Minimizing the Risks of Misappropriation of Trade Secrets

Spring 2000

Author:

Preventive Law Reporter

Many businesses assume that, because they do not deal with "classic" intellectual property issues such as patents or copyrights, they have no reason to worry about misappropriation of trade secrets.  In most cases, this assumption is wrong.  Failure to recognize and properly protect against misappropriation may leave a business exposed to significant losses in an environment where information is the currency of competition.  Indeed, it has been estimated that the loss to American businesses from misappropriation or theft of trade secrets may be as high as $2 billion per month, and this figure is rising.2

Moreover, the cost of litigating a trade secrets case may in some cases be as devastating as the loss of the trade secrets themselves.  The median cost of prosecuting or defending a trade secrets action through discovery exceeds $200,000, and trying such a case may cost more than $350,000.3   However, a small investment in a trade secrets protection program at the outset may help to protect a business from the misappropriation its own trade secrets, as well as insulate the business from liability for the misappropriation of another's trade secrets.  This article outlines some basic steps businesses can take to protect themselves from these risks.

The Risks of Misappropriation

There are secrets and then there are secrets.  Every business has information that would prefer not to disclose to its competitors, but there are some types of information where secrecy is absolutely essential in order to maintain a competitive edge.

A "trade secret" is generally defined as information maintained in secrecy that has economic value because it is not generally known to or readily ascertainable by competitors.4  This includes not only scientific and technical information, but also various types of confidential business information developed through the effort and expense of a company.  For example, courts have recognized that marketing data and strategic plans,5 pricing models and profit margins,6 customer lists and client data7 and manufacturing processes or methods8 may be protected as trade secrets.  A trade secret may also exist in a unique combination of components or data, each of which is in the public domain.9   Such trade secrets are found in businesses ranging from high technology firms to professional and service organizations to local bagel shops.
Because the sine qua non of a trade secret is that it remain a "secret," it is essential that businesses take steps to protect any information that may be considered a "trade secret."  Any public disclosure or use of such information, even without the knowledge or consent of the owner, destroys the "secret" both as a practical matter and as a matter of law.10  Moreover, failure to take reasonable steps to protect the secrecy of such information, even if it is not disclosed, may result in the loss of legal protection for the information as a "trade secret."11  What constitutes "reasonable" efforts to maintain the secrecy of information "depends on a balancing of costs and benefits that will vary from case to case."12   
Aside from protecting one's own trade secrets, however, businesses must also take reasonable steps to reduce their exposure to litigation for the intentional or unintentional misappropriation of another's trade secrets.  Under the Uniform Trade Secrets Act ("UTSA"), a party may be held liable for misappropriation of trade secrets if it receives or uses another's trade secrets without consent.13

While a business may be exposed to liability for misappropriation by the actions of its overzealous employees, the risk arises more frequently in the hiring process.  New employees with knowledge of a former employer's trade secrets, for example, may expose the new employer to liability by using or disclosing secrets in the course of their employment.  It is not necessary that the new employee actually use or disclose a former employer's trade secrets to expose a subsequent employer to liability.  An employer can be enjoined from hiring a new employee where it is "inevitable" that the employee will use or disclose a former employer's trade secrets in the course of subsequent employment.

This so-called "inevitable disclosure" doctrine was articulated in PepsiCo v. Redmond,14 a case that vividly illustrates the risks employers face when hiring a competitor's employees.  In Redmond, Quaker hired Redmond, a high-level executive of PepsiCo, to run Quaker's newly formed beverage operation, which was in direct competition with PepsiCo.  While employed by PepsiCo, however, Redmond had been involved in the development of PepsiCo's strategic and marketing plans to compete with Quaker's beverage products.  Finding that unless Redmond had an "uncanny ability to compartmentalize information," it was inevitable that his performance of his job duties for Quaker would be shaped by his knowledge of PepsiCo's trade secrets. 15  Accordingly, the court enjoined the executive from performing certain duties for Quaker for six months to allow PepsiCo to implement its marketing plans and mitigate any advantage that Quaker might realize from Redmond's advance knowledge thereof.  Courts in 21 other jurisdictions have adopted similar rules.16
Advantages of a Trade Secrets Program

A trade secrets protection program offers many advantages.  Initially, because "secrecy" is an essential element of a trade secret, the existence of a program to protect such information provides affirmative evidence of the very existence of a trade secret.17    Moreover, by heightening employees' awareness of an employer's interest in protecting information, as well as the employees' obligations in that regard, a trade secrets program can discourage or thwart would-be appropriators.

