This is the next in a multi-part discussion of measuring the accounting period for trade secret damages. The common theme across these discussions is the need to untether the liability requirement of secrecy from the damages goal of awarding as much as necessary (but no more than) to eliminate unfair competition. Similar versions of the first and second parts of this series can also be found on the LinkedIn.
Our previous article posed the question as to when it was appropriate to cut-off money damages for trade secret misappropriation. Answer: damages for trade secret misappropriation should last as long as (and no longer than) necessary to eliminate commercial advantage due to misappropriation. This answer justifies extending the damages accounting period beyond the time a trade secret is no longer protected because it has lost its secrecy.
As explained in this article, the opposite is also true. There are circumstances where damages accounting period runs before the loss of secrecy. Why? Because the end of the commercial advantage period — the end of the time necessary to deprive the defendant of a head start or other unfair commercial advantage that is attributable to misappropriation – occurs before the trade secret loses its secrecy.
Practically speaking, the primary consideration in determining the cut-off date for damages is the end date for eliminating the unfair commercial advantage attributable to the misappropriation. This cut-off date may pre-date or post-date the loss of secrecy depending upon the facts in a particular case.
Potential Source of Confusion
A potential source of confusion is that the relevant statutes and commentary describe the commercial advantage or head start period as something that extends damages beyond the loss of secrecy of the trade secrets. The implication is that head start or commercial advantage rules may not apply where there has been no loss of secrecy.
Section 3 of the Uniform Trade Secret Act (“UTSA”) authorizes the award of monetary damages. Although Section 3 does not identify the period for calculating damages, the commentary to Section 3 adopts the same considerations applied in Section 2 of the UTSA to determine the duration of injunctive relief:
Like injunctive relief, a monetary recovery for trade secret misappropriation is appropriate only for the period in which information is entitled to protection as a trade secret, plus the additional period, if any, in which a misappropriator retains an advantage over good faith competitors because of misappropriation.
UTSA, § 3 cmt (emphasis added); see also id. § 2(a). The UTSA’s general policy is that monetary damages should accrue for as long as is necessary, but no longer than is necessary, to eliminate the commercial advantage or “lead time” with respect to good faith competitors that a person has obtained through misappropriation. See UTSA, § 3 cmt; see also id. § 2 cmt.
The Rest. 3d of Unfair Competition (“Restatement”) applies the same or substantially similar methodology to determine the accounting period for trade secret monetary damages. The commentary and reporters’ notes to Section 45 of the Restatement define the accounting period as follows:
Limitation on monetary relief. Monetary remedies, whether measured by the loss to the plaintiff or the gain to the defendant . . . may be measured by the time it would have taken the defendant to obtain the information by proper means such as reverse engineering or independent development. Similarly, the issuance of a patent or other public disclosure of the information by the plaintiff or a third person terminates the secrecy necessary to the protection of the trade secret. Monetary relief based on the defendant’s use of the information after the loss of secrecy is therefore appropriate only to the extent necessary to remedy a head start or other unfair advantage attributable to the defendant’s prior access to the information.
Rest 3d Unfair Competition § 45 cmt. h. (modified and emphasis added); see also id. Reporters Notes cmt. h. (citing UTSA § 3 cmt. and collecting cases).
Notwithstanding any implication from the statutory text and commentary to the contrary, the commercial advantage rule is not limited to situations where damages continue to accrue beyond the time trade secrets have lost their secrecy. As discussed in the following section, in some instances the commercial advantage or head start gained through misappropriation ends prior to the time the trade secrets have become generally known or knowable through proper means. In these cases, the damages accounting period runs within and before the end, if any, of the secrecy period.
Where Trade Secrets Have Remained Secret (The Commercial Advantage Period Ends Prior to Time Trade Secrets are Known or Ascertainable)
Agilent Techs. v. Kirkland, 2010 Del. Ch. LEXIS 34 (Del. Ch. Feb. 18, 2010), provides an example of what this looks like in practice. The case reports the findings of the Delaware chancery court following a bench trial on plaintiff Agilent’s claims for misappropriation of trade secrets and breach of confidentiality agreements. The court found that the asserted trade secrets – relating to unique compositions and processes used in manufacturing products known as high performance liquid chromatography (HPLC) columns – were in fact protectable trade secrets because they had not been disclosed to the public and were not reasonably ascertainable (outside of the knowledge of the Agilent employees who had jumped ship and joined the defendant for purposes of helping it develop competing products), and they derived independent economic value from their secrecy. Id. at *69-79. The court further found that defendant had without authorization used the trade secrets to create a competing HPLC column product, and therefore was liable for trade secret misappropriation.
In fashioning a remedy for the misappropriation, the court calculated monetary damages using what it called the “head start rule.” The court acknowledged that Delaware may not have adopted this rule and surveyed numerous interpretations of the rule in case law precedent and legal commentaries. Common to all of these interpretations was the characterization of the unfair commercial advantage obtained due to misappropriation as the time it would have taken the misappropriator to develop a commercially viable and competitive product absent the unauthorized use of plaintiff’s trade secrets.
