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December 11, 2019 Articles

How a Victim of Trade Secret Misappropriation May Obtain Unjust Enrichment Damages Based on Cost Avoidance Calculations

An in-depth analysis of the interplay between common law unfair competition and trade secret law.

By John A. Stone

Although competing by stealing trade secrets is clearly unfair and unjust, not all misappropriations of trade secrets support a cause of action for unfair competition or recovery based on unjust enrichment.

While most states’ formulations of a cause of action for unfair competition appear to include claims for misappropriating trade secrets, trade secret claims preempt factually similar claims for unfair competition in other states. Either way, not all states allow recovery of the costs the misappropriating party saved by stealing, instead of researching and developing, trade secrets. Both corporate lawyers and litigators need to understand the interplay between these areas of law and the remedies that are available in different jurisdictions.

Common-Law Unfair Competition

While, most of the time, common-law claims for unfair competition focus on “palming off,” such claims are not limited to the wrongful copying of another’s product or service:

[T]he Restatement specifically cautions that the “specific forms of unfair competition [described therein] do not fully exhaust the scope of statutory or common law liability for unfair methods of competition.” Courts have long noted that common law unfair competition is a flexible and evolving concept, not confined to any particular form of unethical behavior.

McGuire v. Gorruso, 800 A.2d 1085, 1091 (Vt. 2002) (citing Restatement (Third) of Unfair Competition, § 1 cmt. G).

Unfair competition is a “broad and flexible doctrine” and “essential allegations can vary with the type of unfair competition the plaintiff is claiming.” The Restatement does not require that “other unfair business practices” implicate deceptive or misleading behavior, instead finding a tort where the conduct “substantially interferes with the ability to compete on the merits of their products or otherwise conflicts with accepted principles of public policy recognized by statute or common law.”

Paccar, Inc. v. Elliot Wilson Capital Trucks, LLC, 905 F. Supp. 2d 675, 691 (D. Md. 2012).

In Illinois, for example, “courts have not specifically enumerated the requisite elements” of unfair competition, a tort that the Seventh Circuit has described as “elusive” and containing “elements [that] escape definition.” LG Elecs. v. Whirlpool Corp., 2010 WL 3521785, at *2 (N.D. Ill. 2010).

New Jersey’s courts have described unfair competition as “amorphous,” containing “no clear boundaries,” and “as flexible and elastic as the evolving standards of commercial morality demand,” because the “prevention of unfair competition is not circumscribed by rigid rules.” “In essence,” under New Jersey law, unfair competition “consists of the misappropriation of one’s property by another-property which has some sort of commercial or pecuniary value,” which occurs in “bad faith or [with] malicious conduct.” Reckitt Benckiser, Inc. v. Tris Pharma, Inc., 2011 WL 773034, at *8 (D.N.J. 2011).

Similarly, in New York, unfair competition “encompasses a broad range of unfair practices,” the “essence” of which are an offending party’s misappropriation of the “labors and expenditures of another . . . in bad faith,” to “exploit some commercial advantage which belonged exclusively to another.” Saniteq, LLC v. GE Infrastructure Sensing, Inc., 2018 WL 4522107, at *16 (E.D.N.Y. 2018).

Trade Secret Claims

The Uniform Trade Secrets Act (UTSA), which “created a model statutory cause of action for misappropriation of trade secrets,” Blue Earth Biofuels, LLC v. Hawaiian Electric Co., Inc., 235 P.3d 310, 313–14 (Haw. 2010), has been adopted, in one form or another, AUA Private Equity Partners, LLC v. Soto, 2018 WL 1684339, at *4 (S.D.N.Y. 2018), “in 48 states,” the District of Columbia, and the U.S. Virgin Islands. Kraft v. Downey, 68 A.3d 329, 333 (Pa. Super. Ct. 2013).

