TRADE SECRETS – ANOTHER SIDE OF INTELLECTUAL PROPERTY

19.06.2016

By Lawrence Hoffman

Picture a situation – your company (or client) is developing a product that has a good chance for a substantial world-wide market. Say it’s a beverage having a recipe including several known ingredients mixed in a specific proportion and perhaps prepared by a particular process that gives it a distinctive taste. Or it’s an improvement in a manufacturing process or the details of your marketing program. Or maybe it’s your customer list or other business information. In broad terms, any information that can give someone an edge over competitors as long as it does not become known to them.

Perhaps you don’t want to patent it. Maybe the information is not patentable subject matter, or there are doubts about its patentability, or you just don’t want to disclose the information and possibly fertilize a competitor’s thinking. Or maybe you think you can keep the information secret for more than the twenty year life of a patent. How can you best protect the confidentiality of the information?

The answer may be in the law of trade secrets.[1]

Protecting trade secrets is not always easy. There are many potential points of leakage – from ambitious ex-employees to dishonest suppliers or outside assemblers to hackers, to name just a few. Moreover, reverse engineering is generally not illegal. You may not be able to build a perfect wall, but there are things you can do so that even if the “bad guy” can run, he won’t be able to hide.

Laws protecting trade secrets are not a new thing. Many countries have such laws, including China, Israel, Japan, and many European countries. Also, the EC parliament is soon likely to issue a Directive that calls for passage of uniform trade secret protection laws throughout the Community. Discussion of such laws is beyond the scope of this article but in many ways these laws are generally similar to the laws in the U.S. discussed below.

Until now, in the U.S., trade secret protection has solely been a matter of state law. The so-called “Uniform Trade Secrets Act” (UTSA) originally proposed by the National Conference Of Commissioners On Uniform State Laws in 1978 and amended in 1985, has been adopted by all the states except New York and Massachusetts (which provide trade secret protection according to the Restatement of Torts or the Restatement (Third) of Unfair Competition). In most cases, the UTSA has been adopted verbatim. Some states, however, have adopted versions containing a variety of amendments.

This May, however, President Obama signed the Defend Trade Secrets Act (DTSA), which amends the Economic Espionage Act (18 U.S.C. 1831 et seq.) to create a federal private cause of action for misappropriation of trade secrets “related to a product or service used in, or intended for use in, interstate or foreign commerce” (18 U.S.C. 1836(b)). Under 18 U.S.C. 1836(c) the federal courts have exclusive jurisdiction over such actions.

In many ways, the DTSA is like the UTSA, and includes identical wording in several sections. The DTSA does not preempt existing state laws. Instead, it provides important additional remedies. Given that most, if not all, cases of trade secret misappropriation are likely to involve interstate and/or foreign commerce, the DTSA will likely be the future basis for most trade secret litigation. Let’s take a look at the similarities and the differences between the UTSA and The DTSA.

What Hasn’t Really Changed?

What is a Trade Secret?

Section 1(4) of the UTSA defines “Trade secret” as:

information, including a formula, pattern, compilation, program, device, method, technique, or process, that: (i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

The following are examples of information that have been found to be trade secrets:[2]

  1. The formula for the soft drink Coca-Cola. Coca-Cola Bottling Co. of Shreveport, Inc. v. Coca-Cola Co., 107 F.R.D. 288, 289 (D. Del. 1985).
  2. A formula for hair conditioner. Thomas v. Soft Sheen Prod. Co., 500 N.Y.S.2d 108 (App. Div. 1986); West v. Alberto Culver Co., 486 F.2d 459, 461 (10th Cir. 1973).
  3. A process for manufacturing a vaccine. Merck & Co. v. SmithKline Beecham Pharms. Co., C.A. No. 15443-NC, 1999 Del. Ch. LEXIS 242, *50-*63 (Del. Ch. August 5, 1999), aff’d per curiam, 746 A.2d 277 (Del.), aff’d, 766 A.2d 442 (Del. 2000).
  4. A process and machine for manufacturing synthetic diamonds. General Elec. Co. v. Sung,

843 F. Supp. 776, 778-9 (D. Mass. 1994).

  1. Know-how such as operating procedures, training manuals and process standards for using equipment to make adhesive resin sheeting. Minnesota Mining & Mfg. Co. v. Pribyl, 259 F.3d 587, 595-96 (7th Cir. 2001).

