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Public Contract Law Journal

Public Contract Law Journal Vol. 53, No. 2

Are Trade Secret Protections in Government Contracts Adequate? An Analysis of FOIA Exemption 4 and Data Rights

Ema Klugman


  • Topics include the various ways trade secret issues arise in government contracts, avenues for relief, and arguments that the lack of trade secret protection in the procurement context may chill companies from contracting with the government.
  • Data rights issues affect the amount of trade secret protection a contractor can assert over its intellectual property.
  • Risks to contractors’ trade secrets can occur at the proposal, contract management, and post-contract stage.
  • Proposed policy solutions include expanding Other Transaction Agreements (OTAs) to allow contractors to negotiate more flexibly with the federal government over trade secret protections.
Are Trade Secret Protections in Government Contracts Adequate? An Analysis of FOIA Exemption 4 and Data Rights
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When a company enters into a contract with the federal government, it often faces a considerable risk: the risk that its trade secrets may be exposed and misappropriated, first by the government, and then by its competitors. Although government contractors have several tools that they can use to protect their trade secrets in the procurement context, including data rights, Freedom of Information Act (FOIA) Exemption 4, and other precautionary measures, the balance of risk still tends to tip against even the most diligent and well-counseled contractor.

This Note outlines the various ways that trade secret issues arise in government contracts, identifies avenues for relief for contractors, and argues that the lack of trade secret protection in the procurement context may chill companies from contracting with the government at all. Finally, this Note proposes that the government should implement better trade secret protections, including amending FOIA Exemption 4, adding an additional data rights provision in the Federal Acquisition Regulation (FAR) and Defense Federal Acquisition Regulation Supplement (DFARS), and/or expanding the use of Other Transactions Agreements (OTAs) to assure contractors that their intellectual property is secure. Such reforms will offer contractors the type of flexibility that they enjoy in the private sector and thus incentivize them to transact with the federal government.

I. Introduction

“A company’s interest in protecting its intellectual property from uncompensated exploitation is as important as a farmer’s interest in protecting his or her seed corn.” When a company contemplates entering the federal marketplace, it considers a myriad of factors: the types of contracts available, the size of such contracts, and the likelihood that it has of winning them. But it also makes another important calculation: whether its trade secrets will be secure in the course of its dealing with the federal government. This decision has been described by one procurement scholar and practitioner as a “Hobson’s choice.”

The private sector creates state-of-the-art technology, but the government may be limiting its access to it because contractors are nervous about the security of their trade secrets in submitting proposals for and performing government contracts. One aerospace government procurement official explained that “contractors … whose entire business is based on their intellectual property [may] walk away from the Government market” because the government procurement system fails to safeguard their intellectual property. This negative incentive can cause “the Government [to] lose much of the private sector creativity it depends on.”

Consider this: Company A is a medium-sized IT business bidding on a government contract. In the proposal stage, Company A runs into a trade secret issue in negotiating its data rights—the agency insists on unlimited rights, and Company A wants to bind the government to limited rights for several of its services and software packages. Still, the company chooses to enter into the contract. Then, during contract administration, Company A faces a FOIA request: one of its competitors is seeking to obtain its trade secrets. Company A requests that the agency not disclose this information, arguing under Exemption 4 that its trade secrets should remain concealed, but the agency discloses it anyway. Company A then files a reverse FOIA suit, winning in court, but most of the damage has already been done because its trade secrets were already disclosed. Finally, the agency puts out a new solicitation for IT services, and Company A realizes that the description matches exactly the services that it provides and thus discloses its trade secrets, including details about its processes and methods. This solicitation essentially discloses Company A’s valuable intellectual property to its competitors.

At each stage, Company A’s trade secrets are in jeopardy. This Note will follow Company A as it “navigate[s] the minefields of government procurement” and tries to protect its trade secrets. The risks are great for Company A—perhaps too great to justify the reward of the government contract. However, at each stage Company A does have some avenues for relief and, crucially, ways to proactively prevent the disclosure of its trade secrets.

As the hypothetical about Company A demonstrates, government contractors often disclose proprietary information to the government through their proposals and through their performance of contracted work. This Note will argue that government contractors’ avenues for redress are limited when they believe their trade secrets have been misappropriated, which may disincentivize them from entering the procurement marketplace in the first place. While there are two main ways for government contractors to protect their trade secrets—under FOIA Exemption 4 and through the Federal Acquisition Regulation (FAR) and Defense Federal Acquisition Regulation Supplement (DFARS) proprietary data protections—these trade secrets protections are inadequate and difficult for contractors to obtain. This Note will show that increasing trade secret protections benefit not only contractors but also the government, in the form of increased competition, more efficient and less costly contracts, and more innovative contracting solutions.

In Part II, this Note will provide background on trade secrets and describe the two main avenues of trade secret protection available to federal government contractors—FOIA Exemption 4 and data rights clauses. Part III will demonstrate that these trade secret protections are inadequate by detailing the numerous risks to trade secrets in the proposal, contract management, and post-contract stages. Part IV will provide an overview of past reforms in intellectual property in government contracts. Finally, Part V will propose policy solutions that balance the costs and benefits of increasing trade secret protections for contractors. This Note will argue that, to this end, Congress should (1) amend FOIA Exemption 4 to expand the definition of “confidential information” that can be protected from disclosure, (2) create a new category of limited trade secret data rights, and/or (3) expand the use of Other Transaction Agreements (OTAs) to allow contractors to negotiate more flexibly with the federal government over trade secret protections.

II. Background

Trade secret law, which is distinct from other forms of intellectual property law such as patent, trademark, and copyright law, is a body of law extensively relied upon in the private sector for companies to protect their proprietary information. Understanding how trade secret law functions in the private sector elucidates the insufficiencies of trade secret protections in the public procurement system. To this end, this section will describe trade secret protections generally, outline the trade secret protections specifically available to federal government contractors, and highlight why protecting trade secrets in government procurement is particularly important in the twenty-first century.

