Category: Trade Secret Litigation

Texas Supreme Court Raises the Bar for Trade Secrets Damages–Again

Texas Supreme Court Raises the Bar for Trade Secrets Damages–Again

Horizon v. Acadia finds expert’s assumptions too speculative to support lost profits verdict

Mamas, don’t let your babies grow up to be damages experts in Texas.

That’s the refrain CPAs may feel like singing after the Texas Supreme Court recently raised the bar for proving lost profits damages in trade secrets lawsuits—again.

It started in 2016 with Southwest Energy v. Berry-Helfand, where the damages expert calculated lost profits for misappropriation of oilfield trade secrets by assuming a flat reasonable royalty rate of 3%, which was consistent with industry standards. As I reported here, the Texas Supreme Court said this opinion was faulty because the information available to the expert would have allowed for a more precise calculation.[1]

More recently, the Texas Supreme Court addressed trade secrets damages again in Horizon Healthcare v. Acadia Healthcare. The court rejected the expert’s calculation of lost profits damages because it was based on assumptions about causation and profitability of contracts that were not supported by the evidence.[2]

Horizon had somewhat complicated facts, but in essence it was a typical departing employee case where a management group left a company to work for a competitor:

  • Horizon provided contract management services to healthcare providers
  • Four Horizon executives, the “Saul group,” signed non-competes with Horizon.
  • The Saul group began negotiating to join Acadia, a Horizon competitor.
  • The Saul group solicited Piechocki, a successful Horizon salesman, to join them in moving to Acadia.
  • Shortly before leaving, Saul secretly copied a “massive amount” of Horizon documents to an external hard drive.
  • The copied documents included contracts, financial models, and lists of Horizon’s sales leads.
  • After leaving Horizon to join Acadia, the former Horizon employees began competing with Acadia and soliciting Acadia’s clients.

If you think these facts are bad, you should read some of the emails recounted in the Court of Appeals opinion. But bad facts don’t necessarily make a good damage model.

The facts concerning damages were a mixed bag. Here is what Horizon’s damages expert had to work with:

  • After leaving Horizon, Piechocki used Horizon’s financial models to win a contract from Westlake.
  • Westlake was on Horizon’s “lead list” but was not a Horizon client.
  • Horizon did not lose any existing clients to Acadia.
  • Piechocki was an at-will employee without a non-compete who could have left Horizon at any time.
  • Piechocki was Horizon’s best salesperson.

So, if you represent Horizon, how do you work with your expert to construct a defensible damages theory?

Keep in mind that Texas law does not require lost profits damages to be “susceptible of exact calculation.” Lost profits must be calculated with “reasonable certainty.”[3]

As I explained here when I reported on the oral argument in Horizon, calculating lost profits damages requires entering a hypothetical world. The question is how much profit the plaintiff would have earned if the defendant had not used the plaintiff’s trade secrets, breached the non-compete, etc. This necessarily requires making assumptions.

Assumptions made in Horizon v. Acadia – the Westlake contract

Take the Horizon case as an example. To calculate lost profits based on the Westlake contract, Horizon’s expert assumed that Westlake would have signed a similar contract with Horizon if it had not signed the contract with Acadia. Based on that assumption, the expert calculated lost profits of $898,000 on the Westlake contract, and the jury included that amount in its verdict.[4]

Was it a mistake for the expert to assume Horizon would have won the Westlake contract? Not necessarily. To prove causation, Horizon had to show it would have obtained the contract but for the defendants’ wrongful conduct. It was an essential assumption.

But was it a reasonable assumption? The challenge for the plaintiff’s lawyer is that there must be evidence to support the assumption. The strategic question is how to support the assumption: with expert opinion or with some other evidence?

Often it will be better to prove the assumption with other evidence. Financial experts are good at crunching numbers, so it’s pretty easy for them to calculate the amount of profits that would have been made on a contract. But whether the plaintiff would have gotten a contract is another story. On that issue, a CPA doesn’t necessarily have any special insight that an ordinary jury member doesn’t have.

The problem for Horizon was not so much that the expert made the assumption, but that there was insufficient evidence to support the assumption. The Texas Supreme Court said it was “pure speculation” to assume Horizon would have won the Westlake contract if the defendants had not. This was especially true given the fact that there was no evidence that Horizon would have included a specific $150,000 incentive that Acadia included in its bid. Thus, “Horizon failed to establish the fact of damages relating to the Westlake contract with reasonable certainty.”[5]

Assumptions made in Horizon v. Acadia – Piechocki’s future contracts

The Westlake contract was not the only one lost. Horizon’s loss of Piechocki, its top salesperson, also caused Horizon to lose the future contracts Piechocki would have obtained if he had stayed at Horizon.

To quantify the lost profits for these hypothetical contracts, Horizon’s expert had to make assumptions about three issues:

(1) how long Piechocki would have stayed at Horizon

(2) how many contracts Piechocki would have generated at Horizon

(3) the amount of profits Horizon would have made on those contracts

Based on ten years of Horizon’s retention data for employees in Piechocki’s position, the expert provided two alternatives: Piechocki would have stayed either two years or four years. This was only an assumption, because Piechocki was an at-will employee not bound by a non-compete or any employment agreement. The court found there was some evidence to support this assumption, including testimony by Piechocki himself that suggested he would have stayed at Horizon if not solicited to work for Acadia.

There was also some evidence to support the assumption that the loss of Piechocki caused Horizon to lose future sales. This included an email from one of the defendants saying “I cannot think of a bigger body blow relative to impacting future new sales for Horizon than to get Piechocki out of there.”

But the Texas Supreme Court said there was no evidence to support the third assumption: the profitability of contracts Piechocki sold or would have sold had he remained at Horizon. In the court’s view, the specific problem with the expert’s calculation of lost profits was that it was based on the historical profitability of Horizon contracts generally, rather than the historical profitability of Piechocki’s Horizon contracts. The court held that the absence of evidence showing the profit associated with Piechocki’s sales was “fatal” to Horizon’s lost profits claim.[6]

A trend of nit-picking expert calculations of lost profits damages

I see the logic in the Horizon court’s criticism of the expert’s third assumption, but isn’t this getting a little nit-picky? The evidence of Horizon’s contract profitability generally seems like at least a scintilla of evidence of the profit Horizon would have made on Piechocki’s contracts. Remember that all it takes to uphold a jury verdict on appeal is some evidence (in theory).

But at least the Texas Supreme Court has been consistently nit-picky about lost profits damage theories lately. As mentioned earlier, the court did the same thing in Southwest Energy v. Berry-Helfand, finding that the reasonable royalty rate assumed by the expert was not precise enough.

So what practice pointers can prudent practitioners pry from this pair of persnickety opinions? First, if you represent the plaintiff in a lost profits case and you hire a damages expert, you need to work closely with the expert to identify the key assumptions underlying the expert’s calculations, and to evaluate whether the evidence will support those assumptions. If you don’t have the evidence, find another theory.

