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Trade Secrets Tutorial


A trade secret is information that is not generally known and is capable of adding economic value to the holder. Usually the information falls into one of several categories: formula, pattern, compilation, program, device, method, technique, or process. Coke's original formula is the canonical example. Trade secrets are also often referred to as "confidential information" or "classified information." Essentially it is knowledge that the holder possesses and that the holder wants to keep hidden from the marketplace because secrecy produces a competitive advantage.

In general, there are three elements that must be shown by plaintiff when bringing a trade secret action: (1) that the information produced a competitive advantage because it was not generally known; (2) that reasonable and diligent steps were taken to protect the information; and (3) that the information in question was acquired through deception or theft. Trade secrets are protected under state law. The majority of states have adopted the Uniform Trade Secrets Act (UTSA). UTSA is a model act that was developed by the National Conference of Commissioners on Uniform State Laws.

Trade secret protection is relatively straight forward to obtain since it does not require application and registration with a government entity. All that is required is that a business take reasonable steps to protect the information. Obviously, what is reasonable is dependent on a number of factors but primarily on the economic value derived from the information. For example, a customer list may be considered a trade secret and if a business deems it as such then at least some steps must be taken to protect it. This might mean marking it as confidential and restricting access on a need to know basis. It does not mean that it need be kept under a "Fort Knox" level of security. On the other hand, Coke's formula may indeed require a level of security akin to a "state secret."

Trade secret protection may be obtained for a potentially infinite duration. Protection is essentially a process problem in that as long as the process to maintain secrecy is reasonable and diligently followed, protection is both triggered and maintained. The latter is both the most beneficial aspect of trade secret protection (because of its relatively low cost) and its Achilles heel. Most businesses either (1) do not have the correct processes in place; or (2) are not diligent in following them. For these and other reasons trade secret protection is often considered fragile. However, that need not necessarily be the case if trade secret fundamentals are attended to.

Even if the fundamentals are followed, trade secret protection has its limits under the law. For example there is no protection from independent discovery (unlike a patent) and neither is there protection from reverse engineering, unless of course the information necessary to reverse engineer was acquired through deception. This tutorial focuses on the UTSA, however, the interested reader should also be aware of the Economic Espionage Act of 1996 which "criminalizes" the theft or misappropriation of a trade secret by making such conduct a federal crime. The relevant USC code sections are 1831 through 1839.

Like many other forms of intellectual property protection, the protection of trade secrets dates back to earlier times. Some argue that trade secret protection started during Roman times where there were laws against corrupting the slaves of another. Presumably the corruption was intended to reveal secrets of the slave owner in possession of the slaves. There is certainly some evidence that trade secret laws were in place during the time of the Renaissance as a form of protection for the guilds. The latter laws became the foundation for the evolution of trade secret law during the industrial revolution, and hence the precursor to modern trade secret law.

Anglo-American jurisprudence followed suit at a later point in time, roughly in the early to mid 19th century. There is some empirical evidence that unlike patent law, trade secret doctrine has proved to be especially important to small businesses. This it probably due to the expense associated with other types of intellectual property protection and the economic impact on a small business when its secrets are revealed. In the 20th century modern trade secret law has its roots in the Restatement of Torts (1939), sections 757 & 758. Section 757 has been, and remains, influential due to its incorporation into the common law. It is highlighted below.

Section 757 Restatement of Torts

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 chemical 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 in that it is not simply information as to single or ephemeral events in the conduct of the business, as, for example, the amount or 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 the 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 the 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 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 knows 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 or formula by independent invention and are keeping it secret. Nevertheless, a substantial element of secrecy must exist, so that, except by the use of improper means, there would be difficulty in acquiring the information.

