For full functionality of this publication it is necessary to enable Javascript.

Click here to see instructions how to enable JavaScript in your web browser.


Difficulties in Enforcing

Confidentiality Agreements for Protection of Trade Secret Thefts

Existing trade secret laws have enforcement difficulties that place additional burden on business owners already facing losses due to theft.  This article reviews these difficulties and provides advice on how to overcome them.

By Syed aftab hayat

Trade secrets fall under the broad category of intellectual property rights, which give owners the right to protect their creations. A “trade secret” can be any information that is valuable to its owner, not generally known,1 and that the owner has made a reasonable effort to keep secret.2 Trade secret information may include a formula, pattern, compilation, program, device, method, technique, or process.3 They are preferred over other types of intellectual property rights in cases where the information is not an invention and the owner wants to keep it secret4 for a long period of time. Trade secrets allow protection for all manner of intangible assets,5 as they tend to be more flexible,6 and can often be a company’s most valuable asset. 


The problem with trade secrets is that they need to be protected. For some businesses, protection of the trade secret may be its only chance of survival. A good example is the formula for Coca-Cola,7 which has remained a trade secret for over 100 years. This has enabled Coca-Cola to remain a global market leader in the beverage industry and has allowed it to vastly expand its business horizons.


One of the biggest problems that businesses face today is that of trade secret theft. This most often stems from its own employees.8 Research analyzing trade secret cases over a period of the last 50 years showed employees to be involved in over 85 percent of such trade secret misappropriations.9 Other than the cost to hire and train replacements,10 trade secret thefts are estimated to cause losses of up to $300 billion a year.11 


Recent jury awards and settlements in trade secret theft cases are summarized in
FIGURE 1. The values include lost profits, loss due to market value, attorney fees, research and development, salary returns, damages, and pre-judgment interest costs. 


Owing to their huge economic value, trade secrets are very important to businesses.12 The importance can be better understood with the following correlation: Trade secrets are to businesses what national secrets are to a country. Countries will go to great lengths protecting national interests. A business owner faces a similar kind of situation when protecting his or her business. While countries may employ sabotage or the use of military power to protect its national secrets, the business owner can only use the law as a legitimate means for protection. Thus, he or she must be aware of the legal remedies available. For this purpose, we will review some of the problems one might encounter when enforcing confidentiality agreements as a means of trade secret protection.


Background of Legislation Protecting Trade Secrets

The foundation of intellectual property rights protection lies in the U.S. Constitution, which states at article 1, section 8: “To promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive right to their respective writings and discoveries.” Before the 1800s, a relationship of confidence and trust existed between craftsmen and their apprentices.13 With the advent of the industrial revolution, this “psychological contract”14 was no longer reliable15 and large factories had non-apprentice employees who were free to take employers’ knowledge, leave jobs, and compete against their former employers.16


The Sherman Antitrust Act, enacted in 1890, and the Clayton Act, enacted in 1916, were passed to curb antitrust practices. The Sherman Act could be used if the solicitation of employees was accompanied by intent to destroy the plaintiff’s business and also provided for treble damages and attorney’s fees.17 In 1933, the National Industrial Recovery Act was passed to allow industries, for the first time, to create “codes of fair competition.”


Improper use or disclosure of a trade secret was traditionally a common law tort.18 The Restatement of Torts of 193919 for the first time set forth the basic principles of trade secret law.20 It stated a trade secret as a process for “continuous use” in the operation of a business.


In 1979, the Uniform Trade Secrets Act (UTSA)21 was passed and proposed a model statute for state legislature. It dispensed with the idea of “continuous use” associated with trade secrets. It was based on a compilation of numerous court decisions that had considered issues relating to confidential and proprietary information. The UTSA now forms the basis of most22 of the modern day litigation involving trade secret thefts and is currently being followed by 48 states in the United States, with the exceptions of New York and Massachusetts.


Confidentiality Agreements and Difficulties in Their Enforcement

A “confidentiality agreement,” also known as a nondisclosure agreement (NDA), is a contract between an employee and an employer that forms the basis of trade secret protection. It restricts an employee to not disclose any confidential information of a business, even after employment. In its absence, an employee still has a “fiduciary of duty” (or “duty of loyalty”) to the employer for maintaining confidentiality, but it remains effective only until the duration of the employment.23 Therefore, restrictive covenants such as NDAs are vital for the post-employment protection of business trade secrets. However, NDAs can be very difficult to enforce and there are a lot of steps involved before a business owner can actually restrict an employee from exploiting trade secret information. These difficulties are discussed as follows. 


