Security Interest in a Patent Is Perfected Under the U.C.C., Not the Patent Act

In Moldo v. Matsco (In re Cybernetic Services, Inc.), the Bankruptcy Appellate Panel of the Ninth Circuit ("BAP") affirmed the bankruptcy court's holding that perfection of a security interest in a patent does not require a filing with the United States Patent and Trademark Office ("PTO"). Thus, a security interest in a patent is perfected against lien creditors, including a bankruptcy trustee, if it is properly recorded in accordance with Article 9 of the Uniform Commercial Code ("UCC").

The primary asset of the chapter 7 bankruptcy estate of Cybernetic Services was a patent for a specialized device designed to capture data from a video signal. Matsco and an affiliate had a blanket security interest in all of Cybernetic's assets, including the patent. The security interest was properly registered as required by Article 9 of the California Commercial Code, but no documents were filed with the PTO. When Matsco moved for relief from the automatic stay to foreclose its security interest in the patent, the chapter 7 trustee objected, arguing that Matsco did not have a perfected security interest in the patent because it had not made the appropriate filing with the PTO to perfect a security interest in the patent.

The Court's Reasoning

In reaching its determination that the UCC, rather than the Patent Act, governs the perfection of a security interest in a patent, the BAP examined the relationship of the federal Patent Act and Article 9 of the UCC, as adopted in California. The court observed that federal law preempts state law when there is a direct conflict, where state law would frustrate a federal scheme, or where Congress clearly intended to occupy the field. Moreover, under the UCC, a security interest in property subject to a federal statute that provides for national registration of security interests can be perfected only pursuant to the procedures set forth in that federal statute. The UCC also excludes from its scope security interests to the extent that federal law "governs the rights of parties to and third parties affected by transactions in particular types of property." Thus, the issue in Cybernetic Services was whether the federal patent registration system preempts state law or excludes the perfection of security interests in patents from the scope of the UCC.

Section 261 of the Patent Act provides that an interest in a patent is assignable, and "an assignment, grant or conveyance shall be void as against any subsequent purchaser or mortgagee" without notice of the assignment unless the assignment has been recorded in the PTO. Accordingly, in the court's view, whether the perfection of security interests in patents is within the scope of the Patent Act depends on whether the term "assignment" in that statute includes the grant of a security interest and whether every secured party and lien holder is a "mortgagee."

Relying on case law, a Supreme Court decision on patent mortgages, and the administrative rules regulating the PTO, the BAP concluded that in patent law, the term "assignment" involves the transfer of title, not the creation of a security interest. The BAP noted that the focus of the Patent Act recording provisions is the transfer of title, and the rules regulating the PTO define assignments as "transfers by a party of all or part of its right, title and interest in a patent or patent application." The court contrasted the omission of any reference to security interests in the regulations governing the Patent Act with their express inclusion in the Copyright Act, where "transfer of copyright ownership" is defined to include "hypothecation," that is, a pledge of property as security for a debt without transfer of title.

No Preemption

The BAP concluded that the Patent Act's failure to include security interests within its scope means that it does not preempt state methods of perfecting security interests in patents. It contrasted the Patent Act with the Copyright Act, which regulates transfers, including security interests and, thus, preempts state law methods of perfecting security interests in copyrights. The court stated, "[b]ecause the Patent Office records security interests on a discretionary basis and such recording does not provide constructive notice, the Patent Act registration system is insufficient to provide the sole method of perfecting security interests in patents." Noting that the Patent Act contains no requirements governing the perfection of security interests, and no provisions concerning the relative priority of security interests or judgment liens, the BAP concluded that these matters should be governed by Article 9 of the UCC, where they are fully addressed. Therefore, the BAP affirmed the determination of the bankruptcy court that Matsco had properly perfected its security interest by filing in accordance with Article 9 of the UCC and that, accordingly, the bankruptcy trustee could not avoid Matsco's security interest.

Ongoing Uncertainty

The decision in Cybernetic Services is consistent with other cases that have considered the issue of perfection of security interest in patents, but the situation for lenders looking to a borrower's patents for collateral remains unclear. Although the decision might appear to make it easier for creditors to perfect security interests in patents because filing under the UCC is easier and less costly than registration with the PTO, the lack of a clearly designated jurisdiction in which to file, such as exists for real property, and the absence of a central filing system, such as exists for copyright, make it difficult for a potential lender to search any existing security interests. Therefore, to be certain that there is no prior perfected security interest, a potential lender would have to undertake a costly and time-consuming state-by-state search.

Additionally, although the court in Cybernetic Services held that a secured creditor could properly perfect under the UCC and obtain protection against competing lien creditors, the Patent Act is controlling as to title and, as a result, perfection under the UCC will not protect the secured creditor against a bona fide purchaser or mortgagee who records with the PTO. As the Cybernetic court stated, although the PTO records lien-type security interests on a discretionary basis, such recording does not provide constructive notice. As a result, it appears to be impossible to perfect a lien-type security interest in a manner that would be effective against a subsequent bona fide purchaser. To protect itself, given the current state of the law, a creditor seeking a security interest in a patent might wish to formulate the security interest as an assignment and record it at the PTO and at the appropriate state offices in accordance with Article 9 of the UCC. However, the creditor undoubtedly would want to structure the transaction to ensure that as the title holder, it would not assume the responsibilities of patent ownership, such as the prosecution of patent infringements.