March 28, 2014 Articles

Key Defenses to an Accusation of Trade-Secret Misappropriation

A crash course for young lawyers

By Onika K. Williams

With the development of exponentially innovative technology, advanced methods of accessing information, and an increasingly aggressive business environment, having a competitor accuse your business of trade-secret misappropriation is a serious allegation.  Trade-secret litigation can be costly and complex for all parties involved.  Whether consisting of a secret recipe, chemical process, or even a list of key clients, trade secrets are prized assets to a business. The key to overcoming an accusation of trade-secret misappropriation is properly defending your company's use of the alleged secret information.  This article will briefly review the key defenses to an accusation of trade-secret misappropriation.

What Is a Trade Secret?

While trade-secret misappropriation is generally a state-law matter, see, e.g., Core
Labs. LP v. Spectrum Tracer Servs., L.L.C., 532 F. App'x 904, 908 (Fed. Cir. 2013), the area of law has become more uniform with the state-by-state adoption of the Uniform Trade Secrets Act (UTSA). As of January 2014, 47 states, the District of Columbia, Puerto Rico, and the U.S. Virgin Islands have adopted the UTSA. See Uniform Law Comm'n, Legislative Fact Sheet—Trade Secrets Act (last visited Jan. 22, 2014). Only Massachusetts, New York, North Carolina have not yet adopted the UTSA. Id. There is a bill pending in the Massachusetts legislature, however, that seeks, in part, to adopt the UTSA. See Bill H. 27: An Act Making Uniform the Law Regarding Trade Secrets, 118th General Court of the Commonwealth of Massachusetts (last visited Jan. 22, 2014).

Even though the UTSA has been enacted by all but three states, it should be noted that differences remain among the state laws because state legislatures have modified the UTSA, and state courts have adopted varying interpretations of the enacted statutes. See, e.g., David Almeling, "Four Reasons to Enact a Federal Trade Secrets Act," 19 Fordham Intell. Prop. Media & Ent. L.J.,  769, 774 (2009.  For example, the District of Columbia adopted the UTSA with several modifications, including the omission of section 10 of the UTSA, which addresses severability.  See D.C. Code §§ 36-401 to -410 (2011); see also D.C. Code § 36-410 (contains an additional provision permitting the disclosure of information to enforce the Occupational Safety and Health Act 1988 and Pesticide Operations Act 1978).

The UTSA defines a trade secret as "information, including a formula, pattern, compilation, program, device, method, technique, or process." UTSA § 1(4) (1985 amendments).  A trade secret "(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." Id.

In addition to the UTSA, another widely recognized authority in the area of trade-secret law is the Restatement of Unfair CompetitionSee TianRui Grp. Co. v. U.S. Int'l Trade Comm'n, 661 F.3d 1322, 1327–28 (Fed. Cir. 2011).  The Third Restatement of the Law: Unfair Competition defines a trade secret as "any information that can be used in the operation of a business or other enterprise and that is sufficiently valuable and secret to afford an actual or potential economic advantage over others." Restatement (Third) of the Law: Unfair Competition, ch. 4, § 39 (1995).

What Is Misappropriation of a Trade Secret?

The UTSA defines misappropriation as the

(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 [or her] 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.

UTSA § 1(2).

Additionally, section 40 of the Restatement (Third) of the Law: Unfair Competition, ch. 4, § 40 ("Appropriation of Trade Secrets"), provides a definition of misappropriation that is often referred to by courts.

Finally, the original Restatement of Torts also contained sections on unfair competition, including a section on trade-secret misappropriation.  See Restatement (First) of Torts, ch. 36, § 757 (1933). These sections were not included in the Restatement Second of Torts (1957) and now appear in the Restatement Third of Unfair Competition. See Restatement (Third) of the Law: Unfair Competition, ch. 4, § 40 cmt. b.

Misappropriation of trade secrets can be a state crime in certain jurisdictions,see, e.g., Md. Crim. Law §§ 7-101, 7-104 (2011),and afederal crime under the Economic Espionage Act, see Economic Espionage Act of 1996, 18 U.S.C. § 1831–39 (2013).  This article does not address criminal misappropriation, focusing only on defenses to civil liability.  For general information on criminal misappropriation, an excellent starting point is Aaron Perahia et al., "Intellectual Property Crimes," 48 Am. Crim. L. Rev. 849 (2013).

