather, it is important to also follow the process for recording security interests in patents with the United States Patent and Trademark Office (see, 35 USC §261).

As patents continue to gain currency as a saleable asset, owners need to be cognizant of the substantial differences between license transactions and sale transactions. In particular, while the cash-flow impact may be similar, in the event of a breach, a licensor’s remedies for a failure to make royalty payments under licenses are very different from a seller’s remedies for a failure to make installment or earn-out payments under a sale contract. Accordingly, unless payment of a purchase price is otherwise guaranteed, patent sellers need to consider, and in most instances insist on obtaining, a security interest in the patents being sold.

Contributing Author

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Jeffrey C. Johnson

Jeffrey C. Johnson is a partner in Pryor Cashman’s Intellectual Property Group. He is experienced in the transactional aspects of technology and intellectual property exploitation...

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