A. Trade Secret Protections Generally: What Is a Trade Secret, Anyway?

Trade secret law is hazy because trade secrets are not straightforward to define. Customer lists, recipes, source code, formulae, design specifications, and business strategies are all examples of trade secrets. Trade secret law can protect proprietary information that is not protectable through a patent, trademark, or copyright, and thus tends to promote further innovation. The Supreme Court has recognized the importance of trade secrets in intellectual property law, declaring that “[t]rade secret law promotes the sharing of knowledge, and the efficient operation of industry; it permits the individual inventor to reap the rewards of his labor by contracting with a company large enough to develop and exploit it.” The logic is that companies are more likely to innovate if they know that their proprietary information can be kept secret and safe from other competitors. The policy objectives underlying trade secret law are to maintain standards of commercial ethics, encourage innovation, and protect trade secret owners’ privacy. The overriding justification for protecting trade secrets is to promote fairness in the commercial context.

A trade secret carries with it perhaps the most essential property right in the bundle of sticks: the right to exclude. The power of a trade secret is in its permanent secrecy. Essential to enforcing that secrecy is a company’s ability to exclude others from knowing its secrets. For government contractors, this property right is often in jeopardy because it is difficult to maintain the secrecy of a trade secret in a government contract.

B. Overview of Trade Secret Protections Currently Available to Government Contractors

Trade secret law is generally “under-explored and under-analyzed in legal scholarship,” and the legal scholarship on trade secret law in government contracts is even more sparse. The government has overlooked the importance of trade secret law and failed to integrate it properly into procurement policy. But trade secret law is here to stay.

The limited avenues for redress in the trade secret context stand in sharp contrast to the relief available for contractors who believe the government has infringed upon their patents or copyrights. Two main regimes in government contract law protect trade secrets of contractors. The first is FOIA Exemption 4, which can be used to protect a company’s trade secrets from disclosure after a FOIA request. The second is the scheme of data rights clauses in the FAR and DFARS, which allows contractors to assign different levels of rights to the government based on the extent to which government funding contributed to the development of the intellectual property at issue. These two regimes overlap at times, but neither provides adequate protection for government contractors to be assured that their trade secrets are protected in the federal marketplace. Other avenues for relief include the Defend Trade Secrets Act, the Trade Secrets Act, and the Fifth Amendment’s Taking Clause, but these avenues are limited by sovereign immunity and provide little additional protection on top of FOIA Exemption 4 and the data rights clauses.

1. FOIA Exemption 4 as Trade Secret Protection

FOIA, 5 U.S.C. §§ 552 et seq., was designed to require disclosure of government information upon request. FOIA’s purpose is to improve public transparency. “Congress was principally was interested in opening administrative processes to the scrutiny of the press and general public when it [passed FOIA].” In short, FOIA protects “the people’s right to know what their government is doing.” However, FOIA has been misused to facilitate access to private companies’ trade secrets, often by a company’s business competitors.

Agencies have an obligation to make information available to the public unless an exemption applies. FOIA’s exemptions are “designed to protect those legitimate governmental and private interests that might be harmed by release of certain types of information.” Of interest in the context of trade secrets is FOIA Exemption 4.

FOIA Exemption 4 states that agencies may exempt from disclosure “trade secrets and commercial or financial information [that are] obtained from a person and [are] privileged or confidential.” This exemption has the effect of precluding the government from disclosing information that private parties have shown fall within the exemption. Exemption 4 is important because “[s]avvy competitors can, and will, submit strategic, tactful, and timely requests to compel federal agencies to disclose information to the measurable detriment of other federal contractors.” These requests “don the FOIA cloak to conceal their competitively harmful nature,” and Exemption 4 can guard against this misuse of FOIA.

Exemption 4 works as follows: government agencies are required to give notice to contractors who are subject to a FOIA request. A contractor can then invoke a FOIA exemption by filing an action under the Administrative Procedures Act. If the FOIA exemption is not granted, the agency can choose to disclose the information. The contractor may then bring a claim in district court that the agency’s decision was either contrary to law or arbitrary and capricious, which is known as a reverse-FOIA suit. However, it may already be too late, because once the confidential commercial information has been released, that company’s competitors will have already gained a competitive advantage.

Exemption 4 must be mounted as an affirmative defense to a FOIA request. There is no guarantee that a contractor’s use of Exemption 4 will be successful; in fact, in many ways, the deck may be stacked against them. The contractor “bears the burden of justifying nondisclosure” and has no right to enjoin government disclosure of its trade secrets; it is at the mercy of the government. In short, while contractors can invoke FOIA Exemption 4 as trade secret protection, they cannot rely on it as a surefire way to protect their trade secrets.

2. Data Rights Clauses as Trade Secret Protection

While FOIA Exemption 4 can be invoked when a contractor wants to protect its trade secrets from a specific FOIA request, data rights are a preemptive, contractually defined method of protecting trade secrets. Just as a company in the private sector can take precautionary measures to protect its trade secrets (for example, through contractual provisions in a joint venture agreement), so, too, can a government contractor take steps to preserve its trade secrets through asserting data rights. Data rights are the government’s license rights to technical data and computer software delivered by contractors.

Data rights were developed in part to improve the quality of proposals that contractors submitted to the federal government. Prior to contractors being able to mark their data rights, proposals contained what commentators called “Swiss-cheese drawings.” These incomplete, difficult-to-understand drawings resulted from contractors excluding proprietary information from their bids.