Defenses to an Accusation of Trade-Secret Misappropriation

Generally, to prevail on a trade-secret misappropriation claim, a plaintiff must show (1) ownership of a trade secret, (2) the defendant's improper acquisition or misuse of the trade secret, and (3) harm or damage as a result of the unauthorized use or disclosure of the secret information.  See, e.g., Kendall Holdings, Ltd. v. Eden Cryogenics, L.L.C., 521 F. App'x 453, 457 n.5 (6th Cir. 2013) (noting the Sixth Circuit's likely outdated formulation of the prima facie case in light of Ohio's adoption of UTSA); Daniels Health Scis., L.L.C. v. Vascular Health Scis., L.L.C., 710 F.3d 579, 583 (5th Cir. 2013) (referring to Texas law). A defendant should review a forum's law to determine what prima facie elements a plaintiff must show to prove trade-secret misappropriation. To read a more in-depth discussion of the respective burdens of persuasion on plaintiffs and defendants in trade secret cases, see Sharon K. Sandeen & Elizabeth A. Rowe, Trade Secret Law In a Nutshell 147–51 (2013).

Bearing in mind the framework of the UTSA, sections 39 through 45 of the Restatement (Third) of Unfair Competition (1995), section 757 of the Restatement of Torts (1939), and the general prima facie elements of a misappropriation claim, defendants may have several key defenses to assert against a claim of misappropriation.

Not a trade secret. Defendants should recognize that "just about anything can constitute a trade secret under the right set of facts." Microstrategy Inc. v. Bus. Objects, S.A., 331 F. Supp. 2d 396, 416 (E.D. Va. 2004).  A key strategy in defending against a claim of trade- secret misappropriation is to attack the elements of the prima facie case. 

In general, a trade secret has four elements: (1) information, (2) economic value or potential, (3) is not generally known, and (4) has been treated as a secret.  Information that can be claimed as trade secret includes business strategies, market analyses, customer lists, machinery, software, and chemical formulas, such as the Coca-Cola formula.  See Gideon Parchomovsky & Alex Stein, "Intellectual Property Defenses," 113 Colum. L. Rev. 1483, 1508–9 (2013).

Information. A trade secret "is one of the most elusive and difficult concepts in the law to define." Lear Siegler, Inc. v. Ark–Ell Springs, Inc., 569 F.2d 286, 288 (5th Cir. 1978).  A jurisdiction's trade-secret law may provide factors in determining whether information constitutes a trade secret.  See, e.g., State ex rel. The Plain Dealer v. Ohio Dep't of Ins., 687 N.E.2d 661, 672 (Ohio 1997) (discussing the six factors that should be considered in analyzing a trade-secret claim under Ohio Rev. Code § 1333.61(D)).  In many cases, the question of whether information constitutes a trade secret is a question of fact to be decided by the fact finder.  See, e.g., Wellogix, Inc. v. Accenture, L.L.P., 716 F.3d 867, 874 (5th Cir. 2013).

Generally known or readily ascertainable. Defendants should take precaution in asserting that an alleged trade secret is not protectable because some or all of the information is well known.  "The fact that some or all of the components of the trade secret are well-known does not preclude protection for a secret combination, compilation, or integration of the individual elements." Essex Grp., Inc. v. Southwire Co., 501 S.E.2d 501, 503 (Ga. 1998). Thus, even if all of the information is publicly available, a unique combination of that information, which adds value to the information, may qualify as a trade secret. Penalty Kick Mgmt. Ltd. v. Coca Cola Co., 318 F.3d 1284, 1291 (11th Cir. 2003).

However, a key defense against an accusation of misappropriation is that the information at issue is not a trade secret because it is readily ascertainable.  See, e.g., Novacare Orthotics & Prosthetics v. Speelman, 528 S.E.2d 918, 922 (N.C. Ct. App. 2000) (customer list not trade secret because information used to contact customers was "easily accessible to defendant through a local phone book"). If information is readily accessible through legitimate means, it is not protectable because the inference is that information is essentially public or of de minimiseconomic value. Trident Prod. & Servs., L.L.C., v. Canadian Soiless Wholesale, Ltd., 859 F. Supp. 2d 771, 779 (E.D. Va. 2012).

No economic value. To have economic value, the alleged trade secret should afford the possessor a competitive advantage.  See, e.g., Capital Asset Research Corp. v. Finnegan, 160 F.3d 683, 688 (11th Cir. 1998) (holding that a database assembling public information about property values and permissible bid amounts is not a trade secret because, among other things, the compilations of information are not 'unique combination[s], afford[ing their possessor] a competitive advantage'"). Defendants can weaken a misappropriation accusation by arguing that the subject matter is of little or no economic value.  See Microstrategy, 331 F. Supp. 2d at 416 (email containing a company's restructuring plans was circulated to a competitor but not deemed a trade secret because "while of interest to anyone in the business intelligence industry, it [was] unclear what potential economic value th[e] email would have had to anyone. In fact, no specific evidence was presented regarding the economic value of this email to competitors.").

