This article has been written by Eriobu-Aniede Onyekachi pursuing the Diploma in US Intellectual Property Law and Paralegal Studies from LawSikho. This article has been edited by Aatima Bhatia (Associate, Lawsikho) and Smriti Katiyar (Associate, Lawsikho).
Secrets are personal and confidential information that a person guards from becoming public because it could be detrimental to their reputation especially if the information is negative. In a business setting, trade secrets are confidential information that gives a business a competitive edge in the market. Sometimes, trade secrets are shared with employers, customers, partners and investors for the objectives of the business to be accomplished. Trade secrets are vital to the survival of any business, especially those who strive basically on their ability to keep their trade secret; the formula for Coca-Cola drinks and its long existence in the market is a top-secret only known to a few.
Trade secrets are ideally guarded through physical security measures that are proven imperfect and so exposed or shared with third parties who may misappropriate them during or after the working relationship. Since employees will naturally keep relationships and work separated , it is natural to request that the confidential information which they come across in the line of duty be kept secret. Employers use restrictive covenants to achieve this purpose.
Restrictive covenants are found in different forms of agreement ranging from employment, property to business agreements. In an attempt to maintain business confidentiality through restrictive covenants, obstacles are met at the point of enforcement depending on the jurisdiction and scope of the restriction. While some jurisdictions favour restrictive covenants for meeting their objectives, the US frowns at them especially in employment contracts for limiting the employee’s choices and operations.
For easy comprehension, this article is limited to trade secrets as a genre of intellectual property (IP) and its relationship if any with restrictive covenants in an employment contract and their available remedies in the US Law?
What is a trade secret?
The World Intellectual Property Organisation (WIPO) defines a trade secret as any information that;
- Is not generally known to the relevant business circles or the public;
- Confers some sort of economic benefit on its owner. This benefit must derive specifically from the fact that it is not generally known, and not just from the value of the information itself; and
- The subject of reasonable efforts to maintain secrecy.
Generally, trade secrets are protected only against improper acquisition as such, no liability if the information is exposed through independent improvement, reverse engineering, leakage or otherwise. The personal information of a business such as its customers’ lists is confidential information that is protected under privacy law. Trade secrets, unlike a patent, last in perpetuity if well kept but are not monopolistic such that, if two businesses independently develop information that is eligible for trade secret protection, both will enjoy the trade secret rights in the same information pending when either or both publish the information. It is pertinent to note, however, that:
- The protection of trade secrets is generally weak in most countries;
- Its eligibility and scope of protection varies from country to country depending on statutory mechanisms and judicial precedents;
- The judiciary mostly requires proof of significant and perhaps costly efforts to preserve its secrecy.
In light of the above stated peculiarities, it is advisable to use trade secrets if the information can be kept secret for over 20 years as with a patent validity period; if the information is not likely to be legitimately and independently developed; if the secret cannot easily be revealed through reverse engineering; if it has little commercial value whether as a product or as a manufacturing process; and if obtaining patent rights is considered too expensive.
Qualification for trade secret
Going by literature reviews and judicial precedents, three key things must be established for a secret qualifying as a trade secret;
- Secrecy: the subject matter for the trade secret must be sufficiently secret in that it is not known and is not easily discoverable.
- Commercial Value: the information is such that provides or will provide the owner with a competitive advantage over competitors simply because it is not capable of being known to others.
- Reasonable Measures: some security effort must have been initiated towards the safeguard of the secret.
Take, for instance, Coca-Cola kept its soft drinks formula a secret instead of patenting it. If it were patented, it would have long been in the public domain and Coca-Cola would no longer have a competitive advantage over it. It is said that Coca-Cola takes security measures in guarding the secret formula by; keeping the formula in the vault of a bank in Atlanta, Georgia; ensuring the formula is only known to a few people within the company who were made to sign a non-disclosure agreement and who are not allowed to travel together. A non-disclosure agreement is a form of a restrictive covenant that can stand alone or be incorporated into an employment agreement to protect secrets.
