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The Defend Trade Secrets Act: Does It Make Secrets Safe(r)?

By Benjamin B. Reed, Plave Koch PLC and Andrea D. Gregory, Hogan Lovells

Historically, the use and disclosure of a franchise system's trade secrets have been governed by the franchise agreement and any applicable state laws. Almost every state has a law, modeled after the Uniform Trade Secrets Act (the Uniform Act), prohibiting the unauthorized use of trade secrets and confidential information. But until recently, there was no federal law analogue that enabled a franchisor to protect against the misappropriation of its trade secrets and confidential information. That changed on May 11, 2016, when President Obama signed into law the Defend Trade Secrets Act of 2016 (the DTSA). This article describes the new law's protections and explains how it affects franchise systems.

New Private, Federal Cause of Action

The DTSA amends portions of Chapter 90 of Title 18 of the United States Code, commonly referred to as the Economic Espionage Act of 1996 (the EEA). The EEA was enacted to address growing concern over cybersecurity and loss of commercially sensitive information to hackers, working independently or for foreign governments. The EEA created criminal sanctions for the theft of trade secrets and for electronic economic espionage, but the law failed to provide a private right of action. The DTSA supplements the EEA by creating a new private, federal cause of action for misappropriation of trade secrets, although the law does not preempt existing state laws.

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The EEA, as amended by the DTSA, defines a "trade secret" as:

  • all forms and types of financial, business, scientific, technical, economic, or engineering information, including patterns, plans, compilations, program devices, formulas, designs, prototypes, methods, techniques, processes, procedures, programs, or codes, whether tangible or intangible, and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing if — (A) the owner thereof has taken reasonable measures to keep such information secret; and (B) the information derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable through proper means by, another person who can obtain economic value from the disclosure or use of the information.

18 U.S.C. § 1839(3).

The EEA has a more detailed definition of information that may constitute a trade secret than does the Uniform Act, which lists only formulas, patterns, compilations, programs, devices, methods, techniques, and processes. Still, the key elements of the definition of a trade secret — maintenance of secrecy and independent economic value from disclosure or use of the information — are the same in the EEA and the Uniform Act, making the trade secrets protected under federal law similar to those protected under many state laws. The DTSA introduces a definition for "misappropriation" into the EEA. Misappropriation is defined to include:

  • Acquiring a trade secret with knowledge or reason to know that it was acquired by improper means;
  • Disclosing or using a trade secret without consent when the trade secret was obtained by improper means;
  • Disclosing or using a trade secret without consent with knowledge or reason to know that the trade secret was derived from someone who used improper means to acquire it;
  • Disclosing or using a trade secret without consent with knowledge or reason to know that the trade secret either was acquired under circumstances giving rise to a duty to maintain the secrecy of or limit the use of the trade secret or was acquired from a person with such a duty; and
  • Disclosing or using a trade secret without consent with knowledge or reason to know that it was a trade secret and had been acquired by accident or mistake.

18 U.S.C. § 1839(5).

The DTSA also introduces a definition for "improper means." This definition includes "theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means," but it excludes reverse engineering, independent derivation, and acquisition by lawful means.
18 U.S.C.§ 1839(6).

These definitions are substantially similar to those in most states' adaptations of the Uniform Act. As a result, courts may turn to existing authority interpreting state trade secret laws to flesh out the scope and bounds of the DTSA's private right of action.

How Franchise Systems Are Affected

Franchise agreements often designate all information a franchisor shares with its franchisees about the system as confidential and proprietary. Courts may not agree with the breadth of this designation. To determine whether the information at issue constitutes a trade secret under the DTSA, fact finders will ask questions such as these:

  • Does the franchisor permit franchisees to disclose the information to all of its employees without any safeguards or limits on access, or is access limited both in practice and through the requirement that employees sign a separate confidentiality agreement?
  • Does the information have any independent economic value, or is it really just knowhow that anyone in the same line of business would have?
  • Has the information been kept reasonably secret, and if so, does that secrecy give it independent economic value?

The terms of franchise agreements will be critical to determining whether conduct violates the DTSA. Franchise agreements generally provide that use of the franchise system’s confidential and proprietary information is limited to authorized employees of franchisees, who are engaged in operating the franchised business. As a result, franchisees and their employees who use or disclose confidential and proprietary information for any other purpose, such as for operating a competing business, would almost certainly be deemed using that information without consent despite an obligation to maintain its secrecy, and thus misappropriating the information under the DTSA.

Remedies Available Under the DTSA

As under the Uniform Act, a claimant under the DTSA may seek damages for actual loss resulting from unauthorized use or disclosure of a trade secret, and for any unjust enrichment not addressed through actual damages. Alternatively, a claimant may seek damages measured by imposing a reasonable royalty. A claimant may recover up to twice its damages if the misappropriation is willful and malicious. In addition, either party deemed a prevailing party may recover attorneys' fees if bad faith or willful and malicious misappropriation is established. These remedies might not be available for a claim of breach of contractual confidentiality provisions.

A claimant may seek an injunction to prevent actual or threatened misappropriation, with two restrictions. The injunction must not prevent a person from entering an employment relationship (and conditions of employment must be limited to addressing evidence of a threatened misappropriation). In addition, the injunction must not conflict with "applicable State law prohibiting restraints on the practice of a lawful profession, trade, or business." 18 U.S.C. § 1836(b). Thus, the scope of relief may be limited by any state law limits on post-termination restraints of trade, such as noncompetition covenants. Moreover, the requirement to show actual evidence of threatened misappropriation means that a party must show more than inevitable disclosure through new employment.

The DTSA also allows for a claimant to obtain a court order for seizure of misappropriated trade secret information without prior notice. This relief requires a heightened showing of immediate, irreparable injury that cannot be addressed through normal procedures for a restraining order or preliminary injunction because of the risk that the person in possession of the trade secret information will move, hide, or destroy it if given notice.

Immunity, Federal Jurisdiction

The DTSA provides immunity to whistleblowers who disclose a trade secret to a government official in connection with reporting a violation of law or filing a whistleblower action against their employer (provided the filing is under seal). Although the DTSA for the most part does not preempt state trade secret or restraint-of-trade laws, this immunity applies to claims under any state trade secret law, as well as the new federal law.

To give effect to this immunity, employers must provide notice of its availability in any contract with an employee that governs use of trade secrets or confidential information. Notably, the DTSA defines "employee" as "any individual performing work as a contractor or consultant for an employer." Failure to provide the notice prevents an employer from recovering exemplary damages or attorneys' fees in a later action under the DTSA. Franchisors that require that their franchisees' employees execute forms of confidentiality and non-disclosure agreements may want to consider adding the required notice provision to those form agreements. At the same time, a franchisor should avoid mandating what its franchisees include in their own employment agreements or otherwise dictating aspects of the employment relationship unnecessarily to protect the franchisor's confidential information. Such heightened control over a franchisee's employment documents and relationships could increase the risk of joint employer or vicarious liability for the franchisee's employment actions.

In addition, the DTSA grants federal courts original jurisdiction over claims under the law. Thus, a franchisor that can state a claim under the DTSA may file in federal court without the need to meet the requirements for diversity of citizenship jurisdiction that might have been necessary to prosecute those claims under the franchise agreement or state trade secret law.

Conclusion

The DTSA gives franchisors another tool to protect their confidential and proprietary information. It will take time, as claims wind through the courts, to establish the scope of protectable trade secrets and actionable misappropriation, but existing state trade secret laws likely provide a measure of what can be expected. The DTSA should prompt franchisors to assess what information they deem secret and how they protect its secrecy, so they are able to invoke the protections afforded by this new federal law.

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