Under the FAR and DFARS, the government receives data rights depending on the level of funding provided to the contractor in the development of the software or technology. The license rights can be unlimited rights, government purpose rights, limited rights, restricted rights, or specifically negotiated rights. These rights describe the government’s rights to the contractor’s intellectual property. For instance, “unlimited rights” give the government “rights to use, modify, reproduce, perform, display, release, or disclose technical data in whole or in part, in any manner, and for any purpose whatsoever, and to have or authorize others to do so.” In contrast, limited rights provide that “the Government may not, without the written permission of the party asserting limited rights, release or disclose the technical data outside the Government, use the technical data for manufacture, or authorize the technical data to be used by another party.”

Data rights clauses are a form of trade secret protection because they restrict what the government can do with a contractor’s proprietary information. As the history of “Swiss-cheese drawings” shows, data rights protection incentivizes contractors to disclose proprietary information because of the assurance that such information will not be disclosed to competitors. Thus, like FOIA Exemption 4, data rights clauses can be a useful avenue of trade secret protection to contractors. However, also like FOIA Exemption 4, this avenue of protection is inadequate because contractors’ use of data rights protections (particularly limited rights, as discussed infra) is often limited or disputed by the government.

3. Other Avenues for Relief: The Defend Trade Secrets Act, the Trade Secrets Act, and the Fifth Amendment’s Taking Clause

Unlike other forms of intellectual property law, trade secret law is not constitutionally enshrined, and, until the passage of the Defend Trade Secrets Act (DTSA) in 2016, no federal regulation existed to protect trade secrets from misappropriation. The DTSA allows companies and individuals to bring trade secret misappropriation claims against commercial entities in federal court. However, plaintiffs cannot sue the government itself under the DTSA because the statute does not abrogate state sovereign immunity. Furthermore, the DTSA does not protect trade secrets from disclosure in the government procurement context.

Although the DTSA does allow contractors to sue the federal government, one statutory protection for trade secrets in the government procurement context is the Trade Secrets Act (TSA). The TSA proscribes government personnel from disclosing trade secrets. However, the TSA has been held to be co-extensive with FOIA Exemption 4 and thus provides little additional protection for contractors. Finally, another possible avenue for trade secret misappropriation claims is the Fifth Amendment. The Court of Federal Claims, through its Fifth Amendment takings jurisdiction, can hear claims for trade secret misappropriation, but these cases are rare.

C. Trade Secret Protections in Government Contracts Are More Important Now Than Ever

More than twenty years ago, government and private sector parties made a key point during hearings hosted by the House Subcommittee on Technology and Procurement Policy Oversight: commercial firms, rather than the federal government, were now in “the driver’s seat” in research and development (R&D) of new technologies. Indeed, the government’s share of R&D dollars in the United States fell from sixty-seven percent in 1960 to twenty-six percent in 2000, and government R&D expenditures have stayed almost stagnant since 2000 while the private sector’s investments have soared (see Figure 1).

Figure 1. U.S. R&D Expenditures by Performing Sector [see PDF p. 469]

The bottom line is that the government is now just another customer, rather than the primary funder, in these markets. This shift is important because the ability of private companies to protect their trade secrets affects their incentives to engage in contracts with the federal government. Recognizing its role as a “mere participant” in the R&D space, the government must enact reforms that allow contractors to negotiate the terms and conditions that affect their intellectual property. Otherwise, contractors can and do turn elsewhere.

In the modern world, “a company’s intellectual property is increasingly the ‘crown jewels’ of its business.” In particular, as one scholar has pointed out, “as data gathering and processing, machine learning, and automation have become more important to our political economy, the law of trade secrets and business confidences has become more important to business . . . .” While sixty years ago the government may have been able to play fast and loose with contractors’ trade secrets because companies relied so heavily on the federal government for R&D dollars, today the private sector can and does develop the majority of its technologies without government dollars. The current regimes of trade secret protection in public procurement are inadequate, and more protection is necessary if the government wants access to quality contractors.

III. Falling Prey: Where and When Risks to Trade Secrets Occur in Government Procurement

Risks to contractors’ trade secrets can occur in multiple stages of the contracting process: in proposals, contract management, and even post-contract. While data rights clauses are most relevant to the proposal and post-contract stages, FOIA Exemption 4 is the main stopgap for trade secret risks during contract management.

A. Trade Secret Exposure in the Procurement Proposal Stage: The Difficultiesof Data Rights

Trade secret vulnerabilities can be an issue for federal contractors at the outset of the contracting process. In the proposal stage, companies often disclose trade secrets to the government as part of their bid for a contract. Returning to our example, Company A has found a solicitation for a government contract on which it is interested in bidding. In its proposal, Company A describes its processes and programs in an effort to show that it is responsive to the solicitation’s requirements. In awarding the contract, the agency insists on unlimited rights even though Company A wants to bind the government to limited rights for several of its services and software packages. Company A still chooses to enter into the contract. Right at the outset, Company A’s trade secrets are at risk.

1. Data Rights Are Trade Secret Rights

Data rights describe rights to proprietary information from the government’s point of view in a given contract. Government contractors must navigate a complex web of rules in order to obtain data rights. While data rights issues are not ordinarily regarded as trade secrets issues, they are trade secrets issues because they affect the amount of trade secret protection a contractor can assert over its intellectual property.

Limited data rights are effectively trade secrets by another name: “[a]ssertion of limited rights in technical data is tantamount to a declaration that the information is a trade secret and many of the same principles apply.” Thus, data rights are trade secret rights. How a contractor marks its data—and whether the government agrees with its markings—affects the amount of trade secret protection it can secure over the course of the contract. Therefore, the way that federal procurement regulations cabin or expand contractors’ ability to assert data rights impacts their ability to protect their trade secrets.

2. The System of Data Rights Tilts the Balance in Favor of the Government

The system of data rights, by its formulation, tilts the balance in favor of the government because data rights describe not what a contractor has the right to protect and keep secret but rather what the government has the right to exploit. Furthermore, the government can dispute the amount of rights with which the contractor marks its data. The onus is on the contractor to define—and justify—the intellectual property that it wants to exclude the government from using.