Difficulties in Getting Injunctive Relief at the Time or Before the Occurrence of a Trade Secret Theft
 
Departing employees tend to join competitors who are eager to accept them as they bring valuable trade secrets from other competitors. If an NDA is in place, then the “inevitable disclosure doctrine”24 can be used to secure a preliminary injunctive relief through a court to ensure the departed employee cannot work for a competitor. The problem with such relief is that it is generally temporary and the actual trade secret theft case is yet to be proven in a court. Another problem with the doctrine is that its acceptability by a court varies from state to state. Some courts might outright reject the doctrine,25 while others may go to such an extent as to grant even permanent injunctions based on it.26


It is Very Hard to Prove a Trade Secret Theft on Time
If you are preempting a trade secret theft before it has actually occurred, it might be very hard to prove it in court unless a business owner has substantial evidence against an employee.27 If you are attempting to prove a trade secret theft after it has occurred, you must realize that the trade secret is “already lost” and all efforts should now be aimed at minimizing further damage or redeeming compensation. In some cases, an employer only know of a trade secret theft after a competitor has surfaced a product in the market.  

 

A Business Owner Might End up in the Worst position if a Trade Secret Theft Cannot be Proven

Regardless of the law, judges really are looking to litigants to give them a reason, consistent with the court’s sense of fundamental fairness, as to why their side should prevail. This often comes down much more to who is able to convince the court that their side has acted in good faith and consistent with traditional notions of fair play and substantial justice. The lawyer that recognizes this salient fact serves his client well and furthers his ultimate success.28 


If you cannot prove trade secret theft and win in court,29 you might end up paying damages and attorney fees in addition to losing the trade secret.


Not Getting the Right Compensation for Your Trade Secret Theft
Even if a trade secret theft is proven in court, one last hurdle remains: how to estimate damages and compensations. It is very hard to estimate the value of trade secret losses as remedies under the UTSA are both varied and expansive. Proof of the defendant’s profit margin can be more challenging than proving the plaintiff’s own margin in the context of an “actual loss” measure.30 Courts may deduct variable (or incremental) costs from such estimates. Courts also tend to reject the use of the entire market value of an infringing product as the starting point for damage apportionment. For example, Egry Register Co. v. Standard Register Co., 23 F.2d 438 (6th Cir. 1928) and LaserDynamics v. Quanta Computer, Inc., Nos. 11-1440, -1470 (Fed. Cir. 2012) show that if a product is separable into constituent parts, the plaintiff almost certainly is not entitled to a royalty base on the overall product.


Legal Intricacies Have Made Business Overprotective
Using the IMR Model

Analyzing these problems, a business owner must realize that rights to protect the company’s trade secrets do not come automatic. An “initial-maintenance-review” (IMR) model can help. 


“Initial”—Start Protection With Existing Knowledge
Employers should enforce all available protections at the hiring stage.31 This may even include provisioning other restrictive covenants such as non-solicitation32 and non-competes,33 along with NDAs. 


“Maintenance”—If There Are Trade Secret Thefts, Do Something About It
These measures symbolize the company’s effort to protect trade secrets. They ensure that a court might consider “adequate” measures were taken with regard to trade secret theft by the company. At this stage, a routine trade secret audit34 should be conducted to identify all such assets and designs that still need to be protected. Companies should define and be more open about policies related to employees leaving or being terminated.35 


“Review”—Be Aware and Improve Existing Knowledge
Interpretation of the law changes even if the law might not have changed. The business needs to remain aware of the legal environment and options36 to be able to keep pace with the law. This will ensure that practices in the “initial” and “maintenance” states are not outdated.