Loss of trade-secret protection. A plaintiff must take reasonable efforts, such as implementing confidentiality agreements, to maintain the trade-secret status of the information at issue.  Catalyst & Chem. Servs., Inc. v. Global Ground Support, 350 F. Supp. 2d 1, 11 (D.D.C. 2004).  Therefore, defendants should know that "[s]imply because information is disclosed outside of a company does not result in the loss of trade secret status. . . . The owner of a trade secret may, without losing protection, disclose it to a licensee, an employee, or a stranger, if the disclosure is made in confidence, express or implied."  Microstrategy, 331 F. Supp. 2d at 416 (internal citations and quotations omitted).  Additionally, the mere fact that documents are filed unsealed and are available in public court filings may not remove the subject matter's secrecy in the absence of further publication.  See Hoechst Diafoil Co. v. Nan Ya Plastics Corp., 174 F.3d 411, 418 (4th Cir. 1999).

However, defendants can challenge trade-secret protection by asserting that the plaintiff did not take reasonable efforts, such as distributing the information on a need-to-know basis, to protect the secrecy of the information. See Buffets, Inc. v. Klinke, 73 F.3d 965, 970 (9th Cir. 1996) (concluding that the job manuals at issue were not protectable for several reasons, including that the employees were permitted to keep and take the manuals home and were not informed that the manuals contained secret information or of security measures to protect the manuals).

Challenging ownership of secret information. Generally speaking, a plaintiff will have to identify not only the information it seeks to protect but also ownership over the information at issue in order to bring a successful claim. See, e.g., Fla. Stat. § 688.002(4)(a) and (b) (providing that the wrongful acquisition or disclosure of a trade secret "of another" constitutes misappropriation). A wise plaintiff will attempt to establish ownership over the alleged trade secret at the earliest stages of the proceeding.  Anticipating this, defendants may be able to attack a plaintiff's ownership of the information, even if the information is deemed protectable.

Statute of limitations. In challenging a misappropriation claim, defendants should review (1) the length of statute of limitations for misappropriation claims in the forum, and (2) what actions "trigger" the forum's statute of limitations.  While the UTSA has a three-year statute of limitations, see UTSA § 6, these requirements will vary by jurisdiction.  Additionally, the argument that a misappropriation claim is time-barred due to a lapsed statute of limitation can be a powerful—and possibly inexpensive—defense strategy. 

Independent development or reverse engineering. Independent development and reverse engineering are well-established defenses to misappropriation claims. See Kewanee Oil Co. v. Bicron Corp., 416 U.S. 470 (1974) ("A trade secret law, however, does not offer protection against discovery by fair and honest means, such as by independent invention, accidental disclosure, or by so-called reverse engineering. . . .").  While independent development or reverse engineering would not apply to secret information that was wrongfully obtained, these defenses can place protection limits on the subject matter at issue.  See, e.g., UBS Painewebber, Inc. v. Aiken, 197 F. Supp. 2d 436, 447 (W.D.N.C. 2002) (customer list not a trade secret despite attempts at secrecy because information was readily available through independent development). 

However, defendants must recognize that a defense of independent development is not proof of it. See 4 Roger M. Milgrim & Eric E. Bensen, Milgrim on Trade Secrets § 16.01[6] (2010).  If independent development appears to happen too quickly or to exceed the capabilities of the defendant without the aid of individuals privy to the secret information, the defense may fail.  Id. (citing Sokol Crystal Prods., Inc. v. DSC Commc'ns Corp., 15 F.3d 1427, 1432 (7th Cir. 1994) (where the defendant had access to trade secrets and produced a similar product, it is "entirely reasonable to infer" that the trade secret was misappropriated)).

UTSA section 7 preemption. Section 7 of the UTSA "displaces conflicting tort, restitutionary, and other law . . . providing civil remedies for misappropriation of a trade secret."  UTSA § 7(a). Defendants in states that have enacted the UTSA should review the respective statute's preemptive effect to determine whether common-law claims or defenses would survive the plaintiff's UTSA misappropriation actions. See John A. Stone, "Preemption Is No Secret," Intellectual Property Litigation, Vol. 25, No. 2 (Winter 2014).  Some courts have interpreted UTSA's preemption language broadly, precluding all common-law actions based on the misappropriation of information.  See, e.g., Ethypharm S.A. France v. Bentley Pharms., Inc., 388 F. Supp. 2d 426, 433 (D. Del. 2005) ("Because all claims stemming from the same acts as the alleged misappropriation are intended to be displaced, a claim can be displaced even if the information at issue is not a trade secret.").  However, courts have also construed the UTSA to preclude only common-law causes of action for misappropriation; thus, if the information at issue is not deemed to be a trade secret, common-law actions remain available. See Burbank Grease Servs., LLC v. Sokolowski, 717 N.W.2d 781 (Wis. 2006) (concluding that the WUTSA does not preempt claims that "do not depend on information that meets the statutory definition of a 'trade secret'").

