Trade Secrets Law – A Primer

World MapIntroduction

Trade secrets are frequently the “forgotten” intellectual property. (The indisputably-recognized types of intellectual property are patents, copyrights, and trademarks.)

According to some commentators, trade secrets were protected as far back as Roman times through a claim known as “actio servi corrupti” (interpreted roughly as an “action of a corrupted slave”). The existence of a claim for trade secrets during Roman times is not without its detractors; according to University of Georgia Law School professor Alan Watson (in “Trade Secrets and the Roman Law: The Actio Servi Corrupti,” 30 Colum. L. Rev. 837 (1930)), while the claim existed, it was not used to protect trade secrets.

Despite this dispute and whether trade secret law in fact traces back to Roman times, the Renaissance (see Mark A. Lemley, “The Surprising Virtues of Treating Trade Secrets as IP Rights,” 61 Stan. L. Rev. 311, 315 n.8 (2008)), or some other time, there is general agreement that trade secrets law as we know it made its first appearance in England in 1817 in Newberry v. James, 35 Eng. Rep. 1011, 1013 (Ch. 1817) and in the United States in 1837 in Vickery v. Welch, 36 Mass. (19 Pick.) 523, 527 (1837). See Lemley, at 315 & n.6.

For over a 100 years following its first appearance in the United States, trade secrets law evolved as a hodgepodge of state laws. Since then, two key sources of law have emerged: Restatement (First) of Torts and the Uniform Trade Secrets Act (the “UTSA”). Each is summarized below.

(On the federal side, the Economic Espionage Act of 1996, 18 U.S.C. §§ 1831-39, provides for criminal prosecution and civil claims made by the United States Attorney General; it does not yet provide for a private right of action, but check back at our Changing Trade Secrets | Noncompete Laws page. In addition, the Computer Fraud and Abuse Act, 18 U.S.C. § 1030, provides protection against the wrongful access to electronically-stored information, regardless of whether or not such information qualifies as a trade secret.)

Restatement (First) of Torts

In 1939, the American Law Institute issued the Restatement (First) of Torts, containing a summary of trade secrets law as it then existed. The summary (sections 757-759) served as the primary resource for most states until the latter part of the century.

Section 757, the key section, provides as follows:

One who discloses or uses another’s trade secret, without a privilege to do so, is liable to the other if

(a) he discovered the secret by improper means, or

(b) his disclosure or use constitutes a breach of confidence reposed in him by the other in disclosing the secret to him, or

(c) he learned the secret from a third person with notice of the facts that it was a secret and that the third person discovered it by improper means or that the third person’s disclosure of it was otherwise a breach of his fiduciary duty to the other, or

(d) he learned the secret with notice of the facts that it was secret and that its disclosure was made to him by mistake.

What is a trade secret?

Although not defined in the text of the section itself, the term “trade secret” is defined by the Restatement in comment b to section 757. Specifically, expressly noting that “[a]n exact definition of a trade secret is not possible,” comment b provides as follows:

A trade secret may consist of any formula, pattern, device or compilation of information which is used in one’s business, and which gives him an opportunity to obtain an advantage over competitors who do not know or use it. It may be a formula for a compound, a process of manufacturing, treating or preserving materials, a pattern for a machine or other device, or a list of customers. It differs from other secret information in a business (see § 759) in that it is not simply information as to single or ephemeral events in the conduct of the business, as, for example, the amount of other terms of a secret bid for a contract or the salary of certain employees, or the security investments made or contemplated, or the date fixed for the announcement of a new policy or for bringing out a new model or the like. A trade secret is a process or device for continuous use in the operation of business. Generally it relates to the production of goods, as, for example, a machine or formula for the production of an article. It may, however, relate to the sale of goods or to other operations in business, such as a code for determining discounts, rebates or other concessions in a price list or catalogue, or a list of specialized customers, or a method of bookkeeping or other office management.

The definition can be summed up as information used in business, which is not generally known to others, and provides a competitive advantage. (The requirement of a commercial advantage is rarely an issue; as Judge Hillman has explained, the “information need not provide competitors with a substantial advantage; any advantage, however small or ephemeral, is sufficient to satisfy these requirements.” Advanced Micro Devices, Inc., No. 13-40007-TSH, slip op. at 16 (citing Optos, Inc. v. Topcon Med. Sys., Inc., 777 F. Supp. 2d 217, 238 (D. Mass. 2011)).)

