The Jury Charge in Texas Trade Secrets Litigation

The Jury Charge in Texas Trade Secrets Litigation

When you hear “misappropriation of trade secrets,” you might picture some elaborate heist where the thief is lowered into the secure underground vault from an opening in the AC duct, like Tom Cruise in Mission Impossible. The thief hacks into the company’s server, downloads the secret weapons technology, then boards a plane to China where he hands the flash drive to a shadowy figure in exchange for a briefcase full of cash.

Of course, most trade secrets lawsuits are nothing like that.

For one thing, the typical trade secrets claim involves boring “soft” trade secrets like customer lists, pricing, and other customer information. And even in cases involving “hard” trade secrets like the literal or figurative secret sauce, the parties to the dispute usually had some legitimate business or employment relationship with each other before things went south.

That means in most trade secrets lawsuits, the person who allegedly “misappropriated” the trade secrets initially acquired them lawfully.

For example, in the typical departing employee dispute, an employee legitimately acquires the company’s trade secrets while working for the company. Another typical scenario is a contract between two companies containing an NDA. It might be an agreement between a vendor and a customer, or an agreement between two companies pursuing some kind of joint venture. They voluntarily share confidential information with each other, agreeing not to use it outside of that particular transaction.

In these situations, the initial acquisition of the trade secrets is not tortious. The claim is that misappropriation happened later, when the person did something with the trade secrets that he wasn’t supposed to do.

Both the Texas trade secrets statute and the federal trade secrets statute anticipate this kind of claim in the same way: a complicated multi-pronged definition of “misappropriation.”

“Misappropriation” means stealing, using, or disclosing

The definition of “misappropriation” is the same in both the Texas and federal trade secrets statutes. See Tex. Civ. Prac. & Rem. Code § 134A.002(3); 18 U.S.C. § 1839(5).  I would quote it but that would just confuse you. Instead, I’ll just sum it up as Wolfe’s Second Law of Trade Secrets Litigation: You can’t steal a trade secret, and you can’t use or disclose a trade secret without the owner’s consent.

(In case you missed it, Wolfe’s First Law of Trade Secrets Litigation says whatever company information the employee takes on the way out the door will be the alleged “trade secrets” in the company’s subsequent lawsuit.)

My Second Law is, of course, an oversimplification. And the statute doesn’t use the word “steal.” But Wolfe’s Second Law does capture the essence of “misappropriation.”

What I call stealing is what the statute calls “acquisition” of a trade secret by someone who knows or has reason to know that the trade secret was acquired by “improper means.”

The statute has a non-exclusive definition of “improper means” that includes “theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, to limit use, or to prohibit discovery of a trade secret, or espionage through electronic or other means.”

As you can see, “acquisition” through “improper means” is not limited to stealing a trade secret. It also includes getting a trade secret from someone you know (or should know) stole it. But for simplicity, let’s stick with “stealing.”

Stealing is fundamentally different from the other kind of misappropriation, use or disclosure. If you steal a trade secret, you can be held liable, even if you never do anything else with it. In other words, if you steal a trade secret in the woods and nobody hears it, it still makes a sound.

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Is this where they keep the trade secrets?

This distinction between stealing and using/disclosing becomes important in litigation. If you’re thinking ahead, you can see where this is going: the use or disclosure of a trade secret will often cause compensable damages to the owner of the trade secret, but how does mere acquisition of a trade secret harm the owner?

To make this more concrete, suppose an employee walks out the door on his last day with the company’s entire secret customer list, throws it in a drawer, and never looks at it again. How does that cause any damages?

Hold that thought.

The Casteel problem in jury trials

In most cases, the trade secrets damages question will be for a jury to decide, if the case gets that far. The Court’s Charge will give the jury questions, definitions, and instructions to guide the decision.

Typically, a trade secrets charge will have three key questions: (1) is the information actually a trade secret? (2) did the defendant “misappropriate” the trade secret? (3) what damages, if any, did the misappropriation cause?

But why only three questions? What if there are multiple trade secrets at issue in the case? And what if there are multiple ways the defendant allegedly “misappropriated” the trade secrets? In cases like that, it seems like it would be more precise to break these broad questions down into more specific questions.

Well, that’s not the way we typically do it. Texas law requires “broad-form” submission of questions to the jury, at least when “feasible.” There is a mountain of literature on what broad-form submission means, but to save you time I’ll sum it up as follows: the trial court should submit one broad question on each element of a cause of action, except when there is a good reason not to.

Let’s apply this to the most ordinary kind of lawsuit, a personal injury claim arising from a car accident. Typically, there will be one damages question that combines multiple elements of recoverable damages. The instruction might look like this:

In determining the damages Big Trucking caused Ms. Smith, you may consider:

    1. Physical pain and mental anguish.
    2. Loss of earning capacity.
    3. Physical impairment.
    4. Medical care.

Yawn. What could be more ordinary?

But suppose during the trial Ms. Smith’s lawyer offered no evidence whatsoever regarding loss of earning capacity. And suppose Big Trucking’s lawyer specifically objected to this instruction ahead of time, saying “Your Honor, you can’t include loss of earning capacity in the instruction because there’s no evidence.”

The judge brushes aside the objection, the jury returns a verdict for $90,000 in damages, and the trial court enters judgment for Ms. Smith in that amount. What should the Court of Appeals do with that?

A. Affirm the judgment. Any error is harmless, because the jury could have based the $90,000 on the other three elements of damages.

B. Reverse the judgment and order that Ms. Smith gets nothing. Her lawyer shouldn’t have included loss of earning capacity in the charge.

C. Reverse the judgment and remand for a new trial. Including an element for which there was no evidence is reversible error because there is no way for Big Trucking to show whether the $90,000 improperly included some amount for loss of earning capacity.

There is a case to be made for A, emphasizing judicial economy and respect for jury verdicts. If you picked B, you might be a sociopath. But if you picked C, you are in sync with the Texas Supreme Court.

These were essentially the facts of Harris County v. Smith, 96 S.W.3d 230 (Tex. 2002), except the defendant was Harris County, not Big Trucking. Harris County held that it was an error for the trial judge to submit a broad-form question that included an element for which there was no evidence, and that this was a harmful error because it prevented the appellate court from determining whether the jury based its verdict on an invalid element of damages. Id. at 234.

The court based this decision on a precedent from two years earlier, Crown Life Ins. Co. v. Casteel, 22 S.W.3d 378 (Tex. 2000). Casteel had followed the same reasoning, except that Casteel involved a liability question (not damages), and the objectionable element in Casteel was improper because it was legally invalid (not because of lack of evidence).

In Harris County the Texas Supreme Court found these distinctions immaterial. It therefore established a general principle for Texas jury trials: If a question to the jury includes an element that should not have been submitted, either because it is legally invalid or there is no evidence to support it, and if the complaining party timely and specifically objects to that defect, then the jury’s affirmative answer cannot stand.

Appellate lawyers now call this a Casteel error. They could call it a Harris County error, but that doesn’t have the same ring to it.

Ok, but what does this appellate procedure detour have to do with trade secrets litigation?

The definition of “misappropriation” is custom-designed to create a Casteel problem

It is easy to see how a trade secrets lawsuit could create a Casteel error. This is likely to happen in several ways.

First, suppose the plaintiff claims that it has two kinds of trade secrets. Maybe one is a customer list and the other is a proprietary software program. Suppose there is evidence that the software is a trade secret, but insufficient evidence that the customer list is a trade secret. If the judge submits a single broad question asking whether the plaintiff owned a trade secret and the jury answers “yes,” how do we know if the jury improperly based that answer on the customer list?

Second, let’s assume the court submits a single damages question, but the plaintiff advances multiple theories about what was a trade secret and how the trade secrets were misappropriated, some of which have no evidence to support them. How do we know which theory the jury based the damages on?

Third, and most to the point here, there is the question on “misappropriation.” Let’s say the plaintiff claims both kinds of misappropriation, i.e. stealing and using/disclosing. What if there is no evidence of stealing? If the jury answers yes, there was misappropriation, there is no way to know if the jury based that answer on stealing or not.

In other words, a Casteel problem.

Fortunately, we have the Texas Pattern Jury Charges to help.

The Texas Pattern Jury Charge tracks the statute’s definition of “misappropriation”

A committee of the State Bar of Texas publishes the Texas Pattern Jury Charges, affectionately known as the PJC. The PJC provides standardized jury questions, definitions, and instructions. It is not legally binding on judges, but most judges will follow it most of the time.

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The 2016 PJC included trade secrets questions for the first time

In 2016 the PJC added new questions specifically addressing trade secrets claims. These questions line up with the three questions I outlined earlier, i.e. (1) existence of a trade secret, (2) “misappropriation” of a trade secret, and (3) damages.

Reviews were largely positive. See Book Review: The New Texas Pattern Jury Charge on Trade Secrets. As one reviewer wrote:

The new questions and instructions on trade secret misappropriation do what the Pattern Jury Charge is supposed to do. They provide a template for submitting trade secrets misappropriation questions that is consistent with Texas law and broad enough to apply to different kinds of cases.

Above all, the one thing you want to avoid in a jury instruction is misstating the law. The PJC question on misappropriation of trade secrets tries to avoid this by asking one simple question, “Did Don Davis misappropriate Paul Payne’s trade secret,” and following that question with instructions that track the statutory definition of “misappropriation.” This is a common PJC approach.