Aside from protecting one's own trade secrets from misappropriation, a trade secrets program can minimize the risk of "infection" from trade secrets new employees may have misappropriated from a former employer.  As noted above, the cost of litigating trade secrets is substantial, and an unsuccessful defendant may be exposed to an injunction, an award of money damages and, potentially, punitive damages and the plaintiff's attorney's fees.18  In extreme cases, misappropriation of trade secrets may lead to the imposition of criminal penalties under the federal Economic Espionage Act19 or various state statutes criminalizing theft of trade secrets. 20  The existence of a trade secrets program designed to identify the risks of "infection" can reduce the risk of expensive litigation and, if litigation results, may also provide evidence to mitigate any inference that the employer intentionally misappropriated a competitor's trade secrets.
Designing a Trade Secrets Program

There is no formula or black letter law that determines what a trade secrets program must include.   However, in general, a successful trade secrets program must (1) identify the risks of misappropriation in the employer's business, (2) effectively communicate to employees those risks and the employees' obligations to minimize the risks, and (3) provide for ongoing monitoring to ensure the requirements are followed.  These factors should be examined at the following phases of a business' operations:
Pre-hiring Considerations

The principal risk of misappropriation facing employers in the hiring process is "infection" of the company with trade secrets imported through new employees.  Many of these risks can be addressed by a careful screening of employees in the pre-hiring interview process.  The following steps should be considered as part of a trade secrets program:

  • Train interviewers in risk factors.  All persons conducting interviews should be thoroughly trained to look out for risk factors that may give rise to liability for misappropriation in the hiring of new employees.  For example, while candidates who promise to bring "inside" information from a previous employer are an obvious risk, interviewers should also be wary of new employees who claim ownership of inventions, programming codes, trade secrets or other intellectual property rights.  Requests for indemnification by the candidate may reflect concerns about liability to a former employer.
  • Conduct in-depth interviews.  Interviewers should also fully understand the requirements of the position for which they are interviewing in order to determine whether a candidate poses a risk of "inevitable disclosure."  Candidates should be asked not only their previous job titles, but also what their duties or responsibilities were so that risks of "inevitable disclosure" can be fully evaluated.21
  • Determine the candidate's knowledge of another's trade secrets.  All candidates should be asked whether they had access to any trade secrets of a former employer.  If the candidate answers in the affirmative, the prospective employer should inquire about the nature of the trade secrets (without actually seeking their disclosure) and the extent of the candidate's knowledge and use of such secrets to determine whether the candidate would be able to perform his or her job duties without disclosing or using those trade secrets.  If the employer decides to hire the candidate, the employer may ask the candidate to execute an undertaking or agreement that the candidate (1) will not disclose or use such information during the course of their new employment and (2) does not have and will not bring to the workplace any documents, files or tangible property constituting a former employer's trade secrets.  Such agreements put the burden on an employee not to use a former employer's trade secrets and may provide evidence to rebut claims that the employer intentionally misappropriated the former employer's trade secrets.
  • Find out about restrictions on employment.  Candidates should also be asked if they have signed any confidentiality agreements or agreements not to compete with respect to the use or disclosure of trade secrets.  Such agreements may pose risks of litigation not only to the candidate, but also to the employer hiring the candidate.  If the candidate has signed such an agreement with any other employer, the candidate should be asked to produce a copy of the agreement and the employer should carefully review the agreement before making any hiring decision.  A non-disclosure or non-compete agreement may not bar the hiring of a candidate if employment in the new position would not violate the agreement, or if the former employer is no longer in business or engaged in work covered by the agreement.
  • Contact former employers.  If the employer is concerned that hiring an employee may violate a non-compete or non-disclosure agreement, the employer may decline to hire the candidate and avoid any potential problem altogether, though this may force the employer to forego a valuable hiring opportunity.  Alternatively, the employer may contact the candidate's former employer to see if a release of the non-compete or non-disclosure can be negotiated, or whether an agreement can be reached that would permit the employer to hire the candidate.  Agreed-upon restrictions or limitations on the candidate's job duties (for example, precluding the candidate from working on projects in direct competition with a former employer) may avoid problems under a non-compete or non-disclosure agreement.

