IP Financing in India – Part II: The Supreme Court and (mis)interpretation of Banking Regulation Act, 1949

Part I of this two-part guest post by Bharat Harne explored the implications of a complicated security perfection regime and non-mandatory registration of copyright on IP financing. Part II focuses on the   Canara Bank v N.G. Subbaraya Setty & Anr, a Supreme Court decision from 2018, that made some important observations on the use of trademarks as collateral. Bharat is a fourth-year student at the National Law School of India University, Bengaluru.

IP Financing in India – Part II: The Supreme Court and (mis)interpretation of Banking Regulation Act, 1949

Bharat Harne

The main question of law before the court in Canara Bank pertained to res judicata. However, it is infamous for unduly restricting the use of the intellectual property as collateral for financing transactions. N.G. Subbaraya Setty owed money to the Canara Bank. When he found it hard to repay the money, he assigned the trademark “EENADU” to the bank through which it received all the rights relating to the trademark, including, the right to use the trademark on its own and assign it to third parties. After a few months, the bank canceled the assignment deed citing banking regulations. After years of complicated litigation, the dispute finally reached the Supreme Court where the bank justified the cancellation of the deed because there was a regulatory bar. This justification was accepted by the court. It held that a combined reading of sections 6, 8, and 46 (4) of the Banking Regulation Act, 1949 leads to the conclusion that banks cannot be assigned all rights in a trademark because this would make the bank the owner and give it right to further assign the trademark and use it on its own to sell goods and earn money. According to the court, this would be in teeth of sections 6 and 8 of the Banking Regulation Act which collectively prohibit a bank from dealing with property or selling goods except when it is done to satisfy its claim.  It has been argued that this holding virtually disallows the use of the intellectual property as collateral.

Indeed, the holding of the court is questionable. Section 6 (1) (f) contemplates a bank ‘managing, selling and realizing any property which may come into the possession of the company in satisfaction or part-satisfaction of any of its claims’ and ‘dealing with any property, any right, title or interest in any such property which may form security or part of the security.’ This was a clear case of a bank managing a property in satisfaction of its claim. When these provisions were cited before the court, it simply responded by holding that ‘trademark cannot be said to be a property which has come into possession of the bank’ and neither is it any ‘security for loan or advance’ made to Mr. Setty.  The court did not realize the fact that intellectual property is intangible in nature, therefore not subject to possession. Moreover, it is true that the trademark was not a part of the original security furnished by Mr. Setty. He decided to collateralize the trademark when he could not pay his installments. However, the bank was, in any case, managing it in satisfaction of its claim as per section 6 (1) (f) of the Banking Act. Having said this it should be noted that-

First, in the facts of this case, the assignment was not the original security that was furnished by Mr. Setty and this was the basis of holding that it is not ‘security for loan or advance’ under section 6 (1) (g). This argument would be extremely hard if not impossible to make if the assignment is part of the original security furnished before the disbursal of the loan.

Second, rather than assigning all the rights relating to intellectual property, the borrower can choose to assign merely the right to receive the royalty (if any) from that trademark through assignments done by the owner himself. In this case, the bank would not have a ‘right to assign a trademark to third parties with which the court was uncomfortable.

 Third, the parties still have the choice to resort to other security arrangements which do not involve the transfer of title of the property. For example, the security arrangement can give the borrower only the right to sell the property on default with no transfer of complete title. In such a case, the bank would be merely selling the property to meet its claim rather than ‘managing’ it.

A brief comparison with the UK : Legal Assignment

Having said this, the holding of the Supreme Court is a major obstacle to the use of intellectual property as security in financing transactions. In jurisdictions such as the United Kingdom, the use of assignment for creating a security interest is quite common. Usually known as ‘legal assignment’ in such a transaction, the owner of the intellectual property transfers all rights to the property to the bank with a proviso that when the owner repays the loan amount, the property will be compulsorily reassigned. If continued exploitation of the intellectual property is necessary, the owner usually gets an exclusive license from the borrower.

This two-part post has identified three key issues that IP Financing reforms have to address at any cost. The Patent Act and the Trademarks Act have clear compulsory registration requirements without which the security interest cannot be perfected. While this gives certainty to lenders, it creates a complicated security perfection regime that disincentivizes the use of IP as collateral. In stark contrast to this, the absence of a mandatory registration requirement under the copyright law is a major disincentive for financial institutions to accept it as collateral because of the practical difficulties involves in tracing the title. Lastly, the Supreme Court’s overly broad reading of the banking law in Canara Bank is a major hurdle in the use of IP as collateral, although, there are still some ways to circumvent its applicability and use IP for financing.

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