You can see the appeal of this. How can the other side complain about your proposed jury instruction if it quotes the language of the statute verbatim?

The problem with the Pattern Jury Charge approach to “misappropriation”

Still, tracking the language of the statute is not always the best approach, and sometimes it’s even the wrong approach, as we will see.

The problem is that the statutory language may not fit the facts of the case. As one reviewer noted back in March 2017:

There is a danger of rote use of the PJC questions when more specific questions tied to the facts of the case would be more appropriate and more understandable to the jury. . . . If the dispute is about whether the former employee used the employee’s customer list, why not just ask “did Don Davis use Paul Payne’s customer list?”

Ok, I confess. That reviewer was me. But still, it’s a valid point.

As I explained in my review, I tend to prefer more factually-specific trade secrets questions. “I like my questions better than the PJC questions,” I wrote. “They get right to the point and are easier for the jury to understand.”

But I neglected to mention another benefit of a trade secrets question that is specifically tailored to the facts of the case: it helps you avoid a Casteel problem.

A case study on “misappropriation” and the Casteel problem: Title Source v. HouseCanary 

The San Antonio Court of Appeals applied Casteel to a trade secrets claim in Title Source, Inc. v. HouseCanary, Inc., No. 04-19-00044-CV, 2020 WL 2858866 (Tex. App.—San Antonio June 3, 2020, no pet. h.). The jury question tracked three alternative elements of the statutory definition of “misappropriation” and quoted the statutory definition of “improper means.” The problem, Title Source argued, was that there was no evidence to support one of those elements.

The stakes for this technical issue of appellate procedure? Only a $706 million verdict, the largest in Bexar County history (according to Title Source’s brief).

The case arose from a contractual relationship in which acquisition of the alleged trade secrets was initially lawful. Title Source, a company affiliated with Quicken Loans that provides services including real estate appraisals, contracted with HouseCanary, a real estate analytics company, to develop an iPad app that could be used to perform appraisals more efficiently. The parties signed several contracts that included nondisclosure obligations.

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Title Source hired HouseCanary to create an iPad app for real estate appraisers

The facts detailed in the opinion are worth reading, but suffice to say that Title Source claimed the app didn’t work, while HouseCanary claimed that in the course of the relationship Title Source misappropriated HouseCanary’s trade secrets to develop its own app, called MyAVM. The jury answered yes to the misappropriation question and then found actual damages of $235.4 million and punitive damages of $470.8 million. Id. at *1-6.

There were also some juicy allegations that came out after the trial, including alleged collusion between HouseCanary and a Title Source officer and “hush money” paid to HouseCanary employees. You can read about that in Title Source’s Brief. (I would also include HouseCanary’s brief, but it was filed under seal.)

The Court of Appeals didn’t need to reach these spicier issues, because it focused on the Casteel problem presented by the misappropriation question. That question told the jury it could find misappropriation based on either a “use” theory” or an “acquisition by improper means” theory (my “stealing”). Id. at *9.

HouseCanary argued that the evidence showed that Title Source used HouseCanary’s trade secrets by relying on the information to assist or accelerate its own research and development. Id. at *10. And there seemed to be at least some evidence to support this argument.

The problem was that the jury question on misappropriation included elements for which HouseCanary had no evidence, i.e. a Casteel error.

The question went wrong in two ways. First, it quoted the statutory definition of “improper means” verbatim. It was therefore a correct statement of the law, but the definition of “improper means” included “bribery” and “espionage,” and there was no evidence that Title Source acquired the trade secrets through bribery or espionage. Because there was no evidence to support those theories, they should have been omitted from the “improper means” definition submitted to the jury. Id.

Hold on a minute. In HouseCanary’s defense, what if no one ever said anything about bribery or espionage in the trial? What is the chance that the jury actually based its answer on a theory that was included in the definition but never argued? This seems like a hyper-technical application of Casteel.

HouseCanary argued this very point, citing a Casteel exception: “a Casteel issue is not reversible if the reviewing court can be ‘reasonably certain’ the jury did not base its findings on the invalid theories.” Id. (citing Romero v. KPH Consol., Inc., 166 S.W.3d 212, 227-28 (Tex. 2005)). HouseCanary never pursued bribery or espionage theories at trial, it argued, so it was reasonably certain the jury did not base its answer on those theories.

But the Court of Appeals sidestepped this argument by focusing on the second problem with the misappropriation question. The question allowed the jury to find misappropriation based on acquisition of the trade secrets through “breach of inducement of a breach of a duty to maintain secrecy, to limit use, or to prohibit discovery of a trade secret.” And HouseCanary argued that theory throughout the seven-week trial, and on appeal. Id.

“But there is no evidence that TSI actually acquired the trade secrets through those breaches,” the Court of Appeals said. “Instead, the evidence shows those breaches, if any, occurred after HouseCanary willingly turned over its data under the NDA, the licensing agreement, and Amendment One.” Therefore, “those breaches do not support a misappropriation finding.” Id.

This was harmful error under Casteel, especially considering the arguments made by HouseCanary’s counsel in the trial. “[B]ecause HouseCanary so heavily emphasized the evidence it presented to the jury of TSI’s alleged post-acquisition breaches, we cannot rule out the possibility that the jury found misappropriation based on those breaches.” Thus, including the acquisition by improper means language in the charge was reversible error. Id.

The result: the Court of Appeals poured out the $700+ million trade secrets verdict and remanded the trade secrets claim for a new trial. Id. at *11. (According to legal-lingo.net, “pour out” is slang for “to deny (a claimant) damages or relief in a lawsuit.”)

Suppose instead that HouseCanary had submitted a simpler misappropriation question like the one I suggested in my review of the PJC, something like “did Title Source use HouseCanary’s trade secrets to aid or accelerate development of its own app?”

Do you think the jury still would have answered yes? Would the verdict and judgment have stood up on appeal?

We’ll never know for sure, and most of my cases don’t involve $700 million verdicts, so what do I know. But I can at least say this simpler question might have avoided the Casteel problem that got the judgment reversed.

Does the Pattern Jury Charge do more harm than good?

To be fair, the PJC question on trade secrets misappropriation anticipates the kind of problem illustrated by Title Source v. HouseCanary. Tucked away in the Comment section to PJC 111.2 (Question and Instructions on Trade-Secret Misappropriation), you will find these nuggets:

For further discussion, see PJC 116.2 regarding broad-form issues and the Casteel doctrine.

The above instruction lists these six alternative improper methods of acquisition, use, or disclosure in brackets, but only the method(s) supported by the pleadings and evidence should be submitted. 

Only those [improper] means raised by the evidence should be submitted.

Only the methods or means raised by the evidence should be submitted! It’s right there in the PJC comments. They even mention Casteel by name.

So, defenders of the PJC could say, with some justification, that the problem in Title Source v. HouseCanary was not that the judge followed the PJC on “misappropriation,” but that the judge didn’t follow the PJC closely enough.

Still, it makes me wonder. Does the PJC question on misappropriation of trade secrets do more harm than good? Might it be better just to tell trial courts to look at the statute and then apply it to the specific facts in dispute?

Keep in mind, it is likely that most Texas trial court judges have never submitted a trade secrets case to a jury. This is based on purely anecdotal evidence, but I’d be willing to bet money on it. Even if I’m wrong, I guarantee most of them could count their trade secrets jury trials on one hand.

I don’t mean this as a criticism, just to point out that jury trials on trade secrets claims are very rare.

As a result, most trial court judges may feel a little unsure of themselves when deciding how to charge the jury on a trade secrets claim. They will tend to fall back on the PJC and the language of the statute, because that feels like the safer thing. It wouldn’t surprise me if that is what happened in Title Source v. HouseCanary.

But the safer thing is not always the best thing.

Just ask Tom Cruise in Mission Impossible.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

Set Phazrs to Stun: Motions to Dismiss in Texas Trade Secrets Litigation

Set Phazrs to Stun: Motions to Dismiss in Texas Trade Secrets Litigation

I’m not big on motions to dismiss, for reasons I’ll explain later.

Still, I often handle lawsuits with trade secrets claims, and sometimes those claims are a little questionable, even on their face. So maybe I should give motions to dismiss another look.

It’s an important issue, because if you represent the defendant, you may be able to get the trade secrets claim dismissed before your client has to pay an arm and a leg fighting over production of documents and other discovery issues. Conversely, if you represent the plaintiff in a suit for misappropriation of trade secrets, you need to know how to adequately plead the  claim so you can survive a motion to dismiss.

That’s true of any kind of lawsuit, but it’s especially important in a trade secrets lawsuit. To understand why, let’s look at a cousin of a trade secrets claim: a claim for breach of a non-compete.

It’s not hard to plead a claim for breach of a non-compete. You allege, for example, that Dawn Davis signed an employment agreement with Paula Payne Windows that includes a non-compete, that Dawn quit and went to work for a competitor, and that she has breached the non-compete by bringing her customers to the new company.

Dawn’s lawyer is going to have a hard time getting that suit dismissed at the pleading stage. In federal court, Dawn could file a Rule 12(b)(6) motion to dismiss, but good luck with that. To overcome a Rule 12(b)(6) motion, all the plaintiff has to do is plead facts that are sufficient on their face. At that point the plaintiff doesn’t have to prove the facts.

It’s even easier for the plaintiff in state court in Texas, where I practice. Traditionally, there was no “motion to dismiss” in Texas procedure. The best you could do was to file “special exceptions” asking the plaintiff to plead the claim more specifically.