The Restatement (Second) of Torts omitted sections 757 & 758 apparently due to the fact that trade secrets had evolved into its own separate doctrine. The UTSA was promulgated in 1979 and its widespread adoption arguably makes it the most important primary legal trade secrets authority in American jurisprudence. As a side note, the U.S. Supreme Court has taken the view that trade secret protection is based on a kind of "property right" (see Ruckelshaus v. Monsanto (USSC 1984)). Others argue that the foundation lies in tort law (as described above) and still others insist protection is grounded in contract doctrine. As a practical matter, what is of value is that the protection exists and that online businesses should leverage it to the greatest extent possible.

There is no precise definition of what constitutes trade secret subject matter because a trade secret depends on a particular business context (i.e. what is considered to be a trade secret within one business may not be considered as such in another). Courts often look to the following factors to determine whether or not a trade secret exists:

  • the extent to which theinformation is known outside of the business
  • the extent to which it is known by employees and others involved in the business
  • the extent of measures taken by the business to guard its secrecy
  • the value of the information to the business and its competitors
  • the amount of effort or money expended in developing it
  • the ease or difficulty with which it could be properly acquired or duplicated by others.

The UTSA defines a trade secret as follows:

(4) "Trade secret" means 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.

Obviously protection is not triggered unless the subject matter in question is deemed to be a trade secret. Equally obvious is that the analysis is highly fact dependent and that sufficient evidence must be proffered in order to make the necessary showing. This is why it is imperative that a business develop, document and diligently follow its trade secrecy policy.

Although the law requires secrecy, absolute secrecy is not required, sans a revelation to the public at large. The 5th Circuit in Metallurgical Industries v. Fourtek (1986) makes this point by quoting the relevant language from the restatement:

He may, without losing his protection, communicate it to employees involved in its use. He may likewise communicate it to others pledged to secrecy.... Nevertheless, a substantial element of secrecy must exist, so that, except by the use of improper means, there would be difficulty in acquiring the information.

Here the court goes on to conclude that the divulging of information to a limited extent in furtherance of the holder's economic interest is not sufficient to require the loss of trade secret status.

In addition to a showing of suitable subject matter the UTSA requires reasonable efforts to maintain secrecy (see 4(ii) above). A leading case here is Rockwell Graphics Systems v. DEV Industries (7th Cir. 1991) wherein the court goes to great lengths to ground the legal rationale for the necessity of the holder to take reasonable measures vis-a-vis trade secret protection. The court concludes that reasonable does not mean extravagant and highlights the cost benefit ratio (i.e. the economic impact) to the holder if forced to take burdensome measures. The court also emphasizes the growing importance of trade secret protection to American industry given the temporary protection and high costs associated with the acquisition of patent rights.

Part of the public policy rationale that underpins trade secret law is "the maintenance of standards of commercial ethics" (see Kewanee Oil Co. v. Bicron Corp.(USSC 1974)). In other words, the interest is in providing protection from unfair competition. The UTSA defines misappropriation as follows:

(2) "Misappropriation" means:

(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 UTSA defines "improper means" as including: bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means. This definition loosely defines  "improper means" because a more rigorous taxonomy would be too broad to be of any practical value. However, notes from section of 757 of the Restatement (Second) of Torts provide some insight by attempting to illustrate what is considered to be "proper."

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.

It should be noted that improper conduct does not necessarily imply illegal conduct.  It may include otherwise lawful conduct which is improper under the circumstances; e.g., an airplane overflight used as aerial reconnaissance to determine the competitor's plant layout during construction of the plant. E. I. du Pont de Nemours & Co., Inc. v. Christopher (5th Cir. 1970).

The theft of trade secrets in the form of economic espionage is big business. Some estimates place that annual loss north of 250 billion annually. A majority of the Fortune 500 are on record as having been victimized, and this number obviously excludes those reticent to make such admissions publicly. In the fast paced innovative business environment of the Web, what an organization knows is valuable. Online businesses of all sizes have trade secrets that are worth protecting, from the niche retail Realtor to Amazon.com.