What are restrictive covenants?
Restrictive covenants are agreements not to do something(s). They often stand alone or are embedded in contracts as nuances; to limit the use and sharing of trade secrets by the receiving party. They are especially found in employment letters, work for hire contracts, partnerships and investment contracts between persons or and organisations. For instance, a former employee is restricted from; setting up competition within a certain radius or a period of leaving and or poaching other employees for a competing business. Its objective is to protect information that is considered fundamental and priceless to the success of a business. So restricting the use of such information by employees during and after their employment has ended is key to the business survival thereafter. It can be imagined that an ex-employee who has knowledge and workings of their former employer’s technology and other strategic information could after they leave the employment, decide to start a similar business within proximity as that of the former employer or become an attractive asset to a competitor. Restricting such an employee will prohibit him or her from competing directly or indirectly even for a reasonable period after the lapse of the business relationship. Setting out such clauses at the beginning of an employment relationship can be the best means through which trade secrets are protected.
Restrictive covenants in an employment contract may take any or all of the following forms;
- Non-competition covenants: a non compete clause, is an agreement that prevents an employee from competing with the former employee within a specified area for a certain period. This covenant when found in an employment contract limits the employee’s ability to use the resources from the current employer to benefit a future employer such as using trade secrets or business methods that are unique to the former employer.
- Non-solicitation covenants: is used to prevent an employee from soliciting or accepting business from the customers of the former employer and it prevents poaching of clients/customers/suppliers of the former employer. It is restricted to customers with whom the employee has some interactions.
- Poaching covenants: this covenant is usually found in a work for hire agreement and it is a promise not to hire any employees of the former employer. This is limited to the non-hire of employees, with whom the former employee supervised, or worked.
Enforceability of restrictive covenants
It is pertinent to understand what avenues are open to an employer whose trade secret has been breached despite having the restrictive covenant signed. An application for an injunction requesting that the employee “hand over” or destroy confidential information is made to the court to stop the employee in his tracks. Depending on the jurisdiction, the employer may pursue injunctive relief and damages against the employee or business partner and can also sometimes directly pursue damages from a former employee’s new employer for interference with the departed employee’s restrictive covenants. An employer that claims damages for breach of a restrictive covenant in an employment contract, must show some loss resulting therefrom, such as the loss of profits on contract opportunities diverted by the act of the employee.
The enforceability test for a restrictive covenant is, whether the restrictive covenant is reasonable in scope, geography and time. For instance, states like California, Montana and North Dakota prohibit employers from asking their employees to sign restrictive covenants. California law bars the non-solicitation of customers and non-compete covenants that restrain anyone from engaging in a lawful profession, trade, or business of any kind. In Edwards v. Arthur Andersen LLP, 44 Cal. 4th 937, the California Supreme Court held that the law should be read strictly, and not only void the “unreasonable” non compete clause, but all non compete clauses, except those allowed as exceptions in the code.
While the courts consider the reasonability test, judicial precedents have further classified grounds for enforcement;
- Geographically: the restriction must be limited to where the Company is physically situated, however this is challenged by globalization. Also, the geographic scope is not necessary for a non-solicitation agreement. The Wisconsin court of appeal in Selmer Co. v. Rinn, 328 Wis.2d 263, 281 (Ct . App. 2010) stated that restrictive covenants are analyzed by examining the totality of the circumstances, such that the court found in Karpinski v. Ingrasci, that the scope of the agreement was too broad because the former employee was restricted from even working in the similar line of business (practice dentistry) as his employer’s practice area, but was able to perform oral surgery as a dentist even though the non-compete agreement was reasonable in duration and geography.
- Legitimate purposes: this established the purpose for the restriction. Was it to preserve the goodwill, protect customer relationships and confidential information and trade secrets of the business? In FTI Consulting, Inc. v. PricewaterhouseCoopers LLP, 8 A.D.3d 145, 146 (N.Y. App. 1st Dept 2004) the court held that finding breach of restrictive covenants constitutes irreparable harm where the loss of goodwill is not readily quantifiable.