The distinguishing element of this formulation in comparison to certain others, most notably the Uniform Trade Secrets Act (see below) and the Restatement (Third) of Unfair Competition, is that it limits trade secrets to information that is currently in use. Accordingly, so-called negative information — or information about what not to do (think the first 39 formulation of WD-40) — does not qualify as a trade secret under this formulation. Nor does information concerning a single, ephemeral event. Such information is simply considered confidential business information and is addressed separately in Restatement (First) of Torts § 759, which, for all intents and purposes, has the same effect as Section 757. See Restatement (First) of Torts § 759 cmt. c.

Regardless of what type of information may qualify, the sine qua non of a trade secret is secrecy. While the Restatement does not address the secrecy requirement in the text of the section, that requirement is instead addressed in comment b as follows:

The subject matter of a trade secret must be secret. Matters of public knowledge or of general knowledge in an industry cannot be appropriated by one as his secret. Matters which are completely disclosed by the goods which one markets cannot be his secret. Substantially, a trade secret is known only in the particular business in which it is used. It is not requisite that only the proprietor of the business know it. He may, without losing his protection, communicate it to employees involved in its use. He may likewise communicate it to others pledged to secrecy. Others may also know of it independently, as, for example, when they have discovered the process of formula by independent invention and are keeping it secret. Nevertheless, a substantial element of secrecy must exist, so that, except for the use of improper means, there would be difficulty in acquiring the information.

To assist in determining whether particular information qualifies as a trade secret, comment b provides the following guidance:

Some factors to be considered in determining whether given information is one’s trade secret are: (1) the extent to which the information is known outside of his business; (2) the extent to which it is known by employees and others involved in his business; (3) the extent of measures taken by him to guard the secrecy of the information; (4) the value of the information to him and to his competitors; (5) the amount of effort or money expended by him in developing the information; (6) the ease or difficulty with which the information could be properly acquired or duplicated by others.

It is this portion of Section 757, inclusive of the comments, that serves as the core analysis in trade secret cases following the Restatement.

Misappropriation

The Restatement (First) of Torts § 757, by its express terms (set out above), proscribes the use and disclosure of trade secrets under certain specified circumstances. It does not, however, proscribe the mere acquisition of a trade secret. Nevertheless, courts have avoided this limitation by focusing on the subsequent violation of the restrictions imposed on the appropriator by the owner of the trade secret. Even in advance of an actual use or disclosure, the fact that the trade secret has been improperly acquired can give rise to an inference that the appropriator of the trade secret is likely to use or disclose the trade secret. See Restatement (Third) of Unfair Competition § 40 cmt. b (“A defendant’s willingness to resort to improper means in order to acquire a trade secret is itself evidence of a substantial risk of subsequent use or disclosure.”).

As a separate matter, nothing in the Restatement focuses on the actor’s purpose. To the contrary, liability “is not based on the actor’s purpose to discover another’s trade secret but on the nature of the conduct by which the discovery is made.” Restatement (First) of Torts § 757 cmts. g, o. Thus, reverse engineering or independently discovering a trade secret are both entirely permissible.

In contrast, receiving a trade secret with knowledge (or reason to know) that the trade secret was acquired or disclosed in breach of a duty subjects the recipient of the trade secret to liability. Restatement (First) of Torts § 757(c), (d) cmts. l–o. The reason for liability under such circumstances is not that the recipient had the purpose to obtain the trade secret, but rather, that the conduct by which it was acquired in the first place was improper and taints all that flows from it.

Consistent with this dichotomy, liability would not exist for the recipient’s use or disclosure of the trade secret prior to the time the recipient knew or had reason to know of the wrongful conduct; it does exist, however, from that moment forward, “unless prior thereto he has in good faith paid value for the secret or has so changed his position that to subject him to liability would be inequitable.” See Restatement (First) of Torts § 758; see also Restatement (First) of Torts § 757(c), (d) cmts. l–o.