Second, the at-will status of departing employees is not necessarily fatal to proving causation. Yes, the Texas Supreme Court ultimately found there was insufficient evidence to support Horizon’s damage theory, but its opinion makes clear that an expert can make a reasonable assumption about how long an at-will employee would have stayed at the company, provided there is evidence to support the assumption.

That brings us to the third tip: Whatever assumptions the damages expert is going to make, the plaintiff’s lawyer must be prepared to offer evidence to support those assumptions.

Easy, right?

__________________________________________________________________

head-shot-photo-of-zach-wolfeZach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands. He correctly predicted that the Texas Supreme Court would not like the lost profits award in Horizon. 

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] Sw. Energy Prod. Co. v. Berry-Helfand, 491 S.W.3d 699, 720 (Tex. 2016).

[2] Horizon Healthcare Co. v. Acadia Healthcare Co., __ S.W.3d __, 2017 WL 2323106, at *5-8 (Tex. May 26, 2017).

[3] Id. at *4 (citing ERI Consulting Eng’rs, Inc. v. Swinnea, 318 S.W.3d 867, 876 (Tex. 2010)).

[4] Id. at *5.

[5] Id. at *6.

[6] Id. at *6-8.

A SLAPP in the Face to Texas Trade Secrets Lawsuits, or Much Ado About Nothing?

A SLAPP in the Face to Texas Trade Secrets Lawsuits, or Much Ado About Nothing?

Part 3 of 3 in my series

Fivers, you may be wondering why I have not yet reported on the Texas legislature’s recent amendments of the Texas Uniform Trade Secrets Act. I like trade secrets law. I like litigation. And I like making fun of whatever the Texas legislature does. So what gives?

Well, three things. First, you can already find other good reports on this topic, like Leiza Dolghih’s blog post here. Second, the recent changes to the Texas trade secrets statute, while important, are not that big of a deal. And third, I predict that recent court decisions applying the Texas Citizens Participation Act (TCPA) are going to be a bigger deal for Texas trade secrets litigation.

That’s because filing a motion to dismiss under the TCPA is likely to become a routine move by defendants in Texas trade secrets lawsuits.

Texas courts have held that the TCPA applies to claims based on disclosure of alleged trade secrets

So how did we get here? To recap Part 1 and Part 2:

  • The TCPA is the Texas “anti-SLAPP” statute intended to protect the “little guy” from nuisance litigation filed in retaliation for exercising free speech rights.
  • The TCPA allows the defendant to file a motion to dismiss that stays discovery and requires the plaintiff to offer evidence proving each element of its claims.
  • The purpose of the statute is to protect constitutional rights, but the Texas Supreme Court has instructed Texas courts to apply the “plain meaning” of the text, which is much broader.
  • In Elite Auto Body, the Austin Court of Appeals followed the Texas Supreme Court’s instructions and held that the TCPA applied to a company’s claim that its former employees communicated the company’s confidential information and trade secrets to a competitor.[1]

In Part 1, I explained how this issue provides a sort of case study for the “textualist” theory of statutory interpretation, which has received some airplay recently with Neal Gorsuch filling the Merrick Garland seat on the Supreme Court. In Part 2, I hypothesized that the holding in Elite Auto Body is inconsistent with the legislature’s intent and suggested that this illustrates a problem with strict textualism.

But if you’re a lawyer or a party in a trade secrets lawsuit, you don’t care about all that. You want to know what Elite Auto Body means for your lawsuit.

Will it become routine for defendants in Texas trade secrets lawsuits to file motions to dismiss under the TCPA?

It seems likely that defendants in trade secrets lawsuits will now routinely file motions to dismiss under the TCPA. First, because Elite Auto Body says they can. Second, because it will usually be good strategy.

The crux of the Elite Auto Body decision was the statute’s broad definition of the “exercise of the right of association” as “a communication between individuals who join together to collectively express, promote, pursue, or defend common interests.”[2]

The court found that the plaintiff alleged two kinds of communications falling under the statute’s broad definitions: (1) communications between the departing employees and the second employer disclosing confidential information or trade secrets; and (2) communications with employees of the first employer to induce them to work for the second employer.[3]

So, in any case where the plaintiff alleges either (1) communication of the plaintiff’s trade secrets or (2) solicitation of the plaintiff’s employees, the defendants have the option to file a motion to dismiss under Elite Auto Body. I will even provide this Form Motion to Dismiss you can use if you want.[4]

Filing a motion to dismiss will often have benefits for the defendant:

  • The motion will take the wind out of the plaintiff’s sails by immediately staying discovery until the court rules on the motion.[5]
  • It requires the plaintiff to respond with evidence of each element of its claims.[6] This will force the plaintiff to put its “cards on the table” early in the case.
  • In some cases, it will be difficult for the plaintiff to meet its burden before it has had any meaningful discovery.

Of course, there are potential disadvantages to filing a motion to dismiss. Despite the Texas Supreme Court’s instruction to apply the plain meaning of the statute, some trial court judges will still be reluctant to dismiss trade secrets claims that do not implicate constitutional free speech rights. Fighting over the motion to dismiss will often be expensive, and if the judge denies the motion, it will tend to embolden the plaintiff, which could make settlement more difficult. Worst case, if the judge finds that the defendant’s motion was frivolous or solely intended to delay, the court can award attorneys’ fees to the plaintiff.[7]

Despite these concerns, in most cases filing an early motion to dismiss under the TCPA will be good strategy for defendants, if the plaintiff alleges “communication” of the alleged trade secrets.

But that’s a big “if.”

Will it become routine for plaintiffs to plead around the TCPA?

If it becomes routine for defendants to file a motion to dismiss in Texas trade secrets lawsuits, plaintiffs will catch on.

And Elite Auto Body suggests a solution for them. As I pointed out in Part 2, the court in Elite Auto Body said that the TCPA does not apply to allegations of using the alleged trade secrets, as opposed to communication of the trade secrets. That’s why the Austin Court of Appeals only dismissed the plaintiff’s claims in part. It did not dismiss the claims based on conduct that does not constitute “communications” as defined by the TCPA.[8]

So, as Patrick Keating suggested on his trade secrets blog here, it may become routine for plaintiffs to avoid a motion to dismiss by pleading only use of the alleged trade secrets rather than disclosure of the alleged trade secrets. (Here is a Form Original Petition that does just that.) If that happens, then case law applying the TCPA to trade secrets claims may become, as Keating says, “much ado about nothing.”

But I’m not sure this maneuver will become totally routine. First, the plaintiff doesn’t always have a basis to claim use of the trade secrets. Second, the disclosure of the trade secrets is sometimes just too good a part of the story to leave out.

In many cases, the employer will discover that an employee has taken company information and joined a competitor, but the employer will not have any direct knowledge that the employee has used the information. And it is not unusual for employees to take company information when they leave but to refrain from using it after coming to their senses (or talking to a lawyer).

In cases like that, it may be dangerous for the employer to plead that the employee has used the alleged trade secrets. The plaintiff must have a good-faith factual basis for the allegation. Look for more plaintiffs to plead “on information and belief” that the defendant has used the alleged trade secrets.