Contractors often view marking requirements as “onerous terms and conditions and overwhelming administrative requirements [that] prove to be costly and bear immeasurable risk for the company.” The good news is that contractors can try to protect their trade secrets if they are diligent in marking their data rights. The bad news is that even diligent marking may not entirely protect them, and, if government funding is responsible for certain trade secrets, it may be impossible to get protection for those trade secrets.

Limited rights expose the contractor to the least amount of trade secret risk. Limited rights restrict what the government can do with the data, including an “express limitation that they will not, without written permission of the Contractor, be used for purposes of manufacture nor disclosed outside the Government.” However, to restrict the government to limited rights, contractors have to establish that they developed the intellectual property in question independent of government funding. If a contractor “has paid to develop an item, component, process, or software without any direct Government contract (or subcontract) payment for that development, the company has the ability to limit the Government’s rights in technical data; restrict the Government’s rights in software; and sell, lease, or license that thing to third parties.”

Unlimited rights, on the other hand, can expose contractors to substantial trade secret risk. The DFARS defines unlimited rights as “rights to use, modify, reproduce, perform, display, release, or disclose technical data in whole or in part, in any manner, and for any purpose whatsoever, and to have or authorize others to do so.” By definition, then, a grant of unlimited rights tends to make a trade secret not-secret. In some jurisdictions, unlimited rights licenses effectively extinguish any trade secret protection that a contractor might otherwise enjoy. Thus, in effect, to assign limited rights is to protect one’s trade secrets; to fail to assign limited rights is to lose one’s trade secrets.

Why would a company enter into a government contract when their technical data rights are at such a high risk? In determining whether to enforce trade secret protections, courts ordinarily consider whether trade secret owners took reasonable precautions to keep their trade secrets secret. In the government procurement context, trade secret owners’ hands are often tied in this regard: they cannot take all of the precautions that they might ordinarily take in a private contract because the contours of their government contract are largely in the government’s hands, particularly with regard to the difficulty of establishing limited data rights.

3. The Difficulty of Establishing Limited Rights

Company A tries to assert limited data rights over its trade secrets, but the government disputes its markings. This scenario is not uncommon. Because limited rights effectively protect a company’s trade secrets, it is no surprise that the question of whether something can be assigned limited rights has been the subject of extensive litigation. The regulation does not itself define the most important phrase in the determination of limited rights: “developed at private expense.” Most of the disputes over data rights turn on the interpretation of this phrase. Courts, contractors, and the government have debated over its definition, and thus effectively over the amount of trade secret protection contractors are able to secure for their proprietary information.

To assert, and be awarded, limited rights protection for its technical data, a contractor must show “not only the substantive elements of novelty, confidentiality, and significant investment, but also that procedural requirements were observed.” The complex substantive procedural requirements tend to put smaller or less experienced government contractors at a disadvantage as compared to larger, more experienced government contractors. Further, the consequences of failing to assert limited rights protection are large: the government, by default, receives unlimited rights when a contractor fails to assert limited rights.

Furthermore, the requirements for limited rights are unclear. For instance, in Megapulse, Inc. v. Lewis,a contractor tried to place restricted legends on hundreds of drawings, and the Contracting Officer disputed that limited rights protection was needed. GAO ruled that “Megapulse had failed to meet its burden of showing no reasonable basis for the agency’s determination that the data were not entitled to limited rights treatment.” In contrast, in Bell Helicopter Textron, the case was remanded after some portions of the contractor’s proposal contained improperly marked data and the parties then negotiated which portions could be given limited rights protection. Thus, while in Megapulse the contractor was not allowed to assert any limited rights at all, in Bell Helicopter the contractor was afforded the opportunity to renegotiate its data rights and obtain some limited rights. The uncertainty that contractors face when trying to assert limited data rights is yet another reason that trade secret exposure frightens contractors away from the federal procurement marketplace.

4. The Dangers Associated with Unlimited Rights

Company A is not able to limit the government’s rights for certain aspects of the contract because they were developed with government funding. Thus, Company A must give the government unlimited rights. Unlimited rights can be an effective death sentence for trade secrets.

Contractors may also unintentionally give the government unlimited rights, thereby putting their trade secrets in jeopardy. This happens in one of two ways: first, DFARS assumes that all intellectual property (IP) delivered to the government is delivered with unlimited rights unless it is marked with a restrictive marking; second, DFARS gives the government the power to determine whether IP has been mismarked, and in such cases the government can assume unlimited rights over this IP.

When the government has unlimited rights over a contractor’s software, competing firms can gain access to “all of the design documents . . . including source code” of the contractor, either by obtaining a license from the government or obtaining the IP through a FOIA request. When a competitor obtains source code, they can recompile it into a computer program and sell it to third parties, which effectively destroys the competitive advantage that the contractor previously had over them. With unlimited data rights, the government can also provide the source code to other contractors, who can then reverse-engineer the software.

While contractors can sometimes assert trade secret protection against third parties even for data provided to the government with unlimited rights, more often the assigning of unlimited rights means the contractor has almost no trade secret protection. For example, in denying a contractor trade secret protection for its source codes, one courtspecifically reasoned that “[g]ranting the government unlimited rights to data without any restrictive legend or markings constitutes a failure to maintain secrecy.” Similarly, the Court of Federal Claims has held that a contractor who failed to mark its data with the appropriate proprietary data legends had no trade secret protection because it failed to take precautionary measures. Courts seem to apply the marking requirements strictly: even a contractor who marked the cover page of its proposal but not each page containing the data failed to obtain trade secret protection.