That has changed to some degree. Texas now has “Rule 91a” motions to dismiss and “TCPA” motions to dismiss. There was a short, glorious era when you could move to dismiss a trade secrets claim under the Texas Citizens Participation Act, but those days are gone. (See Shrinkage: TX Legislature and 5th Circuit Cut the TCPA Down to Size.)

So that leaves us with Rule 91a motions in Texas state court practice. Rule 91a is sort of the Texas equivalent of federal Rule 12(b)(6). I say “sort of” because it’s similar in some ways, different in others. Maybe I’ll cover that in a future post, but for now just Google it and you’ll probably find some decent articles.

Anyway, the point of that detour was that in both state and federal court, it’s not going to be hard for Paula Payne Windows to plead a case for breach of the non-compete. We’re not talking about whether Paula Payne ultimately wins the case, just whether it can plead enough facts to avoid getting dismissed at the outset.

Pleading problems in trade secrets cases

Adequately pleading a trade secrets claim can be more difficult. In a typical departing employee scenario, you often run into three problems.

First, you don’t always know what documents the employee took.

Second, even if you have evidence the employee took documents containing the alleged trade secrets, you may not have any direct evidence that the employee has already used the trade secrets or disclosed the trade secrets to the new employer.

Third, specifically identifying the trade secrets in your pleading may be difficult, or undesirable, or both.

Here’s an example. Suppose a company called Phazr developes cutting-edge millimeter wave (mmwave), virtualized Radio Access Network (vRAN), and Radio Frequency (RF) technology for 5G wireless communications networks. Just hypothetically.

Three of Phazr’s engineers leave the company and go to work for Mavenir, a company that competes with Phazr but does not have the capacity to develop or produce these particular technologies.

Suppose you are Phazr’s outside litigation counsel. Phazr’s general counsel calls you, freaking out. “Mavenir took our three key guys,” she says. “I’m talking about our principal wireless systems engineer, a vice president, and our principal RF engineer.”

“But did they have access to your trade secrets,” you ask.

“Absolutely,” she says. “They had access to the password-protected database and knew everything about our proprietary technology. We’ve got to get an injunction before they give Mavenir everything!”

Trouble is, Phazr doesn’t yet have any evidence that the engineers took documents containing the secret technology, nor does it have evidence that the former employees disclosed the technology to Mavenir or used it to compete with Phazr.

So you do the best you can. You plead the facts about the importance of the secret technology, the positions the employees held, their knowledge of the technology, and their access to the confidential information.

And to establish “misappropriation,” you allege that each employee “misappropriated Plaintiff’s trade secrets by taking trade secrets learned during his employment and stored on a password-protected shared database and has or will potentially use them during his employment with Mavenir to Plaintiff’s detriment.”

These were essentially the facts in the recent case Phazr, Inc. v. Ramakrishna, No. 3:19-CV-01188-X, 2019 WL 5578578, at *1-2 (N.D. Tex. Oct. 28, 2019).

Were these allegations sufficient to state a claim for misappropriation of trade secrets?

Everything I learned was wrong

If this had been a question on my first-year Civil Procedure exam in law school, it would have been easy. Sure, the pleading is not very specific about how and when the employees allegedly used the trade secrets, but the allegations are more than sufficient to give the defendant “fair notice” of the basic nature of the claim. Unless it’s a claim for fraud, which must be pled with “particularity,” that’s all the Federal Rules of Civil Procedure require.

That’s the answer I would have scribbled in my blue book. And I knew a guy like Prof. Mike Tigar wasn’t big on nit-picky pleading standards. And if you had asked me the same question in my second-year Texas Civil Procedure class, it would have been even more of a no-brainer.

That’s because the Texas pleading standard was “fair notice” on steroids. If the pleading isn’t specific enough, file some special exceptions. Or serve some contention interrogatories and take a deposition. This ain’t federal court. I can just imagine Prof. Jack Ratliff saying this in his Texas twang.

But that was a long time ago. Before the dark times. Before Twombly and Iqbal.

Turns out that “fair notice” stuff was all wrong. After I graduated law school, the U.S. Supreme Court decided a pair of cases affectionately known as Twiqbal, holding that a plaintiff has to plead enough specific facts to state a claim for relief that is “plausible” on its face. And plausible means more than merely “probable.” Fair notice isn’t enough.

Technically that’s just for federal court. Texas is still Texas. But the Texas Rules of Civil Procedure are becoming more “federalized” all the time. See Federal-Style Motions to Dismiss May Come to Texas.

Mind you, the “plausible” standard is still a fairly low bar, and it leaves a lot of room for interpretation. But you know if the defendant’s lawyers can make a plausible case that the plaintiff’s allegations are implausible, they’re likely to file a motion to dismiss, even if the chance of success is low.

Why BigLaw likes motions to dismiss

Motions to dismiss are especially popular in the BigLaw world. Big law firms often defend big lawsuits filed in federal court. And a Rule 12(b)(6) motion to dismiss is the perfect assignment for a BigLaw associate. You study the petition, research the law that applies, write a nice legal research memo, and then draft the motion. The partner revises the motion, and then you file it. The plaintiff files a response, you file a reply, and if you’re lucky you even get a hearing with the judge. It’s good for at least 20 billable hours.

Chances are, you will lose the motion, but that’s ok. In addition to the billable hours, this approach suits the standard BigLaw defense playbook: delay. Stop the plaintiff’s momentum. Drive the cost of the litigation up for the plaintiff. Plus, you want to try to put off the time and expense of discovery to your client as long as possible.

Even aside from the billable hours, motions to dismiss are often important in the lawsuits big law firms like to defend, like securities fraud class actions against big public companies. The pleading standard is even higher for such cases, especially in the Fifth Circuit, so beating a motion to dismiss is a huge win for the plaintiff. There’s a decent chance the case will then settle because of the cost of discovery to the defendant. So the motion to dismiss is often the key event in the lawsuit.

In my litigation practice, not so much. In a typical case I’m representing a smaller business, a startup, an entrepreneur, or an individual executive or salesperson. The damages are more often in the low to mid six figures, not the millions. So like a lot of small-firm lawyers, I’m not looking to delay things and drive up the cost. I usually want to get right to the merits and either settle or duke it out in court.

So like I said, I’m not big on motions to dismiss.

But two developments may change my mind. First, I see increasing use of contrived trade secrets claims to try to impose a “de facto” non-compete on departing employees. I touched on this issue in When Is a Customer List a Trade Secret?

Second, I’m seeing cases like Phazr that can be cited in support of a motion to dismiss.

The Phazr Case

The complaint in Phazr stated a pretty plausible case that the three employees had access to the company’s confidential technology. But the pleading fell short because it did not state enough facts to make a plausible case for the misappropriation element of the claim. Phazr, 2019 WL 5578578 at *4. There were three reasons for this.

First, while the complaint said the right words–“misappropriated and used or disclosed”–this was insufficient, because the “formulaic recitation of the elements of a cause of action will not do.” Id.

Second, the the complaint only speculated that the three employees misappropriated trade secrets. While the complaint alleged the employees took trade secrets stored on a password-protected database, it “fail[ed] to identify what trade secrets the individual defendants took from the database.”

Even aside from that, the plaintiff did not allege facts establishing that the defendants disclosed or used the alleged trade secrets:

Even if Phazr had identified the trade secrets the individual defendants took from its database (which it did not), it still fails to adequately allege that the individual defendants ever disclosed the trade secrets to Mavenir or used them at Mavenir. Indeed, Phazr has failed to show that Mavenir ever acquired the trade secrets from the individual defendants. In short, Phazr at best pleads possibility rather than plausibility.

The court added that Mavenir’s mere employment of three former Phazr employees did not establish that Mavenir acquired and used Phazr’s trade secrets. Id. This was obviously a nod to my post The “Inevitable Disclosure” Doctrine in Texas Trade Secrets Litigation.

Third, the allegation that Mavenir lacked the capacity to develop competing technologies before it hired the three employees did not establish “actual causation,” i.e. that Mavenir gained the capacity to develop the technologies by hiring the employees. Id. at *5.

The court concluded that Phazr had failed to adequately alleged misappropriation of trade secrets and therefore failed to state a claim. Id.

This conclusion was consistent with precedent, the court said. The court acknowledged that plaintiffs have survived motions to dismiss by “identifying specific trade secrets that defendants used to assist competitors in stealing clients.” Id. (citing BRG Ins. Sols., LLC v. O’Connell, No. 3:16-CV-2448, 2017 WL 7513649, at *8 (N.D. Tex. July 18, 2017)).

In another case, the plaintiff avoided dismissal by alleging that employees emailed themselves confidential data and that, when they joined a competitor, the competitor acquired the data and used it to bid against the first employer. Id. (citing Clean Energy v. Trillium Transp. Fuels, LLC, No. CV H-19-244, 2019 WL 1522521, at *3 (S.D. Tex. Mar. 22, 2019)).

But this was not such a case. When the complaint lacks factual content showing that a defendant took or participated in using specific information, dismissal of a trade secrets claim is appropriate. Id. (citing Red Ball Tech. Gas Servs., LLC v. Precise Standards & Sols., Inc., No. 4:17-CV- 2090, 2018 WL 276467, at *4–5 (S.D. Tex. Jan. 3, 2018)).

