• Paul Peter Nicolai

IP in Project Financing



Power plants, manufacturing and logistics facilities, and other infrastructure projects are not typically seen as operations in which intellectual property (IP) plays a key role in maintaining continuous functionality. IP of all types is often an afterthought in a lender’s due diligence and documentation. Project sponsors may not recognize the need to obtain and protect their rights to use IP which may be essential to their business. Given the state of today’s computerized and technology focused world, however, both project sponsors and lenders should take a careful look at the technology and IP risks inherent in a project and work to assess and mitigate those risks.

In many cases, the project sponsor and the lender will have a common interest in making sure the right provisions are in place to protect a project company’s ability to use essential technologies. A lender needs more. It will have to ensure that it has the ability to use key technology in a foreclosure or sale scenario. This memo provides an overview of issues project sponsors and lenders both should ensure are addressed for the operational stage of a project, provisions that lenders should be sure are in place in the event of a foreclosure and subsequent sale of a project, and concerns to look for in due diligence of a project.

We focus here on US IP issues, where IP protection laws are strong and are generally enforced. Other significant issues can arise when technology is transferred to jurisdictions where IP interests enjoy more limited protection. If IP will be transferred outside the United States or is being licensed from outside of the United States, more work will need to be done to determine what protections are available and help the technology owner or licensee assess the risks associated with the transfer or use of the IP.

Project companies can use technologies that are subject to IP protection through copyright, patent or trade secret laws. Software, protected by copyright laws and possibly as a trade secret, is used in the operations of many facilities. Software is commonly used to operate and monitor machinery like wind turbines and conveyor belts, to track consumption of power and to track delivery mechanisms like connectivity to the electrical grid.

Patents are the category of IP most often associated with infrastructure projects. Ensuring that a project company has the right to practice any patents that might cover its use of machinery or processes is essential to ensuring continuous operations. In addition, care should be taken to ensure that a project does not infringe on third-party patents, as injunctions prohibiting infringing operations could also stop a project from operating.

Companies also seek trade secret protection for technologies that require confidentiality or are not otherwise protectable. Formulas like the composition of fracking fluid, chemical processes, and refining and extraction methods may be trade secrets. Trade secret protection is often used to protect technologies where infringement is difficult to detect, where protection for a term longer than the patent term is desired, or where patent or copyright protection may not be available. Constant vigilance is needed to maintain trade secret protection. A trade secret holder must ensure that a secret formula or process is disseminated within the company only to trusted employees or consultants who have signed nondisclosure agreements or are otherwise subject to policies regarding confidentiality. When disclosing the secret information to third parties like contract counterparties or financing sources, the information should be similarly subject to a strict confidentiality agreement and should be revealed on a need-to-know basis. Some courts have required that to qualify for trade secret protection, the owner of the trade secret must have taken action to physically protect the trade secret. If the design of a power plant is intended to be kept as a trade secret, for example, protecting the design as a trade secret may also require physical security limiting visitors to the plant.

JOINT IP AND TECHNOLOGY CONCERNS

Rights to Use IP

Typically, a project company will not hold title to IP itself. IP will usually be licensed either from the project sponsor or a third-party provider. In either case, be sure the project company has an appropriate license to use the IP to the extent contemplated for the project. IP licenses can be standalone or can be part of a construction, equipment supply, or operations and maintenance agreement.

Where IP is held by the project sponsor, the sponsor should enter into a separate license agreement with each project company on arm’s length terms. Tax and valuation experts may be needed to determine the appropriate royalty based on the project sponsor’s internal valuation of the IP.

If the project sponsor owns the IP, it should be sure it holds valid title to the IP it will license to the project company by ensuring it has appropriate IP assignment agreements from founders, employees and consultants who contributed to the IP development. If a contributor later decides to leave the business and has not assigned IP to the project sponsor, it may be difficult to negotiate a cost-effective transfer of IP. Project sponsors should also consider whether to enter into noncompetition agreements with key IP contributors so that they are unable to take the ideas behind key IP and use them in competing ventures. If patent protection will be sought for the technology, each inventor will need to execute a separate document to assign the patent application to the entity seeking to own the application. The Patent Office will require these separate assignments to assign the patent application and any resulting issued patent to a company entity.

If the IP for the project is to be licensed from an unaffiliated third party, the license will typically be between the project company itself and the licensor. In some cases, the licensor may require a project sponsor guarantee of payment of royalties and other obligations (like indemnity obligations) in the license. In other cases, the licensor may want to enter into a license agreement with the project sponsor directly. In that case, the project sponsor will need to enter into sublicenses with each project company that will use the IP, and the project sponsor should be sure the license includes appropriate rights to sublicense the IP to its project companies.