B. Trade Secret Risk in the Contract Management Stage: FOIA as a Threat

During contract management, government contractors can face threats to their trade secrets in the form of FOIA requests. Company A has now completed the majority of its contracted work. One of its competitors, Company B, submits a FOIA request. While FOIA requests improve public transparency, they also provide businesses with an avenue to uncover their competitors’ proprietary information. This is Company B’s strategy. Company A tries to enjoin the government from releasing the information under FOIA Exemption 4 in an effort to protect its trade secrets. The agency discloses the information anyway, and Company A then files a reverse-FOIA suit. Unfortunately, the litigation does not go Company A’s way: it is unable to protect its proprietary information. While FOIA Exemption 4 can protect a contractor’s trade secrets, the protection of FOIA Exemption 4 is only granted in certain narrow circumstances.

1. Exemption 4: Balancing Public Transparency and Trade Secret Protections

FOIA Exemption 4 is not only an important tool for government contractors to protect their trade secrets; it can also serve as an incentive to encourage contractors to disclose proprietary information to the government under the assurance that it will not be disclosed. However, because the exemption is difficult to obtain, this assurance is far from guaranteed. FOIA Exemption 4 is not always granted: courts must balance the privacy interests of companies with the public interest in transparency of information.

Some scholars have argued that protecting trade secrets in government procurement inevitably reduces government transparency because it undercuts the purpose of FOIA. However, trade secrecy and government transparency are not necessarily orthogonal policy goals. It is not private citizens who usually make FOIA requests for intellectual property in government contracts: rather, it is the companies who compete with the government contractor and want to obtain the government contractor’s proprietary information to gain a competitive advantage. In an analysis of hundreds of FOIA requests filed in September 2005, the Coalition of Journalists for Open Government found that almost two-thirds of the requests came from commercial interests. Given the relatively minimal time and effort costs associated with submitting FOIA requests, it is no surprise that discerning contractors use this avenue to seek a competitive advantage.

When public transparency is used as a backdoor for a company to achieve the nefarious goals of industrial espionage, FOIA is not being used in a way that Congress intended. Economist Joseph Stiglitz has argued that “a governmental entity should generally not be allowed to withhold information from the public solely because it believes such withholding increases its net revenue.” However, applying such reasoning to argue against trade secrecy protections in government contracts ignores the key incentive structure in trade secret law: when businesses are assured that their investments in intellectual property will be protected, they are more likely to make such investments. Thus, while the argument for uninhibited public transparency may be attractive in theory, it ignores the economic incentives underlying trade secret protection.

2. Following the Policy Pendulum: How Exemption 4 Expansions and Contractions Have Impacted Trade Secret Protections over the Past Twenty Years

a. How Presidential Administrations Have Increased or Cabined the Scope of Exemption 4: Contrasting the Obama and Bush Administrations

FOIA “mandates a strong presumption in favor of disclosure,” but the strength of FOIA’s presumption of disclosure has varied depending on the policy preferences of various presidential administrations. For example, the Obama administration was committed to “creating an unprecedented level of openness in Government,” and thus sought to discourage the alleged overuse of FOIA exemptions. The Obama administration instructed all federal agencies to apply a “presumption of openness” when processing FOIA requests, which severely narrowed trade secret protections available to federal contractors. These policy preferences manifested in a piece of subsequent legislation: the FOIA Improvement Act of 2016 (FIA). The FIA increased the standard for contractors to a showing of “foreseeable harm”—in other words, that disclosure of their information would foreseeably harm an interest protected by Exemption 4. In Seife v. U.S. Food and Drug Administration,the Second Circuit explicitly demonstrated how the language of the FIA mirrors that of a 2009 Department of Justice (DOJ) memorandum in which Attorney General Eric Holder announced the heightened foreseeable harm standard.

In contrast, the Bush administration had more restrictive FOIA practices. They were criticized in some areas, including on foreign policy, but were generally accepted as positive in the context of promoting “the steadfast protection of valuable information belonging to federal contractors and held by federal agencies.” The discrepancy in policies between the Bush and Obama administrations shows how FOIA Exemption 4 can bend and flex depending on the political climate of Washington, making it difficult for contractors to rely on the availability of trade secret protection in the federal marketplace.

b. How the Courts Have Increased or Cabined the Scopeof Exemption 4

Just as different presidential administrations have increased or narrowed the scope of FOIA Exemption 4 over the years, so too have courts in their interpretation of the statute. FOIA offers no definition for “confidential information,” so its interpretation has been left to the courts.

In the 2019 case of FMI v. Argus Leader Media,the Supreme Court broadened the definition of “confidential information” that can be protected from FOIA disclosure. The Court held that information is “confidential” when it is (1) “customarily and actually treated as private by its owner” and (2) “provided to the government under an assurance of privacy.” Prior to this decision, a contractor requesting trade secret protection was required to meet the high burden of demonstrating that it would suffer “substantial competitive harm.” Argus Leader has the effect of lowering this standard, expanding the scope of Exemption 4, and thus increasing the trade secret protections available to contractors.

While the Argus Leader decision is encouraging for contractors, recent decisions suggest that the standard is being applied inconsistently. For example, a 2021 decision in the D.C. District Court seems to have brought back a kind of competitive harm requirement. In Judicial Watch Inc. v. U.S. Department of Health and Human Services, the court held that Exemption 4 only applies when contractors have a “commercial interest” in the information, which is a higher standard than Argus Leader suggests. In that case, the court held that the Department of Homeland Security (DHS) was unable to withhold information under FOIA exemption for trade secrets and financial information because DHS did not meet its burden of establishing that names and addresses were “commercial.” In another D.C. Circuit case, Gandhi v. Centers for Medicare & Medicaid Services, the court found that the defendant had to disclose its data because it could not prove foreseeable harm. There, the agency, Centers for Medicare and Medicaid Services, could not show that releasing data on the ownership structures of health care providers would cause foreseeable harm: the court concluded that “the risks of harm are low.” Thus, even though the Argus Leader decision suggests increased access to Exemption 4 for contractors, they may not be able to rely on the standard remaining so liberal should courts continue to cabin its scope in the future.