Trade secret protection is often extended through the law of private agreements (i.e. through contract doctrine). These agreements take many forms including employment contracts with non-compete clauses, non-disclosure agreements and licensing agreements. In short, when drafted correctly these agreements provide protection over and beyond the protection provided by meeting trade secret requirements. These agreements may indeed provide specific relief despite the fact that a trade secret is now in the public domain. The rationale that underpins the controlling legal theory is predicated upon the freedom to contract. Trade secret protection via contract doctrine is yet another example of how contracts dominate the world of business, whether online or off. Contract doctrine is so ubiquitous that it often goes unnoticed, until of course the lack of an effective agreement denies a business owner relief that they otherwise would have been entitled to.

Want to protect against the adverse effects of key employees leaving and taking your trade secrets with them to the competition? Sure, you may have met all the trade secret requirements but the mere fact that trade secrets could be revealed will not, in and of itself, prevent a court from upholding the right of an employee to work for a direct competitor. Of course, if there is evidence (post "defection") that trade secrets have been revealed, then you have a cause of action; but by then most of the damage has been done. What you need in order to provide additional protection is an enforceable non-compete clause that was included in the employment contract signed by the employee as a condition of employment. This clause must be reasonable in "time, scope and geography" otherwise a court will consider the clause to be an unfair restraint of trade (i.e. preventing the employee from earning a living). But remember, what is "reasonable" for an online business may differ significantly from what may be considered reasonable in the "world of atoms." Your direct competitors may in fact be in an entirely different jurisdictions and therefore the concept of "geography" must of necessity be more expansive, yet still meet the reasonableness test of the local jurisdiction.

Similarly, with more and more knowledge work being outsourced, an online entrepreneur has a need to protect secrets that may be shared with any number of third party service providers. In this instance, an enforceable non-disclosure agreement is in order. In short, there are numerous permutations to the scenarios described here wherein the law of private agreements provides protection. What is required is that a business have a well drafted set of standard instruments to be used when the need arises. The use of such instruments is usually standard operating procedure for most businesses, but an alarming number of small to medium size businesses simply fail to take the necessary precautions.

The UTSA provides for both injunctive relief and relief in the form of money damages. Money damages are provided for as follows:

a) Except to the extent that a material and prejudicial change of position prior to acquiring knowledge or reason to know of misappropriation renders a monetary recovery inequitable, a complainant is entitled to recover damages for misappropriation. Damages can include both the actual loss caused by misappropriation and the unjust enrichment caused by misappropriation that is not taken into account in computing actual loss. In lieu of damages measured by any other methods, the damages caused by misappropriation may be measured by imposition of liability for a reasonable royalty for a misappropriator's unauthorized disclosure or use of a trade secret.

(b) If willful and malicious misappropriation exists, the court may award exemplary damages in an amount not exceeding twice any award made under subsection (a).

As illustrated above, the money damages available are potentially significant, including exemplary damages. The threat of an adverse judgment may be sufficient to persuade a would be infringer from engaging in inappropriate conduct, if such a warning is issued in a timely manner. In addition, a business person may seek injunctive relief, provided for as follows:

(a) Actual or threatened misappropriation may be enjoined. Upon application to the court, an injunction shall be terminated when the trade secret has ceased to exist, but the injunction may be continued for an additional reasonable period of time in order to eliminate commercial advantage that otherwise would be derived from the misappropriation.

(b) In exceptional circumstances, an injunction may condition future use upon payment of a reasonable royalty for no longer than the period of time for which use could have been prohibited. Exceptional circumstances include, but are not limited to, a material and prejudicial change of position prior to acquiring knowledge or reason to know of misappropriation that renders a prohibitive injunction inequitable.

(c) In appropriate circumstances, affirmative acts to protect a trade secret may be compelled by court order.

Finally, under certain conditions attorney fees may also be available under the Act. The fact that relief is available, in the manner prescribed by the Act, is obviously a good thing. However, relief requires litigation and as mentioned often in these tutorials, litigation is expensive and time consuming. The latter may in fact be more insidious. The passage of time could be the greater evil. It is imperative that the necessary precautionary steps be taken to protect the business, and equally important that a timely action be filed upon notification of actual or potential wrongdoing.

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