- The Inevitable Disclosure Doctrine: court considers the inevitable disclosure doctrine where a former employee’s new employment threatens disclosure of his or her former employer’s trade secrets, though the employee has not misappropriated the information. This particularly depends on the employee’s prior role. In Alliance Intl., Inc. v. Ferreira, 530 F. Supp. 2d 477, 482 (S.D.N.Y. 2007), the court enjoined a former executive from working for “a direct competitor” where the executive “possesses detailed knowledge” of “non-public information” regarding former employer’s “customers and marketing strategies that would undeniably be of value to one of its direct competitors.”
The court explained that “even if [the former executive] acted with the best of intentions, he may unintentionally transmit information gained through his association with his former employer during his day to day contact with his new employer” and that the former executive’s employment with the new employer creates the risk that disclosure of the former employer’s trade secrets is inevitable.” Id. (internal quotations omitted). In I.B.M. Corp. v. Papermaster, 2008 U.S. Dist. LEXIS 95516, at *25 (S.D.N.Y. Nov. 21, 2008), the court enforced a covenant not to compete where a former employee had access to “sensitive and confidential information through his work” concerning the former employer’s “strategic plans, product development, technical recruitment, and long-term business opportunities.” The court found that the “likely inevitability of even inadvertent disclosure is sufficient to establish a real risk of irreparable harm to IBM.” 2008 U.S. Dist. LEXIS
- Proof of Irreparable Harm: some jurisdictions like New York require proof of irreparable harm should an injunctive relief not be granted against an ex-employee who misappropriated trade secrets leading to loss of client relationships or goodwill. Proof of irreparable harm if injunctive relief is not granted may move the court to enforce a restrictive covenant. The court in Chertoff Diamond & Co. v. Fitzmaurice, 234 A.D.2d 200, 203 (N.Y. App. 1st Dep’t 1996) held that “it clearly shows that plaintiff would suffer irreparable harm should its clients terminate their relationships with it to use defendants’ services and in Alside Div. of Associated Materials Inc. v. Leclair, 295 A.D.2d 873, 874 (N.Y. App. 3d Dept 2002) the court held that if defendants are permitted to compete unfairly by using plaintiff’s confidential and proprietary pricing information to underbid it, plaintiff will not only lose business but will also suffer a dilution of the goodwill it has developed with its customers. Such a loss of customer goodwill can constitute irreparable harm for preliminary injunction purposes.
- Permissible durations: what is the reasonable allowed period for such restriction perhaps; 3-5 years sale of a business or work for hire if it involved the disclosure of trade secrets and o-1 year in an employment relationship.
The US trade secret law
Before now, the US Trade secret laws had been handled by the individual states in the United States until 1979 when a Uniform Trade Secrets Act (UTSA) was proposed to the states and it was widely adopted except with varying provisions that made national implementation fairly complex. In 1996, the federal government enacted the law limiting its scope to criminal remedies. By 2016 the US Congress had enacted the Defend Trade Secrets Act (DTSA), and a harmonized rule. This Act allows trade secret holders the option to bring civil claims on trade secret matters before the federal court.
In the US, trade secrets are classified under IP law and one year preceding the enactment of the (DTSA), the number of trade secret actions increased to 1,134 from an average of about 900 per annum between 2009-2016.2 Here are some of the ways the enactment of the DTSA impacted trade secret litigation in the US.
Benefits of the DTSA
- Access To Federal Court: The DTSA brought an increase in the number of trade secret cases filed in the federal court but with a prerequisite. It requires that the alleged trade secrets should be “related to a product or service that is used in or is intended for use in interstate or foreign commerce. This requirement though easily complied with, the courts have had to dismiss DTSA claims where the complainant failed to aver a nexus between the alleged trade secrets and interstate or foreign commerce.