Today, if a business is not overprotective, it might be more prone to trade secret thefts.37 The current trade secret protection legislation will make you suffer38 if you did not invest enough to protect yourself, and it is very hard to prove a trade secret theft if you didn’t. Sometimes, the benefit of the trade secret might already be gone and you might not have been compensated accordingly. This is why businesses should become overprotective. However, although this may curb trade secret thefts to some extent, it does bring other negative repercussions. It will make businesses counterproductive, as it will take away the focus from entrepreneurial innovation and put it toward protection. This may increase time, effort, and monetary costs.39 Being defensive may also lead to “employee stalking,” in which the employee tends to demand higher salaries from current employers or they’ll jump from competitor to competitor selling trade secrets and getting higher salaries in return. 


Conclusion

The current trade secret protection law is hard to seek justice from. The courts are putting additional burden and responsibility of trade secret protection on employers, which in turn has its own demerits. With regard to confidentiality agreements, the current trade secret laws provide a lose-lose situation for the employer. The law should be changed to facilitate business owners by putting harsher penalties on people involved in misappropriations and making the legislation easier to put into practice, rather than forcing the employers to become overprotective. 


ABOUT THE AUTHOR
SYED AFTAB HAYAT is a joint owner of a group of large-scale manufacturing industries with expertise in finance and information technology. This article was published during his MBA studies at Maryville University in St. Louis, Missouri. He has also been published in several international publications in the fields of multi-agent systems and image processing. 

The author would like to thank his beloved father and mother, as well as Chepp and all his other dearly loved ones—without whose support this research could not have been accomplished. 


Send comments about this article to cm@ncmahq.org.


ENDNOTES

1. See Keith M. Gregory and Stephen J. Baumgartner, “Protect Your Trade Secrets—Know Your Rights When an Employee Leaves,” Graziado Business Review, vol. 5, issue 4 (2002), available at link

2. See Guriqbal Singh, Jaekap Yoon, and Lien Verbauwhede; “Best Practices in Providing Intellectual Property Services to Beneficiary of Business and Technology Incubators (in Switzerland)”; World Intellectual Property Organization (WIPO); available at link.

3. U.S. Patent and Trademark Office, Department of Commerce, available at link.

4. See “A Primer on Trade Secrets Law,” available at link.

5. For example, in Association for Molecular Pathology v. Myriad Genetics, 569 U.S. 12-398 (2013) the Supreme Court held “that genes and the information they encode are not patent eligible….” In such business areas, companies may have trade secrets as their only option to resort to for commercialization.

6. For example, Aronson v. Quick Point Pencil Co., 440 U.S. 257 (1979), reaffirmed that with patents the royalties may finish with the completion of a patent time limit that may not apply to trade secrets.

7. The secret formula for Coca-Cola is codenamed “Merchandise-7X.” It is a “paradigmatic trade secret—one of the best-kept secrets in the world,” as described in Magellan International Corp. v. Salzgitter Handel GmbH, U.S. Dist. Court N.D. IL, 99 C 153 (1999).

8. A study by Symantec shows that approximately 50 percent of the employees who left or lost their jobs in the past year kept confidential corporate data and 40 percent of them planned to use it at a new job. See Charles Post, “Employee Theft of Employer Confidential Information is Widespread,” and “Hiring a Competitor’s Employees, Protecting Trade Secrets, and Other Business Information” (March 7, 2013), available at link.

9. David Almeling, Darin W. Snyder, Michael Sapoznikow, Whitney E. McCollum, and Jill Weader; “A Statistical Analysis of Trade Secret Litigation in Federal Courts;” available at link.

10. See Cassandra M. Ferrannini, “Remedies for Improper Employee Raiding,” Downey Brand LLP, available at link.

11. Office of the National Counter Intelligence Executive, “Annual Report to Congress on Foreign Economic Collection and Industrial Espionage 2002,” available at link.

12. See “Trade Secrets are Gold Nuggets: Protect Them,” WIPO Magazine (2002), available at link.

13. See O. Lee Reed, Peter Shedd, Marissa Pagnattaro, and Jere Morehead; Legal and Regulatory Environment of Business; 15th edition (McGraw Hill, 2010).

14. See Jerald Greenberg and Robert A. Baron, Behavior in Organizations, eighth edition (2003).

15. See Talhiya Sheikh, “Trade Secrets and Employee Loyalty,” World Intellectual Property Organization, available at link.

16. One of the earlier cases in the United States that recognized trade secrets was Peabody v. Norfolk, 98 Mass. 452 (1868), in which it was held that a secret manufacturing process is property, is protectable against misappropriation, the secrecy obligation for an employee outlasts the term of employment, a trade secret can be disclosed confidentially to others who need to practice it, and a recipient can be enjoined from using a misappropriated trade secret. 

