Venue of trade secret litigation can lie in either state or federal courts, and the Defend Trade Secrets Act, 18 U.S.C. § 1836 et seq., attempts to provide certain uniformity in trade secret disputes. While there is no equivalent to the Federal Circuit in the trade secrets arena, patent case law can provide guidance regarding the determination of damages in trade secret litigation. For example, the California Court of Appeal’s decision in Ajaxo v. E*Trade, 187 Cal. App. 4th 1295 (Cal. Ct. App. 2010), borrows from patent law to address reasonable royalties in trade secret litigation. Indeed, under Ajaxo, damages in trade secret litigation can be based on the outcome of a hypothetical negotiation between the litigants when neither the plaintiff’s actual loss nor the defendant’s unjust enrichment are “provable.” Id. at 1310.
A continued area of frustration in patent litigation is the lack of clarity as to the scope of the claimed invention. In a patent litigation Markman proceeding, a judge is required to interpret the claims of the patent in dispute, but in certain jurisdictions, claim construction can occur after expert reports on damages have been submitted. If the scope of the claimed invention changes significantly after a Markman ruling, this can present challenges for damages experts who have previously evaluated damages under alternative assumptions. This dynamic is amplified in trade secret litigation, where there is no equivalent to patent claim construction and plaintiffs may attempt to modify the scope of the claimed trade secrets as discovery unfolds. Damages experts must learn to embrace this ambiguity and prepare for potential changes to their analyses and opinions with the evolution of these case facts.
In determining actual loss attributable to trade secret misappropriation, an assessment should first be made as to whether and to what extent the plaintiff would have realized additional profits but for the alleged wrongful conduct. These actual losses—commonly referred to as lost profits—typically stem from lost sales, increased costs, or some combination thereof.
As in patent infringement litigation, plaintiffs in trade secret litigation often attempt to establish causation to lost profits damages through the analytical framework set forth in Panduit. If applied in the context of determining lost profits in trade secret litigation, the Panduit framework would indicate that the plaintiff must establish (1) demand for the product or service embodying the subject trade secrets, (2) the absence of alternative means available to satisfy this demand without use of the trade secrets, (3) the ability to satisfy this demand, and (4) the ability to quantify corresponding losses to a reasonable degree of certainty. To the extent that the plaintiff is unable to satisfy all four of these factors for some or all of the alleged wrongful sales, those sales can be either subject to a reasonable royalty or the basis for a claim of unjust enrichment. Defend Trade Secrets Act of 2016.
Notably, and notwithstanding the framework set forth in Panduit, individual case facts can provide alternative bases on which to assess a plaintiff’s actual loss. For example, if the plaintiff and defendant had been partners in a development and revenue-sharing arrangement and, unbeknownst to the plaintiff, the defendant sold a business based on the plaintiff’s trade secrets, one measure of the plaintiff’s actual loss could be a portion of the proceeds the defendant generated from the sale.
Damages in trade secret litigation can be based on a reasonable royalty when neither the plaintiff’s actual loss nor the defendant’s unjust enrichment are “provable.” Again, lessons from patent litigation in determining a reasonable royalty based on the outcome of a hypothetical negotiation, as prescribed in Georgia-Pacific, can provide insights and challenges regarding this remedy in trade secret litigation.
A shortcoming of the hypothetical negotiation construct is that it is a theoretical exercise that can be confusing and difficult for a jury to follow. This is especially true when the subject matter under license is an intangible and indefinite asset such as a trade secret, which can be difficult to articulate, as compared with a patent, in which the claims have already been reduced to writing and are then interpreted by the court.
To provide a baseline to assist in this exercise, a damages expert can start by considering commonly accepted quantitative approaches used to value tangible and intangible assets: the market, income, and cost approaches. The application of these commonly accepted valuation approaches can yield a fair market value of the subject property, which can itself be a basis for determining damages in trade secret matters. See Gaylord v. United States, 678 F.3d 1339 (Fed. Cir. 2012); Teledyne Techs., Inc. v. Shekar, 2017 U.S. Dist. LEXIS 224364 (N.D. Ill. 2017). Quantitative royalty indicators derived from these valuation techniques can be adjusted by the 15 qualitative factors prescribed in the Georgia-Pacific decision noted above. An expert may hesitate, however, in using the hypothetical negotiation construct and the Georgia-Pacific factors in assessing a reasonable royalty in trade secret litigation. Notably, and in addition to the fact that licensing a trade secret is counterintuitive given the proprietary and confidential nature of the subject matter, the invocation of the Georgia-Pacific factors—an exercise that can be confusing for a jury in patent matters—may invite unnecessary subjectivity into a damages construct that is already difficult for the juror.
The market approach, which is based on the premise that the value of assets such as trade secrets can be assessed by reference to other marketplace transactions, can be particularly challenging when applied to trade secret litigation. By definition, and in contrast to patents, trade secrets are intended to be kept out of the public domain and are not typically licensed on a stand-alone basis. Therefore, it can be difficult to find evidence of license agreements for assets comparable to the subject trade secrets. Even in situations where potentially comparable agreements can be identified, the damages expert is often tasked with adjustments necessary to control for patents or other intellectual property rights bundled under the same license. The comparability of licenses under the market approach is an area that has come under a great deal of scrutiny in patent damage claims, and comparability can prove even more challenging in trade secret disputes.
