Security interests for tangible assets have long been used by lenders to ensure payback. Setting up a loan with a security interest attached to the property as collateral makes sure that either the lender will get paid, or the lender will have an interest in the property upon default. The lender can then rely on the market to buy back the asset, thus returning to the lender the cash it lent. This lowers the risk of a loan, giving the lender the ability to charge lower interest rates. For example, compare your car interest rate (if it is secured) with your credit card interest rate (unsecured).
It is also possible for intangible assets to be used as security interests. This is good news because intellectual property is quickly becoming the most prized asset of many companies. According to the USPTO, U.S. intellectual property is worth more than $5 trillion. This means that IP in the U.S. is more valuable than any other country’s nominal GDP. Patents and patent applications make up a large portion of such intangible assets. A creditor uses the patent or patent application as collateral to secure the repayment of a loan by a debtor or when a seller takes a security interest in purchased goods to secure payment of the purchase price.
While both intellectual property and traditional property can be used as a security interest, it is interesting to note a practical difference in this increasingly important type of asset. When tangible property is used as a security interest, typically the borrower wants a piece of property and is willing to offer it as collateral for a loan in case the borrower defaults. For instance, I want to buy a house, but I can’t afford the entire amount. So the bank steps in to loan me the full amount provided the house will be secured as collateral to ensure that I pay the bank back. This type of arrangement is referred to in property law as a purchase money mortgage. Unlike tangible transactions, where the property secures the loan to the property, patents and patent applications are instead classically used to ensure payment of unrelated loans. For instance, rather than the lender securing interest in the patent for the reason of the borrower buying the patent (like traditional tangible property), with intangible property the borrower uses the patent he already has to ensure payment of an unrelated loan. One reason for this is that patents typically are more of a niche market. For instance, lots of people will want to buy your house or car from the bank if you default. But depending on the technology that your patent comprises, it might be tough for the lender to get the invested money back.
However, it seems to be increasingly common for patents to change hands. As companies inevitably merge, get acquired, go bankrupt, or shift focus, valuable patents, through auctioning, liquidating and selling, are changing hands. For instance, most recently in the news, Novell’s patent portfolio being sold off, Nortel’s patent portfolio being auctioned, and RPX, which maintains a large patent portfolio to ward off infringement suits for its clients, just came out with its IPO. The more that patents and patent applications change hands, the more accurate the valuation of such transactions. This will lead to the secondary market being more willing to enter the secondary market. Furthermore, as companies continue to seek to strengthen their patent portfolios, I foresee intangible property being used in very similar ways as tangible property. Company X will try and buy patent Y with a loan and use the patent as collateral for the bank to use as a security interest.