trade secret misappropriation

In E.J. Brooks Company v. Cambridge Security Seals, the Court of Appeals of New York narrowed the scope of permissible damage claims plaintiffs can assert in trade secret actions under New York law. The ruling denies plaintiffs the ability to recover costs that defendants avoided through misappropriating trade secrets (known as “avoided costs” theory), making New York law less attractive to certain types of trade secret actions due to the state’s conservative approach in calculating damages.

E.J. Brooks Company d/b/a TydenBrooks (“TydenBrooks”), the largest manufacturer of plastic indicative security seals in the United States, brought an action in federal district court against rival manufacturer Cambridge Security Seals (“CSS”), asserting causes of action that included common law misappropriation of trade secrets, unfair competition and unjust enrichment. TydenBrooks alleged that former TydenBrooks employees misappropriated trade secrets after defecting to CSS and sought damages based on an “avoided costs” theory.

Under an “avoided costs” calculation, the plaintiff estimates damages based on the amount the defendant saved in research and development costs by unlawfully acquiring the plaintiff’s trade secrets. At trial, the jury found CSS liable under all three claims and awarded TydenBrooks a $3.9 million judgment based solely on the TydenBrooks’ avoided cost theory.

On appeal, the Second Circuit requested guidance from the New York State Court of Appeals on the issue of whether, under New York law, a plaintiff asserting claims of misappropriation of a trade secret, unfair competition, and unjust enrichment can recover damages measured by the costs the defendant avoided due to its unlawful activity. Prior New York precedent had not conclusively addressed whether a plaintiff could recover damages based solely on the cost avoidance of a defendant’s unlawful misappropriation of trade secrets.

In a 4-3 decision, the Court of Appeals held that a plaintiff may not elect to measure its damages by the defendant’s avoided costs in lieu of the plaintiff’s own losses. The majority went on to explain that the calculation of damages must be narrowly focused on the economic injuries incurred by the plaintiff. The minority noted that the decision departs from the predominant rule accepted by most states and may even encourage unlawful theft of trade secrets in circumstances where the unlawful actor’s benefit far exceeds the likely cost of defending against a trade secret action. Other jurisdictions, such as the Fifth, Tenth and Eleventh Circuits, have either allowed actions based solely on an “avoided cost” theory, or allowed a calculation of reasonable royalty[1] in lieu of a calculation of the plaintiff’s own losses.

Companies should be aware of New York’s conservative approach to damage calculations when entering into litigation surrounding trade secrets. Plaintiffs should also pay special attention to choice of law and choice of forum provisions in their contractual dealings with employees and contractors, as these may have an impact on the type of calculations that can be used to assess damages.

It is also important to note that the federal government expanded protections for trade secrets in adopting the Defend Trade Secrets Act (“DTSA”) of 2016. DTSA claims were not at issue in this case, because it predated DTSA’s enactment, but are an important consideration given the current case law in New York.

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[1] A reasonable royalty is similar to “avoided costs” because it allows a plaintiff to recover damages in lieu of showing actual loss.

This post was written with significant assistance from Eduardo J. Quiroga, a 2018 Summer Associate at Epstein Becker Green.

Financial analytics firm Novantas, Inc. and two individual defendants closed out 2017 with a victory, securing the dismissal of claims by rival First Manhattan Consulting Group LLC (“First Manhattan Consulting Group”) [1], which accused them of competing unfairly by poaching First Manhattan Consulting Group’s employees in order to steal its trade secrets.  The result demonstrates the need for plaintiffs in such cases to be able to prove with specificity which trade secrets were taken or threatened by the defendants’ conduct.

The Complaint alleged that Novantas engaged in a “pattern and practice of poaching” First Manhattan Consulting Group’s employees, including defendants Peter Gilchrist and Andrew Frisbie in 2014, to gain access to First Manhattan Consulting Group’s confidential information.  These individuals, who were officers of First Manhattan Consulting Group, were subject to contractual confidentiality and employee non-solicitation obligations.  First Manhattan Consulting Group asserted causes of action for breach of contract against the individuals, for tortious interference with contract and unfair competition against Novantas, along with a misappropriation of trade secrets claim against all defendants.

The case went to trial in Supreme Court, New York County. Justice Barry Ostrager declined to submit the misappropriation claim to the jury, because the information presented by First Manhattan Consulting Group at trial did not appear to the Court to be a trade secret, and there was no testimony concerning trade secrets.  In its verdict, the jury unanimously found no liability on any of the other claims.  On December 19, 2017, the Court dismissed First Manhattan Consulting Group’s claims.

For practitioners, this outcome is a useful reminder that trade secret misappropriation claims require in-depth understanding of the client’s business, detailed allegations in pleadings of the legally required elements of a misappropriation claim and, at trial, a full presentation regarding the wrongdoing and what specific information was taken and how the plaintiff has been damaged.

 

[1] First Manhattan Consulting Group is unrelated to First Manhattan Co.

Consider the following scenario that was the premise of the book Charlie and the Chocolate Factory (1964), and later adapted into the classic film Willy Wonka & the Chocolate Factory (1971): your company (Willy Wonka Chocolates) is in the candy business and develops an idea for an everlasting gobstopper (a sucking candy that never gets smaller).  Anticipating substantial profits from the product, the company designates the everlasting gobstopper formula as a trade secret.  As in the book and film, a rival chocolate company (Slugworth Chocolates) seeks to steal the trade secret formula in order to develop and market a competing gobstopper.