The only two states that have not adopted some form of the UTSA are New York and Massachusetts. Reed Const. Data Inc. v. McGraw Hill Cos., Inc., 49 F. Supp. 3d 385, 427 (S.D.N.Y. 2014); Fast Enters., LLC. v. Pollack, 2018 WL 4539685, at *4 (D. Mass. 2018). “Under New York common law, [a] plaintiff claiming misappropriation of a trade secret must prove: ‘(1) it possessed a trade secret, and (2) defendant is using that trade secret in breach of an agreement, confidence, or duty, or as a result of discovery by improper means.” Six Diminensions, Inc. v. Perficient, Inc., 2017 WL 10676897, at *8 (S.D.N.Y. 2018) (internal quotations omitted). In Massachusetts, a plaintiff alleging trade secret misappropriation must prove that the defendant “embezzle[d], st[ole] or unlawfully t[ook], carrie[d] away, conceal[ed], or copie[d], or by fraud or by deception obtain[ed], from any person or corporation, with intent to convert to his own use, any trade secret, regardless of value”—in essence that the defendant “obtained the information at issue improperly.” CardioNet, LLC v. InfoBionic, Inc., 2017 WL 1115153, at *3 (D. Mass 2017) (citations omitted).

Despite the best intentions of the designers of the USTA to create “uniform” trade secret law, many USTA-based statutes “vary in a number of ways and contain built-in limitations that make them not wholly effective in a national and global economy.” Farmers Edge Inc. v. Farmobile, LLC, 2018 WL 3747833, at *6 (D. Neb. 2018). Therefore, in 2016 Congress enacted the Defend Trade Secrets Act (DTSA), which “creates a federal private right of action for ‘[a]n owner of a trade secret that is misappropriated . . . if the trade secret is related to a product or service used in, or intended for use in, interstate or foreign commerce.” Farmers Edge, 2018 WL 3747833, at *6 (citing 18 U.S.C. § 1836). The DTSA “models its definition of ‘misappropriation’” on the UTSA. UA Private Equity Partners, LLC v. Soto, 2018 WL 1684339, at *4 (S.D.N.Y. 2018).

Possible Preemption of Common-Law Unfair Competition Claims by Trade Secret Law

“The UTSA contains a preemption provision, a form of which the majority of states have adopted[,]” which “explicitly preempts”

contract remedies and criminal remedies . . . regardless of whether they are based on misappropriation of a trade secret. However, courts are in conflict on whether this provision preempts other common law remedies, including claims premised on the misappropriation of confidential information, i.e., information that cannot be proven to be a trade secret.

Warrington S. Parker III & Daniel D. Justice, “The Differing Approaches to Preemption under the Uniform Trade Secrets Act,” 49 Tort Trial & Ins. Prac. L.J. 645, 646–47 (Winter 2014).

For example, even though subsection (b) of the New Jersey Trade Secrets Act provides that “[t]his act shall supersede conflicting tort, restitutionary, and other law of this State providing civil remedies for misappropriation of a trade secret,” subsection (a) of the same statutory section provides that

[t]he rights, remedies and prohibitions provided under this act are in addition and cumulative of any other right, remedy or prohibition provided under the common law or statutory law of this State and nothing contained herein shall be construed to deny, abrogate or impair any common law or statutory right . . . except as expressly provided in subsection b. of this section.

N.J. Stat. Ann. § 56:15-9.a (emphasis added).

As one New Jersey court noted,

at the time of its enactment of the New Jersey Trade Secrets Act, our legislature was well aware of the rights and remedies afforded aggrieved litigants under our common law and expressly intended to preserve, rather than abrogate or preempt, those rights and remedies. Any other construction would render [subsection (a)] meaningless.

SCS Healthcare Mktg., LLC v. Allergan USA, Inc., 2012 WL 6565713 (N.J. Ch. 2012).

On the other hand, under California’s and Hawaii’s versions of the UTSA, “civil claims such as fraud and unfair competition are preempted, unless they are based upon a broader spectrum of misconduct than the misappropriation of confidential information.” Moddha Interactive, Inc. v. Philips Elec. N. Am. Corp., 92 F. Supp. 3d 982, 991 (D. Haw. 2015).

