Insolvency of IP Startups: India’s IP Quandary

[By Yash Raj]

The author is a student of Dr. Ram Manohar Lohiya National Law University.

 

Introduction

India has witnessed an unprecedented surge in startup activity, with the ecosystem booming across the country. The exponential growth of startups in India can be attributed to various governmental schemes and initiatives like the Startup India Action Plan (SIAP) and the National Initiative for Developing and Harnessing Innovations (NIDHI) launched by the Government of India. Today, India has the world’s third-largest startup ecosystem after China and the US. 

The Vulnerability of IP-Driven Startups

In the rapidly changing business environment, startups nowadays often rely on intellectual property (IP) as their key asset, with trademarks, copyrights, patents, and other forms etc. forming the foundation of their business model. Every business, no matter how ambitious, is vulnerable to financial instability. A significant number of startups are now IP-driven startups dealing with proprietary tech, software, and various other forms of intellectual property to gain a competitive advantage in the market. Take, for example, an ed-tech company that may rely on its copyrighted content, while biotech firms could hold patents on drugs or medical devices. When such startups face insolvency, how their intellectual property is to be treated becomes a crucial issue and raises various questions regarding valuation, protection, and broader applications for the innovation ecosystem in India. The value of these companies is tied intrinsically to their intellectual property, making it a critical asset for the startup in any financial assessment done to the firm. Reports emphasize that a growing number of DeepTech startups in India rely on IP, especially patents, with over 900 patents filed by DeepTech startups since 2008. The focus on technology-driven sectors like artificial intelligence, healthcare, and blockchain has fueled this surge in patent activity, underlining the importance of IP in fostering innovation  

Insolvency of companies in India is governed by the Indian Bankruptcy Code (IBC) 2016, which is applicable all over India with some exceptions relating to J&K. However, the Indian Bankruptcy Code does not have any specific provisions that deal exclusively with intellectual property (IP) rights during insolvency. It treats intellectual property as any other asset, forming part of the insolvency estate. In a significant case, Enercon (India) Ltd. v. Enercon GmbH, the importance of protecting IP rights during insolvency proceedings was highlighted. The dispute was between a German wind turbine manufacturer and its Indian subsidiary regarding the ownership and use of trademarks during Enercon India’s insolvency proceedings. This case highlights the importance of having clearly defined and well-drafted IP agreements to avoid potential disputes and protect the interests of the IP owner during insolvency. 

The Problem in IP Valuation

Unlike physical assets, IP assets are intangible, making their value difficult to estimate often leading to undervaluation. Undervaluation reduces creditor recovery, leading to losses and making them less likely to invest in similar startups. The ASSOCHAM and PwC reports on the Insolvency and Bankruptcy Code (IBC) highlight the poor recovery rates generally in India’s insolvency cases, attributing much of this to the absence of timely resolutions and specialized handling of intangible assets like intellectual property. 

The absence of clear guidelines for valuing IP assets can result in undervaluation during insolvency, undervaluation can result in lower recovery for creditors, diminished returns for founders, and a loss of long-term growth potential, affecting the broader innovation ecosystem. When a business goes into liquidation and its assets are sold, the IP could drastically lose its value if it is not managed correctly. This is a critical issue for startups, whose most crucial value often lies in their intellectual property. New startups usually fail to acknowledge this value due to a lack of awareness and proper guidelines, leading to significant economic setbacks. 

 Countries like the U.S. and U.K. have specific rules in their bankruptcy laws that treat intellectual property (IP) as a unique asset. For example, the U.S. Bankruptcy Code allows licensors to maintain their licensing rights during bankruptcy (under Section 365(n)), protecting the value for startups and investors. Japan also has guidelines for valuing IP during insolvency, suggesting different strategies depending on the asset type. These approaches could serve as models for India to develop its own IP valuation frameworks.  

Reforms to Address the Insolvency Challenges of IP-Driven Startups

A proper approach is necessary to effectively resolve the insolvency challenges faced by IP-driven companies in India.

Specific Provisions in the IBC for IP Assets

The Indian Bankruptcy Code (IBC) lacks explicit provisions regarding the treatment and valuation of intellectual property during insolvency proceedings. Addressing this issue is critical for protecting the interests of both startups and creditors. A dedicated section in the IBC could bring much-needed clarity by recognizing IP as a distinct asset category with specific valuation and management protocols. The reforms should focus on: 

• IP as a Separate Class of Asset: Including provisions that treat IP as separate assets rather than grouping them with physical and other assets. This will allow for more tailored handling during liquidation and insolvency proceedings. Jurisdictions like Japan treat IP as a distinct asset, allowing for specialized handling separate from physical assets. Countries like the U.S and the U.K. also provide some special considerations for IP, but Japan’s approach emphasizes preserving the value and operational integrity of IP throughout the insolvency process. 