In the DTSA, the definition (18 U.S.C. 1839) is more inclusive:

all forms and types of financial, business, scientific, technical, economic, or engineering information, including patterns, plans, compilations, program devices, formulas, designs, prototypes, methods, techniques, processes, procedures, programs, or codes, whether tangible or intangible, and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing if—(A) the owner thereof has taken reasonable measures to keep such information secret; and (B) the information derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable through proper means by, the another person who can obtain economic value from the disclosure or use of the information.

In terms of technology-related material, even though the DTSA provides a more explicit listing, this has generally been protected under the UTSA subject to the other requirements of the definition and no drastic changes are expected. Notice, however, the inclusion in the DTSA definition of financial, business, and economic information. Does this really add anything new? Consider, for example, customer lists. Under the UTSA, mere listings of names, addresses and telephone numbers have been treated as nothing more than a telephone book and are typically not afforded protection. On the other hand, a database that includes detailed information about the customers’ requirements, personal information about your contacts and other useful information compiled over time is typically treated as protectable.[3]

Will the definition in the DTSA make any difference? It’s obviously too early to tell, but as of this writing, three actions have been filed under the DTSA, two of which allege activities related to customers of the plaintiff, and one in which the court may have to determine if employee salary information is a trade secret.

Notice also that the UTSA and the DTSA both require that the information derive independent economic value from secrecy and not be readily ascertainable through proper means by one who can benefit economically from use of the information. The DTSA includes in its definition of the term ‘improper means’ [18 U.S.C. 1839(6)(A)] “theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means”. That’s not significantly different from what the UTSA says. However, 1839(6) (B) explicitly states that “improper means does not include reverse engineering, independent derivation, or any other lawful means of acquisition”. The UTSA does not include such a provision in its text, but specifically refers to it in the related comments.

Another important similarity is that the owner must take reasonable precautions to keep the information secret. The UTSA does not define what is reasonable. That’s true, but the comment to Section 1 of the UTSA points out that:

reasonable efforts to maintain secrecy have been held to include advising employees of the existence of a trade secret, limiting access to a trade secret on “need to know basis”, and controlling plant access.

The definition of ‘trade secret’ in 18 U.S.C. 1839(4) also requires that “the owner thereof has taken reasonable measures to keep such information secret” and also does not define ‘reasonable measures’. I believe the UTSA comment will provide a starting point for a court’s consideration, and that more explicit guidance will be developed over time.

One might say that a particular kind of information is a trade secret whether or not you took reasonable care to protect it and that you should bear some or all of the loss only in proportion to your share of the blame. Perhaps some would agree with that, but either way, taking reasonable care is critical, and arguably, the first line of defense in protection of trade secrets. At the end of this article, I will provide some specific suggestions as to actions you should take to cover most situations.

What Constitutes Misappropriation?

Under the UTSA, Section 1(2) defines “misappropriation” as:

(i) acquisition of a trade secret of another by a person who knows or has reason to know that the trade secret was acquired by improper means; or

(ii) disclosure or use of a trade secret of another without express or implied consent by a person who

(A) used improper means to acquire knowledge of the trade secret; or

(B) at the time of disclosure or use, knew or had reason to know that his knowledge of the trade secret was

(I) derived from or through a person who had utilized improper means to acquire it;

(II) acquired under circumstances giving rise to a duty to maintain its secrecy or limit its use; or

(III) derived from or through a person who owed a duty to the person seeking relief to maintain its secrecy or limit its use; or

(C) before a material change of his [or her] position, knew or had reason to know that it was a trade secret and that knowledge of it had been acquired by accident or mistake.

An identical definition has been carried over into the DTSA (18 U.S.C. 1939(5)) and it is likely that existing case law under the UTSA will carry over as well.

What Are Your Remedies?

The UTSA provided damages for actual loss and (II) for unjust enrichment not addressed in computing damages for actual loss. It also provided for imposition of liability for a reasonable royalty as an alternative measure of damages and for doubling the actual damage award and attorneys’ fees in cases of malicious and willful misappropriation. Essentially the same provisions are found in 18 U.S.C. 1836(b). There is no reason to expect that existing state law precedents will not form a basis for interpretation of 18 U.S.C. 1836(b).

Also carried over to the DTSA is the three year statute of limitation of the UTSA.

What’s Different in the DTSA?

In a word – lots. To begin with, 18 U.S.C. 1831 et seq. began as a criminal law. Section 1836(a) did provide for civil seizure but only by the Attorney General. It does not appear, however, that this provision is often used. Addition of the private cause of action alone is a game-changer.