Dealing With New Hires

After the decision is made to hire a candidate, the employer should advise the new hire of his or her obligations to maintain the confidentiality of the new employer's trade secrets.  While employees may be legally liable in tort for the unauthorized disclosure of trade secrets, they are unlikely to have resources to compensate an employer for their loss.  Advising employees of their obligations can avoid the need to rely on such remedies after the misappropriation has occurred.  Other steps to consider include:

  • Non-disclosure agreements.  In order to put employees on notice of their obligations and to clarify the confidential nature of the employment relationship, all new employees who will have access to trade secrets should be required to execute a nondisclosure agreement at the time of hire as a condition of employment.  Because vague or overly broad non-disclosure agreements may not be enforceable, the agreement should recite the employer's interest in maintaining secrecy and the information that may not be disclosed.  The agreement should recite that the nondisclosure obligation is intended to be ongoing in the event of the employee's termination or resignation.  In addition, to avoid any confusion as to ownership of trade secrets developed on the job, the agreement should provide that all such trade secrets are the exclusive property of the employer.22

Similar agreements may be required of consultants, interns or other temporary employees at the time of hire.  Existing employees given access to trade secrets should also be required to execute nondisclosure agreements, though some consideration above and beyond a mere continuation of employment will likely be required for the agreement to be enforceable.

  • Non-compete agreements.  Key employees who will be actively involved in the development and use of trade secrets should be required to execute non-compete agreements.  While non-compete agreements are generally disfavored and strictly construed by courts, covenants that are required for the protection of trade secrets have been held to be valid and enforceable.23   Accordingly, the non-compete agreement should be narrowly tailored, carefully describing the relevant market, the nature of the competition in the market, the conduct prohibited by the agreement, and how the covenant is necessary for the protection of the employer's trade secrets.  As with non-disclosure agreements, some recitation of consideration may be required where an existing employee is required to execute a non-compete agreement.24

Ongoing Compliance Monitoring

As noted above, trade secrets remain protected only as long as they are maintained in secrecy.  While extreme or unduly expensive measures are not required, an employer must take reasonable steps under the circumstances to maintain the secrecy of such information.25   Thus, a trade secrets program should provide for the following:

  • Inform employees about their obligations.  All employees should be put on notice as to which information the employer considers to be trade secrets and their obligation not to disclose or use such information.  Such policies may be set forth in any employee handbook or materials provided to the employee at the time of hire.  The policies may be reinforced by restating them on start-up screens that are accessed each time an employee logs in to the employer's computer or network.
  • Require written acknowledgements.  Employees should be required to sign a written acknowledgment that the compliance policies have been reviewed and are understood by the employee. Moreover, compliance policies should be reviewed with the employee on a periodic basis, such as during an annual review.
  • Identify trade secrets.  To assist employees in understanding what they are obliged to protect, and to enable the employer to track trade secrets, all information considered to be a trade secret should be identified and marked as confidential or "secret."  A general description of the categories of information the employer seeks to protect may suffice, though the better practice is to legend or label individual documents or files as trade secrets.  Similarly, computer files and databases should include a legend advising employees that the information contained therein constitutes the employer's trade secrets.  These designations should be periodically reviewed and updated.
  • Limit access.  Access to trade secrets should be limited to those employees who are required to utilize such information as part of their normal work activities.  Trade secrets should be kept in areas that are inaccessible to the public, and files or rooms where such information is maintained should be locked. Passwords may be employed to restrict access to confidential information maintained on computers.
  • Review publications.  A risk that is commonly overlooked is the publication or presentation of trade secrets by key employees, such as articles appearing in periodicals, scientific journals or academic presentations. While presentations or publications may be beneficial for business development, publication of trade secrets or disclosure in a seminar destroys the trade secret.26   Thus, all materials for publication or presentation should be submitted to a manager or compliance officer prior to publication or distribution.
  • Properly dispose of sensitive documents.  Another area that may be overlooked in trade secrets programs is document disposal.  Documents containing trade secrets may inadvertently become public or subject to espionage by competitors if improperly disposed.27  To avoid this problem, employers should require that all documents that may contain trade secrets be shredded prior to disposal.   Employers may also hire bonded document disposal services to handle waste that may contain trade secret information.

Terminations or departures

Although an employee's duty not to use or disclose trade secrets extends beyond the employment relationship, the employer is at risk of misappropriation through the removal of documents or files, information downloaded or stored on personal computers, or even an employee's memorization of confidential information.28   To minimize these risks, the following steps should be taken:

• •Conduct exit interviews.  Exit interviews should be required for all departing employees.  The employer should ask whether the employee possesses any originals or copies of the employer's files, documents or other information, including copies made on a home computer.  All such information should be returned to the employer (including all copies), and any computer files maintained outside the office should be deleted.  In addition, departing employees should be advised of their continuing obligation to maintain the secrecy and non-use of the employer's trade secrets, and should be provided a copy of any applicable non-disclosure or non-compete agreements to reinforce these obligations.