With respect to common-law jurisdictions, a New York common-law “claim for unfair competition based on the same allegations as a claim for misappropriation of trade secrets is treated as a single cause of action.” Uni-Systems, LLC v. U.S. Tennis Ass’n, Inc., 2018 WL 4863589, at *16 (E.D.N.Y. 2018). Although less clear, Massachusetts law seems similar. Cf. I.P. Lund Trading ApS v. Kohler Co., 163 F.3d 27, 35 (1st Cir. 1998) (the “laws of patents, copyright, trade secrets, trademarks, unfair competition, and misappropriation balance the conflicting interests in protection and dissemination differently in different contexts through specific rules that determine just who will receive protection, of just what kind, under what circumstances, and for how long”).

Irrespective of whether a state’s trade secrets law is based on the UTSA or the common law, DTSA-based misappropriation claims do not preempt other causes of action. See, e.g., Xavarian Ins. Co. v. Marsh & McLennan Cos., Inc., 2019 WL 16207544, at *4 (S.D.N.Y. 2019); OROS, Inc. v Dajani, 2019 WL 2361047, at *2 (E.D. Va. 2019).

Obtaining Cost Avoidance Damages

Both the DTSA and UTSA authorize “damages for the actual loss and any unjust enrichment caused by the misappropriation” or, in the alternative, the imposition of a “reasonable royalty on the misappropriator.” Sterling Computs. Corp. v. Haskell, 2018 WL 671210, at *4 (D.S.D. 2018) (emphasis added); accord Sapienza v. Trahan, 2019 WL 348820, at *21 n.148 (W.D. La. 2019) (“under the DTSA[,] . . . a court may award ‘damages for any unjust enrichment caused by the misappropriation of the trade secret” for only those damages “not addressed in computing damages for actual loss’”); Lightning Box Games, Pty v. Plaor, Inc., 2017 WL 7310782, at *11 (N.D. Cal. 2017) (“Like the CUTSA, the DTSA authorizes recovery [of] ‘damages for the actual loss caused by misappropriation of the trade secret’” and for “unjust enrichment caused by the misappropriation of the trade secret that is not addressed in computing damages for actual losses”); Beard Research, Inc. v. Kates, 8 A.3d 573 (Del. Ch. 2010) (allowing non-duplicative recovery of damages for “both the actual loss caused by misappropriation and the unjust enrichment caused by misappropriation that is not taken into account in computing actual loss”), judgment aff’d, 11 A.3d 749 (Del. 2010).

Although unjust enrichment damages are clearly available, “neither statute precisely defines the scope of those damages.” Steve & Sons, Inc. v. JELD-WEN, Inc., 2018 WL 2172502, at *6 (E.D. Va. 2017). Therefore, courts may look to the common law to determine under what facts or proofs unjust enrichment is available—and therein lies the problem, as demonstrated by two differing opinions from Texas and New York.

Texas common law regarding trade secrets, which follows the Restatement, “takes a ‘flexible and imaginative’ approach” that “allows calculation of damages based on defendant’s avoided costs,” which may, for example, be based on the amount the plaintiff “spent on research and development for” the misappropriated information. GlobeRanger Corp. v. Software AG United States of America, Inc., 836 F.3d 477, 499 (5th Cir. 2016).

In stark contrast, New York, despite also following the Restatement, takes an approach that is nearly 180 degrees different. New York’s highest state court explained as follows:

Where disclosure of a trade secret has “destroy[ed] that competitive edge,” the plaintiff’s costs of developing the product may be the best evidence of the (now-depleted) value that the plaintiff placed on the secret. However, it is neither automatically nor presumptively the case that the costs avoided by the defendant will be an adequate approximation of the plaintiff’s investment losses, any more than it can be presumed that the defendant’s sales would approximate those of the plaintiff. Indeed, [a] plaintiff’s actual development costs will commonly be used as a proxy for the defendant’s saved development costs (under a damages regime that permits recovery of unjust gains). This is only logical; the plaintiff’s actual development costs have actually been incurred and are known, whereas the defendant’s avoided costs, by definition, are hypothetical. Flipping this formula—measuring the plaintiff’s actual expenditures, a known quantity, by the defendant’s projected expenditures, an unknown one—is precisely the kind of “wholly unsubstantial and imaginary” nexus that Judge Cardozo warned of.