3. How FOIA Exemption 4 Can Be Safely Expanded Without Jeopardizing Constitutional Rights

Some scholars have argued that Exemption 4 should never be used to violate constitutional rights of individual citizens and in certain other scenarios where there is a compelling public interest in transparency. At times, individual rights and trade secret protections seem to be in direct conflict. For instance, in State v. Kuhl,the defendant, who had been charged with driving under the influence, sought the source code of the breathalyzer machine to challenge its results. The manufacturer of the machine refused to provide the source code to the defendant or the state, citing trade secret concerns, and the court agreed. While the defendant presented a need to “cross examine the machine and determine if it was in proper working order,” the court did not order the company to hand over its source code.

While Kuhl might be read to demonstrate how trade secrecy can undermine constitutional rights, the Kuhl court got it exactly right: the source code of a breathalyzer is clearly a trade secret, and there are ways to test the validity of technologies without forcing a company to divulge its trade secrets. For example, one does not need source code to put a breathalyzer machine through empirical testing of samples. If such empirical testing does not create a definitive answer, the source code could have been subject to in-camera review or produced under a protective order. FOIA Exemption 4 should not be granted in situations where violating constitutional rights is unavoidable. However, in most situations alternative solutions can both protect a contractor’s trade secrets and individual constitutional rights.

C. Trade Secret Risk in the Post-Contract Stage

1. Subsequent Solicitations That Contain Trade Secrets

Another illustration of the importance of data rights as trade secret rights is in the context of re-solicitations, which can occur as separate solicitations for similar work or as subsequent solicitations for the same work. Suppose that Company A wins the contract and completes the work. The government then issues additional procurements for similar contract work. One important measure exists that ensures that the government does not divulge proprietary data contained in Company A’s winning bid: the Federal Acquisition Regulations (FAR) expressly limit agencies, in post-award notices to unsuccessful offerors, in releasing an offeror’s proposal information. However, there is another risk to Company A: the government could use or misuse its trade secrets in a subsequent solicitation if it failed to mark them with limited data rights. This was the situation in Universal Target Co.

In that case, Universal Target Company (UTC) had developed an aluminum target for Air Force training at its own expense and subsequently sold several hundred of them to the government in three contracts. Prior to these contracts, the Air Force had used plywood targets, which were far less durable than UTC’s aluminum ones. The contracts contained standard technical data provisions, but did not restrict the government to limited data rights. Subsequently, the Air Force issued an Invitation for Bids (IFB) to procure 2,494 more targets. In the IFB, the government included the exact engineering drawings from UTC, thereby divulging UTC’s design to many of its direct competitors. Although UTC bid on the contract, it did not win. UTC suffered a double blow: it lost the subsequent contract and its trade secrets.

2. Why Data Rights Are Important in the Post-Contract Stage

Universal Target Co. highlights the dangers associated with failing to establish limited data rights. While the government maintains strict standards for controlling proposal information submitted by bidders, when it has unlimited rights, it can effectively authorize itself to use a contractor’s intellectual property in subsequent solicitations. Technical data is often used in competitive re-procurements, and, if contractors like Company A have not established limited rights, their designs and drawings can be made public in subsequent solicitations. The effect is that “trade secrets are revealed to the contractor’s competitors,” with possibly devastating effects on their business.

Contractors can protect themselves against this kind of situation by (1) marking their data with limited rights or (2) protesting at GAO after the re-solicitation has been made. Obtaining limited rights is not always a straightforward endeavor, especially if the government disputes the contractor’s markings. When a contractor successfully assigns limited data rights to the government, the government does not have the right to demand complete engineering drawings and use them for an IFB or Request for Proposals (RFP). Another avenue for recourse is that the contractor can protest at GAO, which may recommend that the agency make a sole-source award to the firm whose trade secrets it has misused in the solicitation or, alternatively, that the agency cancel the solicitation and resolicit bids without the proprietary data. However, even if the protest is successful, the damage may already be done at this point, and the contractor’s competitors may already have gained access to their trade secrets.

The risks to contractor’s trade secrets in the post-contract stage—particularly for contractors who cannot establish limited data rights—are not insignificant. A contractor who knows that its trade secrets could be used in a subsequent solicitation may avoid dealing with the government at all, which is an incentive problem that further highlights the inadequacy of data rights clauses in protecting contractor’s trade secrets.

IV. A Brief History of Past Reforms in Intellectual Property in Government Contracts

If the government wants the best quality and variety of contractors, it must improve the trade secret protections available to attract them to the procurement marketplace. Past reforms involving data rights provide a useful blueprint for solutions. In addition, prior reforms in patent law offer a useful model for reforming trade secret protections in government contracts.

A. FASA and Data Rights

The idea that risks to intellectual property affect contractors’ incentives to engage in government contracting is not new. The federal government has made some policy reforms to protect the intellectual property of its contractors. The most significant reforms occurred in 1995 when Congress passed both the current DFARS data rights regulations and the subsequent amendment of those regulations in the Federal Acquisition Streamlining Act (FASA). Indeed, one of the key purposes of FASA was “to remove barriers preventing commercial companies from participating in the government marketplace.”

As discussed above,one impetus for the creation of data rights in government contracting was to solve the issue of “Swiss-cheese drawings.” These partial, difficult-to-understand drawings resulted from contractors excluding proprietary information from their bids, which often made the bid nonresponsive. Thus, the history of data rights shows that they were implemented to incentivize contractors to submit more complete and responsive bids under the assurance that providing more details—but marking them with legends—would keep their intellectual property safe.

Unfortunately, the spirit of this system has been lost in the fight over defining data rights.