  • Restrict access.  Immediately upon notice of an employee's termination or resignation, an employer should restrict the employee's access to trade secrets and other confidential information.  Computer passwords should be changed and any remote access privileges (such as access from a home computer via modem) should be revoked.
  • Require termination certificates.  The employer may require a departing employee to execute a termination certificate that acknowledges the continuing obligation to maintain the secrecy of the former employer's trade secrets.

Conclusion

In scrutinizing the bottom line, a business may be tempted to put off the expense of developing a trade secrets program.  However, the loss of a key trade secret or the cost of litigating a single trade secrets lawsuit may greatly exceed the cost of such a program.  Thus, a trade secrets program is a wise investment in risk management.

Footnotes:
1.  Craig N. Johnson is a partner with Fairfield and Woods PC in Denver, Colorado, where his practice emphasizes commercial and intellectual property litigation.  Mr. Johnson has authored numerous articles on intellectual property and trade secrets litigation and routinely advises clients on preventive measures to avoid litigation risks in these areas.  More detailed information regarding trade secret protection may be obtained by contacting Mr. Johnson at cjohnson@fwlaw.com.
2.  See Robert G. Bone, A New Look at Trade Secret Law: Doctrine in Search of Justification, 86 California Law Review 241, 274 (March 1998).
3.  See Judith A. Szepesi, Maximizing Protection for Computer Software, 12 Santa Clara Computer & High Technology Law Journal 173, 200 (Feb. 1996).  The high costs result, in large part, from the fact-intensive nature of trade secrets litigation and the frequent need for extensive expert testimony regarding technical issues and damages.
4.  The Uniform Trade Secrets Act ("UTSA"), which has been adopted in some form in 42 states and the District of Columbia, broadly defines a "trade secret" as information that (1) "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 (2) "is the subject of efforts that are reasonable under the circumstances to maintain its secrecy." Unif. Trade Secrets Act § 1(4), 14 U.L.A. 438 (1990).  Similarly, the Restatement of Unfair Competition defines a "trade secret" as "any information that can be used in the operation of a business or other enterprise and that is sufficiently valuable and secret to afford an actual or potential economic advantage over others."  Restatement of Unfair Competition § 39 (1995).  The Restatement (First) of Torts takes a different approach, setting forth six factors for determining whether a "trade secret" exists, including the extent of knowledge of the secret outside the plaintiff's business, the extent to which the secret is known to employees and others, measures taken to preserve secrecy, the value of the information, the time and money expended to develop the information and the difficulty with which others might independently develop such information.  Restatement (First) of Torts § 757 (1939).
5.  PepsiCo v. Redmond, 54 F.3d 1262 (7th Cir. 1995) (marketing plans to deal with competitor's soft drink products held to be trade secrets).
6.  Cardinal Freight Carriers, Inc. v. J.B. Hunt Transp. Serv., Inc., 987 S.W.2d 642 (Ark. 1999) (knowledge of pricing models, profit margins and customer information in transportation system held to be trade secrets).
7.  See Surgidev Corp. v. Eye Technology, Inc., 828 F.2d 452 (8th Cir. 1987) (lists of high volume implanters of intraocular lenses were protected as trade secrets); IDS Financial Serv., Inc. v. Smithson, 843 F. Supp. 415 (N.D. Ill. 1994) (identity of clients a financial planner learned in course of employment protected as trade secret).
8.  Rockwell Graphics Sys. v. DEV Indus., Inc., 925 F. Supp. 174 (7th Cir. 1991) (manufacturing specifications and methods for printing press components held to be trade secrets).
9.  See Salsbury Labs., Inc. v. Mereiux Labs., Inc., 735 F. Supp. 1555 (M.D. Ga. 1989), aff'd 908 F.2d 706 (11th Cir. 1990) (the combination of steps into a process for the production of a poultry vaccine constituted a trade secret, even though all component steps were available in the public domain); Essex Group, Inc. v. Southwire Co., 501 S.E.2d 501 (Ga. 1998) (though computer components were generally available to the public, the arrangement and selection of components were unique and protected as a trade secret).