E.J. Brooks Co. v. Cambridge Sec. Seals, 105 N.E.3d 301, 311–12 (N.Y. 2018) (emphasis in original).

Therefore, even

where a defendant saves, through its unlawful activities, costs and expenses that otherwise would have been payable to third parties, those avoided third-party payments do not constitute funds held by the defendant “at the expense of” the plaintiff. Therefore, a plaintiff bringing an unjust enrichment action may not recover as compensatory damages the costs that the defendant avoided due to its unlawful activity in lieu of the plaintiff’s own losses.

Id. at 313.

Practice Tips

Given the possibility that state law will affect UTSA and DTSA claims, businesses seeking trade secret protection must be aware of the remedies under the law of the state that applies. Although that law may often be agreed upon in advance in, for example, employment contracts and joint venture agreements, such provisions are not always enforced. See, e.g., BI3, Inc. v. Hamor, 2011 WL 1231156, at *6 (N.D. Ill. 2011).

The following analysis in Nostrum Pharmaceuticals, LLC v. Dixit, a case decided by the Southern District of New York in 2014, is instructive.

Where, as here, a plaintiff’s complaint invokes federal diversity jurisdiction, courts apply the choice-of-law rules of the forum state—here, New York. Because New Jersey and Missouri have each adopted a version of the Uniform Trade Secrets Act, and New York has not, the choice of which state’s law to apply will make a difference in the Court’s analysis of Nostrum’s trade-secret claim. If Missouri trade-secrets law applies, Nostrum’s common-law claims for breach of fiduciary duty, tortious interference with contract, and usurpation of corporate opportunities will be preempted. The recently adopted New Jersey Trade Secrets Act, however, does not preempt these common-law remedies. Thus, an actual conflict of law exists for these counts.
Although the 2011 Employment Agreement specifies that it “shall be governed by, construed, interpreted, and enforced in accordance with the laws of the State of New York, New York courts are reluctant to construe choice-of-law provisions broadly to encompass non-contractual claims.” Accordingly, under New York law, for a choice-of-law provision to apply to a tort claim arising incident to the contract, the express language of the provision must be “sufficiently broad” so as to encompass the entire relationship between the contracting parties. . . .
Here, the 2011 Employment Agreement’s language is insufficiently broad to cover the Amended Complaint’s tort-based claims:
This Agreement and all rights and obligations of the Parties hereunder shall be governed by, construed, interpreted and enforced in accordance with the laws of the State of New York applicable to agreements made and to be performed entirely within the State, including all matters of enforcement, validity and performance.
The next step, then, would be to perform the choice-of-law analysis. In tort actions, New York courts apply an “interest analysis,” under which the law of the jurisdiction having the greatest interest in the litigation is applied. In trade secret cases, the Second Circuit and its district courts have often used the locus of the misappropriation to determine the locus of the tort and the state with the greatest interest.

Nostrum Pharm., LLC v. Dixit, 2014 WL 4370695, at *9–10 (S.D.N.Y. 2014) (citations omitted, emphasis added),

And Nostrum does not appear to be all that unique. See, e.g., Vesta Corp. v. Amdocs Mgmt. Ltd., 80 F. Supp. 3d 1152 (D. Or. 2015). Thus, Nostrum and cases like it compel corporate attorneys to draft broad choice-of-law provisions that expressly reach beyond the four corners of an agreement and apply to torts as well as contract claims. Litigators should be equally mindful of the contractual language—and the facts in play—when evaluating claims and defenses and which law may apply.

John A. Stone is a litigation partner at DeCotiis, FitzPatrick, Cole, & Giblin, LP’s New Jersey and New York offices.

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