In other cases, the plaintiff will really want to plead disclosure of the trade secrets, because that will be the juiciest part of the story. When an employee secretly emails confidential company information to his next employer, who can resist emphasizing that fact in the lawsuit? In those situations, the plaintiff’s lawyer will have to weigh the value of pleading bad acts by the defendants against the possibility of inviting a motion to dismiss.

Or just make a federal case of it

On the other hand, the plaintiff’s lawyer can simply avoid this dilemma by filing suit in federal court under the federal Defend Trade Secrets Act. All you need is a sufficient connection to interstate or foreign commerce, and any claim you would make under the Texas trade secrets statute can be made under the federal statute. And then the TCPA would not apply.

Or would it? I will let the appellate lawyers and former law review editors discuss among themselves.

____________________________________________________________

head-shot-photo-of-zach-wolfeZach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands. 

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. The provided forms are only for the convenience of other lawyers. Every case is different, so don’t rely on this post or the forms as legal advice for your case. 

[1] Elite Auto Body LLC v. Autocraft Bodywerks, Inc., No. 03-15-00064-CV, 2017 WL 1833495 (Tex. App.—Austin May 5, 2017, no pet. h.).

[2] Tex. Civ. Prac. & Rem. Code § 27.001(2).

[3] Elite Auto Body, 2017 WL 1833495 at *8.

[4] See my disclaimer about forms above.

[5] Tex. Civ. Prac. & Rem. Code § 27.003(c). Under Section 27.006(b), for good cause the court may allow “specified and limited discovery” relevant to the motion.

[6] See Tex. Civ. Prac. & Rem. Code § 27.005(c).

[7] Tex. Civ. Prac. & Rem. Code § 27.009.

[8] Elite Auto Body, 2017 WL 1833495 at *9.

A SLAPP in the Face to Texas Trade Secrets Lawsuits – Part 2

A SLAPP in the Face to Texas Trade Secrets Lawsuits – Part 2

Even before I went to law school, one of my favorite Shakespeare plays was The Merchant of Venice, and now that I’m a trial lawyer I like it even more. The climactic scene is basically a courtroom drama. More about that later.

In my last post, I set the stage for Elite Auto Body v. Autocraft Bodywerks, a recent case holding that the Texas anti-SLAPP statute allows a defendant in a trade secrets lawsuit to file an early motion to dismiss before the plaintiff has any real chance to take discovery.

To recap Part 1:

  • Despite its literal language, the First Amendment’s protection of “freedom of speech” generally does not apply to communication of trade secrets.
  • The Texas Citizens Participation Act (TCPA) is an “anti-SLAPP” statute intended to protect free speech rights.
  • The problem with the statute is that its literal text goes far beyond speech protected by the First Amendment.
  • Elite Auto Body is therefore an interesting test case for the “textualist” approach to interpreting statutes.

So how did the court interpret the statute, and what does it mean for trade secrets litigation?

A typical trade secrets lawsuit

For a case raising important First Amendment and statutory interpretation issues, the facts of Elite Auto Body were about as ordinary as you can get.

Autocraft Bodywerks was an auto-repair shop specializing in high-end collision repair services. Precision Auto Body was a competing auto-repair business founded by a former Autocraft employee. When two Autocraft employees left to join Precision, Autocraft sued, claiming the employees provided Autocraft’s confidential information and trade secrets to Precision.[1]

The alleged trade secrets were typical internal company information: salary and personnel information, financial information, proprietary compilations of technical information, and proprietary client forms. Like every company that files this kind of trade secrets suit, Autocraft claimed that Precision and the former employees used the information to obtain an unfair advantage.[2]

The usual defense would be to challenge the trade-secret status of the information, and/or to claim the defendants did not take or use the information. But Precision asserted an additional defense: it filed a motion to dismiss under the TCPA.

So does the statute apply to an ordinary trade secrets misappropriation case?

The plain language of the TCPA applies to disclosure of trade secrets

The language of the statute is quite simple about when it applies: “If a legal action is based on, relates to, or is in response to a party’s exercise of the right of free speech, right to petition, or right of association, that party may file a motion to dismiss the legal action.”[3]

If that was all the statute said, you could easily argue that these “rights” mean constitutional rights. But the statute has more expansive definitions:

  • “Exercise of the right of association” means “a communication between individuals who join together to collectively express, promote, pursue, or defend common interests.”
  • “Exercise of the right of free speech” means a “communication made in connection with a matter of public concern.”
  • “Communication” includes “the making or submitting of a statement or document in any form or medium, including oral, visual, written, audiovisual, or electronic.”
  • “Matter of public concern” is defined broadly and includes an issue related to “a good, product, or service in the marketplace.”[4]

Under the broad definition of “right of association,” when employees of one company go to work for a competitor and communicate the first company’s confidential information to the competitor, that is a “communication between individuals” who are joining together to “pursue common interests,” i.e. making money by competing with the first company.

This was the defendants’ argument in Elite Auto Body, and the Austin Court of Appeals agreed. The court reasoned that the statute would not apply to allegations of using the alleged trade secrets that did not involve communication of the information. But the plain language of the statute would clearly apply to the alleged disclosure of the trade secrets:

Yet it would also be true, at least under a literal reading of the “communication” definition, that Autocraft also bases each of its claims, at least in part, on two types of alleged “communications”—(1) appellants’ “communications” (so defined) among themselves and others within the Precision enterprise through which they have allegedly shared or utilized the information that Autocraft claims is its trade secrets or confidential information; or (2) “communications” (so defined) by appellants to current Autocraft employees to induce them to leave Autocraft and come work for Precision.[5]

So what do you do if you’re Autocraft, the plaintiff in Elite Auto Body, and you want to avoid the motion to dismiss? You argue against a literal reading of the statute. The court should interpret the statute based on its larger context and purpose, you argue, which is to protect constitutional rights and provide a remedy for “SLAPP” lawsuits.

But how do we know the purpose of the statute?

The purpose of the TCPA is to protect constitutional rights

In this case, the legislature made it easy for us by expressly stating the purpose of the statute:

The purpose of this chapter is to encourage and safeguard the constitutional rights of persons to petition, speak freely, associate freely, and otherwise participate in government to the maximum extent permitted by law and, at the same time, protect the rights of a person to file meritorious lawsuits for demonstrable injury.[6] (emphasis added)

The statute also says it “shall be construed liberally to effectuate its purpose and intent fully.”[7]

This gives you Autocraft’s argument: the statute has a First Amendment “overlay.” Despite the broad definitions of “right and association” and “right of free speech,” you should limit the statute to its stated purpose of protecting constitutional rights. There’s no constitutional right to communicate trade secrets, so the statute shouldn’t apply to trade secrets lawsuits.

This is a plausible argument, the Austin Court of Appeals said, but it is foreclosed by the Texas Supreme Court’s recent decision in ExxonMobil Pipeline Co. v. Coleman.