In short, “Phazr fail[ed] to allege particular acts of acquisition, disclosure, or use of its trade secrets that would constitute actual—and not merely possible—misappropriation.” Id.

The philosophical divide

So maybe next time I feel like a trade secrets claim against my client is especially weak, I’ll file a motion to dismiss and cite Phazr and the other cases it cites.

But the response I’ll get from the plaintiff’s lawyer is obvious: we don’t yet have specific evidence of how the defendants used or disclosed our trade secrets because they have hidden that information from us. We need discovery to find that out.

It’s at least a reasonable argument, and it points to the fundamental philosophical divide over pleading standards and motions to dismiss. One side thinks that you should not have the right to file a lawsuit and open the floodgates of discovery unless you already have evidence to support your allegations. The other side thinks you should only need a reasonable basis for pleading the claims, and the purpose of discovery is to allow you to obtain evidence to support the claims.

There’s enough wiggle room in the pleading standards to allow judges of either school of thought to decide whether they think a particular trade secrets claim is strong enough to proceed. There’s also enough room for interpretation to allow judges to block trade secrets claims they think are contrived and without merit. And maybe that’s how it should be.

For litigators like me, the bottom line is that cases like Phazr identify some common pitfalls to try to avoid when drafting the complaint (or petition), and conversely, opportunities to move to dismiss lawsuits that fall short.

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IMG_4571

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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.

Let’s Roll: Do’s and Don’ts for Texas Trade Secrets Injunctions

Let’s Roll: Do’s and Don’ts for Texas Trade Secrets Injunctions

Recent case offers lessons on how to get (or avoid) a trade secrets injunction in Texas

When I say “drywall installation,” I’m guessing “trade secrets” is not the first thing that pops into your mind. Personally, I think of John Goodman’s character Dan Conner from the TV show Roseanne.

But a recent opinion from a federal district court in Dallas may change that. See Marek Brother Systems, Inc. v. Enriquez, No. 3:19-CV-01082, 2019 WL 3322162 (N.D. Tex. July 24, 2019).

Marek Brother Systems offered commercial and residential construction services, including ceilings, “acoustical solutions,” flooring, and paint. Juan Enriquez was a Marek project manager. Id. at *1. It does not appear that Enriquez signed any non-compete.

Enriquez did two typical things before resigning from Marek to run his own business. First, he formed an LLC, JP Acoustics and Drywall. Second, he sent a Marek customer list to his personal email address.

Let’s pause here for just a moment. Neither one of these things is necessarily wrongful, but both are a bad idea.

Under Texas law, it is not a breach of an employee’s limited fiduciary duty to make plans to compete with his employer. This can even include forming the entity the employee plans to use to compete. See Fiduciary Duty Lite: What Employees Can and Can’t Do Before Leaving.

But employees, why would you want to do this? Forming an LLC is relatively quick and easy. You can do it the day after you resign, and that’s one less thing for the employer to complain about.

Likewise, sending a company customer list to your personal email address is not necessarily wrong. In most businesses, it’s not unusual for employees to email or transfer company documents to their personal devices or accounts for work at home or on the road. This often happens, even when the company prohibits such personal use on paper. So, if a salesman emails himself an open orders list every week, it’s less suspicious if he does so the week before leaving, and if everybody at the company knows employees sometimes do this.

But again, unless you’re certain you will stay with the company until retirement, why would you do this? You should keep in mind Wolfe’s First Law of Trade Secrets Litigation: whatever company information the employee takes on the way out the door will be the alleged “trade secrets” in the company’s subsequent lawsuit.

Enriquez’s third mistake was naming the company “JP Acoustics and Drywall.” I would have called it “JP Drywall . . .” An “acoustics” company sounds like it has trade secrets; a “drywall” company doesn’t.

But let’s get back to the legal issues. Marek claimed that Enriquez’s email included confidential contact information for Marek’s customers and “proprietary notes” about the customers. Id. at *1. One of Marek’s customers was Muckleroy and Falls, id. at *1, which sounds like a business in a Frank Capra movie. Both Marek and JP Acoustics did work for Muckleroy and Falls after Enriquez left Marek. Id. at *4.

Marek claimed that Enriquez was using Marek’s confidential information to advance his business. Id. at *1. Marek sued Enriquez and JP Acoustics, claiming misappropriation of trade secrets, as well as breach of fiduciary duty, tortious interference with contract, and violation of the Computer Fraud and Abuse Act. Marek asked for an injunction to stop the defendants from doing business with any company that was a customer of Marek during the 12 months before Enriquez resigned. Id. at *2.

Marek claimed it spent years accumulating the customer information, and that it made diligent efforts to ensure the secrecy of its customer information, including restricted access to facilities, computer passwords, and disclosure to employees only on a “need to know” basis. Id. at *4.

The defendants responded that the customer information was readily available online or in the Yellow Pages. Id.

So was Marek entitled to a trade secrets injunction?

Let’s pause again to note that this is about as plain-vanilla a soft trade secrets case as you are going to find. You could have said to me “drywall manager leaves company, company files trade secrets suit,” and I could have guessed the essential facts (except maybe the name of the customer). So the outcome of the case may tell us something about how courts deal with typical customer list cases.

The federal district court judge said no, Marek was not entitled to an injunction.[1] First, the court said that the claims for breach of fiduciary duty and violation of the Computer Fraud and Abuse Act were based on conduct that occurred before termination of employment, any resulting damage was “readily quantifiable,” and therefore there was no threatened irreparable harm. Id. at *3. For the authoritative explanation of these concepts, see Injunction Junction, What’s Your Function?

Then the court turned to the claims of trade secrets misappropriation and tortious interference with contract. Illustrating Wolfe’s First Law, Marek claimed that its trade secrets were the customer information Enriquez emailed to himself.

But the court was not persuaded. It started by quoting the Trilogy Software case:

“[I]nformation that a firm compiles regarding its customers may enjoy trade secret status under Texas law.” Trilogy Software, Inc. v. Callidus Software, Inc., 143 S.W.3d 452, 466 (Tex. App.—Austin 2004, pet. denied) (citations omitted). “But this does not mean that trade secret status automatically attaches to any information that a company acquires regarding its customers; if it did, it would amount to a de facto common law non-compete prohibition.” Id. at 467. “Before any information can be a trade secret, there must be a substantial element of secrecy.” Id. (citation omitted). Secrecy requires that the information “is not generally known or readily ascertainable by independent investigation.” Id. (citations and quotation marks omitted). “It is the burden of the party claiming secrecy status to prove secrecy.” Id. (citations omitted).

If this sounds familiar, it might be because I discussed this case in my post When is a Customer List a Trade Secret?

Marek failed to persuade the court that the customer information was not “readily ascertainable.” The court cited several things missing from Marek’s case:

  • Marek did not provide the court with the email attachments containing the alleged trade secrets.
  • Marek did not describe the nature of the “proprietary notes” or why they should be considered proprietary information.
  • Marek did not offer specific facts to support its allegation that it “spent years accumulating” the customer contact information.

Id. at *4.

Maybe Marek should have seen it coming. The same judge had denied a TRO two months earlier in Computer Sciences Corp. v. Tata Consultancy Servs. Ltd., No. 3:19-cv-970-L, 2019 WL 2058772, at *3-4 (N.D. Tex. May 9, 2019), finding there was no evidence the emailed confidential software source code was actually shared with software developers.

But let’s not be too quick to fault Marek’s counsel. The deficiencies in Marek’s evidence seem obvious, but maybe the email attachments were not that helpful to Marek’s case. Perhaps the proprietary notes were not that proprietary. Perchance there were no more specific facts to be offered. Or maybe there was just not enough time to get the evidence needed.

And even if Marek had proven the customer information was a trade secret, there was another big hole in Marek’s evidence: proof of some nexus between the use of the alleged trade secrets and loss of sales to customers. (Picture Marek saying “Causation!” the way Jerry Seinfeld says “Newman!”)

The court said Marek did not allege that Defendants outbid Marek for any particular job or otherwise took Muckleroy and Falls business from Marek. Rather, both parties were servicing Muckleroy and Falls “to neither’s detriment and without direct competition.” In the absence of evidence that the defendants were injuring Marek’s business relationship with the customer, the court said, it could not find that Marek was substantially likely to suffer an irreparable injury due to the defendants’ contact with the customer. Id. at *4.

Injunction denied.

Nevertheless, the story had a happy ending. The parties later signed this Agreed Injunction that barred Enriquez and JP Acoustics from initiating new business with a list of specified customers.

And the Marek case provides lessons for both employees and employers in trade secrets cases.

Employees:

  • DON’T form an LLC for your future competing business any sooner than you really need to.
  • DON’T send company documents to personal devices or email accounts, even for valid reasons.
  • DON’T take customer lists when you leave. Is it really that hard to find the customers? (If so, the list might actually be a trade secret.)
  • If you take a customer list, DO show that the information in it is readily ascertainable.
  • If you do something you shouldn’t have before leaving, DO argue that it can be compensated with damages, so no injunction is warranted.
  • DO watch my video Dumb Things Employees Do Before Leaving a Company for similar tips in convenient audiovisual form.

Employers:

  • DO offer the misappropriated confidential documents as evidence, under seal if necessary.
  • DO specifically explain why the customer information is valuable and not readily ascertainable.
  • DO try to offer evidence that the employee has actually used the confidential information to take specific customer business from you (I know, this is often easier said than done).
  • DON’T expect to get an injunction merely because an employee has taken confidential company documents.
  • DO watch my video Smart Things Companies Can Do to Protect Confidential Information.