The income approach attempts to isolate (i.e., apportion) the profits attributable to the trade secrets at issue vis-à-vis other factors. This concept of apportionment has been a critical issue in patent litigation since Rite-Hite, and the EMVR concept has been heavily vetted in patent case law. While the EMVR and apportionment issues can be particularly complicated with trade secrets, analytical techniques deployed in the assessment of damages from patent infringement can be useful in isolating the trade secret’s contribution to product profitability. For example, in determining the profits attributable to the use of a patented technology, one might consider an analytical approach that quantifies the incremental profitability of a patented product vis-à-vis a comparable product that does not embody that patented technology. This analytical approach is often equally applicable in assessing profits attributable to the use of a given trade secret. While this analysis can inform the determination of a reasonable royalty, this analysis is also often deployed in the assessment of unjust enrichment, discussed in the next section.
The cost approach is based on the premise that rational and willing negotiators for intellectual property rights would appropriately consider the cost of an acceptable, non-infringing alternative available to the licensee when negotiating a royalty. While both the plaintiff and defendant in a trade secret litigation might identify their respective investment in research and development (R&D) as either an indication of the value of the subject trade secret or the efforts deployed to avoid its use, this approach can be subject to challenge. Indeed, even beyond arguments relating to the inapplicability of sunk costs, companies often do not diligently track R&D expenditures and it can be difficult to compartmentalize R&D efforts into discrete classifications. For that reason, and as with the assessment of a reasonable royalty for the use of patented technology, a generally acceptable application of the cost approach focuses on quantifying the incremental cost that the defendant would incur to develop and deploy the accused product or service without the use of the subject trade secret. In addition, as addressed in more detail below, this cost measurement exercise can be useful in determining unjust enrichment as measured by the expenses the defendant avoided as a result of the alleged wrongful conduct.
Assuming liability is found, the plaintiff in trade secret litigation can also recover gains realized by the defendant due to the alleged misappropriation that were not considered in computing the plaintiff’s actual loss. See, e.g., Uniform Trade Secrets Act § 3(a). In University Computing Co. v. Lykes-Youngstown Corp., 504 F.2d 518 (5th Cir. 1974), the court explained that “[t]he appropriate measure of damages, by analogy to patent infringement, is not what [the] plaintiff lost, but rather the benefits, profits, or advantages gained by the defendant in the use of the trade secret.” This “unjust enrichment” is typically measured through an accounting of the profits the defendant earned as a result of using the misappropriated trade secrets.
In the absence of specific direction from the courts, the calculation of the defendant’s profits attributable to the alleged wrongful conduct typically follows the order established under the Lanham Act (15 U.S.C. § 1051 et seq.). As stated therein, it is the plaintiff’s burden to first establish the defendant’s sales attributable to the use of the trade secret. 15 U.S.C. § 1117. The burden then shifts to the defendant to “prove all elements of cost or deduction claimed.” Id. The ensuing debate over such deductions is typically the domain of damages experts who opine on the appropriate level of profit (e.g., gross margin, contribution margin, incremental margin, operating margin), the incrementality of expenses, and other means of potential apportionment. While this debate typically focuses on the defendant’s incremental profitability, the determination of those incremental profits is subject to the experts’ respective opinions of fixed and variable expenses, as well as the facts and circumstances of the case at hand. As with the assessment of patent damages, however, additional analyses may be necessary to further apportion the resulting profits to isolate those that are uniquely attributable to the alleged use of the subject trade secrets. For that reason, various apportionment analyses deployed in the assessment of patent infringement damages can be helpful here. These analyses may include the following, among others:
- Conjoint analyses that use customer surveys to determine values for product attributes;
- Valuing product features by reference to feature usage data or component cost (or both);
- Consideration of the smallest saleable unit practicing the subject technology;
- Cost savings from the use of the subject technology; and
- Analytical approaches to evaluate the incremental profitability of products incorporating the subject technology.
See generally Apple Inc. v. Samsung Elecs. Co., Ltd., No. 5-12-cv-00630 (N.D. Cal. Feb. 25, 2014); TV Interactive Data Corp. v. Sony Corp., No. 3-10-cv-00475 (N.D. Cal. Mar. 1, 2013); SUMMIT 6, LLC v. Samsung Elecs. Co., 802 F.3d 1283 (Fed. Cir. 2015); LaserDynamics, Inc. v. Quanta Comput., Inc., 694 F.3d 51 (Fed. Cir. 2012); Hanson v. Alpine Valley Ski Area, Inc., 718 F.2d 1075, 1080–81 (Fed. Cir. 1983); TWM Mfg. Co., Inc. v. Dura Corp., 789 F.2d 895 (Fed. Cir. 1986).
An alternative analysis and means of isolating the benefit derived by the defendant from the alleged wrongful conduct can focus on the incremental development cost that the defendant would have incurred to develop an alternative product absent access to the subject trade secrets. The courts have measured such incremental development cost by reference to the standard of comparison method, which was discussed in International Industries, Inc. v. Warren Petroleum Corp., 248 F.2d 696 (3d Cir. 1957), as a “comparison of the cost of [obtaining a result] by means of the use of the trade secret with a method of accomplishing the same result which would have been open to [the] defendant had he not appropriated the trade secret.” Id. at 701–2. As with an analysis of the cost approach in patent litigation, the defendant’s incremental cost in the absence of the alleged misappropriation could include incremental development expenses, incremental operating expenses, and forgone profits from delayed market entry.
Patent case law can provide useful insight and clarity as to the determination of damages in trade secret matters, especially with respect to profit apportionment. At the same time, valuation approaches that have been extensively vetted in the context of patent infringement damages can be useful starting points in trade secret litigation. This is particularly the case with various cost and income approaches, which are often appropriately applied in assessing reasonable royalties or unjust enrichment attributable to the alleged misappropriation. The applicability of these methods notwithstanding, the trade secret context can also entail additional challenges with respect to the application of the market approach as well as the use of the hypothetical negotiation construct and invocation of the Georgia-Pacific factors, as these avenues may not provide additional certainty when damages are otherwise not “provable” in trade secret cases.