A second important difference is in 18 U.S.C.(b)(2) which provides for civil seizure on behalf of the trade secret owner. This section provides for an ex parte order for seizure under ‘extraordinary circumstances’ and subject to other quite complex procedures and limitations. Basically, its intended application is in situations where a court finds that ordinary injunctions will not be effective. Perhaps precedent related to Temporary Restraining Orders will provide guidance as to interpretation of this section of the law, but for now, those seeking civil seizure must be aware that an application must clearly demonstrate the predicate facts spelled out in 18 U.S.C.(b)(2)(ii). The provision may prove to be of great significance under the right circumstances.

A third important difference relates to injunctions. This has been the most common relief sought under the UTSA[4] and this will likely be the case under the DTSA. Section 2 of the UTSA states:

(a) Actual or threatened misappropriation may be enjoined.  Upon application to the court, an injunction shall be terminated when the trade secret has ceased to exist, but the injunction may be continued for an additional reasonable period of time in order to eliminate commercial advantage that otherwise would be derived from the misappropriation.

(b)  If the court determines that it would be unreasonable to prohibit future use In exceptional circumstances, an injunction may condition future use upon payment of a reasonable royalty for no longer than the period of time the for which use could have been prohibited. Exceptional circumstances include, but are not limited to, a material and prejudicial change of position prior to acquiring knowledge or reason to know of misappropriation that renders a prohibitive injunction inequitable. Illinois

(c)  In appropriate circumstances, affirmative acts to protect a trade secret may be compelled by court order.

The last clause of the second sentence of Section 2(a) might be the epitome of fuzziness. Suppose, for example, the recipe for Coca Cola were somehow misappropriated. What could possibly be an appropriate duration of an injunction for information that the Coca Cola Co. has managed to keep secret for about 150 years? Similarly, except in cases in which a trade secret has been reverse engineered, for example, by a competitor or by the defendant’s expert for purposes of trial testimony, any estimate of the lead time gained through the misappropriation would seem to be highly speculative.

The Comments for Section 2 refer to 1973 decision in Elcor Chemical Corp. v. Agri-Sul, Inc.,[5] in which the court granted a perpetual (essentially punitive) injunction against use of a misappropriated trade secret, but the time limitations is Section 2 are said to reflect a contrary “trend of authority”.

Nevertheless, Alabama, Colorado, Illinois, Georgia, Nevada, and Tennessee have adopted versions of the UTSA that omit the second sentence of Section 2(a) altogether or otherwise do not exclude the possibility of perpetual injunctions. Texas expressly allows such injunctions.[6] A disapproving commentary on such perpetual injunctions may be found in Dole, Jr. Permanent Injunctive Relief For Trade Secret Misappropriation Without An Express Limit Upon Its Duration: The Uniform Trade Secrets Act Reconsidered.[7]

In contrast, 18 U.S.C. 1836(b)(3)(A) states:

(i) to prevent any actual or threatened misappropriation…on such terms as the court deems reasonable, provided the order does not— (I) prevent a person from entering into an employment relationship, and that conditions placed on such employment shall be based on evidence of threatened misappropriation and not merely on the information the person knows; or (II) otherwise conflict with an applicable State law prohibiting restraints on the practice of a lawful profession, trade, or business; (ii) if determined appropriate by the court, requiring affirmative actions to be taken to protect the trade secret; and (iii) in exceptional circumstances that render an injunction inequitable, that conditions future use of the trade secret upon payment of a reasonable royalty for no longer than the period of time for which such use could have been prohibited.

Clearly, this does not create an open season for obtaining injunctions. However, it does not exclude the possibility of a perpetual injunction.

Will such injunctions be granted? The classical purpose of an injunction is often stated to be prevention of future harm rather than punishment for past misbehavior. Under that theory, once a trade secret has become public in a legal way, e.g., through reverse engineering, the rights of the original owner are extinguished. Nevertheless, the DTSA includes language identical to that of the UTSA in many of its provisions, and the failure to include the language of the second sentence of UTSA Section 2(a) suggests a good argument that perpetual injunctions should be granted under the right circumstances. Perhaps a perpetual injunction will become the equitable remedy most often granted. However, I will not be surprised if the issue is before the Supreme Court sometime in the future.

Suppose, however, that the owner of the trade secret files a patent application claiming the subject matter of the trade secret. That might be a sound decision, for example, in a rapidly developing art where the owner is an early entrant in the field and there is a realistic possibility of obtaining broad claims. Between the filing date and the publication of the application, the owner’s trade secret rights would continue to exist and an action could be brought under the DTSA in the event the trade secret were misappropriated during that period or before the patent application is filed.