IP licenses from unaffiliated third parties will generally restrict the field in which a project company may use the licensed IP. Typically, the project company may only use the IP for the specific project contemplated when the license is entered into. If it is anticipated that the project will be constructed in stages, or that the facility may expand over time, the licensee should get a provision that would permit expansion of the scope, rather than trying to negotiate an expansion when the need becomes critical. At that point the licensor may either decline to amend the license agreement or demands a high price for the expansion. This could be done by including an option right in the license agreement with pre-negotiated pricing and other terms that would kick in if the option is exercised.

Software License Provisions

Licensees should confirm any software license contains provisions requiring the licensor to maintain the software, including fixing code errors as they are identified and providing the most updated versions. If the license does not provide this right, a separate software maintenance agreement may be needed. Failure of a key software program can paralyze operations. For example, if monitoring software is no longer able to determine when project equipment exceeds tolerance levels, the plant may become unsafe to operate or may fail to meet regulatory requirements.

A licensor will not typically give the project company or sponsor permission to modify software (even to fix malfunctioning code), and will only provide the project company with “object” or “run-time” code to the software. However, the project company or sponsor may be able to negotiate an escrow arrangement where the licensor deposits the “source code” with a trusted escrow provider. Under a standard source code escrow arrangement, if the licensor files for bankruptcy or otherwise ceases to do business or, in certain cases, to fulfill its code maintenance obligations, the project company or sponsor would have the right to receive the source code and to edit and repair outdated or malfunctioning code. As a practical matter, the project company or sponsor may not have the expertise to maintain or repair the code. Other options, like the right to hire a third-party vendor to host, maintain and repair the software, should also be considered in the negotiations.

Unfortunate Events

As with any other aspect of a project, things can go wrong with IP. Project sponsors, project companies and lenders should all attempt to mitigate the risks that can arise in the event of a technology or IP-related issue.

Claims that a project is infringing on a third party’s IP can stop a project indefinitely if a court issues an injunction preventing further infringement. Even without an injunction, important resources could be tied up in litigation for years. For software, equipment and other materials purchased or licensed from third parties, project sponsors and lenders should be sure the license or sales agreement contains provisions to address potential infringement claims. The licensee or transferee should ask for a representation that the purchased or licensed technology is non-infringing, including specific indemnity for infringement claims. Licensees often request a provision that would require the licensor or seller to provide a non-infringing version if the technology is later discovered to infringe on third-party IP. Many technology providers resist this since changing technology to make it non-infringing can range from modifying a few lines of code to completely redesigning a piece of equipment and instead often offer a partial refund

of the license fee. However, shutting down operations while searching for replacement non-infringing IP is not an ideal solution for project operators, so this subject is heavily negotiated.

As part of the development of a project, sponsors can also do patent searches and software code searches to determine if the technology they plan to use could be considered to infringe third-party IP. If a project sponsor has developed a new patentable technology, it should consider whether to apply for a patent in that technology or to maintain it as a trade secret. This calculation is sometimes difficult one to make. Once an inventor applies for a patent and the application is published, the described in the patent application can no longer be protected as a trade secret and may be subject to a complete loss of protection if the patent application is denied. However, even if a patent is not granted, publishing the invention will block third parties who later try to obtain patent protection since US patent protection is given on a “first to file” basis. That said, prior use of a technology will not prevent a third party from getting a patent and filing a patent infringement claim if the project sponsor’s use of the technology remains secret, though a prior use defense to the infringement claim could remain available to the project sponsor.

Certain processes and formulas are maintained by project sponsors as trade secrets. Patent protection expires after a set time (most typically 15 or 20 years from the date of filing depending on the type of patent) and thereafter are usable by anyone. Software may also be protected as a trade secret if it is maintained in confidence. Trade secret projection is easily lost. If the secret technology becomes public knowledge, it is no longer a trade secret. Trade secret protection is also of little use against a third party who independently develops competing technology. Loss of trade secret protection may not derail a project, but it can make a project less profitable as others exploit the technology. Project sponsors and lenders should be especially careful when working with government authorities that may require disclosure of new technologies either to the public or to the governmental agency, which may not be as careful with secret information as the owner.

If a licensor goes bankrupt, it has the right to assume or reject executory contracts, including most IP licenses. Section 365(n) of the U.S. Bankruptcy Code provides special protection for IP licenses. If the bankrupt licensor or its trustee rejects a license, a licensee can elect to retain its rights to the licensed IP. In return, the licensee must continue to make required payments. The licensee also can retain rights under any agreement supplementary to the license, which should include source code or other forms of technology escrow agreements. Project sponsors (and lenders) should be sure that technology licenses specifically state that they are subject to Section 365(n). Such a provision is helpful to ensure a bankruptcy court or trustee will be persuaded that the bankrupt licensor may not reject the license. Section 365(n) will not require the licensor to perform any services like maintenance or updates. Given that in many cases licenses to project companies are embedded in other services contracts, project sponsors and lenders should be sure that if a key service or equipment provider goes bankrupt, another provider is available to take its place. Even where the only service provided by the licensor is continued maintenance of the IP, the project company should get a source code escrow with the right to maintain the software itself or to hire a third party to do so in the event the licensor enters bankruptcy.