Finally, whether you’re an employee or employer, do get advice from a lawyer as early as possible, preferably one with experience handling departing employee disputes. That might help you avoid the common mistakes above. In the words of another John Goodman character, “Donny you’re out of your element!”

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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] To be precise, the court construed the motion for preliminary injunction as a motion for temporary restraining order, denied a TRO, and set a hearing on a preliminary injunction.

The “Inevitable Disclosure” Doctrine in Texas Trade Secrets Litigation

The “Inevitable Disclosure” Doctrine in Texas Trade Secrets Litigation

Does Texas law recognize the “inevitable disclosure” doctrine? Should it?

This strikes me as the wrong question. The right question is not “should Texas follow the inevitable disclosure doctrine?” but rather “what evidence is sufficient to establish imminent harm from the threatened use of trade secrets?” I propose the following dichotomy:

  1. In a “soft” trade secrets case, the mere fact that a former employee knows a company’s trade secrets and has gone to work for a competitor should usually be insufficient to establish the “imminent harm” necessary to support a temporary injunction barring the employee from working for the competitor. There must be something more, such as evidence of a plan to use the trade secrets, or evidence that the employee has already used or disclosed the trade secrets.
  2. But in a “hard” trade secrets case, “something more” might not be required if the trade secret is so super-secret and valuable the employee’s mere knowledge of it creates an imminent risk that the employee will disclose it to her new employer.

I admit that no. 2 is a little circular, but there’s really no getting around that. At least my test puts the emphasis on the degree of the threat, where it should be.

But what is a “soft” trade secret? Or a “hard” trade secret? And what is the inevitable disclosure doctrine in the first place? Let’s back up a bit.

The Inevitable Disclosure Doctrine

The inevitable disclosure doctrine is a concept in trade secrets law. It is the idea that a person who knows a company’s trade secrets can be enjoined from working for a competitor on the theory that the person will inevitably use that knowledge.[1] For example, in T-N-T Motorsports, Inc. v. Hennessey Motorsports, Inc.,[2] the court held that evidence that the defendants possessed the plaintiff’s confidential information and were “in a position to use it to compete” showed an “inherent threat” sufficient to support an injunction.

The Texas Uniform Trade Secrets Act (TUTSA) and the federal Defend Trade Secrets Act (DTSA) do not expressly refer to the inevitable disclosure doctrine. The doctrine can be seen as an application of the common-law “imminent harm” requirement for an injunction. The question is whether harm is imminent when a person with knowledge of the company’s trade secrets is working for a competitor.

The DTSA indirectly rejects—or at least constrains—application of the inevitable disclosure doctrine in two ways. First, it authorizes the court to grant an injunction “to prevent any actual or threatened misappropriation,” but with the important limitation that the court cannot “prevent a person from entering into an employment relationship.” The court can place conditions on such employment, provided the conditions are based on “evidence of threatened misappropriation and not merely on the information the person knows.” In other words, the court cannot limit a former employee’s work for a competitor based merely on the idea that the employee will inevitably disclose the employer’s trade secrets. Second, the injunction cannot conflict with an applicable state law “prohibiting restraints on the practice of a lawful profession, trade, or business.”[3]

Similarly, TUTSA codifies the common-law principle that an injunction may not prohibit a person from using “general knowledge, skill, and experience” acquired during employment.[4] This limitation emphasizes that injunctions should be narrowly tailored to prevent disclosure of trade secrets, not to unreasonably restrict employee mobility. Still, TUTSA at least leaves open the possibility that a risk of “inevitable disclosure” of trade secrets could establish the “imminent harm” needed to support a temporary injunction.

Texas law is unsettled on whether and to what extent the inevitable disclosure doctrine applies.[5] But we can draw some preliminary conclusions from the case law.

First, if there is evidence that the employee has already disclosed the alleged trade secrets to the competitor, or used the alleged trade secrets while working for the competitor, then resort to the inevitable disclosure doctrine is unnecessary. The doctrine only becomes a real issue when the evidence is that the employee possesses or knows the trade secrets but has not done anything wrong with them—yet.

Second, inevitable disclosure really goes to the question of an injunction, not damages.

Global Supply v. Riverwood

Both principles were apparent in Global Supply Chain Solutions, LLC v. Riverwood Solutions, Inc., No. 05-18-00188-CV, 2019 WL 3852661 (Tex. App.—Dallas Aug. 16, 2019, no pet. h.), a recent case showing the limits of the “inevitable disclosure” argument.

In that case, Global Supply and Riverwood were competitors in the supply chain management industry, including product data management (PDM) services. Id. at *1. They had merger discussions in which Global Supply provided a seven-page PowerPoint presentation containing financial information about Global Supply. Id. at *2. After these discussions were abandoned, Riverwood unsuccessfully solicited two customers of Global Supply and recruited Lori Austin, a consultant for Global Supply, to be Riverwood’s director of PDM services. Id. at *2-3.

Global Supply sued Riverwood and Austin in Collin County District Court, claiming misappropriation of trade secrets, but Global Supply never set a hearing on a temporary injunction. Id. at *4. After some discovery and designation of experts, the parties filed motions for summary judgment, including Riverwood’s motion for summary judgment on Global Supply’s trade secrets claim. Id.

The problem for Global Supply was that there was no “direct evidence” that Austin disclosed any trade secret to Riverwood. Id. at *7. So Global Supply argued that it was “inevitable” that Austin would disclose its trade secrets in the course of her employment at Riverwood. Id. In other words, the inevitable disclosure doctrine.

In support of its argument, Global Supply cited the Seventh Circuit’s statement that “a plaintiff may prove a claim of trade secret misappropriation by demonstrating that defendant’s new employment will inevitably lead him to rely on the plaintiff’s trade secrets.” Id. (citing PepsiCo, Inc. v. Redmond, 54 F.3d 1262, 1269 (7th Cir. 1995)).

But Collin County ain’t in the Seventh Circuit, and the trial court granted summary judgment for Riverwood and Austin.

The Dallas Court of Appeals affirmed, rejecting Global Supply’s inevitable disclosure argument. The court cited Cardinal Health Staffing Network, Inc. v. Bowen, 106 S.W.3d 230, 241-42 (Tex. App.—Houston [1st Dist.] April 3, 2003, no pet.), which said “[w]e have found no Texas case expressly adopting the inevitable disclosure doctrine, and it is unclear to what extent Texas courts might adopt it or might view it as relieving an injunction applicant of showing irreparable injury.” Id.

Global Supply argued that the adoption of TUTSA brought the inevitable disclosure doctrine to Texas, but the court disagreed. The court reasoned that the “ultimate merits” are not at issue in a temporary injunction hearing in a trade secret misappropriation case. Thus, whatever merit the inevitable disclosure argument may have in support of a temporary injunction, the court said the argument is insufficient to raise a fact issue on damages in response to a motion for summary judgment. Id. at *8.

The court then turned to whether Global Supply had offered sufficient evidence on the elements of its TUTSA claim. Global Supply offered the following:

  • The idea that building supply sourcing could be operated as a standalone business was the trade secret misappropriated by Riverwood.
  • Riverwood contacted a Global Supply customer about using Riverwood for sourcing building supplies, knowing he was a Global Supply customer.
  • Austin was doing the same work at Riverwood that she did for Global Supply.
  • Peck, Global Supply’s president, testified that Austin “must have” disclosed Global Supply’s confidential information in order to do her job at Riverwood.
  • Peck also testified that building supply sourcing “was unlike anything Riverwood was doing at the time.”

Id. at *14-15.

So, the evidence of misappropriation was pretty thin, especially in light of controverting evidence:

  • Global Supply did not share any information about its building supply sourcing business model with Riverwood.
  • The seven-slide PowerPoint presentation did not include this information, and Global Supply conceded that the merger discussions did not involve delivery of trade secrets other than that delivered in writing.
  • Riverwood had sourced building supplies before the merger discussions.
  • Peck conceded Riverwood could have provided building supply sourcing without his being aware of it.
  • Global Supply did not lose any business from the customer Riverwood contacted.
  • Austin testified she returned all company property to Global Supply, did not retain Global Supply documents, complied with her confidentiality agreement, never disclosed Global Supply’s confidential information or trade secrets to Riverwood, and only used generally known information.
  • Peck conceded he had no knowledge of the work Austin was actually doing at Riverwood.
  • Austin testified about how she performed her job responsibilities at Riverwood without using Global Supply’s confidential information.

Id. at *14-15.

Based on the evidence, the Court of Appeals held that the trial court properly granted summary judgment against Global Supply’s trade secrets claim. Id. at *15-16. Thus, the “inevitable disclosure” argument could not fill the gaps in Global Supply’s evidence of misappropriation of trade secrets.

So did Global Supply reject the inevitable disclosure doctrine? Not really. Two significant factors limit the reach of Global Supply. First, it was not a temporary injunction case. Trying to use the inevitable disclosure doctrine as a substitute for direct evidence of damages was a stretch.

Second, the court seemed skeptical of Global Supply’s theory that its business model was a trade secret in the first place. This was apparent in the court’s statement that “Global supply does not point to any summary judgment evidence that it shared with Riverwood any information about its ‘business model’ that ‘took extensive effort to develop.’” Id. at *15.