After issuance of the patent, the subject matter would no longer be secret and in theory, an action under the DTSA would be barred at least as to a later-occurring misappropriation.[8] But what about the duration of an injunction granted against a pre-publication or pre-filing misappropriation?

These two situations have been extensively litigated over the years. There are two lines of cases: The “Shellmar cases”[9] dealing with pre-issuance misappropriation and the “Conmar cases” dealing with misappropriation post-issuance.[10] Decisions following Shellmar grant perpetual injunctions; decisions following Conmar do not grant injunctions at all.

Another point worth noting is that rights of former employees are protected to the extent that an injunction cannot be obtained that will:

prevent a person from entering into an employment relationship, and that conditions placed on such employment shall be based on evidence of threatened misappropriation and not merely on the information the person knows;

or will otherwise conflict with an applicable State law prohibiting restraints on the practice of a lawful profession, trade, or business.

This has always been a matter of state law and is not even mentioned in the UTSA. Reference in the DTSA should avoid any implication of preemption.

One final issue that may prove to be of importance is appellate jurisdiction. Will appeals be heard by the Court of Appeals for the Federal Circuit (CAFC), or by the respective Circuit Courts of Appeal? 28 U.S. Code § 1295(a) provides that the CAFC:

shall have exclusive jurisdiction (a) of an appeal from a final decision of a district court of the United States… in any civil action arising under, or in any civil action in which a party has asserted a compulsory counterclaim arising under, any Act of Congress relating to patents…

The DTSA does not address appellate jurisdiction, and in fact, expressly states that:

(g) APPLICABILITY TO OTHER LAWS.—This section and the amendments made by this section shall not be construed to be a law pertaining to intellectual property for purposes of any other Act of Congress.[11]

That would appear to nullify any possibility of jurisdiction under 28 U.S.C. 1295(a) and no other part of Section 1295 appears to apply to the DTSA. What about an appeal from a district court case that includes both claims arising under the patent laws[12] and claims under some other state or federal law? That situation arose in Atari, Inc. v. JS & A Group, Inc., 747 F.2d 1422, 223 USPQ 1074 (Fed.Cir.1984) (en banc ). In Atari, the complaint alleged claims for patent and copyright infringement and several state matters. The court granted a preliminary injunction on the copyright claim and thereafter granted a motion to separate the patent claims for trial purposes under Fed.R.Civ.P. 42(b). The defendant appealed the grant of the injunction to the CAFC and plaintiff moved to transfer the appeal to the Court of Appeals for the 7th Circuit.

In denying plaintiff’s motion, the Court held that despite the separation order, the case was still one that “arises under” the patent laws.

However, what about a case like Atari, in which the patent claim has been dismissed without prejudice under Rule 41(b)? Or one in which the patent claim is settled and is dismissed with prejudice?

The first situation arose in Nilssen v. Motorola, Inc.[13]  Here, the original compliant included claims for patent infringement and state law claims for misappropriation of trade secrets and other state law based claims. For various reasons, the court dismissed the patent-related claims without prejudice and Nilssen refiled its patent infringement claims in a separate action.

Thereafter, the court entered judgment against Nilssen on all of the state law claims, and Nilssen appealed to the CAFC. Motorola then moved to transfer the appeal to the United States Court of Appeals for the Seventh Circuit on the ground that the district court’s jurisdiction over the remaining state law claims was no longer based, either in whole or in part, on 18 U.S.C.  1338. The Court agreed with Motorola that it lacked jurisdiction and transferred the appeal to the Seventh Circuit.

The second situation arose in Zenith Electronics Corp. v. Exzec, Inc.[14] Here, the case originally included patent-related claims as well as trademark and unfair competition counterclaims, but the patent infringement claims had been dismissed with prejudice and that made all the difference in the world. The appeal was based on denial of a motion by the plaintiff to dismiss the non-patent claims as preempted by the anti-trust laws. The CAFC affirmed the denial of plaintiff’s motion, First, however, it addressed the question of appellate jurisdiction. On this issue, the Court held that its exclusive jurisdiction was not defeated by the fact that the patent claims had been dismissed with prejudice. “The path of appeal is determined by the basis of jurisdiction in the district court, and is not controlled by the district court’s decision or the substance of issues that are appealed.”

What To Do to Protect Your Trade Secrets?

Because of the common features of trade secret law world-wide, there are several things you can do that should help you protect your trade secrets in most situations:

Restrict Access only to trusted employees having a legitimate need to know:

The success of the Coca Cola company in protecting its recipe – one of the most valuable trade secret ever – should be an example for everyone, but access to almost every other kind of trade secret should also be restricted. Digitally stored information should be password-protected. You should consider this the first line of defense.