LENDER CONCERNS

In addition to joint concerns, a lender will want to make sure it has additional protections if the project company defaults. Following a default, the lender may permit the project company to continue to operate the project, but often the lender will want to be able to step in and take over if the project company proves itself unable to continue operations in a way that ensures a consistent revenue stream. Lenders should seek a number of protective provisions in their agreements with debtors to ensure they have sufficient IP rights to operate the project without interruption in a foreclosure.

Third-Party License Protections

While a project lender will want to confirm that its agreements with the debtor provide the lender with a security interest in the IP (including licenses) necessary to operate the project, a security interest is not enough. While the Uniform Commercial Code permits a lender to obtain a security interest in and “foreclose” on an IP license, preventing the debtor from exercising rights thereunder, a foreclosing lender cannot enforce the license against the licensor unless the license permits it to. IP licenses typically prohibit the licensee from assigning the license to an unaffiliated third party. While the Uniform Commercial Code says that such a prohibition cannot be used to prevent a licensee from granting a security interest in a license, case law is unsettled as to whether a lender who forecloses can enforce the license or is limited to getting the proceeds of the license if it is transferred or sold. Lenders deal with this by seeking to have licensors of key technology consent to the assignment of the license when and if the lender has the right to initiate foreclosure proceedings against the licensee.

Typically, lenders will insist that the licensor execute a consent to collateral assignment granting the lender affirmative “step-in rights.” This document is an agreement by the licensor that the lender will be permitted to enforce the license upon a foreclosure where it operates the project. The lender will also want the right to “step out” if the lender desires that the project company or sponsor resume operation of the project, so that the lender does not have continued responsibility for the obligations under the license. The lender will also want the licensor to agree that the license may be transferred if the lender sells the entire project in a foreclosure or similar process.

The consent also generally includes other provisions protecting the lender like a prohibition on amending the license without the lender’s written consent. The lender will also want to have the right to cure any breach or default under the license on the part of the project company, with additional cure periods extending after the expiration of any cure period in favor of the project company. In a typical case, any expenses incurred by the lender in curing any default will become obligations of the project company under its financing documents

Project sponsors will often be required to be the conduit between the lender and the licensor in negotiating step-in and related rights in the consent. Some licensors may need to be educated both about the need for the lenders to have these rights and the ability of the lenders to understand licensed technology and abide by license terms.

Project sponsors should take a potential foreclosure and the exercise of lender step-in rights into account when structuring their licensing arrangements generally. A sponsor may want to avoid a hub-and-spoke model where the sponsor is the party to the inbound license, granting sublicenses to individual project companies. While this may seem efficient, if a project goes into foreclosure or a lender wants to exercise step-in rights, it will be easier to do if the project company is the only licensing party to the license. If the third-party licensor requires the project sponsor to guarantee the obligations of the project company under the license, the licensee should have the agreement provide that the guarantee automatically terminates if the license is transferred in a foreclosure sale. Lenders are likely to insist that the project company be party to the main license agreement since lenders will not want to take the risk of sponsor nonperformance or bankruptcy.

Other Issues in Sponsor Licenses

Lenders will want to be sure licenses from project sponsors to project companies include the same step-in rights for the lender that would be included in a third-party license. Licenses from project sponsors should otherwise be on arms’ length terms. This is important should a foreclosure occur, where a project sponsor may find itself in a licensing relationship with a nonaffiliated third party. Payment provisions, including provisions related to taxes, should be clearly laid out and should not include intercompany discounts. Indemnification and limitation on liability provisions are also important, as are restrictions on the field in which the licensed IP can be used. The project sponsor should document the deal accounting for the possibility that the project will cease to be operated by an affiliate in the future. When foreclosure looms it will be too late to make significant changes. A lender is likely to prohibit any changes for the benefit of the project sponsor at that point.

BEFORE THE FINANCING

Besides negotiating these provisions, project sponsors and lenders should work together to make sure the lender understands the technology and IP that will be used in the project and the various third-party rights and licenses that will be required. Ensuring the lender has a good basis for understanding the project’s technology will not only make the lender more comfortable with the project, but will also enable the lender and the project company to reach the best solution for the many technology issues that can arise.

Project sponsors should be forthcoming with lenders regarding technology and IP due diligence. If the project sponsor has conducted a patent search, the sponsor should consider sharing the results with the lender. Lenders also may wish to conduct additional diligence on providers of key technology. Project sponsors should help with that diligence. If a lender is there at the start of the project, the lender may want to review and comment on license agreements.

Technology and IP issues are one aspect of the complex negotiations parties must work through in a project financing transaction. If ignored they can have a significant impact or even stop operations when problems arise. In order to take full advantage of a project financing opportunity, sponsors need to invest time and resources before construction starts to work through not only traditional “project” issues like construction and loan terms, but also technology and IP concerns that could impact the ongoing operation of a project.

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