Thus, if the statute's preemptive effect is uncertain, defendants may want to assert applicable common-law or contractual claims or defenses. See Stone, supra. Where a common-law action is preempted due to adoption of UTSA, a defendant can move for summary dismissal by a motion to dismiss, a motion to strike, or a motion for partial summary judgment.  See Amy E. Davis et al., Guide to Protecting and Litigating Trade Secrets 142 (2012).

Authorized use. If there is a license agreement between the parties, the defendant may be able to point to an authorized use of a trade secret.  See, e.g., De Lage Landen Operational Servs., L.L.C. v. Third Pillar Sys., Inc., 2010 WL 3431105, at *3 (E.D. Pa. Aug. 27, 2010) (use of a trade secret authorized under a software license agreement).  However, authorization of one specific type of use of a trade secret, such as to manufacture under contract for the plaintiff, does not permit other uses. See Milgrim & Bensen, supra, § 16.01[6].  Additionally, defendants should be aware of any contractual limitations on reverse engineering.  See, e.g., Bowers v. Baystate Techs., Inc., 320 F.3d 1317, 1325 (Fed. Cir. 2003) (copyright law did not preempt breach of contract claims for violation of a provision that prohibited reverse engineering).

Unclean hands. The defense of "unclean hands" seeks to prevent a plaintiff who has not acted equitably from being awarded equity in court.  See, e.g., Precision Instrument Mfg. Co. v. Auto. Maint. Mach. Co., 324 U.S. 806, 815–16 (1945).  When asserting an "unclean-hands" defense, the plaintiff's alleged actions should be in some way related to the subject matter of the proceeding, and the defendant may have to show harm due to the plaintiff's improper actions.  See, e.g., Alcatel USA, Inc. v. DGI Techs., Inc., 166 F.3d 772, 795–97 (5th Cir. 1999) (denying unclean-hands defense because improper conduct was unsuccessful and caused no harm); see also T. Leigh Anenson, "The Role of Equity in Employment Noncompetition Cases," 42 Am. Bus. L.J. 1, 47–53 (2005) (explaining that the clean-hands doctrine is distinguishable from the equitable maxim that "one seeking equity must do equity").

Constitutional violations.

a. First Amendment Violations. Lastly, violations of First Amendment rights are rarely asserted in trade-secret cases and are even more rarely successful. See Davis et al., supra, at 141. However, First Amendment concerns can arise when enjoining a party's publication of a trade secret; thus, trade-secret cases are not exempt from constitutional scrutiny. See, e.g., DVD Copy Control Ass'n v. Bunner, 75 P.3d 1 (Cal. 2003) (trial court's preliminary injunction against Bunner's publication of a reverse-engineered computer code was deemed content-neutral and did not violate Bunner's First Amendment rights, even though his publication of the code was entitled to some First Amendment protection).

b. Fifth Amendment Violations. Similarly, Fifth Amendment defenses rarely arise in trade-secret cases and are only invoked in very specific cases that involve compelled testimony.  See Sandeen & Rowe, supra, at 171. As mentioned previously, misappropriation can be a state and federal crime. See, e.g., United States v. Williams, 526 F.3d 1312 (11th Cir. 2008) (upholding the defendants' convictions of federal conspiracy to commit theft of trade secrets).

Three facts must be considered when determining the applicability of the Fifth Amendment privilege in a trade-secrets case: (1) the privilege only applies to individuals, not business, see Bellis v. United States, 417 U.S. 85 (1974); (2) the ability to invoke the privilege is not limited to criminal cases because the concern is whether there is a risk for criminal prosecution; and (3) the privilege may be invoked when an individual is compelled to provide any type of testimonial evidence, see Fisher v. United States, 425 U.S. 391, 407–12 (1976). See generally Sandeen & Rowe, supra, at 172.

Conclusion

From receipt of a complaint, defendants should seriously defend against an accusation of trade- secret misappropriation. As discussed, misappropriation cases can be fact-intensive, and just about anything may constitute a trade secret under the right circumstances. A strategy that recognizes the differences among state trade-secret laws and defends against the accusation using applicable defenses could limit future disclosure of your client's proprietary information and save the client from having to participate in lengthy, costly litigation.

Keywords: litigation, intellectual property, trade secrets, misappropriation, defenses, Uniform Trade Secrets Act (UTSA), Restatement (Third) of the Law: Unfair Competition


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