As to the nature of the conduct to discover a trade secret, the Restatement explains that “[a] complete catalogue of improper means is not possible. In general they are means which fall below the generally accepted standards of commercial morality and reasonable conduct.” Restatement (First) of Torts § 757 cmt. g. The comment provides the following nonexhaustive list of examples: taking by physical force, “fraudulent misrepresentations to induce disclosure, tapping of telephone wires, eavesdropping or other espionage.” Restatement (First) of Torts § 757 cmt. g.

Uniform Trade Secrets Act

In 1979, the National Conference of Commissioners on Uniform State Laws issued the Uniform Trade Secrets Act (UTSA). The UTSA was later revised in 1985 to its current form today. As of today, all but two states (Massachusetts and New York) have adopted some version of the Uniform Trade Secrets Act. (Technically, North Carolina has not officially adopted the UTSA, though it certainly has adopted language that parallels the UTSA.)

The UTSA’s structure and terms are as follows:

Section 1—Definitions of Improper Means, Misappropriation, Person, and Trade Secret

“Improper means” is defined only as “include[ing] theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means.” Recognizing, as the Restatement before it did, that “[a] complete catalogue of improper means is not possible,” the definition is intentionally not exhaustive. It does, however, provide the other end of the spectrum by identifying a nonexhaustive list of “proper means.” Specifically, the comments provide as follows:

Proper means include: 1. Discovery by independent invention; 2. Discovery by ‘reverse engineering’, that is, by starting with the known product and working backward to find the method by which it was developed. The acquisition of the known product must, of course, also be by a fair and honest means, such as purchase of the item on the open market for reverse engineering to be lawful; 3. Discovery under a license from the owner of the trade secret; 4. Observation of the item in public use or on public display; 5. Obtaining the trade secret from published literature.

“Misappropriation” is defined as follows:

(i)   acquisition of a trade secret of another by a person who knows or has reason to know that the trade secret was acquired by improper means; or

(ii)  disclosure or use of a trade secret of another without express or implied consent by a person who

(A)  used improper means to acquire knowledge of the trade secret; or

(B)  at the time of disclosure or use, knew or had reason to know that his knowledge of the trade secret was

(I)   derived from or through a person who had utilized improper means to acquire it;

(II)  acquired under circumstances giving rise to a duty to maintain its secrecy or limit its use; or

(III) derived from or through a person who owed a duty to the person seeking relief to maintain its secrecy or limit its use; or

(C)  before a material change of his [or her] position, knew or had reason to know that it was a trade secret and that knowledge of it had been acquired by accident or mistake.

The definition of “trade secret” is

information, including a formula, pattern, compilation, program, device, method, technique, or process, that: (i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

This definition was intended to expand the definition in the Restatement. Specifically, the definition

extends protection to a plaintiff who has not yet had an opportunity or acquired the means to put a trade secret to use. The definition includes information that has commercial value from a negative viewpoint, for example the results of lengthy and expensive research which proves that a certain process will not work could be of great value to a competitor.

UTSA § 1 cmt. Further, use of the terms “method” and “technique” were intended to capture the concept of “know-how.” UTSA § 1 cmt.

Section 2—Injunctive Relief

Under Section 2, injunctive relief may be used to prevent an “[a]ctual or threatened misappropriation.”

It is this section that courts have relied upon to enjoin a former employee (who is not bound by a noncompetition agreement) from working at a competitor where the employee’s new employment would inevitably lead to the use or disclosure of the former employer’s trade secrets. See PepsiCo, Inc. v. Redmond, 54 F.3d 1262 (7th Cir. 1995).

Section 3—Damages

Under Section 3, damages include exemplary damages up to two times the actual damages. As such, treble damages are recoverable under the UTSA, although only for misappropriations that are “willful and malicious.” No damages are available, however, where the recipient of the trade secret “material[ly] and prejudicial[ly] changed its position prior to acquiring knowledge or reason to know of a misappropriation” such that an award of damages would be inequitable.

Section 4—Attorney Fees

Under Section 4, attorney fees must be paid to the prevailing party where the other party acted in bad faith or where the misappropriation was willful and malicious.

Remaining Sections

The balance of the UTSA addresses preservation of secrecy during an action (Section 5), three-year statute of limitations (Section 6), preemption of “conflicting” laws (Section 7), uniformity of application and construction (Section 8), and other miscellaneous matters.

 

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