- Covers Continuity in Misappropriation: While the DTSA like any other law is not retrospective in nature and , therefore, does not apply to acts of misappropriation that occurred before its enactment in May 2016. It however, does apply to misappropriations that began before the DTSA’s enactment but that continued to occur (through wrongful use or disclosure) after the enactment date. Thus, the DTSA covers cases of “continuing misappropriation in contrast with the UTSA, which does not entail such provisions.”
- Pleading a DTSA Claim: Pleading a claim under the DTSA and UTSA are similar except with two variations; a claim under the DTSA should allege a nexus between the alleged trade secrets and interstate or foreign trade and; pleading damages in a claim under the DTSA is not necessary.
Remedies available under the DTSA
There is both equitable and monetary relief under the DTSA like the UTSA, it provides for an injunction to avert actual or threatened misappropriation of trade secrets. As it stands, there is little judicial precedent to analyze damages under the DTSA. However in Steves and Sons, Inc. v. JELD–WEN we see an extended and thoughtful discussion of damages under the DTSA and UTSA. Some damages that the court may award:
- Actual losses: the plaintiff’s lost profits from the misappropriation.
- Unjust enrichment: a plaintiff may also recover the amount of unjust enrichment received by the defendant, but only to the extent it is not duplicative of its actual losses.
- Reasonable royalty: as an alternative to damages based on actual losses or unjust enrichment, the plaintiff may be awarded a reasonable royalty for the unauthorized disclosure or use of the trade secret. This is not the preferred remedy based on legislative intent. A better approach would be to immediately halt the misappropriator’s use and dissemination of the misappropriated trade secret and, make available appropriate damages7
- Courts may double damages and award attorneys’ fees in the event of willful and malicious appropriation of trade secrets.
- Employers can also sometimes pursue damages from a former employee’s new employer for interference with the departing employee’s restrictive covenants.
Protecting trade secrets from unlawful disclosure- lessons from Coca-Cola
- Employer-Employee Relationship: it is needless to say that employees are the biggest source of trade secret loss, therefore;
- The employer should endeavour to share trade secrets or confidential information minimally and only with staff who necessarily need to know.
- The employees’ welfare and bonus packages should be taken seriously, as it increases trust and gives the employee a sense of ownership in the business.
- All other ideas and inventions that are not necessarily protectable by trade secrets should be protected through other intellectual property regimes.
- Every employee should be made to sign restrictive agreements such as a non-disclosure agreement, a non-compete and a non-solicit agreement at the point of entry. This remains valuable even after the employment relationships terminate.
- The employee’s contract should contain terms and penalties for breach, misuse or disclosures of confidential information outside the scope of their employment and;
- Employees should be constantly trained and reminded of the importance and benefits of trade secrets to the business and their welfare.
2. Business Partners/Customers:
- Businesses should include restrictive covenants or agreements such as non-disclosure agreements, non compete and non-solicit agreements in their dealings internally and externally.
- Businesses should ensure that all transactions and dealings with customers and partners are recorded and safeguarded through; physical security as well as well-drafted and executed contracts.
- The sharing ratio of rights over IPs that are developed from such business relationships should be spelt out, agreed upon, documented and protected accordingly.
- Businesses should engage the services of IP professionals/lawyers for proper guidance in contract drafting, the perusal of legal documents, negotiation of contracts, protection mechanisms, and for a hitch-free enforcement process etc.
While it is needful to include restrictive nuances for the protection of trade secrets, the attitude of the US courts presupposes that an employer who wants to benefit from the restriction imposed on an employee must be willing to show consideration for the same. Whereby proving; the continued employment of an employee at will, offering an employee a bonus or a severance package or by tying the receipt of a current employee’s annual bonus or increment to the covenant. It is therefore suggested that while drafting an employment contract, it is not sufficient to embed restrictive covenants, it is more important to tie restrictive covenants in equity option, grant, or an award of deferred compensation which would be forfeited or the amount if already paid is clawed once a breach is traced to the beneficiary-employee. This administrative approach provides employers with an option for a less expensive but cognitive measure for the enforcement of trade secrets because court injunctions can be unpredictable and expensive.
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