Promissory Notes: Practical Considerations When Entering Into A Note

By: Serge Filatov, Esq.

One of the easiest ways to document a loan is through the use of a promissory note. Practicing here in Silicon Valley and San Jose, I have documented countless promissory notes for clients. If you are considering entering into a promissory note, whether as a lender or borrower, you should know the basic options that you have in structuring the note.

Before we delve deeper into the specifics of preparing promissory notes, one thing to keep in mind is that a promissory note is often entered into as part of a larger loan package. While some loans are just made with a simple promissory note, other loans are made with a variety of documents, which can include documents like a promissory note, loan agreement, security agreement, deed of trust, subordination agreement, guaranty, etc. While the scope of this blog is limited to promissory notes, it is important to consider all of the documents that may be needed as part of a loan, not just a promissory note. The complete set of documents required to evidence a loan are usually driven by the unique business terms of the transaction.

That said, let’s get back to the common considerations of promissory notes. Below is a breakdown of some of the common considerations that I go through with my clients before preparing a promissory note:

Timing of Payments

When will payments be made? Will they be made weekly, monthly, quarterly, annually?

Mode of Payments

Will payments be fixed or variable? Note that a large factor in this is whether the interest rate is fixed or variable.

Will payments be interest only or will they include principal as well? What will be the principal amortization schedule?

What will be the maturity date and will the note have a final, larger “balloon payment” at maturity?

Interest Rate

What will be the interest rate?

Will interest accrue annually, quarterly, monthly, daily?

Will the note be fixed or variable (as mentioned above)?

If variable, will the loan be tied to a reference rate or some other commonly used benchmark?

If the commonly used benchmark ceases to exist, is there a backup index that will be used?

Late Charges

Will a late charge be imposed? If so, will the late charge be a fixed percentage of the regular installment payment or a fixed amount?

Prepayment

Can the note be prepaid? If so, is there a penalty associated with prepayment?

Default

What is considered a default (besides just a missed payment)? What occurs upon default?

Collateral

Will there be collateral for the loan and how does this factor into the documentation?

The list above is an illustration of the type of items that a lender or borrower should consider when entering into a promissory note. This is by no means an exhaustive list and there are always numerous other factors to consider depending on the specific situation of the parties. I always recommend for people to sit down with their attorney to go over the loan concept in detail before documenting it. The less ambiguity that there is in the document, the less likely you will end up in protracted litigation trying to explain the original intent of the parties if there is ever an issue. Ideally, any document that you enter into should be detailed enough that, if necessary, a court can look at it and make a determination on the spot regarding the document without having to look at the intent of the parties – which can become very costly for both sides.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

I’m So Happy – Keeping the Peace With IP Infringement Clauses

By: Robert V. Hawn, Esq.

Many technology companies generate their revenue by providing their technology, often in the form of software, to customers through licenses, subscriptions, or software as a service platform. As a technology lawyer practicing in Silicon Valley, I work with a number of companies which actively distribute their technology though licensing deals. Their customers, who are almost always licensees or subscribers, require that they are covered if sued by a third party claiming that the licensed technology is owned by that third party. The legal term for a licensor covering its licensee against claims from a third party is indemnification.

As we discussed in my prior blog about how indemnification are triggered , indemnification obligations get triggered by the threat of a lawsuit or an actual claim. Once the threat or claim hits, the licensee is required to do certain things, e.g., provide notice to the licensor. So, what happens next?

Indemnification clauses try to keep everyone happy by striking a balance between two competing interests. The first is the interest of the licensor in trying to minimize its exposure. The second is the interest of the licensee which wants to continue to use what it has paid for. The manner in which these tensions are resolved is often a function of the relative bargaining power of the licensor and the licensee.

Typically, if a claim hits, the licensor will agree to do certain things. First, it may agree to defend the licensee from the claim and hold the licensee harmless from its effects. As part of this obligation, the licensor will outline certain remedies which will be offered to the licensee. The first is that the licensor will try to provide a work-around, and a licensee will often want a commitment that the work-around does not materially reduce the functionality they have paid for. The second is that the licensor will agree to take a license from the third party bringing the claim and pay any royalties or other damages that may result. The third is that the licensor may offer some sort of refund to the licensee, particularly if the licensor is unable to develop a workaround or get a license. The refund may also be coupled with the ability to walk from the deal without a further indemnification obligation.

As mentioned above, the indemnification obligation is often triggered when the licensee receives a threat of a claim or is hit with a claim. There are situations, however, when a licensor may want to trigger the above remedies. This might occur when the licensor believes that a claim may be forthcoming and may want to deal with the issue without having to be involved in expensive litigation. In this situation, indemnification clauses often provide that the licensor can invoke the above remedies to minimize its ultimate liability.

Indemnification provisions often contain other methods to reduce or eliminate a licensor’s liability. Stay tuned, and we’ll discuss that in our next blog.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Loans and Liens and . . . What Can Go Wrong Here (Part 2)? The Devil is in the Details – Protecting a Lender’s Collateral Position Under the UCC

By: Jack Easterbrook

The lender gets loan documents signed by the borrower and takes collateral from the borrower to secure the debt. It sounds easy and familiar. So what could go wrong? The progression of cases interpreting the Uniform Commercial Code (UCC) provides insight into the mistakes, large and small, that can create unexpected exposure for lenders and surprise defenses for borrowers. Earlier this year two new cases shed additional light on this question. This article takes up the second of these two (and follows an earlier article by the author , which addressed the other new case).

