Information Meeting On Intellectual Property Financing

World Intellectual Property Organization Geneva

March 10, 2009

Software Financing Structures and PoliciesLeianne S. Crittenden

Vice President, Chief Counsel Oracle Financing Division

Agenda

Business BackgroundBusiness Factors Driving

Transaction StructureLegal BackgroundTransaction StructuresPolicy Considerations for

Software FinancingQ&A

Business Background

Oracle Financing – Global Locations

Oracle Financing 50+ countries

Andorra to New Zealand (not Zaire-yet!)

20 years experienceAll credit rangesAll products (license, support, consulting, distribution rights)Provide alternative payment structures for customers to acquire Oracle products and services

Installment Payment Agreements Leases

Transaction model

Oracle originates the order for a license or services transaction with a customer

Oracle Financing enters a separate financing contract that replaces payment terms in the order

The financing contract is assigned to a financial institution on a non-recourse basis

License relationship between Oracle and customer remains intact

“Vendor” model integrated with sales of products; not a retail/third party financing model

Transaction Structure / Vendor Finance Model

Conduit for Secondary Market

Oracle Customer

Software

License

Assignment Financing Contract

Bank/Lessor

Business Factors Driving Transaction

Structure

Business Factors Driving this Model Sales Cycle/Payment flexibility

– Customers may choose to pay cash or enter financing contract as they decide to acquire products or services

Software Accounting Rules: SOP 97-2– Presumption that extended payments

(more than 12 months) are not “fixed and determinable” so revenue is recognized as cash is received

– Presumption can be overcome if the vendor has a “track history” of collecting on the original payment terms without concession

Program is designed to preserve rights of licensor, licensee and funder

Questions and comments over the years “Software Financing- that’s a very funny

idea” “It’s just air” “Can you do that?” “How do you do that?” “How do you lease something you don’t

own?” “You can only lease tangible goods; it’s

against the law to lease software” “Software has no value” “Why would I do this?”

Some possible responses “Software Financing- that’s a very funny

idea”– Ha, ha: there has been a dramatic shift in

value of assets financed from primarily hardware (which is quickly obsolete) to software (which retains its value if technical support provides software updates and bug fixes)

“It’s just air”– But it is very expensive air, check the revenue

numbers for software companies “Can you do that?”

– Yes, but it could be made easier with statutory endorsement

“How do you do that?”– I’m going to tell you

Some possible responses (cont.) “How do you lease something you don’t own?”

– A lessor needs some ownership interest in the leased asset, and the right to let the lessee use that interest

“You can only lease tangible goods; it’s against the law to lease software”

– I hate hearing this one, then I need to ask local counsel about whether leasing laws are actually limited to “goods” – if they have a leasing law in their country

“Software has no value”– See above

“Why would I do this?”– Because if it is done right, the Funder will be paid

and it makes the acquisition of technology easier by providing a capital market for these transactions

Business BargainWhere Customer elects payments over time

Recognize revenue based on commitment

Price for licenses is based on commitment to pay

Economic value based on right to payments up-front (once order is

signed, full payment is due)

License value based on right to use up-front

(all licenses delivered upon execution of the

license)

LicensorCustomer

Legal Background

Contract Terms Reflect Expectations of Parties

Licensor wants to have its IP rights (those expressed in the license terms), as well as control over distribution of their IP; wants to be paid for the use of IP

Licensee wants its rights under the IP License; rights to use, rights to claim directly against the licensor

Funder wants to be sure it is paid, and needs an effective remedy

Transaction Structure and Terms License is separate agreement between

Licensee/debtor and Licensor– terms reflect ongoing relationship and

obligations– defines terms of use, duration, restrictions

Payment terms– Can be cash pursuant to terms of license– Customer can elect to enter a Financing

Contract  Financing Contract

– Separate contract from the license– Replaces payment terms in license– Allows payments over time– Changes timing of payments, but not whether

there is a payment obligation

Transaction Structure: Assignment Financing Contract can be assigned

– Funder pays Licensor the value of the discounted cash flows

Licensee has unconditional payment obligations, and agrees that it has no claims against Assignee

Financing Contract explicitly preserves Licensee’s rights under the license against the Licensor

Assignee may enforce remedies in financing contract directly against Licensee

– Funder may exercise its remedy to terminate the license under the financing contract

Assignee acknowledges that Licensee’s use of the license also continues to be subject to the license

– Licensor may terminate the license upon a default (eliminating Funder’s ability to terminate the license -- the “Poof” theory) 

Legal framework for IP is inconsistent

Current commercial, insolvency and intellectual property laws are inconsistent

These laws all have different, but legitimate, objectives Commercial law seeks to facilitate the use of capital

by providing clear statements of rights, priorities and remedies

Insolvency law seeks to reorganize or liquidate a debtor in the most efficient manner to the benefit of all creditors, in accordance with their rights under commercial laws

Intellectual property law seeks to protect owners of ideas, images and processes, and allows them the right to obtain value from the distribution of those assets

Transaction Structures

Structures for Software Financing Contracts –IPA

Provides for installment payment terms to acquire a specific asset – not a general credit facility to an entity

Terms include an unconditional promise to pay, and specific events of default and remedies 

Licensee has a license from the Licensor (under the terms and conditions of the license), but the license is subject to the remedies in the IPA