Coleman held that the TCPA applied to a former employee’s defamation claim based on internal company statements about his job performance. The Coleman court based this holding on a textbook formulation of textualism. “We do not substitute the words of a statute in order to give effect to what we believe a statute should say,” the court said, but “instead, absent an ambiguity, we look to the statute’s plain language to give effect to the Legislature’s intent as expressed through the statutory text.”[8]

Let me pause here to note that the TCPA itself seems to instruct courts not to construe it this way; the statute says it should be liberally construed to effectuate its purpose. Oh well.

Citing this language, Elite Auto Body construed Coleman as an instruction that Texas courts must adhere to a “plain-meaning” construction of the statute, “notwithstanding an acknowledged expansiveness and breadth.”[9]

Reading between the lines, Justice Pemberton’s opinion in Elite Auto Body seems to be saying “we know this result is kind of crazy, but that’s what the statute says, and the Texas Supreme Court says we have to apply the statute literally, so our hands our tied.”

That’s a reasonable position, but is this really the result the legislature would have wanted?

Elite Auto Body shows us the problem with strict textualism

I haven’t researched the legislative history of the Anti-SLAPP Statute. But I think it is safe to say that the legislature did not intend the statute to apply to ordinary claims for misappropriation of trade secrets.

Let’s assume I’m right, and (1) the literal terms of the statute apply to trade secrets lawsuits, but (2) the legislature did not intend the statute to apply to trade secrets lawsuits, because there is no constitutional right to disclose trade secrets.

So what is a judge to do? Apply the “plain meaning” of the text even though it leads to a result the legislature didn’t intend?

This is where the true textualist must bite the bullet. Yes, the strict textualist would say, you apply the plain meaning of the statute, even if the result is bad public policy or not what the legislature intended. You do that because the plain meaning of the text is objective, while the subjective intent of the legislature is too easy for litigants and judges to manipulate to serve their own agendas. Focusing on “purpose” rather than the text would allow courts to substitute their own policy judgments for the decisions of the legislature.

There is some merit to this line of argument, but on the whole I think it is wrong, and the odd result in Elite Auto Body illustrates why.

The problem with this kind of strict textualism is that it thwarts the intent of the legislature in the name of deference to the legislature.[10]

In practice, strict textualism tends to undermine the legislature’s purpose—and can lead to absurd results. When courts strictly apply the “plain meaning” of a statute, in conflict with its obvious purpose, they are effectively saying to the legislature, “we know what you were trying to do, but you screwed up in the language you used, and we’re going to hold you to your sloppy language.” Hey, if you don’t like it, amend the statute.

Shakespeare’s view of anti-SLAPP statutes

This kind of textualism reminds me of the final “courtroom” scene in Shakespeare’s Merchant of Venice, where Portia, posing as a man and a legal scholar, thwarts Shylock’s purpose by strictly construing his contractual right to a “pound of flesh.” The audience, typically, is rooting for Portia because she is trying to save Antonio from the horrific results of an unjust contract. But there is no denying that she effectively deprives Shylock of the remedy intended by the parties to the contract.

Texas courts are doing something similar with the TCPA when they say we’re going to hold you to your incredibly broad definitions, even when they conflict with your obvious purpose.

As in The Merchant of Venice, this may lead to a just result in some cases. Instinct tells me the information at issue in Elite Auto Body probably did not deserve trade-secret protection, so maybe early dismissal of part of the trade secrets claim was a good thing. But as a broader matter of public policy, applying the TCPA to trade secrets lawsuits that do not involve any constitutional rights seems like a mistake.

Ok, you say. That’s all very interesting, Mr. Smarty Pants. But what if I’m a litigator who sometimes handles non-compete and trade secret cases? What are the practical consequences?

I’ll cover that in Part 3.

______________________________________________________________________________________

head-shot-photo-of-zach-wolfeZach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands. 

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] Elite Auto Body LLC v. Autocraft Bodywerks, Inc., No. 03-15-00064-CV, 2017 WL 1833495, at *1 (Tex. App.—Austin May 5, 2017, no pet. h.).

[2] Id.

[3] Tex. Civ. Prac. & Rem. Code § 27.003.

[4] Tex. Civ. Prac. & Rem. Code § 27.001.

[5] Elite Auto Body, 2017 WL 1833495 at *4.

[6] Tex. Civ. Prac. & Rem. Code § 27.002.

[7] Tex. Civ. Prac. & Rem. Code § 27.011.

[8] ExxonMobil Pipeline Co. v. Coleman, 512 S.W.3d 895, 901 (Tex. 2017). The qualification “absent an ambiguity” further complicates the issue, but I don’t have time to address that here.

[9] Elite Auto Body, 2017 WL 1833495 at *7.

[10] Personally, I have little confidence in the Texas legislature doing anything right, especially when it meddles with the civil justice system, but as a general proposition I agree that courts should interpret statutes to effectuate the legislature’s purpose.

A SLAPP in the Face to Texas Trade Secrets Lawsuits – Part 1

A SLAPP in the Face to Texas Trade Secrets Lawsuits – Part 1

In Elite Auto Body v. Autocraft Bodywerks, the Austin Court of Appeals held that the Texas anti-SLAPP statute applies to a company’s claim that a former employee communicated confidential information and trade secrets to a competitor. This meant that the company was required to produce evidence to support every element of the claim at the beginning of the lawsuit—a significant burden.

This sounds like a fairly technical issue, but it’s an important development, with potentially far-reaching consequences for departing employee litigation—and other kinds of litigation. Elite Auto Body is also a great case to read if you’re fascinated by questions of statutory interpretation. And who isn’t?

Textualism vs. originalism

Interpreting the text of a statute or constitution is a fundamental challenge in the law.  The “textualist” would say that courts should apply the “plain meaning” of the text of a statute, without resort to any extrinsic sources such as the intent of the legislature or what would make better public policy.

This view probably resonates with the average “man on the street,” but in its strict form, textualism borders on the absurd.  If hard cases could really be decided by simply applying the plain text, we wouldn’t need judges schooled in the law.

Textualism is often associated with “originalism,” which is the view that a statutory or constitutional provision should be interpreted based on the original understanding of the text. But the two are not the same. In fact, originalism shows that textualism is insufficient (at least in hard cases). If the text alone were sufficient to resolve disputes, then resort to the original understanding of the text would be unnecessary.

Trade secret protection vs. freedom of speech

Let’s take an example everyone knows: the First Amendment protection of “freedom of speech.” Then let’s take a statute pertinent to the Elite Auto Body case: the Texas Uniform Trade Secrets Act (TUTSA). TUTSA provides civil remedies for “misappropriation” of “trade secrets.”[1]  Emailing your employer’s trade secrets to a competitor would be a clear violation of TUTSA.

So does TUTSA violate the First Amendment? If I can’t email my employer’s confidential information to another company, doesn’t that restrict my “freedom of speech”?

The “vulgar textualist” would say no, under the plain meaning of the First Amendment, sending an email is not “speech,” so the First Amendment doesn’t apply. But no serious person in the law, even a “textualist,” would apply such a hyper-literal interpretation. Obviously, the First Amendment is intended to protect forms of communication broader than actual “speech.”

