This is the third in a multi-part discussion [first part] [second part] about whether and when to cut-off damages for trade secret misappropriation. Similar posts on LinkedIn at [first], [second] and [third].
Guidance from the courts on these questions is not always consistent and depending upon the jurisdiction may not exist. This makes it hard 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 commentary, is extending the damages accounting period for as long as necessary to eliminate the unfair commercial advantage gained from actionable misappropriation. See Uniform Trade Secret Act (UTSA), § 3 cmt. (“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.”).
Our first installment explained that the damages accounting period may extend beyond the time a trade secret is no longer protected because it has lost its secrecy.* Our second installment acknowledged that there are circumstances where damages end 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 an unfair commercial advantage that is attributable to misappropriation – occurs before the trade secret loses its secrecy.
This installment addresses the use of the so-called “head start” rule as a temporal limitation on damages and flags different interpretations of the rule that may cause confusion or misunderstanding about the proper duration of a damages award. The many and varied head start concepts may compel a court to limit or expand damages in a manner that is inconsistent with the core principle of eliminating unfair commercial advantage.
Head Start as a Temporal Limitation on Damages
The traditional formulation of the head start rule is that it limits damages to the time it would have taken the defendant to discover the plaintiff’s trade secrets without having misappropriated them. See, e.g., Ajaxo, Inc. v E*Trade Grp., Inc., 2015 Cal. Super. LEXIS 190, at *30 (Cal. App. Sept. 16, 2015); see also Robin Singh Educ. Servs. v. Blueprint Test Preparation, LLC, 2013 Cal. App. Unpub. LEXIS 537, *138 n. 39 (Cal. App. January 23, 2013), citing 2 Callmann, Unfair Competition, Trademarks and Monopolies (4th ed. 2012) Misappropriation of a Competitor’s Values, § 14:42.
Perhaps due to the rule’s emphasis on the discovery or disclosure of the content of a trade secret as the key metric for determining the end of the damages period, some courts interpret the head start rule as cutting off damages as of time that a trade secret has lost its secrecy. For example, in Liqwd, Inc. and Olaplex v. L’Oreal USA, Inc., 1:17-cv-14, D.I. 1078 at 3 (D. Del. Aug. 20, 2019), the court reduced the jury’s compensatory damages award for trade secret misappropriation from $22,265,000 to $9,499,733. In reaching this decision, the court interpreted the law as cutting off trade secret damages as of the disclosure of the trade secrets in a published patent application. Upon applying this principle to facts of the case, the court determined that the damages accounting period applied by the jury should have been reduced from 20 months to 9 months. Damages therefore needed to be reduced consistent with the shorter accounting period. The court explained: “there can be no further trade secret damages after the date the trade secret is made public . . . [a]ny advantage defendants gained started on the date they became aware of the trade secret and ended when the information was no longer a trade secret.” Id., D.I. 1078 at 3; see also id. D.I. 1162 at 9, 2019 U.S. Dist. LEXIS 215668, at *12-13 (D. Del. Dec. 16, 2019) (denying plaintiffs’ motion to alter judgment); id. D.I. a1184 at 2 (D. Del. Mar. 24, 2020) (entry of final judgment).
Similarly, in Web Graphics, Inc. v. Jos. Hunkeler, Ltd., 682 F.2d 59, 60 (2d Cir. 1982) (applying New York common law), the Second Circuit affirmed the trial court’s determination that the duration of injunctive or monetary relief will not be extended beyond the secrecy period to address any unfair head start.
The concern with the manner in which Liqwd and Web Graphics apply the head start rule is that their approach tethers the duration of damages to the loss of secrecy, which may deny a full recovery for the entire economic impact of the misappropriation (i.e. denying recovery for the profits lost by plaintiff or the illicit gains received by defendant after the loss of secrecy). The head start rule should not be applied in a way that it might prevent recovery for post-loss-of-secrecy damages flowing from pre-loss-of secrecy misappropriation.
Not all courts apply this formulation of the head start rule. Instead of defining the head start as the time it would have taken the defendant to discover the trade secret through proper means, they interpret the head start rule as cutting off damages as of the date that the defendant could have developed the trade secret and/or a comparable product without the use of the trade secrets. See, e.g., NuCar Consulting, Inc. v. Doyle, 2005 Del. Ch. LEXIS 43, at *47-48 (Del. Ch. April 5, 2005); Russo v. Ballard Med. Prods., 550 F.3d 1004, 1020 (10th Cir. 2008).
Further confusing matters is that in some instances both interpretations are cited in the same decision as explanations of the head start rule. See, e.g., Agilent Techs. v. Kirkland, 2010 U.S. Del. Ch. LEXIS 34, at *99 n. 230 (Del. Ch. Feb. 18, 2010); Sokol Crystal Products, Inc. v. DSC Communications Corp., 15 F.3d 1427, 1433 (7th Cir. 1994).
The difference between the discovery and development interpretations is of no small consequence. As discussed above, a logical consequence of the discovery formulation is that the head start period and therefore damages are limited to the secrecy period. In comparison, under the development formulation, the head start period may be extended beyond secrecy to capture any and all time necessary to develop the trade secret into a commercially beneficial product or process. The development concept therefore appears more consistent with the policy of the Uniform Act to extend damages beyond the period that a trade secret may be entitled to protection to include “the additional period, if any, in which a misappropriator retains an advantage over good faith competitors because of misappropriation.” UTSA, § 3 cmt.
