I got an injunction earlier this week that is at the intersection of patent law, the UCC, and Massachusetts equity practice and that you might find interesting. Here is the case. My client had obtained a relatively small judgment for damages against a corporation that was in financial distress. According to the last financial statement published before the company’s stock was delisted, the company had millions in debt and its only asset was a patent portfolio worth about $700,000.

The company’s lawyers wanted my client, and the other creditors too, to participate in a plan in which a new investor would assume part of the company’s debt in return for an issuance of new shares in the company. But the amount that any particular creditor would receive would not be known until the investor decided how much it wanted to invest; and the creditors had to commit before knowing the answer to that important question. I asked why my client should participate in the plan rather than simply looking to the patents as a source of recovery. The answer was that a secured creditor had a security interest in the patents.

Well. When I looked, I saw that the secured creditor had filed UCC financing statements years ago, but that no continuation statements had been filed. The secured creditor had also filed a copy of the UCC financing statement with the USPTO, which keeps a registry for filing patent assignments.

So what is the law about this?

First, in Massachusetts, you cannot take patents to satisfy a money judgment through the ordinary means of a writ of execution. That’s nothing particular about patents. You also can’t reach shares of stock or other kinds of intangible property through a writ of execution. Instead, you have to “reach and apply” the patents, either in a suit in equity or else under a statute that codifies reach and apply practice. The courts have held that patents can be reached this way. The process has two steps. First is the “reach.” The court enjoins any transfers, encumberances, etc. of the property in question. Some cases hold that this step actually creates a lien. The second step is the “apply.” The property is sold or tranferred or whatever in order to satisfy the claim.

Second, of course, you can’t take property to satisfy a judgment if some secured creditor has rights in the property that are senior to yours. So, did the secured creditor have superior rights? There are two key steps in the creation of a security interest that can defeat the claims of other creditors: attachment, and perfection. Let’s assume for our purposes that the secured creditor’s security interest attached because of the security agreement between him and the debtor. In order to perfect an interest in intangible property like a patent, it’s necessary to file a UCC financing statement in the state where the debtor is located (for a corporation, that is generally the state of incorporation). Why? To oversimplify, in cases where the secured creditor doesn’t simply take possession of the collateral (think of pawning property to secure a loan), it’s necessary to have a system that gives the world notice of the existence of security interests.

One quirk of the UCC filing system is that a financing statement lapses after five years if a continuation statement is not filed (UCC 9-515). Here, the secured creditor filed financing statements in Delaware, the state of incorporation, and (superfluously) in California, the state where the company operated. But five years and passed, and he had not filed continuation statements. In consequence, the financing statements that perfected his security interest were no longer effective. And my client was free to swoop in and try to reach and apply the patents.

Or was it?

The UCC provides that a financing statement is not necessary to perfect a security interest in property subject to “a statute, regulation, or treaty of the United States whose requirements for a security interest’s obtaining priority over the rights of a lien creditor with respect to the property preempt” the UCC. (UCC 9-311). An example is a registered copyright under the Copyright Act. Some cases have held that because the Copyright Act has its own priority scheme, which differs from the scheme in Article 9, the Copyright Act preempts the UCC and a UCC financing statement is unnecessary to perfect a security interest in a registered copyright.

What about the Patent Act? The patent laws do not address priority at all, and the USPTO’s regulations implementing the statute require recording “assignments,” but not other kinds of transfers, and they provide that other documents affecting title may be recorded, in the Commissioner’s discretion. Courts have held that the Patent Act does not have the same preemptive force as the Copyright Act, and therefore, that the UCC, not federal law, governs perfection of security interests in patents.

So in short, yes, my client could assert rights superior to the rights of the (formerly) secured creditor.

Aside from the interest inherent in this small quirk in the law, there is no great lesson here, except to “trust but verify” when someone tells you about rights that could defeat your client’s rights. There might be some way to get around what, on its face, seems like a devastating point that will deprive an unsecured creditor of any meaningful recovery.