Make Sure Employees Understand Their Obligations Regarding Trade Secrets:

A second line of defense is an employment contract. Every employee should be required to sign one. This is particularly applicable to customer lists and other information for which tight access control is not practical. Among its other provisions, employment agreement should include an broad definition of what might be a trade secret, an acknowledgment by the employee that if he or she gains access to trade secrets in the course of the employment and an agreement not to disclose the information to other employees or non-employees without express written permission. It should also include a provision prohibiting disclosure after termination of employment but should exclude from this, general knowledge and experience gained in the course of the employment.

A word of caution however – which almost goes without saying – make sure that relevant state laws governing duration and geographical limitations, etc. are not violated.

Clearly Identify Your Trade Secrets:

Neither of the above steps will help you much if your trade secrets are not clearly identified. Wherever possible, information concerning trade secrets, whether on paper or digitally stored, should be clearly marked with a legend such as

Company Confidential Information – Not To Be Disclosed to other Employees or Outsiders Without Express Written Authorization.

There should be no exceptions to this procedure.

Protect Your External Disclosures:

Sometimes, you have to disclose trade secrets, for example to suppliers and assemblers. Never do so without a Non-Disclosure Agreement (NDA). It is best to use a standard NDA written by the attorney for the trade secret owner in a form that can easily be modified to cover particular situations. If the potential recipient of the information resists this, and is ultimately unwilling to yield or include provisions regarded as important you probably should consider the trustworthiness and/or motives of the intended recipient. Also, be sure that all information disclosed is in writing, and is clearly marked as “Trade Secret”.

Be Vigilant:

Since a trade secret can often lose its value just by becoming public, employees who have contact with competitors’ employees, outside contractors and especially trade gossip need to be alert to any hint of a problem so that management can be informed immediately. Prompt action materially increases the likelihood of minimizing harm to your company. You also need to vigilant, when a key employee leaves, especially under suspicious circumstances. That doesn’t mean paranoia should get the better of you, but you must take any reasonable suggestion of a problem seriously.

Conclusion:

The DTSA and the UTSA are similar enough that district courts are likely to have dealt with trade secret protection in diversity cases of cases governed by 18 U.S.C. 1339. Nevertheless, there are significant differences and complexities that will require interpretation. Trade secret owners must be sure that adequate protective steps have been taken and should be prepared to act promptly and vigorously to avail themselves of their rights under the new law.

[1] For a thoughtful and thorough discussion of strategy considerations that can influence the decision whether to rely of trade secret or patent protection, see The Corporate Preference For Trade Secret (Draft, 18 April 2013) by Andrew A. Schwartz, Associate Professor of Law, University of Colorado Law School, available at http://www.law.northwestern.edu/research-faculty/searlecenter/events/innovation/documents/Schwartz_The_Corporate_Preference_for_Trade_Secret.pdf.

[2] Referred to in Trade Secrets – The Basic Principles and Issues, ABA Litigation Section “Core Knowledge” Project November 2014 by Ronald T. Coleman, Jr. et al.

 

[3] See, for example, Zoecon Industries v. American Stockman Tag Co., 713 F. 2d 1174 (5 th Cir., 1983)

[4] See 4 Milgrim On Trade Secrets § 15.02[1][a] (2010)

[5] 494 S.W.2d 204 (Tex.Civ.App.1973)

[6] See Metallurgical Industries Inc. v. Fourtek, Inc., 790 F.2d 1195 (5th Cir. 1986)

[7] Vol. 17, B.U. J. Sci. & Tech. L. (2011)

[8] The trade secret rights would, of course, be replaced by the rights provided under patent law once the patent issues.

[9]  Shellmar Products Co. v. Allen-Qualley Co., 36 F.2d 623 (7th Cir., 1929)

[10]  Conmar Products Corp. v. Universal Slide Fastener Co., 172 F.2d 150 (3rd Cir., 1949)

[11] DTSA, Section IV (Uncodified Sections)

[12] 18 U.S.C. 1338(a) establishes exclusive jurisdiction of the district courts over “any civil action arising under any Act of Congress relating to patents, plant variety protection, copyrights and trade-marks”.

[13] 203 F.3d 782 (CAFC, 2000)

[14] 182 T. 3d 1340 (CAFC, 1999)

contact any attorney at E&F at http://www.ipatent.co.il/contact/

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