Furthermore, using the head start rule to calculate the damages accounting period may unduly restrict plaintiff’s recovery. Courts have rejected efforts by defendants to limit damages to the head start gained in their development of a competing product where this excludes or could exclude recovery for other losses sustained by the plaintiff or other ways in which the defendant has been unjustly enriched. Johns Manville Corp. v. Knauf Insulation, LLC, 2017 U.S. Dist. LEXIS 155206, at *27-28 (D. Colo. September 22, 2017) (denying defendant’s motion for summary judgment seeking to limit plaintiff’s damages to the head start period); Sabre GLBL, Inc. v. Shan, 779 Fed. Appx. 843, 851 (3d Cir. 2019) (rejected challenge to arbitrator’s award of head start damages based on lack of evidence of saved development costs because head start damages and saved development costs are not “the same thing”); Alifax Holding SpA v. Alcor Sci. Inc., 404 F. Supp. 3d 552, 573 (D.R.I. 2019) (head start damages was one of two alternative approaches for calculating unjust enrichment damages); Agilent Techs., 2010 Del. Ch. LEXIS 34, at *102-103 (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).
As the court explained in Johns Manville Corp. v. Knauf Insulation, LLC, “JM [the plaintiff] may be entitled to damages from any period during which the trade secrets afforded Knauf [the defendant] a competitive advantage and for any profits Knauf derived from its use of JM’s trade secrets, rather than just those benefits that accrued during a hypothetical “head start” period.” Johns Manville Corp., 2017 U.S. Dist. LEXIS 155206, at *27-28.
The practical insight is that to the extent there is a temporal limitation on damages that applies across all cases it is best defined as the length of time necessary to eliminate the unfair commercial advantage resulting from misappropriation. Emphasizing the elimination of an unfair commercial advantage as compared to focusing exclusively or too intently on the application of the head start rule reduces the potential for inconsistent or poorly reasoned results in measuring trade secret damages.
Head Start as a Category of Unjust Enrichment Damages
Another potential source of confusion regarding the application of the head start rule is that it refers not only to a temporal limitation on damages but also to a specific category of unjust enrichment damages. The head start rule for unjust enrichment damages is distinguished by its focus on awarding damages based on a temporal advantage; in contrast, the head start rule for calculating the damages accounting period imposes a temporal limitation on the amount of damages awarded.
The underlying policy justification for measuring unjust enrichment damages using a head start theory is that a plaintiff should be able to recover the benefit to the defendant of being able to develop a competing business or product faster than would otherwise have been possible absent misappropriation. Specific examples include:
- Plaintiff awarded the “head start benefit” measured by defendant’s incremental profits on sales over a period of time representative of the research and development time bypassed due to misappropriation. Sensormatic Elecs. Corp. v. Tag Co. US, LLC, 632 F. Supp. 2d 1147, 1187 (S.D. Fla. 2008).
- Defendant required to disgorge “head start damages” reflecting increased value of defendant’s company due to being 2 years further along than it otherwise would have been in developing and commercializing its products. Sabre GLBL, Inc., 779 Fed. Appx. at 851.
- Evidence supported jury award of “head start damages” reflecting defendant’s net profits on sales that began one year earlier than would have otherwise been possible without misappropriation – but for the misappropriation the defendants could not have launched its product at a key trade show, thereby delaying sales for a year or more. Alifax Holding SpA, 404 F. Supp. 3d at 556 (court denied renewed Rule 50 JMOL and accepted and applied a head start damage theory, but granted Rule 59 motion for new trial on damages due to potentially prejudicial errors in the admission of supporting proofs).
- Defendant gained a three-year head start on developing a competitive bid and business model for fixed-wing aircraft market, entitling plaintiff to recover “head start damages” measured by defendant’s profits during this period. T K C Aero. Inc. v. Phoenix Heliparts Inc., 2015 Ariz. Super. LEXIS 981, at *1 (Ariz. Super. Ct. January 30, 2015) (court accepted and applied a head start damages theory, but deemed the underlying evidence of defendant’s profits not sufficiently reliable to support such an award).
By all accounts, consideration of whether and to what extent defendant has gained an unfair head start is relevant to determining the duration of trade secret damages (and in some instances may also be relevant to measuring unjust enrichment damages). But focusing more generally on eliminating the unfair commercial advantage caused by the misappropriation may deserve greater emphasis as better aligned with core principles of trade secret misappropriation. The head start rule also is not consistently defined or applied across jurisdictions, making it necessary to pay close attention to the head start law (or lack thereof ) of the forum in which a particular case is pending.
* The end of the damages accounting period is different from and should not be confused with the end of the secrecy period (i.e. the period the trade secrets are unknown or not ascertainable through proper means). The former is a temporal limitation on damages and is directed to eliminating any unfair commercial advantage due to trade secret misappropriation, while the latter is required to establish liability for misappropriation and is directed to ensuring that business information is in fact secret and therefore qualifies for protection against misappropriation.