Intellectual Property for Management:

By Charles Boulakia

This series is meant to provide the business manager with some insight, context and useful tools for how to deal with patent-based issues on a business level. This article is not legal advice or opinion. Intellectual property issues are complex and often unique circumstances need to be considered. Consult your intellectual property professional before making any decisions based on the educational information provided below.

So you’ve finally found a financial institution who will loan your business some money. You’ve worked out the broad brushstrokes – the interest rate, the amount borrowed, and the repayment schedule. You’ve even discussed the collateral – the bank has asked for a security interest in everything you own, including your intangible property. You’re pretty sure you know what this means, and that you’re willing to accept that risk.

But then you receive the agreement from the bank, and, because it’s an important loan, you actually read it. And it turns out there’s a whole lot in there you didn’t discuss in the “broad brushstrokes”.

One section is particularly worrisome. Labelled something like “borrower’s representations and warranties”, it is a long laundry list of promises about your business. One has you especially worried. It’s long and convoluted and in legalese, but as best as you can translate, it says something like “Borrower’s business activities do not infringe on any third party intellectual property”.

The problem with this clause, of course, is that you have no idea whether you infringe on any third party intellectual property. So how can you promise something if you have no idea whether it’s true? And what are the implications of making this promise?

The most frustrating thing about this clause is that, if your business (like any business) makes, uses, or sells something, there is no way you can be 100% sure you don’t infringe a third party’s intellectual property. There is no comprehensive search that can be done. There is nothing you can look up. No permit or license you can buy.

And the reality of today’s business environment is that if your business is successful enough, you will be sued by a third party for infringement of intellectual property. Whether you actually infringe that intellectual property or not will take years to determine (if it’s ever determined at all). And based on the outcome of that suit, dozens of other “third parties” may come out of the woodwork contending that you infringe their intellectual property.

So, as a manager, who is negotiating the loan, how do you deal with this clause?

The easiest thing to do, short term, is to accept the risk of this clause as part of the cost of doing business. You won’t notice a cost to this on signing, and the clause is unlikely to have any implications until you are sued for infringement. The problem is that if/when you are sued for infringement, the bank may hold you in breach of your loan agreement. The last thing you need while preparing for expensive and time consuming litigation is a financing emergency like a bank calling an important loan. But for a short-term loan, this might be a viable option.

The opposite strategy is “striking out” the representation. If you can get the bank to agree to this, fantastic. But it’s unlikely. After all, they put it in for a reason. The problem with being sued for infringement is that it eats up money, fast. And the bank isn’t lending money for this purpose, since there’s no revenue stream that will result from this spend. They want to mitigate their risk, and this clause does that.

So what to do?
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Like any clause, sometimes you can work out a middle ground. By adding a “knowledge” qualifier to the clause, the risk is shared. But there are subtleties to “knowledge” qualifiers that determine how the risk is shared. The minimum risk to the company would be a clause saying “to the actual knowledge of the Company, the Company does not infringe any third party intellectual property”. If you are unaware of any infringement at the time the loan is signed, you’re OK. More onerous is a clause saying “to the knowledge of the Company, after due inquiry”. “Due inquiry” can mean a patent freedom to operate search and opinion from a reputable law firm, as well as trademark opinions.

The cost of such opinions can easily be in the tens of thousands of dollars – a cost that must be added to the cost of the loan. Even more troublesome is that such an opinion can take weeks and often months to prepare – which can mean holding up the financing. Beware of the third, even more onerous “best of the Company’s knowledge” clause – it is unclear what “best” means, and it may require even more cost and diligence.

Another creative option is to strike out the clause, but to replace it with a warranty that the Company will perform regular freedom to operate searches and will inform the bank of any pertinent results. These searches are a good idea anyway, so if you can convince your bank to agree to this, you’re in good shape (though sharing the results with your bank is another, complex issue, best left for another article). A sophisticated bank may agree to remove the clause if you can provide them with evidence that you have performed regular, diligent searches of the intellectual property landscape, have not found any issues, and agree to continue doing so.

At the end of the day, the “borrower’s representations and warranties” determines how certain risk is shared. The bank’s first draft will push as much risk as possible to the company. Even though it doesn’t appear to directly effect the bottom line (i.e. the cost of the loan), understanding the repercussions, and how and why to mitigate that risk, is a key part of the manager’s job in negotiating the agreement.

Charles Boulakia is a patent attorney with the Toronto-based IP firm Ridout & Maybee LLP, cboulakia@ridoutmaybee.com.
www.ridoutmaybee.com