17. See Ferrannini, note 10.

18. See John Hodgson and John Lewthwaite, Tort Law, second edition (2007): LIV.

19. See link.

20. See link.

21. See link for the text of the law and its 1985 amendments. 

22. In addition to the civil liability provided under the UTSA and common law, Congress passed the federal Economic Espionage Act (EEA) in 1996, which provides criminal penalties for misappropriation of trade secrets. The Stored Communication Act of 1986 (SCA) and the Computer Fraud & Abuse Act of 1984 (CFAA) take care of the technological issues of these thefts. The EEA, SCA, and CFAA together constitute almost all of the available legislation complementing the UTSA to date.

23. See Ferrannini, note 10.

24. Courts might rule that the theft may not qualify as a “trade secret” if it consists of information from publicly available sources (such as business directories” (see Morelife, Inc. v. Perry, 56 Cal. App. 4th 1514, 1521–1527 (1997)) or customer lists (see Reed, Roberts Assocs. v. Strauman, 353 N.E.2d 590 (N.Y. 1976))). Such interpretations fail to realize that inventions are not made every day; it is often the processing of information that makes it advantageous to a business. So a competitor who previously might not know how to use the publicly available information might be able to do so now by “legally” stealing it.

25. See Christopher P. Stief, “Employees ‘Jumping Ship’: What Can We Do When We Don’t Have a Contract?” (June 18, 2010), available at link.

26. See Richard F. Dole Jr., “Permanent Injunctive Relief for Trade Secret Misappropriation Without an Express Limit Upon its Duration: The Uniform Trade Secrets Act Reconsidered,” Boston University Journal of Science & Technology Law (Summer 2011).

27. Courts also tend to reject trade secret theft claims if they feel “adequate” protection measures were not taken for the protection of the trade secret by the employer. The definition of “adequate” is not defined in the UTSA and courts tend to interpret it in the favor of either the defendant or the plaintiff on a case-by-case basis, hence an employer cannot know if it is taking “adequate” measures for trade secret protection until a judge decides so.

28. Columbus R. Gangemi Jr. and Tracy A. O’Flaherty, “Playing Trade Secret Offense and Defense: Protecting Your Trade Secrets While Recruiting Your Industry’s Best and Brightest,” available at link.

29. The UTSA allows reverse-engineering as a legal form of discovery of trade secrets. If a competitor can prove they reengineered the product, then there is no trade secret theft claim. 

30. See Christina Hernandez, BLA Schwartz, John McCann Jr., Miles Stockbridge, and Michael Martin; “When Your R&D is no Longer a Trade Secret: Litigating and Calculating Damages”; The ABA Section of Litigation; Section Annual Conference (April 2013). 

31. See Fox Rothschild, “Tools Employers Need to Protect Trade Secrets” (December 2002), available at link.

32. See Christine M. Westphal, “Restrictive Covenants in Employment Contracts: Regulating Employee Solicitation,” Journal of Legislation (2011).

33. See Mark J. Garmaise, “Ties that Truly Bind: Non-competition Agreements, Executive Compensation, and Firm Investment,” UCLA Anderson, available at link.

34. See “Alternatives to the Non-Compete,” available at link.

35. See John Marsh, “The Trade Secret Litigator’s 7 Deadly Sins of Departing Employees in Trade Secret and Non-Compete Disputes” (August 2012), available at link.

36. See Justine H. Brousseau, Mark H. Burak, Anthony J. Cichello, David C. Henderson, Jody L. Newman, Andrew C. Pickett, and Valerie Samuels; Employment LAW Guide: A Practical Guide to Understanding Massachusetts Law (Boston Bar Association, 2007).

37. See Margo E.K. Reder and Christine Neylon O’Brien, “Managing the Risk of Trade Secret Loss Due to Job Mobility in an Innovation Economy with the Theory of Inevitable Disclosure,” Journal of High Technology Law (2012).

38. See Ferrannini, note 10; and “You Need to Work Harder to Fight Trade Secret Theft,” available at link.

39. See Robert G. Bone, “A New Look at Trade Secret Law: Doctrine in Search of Justification,” California Law Review (March 1998).