In today’s post we will discuss a common issue that comes up in secured deals: anti-assignment restrictions on collateral.
Let’s start with a basic example: Our company is a licensee of a valuable software license that is integrated into its products that would not work without it. The licensor naturally wanted to control who held the license, so it prohibited any assignment of the license without the licensor’s consent. Our company is borrowing money from a bank that wants to take a blanket security interest in all of the company’s assets as a condition to the loan.
The question for both the bank and the company is what can and should be done about the license that on its face cannot be assigned. From the bank’s perspective, how important is the license to the bank? In other words, how critical is the bank’s ability to step into the company’s shoes and foreclose on the license?
In cash-flow deals,unless the license represents a very substantial part of the collateral, the bank is less likely to want to go an extra mile to ensure that the pledge of the license is fully buttoned up. In such deals, borrower’s counsel often requests (and gets) a carveout from the collateral grant excluding the collateral that cannot be freely pledged until the law overrides the restrictions on assignment or the licensor consents to the pledge (and still, banks sometimes may require the company to at least try to get the licensor’s consent). Such a carveout would protect the company from potentially breaching its promise to the licensor not to assign the license without its consent. More on the legal overrides in our next post (we will try to keep you awake through that one!).
By contrast, in asset-based deals, the license may have played a critical role in the bank’s credit approval process. If that is the case, both counsel will need to analyze whether the license restrictions are invalidated by the legal overrides and to what degree. We say both counsel because even if the company is willing to bear the risk of breaching its license terms, the company’s grant would not do any good to the bank if its critical objective of foreclosing on the license after default cannot be met.
To sum this up, if the license is a critical component of the collateral package, the bank is likely to require the company to obtain the licensor’s consent in order to protect the bank’s rights to foreclose on the license.
As we conclude, just for the fun of it, let's flip our example and have the licensor be the borrower of the loan. Imagine that the license and the payment stream from it represent substantially all of the licensor’s assets. Now, even in a cash-flow deal, the bank may be especially interested in ensuring that it can foreclose on the license and the revenue stream. The law, not surprisingly, treats different collateral differently, giving more protection to the bank if the revenue stream has been assigned (as opposed to the license itself). We will cover this in more detail in our next post, but to avoid keeping you, our readers, in suspense, let’s just say that in this case the bank can rely (more comfortably than in the first example) on the law’s protections of its right to foreclose on the license and dispense with getting the licensee’s consent.