Licensee agrees that Licensor is permitted to observe the exercise of remedies by funder

Licensor confirms to funder that it will observe remedies exercised by funder observe any exercise of remedies by the funder

Structures for Software Financing Contracts - Lease

The “asset” that is leased is the right to use the license, and the Lessor obtains that right (either from the Licensor directly or from the Licensee with Licensor’s consent)

– The leased asset is not the intellectual property In order to provide a lease, Lessor must acquire an asset to

convey to the “lessee” through the lease contract (otherwise the transaction is a financing arrangement)

Under the lease contract, the Licensor retains all rights, remedies and obligations except the lease of the right to use the software to protect the Lessor from assuming Licensor obligations (such as warranty and refunds for product performance, or indemnification for infringement claims)

Structures for Software Financing Contracts - Lease

The license is amended to provide the Licensee/ debtor with a limited right to use during the specified lease term, until all the lease payments are made

– Amendment of license creates a Term License

At the end of the lease term, the Licensee may (depending on applicable local law) acquire the right to use, renew the lease or return the leased software

Is it really a Lease? A Licensor owns the rights to the license, and can

structure payments and rights to use the software as it wishes

Transaction may not be classed as a statutory lease – So transaction may not be entitled to the benefits of those laws

like unconditional payments– But if it is not a lease under the statute does not mean it is not

a lease, or that the payment obligations are not enforceable– Transaction may still be classed as a lease for Licensee’s

accounting or tax purposes– The license is amended to provide the Licensee/debtor with a

limited right to use during the specified lease term, until all the lease payments are made.

A Lessor can take assignment of rights to obtain an asset to lease

Policy Considerations for Software Financing

Policy Issues to Consider in Software Financing

Whose rights will be compromised? Can all parties’ needs be met? 

Who gets paid? Does Licensor always get paid or does a Funder have priority? 

What remedies can lenders get? Asset characteristics of intellectual property are

different than tangible goods, and are always subject to the license terms

When is it appropriate to ignore restrictions on assignment in a license?

Who should have the right to control distribution?  Should Licensee’s insolvency change anything?

Acquisition Financing Rights; Priority in Payments and Remedies Does Licensor always get paid or does a Funder have

priority?  Vendors of goods (or a lessor or other party extends credit for the

acquisition of assets), can obtain priority in those goods over the debtor’s other secured creditors by obtaining an acquisition security right, and then they can claim for either payment or return of the goods.

If Licensors cannot get that priority, then a Licensor that extends payment terms to its customer (or a lessor that enters a lease for acquisition of an intangible asset) will not have priority in that license asset.

This does not reflect the commercial expectations of licensors who extend credit

Does not reflect equal treatment of all providers of acquisition financing.  

Who has Rights to Use or Control a License?

What remedies can Funders get?– If Funder is a “secured” lender, it will want to treat Licensee’s

license as “collateral” that secures the payment of the debt– They want an effective remedy to encourage payment– Does that mean that if the debt is not paid the Funder can seize

the license (and use or transfer it) even though Funder is not a party to the license and not a distributor of the Licensor?

Funder’s rights derive from the rights of its debtor, and Funder does not get any greater rights than the Licensee has

– If Licensee has no right to assign then its Funder does not have that right either

Absent Licensor consent, how can Funder assure that its exercise of a termination remedy (analogous to a repossession of tangible goods) will be effective?

Is There any “Collateral Value”?

Asset characteristics of intellectual property are different than tangible goods, and are always subject to the license terms

Licensor can always exercise its remedies if the license is breached, and can terminate the license (the “Poof theory” license has disappeared)

Since license rights cannot always be assigned, the transaction is not based on the “collateral value” (what Funder would receive upon a seizure and transfer of the license)

– “In-Place Value” is a better analysis– if the license is terminated, then how difficult is it for Licensee to replace that functionality?

Who has Right to Control Distribution of Software?

When is it appropriate to ignore restrictions on assignment in a license?

– The restrictions may be important to the Licensor and impact their business if they are ignored

Who should have the right to control distribution?– Does a Funder have any rights to ignore license terms

restricting assignments when the Funder is not a party to that license?

If it is clear that the applicable body of law (copyright, patent, trademark) will determine the characteristics of the asset and the rights of parties, then a Licensor’s rights should be protected

Should a Licensee’s Insolvency Change Any Party’s Rights? Licensors will want a confirmation that they will control the

distribution of their intellectual property, so the local application of default and remedy provisions would need clarification.

Since the Funder’s rights in its collateral cannot expand on the rights a debtor has in that collateral, if the agreement governing the intellectual property right that is collateral does not permit an assignment, then a claim by a Funder could not expand or ignore that limitation.  

A Receiver or Trustee will want to transfer assets to facilitate a reorganization of a debtor– what rights should a Licensor have to object to those transfers?

Cutting Through the Gordian Knot

How to make these models work?– Preserve the legitimate rights and

expectations of the parties– Make clear who has what rights (and

remedies) Why make it work?

– Allowing financing mechanisms for acquisition of intellectual property will increase availability for all parties

– Increased distribution can allow countries to rapidly improve their technologies and improve their economies

Thank You!

AQ&Q U E S T I O N SA N S W E R S