And it is well established that there are certain categories of communication that do not enjoy full First Amendment protection: fraudulent statements, intentionally defamatory statements, communications between participants in a criminal conspiracy, just to name a few. People may disagree on the exact contours of the categories of expression that do not enjoy First Amendment protection, but no one seriously questions the basic premise that some kinds of communication are not protected (even though the premise is not derived from the “plain meaning” of the text).

Similarly, just about everyone would agree that communication of trade secrets is one of these categories. People may argue about where to draw the line on trade secret protection, but few would seriously dispute the general principle that the First Amendment allows laws that prohibit the communication of trade secrets.

With this point established, we have set the stage for the Texas anti-SLAPP statute, the recent Elite Auto Body case, and an interesting test for textualism.

The Texas anti-SLAPP statute

Texas adopted its anti-SLAPP statute in 2011. SLAPP stands for Strategic Lawsuit Against Public Participation. The term SLAPP doesn’t actually appear in the statute, but the “anti-SLAPP” purpose of the statute is widely recognized. (For background, see A Primer on the Texas Anti-SLAPP Statute and Five Years of Anti-SLAPP in Texas.)

The idea was to give defendants the right to seek early dismissal of unfounded lawsuits that plaintiffs file to punish Texas citizens for exercising their free speech rights. When the statute applies, the defendant can require the plaintiff to produce evidence to support each element of its claims at the beginning of the lawsuit. If the plaintiff fails to meet this burden, the lawsuit gets dismissed.[2]

This is a big deal. As Texas litigators will recognize, a SLAPP motion is equivalent to a “no-evidence” motion for summary judgment. The Texas Rules of Civil Procedure allow a defendant to file a no-evidence motion for summary judgment, which places the burden on the plaintiff to come forward with evidence to support the challenged elements of its claims. If the plaintiff fails to respond with evidence, the claim gets dismissed.

That’s effectively the same thing the anti-SLAPP statute does. So why is it such a big deal? The key difference is that you can’t file a no-evidence motion for summary judgment until after the plaintiff has had adequate time for discovery.[3] This is a significant limitation.

The anti-SLAPP statute, in contrast, allows the defendant to file a motion to dismiss at the beginning of the case, before the plaintiff has had any time for discovery.[4] This is a major strategic advantage for the defendant. Often the plaintiff needs discovery in order to obtain evidence to support all of the elements of its claims. If the legislature gave defendants the right to file this kind of motion in every case, it would be a tectonic shift in the balance of power between Texas plaintiffs and defendants.

But the anti-SLAPP statute only applies to SLAPP lawsuits, right?

The problem with the anti-SLAPP statute

The problem is that it is not so easy to distinguish between a SLAPP lawsuit and an ordinary lawsuit. A SLAPP, as the term is commonly used, has two distinguishing characteristics, one going to the merits of the lawsuit and the other going to the motive behind it. First, a SLAPP lawsuit has no merit, meaning no evidence to back it up. Second, a SLAPP lawsuit is filed for an improper motive—i.e. to silence or punish the defendant by forcing the defendant to spend money defending a lawsuit.

But defendants say these things about all kinds of lawsuits. So the first problem with the anti-SLAPP statute is that it singles out one type of litigation, when the problem it purports to address applies to all kinds of litigation.

In my view, this sort of thing is generally a bad idea. I haven’t seen a compelling explanation for why defendants in SLAPP lawsuits should get to file an early motion to dismiss while defendants in other kinds of unfounded lawsuits don’t.

Of course, there is a long tradition of the Texas legislature singling out certain types of litigation for special treatment. For example, plaintiffs in medical malpractice cases have to get an expert report just to file a lawsuit, before any discovery, while plaintiffs in other cases don’t. Defendants in residential construction lawsuits have special statutory rights that defendants in other lawsuits don’t. But why? Why should special rules apply to medical malpractice lawsuits and not, say, architectural malpractice suits?

The answer is pretty obvious. You don’t have to be a political scientist or a reporter covering the Texas legislature to understand that laws like this get passed in response to pressure from interest groups seeking protection from lawsuits. That doesn’t necessarily mean that these laws are bad public policy. We could debate all day whether the limits on medical malpractice suits are good policy or not.

But it does mean that we should approach these special-interest statutes with some skepticism. The same is true of the anti-SLAPP statute. Granted, it appears that a wide range of groups from across the political spectrum backed it, but we should still ask whether it makes sense to single out one type of lawsuit for special treatment.

While it is clear that the anti-SLAPP statute singles out one type of lawsuit, it is not so clear what type of lawsuit that is. This gets to the second problem with the statute: it tries to do surgery with a meat cleaver. The “cancer” it tries to cut out is the “big guy” filing a frivolous lawsuit against the “little guy” to try to deter the little guy from exercising his First Amendment right to criticize the big guy.

The statute does say that its purpose is to safeguard constitutional rights, but the operative language of the statute–particularly the definition of the “right of association”–is much broader than that. Nothing in the statute expressly limits its reach to “big guy vs. little guy” lawsuits, or even to lawsuits involving the exercise of First Amendment rights.

Perhaps the language of the statute could be made more precise so that it cuts like a scalpel. But no, this second problem is almost unsolvable. It would be very difficult to come up with language that would apply only to “true” SLAPP lawsuits and not to ordinary lawsuits. Like obscenity, a SLAPP is hard to define with precision. You just “know it when you see it.” That doesn’t make for a good statutory definition.

Does the anti-SLAPP statute apply to trade secrets lawsuits?

And that brings us to the question presented in Elite Auto Body v. Autocraft Bodywerks.

Misappropriation of trade secrets is not protected by the First Amendment, and it does not appear that the Texas legislature had trade secrets lawsuits in mind when it passed the anti-SLAPP statute. Yet the plain language of the statute is broad enough to apply to a claim that an employee communicated a company’s trade secrets to a competitor she has joined. So, can the defendant in that kind of trade secrets case file a motion to dismiss under the statute?

Stay tuned. I’ll address that in Part 2.

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head-shot-photo-of-zach-wolfeZach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands.

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] See Tex. Civ. Prac. & Rem. Code § 134A.002-004.

[2] Tex. Civ. Prac. & Rem. Code §§ 27.001-011.

[3] Tex. R. Civ. Pro. 166a(i).

[4] The defendant must serve the anti-SLAPP motion within 60 days of service of the lawsuit. Tex. Civ. Prac. & Rem. Code § 27.003(b). On the filing of such a motion, all discovery is suspended until the court has ruled on the motion. Tex. Civ. Prac. & Rem. Code § 27.003(c). For good cause, the court can allow specific limited discovery relevant to the motion. Tex. Civ. Prac. & Rem. Code § 27.006(b).

How Low Can You Go? Courts Set Bar for “Reasonable Measures” to Protect Trade Secrets

How Low Can You Go? Courts Set Bar for “Reasonable Measures” to Protect Trade Secrets

This is part four of my four-part series commemorating the one-year anniversary of the Defend Trade Secrets Act. The series culminates tomorrow with a live webcast from the Texas State Bar: “One Year of Defend Trade Secrets Act Litigation.”

