By Ron Borod, Esq., partner and the head of, the Structured Finance Group of Brown Rudnick Berlack Israels LLP
Intellectual property securitization continues to be a hot item in the ABS zeitgeist. Although the volume of rated IP-backed transactions has been limited, a sufficient variety of deals have been rated and closed to inspire confidence that this will be a growing asset category. The earliest ABS deals involved music royalty securitization, beginning with the much-heralded 1997 transaction backed by the revenues generated by the David Bowie music catalog, rated A3 by Moody's Investors Service.
Copyrights present both strengths and weaknesses as an asset class for the securitization market. Strengths include the fact that copyrights receive relatively reliable protection from the copyright laws for the full term of the copyright and copyright challenges are relatively rare. Special challenges include the fact that revenues generated from music copyrights are often derived from a complex mixture of sources, and it is often difficult to obtain reliable historical data on revenue performance.
Other categories of intellectual property, which have also been securitized are patents and trademarks. One of the first patent royalty securitizations was the BioPharma Royalty Trust transaction in 2000, which was backed by royalties under a licensing agreement between Yale University, as licensor, and Bristol-Myers Squibb Co., as licensee.
The license involved the patent for an HIV-aids medication. The deal used a senior-subordinated structure, consisting of $57 million in senior debt and $22 million in mezzanine debt. The senior securities, which received an A rating from S&P, were structured with a 1.6 debt service coverage. The mezzanine securities had a 1.3-times debt service coverage but received a double-A rating based on a third-party financial guaranty provided by a subsidiary of Center Re. The contributed triple-A ratings of Bristol-Myers Squibb and Yale University added credit support.
Several additional IP transactions have subsequently been rated, including film royalty receivable transactions wrapped by MBIA and Ambac, as well as a patent license royalty transaction also wrapped by MBIA. Each of these three transactions employed a revolving credit structure. The shadow ratings which were necessary for the monoline wraps were obtained on the basis of a variety of factors including overcollateralization based upon historical royalty revenues, diversity of the portfolios, credit quality of the licensees, experience of the servicer, and structural features such as isolation of the assets from bankruptcy risk.
Perhaps the most interesting of recent IP deals was the Guess? Royalty Finance LLC transaction, involving the securitization of the cash flow related to various licensing agreements involving the Guess? trademark. The securities were issued unenhanced and were assigned ratings of BBB/Baa2 by Standard & Poor's and Moody's Investors Service, respectively, which were several notches above the below-investment grade ratings of the sponsor company's debt.
The transaction had to be structured to avoid a "core asset" problem. This was achieved by having the SPV to which the trademarks and licenses were assigned re-license the trademarks back to the operating company, having the SPV pledge only the cash receivables as collateral for the notes, and having the trademarks and licenses themselves pledged only to secure the payment of principal at final maturity.
An advantage which patents and copyrights have over trademarks in a securitization context is the special treatment afforded under Section 365(n) of the Bankruptcy Code in the case of a rejection of a copyright or patent license by the licensor in bankruptcy. Section 365(n) provides that in the event of such rejection the licensee may elect to retain its rights under the license and continue to use the copyright or patent, provided that the licensee continues to perform its obligations under the license agreement.
S&P has relied on this provision in assigning a rating to the revolving patent royalty credit facility discussed above even though the unrated originator of the patents continued to hold title to the patents and assigned only the rights to royalty payments to the SPV. S&P concluded that even though the patents were not assigned, the notes could be rated higher than the rating of the licensor because even if the licensor went bankrupt and rejected the license, the licensees could continue to enforce the licenses.
The potential for IP securitization is huge. The total asset value of patents worldwide is estimated to be $1 trillion, and revenues from patent licensing alone has increased in the U.S. approximately 700 percent between 1990 and 1998.
Securitizing royalty revenues should also become an increasingly important liquidity tool for non-profit institutions with active technology transfer or applied research programs. Adjusted gross license income from patent licenses and options for the non-profit sector is in excess of $1 billion annually, and monetizing this revenue to offset predicted reductions in federal funding should be seriously considered by the CFOs of these institutions.
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