For example, the court emphasized how much time defendant saved in the development of a competing product and manufacturing processes due to its misappropriation of the trade secrets: “[A] very short development period occurred at AMT before a bonding and a slurry solvent for packing columns were selected for commercial use, and AMT was able to produce a successful multilayering process in just ten months, which would have been impossible without misappropriation of Agilent’s trade secrets. Therefore, the defendants misappropriated Agilent’s trade secrets in order to save themselves the time and expense of testing new bondings and slurry solvents suitable for commercial manufacturing, and creating the starting point for a multilayering process.” Id. at *87-88 (emphasis added). In an extended footnote, the court collects cases and legal commentaries defining the head start period as the time it would have taken the misappropriator to develop a suitable product. Id. at *99 n. 230.
Applying these principles, the court adopted the testimony of Agilent’s expert that the misappropriation gave the defendants a head start of approximately one year per each of the three asserted trade secrets to develop a competing product and process. The court therefore awarded actual loss damages and unjust enrichment damages accruing over a three year period. The damages were based on sales made by defendants during the three year accounting period that but for misappropriation either (a) would have been made by Agilent (the diverted sales on which to award lost profits/actual loss damages) or (b) that would not have been made by Agilent and were not taken into account in the calculation of actual losses (the non-diverted sales on which the defendant should be required to disgorge profits). Id. at *105, 121.
In an interesting wrinkle, the Agilent court also found that “Agilent is entitled to damages beyond the three year head start period.” Id. at *102-103 (emphasis added). The court found that the defendants enjoyed “increased market share . . . and will continue to gain customers and profits from using Agilent’s technology” due to misappropriation of Agilent’s trade secrets “after the three year ‘head start’ period end[s].” To prevent what the court deemed “underenforcement” and in order to avoid having to enter an injunction enjoining sales of the defendant’s competing product, the court awarded an additional year of actual loss damages beyond the head start period (the award of unjust enrichment damages was not similarly increased). The court added, “[a]lthough the ‘head start period’ is an acceptable way to limit the amount of damages available to a plaintiff in a trade secret misappropriation case, such a limitation is not mandatory.”
One can reasonably question why it was necessary to award damages “beyond” the head start period in the Agilent case to achieve the stated goals. If the purpose of the head start rule is to eliminate any unfair advantage or lead time due to the misappropriation, it presumably would have been appropriate for the Agilent court to include what it deemed increased/beyond-the-head-start-period damages within the calculation of the head start period, e.g., award three years unjust enrichment damages and four years actual loss damages to eliminate all unfair advantages enjoyed by the defendant. This avoids the ambiguities arising from the Agilent decision, to wit: whether there is a policy that justifies extending the damages period beyond the time necessary to eliminate an unfair head start, whether courts are required to apply a time limitation of any duration when calculating monetary trade secret damages, or perhaps even whether there is a mandatory accounting period.
There are other cases besides Agilent that cut-off damages prior to or independent of any loss of secrecy based upon the application of a commercial advantage or head start rule.
In Progressive Prods. v. Swartz, 2014 Kan. App. Unpub. LEXIS 668, *2-3 (Kan. Ct. App. August 15, 2014), the Kansas Appellate Court affirmed the award of a reasonable royalty on the misappropriator’s sales over a three year period on the grounds that this was sufficient to address any unfair commercial advantage due to the misappropriation. Id. at *10-11. Following a bench trial, the court held that defendants misappropriated trade secrets consisting of the formula for a compound which extends the life of elbow pipes used in pneumatic conveyance systems as well as the method of calculating the amount of the compound and its cost for a particular application (batch calculation program). The court entered judgment allowing defendant to use the trade secrets provided it paid royalties to the plaintiff for a 3-year period commencing prior to trial and continuing for some time thereafter. Id. at *2-3.
On appeal, plaintiff argued that the damages accounting period should be extended to reflect several decades spent developing a commercial business around the trade secrets. The appellate court disagreed. It found that the 3-year period better reflected the time it would have taken the defendant to independently develop a “saleable product,” citing the testimony of plaintiff’s former owner that it took about 3 years developing the formula and the batch calculation program which was later misappropriated by defendant. Accordingly, the 3-year royalty period addressed any commercial advantage or head start obtained by the defendant due to misappropriation and the law supported the limitation of misappropriation damages to this time period. Id. at *10-11.
In 3M v. Pribyl, 259 F.3d 587, 609-610 (7th Cir. 2001), the Seventh Circuit upheld the decision of the Wisconsin district court to award plaintiff 3M money damages for the defendant’s avoided development costs (reflecting the unjust enrichment of the defendant due to misappropriation of a 3M trade secret), and not to award an injunction enjoining use of the trade secret. Id. at 607. 3M did not prove any actual losses or any future losses or future unjust enrichment resulting from misappropriation. Id. The district court therefore found that the damages measured by the defendant’s avoided development costs were sufficient to address any unfair commercial advantage obtained by defendant. Id. at 609. Separate and independent of the calculation of commercial advantage damages, the district court found that defendant would have been able to independently develop the trade secret within less than two years and 3M did not dispute this determination. Id. Accordingly, since the avoided cost damages were deemed sufficient to alleviate the unfair commercial advantage, and since the trade secret at issue could have been developed through proper means prior to trial and the decision on the injunction, the Seventh Circuit, affirmed the district court’s refusal to enjoin further use of the trade secret. Id.