A Harder Case

Imagine instead a temporary injunction case with evidence that the alleged trade secret is really secret and really valuable. Let’s say an oilfield services company develops a secret drilling technology that a competitor would pay millions for. The engineer who developed the technology for the company gets hired by a direct competitor as Director of Engineering. There’s no evidence that the engineer has disclosed the technology to the competitor, or even evidence that he plans to do so, but the trial court enters a temporary injunction barring the engineer from working for the competitor, citing the imminent risk that the engineer will disclose the technology.

Even then, you might question whether an injunction is warranted when the engineer hasn’t done anything wrong yet. But this scenario provides at least a stronger case for application of the inevitable disclosure doctrine, first because it involves an injunction and second because it involves a “hard” trade secret.

The two quintessential types of hard trade secrets are “secret sauce,” like the Colonel’s herbs and spices or the formula for Coke, and secret cutting-edge technology, like say, laser guidance for self-driving cars. When an employee runs off to a competitor with that kind of secret, it does seem a little unfair to require proof that employee has already given the secret to the competitor.

“Soft” trade secrets are different. Soft trade secrets are things like customer lists, customer information, and pricing information. Virtually every business has this kind of information. That doesn’t mean the information can’t be a trade secret. It can, as I explained in When Is a Customer List a Trade Secret?

But there’s a danger here. If courts grant injunctions too freely in soft trade secret cases, they risk turning trade secret law into a “de facto” non-compete for all employees who have customer information. And Texas courts have recognized we don’t want to do that. See Trilogy Software, Inc. v. Callidus Software, Inc., 143 S.W.3d 452, 466-67 (Tex. App.—Austin 2004, pet. denied) (“this does not mean that trade secret status automatically attaches to any information that a company acquires regarding its customers; if it did, it would amount to a de facto common law non-compete prohibition”).

That’s why I say in a soft trade secrets case, there should be some evidence that the employee has used or disclosed the trade secrets—or plans to do so—before the court grants a temporary injunction. If Texas courts are going to embrace the notion of “inevitable disclosure” at all, it should be limited to cases involving hard trade secrets.

Of course, the distinction between hard and soft trade secrets is not in the statutes; it’s just my terminology. And you could always have borderline cases (“semi-soft” trade secrets?) But the underlying concept—that the degree of secrecy and value of the alleged trade secrets is a factor in determining whether a temporary injunction should be granted—is sound. At least it focuses on the right question.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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 The Inevitable Disclosure Doctrine: A Necessary and Precise Tool for Trade Secret Law.

[2] 965 S.W.2d 18, 24 (Tex. App.—Houston [1st Dist.] 1998, pet. dism’d).

[3] 18 U.S.C. § 1836(b)(3).

[4] Tex. Civ. Prac. & Rem. Code § 134A.003.

[5] Cardinal Health Staffing Network, Inc. v. Bowen, 106 S.W.3d 230, 241-42 (Tex. App.—Houston [1st Dist.] April 3, 2003, no pet.); DGM Services, Inc. v. Figueroa, No. 01-16-00186-CV, 2016 WL 7473947, at *5 (Tex. App.—Houston [1st Dist.] Dec. 29, 2016, no pet.) (mem. op.).

Houston Judge Calls Out Texas Supreme Court’s Simplistic “Textualist” Approach to TCPA

Houston Judge Calls Out Texas Supreme Court’s Simplistic “Textualist” Approach to TCPA

I don’t know if Justice Terry Jennings is one of my Fivers, but apparently he agrees with a lot of Five Minute Law’s past propaganda regarding textualist application of the Texas Citizens Participation Act (TCPA).

In a concurring opinion issued just before Christmas 2018, Justice Jennings criticized the Texas Supreme Court’s overly broad and literal interpretation of the TCPA, urging both the legislature and the Texas Supreme Court to fix the problem. His opinion echoes some of the points I made in past hits like It’s Alive, It’s ALIVE! How to Kill a TCPA Motion in a Trade Secrets Lawsuit.

But what’s the problem? First let’s back up a little and recap:

  • The TCPA was intended as an “anti-SLAPP” statute, i.e. to discourage a litigation bully from filing a lawsuit against a “little guy” in retaliation for the little guy exercising his free speech rights.
  • When the TCPA applies, it gives the defendant the valuable procedural right to file a motion to dismiss that puts the burden on the plaintiff to support its claims with evidence, before the plaintiff has had any opportunity to take discovery.
  • The TCPA applies when the plaintiff’s claim “is based on, relates to, or is in response to” the defendant’s exercise of the “right of free speech” or the “right of association.”
  • The statute defines the “exercise of the right of free speech” broadly as a “communication made in connection with a matter of public concern,” with “matter of public concern” also defined broadly to include an issue related to “a good, product, or service in the marketplace.”[1]
  • The statute defines the “exercise of the right of association” broadly as “a communication between individuals who join together to collectively express, promote, pursue, or defend common interests.”[2]

You can see from this language how the TCPA could lead to good results. A neighborhood group forms to stop a nearby refinery from releasing toxic gases. Global Oil Conglomerate instructs its BigLaw minions to sue the group for defamation based on posts on its Facebook page. Rather than buckling under the weight of enormous legal fees, the plucky neighborhood group hires a small town lawyer to file a TCPA motion to dismiss. The judge grants the motion, orders Global to pay the group’s legal fees, and Matthew McConaughey wins an Oscar for his portrayal of the lawyer.

Everyone’s happy. Alright, alright, alright.

But you can also see how the broad language of the TCPA could apply to lawsuits the legislature never had in mind. Imagine a porn star sues the President for defamation. The judge dismisses the case and orders the porn star to pay the President’s legal fees. It could happen.

That was at least a defamation case, which is clearly the type of case the legislature had in mind when it passed the TCPA. It seems much less likely that the legislature intended to fundamentally change the way departing employee cases are litigated.

Departing employee litigation is near and dear to my heart because it’s the kind of lawsuit I often handle. This is the type of case where an employee or group of employees leaves a company and either forms a competing company or goes to work for a competitor. Usually the first company asserts claims like breach of a non-compete and misappropriation of trade secrets.

These cases usually don’t raise any true “free speech” or “free association” issues. The “right of association” is not a defense to enforcement of a non-compete (provided the non-compete is reasonable and enforceable), and there is no First Amendment right to communicate your employer’s trade secrets to a competitor.

So what should the judge do in a departing employee case where the defendant files a TCPA motion to dismiss? On the one hand, the TCPA applies when a claim is based on “a communication between individuals who join together to collectively express, promote, pursue, or defend common interests.” Construed literally, that language applies to the allegation that an employee joined a competitor and disclosed his former company’s trade secrets.

On the other hand, the purpose of the statute is to protect constitutional rights, and a claim of trade secret misappropriation really doesn’t implicate such rights. Should the judge apply the statute literally, even though the result is not what the legislature intended?

Enter textualism.

We are all textualists now

Textualism is somewhat controversial. In part this is because in practice textualism is popular with one particular political party and ideology. But everyone who works in the law—at least everyone who is serious—is a textualist to some extent. No one seriously argues that the text of a statute—or a Constitution—should be ignored.

The fact that we are all textualists to some extent is apparent in the absence of any real “-ism” that is the opposite of “textualism.” No group identifies itself as the “Non-Textualists” or the “Anti-Textualists.” (The same point applies to “originalism,” but I won’t open that can of worms here.)

No, we all agree that when you interpret a text, the starting point is, duh, the text. You might find some radical academic types who question that premise, but no one who works in the law would seriously say “the text of the statute is totally irrelevant to me.”

On the other side of the spectrum, even the most committed textualist will concede that sometimes a judge should look to extrinsic sources to interpret the text. For example, if a statute is ambiguous, even after applying canons of statutory construction, then just about everyone would agree you can look to the purpose of the statute, or some other extrinsic source, to  decide which of two reasonable constructions of the statute makes more sense.

Similarly, even the strict textualist camp would concede the principle—recognized in many court decisions—that extrinsic sources should be consulted when the literal application of a statute would produce a truly absurd result.

So if we all agree on these basic principles, what’s all the controversy about?

Here’s where it gets hard: when literal application of a statute would produce a result that, while not rising to the level of absurd, is contrary to the intended purpose of the statute. That’s where I think the dividing line is.

In this scenario, the true textualist bites the bullet and says “no, the judge should not look outside the text of the statute just because the result doesn’t make sense to the judge.”[3]

This is where textualism loses me, and I’m not the only one. When the literal application of a statute would produce a result at odds with the intended purpose of a statute, I tend to side with the non-textualists who say “no, in this case we’re not going to apply the literal meaning of the statute.” As I’ve written before, following the literal text in this situation “thwarts the intent of the legislature in the name of deference to the legislature.” See A SLAPP in the Face to Texas Trade Secrets Lawsuits – Part 2.

And I’ll give you a good example: application of the TCPA to departing employee litigation.

Application of the TCPA to departing employee litigation

Step one was the Texas Supreme Court holding in Coleman that the plain meaning of the TCPA’s broad definitions must be applied.[4] The Texas Supreme Court reaffirmed this plain meaning approach in Adams.[5]

Step two was the Austin Court of Appeals holding in Elite Auto Body that the TCPA applies to a claim that a departing employee disclosed trade secrets to his new employer. The court reasoned that a literal reading of the statute’s definition of “communication” would clearly include alleged communications among the departing employees and their new enterprise through which they allegedly shared or used the confidential information at issue.[6]

Elite Auto Body acknowledged that it would be reasonable to limit the statute to its stated purpose of protecting constitutional rights, but it found that argument foreclosed by Coleman’s plain meaning approach.[7]

One more note about Elite Auto Body: the court did not address the argument that the claims fell under the TCPA’s “commercial speech” exemption because it found that issue had been waived.[8] More about this exemption later.