Don’t Count on Equitable Arguments to Work in Protecting Lien Rights

DivLend (“Lender”) made a loan to Ajax (“Borrower”) secured by 30 vehicles. The agreement between Lender and Borrower granted the security interest in the vehicles. Although this agreement was titled a lease agreement, the court observed and the parties agreed that the transaction was really intended to be a secured loan. Title to the vehicles (the collateral) was evidenced by certificates, so the Lender was required to deliver the original certificates to the department of motor vehicles along with a notice of lien signed by the borrower (owner of the vehicles) and the requisite fee. The lender obtained the certificates, but the loan closed without the Borrower executing the notices of lien.

The loan agreement contained provisions, as well, that the Borrower must cooperate with the Lender. Relying on these, the Lender made multiple attempts to have the notices of lien signed but they never were executed. About seven months later an involuntary bankruptcy petition was filed against the Borrower.

The court disregarded the Borrower’s non-cooperation and held that the Lender was unsecured because it had not perfected its security interest (the case was decided under New York law). According to the court, the Lender could have protected itself by: (1) having the notices signed before advancing funds; or (2) exercising its rights to accelerate and reclaim the vehicles once it became apparent that the Borrower was not signing the notices. The Lender had not done either of these.

The bankruptcy court conceded that the Lender held an equitable lien based on the Borrower’s lack of cooperation. While this might have had value in some situations, in bankruptcy it did not trump the trustee’s strong arm powers to avoid an equitable lien.

The takeaway here is that the courts cannot be counted on to protect the lender, even when the borrower’s conduct is causing the problem. The courts, instead, expect the lender to take advantage of its legal rights if it is not obtaining the cooperation it needs. Fangio v. DivLend Equipment Leasing, LLC (In re Ajax Integrated, LLC), 2016 WL 1178350 (Bankr. N.D.N.Y. Apr. 4, 2016).

A related item: if a loan agreement has post-closing requirements, the lender must take action if the requirements are not met. The argument that the borrower would not cooperate is unlikely to prevail, at least in bankruptcy court.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Dealing with the Unknown – How Does Indemnification Get Triggered and What Happens Next

By: Robert Hawn

As a start-up lawyer in Silicon Valley, I work with a number of companies that generate revenue through licensing their intellectual property, or access to it. In creating and negotiating licensing agreements, my client, as the licensor, often wants to describe what will happen if someone claiming better rights to the technology my client has licensed sues my client’s customer and tells them to stop using the property my client licensed to their customer. In that case, a customer, who is the licensee, will often look to my client, the licensor, and say, “I paid you so I could use this stuff, so get this other guy off my back.”

The fancy term for a licensor covering its licensee against claims from a third party is indemnification. Although the language used in indemnification provisions is a bit formal and tortuous, the basic ideas are pretty simple. In my prior posts on this subject ( May 18 th and August 3 rd ), I discussed the basic concept around indemnification, and the types of items, from an intellectual property context, that these provisions address. In this blog, let’s look at what happens if an indemnification claim arises.

The first issue is the trigger for the obligation. Indemnification provisions will often describe two different events that will trigger the required tasks for a licensor. Most agreements describe the first event triggering the indemnification obligation as the presence of a claim. Typically, this will occur when the customer receives what lawyers call a “cease and desist” letter. These letters allege that someone else owns the licensed IP, and demands that the customer stop using the IP if the customer does not want to be sued. Often, a cease and desist letter is the opening salvo in an attempt to extract royalties from the customer in exchange for calling off the threatened lawsuit. Related to a cease and desist letter is the filing of an actual lawsuit.

A second trigger could exist. Sometimes a licensor may suspect that its IP may become the subject of a claim from a third party. It may find out because it has received a cease and desist letter, or it becomes known in the industry that an infringement risk has arisen. It may be because the licensor itself has been sued. If so, the licensor may want to take advantage of certain tasks that will allow the licensor to minimize its risk. These risk minimization tasks will be discussed in my next blog.

The second issue is what happens once the obligation gets triggered. Essentially, two separate sets of responses are described. The first response is procedural, and discusses how the claim is going to get managed. The second concerns some of the options the licensor can take if it loses the claim, or it decides it wants to fight it.

There are a small number of key concepts with the procedural response. The first is that the licensee must provide notice of the claim to the licensor. This is really important, because if the licensor doesn’t know about the claim quickly, it can lose some valuable rights. Often, you’ll see clauses that will impact the licensor’s indemnification obligations if the notice is delayed or not sent. The second is that control for the defense of the action must be assigned to one of the parties. Usually, but not always, the licensor gets to take control, but the licensee can allow their attorneys to be involved at the licensee’s expense. The third is that the licensee will often request approval rights over any settlement.

One of the standard issues that gets discussed is what will happen if a licensor can’t beat a claim, or can’t afford to fight a claim and wants to resolve it. Because a licensee will have a strong vested interest in continuing to use the IP, a number of approaches have been developed that often appear to resolve this issue. I’ll discuss those in my next blog.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.