Similarly, in Wal-Mart Stores, Inc. v. Cuker Interactive, 2017 U.S. Dist. LEXIS 119147, *9 (W.D. Ark. July 28, 2017), the Arkansas district court awarded damages to address unfair commercial advantage separate and independent of any loss of secrecy of the asserted trade secrets. Like 3M, the jury compensated the unfair commercial advantage by awarding avoided development costs (over $12 million based on the roughly six months of development time saved by cross-defendant Walmart through the use of the use of cross-plaintiff Cuker’s trade secrets). However, unlike 3M, the asserted trade secrets had not lost their secrecy as of the time of trial and there was no evidence that the misappropriator, cross-defendant Wal-Mart, would have ever been able to develop the trade secrets through proper means. Id. at *10-11. The damages awarded for avoided development costs therefore did not address commercial advantage to Wal-Mart from future use of the trade secrets. The court therefore entered a permanent injunction enjoining Wal-Mart’s future use of the trade secrets, stating “[U]nlike in 3M, it cannot be said that ‘there would be nothing further gained by enjoining [Walmart] from using the trade secret which they would have by [this] time developed,’ since there is no basis for concluding in the first place that Walmart would have developed Cuker’s trade secrets by now.” Id.
Unauthorized Use by a Competitor Does Not Necessarily Result in Trade Secret Losing its Secrecy
All of the above cases involved the unauthorized acquisition and use of the trade secrets by someone other than their owner. In other words, a third-party acquired without authorization possession of the trade secrets. One might assume this meant the trade secrets lost their secrecy (i.e. they were no longer protectable trade secrets), but this is not what happened. Why not?
While these cases don’t expressly address the question, an answer can be inferred from certain facts common to all of them. Specifically, in all of these cases, the risk of disclosure beyond the misappropriating competitor was quite because: a) the misappropriator was a competitor of the trade secret owner, b) there was nothing in the record indicating the misappropriator had previously disclosed the trade secrets to third parties or threatened to do so in the future – instead, the misappropriator had apparently chosen to keep them secret for the misappropriator’s own competitive advantage, and c) at least in Agilent, 2010 Del. Ch. LEXIS 34, at *130-131, 3M, 259 F.3d at 610, and Wal-Mart Stores, Inc., 2017 U.S. Dist. LEXIS 119147, *17-18, the court permanently enjoined the misappropriator from disclosing and/or using the trade secrets in the future. (See * endnote.) Under these circumstances, the competitive self-interest of the misappropriating competitor (sometimes with a nudge from a court injunction) dissuaded further disclosure and consequently preserved the value of the trade secret. Accordingly, in these low-risk-of-further-disclosure cases, it is fair to say that any loss of secrecy in the trade secrets fell far short of destroying their value and/or precluding their protection as trade secrets. (And therefore it is fair to refer to the commercial advantage period used to determine the duration of damages as having run prior to the loss of secrecy.)
Guidance from the courts on when and how to limit the duration of the trade secret damages is not necessarily consistent and sometimes not available. This makes it harder to predict in a particular matter the length of time that will be allowed for recovery of trade secret damages.
A possible solution, one which is well-grounded in UTSA principles and related commentaries, is focusing on eliminating the commercial advantage gained from actionable misappropriation. The duration of the period to recover damages extends up until the time that this has occurred, but no longer. Depending upon the facts in a particular case, this test may extend the cut-off for damages beyond the secrecy period (as discussed in the previous article), or, alternatively, may cut-off damages before the end of the secrecy period (as discussed in this article). Giving primacy to the elimination of any unfair commercial advantage is not only consistent with core principles of trade secret law but also mitigates against confusion that otherwise exists regarding when and how the loss of secrecy factors into the determination of the accounting period.
Note re above discussion of low-risk-of-disclosure-by-misappropriator cases:
*Courts have cited the same or similar facts in the course of resolving the separate question whether to enter a permanent injunction enjoining further use of the trade secrets. In these cases, the very low risk of disclosure beyond the misappropriating competitor obviated the need for a use injunction. See, e.g. 3M, 259 F.3d at 610 n. 8. See also Faiveley Transp. Malmo AB v. Wabtec Corp., 559 F.3d 110, 118-119 (2d Cir. N.Y. March 9, 2009) (refusing to presume irreparable harm from finding of misappropriation, and based thereon reversing entry of a preliminary injunction, stating: “Where a misappropriator seeks only to use those secrets–without further dissemination or irreparable impairment of value–in pursuit of profit, no such presumption is warranted because an award of damages will often provide a complete remedy for such an injury. . . [O]nce a trade secret is misappropriated, the misappropriator will often have the same incentive as the originator to maintain the confidentiality of the secret in order to profit from the proprietary knowledge.”).