While Charlie and the Chocolate Factory is premised on a local competitor seeking to steal trade secrets for its own business, this post focuses on an adaptation to the story based in today’s global economy, and more specifically, the actions a company may take within the United States and abroad to protect against trade secret misappropriation.

Most U.S. companies are now aware of the protections afforded by the Defend Trade Secrets Act of 2016, 18 U.S.C. §§ 1836, et seq. (the “DTSA”).  Of most importance is that the DTSA created a uniform legislation that provides companies with a private civil cause of action for trade secret misappropriation.  As a result of enactment of the DTSA, a company that is the victim of trade secret theft has standing to file a civil suit in federal court.  The company may also report the theft to the United States Department of Justice because, in certain cases, the theft of trade secrets constitutes a crime under the federal Economic Espionage Act, 18 U.S.C. §§ 1831, et seq. (the “EEA”).

Due to jurisdictional limitations, however, the DTSA and EEA may not provide adequate protection when there has been a misappropriation of trade secrets in the international arena. Companies should, therefore, be aware of other methods to protect against trade secret misappropriation abroad.  One method is through the United States International Trade Commission (the “ITC”), an independent, quasi-judicial federal agency with broad investigative responsibilities on matters of trade. Pursuant to the Smoot-Hawley Tariff Act of 1930 (the “Act”), the ITC has jurisdiction to investigate and can render unlawful, the importation of goods stemming from “unfair methods of competition and unfair acts in the importations of articles … in the United States.”  The ITC has determined that trade secret misappropriation is a form of unfair competition that is protected under Section 337 of the Act, and the United States Courts of Appeals for the Federal Circuit has affirmed this interpretation in two separate cases. See Sino Legend Chemical Co. v. ITC, 623 Fed. Appx. 1016 (Fed. Cir. 2015), cert. denied, 196 L. Ed. 2d 517 (2017); TianRui Group Co. Ltd. v. ITC, 661 F.3d 1322, 1327 (Fed. Cir. 2011).

In Sino Legend Chemical Co., employees had been working for a U.S.-based company at a facility in China.  The employees stole trade secrets from the company and brought them to Sino Legend Chemical Co., a competitive Chinese company that began developing a competitive product and sought to sell it in the United States.  The U.S. company filed a complaint with the ITC, and after investigation, the ITC instituted a 10-year ban on the importation of products resulting from trade secret misappropriation that had occurred entirely outside the United States.  On appeal, Sino Legend urged the Federal Circuit to overturn the ITC’s decision, arguing that Section 337 of the Act should not apply because the trade secret misappropriation occurred entirely outside the United States.  The Federal Circuit disagreed and affirmed the 10-year ban instituted by the ITC, and in 2017, the United States Supreme Court declined review.

A company should be aware that even if a theft of trade secrets occurs abroad, the company may seek relief through the ITC to prevent the importation of competitive products into the United States that are developed as a result of the stolen trade secrets. Of course, relief through the ITC is limited because the ITC cannot stop the offending company that stole the trade secrets from marketing a competitive product in countries outside the U.S.  There remain, however, other methods to protect against the misappropriation of trade secrets abroad.

Similar to the DTSA, the European Union (“EU”) enacted its own framework for the protection of trade secrets via a directive that went into effect on June 8, 2016. The EU directive provides protection of “undisclosed know-how and business information against their unlawful acquisition, use and disclosure.”  Although the EU directive does not establish criminal sanctions, it does provide for civil means through which victims of trade secret misappropriation can seek protections, such as: (i) allowing for temporary restraining orders and injunctive relief; (ii) removal from the market of goods manufactured based on stolen trade secrets, and (iii) monetary damages.  Pursuant to the EU directive, each member country must incorporate the required provisions into its laws by June 9, 2018.  Importantly, the EU directive contains only the minimum requirements for the protection of trade secrets; however, each EU member country may elect to enact stronger protections.  It remains to be seen whether the EU countries will enact provisions more stringent than the EU directive.

Companies need to protect themselves from the Slugworths of the world. In Charlie and the Chocolate Factory, Slugworth was a local competitor that sought to steal Willy Wonka’s trade secrets, but in today’s global economy, Slugworth can steal trade secrets from anywhere and can also market competitive products throughout the globe.  As a result, companies need to be well versed in the various global protections against misappropriation of trade secrets.  Use of counsel knowledgeable of these various protections is critical to ensure that all avenues of relief are considered.

After years of stops and starts in Congressional efforts to pass a law creating a federal claim for misappropriation of trade secrets that can be pursued by private citizens and companies (as opposed to federal prosecutors), the last few weeks have produced an astonishing acceleration of those efforts.  This month, the Defend Trade Secrets Act has been approved by both houses of Congress in resounding fashion.  It is on the brink of being enacted into law.

On April 27, 2016, the House of Representatives voted 410-2 to pass the Defend Trade Secrets Act.  That vote came quickly on the heels of the April 20, 2016 approval of the bill by the House Judiciary Committee, where the bill had languished since July 2015.  The Judiciary Committee finally took action on the bill after the Senate voted unanimously by a tally of 87-0 to approve the bill on April 4, 2016.

The bill will soon be sent to President Obama for signature, and his administration has previously stated that it strongly supports it. The law is designed to go into effect on the day it is enacted and apply to any misappropriation that occurs thereafter.

For further discussion of the efforts to make a federal private right of action for trade secret misappropriation a reality, as well as discussion of some of its significant provisions, see our recent blog posts, and also Epstein Becker Green’s Take 5 article Will There Finally Be a Federal Private Right of Action for Trade Secret Misappropriation?