Application of the TCPA to departing employee cases has since expanded. In Craig v. Tejas Promotions, the Austin Court of Appeals held that the TCPA applies to a claim of conspiracy to misappropriate trade secrets. The court reasoned that the claim rested on allegations that included “communications” between the alleged co-conspirators.[9]

In Morgan v. Clements Fluids, the Tyler Court of Appeals held that the TCPA applies to a claim based on departing employees’ communications among themselves and within the competitors, through which they share or utilize the alleged trade secrets.[10]

And that brings us to Gaskamp.

Gaskamp applies the TCPA to departing employee claims

In Gaskamp v. WSP, the WSP companies sued a group of former employees for allegedly starting a competing company while employed by WSP and then taking WSP’s trade secrets to the new company. WSP alleged that the former employees violated the Texas Uniform Trade Secrets Act (TUTSA) by using and disclosing WSP’s trade secrets, including proprietary design software used to create architectural designs.[11]

WSP argued that the TCPA did not apply. First, WSP said its lawsuit was based on theft and use of its trade secrets, not the employee’s right to freely associate or right of free speech as required by the TCPA. Second, WSP argued that the TCPA’s commercial-speech exemption applied.

The Court of Appeals rejected the first argument. The court cited WSP’s allegations that the employees used and disclosed WSP’s trade secrets to establish a competing engineering firm called Infinity MEP. The court reasoned that the alleged “transfer and disclosure” of WSP’s trade secrets to Infinity MEP “required a communication.” In addition, the allegation of inducing customers to reduce their business with WSP would “necessarily involve communications as defined by the TCPA.” And the allegation that the employees conspired among themselves to misappropriate trade secrets and interfere with WSP’s business also necessarily involved a communication.[12]

“All these communications were made by individuals who ‘join[ed] together to collectively express, promote, pursue, or defend common interests,” the court said, “the common interest being the business of Infinity MEP, operating as WSP’s competitor.” The alleged interference with customers involved communication “made in connection with a matter of public concern.” Thus, the claims related to the employees’ exercise of their rights of association and free speech, respectively, as broadly defined by the TCPA.[13]

This part of Gaskamp is important because the same reasoning would apply in almost any suit against departing employees that involves misappropriation of trade secrets. A plaintiff might be able to avoid this part of Gaskamp by alleging use of the trade secrets without any allegation of disclosure or communication of the trade secrets, but even in that case the employee could argue that the allegation necessarily relates to communications with the customers. The argument that the TCPA does not apply to trade secret misappropriation seems unlikely to succeed.

But the second argument in Gaskamp may be more promising for plaintiffs in departing employee cases. WSP argued that the statute’s commercial-speech exemption applied. That exemption states that the TCPA does not apply to a suit against “a person primarily engaged in the business of selling or leasing goods or services, if the statement or conduct arises out of the sale or lease of goods, services, or an insurance product, insurance services, or a commercial transaction in which the intended audience is an actual or potential buyer or customer.”

The Court of Appeals agreed with this argument (although for narrow procedural reasons).[14] Thus, the commercial-speech exemption applied, and the trial court was correct to deny the employees’ motion to dismiss under the TCPA as to two of the WSP plaintiffs.

This was no consolation for a third WSP plaintiff that failed to file a response to the TCPA motion (believing it had already been non-suited from the case). As to that entity, the Court of Appeals held that the motion to dismiss should have been granted.[15]

But at least one justice thought this result was “manifestly unjust.”

Justice Jennings questions the “textualist” approach to the TCPA

Justice Jennings wrote a concurring opinion. He joined in the majority opinion but wrote separately “to warn of the inherent dangers to Texas Jurisprudence posed by a rigid adherence to the ideological doctrine of so-called ‘textualism’ in construing our Constitution and statutes.”[16]

By applying the literal text of the TCPA’s definitions without considering the purpose of the statute, Justice Jennings said, the Texas Supreme Court has interpreted the TCPA “much more broadly than the Texas Legislature ever intended.” Applying the Texas Supreme Court’s literal interpretation of the statutes definitions necessarily led to a “manifestly unjust and absurd result,” but he and his colleagues were required to apply the definitions as instructed by the higher court.[17]

Still, Justice Jennings wanted to make his own view clear:

I respectfully disagree with the Texas Supreme Court’s unnecessarily broad interpretation and application of the TCPA to matters that exceed its expressly stated purpose to protect only the constitutional rights of free speech, to petition, and of association. A reasonable interpretation of the TCPA, when read in its entirety, reveals that it was never intended to apply to any of the claims at issue in this case. It should go without saying that communications allegedly made in furtherance of a conspiracy to commit theft of trade secrets and breaches of fiduciary duties do not implicate “citizen participation.”[18]

Justice Jennings went on cite the statute’s stated purpose “to encourage and safeguard the constitutional rights of persons to petition, speak freely, associate freely, and otherwise participate in government,” language indicating “the legislature intended to protect only constitutionally-protected freedoms that rise to such a level that they can be considered participation in government.”[19]

He acknowledged that the statute’s “awkward” definitions, standing alone, appear to include communications that are not constitutionally protected but said “we cannot read these definitions in isolation.” While the plain meaning is the best expression of legislative intent, that is not the case when “a different meaning is apparent from the context or the plain meaning leads to absurd or nonsensical results.”[20]

In Justice Jennings’ view, the broad definitions in the TCPA should be limited by the statute’s expressly-stated purpose of safeguarding constitutional rights. “Here, unfortunately, the Texas Supreme Court, in construing the TCPA by focusing like a laser on the literalness of the bare words of its pertinent definitions, has effectively strangled the real meaning and purpose of the statute.”[21]

But again, Justice Jennings was careful to concede that the Court of Appeals is bound by the decisions of the Texas Supreme Court. That’s why he wrote a concurring opinion rather than a dissent.

So what is to be done? Justice Jennings urged two potential solutions: (1) the legislature should revise the TCPA’s definitions to include qualifying language repeating the stated purpose of the TCPA to protect constitutional rights, and (2) the Texas Supreme Court should “revisit and correct is overly-broad interpretation of the TCPA.”[22]

Those sound like reasonable suggestions. But convincing the Texas Supreme Court to change its approach sounds like an uphill battle. And the legislature? Who knows. I’m not sure there’s any powerful interest group that has enough of a stake in reigning in the TCPA. Maybe business groups who want to make it easier to protect trade secrets and stop employees from competing?

But in the meantime, as we’ve already seen, the Gaskamp opinion suggest a simpler way to limit the application of the TCPA to departing employee litigation.

A textualist solution to the TCPA problem?

The solution I have in mind is right out of Shakespeare. The Merchant of Venice teaches us that when the bad guy goes textualist, the way to beat him is to go hyper-textualist. When Shylock insists on enforcing the plain meaning of a “pound of flesh,” Portia responds that his contract means exactly a pound—no more, no less. And only a pound of “flesh”—nothing else.

The commercial-speech exemption applied in Gaskamp could offer plaintiffs in departing employee cases a similar way out of the TCPA. The exemption applies when the defendant’s “statement or conduct” arises out of the sale or lease of goods or services.

What if we apply that definition literally? One could argue that a departing employee’s use or disclosure of the employer’s trade secrets always arises from the sale or lease of goods or services. What the TCPA giveth as “communication,” it taketh away as “commercial speech.”

Maybe that could work. But strangely enough, the Texas Supreme Court has not construed the commercial speech exception literally, instead adopting a four-part test based on the “context” of the exemption. See Castleman v. Internet Money Ltd., 546 S.W.3d 684, 688 (Tex. 2018).

What’s up with that?

*Update: The Dallas Court of Appeals later rejected a literal application of the TCPA and held that an element of public participation is required. See Metroplex Courts Push Back on Broad Application of the TCPA. Then the legislature and the Fifth Circuit carved back the TPCA even more. See how the story ends at Shrinkage: TX Legislature and 5th Circuit Cut the TCPA Down to Size.

___________________________________________________________________

IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. So far no videos of him dancing on a rooftop in college have surfaced.

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] Tex. Civ. Prac. & Rem. Code § 27.001(3), (7).

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

[3] The realists—another camp!—might question how many “textualists” actually do this in practice when applying the literal text would yield a result they don’t like. But in theory this is what the true textualist is supposed to do.

[4] ExxonMobil Pipeline Co. v. Coleman, 512 S.W.3d 895, 901 (Tex. 2017).

[5] Adams v. Starside Custom Builders, LLC, 547 S.W.3d 890, 894-97 (Tex. 2018).

[6] Elite Auto Body LLC v. Autocraft Boywerks, Inc., 520 S.W.3d 191, 205 (Tex. App.—Austin 2017, pet dism’d).

[7] Id. at 204.

[8] Id. at 206 n.75.