What is the minimum it takes to meet the Defend Trade Secrets Act’s “reasonable measures” requirement?

Meet Kenny Ribler. He was a regional sales manager for Protech, a company that sells world-class perimeter security systems for sensitive sites. Protech fired Kenny on February 16. In the early morning hours of the following day, Kenny downloaded files from Protech’s customer-management database to a private drive. Then he emailed the files to his personal email account and deleted the emails from his company account.

Protech claims the downloaded files contain confidential Protech information concerning customers, products customers purchased, and profit margins. The customer information includes:

  • Product preferences
  • Buying patterns
  • Credit profiles
  • Customer invoices and pricing
  • Customer practices
  • Margins and profit variances

In other words, Protech claims that Kenny took the typical sort of customer list information at issue in “soft” trade secrets cases. As I explained here, this has been the most common type of lawsuit in the first year of the Defend Trade Secrets Act.

Protech argues that this information would give a competitor an unfair advantage. A competitor could use the information to undercut Protech’s price quotes, to offer better service, and to divert Protech’s customers.

Time out. Isn’t price competition a good thing? Don’t we want competitors to try to take business away by charging lower prices? Don’t we want competitors to divert business by offering better service? Aren’t these basic foundations of our free-market system?

Hold that thought.

Protech also claims that it took “significant” steps to protect its confidential information, including (1) requiring employees to sign confidentiality agreements, and (2) only enabling its employees to gain access to the data through “password-protected entry points.” I assume this means computer passwords.

Here’s the legal question. In a federal lawsuit under the Defend Trade Secrets Act, are these facts enough for a judge to issue a Temporary Restraining Order barring Kenny from using any of the information he downloaded or soliciting business from any Protech customer?

The judge in Protection Technologies, Inc. v. Ribler thought so. “At this stage,” the judge wrote, “the court is satisfied that the customer data that Ribler allegedly downloaded constitutes a trade secret.” “Moreover,” the judge said, “the court finds that Protech took reasonable measures to keep this information secure by requiring employees to sign confidentiality agreements and limiting access to the data to password-protected entry points.”[1]

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“Reasonable measures” is one bar that must be cleared in trade secrets litigation

Why this last part about “reasonable measures”? It has to do with the definition of “trade secrets” in the Defend Trade Secrets Act (which is roughly the same as the definition in the Uniform Trade Secrets Act). Essentially, you have to prove three things to show that a customer list, or any kind of information, is a trade secret:

  • The information has “independent economic value”
  • The information is not “readily ascertainable” by competitors
  • The company took “reasonable measures” to keep the information secret

The big fight is usually over the first two elements. The “reasonable measures” element gets relatively less attention. Perhaps that is because courts tend to set the bar low for reasonable measures. If it’s enough to show that the company requires confidentiality agreements and has password-protected computers, then most companies are going to be ok.

Can the bar go any lower? What if the company doesn’t require employees to sign confidentiality agreements? In Texas, an employee has a common-law duty of confidentiality anyway, so should the lack of a written agreement make a difference? Is it enough if the company just has a written policy that company information is to be kept confidential?

That remains to be seen. In the meantime, companies that want to protect their trade secrets should be careful not to neglect the “reasonable measures” requirement. It may be a low bar, but it’s still a bar that must be cleared.

Just ask the plaintiff in M.C. Dean v. City of Miami Beach. As I wrote here last August, in that case the federal district court dismissed a Defend Trade Secrets Act lawsuit because the plaintiff failed to plead a plausible case that it made reasonable efforts to maintain the secrecy of the information. The key fact that doomed the trade secrets claim was that the plaintiff sub-contractor signed a contract that expressly stated the information at issue could be used by the City of Miami Beach without restriction.

But in most cases, it won’t be that hard for the plaintiff to plausibly plead and prove “reasonable measures” to keep the information secret.

“Reasonable measures” in price undercutting cases

This means companies that take basic steps to protect the confidentiality of their customer information, including prices, will be able to pursue the “price undercutting” theory seen in Protection Technologies and many other soft trade secrets cases. But as I asked earlier, shouldn’t courts want to promote price competition?

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Price “undercutting” is a common theory in trade secrets cases

Well, yes, of course. We don’t want to discourage competition. On the other hand, we don’t want to allow a competitor to undercut a company’s prices by using the company’s trade secrets. Deciding whether price information is in fact a “trade secret” therefore becomes critical. It is the dividing line between fair and unfair competition.

Here the “reasonable measures” issue becomes important. If a company wants to argue that its prices are trade secrets, it must take reasonable measures to keep the prices confidential.

Wouldn’t this include requiring customers to sign confidentiality agreements barring them from disclosing the company’s prices? If Protech, for example, did not require its customers to keep its prices confidential, did it really take reasonable measures to keep those prices secret?

As in most cases addressing the price undercutting theory, this argument was not addressed in the Protection Technologies opinion. But if you represent the plaintiff in a price undercutting case, you should be ready to address it. Especially after people read my blog.

This is my 50th blog post! I want to thank some special people who helped Five Minute Law get this far: Chief of Proofreading Barbara Hoffman, Graphic Design Guru Rebecca Wolfe, Director of Small Business Mentoring Allan Wolfe, and No. 1 Fan Valerie Figone.

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head-shot-photo-of-zach-wolfeZach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Austin, Houston, and The Woodlands. 

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] Protection Technologies, Inc. v. Ribler, No. 3:17-cv-00144-LRH-WGC, 2017 WL 923912 (D. Nev. Mar. 8, 2017).

Location, Location, Location: It’s Important in Trade Secrets Litigation Too

Location, Location, Location: It’s Important in Trade Secrets Litigation Too

TexasBarToday_TopTen_Badge_VectorGraphicThis is part three of my four-part series commemorating the one-year anniversary of the Defend Trade Secrets Act. The series culminates with a live webcast from the Texas State Bar on May 16: “One Year of Defend Trade Secrets Act Litigation.”

How did the Defend Trade Secrets Act change where trade secrets lawsuits get filed?

Congress passed the Defend Trade Secrets Act in May 2016. As I wrote here last week, the first year of case law seems to confirm that “the main effect of the DTSA has been to shift some typical customer list cases from state court to federal court.” Or as this recent article in Business Law Today stated, “the DTSA’s primary function to date has been to create a path for plaintiffs to litigate what historically were essentially state law trade secret claims in federal court.”

In most cases, the Defend Trade Secrets Act effectively gives the plaintiff the option to file a trade secrets lawsuit in state or federal court.  Why?  The language of the Defend Trade Secrets Act is largely—but not entirely—the same as the language of the Uniform Trade Secrets Act, which most states have enacted.