Indeed, some evidence suggests that contractors’ ability to protect their trade secrets has worsened over the past twenty-five years, particular in defense procurement. One scholar suggests that “1995 was about the high watermark of . . . DoD’s respect for contractors’ technical data investments.” Reforming the data rights system to match its initial purpose—to incentivize contractors to submit complete, responsive, and creative bids—would not only assure contractors that their trade secrets will be protected, but would also give the government better contract quality and prices.

While the government has purported to realize the extent to which intellectual property rights are important to commercial companies, its limited reforms tell a different story. A 2017 Law360 report found that “[e]fforts to further clarify intellectual property rights for contractors [have] only been barely touched on by lawmakers . . . .” Congress has passed a few policies that address these issues: for example, Congress mandated changes to DoD’s acquisition and use of IP in recent years, including establishing a preference for specially negotiated licenses for technical data in major weapon systems and requiring DoD to establish an IP policy that encourages customized IP strategies for each system based on factors such as the unique characteristics of the system and the commercial market. On December 23, 2022, President Biden signed the National Defense Authorization Act (NDAA) for Fiscal Year 2023, which in part requires that DoD develop new guidelines to facilitate consistent application of the agency’s IP rules. Although these reforms suggest that contractors will have more opportunities to negotiate their data rights and thus their extent of trade secret protection, one scholar has suggested that the reforms actually cut against contractors. Some evidence even points to explicit efforts by DoD to lobby Congress to allow the agency to access and use companies’ trade secrets.

B. Lessons Learned from Patent Law: The Bayh-Dole Act

Government regulators can draw lessons from the 1980 Bayh-Dole Act about incentives to innovate in patent and trademark law and apply those lessons to trade secret law. The Bayh-Dole Act allowed small businesses and nonprofit organizations, including universities, “to (1) retain title to the inventions they created while working on a government-sponsored program, (2) apply for and receive patents on those inventions, and (3) pursue options to commercialize those discoveries.” Prior to the passage of the Act, universities could not profit from their federally funded research. Because they had no right to exclude others from using their intellectual property, they had no justification for the expense and effort of creating it.

The Bayh-Dole Act worked: it solved this incentive problem. Suddenly, lots of government-sponsored inventions were made into commercial products, to the benefit of not only commercial companies but the public at large. With the incentive of retention of intellectual property rights, university and other federally funded nonprofit research took off: the Act is responsible for over $1.3 trillion in U.S. economic growth, as well as the creation of more than 4.2 million jobs and over 11,000 new start-up companies.

Congress can learn from the Bayh-Dole Act and implement similar incentives in the government procurement context by strengthening the trade secret protections available to contractors. Bolstering patent protection led to an extreme increase in innovation due to expanded incentives in the market. In the same way, strengthening trade secret protections in the federal marketplace by expanding Exemption 4 and data rights protections would lead to increases in innovation and quality of products and services available to the federal government.

V. Proposed Legislative and Policy-Based Solutions

To incentivize “more competitive bids, which might lead to cheaper and/or better services,” the government must be willing to give contractors the kind of trade secrecy protections companies routinely bargain for in the private sector. These protections could be achieved through amending FOIA to encode the Argus Leader test for confidentiality, amending the FAR and DFARS data rights to include a new category of limited trade secret rights, and expanding the use of Other Transaction Agreements (OTAs) to allow for more flexibility for contractors to bargain for better trade secret protections.

A. Amending Exemption 4

The difficulty of obtaining Exemption 4 protection for trade secrets can lead to “debilitating consequences for businesses large and small.” Exemption 4 is “critical to the maintenance of a competitive economic balance, because a single disclosure could alter the market balance created by private competition.” However, FOIA exemptions “have been consistently given a narrow compass,” and doubts about exemptions tend to be “resolved in favor of disclosure.” In the context of Exemption 4, the government should resolve trade secret issues in favor of non-disclosure to protect the interests of government contractors. To that end, Congress should codify the Argus Leader standard of broadened confidentiality, which improves trade secret protection for government contractors, in FOIA itself.

Argus Leader has had the effect of liberalizing the protectionary power of FOIA Exemption 4 by broadening the confidentiality test, but Congress should encode this standard into law so that government contractors can be assured that their trade secrets will be protected from disclosure.

Congress has previously amended FOIA in response to judicial decisions with which it has disagreed or sought to clarify. In creating the FOIA exemptions, “Congress . . . created a scheme of categorical exclusion; it did not invite a judicial weighing of the benefits and evils of disclosure on a case-by-case basis.” However, it seems that recent decisions have amounted to a kind of judicial weighing, and, therefore, Congress should step in to resolve the discrepancy. Contractors cannot rely on the courts to keep the definition of confidentiality in FOIA exemption 4 predictable, and thus it is difficult for them to conform their behavior and plan their businesses around a volatile trade secret policy in government contracts. Congress should adopt Argus Leader’smoreexpansive definition of confidential information to promote reliance and stability.

One reason that Exemption 4 has been historically difficult to obtain is the asymmetry of information that the government and contractors have about the contractor’s business. Information “that may seem fairly innocuous to an agency official may be highly confidential to a contractor based on its experiences and understanding of the commercial marketplace.” Thus, the contractor is often the best judge of the sensitivity of their proprietary information, but it bears the burden of making this case to the agency (or a court, in the case of a reverse-FOIA suit). Broadening the definition of confidentiality would account for this gap in knowledge and allow contractors to protect their trade secrets.

Another reason for Congress to encode the Argus Leader standard into law is that it would prevent presidential administrations from narrowing FOIA Exemption 4 in the future. A narrow conception of Exemption 4 needlessly increases transactions costs, reduces innovation, and disincentivizes companies from participating in government contracts. When an administration adopts an open FOIA policy and limits Exemption 4 to narrow applications, as the Obama administration did, contractors are forced to make a choice: to invest more money and effort in protecting their proprietary information, or to not bid on government contracts at all because of these real and consequential risks. Even if Congress chose the former, the increased transaction costs will likely be passed on to the procuring agencies in the form of higher contract prices because contractors have to invest more in other types of trade secret protections. When the government so forcefully prioritizes transparency, it has created a new risk: “it has increased the likelihood that contractors will be deterred from working with the Government and decreased the likelihood that federal agencies will get the best value for taxpayers’ money.”

