Contract Terms Alone Do Not Establish Trade Secret Protection

Vol. 17 No. 1

By

Peter C. Lagarias, Lagarias Law Offices

Trade secret protection ensures that mouths will continue to water with the secret spices of Colonel Harlan Sanders. The guru of Kentucky Fried Chicken carefully guarded his secret blend of eleven herbs and spices, and few would question the propriety of treating such a recipe as a trade secret. But modern franchise agreements often purport to bring much more information under the umbrella of trade secret protection. A not atypical franchise agreement provision might read:

Confidentiality. During and after the term of this Agreement, Franchisee shall not disclose, except to Franchisee’s employees, or use for any purpose other than operating the franchise business, any trade secret, confidential or proprietary aspect of the System including, but not limited to, the contents of the Franchisee Orientation and Training Manual, Operations Manual, training videos, DVDs and other materials or communications, the training program, the Franchisor’s Web Site and other on-line communications, marketing calendars, marketing plans, or other information or know-how distinctive to a franchise outlet. Franchisee is further responsible for ensuring that Franchisee’s employees maintain the same level of confidentiality.

Are such trade secret provisions enforceable? Or are they unenforceable as overreaching by franchisors?

The Uniform Trade Secrets Act

Most states have adopted the Uniform Trade Secrets Act (UTSA), which sets forth the requirements for determining an enforceable trade secret. Section 1 of the UTSA provides the following definition:

“Trade secret” means 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.

In sum, the basic requirements for trade secret protection are that the asserted trade secret: has independent economic value; is not generally known and not readily ascertainable; is the subject of reasonable efforts to maintain its secrecy; and has been misappropriated.

Economic Value, Secrecy

As for the first element, courts with little analysis find most asserted trade secrets in franchise cases to have independent economic value.

The second element, secrecy, often receives little analysis from the drafters of trade secret provisions in franchise agreements. As a result, much of the information franchisors seek to protect as trade secrets is commonly known or readily accessible. Is there anything not well-known about cooking burgers and fries or selling frozen yogurt?

A seminal franchise case on the parameters of generally known business information involved a national fish and chip franchisor. In re Arthur Treacher’s Franchisee Litigation, 537 F. Supp. 311 (E.D. Pa. 1982). In that case, the district court denied a motion for a preliminary injunction after finding the franchisor failed to show that its business operations manual, describing how to prepare its fish and chips, contained trade secrets:

There is no evidence other than the above testimony that the temperature at which plaintiff fries food, or the length of time the food is immersed in oil, or the length of time the food is held after frying, is a trade secret of plaintiffs or is any different from the process used by plaintiff’s competitors.

Id. at 322.

A temporary personnel franchisor was similarly unsuccessful in asserting that its customer lists and business forms were trade secrets in Scott v. Snelling and Snelling, Inc., 732 F. Supp. 1034 (N.D. Cal. 1990). Plaintiff franchisees established that temporary personnel agency customers are typically large and small companies which are easily identifiable. In addition, the plaintiff franchisees had obtained the customers through their own efforts, personal knowledge, and business contacts. Finally, plaintiff franchisees also demonstrated that the franchisor’s business form and procedures were widely used in the industry, thus negating trade secret status. Id. at 1045. See also O.V. Marketing Associates, Inc. v. Carter, 766 F. Supp. 960, 966 (D. Kan. 1991) (sporting goods franchisor failed to establish that asserted trade secrets were not within general knowledge of retailers); BSM & Associates, Inc. v. Norrell Services, Inc., 855 F. Supp. 1481 (E.D. Ky. 1994) (temporary personnel services franchisor not entitled to trade secret protection for its business forms and procedures, which were in general use in the industry and for sale by private vendors); Allen v. Hub Cap Heaven, Inc., 225 Ga.App.533, 484 S.E.2d 259 (1997) (combination of several mundane services was not entitled to trade secret protection); compare Great Expectations Franchise Corp. v. U.C.P. Enterprises, Bus. Fran. Guide (CCH) ¶11,434 (S.D. Cal. 1998) (only data developed by the franchisor was entitled to trade secret protection).

Likewise, a yogurt franchisor unsuccessfully sought to protect its business procedures in I Can’t Believe It’s Yogurt v. Gunn, 1997 WL 599391 (D. Colo. April 15, 1997). The franchisor in that case failed to establish whether other businesses used the same or similar procedures. Indeed, the court found that “much of the information claimed as trade secrets is taught at business schools.” Id. at 14.

Reasonable Efforts to Protect Secrecy

Franchisors have also lost protection by failing to satisfy the third requirement of the trade secret test, making reasonable efforts to protect the information they assert to be secret. In the Arthur Treacher’s decision mentioned above, the court denied trade secret protection after finding that “hundreds and probably thousands of present and former employees of Arthur Treacher’s undoubtedly knew plaintiff’s cooking process” and there was no evidence that the franchisor “attempted to ascertain if the [confidentiality] clause was being enforced” or “took any steps to ensure that a ‘substantial element of secrecy’ would exist with regard to its processes for preparing food.” Arthur Treacher’s, supra, 537 F. Supp. at 322. See also Hub Cap Heaven, 225 Ga.App.533, 484 S.E.2d 259 (no trade secret protection because alleged secret information was shown to all customers on the route); Maaco Franchising, Inc. v. Augustin, 2010 WL 1644278 (E.D. Pa. April 20, 2010) (no trade secret protection because the elements of Maaco’s system were shown to customers and to the public).

In I Can’t Believe It’s Yogurt, supra, 1997 WL 599391, the yogurt franchisor failed to establish that adequate efforts were undertaken to protect asserted trade secrets. In particular, the asserted trade secret business procedures were taught at “Yogurt University” to innumerable managers and employees who were not required to execute confidentiality agreements and were included in company publications not marked confidential. Id. at p. 14-15. Trade secret status was therefore denied.

Misappropriation

Sometimes franchisors wrongly conflate competition by a former franchisee with misappropriation of trade secrets. The act of competing is not enough to establish a right to trade secret relief. The trade secret also must have been “misappropriated,” a defined term under the UTSA. In the context of former franchisees, misappropriation typically is proven by establishing that the former franchisee disclosed or used a trade secret acquired while a franchisee. See, e.g., H&R Block Eastern Tax Services, Inc. v. Enchara, 122 F. Supp. 2d 1067 (W.D. Mo. 2000); Keller Corp. v. Kelly, 187 P.3d 1133 (Colo. App. 2008).

Conclusion

Trade secret provisions in franchise agreements, like the franchise agreements themselves, are increasingly prolix and more one sided than ever. Secret recipes may be the quintessential trade secrets. But business practices generally known in the industry and lists of customers who are easily identifiable often may not be trade secrets, even under the most artfully drafted trade secret provisions. Just because a franchise agreement says so does not make it so, and someday soon overbroad trade secrets provisions in franchise agreements may be voided in their entirety.

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