So, a plaintiff with a trade secrets claim can usually assert the same claim under both state and federal law. Usually, the plaintiff chooses from two options: (1) assert a state-law trade secrets claim in state court, or (2) assert both state-law and federal trade secrets claims in federal court.[1]

This is a significant advantage for a plaintiff. Whether a case ends up in state or federal court can be a game-changer. Litigators and their clients generally view federal courts as less hostile to big companies and state courts as friendlier to the “little guy,” although this is only a generalization.

Regardless of which you choose, it’s nice to have the choice if you’re the plaintiff.

But do you get to choose the location where you file your trade secrets lawsuit? It depends. If the suit includes a DTSA claim, then any federal court in any place in the country has jurisdiction over the subject matter of the suit. But the court must also have personal jurisdiction over the defendant. If the defendant resides in the state where he is sued, then it’s simple. If not? Then it gets messy. The defendant must have sufficient contacts with the forum state to be subject to personal jurisdiction there.

Personal jurisdiction in Defend Trade Secrets Act cases

Personal jurisdiction law is messy because it’s based on vague notions of “reasonableness.” It essentially comes down to this: Did the defendant have enough contact with the forum state that it would be reasonable for him to expect that the lawsuit at issue would be filed there?

As I wrote here, the personal jurisdiction buzzwords that lawyers learned in law school don’t give you the answer. You have to look at the “sub-rules” that have developed in the case law. The key sub-rule for trade secrets cases is this: generally, a defendant will be subject to personal jurisdiction if he was physically present in the state when he obtained or disclosed the alleged trade secrets. It’s only a general rule, but it will usually give you the right answer.

So, when a defendant’s contact with California was that he once lived there and that he received the confidential information at issue in his Gmail account, that was not enough. The fact that his Gmail account “lived” on Google’s servers in Silicon Valley? A creative argument, but it was not enough to convince the judge in OOO Brunswick Rail Management v. Sultanov, a case I wrote about here.

Gold Medal Products v. Bell Flavors & Fragrances was a closer case.[2] The question in that case was whether an Illinois company that allegedly obtained an Ohio company’s trade secrets could be sued in Ohio.

So far, most of the cases applying the Defend Trade Secrets Act have involved customer lists and other “soft” trade secrets, but Gold Medal was a good old-fashioned “secret sauce” case. The employee, Sunderhaus, was the company’s chief “food technologist” with access to the company’s secret recipes for its Glaze Pop® popcorn coatings.

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Gold Medal v. Bell Flavors shows that jurisdiction can be a sticky issue in trade secrets litigation

Gold Medal engaged an Illinois company, Bell Flavors, to help develop new flavors. Bell Flavors signed a confidentiality agreement with Gold Medal and repeatedly visited Gold Medal’s facility in Ohio. Sunderhaus later left Gold Medal and joined Bell Flavors in Illinois as a “savory flavorist.” Bell Flavors then assigned Sunderhaus to work for a Chinese company that developed a new caramel-flavored popcorn glaze to compete with Gold Medal.

I don’t make this stuff up, people.

The jurisdiction issue was whether Bell Flavors, located in Illinois, could be sued for trade secret misappropriation in Ohio, where the employee allegedly obtained the trade secrets. The federal district court said no.

The key was that Bell Flavors did not travel to Ohio to recruit Sunderhaus or misappropriate the trade secrets in Ohio. Rather, Sunderhaus lawfully obtained the alleged trade secrets in Ohio, left to work for Bell Flavors in Illinois, and then allegedly provided the trade secrets to Bell Flavors in Illinois.

So, Gold Medal‘s holding is consistent with my “sub-rule” for personal jurisdiction in trade secrets cases. Under that sub-rule, there is no question Sunderhaus would be subject to jurisdiction in Ohio; he worked for the company there and allegedly obtained the trade secrets there. But Bell Flavors was not subject to jurisdiction in Ohio because it did not obtain or use the trade secrets in Ohio.

Promoting uniformity in trade secrets law?

As we’ve seen, the Defend Trade Secrets Act didn’t change the fact that the defendant has to be subject to personal jurisdiction in the state where you sue him for misappropriating your trade secrets. But did it change the law that will apply to your claim?

Not really. That’s because the Defend Trade Secrets Act is largely the same as the Uniform Trade Secrets Act that most states have adopted. I have to hedge a bit, because there are some differences.[3]

Lawyers Alex Harrell and Michael Yim wrote an excellent article in the April 2017 Texas Bar Journal called The Defend Trade Secrets Act: Comparing the New Federal Statute with the UTSA. It provides a thorough and detailed comparison with the Uniform Trade Secrets Act.

But there is one statement in the article I disagree with: “The DTSA strengthens trade secret protections by furthering nationwide uniformity in this area of law.”

Yes, uniformity was one of the purported benefits of the Defend Trade Secrets Act. But think about it. As the authors of the Texas Bar Journal article also point out, the DTSA does not preempt state trade secrets law. That means the DTSA just adds an additional layer of federal trade secrets law on top of the trade secrets laws of 50 states. How does that promote uniformity?

No, the Defend Trade Secrets Act doesn’t necessarily promote uniformity in trade secrets law. But apparently it will help the US maintain its strategic superiority over China in savory popcorn flavor technology.

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head-shot-photo-of-zach-wolfeZach Wolfe is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Austin, Houston, and The Woodlands. Rumors that he once ate an entire bag of Glaze Pop® popcorn by himself are exaggerated. 

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] Theoretically, a plaintiff could initiate a federal trade secrets claims in state court, but there would not be much point in that.

[2] Gold Medal Prods. Co. v. Bell Flavors & Fragrances, Inc., No. 1:16-CV-00365, 2017 WL 1365798 (S.D. Ohio Apr. 14, 2017).

[3] Houston litigator Jason Sharp informed me there is a bill pending in the Texas legislature that would change the Texas statute. We’ll talk about that in our upcoming webcast.

It’s All In Your Head: Customer List Cases Under the Defend Trade Secrets Act

It’s All In Your Head: Customer List Cases Under the Defend Trade Secrets Act

TexasBarToday_TopTen_Badge_VectorGraphicThis is part two of my four-part series commemorating the one-year anniversary of the Defend Trade Secrets Act. The series will culminate with a live webcast from the Texas State Bar on May 16: “One Year of Defend Trade Secrets Act Litigation.”

Has the Defend Trade Secrets Act put a stop to corporate espionage by foreign governments and companies?

The NFL draft was last week, so it was a time for predictions. My Dallas Cowboys used their first two picks on guys named Taco and Cheeto. I predict TV commentators will have fun with that.

Speaking of predictions, back in May 2016 when the federal Defend Trade Secrets Act became law, I wrote this:

People think of a shadowy foreign company smuggling sophisticated plans for the next iPhone out of the country.  But the typical trade secrets lawsuit is more mundane.  Given the fact that a “customer list” can be a trade secret, an employer can sue for misappropriation of trade secrets just about every time a low-level sales employee leaves the company with the names and numbers of her customers on her smartphone.  Are routine customer list cases now headed for federal court?  We will see.

A customer list case is a “soft trade secrets” case. Soft trade secrets are the kind almost every company has or claims to have: customer lists, customer information, pricing, business strategies, etc.