Beyond the advantages of stronger trade-secret protection for individual contractors, a broader conception of Exemption 4 would also be advantageous for the government. Procuring agencies can make better-informed decisions about awarding contracts if bidders include confidential information under the assurance that it will not be shared or misappropriated. If bidders believe that their trade secrets may be divulged through a FOIA request against which they have little recourse because of the narrowness of Exemption 4, however, some contractors likely will submit proposals with less detail, novelty, and creativity. Thus, thin trade secret protections are not only bad for contractors: they are also bad for the government. By broadening the reach of Exemption 4 by encoding the Argus Leader standard of confidentiality into law, the government would increase its access to innovation.

B. Creating a New Category of Data Rights: “Limited Trade Secret Rights”

Congress could also amend the FAR to specifically allow trade-secret protection in data rights provisions. To incentivize contractors to engage in federal procurement, the government should insist on obtaining only the data rights that it actually needs. The current scheme of data rights, which is based almost entirely on the extent to which the government funded a contractor’s intellectual property, is inflexible and disincentivizes contractors from dealing with the government.

Congress should amend the FAR and DFARS to include “limited trade secret rights.” Limited trade secret rights would specifically enjoin the government from sharing the marked intellectual property with that contractor’s competitors without their consent. It would also prohibit the government from using it in a new solicitation without the contractor’s consent. Limited trade secret rights would have built-in flexibility. Such flexibility would allow both parties to negotiate the terms of the contract much more fully than they can currently. Contractors would have to mark their data with legends specifying limited trade secret rights, just as they currently mark limited and restricted rights.

Creating a new category of data rights would solve the trade secret incentive problem in two key ways: first, it would signal to contractors that the government is taking their concerns about trade secret protections seriously, and, second, it would allow the government to be more flexible in negotiating with contractors.

A model of limited trade secret rights might be criticized for giving too much leeway to contractors; however, the new category does not suggest that the government has to give contractors whatever they want in terms of data rights. Rather, this development should be a system in which contractors have the potential to bargain more flexibly with the government: a system in which, for example, contractors are not automatically forced to give up their trade secrets when the government has provided funding for them. By opening its door to these possibilities, the government will also open its door to attracting contractors who previously believed government contracting was where trade secrets go to die.

This conception of trade secret protection is not foreign to government contracting. DoD’s stated policy is to negotiate rights in software whenever the parties so desire. The problem is that “institutional inertia resists deviation from the standard licenses,” particularly because the DFARS does not guide contracting officers about how to negotiate. When the government takes more rights than necessary, the contractor may charge a significant amount more for those unnecessary rights. Thus, allowing more flexibility in data rights will not only be better for contractors because they can protect their trade secrets—it may even result in lower contract prices for the government.

C. Expanding the Use of OTAs

Other Transaction Agreements (OTAs) have been described as “catnip for technology companies” because they provide “the promise of a streamlined contracting process with built-in flexibilities to give them maximum protection of preexisting IP and the benefits of IP produced under the OTA.” Congress has authorized eleven agencies to use OTAs, including DoD and the Department of Energy. OTAs are attractive to prospective contractors because contracting officers utilizing OTAs are permitted to create “a tailored IP scheme” based on the needs of the contractor. In this sense, the flexibility of OTAs reflects the reality of contracting in the private sector: that companies negotiate IP rights. Congress could authorize more agencies to use OTAs in order to allow contractors the flexibility of negotiating their trade secret rights, which would help solve the incentive problems with the current lack of trade secret protections.

OTAs will increase trade secret protections for contractors, but they also offer benefits to the government because they tend to attract new contractors. In 2015, Congress expanded the types of acquisitions eligible for OTAs in DoD, and the growth in OTAs since then has been “explosive.” For instance, in fiscal year 2016, DoD signed 342 OTAs, which amounted to about $1.4 billion. By fiscal year 2020, DoD signed 3,210 OTAs, which were valued at $16.2 billion. This significant growth in OTAs since the expansion of their eligibility in 2015 suggests that OTAs can attract contractors to the federal marketplace. If Congress broadened access to OTAs to increase flexibility and strengthen trade secret protections, the government would attract more contractors to the marketplace.

Finally, if Congress expanded OTAs to more agencies, the government would indicate that it is willing to negotiate in a way that matches the modern reality of the private sector. The inability of government contractors to negotiate their intellectual property rights effectively—whether because of the complexity and rigidity of the rules or the default powerful position of the government—means that government contracting is less attractive to companies than the private sector, where they have more flexibility, autonomy, and negotiating power. Broadening access to OTAs to strengthen trade secret protection for contractors would help to solve this problem.

VI. Conclusion

Fear, reticence, and shyness. These are all words that have been used to describe the attitude of contractors toward dealing with the federal government because of the lack of trade secret protections in federal procurement. When contractors face the risk of losing their prized trade secrets, the cost of doing business with the government becomes much higher—sometimes unjustifiably high. The DoD has itself admitted that its outdated, onerous IP regulations discourage commercial contractors from dealing with the government. Thus, reforms are not only important for efficiency reasons—they are necessary for keeping the United States at the forefront of some of the most important technology developments in human history.

If the government hopes to reap the benefits of innovation that these kinds of companies tend to create, it must make its trade secret protections stronger. The incentive problems that a lack of trade secret protections create are simple, but their consequences are enormous. The government would do well to recognize that expanding trade secret protection for contractors is good for not only the contractors but for the government itself.