10.  See Eli Lilly & Co. v. E.P.A., 615 F. Supp. 811 (D. Ind. 1985) (trade secret protection extinguished when company discloses information to persons not obligated to maintain confidentiality).
11.  See, e.g., Gordon Employment, Inc. v. Jewell, 356 N.W.2d 738 (Minn. App. 1984) (court held client lists not protected as trade secrets where plaintiff made no effort to maintain secrecy, kept information in unlocked files, maintained no secrecy program and never discussed secrecy with employees).
12.  Rockwell Graphics Sys., Inc. v. DEV Indus., Inc., 925 F.2d 174, 179 (7th Cir. 1991).
13.  Unif. Trade Secrets Act § 1(2).
14.  54 F.3d 1262.
15.  54 F.3d at 1270.  In contrast, the hiring of an employee who simply takes general business knowledge from one job to the next would ordinarily not constitute misappropriation because such generalized knowledge is not protectable as a trade secret.  See Rivendell Forest Prods., Ltd.  v. Georgia-Pacific Corp., 824 F. Supp. 961 (D. Colo. 1993).
16.  Courts in the following jurisdictions have followed the "inevitable disclosure" doctrine: Arkansas, Connecticut, Delaware, Florida, Illinois, Indiana, Iowa, Kansas, Louisiana, Massachusetts, Michigan, Missouri, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Texas, Utah, Washington and Wisconsin.
17.  See Surgidev Corp., 828 F.2d 452 (examining plaintiff's security program in determining that information was a protected trade secret).
18.  Unif. Trade Secrets Act §§ 2, 3 and 4.
19.  18 U.S.C. § 1831, et seq.  The Economic Espionage Act prohibits the knowing intentional theft, copying, disclosure or receipt of trade secret information that is related to or included in a product that is produced for or placed in interstate commerce.  18 U.S.C. § 1832.  Individuals who participate in the theft of trade secrets may be fined or imprisoned for up to 10 years, and organizations committing such theft may be fined up to $5 million.  Id.
20.  States that have adopted statutes criminalizing theft of trade secrets include Alabama, Arkansas, California, Colorado, Florida, Georgia, Maine, Maryland, Minnesota, Pennsylvania, Tennessee, Texas and Wisconsin.
21.  Similarity of job duties is a significant factor in determining whether an employee's subsequent employment will result in the inevitable disclosure or use of a former employer's trade secrets. See Redmond, 54 F.3d at 1270.  
22.  See Wesley-Jessen, Inc. v. Armento, 519 F. Supp. 1352, 1362 (N.D. Ga. 1981).
23.  See Hayes v. MSP Communications, 1998 WL 188567, *3 (Minn. App. Apr. 21, 1998)("Noncompete agreements are enforceable if they serve a legitimate interest and are not broader than necessary to protect this interest."); Gold Messenger, Inc. v. McGuay, 937 P.2d 907 (Colo. App. 1997).
24.  See, e.g., Reynolds & Reynolds Co. v. Tart, 955 F. Supp. 547, 533 (W.D.N.C. 1997) (a non-compete agreement "entered into after an employment relationship already exists must be supported by new consideration, such as a raise in pay or a new job assignment");  Prudential Ins. Co. v. Stella, 994 F. Supp. 308 (E.D. Pa. 1998) (same).  Some jurisdictions, however, have held that continued employment of an "at will" employee is sufficient consideration.  See, e.g., Curtis 1000, Inc. v. Suess, 24 F.3d 941 (7th Cir. 1994).  The better practice is to recite some consideration in the agreement to avoid any dispute as to whether the agreement was supported by consideration.
25.  See, e.g., Network Telecommunications, Inc. v. Boor-Crepeau, 790 P.2d 901 (Colo. App. 1990).
26.  See, e.g., American Paper & Packaging Prods., Inc. v. Kirgan, 183 Cal. App. 3d 1320 (1986); see also Unif. Trade Secrets Act § 1, cmt. ("Information is readily ascertainable (and hence not protected as a trade secret) if it is available in trade journals, reference books, or published materials.").
27.  See Tennant Co. v. Advance Machinery Co., 355 N.W.2d 720 (Minn. App. 1984) (competitor obtained plaintiff's trade secrets by rummaging through plaintiff's trash).
28.  See Rivendell Forest Prods., 824 F. Supp. at 968.


This Article is published for general information, not to provide specific legal advice. The application of any matter discussed in this article to anyone's particular situation requires knowledge and analysis of the specific facts involved.

Copyright © 2000 Fairfield and Woods, P.C., ALL RIGHTS RESERVED.

Comments or inquiries may be directed to:

Craig N. Johnson