“Hard” trade secrets are what people commonly think of as trade secrets: secret technology, secret sauce. This is the kind of thing most members of Congress probably had in mind when the Defend Trade Secrets Act passed with bipartisan support. It is probably also what the press had in mind when they hailed the DTSA as the dawn of a new era of protection of U.S. companies.

Indications from the first opinion applying the DTSA

Henry Schein, Inc. v. Cook was the first opinion I saw applying the Defend Trade Secrets Act. It augured that the typical DTSA case would be a soft trade secrets case. As I reported here, Henry Schein involved customer information in the sale of medical, dental and veterinary supplies and equipment.

Of course, that was just one case. But at that time I made this prediction:

A year from now when we look back at the cases filed in federal court under the Defend Trade Secrets Act, many more of them will be ordinary “customer list” cases like Henry Schein than complex schemes involving sophisticated secret technology. It will turn out that the first case applying the Defend Trade Secrets Act was the typical case.

So has the first year of litigation under the Defend Trade Secrets Act proven me right? Largely, yes. Judging by the opinions available on Westlaw (an admittedly unscientific sample), most Defend Trade Secrets Act lawsuits have been soft trade secrets cases like Henry Schein. I haven’t seen a single DTSA case that involved a foreign government or company stealing secret technology from a U.S. company.*

Another customer list case: First Western

Another good example is First Western Capital Management v. Malamed.[1] It was a classic customer list case.

The customer lists in trade secrets lawsuits usually fall into two categories: (1) a “big” list covering the company’s entire clientele; (2) a shorter list of the employee’s own customers.

The customer list in First Western was a big list: 130 pages, printed from the company’s “CRM” system, containing roughly 5,000 names, including 331 current company clients. The employee also printed out 22 pages of spreadsheets listing names of clients, the total market value of their holdings under management, the management fees being charged by the company, and “similarly sensitive information.”

In short, the customer list in First Western provided the identity of the customers, their specific preferences, and the prices charged to them. These are commonly the alleged trade secrets in a customer list case.

The issue in First Western was whether the company was entitled to a preliminary injunction barring the employee from using the alleged trade secrets to compete for the company’s clients. It’s a good DTSA case to study because it addresses so many interesting issues.

1. Witness credibility

First Western illustrates the paramount importance of witness credibility. The employee, Malamed, instructed his assistant by email to print three copies of the company’s “Client book” that was “on the disc.” Malamed admitted keeping a copy of the printout but said he never looked at it.

The district judge was not impressed with Malamed’s testimony at the temporary injunction hearing. Malamed said he had no idea how the last 22 pages of the printout were included, denied those pages contained highly sensitive client information, and claimed he was not sufficiently computer literate to use a disk or to “really know what a disk is.”

The judge wryly observed: “All of these examples, and others, lead this Court to conclude that Malamed has become willing to make statements or take positions with reference to what he believes will prevent liability in this case.”

Ouch. You could tell it was going to go downhill from there.

Lawyers, push hard on your clients when they plan to offer testimony that is going to raise judicial eyebrows. For example, if your client is going to deny that a customer list contains sensitive confidential information, test that assertion. If it holds up, and that’s really what the client thinks, then prepare the client to stick to his guns. But if not, persuade your client not to deny the obvious.

2. Employee intent

Malamed denied the client list contained trade secrets, claimed he could use public sources or his own memory to recreate a similar list, and did not deny his intent to go to work for a competing firm and service clients on the list. This was enough to convince the judge that Malamed would use the client information to compete with the company if not enjoined.

Again, as First Western illustrates, the lawyer representing the employee who took a customer list has a difficult choice. If you admit the customer list is a trade secret, you’ve helped the plaintiff prove half of its trade secret claim. But if your client denies the list is a trade secret, the judge may see that as evidence your client intends to use it.

3. Price undercutting

The judge in First Western saw a real threat of the employee using his knowledge of the company’s pricing to take its clients:

[W]ithout making any explicit comparison to FWCM, [Malamed] can offer management fees that are, say, a quarter of a percent lower than what he knows the individual was paying at FWCM, and thereby entice the client—who almost certainly would recognize that he or she was being offered a discount as compared to FWCM.

This is the usual “price undercutting” theory. I’ve made the same kind of argument for my clients. But this theory has some problems that the First Western opinion doesn’t address. I’ll have to save that for another blog post.

4. Is a customer list a “trade secret” in the first place?

A trade secret must have “independent economic value” to a competitor in the industry. The judge found that the company’s big customer list had value in two ways. First, the identity of the clients had value. The judge said a compilation of wealthy individuals willing to consider the financial management services the company provided was a valuable asset because it would at least save a competitor the time of identifying prospects by, for example, cold-calling individuals employed in high-paying professions.

Second, the judge found that information about the clients had value: their management fee percentages, preferences regarding risk, time horizon, communication style, etc. These were “informational assets” that a competitor would find “especially valuable.”

Ok, that sounds plausible. But riddle me this, Batman. Couldn’t Malamed just call up a client and say, “Hey, Jim Bob, it’s your buddy Kenny. Can I ask you something? What is your investment manager charging you for management fees? What’s your risk preference? What’s your time horizon?”

That’s the other side of the coin in customer list cases.

5. Does a trade secret have to be on paper, or can it be in your head?

What if the employee credibly testifies that he doesn’t have the customer list anymore and isn’t going to use it? Does that get the employee off the hook?

The judge in First Western didn’t think so. He found it sufficient that Malamed would remember the names of clients and the information about them. “Thus, the Court finds that Malamed, at a minimum, remembers trade secret information, even if he does not possess any trade secrets in physical or digital form.”

What does First Western tell us about the effect of the DTSA?

These were just some of the issues in First Western. None of these issues are unique to the Defend Trade Secrets Act. They are the same issues that would have come up under Colorado’s version of the Uniform Trade Secrets Act.

There was one issue in First Western that was particular to the DTSA, but you’ll have to tune in to our May 16 webcast to hear about that.

While the issues in First Western are interesting, the case is further confirmation that the main effect of the DTSA has been to shift some typical customer list cases from state court to federal court.

That is a significant change for lawyers who handle trade secret litigation, but it doesn’t show there was any compelling need to place a federal trade secrets statute on top of the trade secrets laws already found in 50 states.

The defensive line of the Dallas Cowboys generating a more disruptive pass rush next season? Now that’s a compelling need.

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head-shot-photo-of-zach-wolfeZach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation. His firm Fleckman & McGlynn, PLLC has offices in Houston, Austin, and The Woodlands. His client list is not 130 pages long.

These are his opinions, not the opinions of his firm or clients, so don’t cite part of this post against him in an actual case. Every case is different, so don’t rely on this post as legal advice for your case.

[1] First Western Capital Mgmt. Co. v. Malamed, No. 16-cv-1961-WJM-MJW, 2016 WL 8358549 (D. Colo. Sept. 30, 2106).

*After publishing this post, I saw a case where a Chinese company allegedly received a secret recipe for caramel popcorn coating. I’m not kidding.