• Expert valuation: Mandating that intellectual property be valued by qualified IP experts during insolvency cases. This will prevent the undervaluation of these assets and ensure that creditors receive fair compensation. 

• Safeguarding Ownership Rights: The IBC should incorporate provisions that protect the ownership rights of intellectual property holders during insolvency. This will ensure that critical IP assets are not lost or diluted in insolvency, particularly in patent or trademark licensing cases.  

• Establish an IP Valuation and Insolvency Oversight Committee: This committee will guide courts and insolvency professionals on managing and valuing IP assets. Modeled after the U.S. Patent and Trademark Office (USPTO), this committee would standardize valuation practices, reduce undervaluation risks, and improve creditor recovery outcomes during insolvency.

Development of Standardized Valuation Frameworks

A significant challenge during insolvency proceedings is the absence of standardized frameworks for valuing different types of intellectual property assets. IP is diverse and complex, with patents, copyrights, trademarks, and trade secrets having different valuation metrics. The lack of consistency often leads to undervaluation, affecting creditors and startups. A standardized valuation approach can help bring transparency and accuracy to the process. 

• Standardized Approach: A common, standardized framework should apply the valuation approaches for different types of IP assets, such as patent portfolios, software copyrights, and trademarks. This can be fine-tuned according to industry benchmarking, market potential, and the life cycle of an asset. 

• Regulatory Standards for IP Valuation: India could adopt regulatory standards, perhaps modelled on international best practices, governing how IP assets are valued during insolvency. For example, these could include methods like income-based valuation (based on the IP’s potential to generate future income), cost-based methods, or market-based valuations where comparative sales are possible. 

• Third-Party IP Valuation: Independent bodies comprising IP experts and financial specialists should provide unbiased valuations in the event of bankruptcy. This would ensure consistency in the valuation of the IP asset across various cases and industries. Countries like the United States have established guidelines for valuing IP during insolvency. India can learn from these models to develop standardized procedures that promote fairness and transparency.

Awareness and Education for Startups

Intellectual property plays a lead role in the promotion of economic growth and innovation in a knowledge-based economy. Many Indian startups lack awareness about protecting, valuing, and managing their intellectual property assets. Therefore, there is a need to improve knowledge and information about intellectual property and its utilization. Increasing awareness through education and resources will empower startups to take control of their IP assets, ultimately leading to better outcomes. 

• National IP Awareness Campaigns: Government-led campaigns through initiatives like Startup India or the Department for Promotion of Industry and Internal Trade (DPIIT) could raise awareness among startup founders about the importance of IP management. These campaigns could emphasize critical areas such as IP registration, valuation, and protection. 

• IP Training for Entrepreneurs: Workshops, seminars, and webinars on intellectual property management should be organized, explicitly focusing on IP-driven startups. Founders must understand how to evaluate their IP assets and ensure they are included in all financial assessments. This will also help them negotiate better terms during potential insolvency or acquisition deals.

Encouraging the Development of Specialized IP Professionals

The shortage of specialized IP professionals in India who can guide startups through insolvency proceedings, particularly concerning intellectual property, is a severe gap in the current ecosystem. To address this gap, it’s essential to promote training and specializations in IP law and management through partnerships with universities and legal institutions. Encouraging the development of experts in this field would ensure that startups can access the right resources when dealing with complex IP valuation and management issues. 

• Incentivizing IP Specializations: The government can partner with universities and business schools to promote IP law specializations by offering scholarships and certifications, encouraging more students and professionals to enter the field. 

• IP Insolvency Experts: Establishing a new class of professionals focused on IP insolvency could be a critical step forward. These experts would possess a deep understanding of insolvency law and intellectual property management, ensuring they can effectively navigate the complexities of IP-driven companies during financial distress. 

•  Joint Workshops and Training: Organizing events that bring together legal experts, financial advisors, and tech innovators can facilitate knowledge sharing and networking 

Conclusion

The lack of IP-specific provisions and regulations for their treatment has led to lower valuations and recoveries for IP-heavy firms. This gap in the legislative framework not only undermines the potential of these businesses but also reflects a broader undervaluation of intellectual capital in the marketplace. Implementing these reforms within the IBC can act as a catalyst for sustaining innovation-driven businesses, particularly those relying on intellectual property as a core asset. By recognizing IP as a distinct asset class and establishing robust valuation standards, the IBC would help prevent IP undervaluation, ensuring fair recovery for creditors and incentivizing investment in IP-focused ventures. These measures would enhance IP asset security during financial distress, boosting investor confidence and fostering a culture that values intellectual property as a crucial component of economic growth. Looking ahead, the successful integration of these reforms could significantly fortify India’s standing as a global innovation hub.