[9] Craig v. Tejas Promotions, LLC, 550 S.W.3d 287, 296-97 (Tex. App.—Austin 2018, pet. filed). See also Grant v. Pivot Tech. Solutions, Ltd., 556 S.W.3d 865, 881 (Tex. App.–Austin 2018, pet. filed) (TCPA applied to claims similar to those in Elite Auto Body based on hiring of competitor’s employees and alleged sharing and use of confidential information).

[10] Morgan v. Clements Fluids South Texas, Ltd., No. 12-18-00055-CV 2018 WL 5796994, at *3 (Tex. App.—Tyler Nov. 5, 2018, no pet. h.).

[11] Gaskamp v. WSP USA, Inc., No. 01-18-00079-CV, at *1-3 (Tex. App.—Houston [1st Dist.] Dec. 20, 2018).

[12] Id. at *11.

[13] Id. at *12 (citing Tex. Civ. Prac. & Rem. Code §§ 27.001(2), (3), 27.003(a)).

[14] Id. at *9.

[15] Id. at *13.

[16] Id.

[17] Id.

[18] Id. at *14 (citation omitted).

[19] Id.

[20] Id. at *15 (citing Molinet v. Kimbrell, 356 S.W.3d 407, 411 (Tex. 2011)).

[21] Id. at *16.

[22] Id.

Texas Trade Secrets 101 2.0

Texas Trade Secrets 101 2.0

Ready for an early Christmas present?

I originally published my “Trade Secrets 101” memo in Trade Secrets 101: What Texas Businesses and Lawyers Need to Know. I designed it to give Texas businesses and their lawyers a helpful overview of Texas and federal trade secrets law.

With generous help from lawyer Paul T. Freeman, I have now updated that memo. You can download the new version here.

Regrettably, the new version is longer. But it has significant improvements, including:

  • More case cites
  • A new section on TCPA motions to dismiss
  • Less of my unsupported editorializing

Finally, despite my general preference, the case cites have been moved to footnotes. Don’t @ me.

___________________________________________________________________

IMG_4571

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC.

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.

 

 

 

It’s Alive, It’s ALIVE! How to Kill a TCPA Motion in a Trade Secrets Lawsuit

It’s Alive, It’s ALIVE! How to Kill a TCPA Motion in a Trade Secrets Lawsuit

It’s Franken-steen

First let’s get something out of the way. The Texas Citizens Participation Act (TCPA) is a Frankenstein’s monster that the legislature created and now needs to reign in (not that they listen to me).

As I explained in a three-part series back in the summer of 2017, the TCPA grants defendants in certain cases the unusual right to require the plaintiff to prove its case before taking any discovery. In litigator jargon, it effectively lets the defendant file a “no-evidence” motion for summary judgment without first requiring an adequate time for discovery.

The statute was intended to curtail “SLAPP” lawsuits, e.g. where a big company sues a “little guy” in retaliation for exercising his right to publicly criticize the company. The idea was to stop litigation bullies from using groundless lawsuits to grind ordinary people into submission under the weight of crushing legal fees.

But the legislature in its wisdom used broad language in the TCPA, and the Texas Supreme Court applies the plain meaning of statutes (in theory). So the TCPA has taken on a bizarre life of its own. It can apply to just about any kind of lawsuit, including “departing employee” lawsuits where a company claims its former employees misappropriated trade secrets or other confidential information.

This really makes no sense. There is no compelling public policy reason why some defendants should have a right to file a motion to dismiss before any discovery takes place and others should not, depending on whether the lawsuit falls under the byzantine definitions in the TCPA.

Might this have been avoided by construing the statute “liberally”–rather than literally–as the statute itself tells courts to do?[1]

Maybe. But that ship has sailed. As Justice Pemberton wrote in a recent dissent, Texas courts now apply the TCPA as written, even when the implications “sound crazy.” As he noted, unintended consequences are likely when courts interpret statutes “superficially in a mistaken perception of plain-meaning textualism.”[2] So here we are.

The bottom line is that the TCPA will apply to most trade secrets lawsuits in Texas state court. And maybe in federal court too.

This raises several strategic questions in a Texas trade secrets lawsuit:

1. Can the plaintiff avoid the TCPA by filing the trade secrets lawsuit in federal court under the federal trade secrets statute?

2. Can the plaintiff in a trade secrets suit avoid the TCPA by “pleading around” it?

3. When should the defendant in a trade secrets case file a TCPA motion to dismiss?

4. What evidence does a trade secrets plaintiff need to offer to defeat a TCPA motion to dismiss?

In the words of MC Hammer, let’s “break it down.”

Some trade secrets strategery

First, it’s possible that the plaintiff may be able to avoid the TCPA by filing the trade secrets lawsuit in federal court rather than state court. The federal Defend Trade Secrets Act (DTSA) allows a plaintiff to file a trade secrets lawsuit in federal court as long as the case has some connection to interstate or foreign commerce, which means virtually every case.

Courts are divided about whether the TCPA applies in a federal case, and the Fifth Circuit has not yet resolved the issue.[3] It turns on whether the TCPA is considered “procedural” or “substantive,”[4] which is kind of like asking whether the Beatles were a rock band or a pop band.

Law professors and people who were on law review love this kind of question. Personally, I’m less intrigued. I initially assumed the TCPA was procedural and would not apply in federal court, but there are people smarter than me who argue it is substantive, and I’ll concede you can make a reasonable case for that. (If you want more details on this issue see the good summary in this Law360 article by April Farris and Matthew Zorn.)

If I had to predict, I’d say the Fifth Circuit will hold that the TCPA does not apply in federal court. But for now it remains an open question.

That means that filing your trade secrets lawsuit in federal court won’t necessarily get you out of the TCPA woods. Your choice of state or federal court will likely depend on other considerations, i.e. whether you prefer a judge appointed for life who can do whatever the *#$% he wants, or a judge with no experience who got swept into office because he picked the right political party.

Regardless of where you file your trade secrets suit, you can try to avoid a TCPA motion by pleading around the TCPA. Without getting too much into the weeds, the TCPA applies to claims that relate to “communications” about a matter of public concern. So one theory is that the plaintiff in a departing employee case can avoid the TCPA by pleading only use of the trade secrets rather than disclosure of the trade secrets. Disclosing a trade secret to the new employer is obviously “communicating” the information, so just don’t say anything about disclosure.

That’s what I mean by “pleading around” the TCPA. But this may be easier said than done. Even if the plaintiff does not expressly plead that the employee disclosed the trade secrets to the new employer, that allegation will often be implied.

Plus, the mere allegation that the employee has joined another company and used the plaintiff’s trade secrets may be enough to ensnare the plaintiff in the TCPA’s definitional web. The TCPA covers “a communication between individuals who join together to collectively express, promote, pursue, or defend common interests.”[5] Arguably, any time an employee goes to work for a competitor, there is necessarily going to be communication between employee and employer to “collectively . . . pursue . . . common interests.”

So, omitting allegations of trade secrets disclosure from your pleadings may not be sufficient to avoid the TCPA.

Defense wins championships

Now let’s look at it from the other side. If you represent the defendant in a trade secrets case, should you file a motion to dismiss under the TCPA? I see three potential benefits:

(1) obviously, the potential early dismissal of the lawsuit;

(2) smoking out the plaintiff and making him put his cards on the table (talk about mixed metaphors); and

(3) slowing down the plaintiff’s momentum.

Also, if you win the motion you have the right to recover legal expenses “as justice and equity may require.”[6]

The potential downside of filing a TCPA motion in a trade secrets case is that, if the court finds your motion was “frivolous or solely intended to delay,” you will lose the motion and be ordered to pay the plaintiff’s attorneys’ fees for responding to the motion.[7] That’s a momentum shift like throwing a pick-six in the first quarter.

So, deciding whether to file a motion to dismiss a trade secrets case will likely come down to whether you think the plaintiff has enough evidence to prove the claim.

This gets us to the last question: if the defendant files a motion to dismiss, what evidence does the plaintiff need to offer to defeat the motion?

As a threshold matter, the plaintiff can try to prove the TCPA does not apply to the lawsuit. But if the TCPA applies, the plaintiff will need to offer evidence of three essential elements:

(1) the information at issue is a “trade secret”;

(2) the defendant “misappropriated” the trade secret; and

(3) the misappropriation caused some injury to the plaintiff.

I cover the key points of these elements in my Trade Secrets 101 memo (soon to be updated and published in the Texas Journal of Business Law). And a recent opinion from the Tyler Court of Appeals provides a roadmap for offering evidence to support these elements.

But if that salt has lost its flavor . . .

In Morgan v. Clements Fluids South Texas, three employees left Clements, an oil and gas services company, to work for two competitors. Clements claimed it trained the employees on its proprietary system for well completion and production called “salt systems.” It sued the former employees in state court for breach of their NDAs and misappropriation of trade secrets, and the employees filed a motion to dismiss under the TCPA.[8]

The defendant employees met their initial burden to show that the trade secrets claim was factually predicated on conduct that falls within either the “exercise of the right of association” or the “exercise of free speech,” as defined by the TCPA. The court reasoned that the claim was “based on, relates to, or is in response to,” at least in part, the employees’ communications among themselves and within the competitors through which they allegedly “shared or utilized” the alleged trade secrets.[9]

The court then turned to the plaintiff’s burden to establish by “clear and specific” evidence a prima facie case for each element of its trade secrets claim. The TCPA “does not impose an elevated evidentiary standard,” the court said, “and circumstantial evidence and rational inferences may be considered.”[10]

To prove the information at issue was a trade secret, Clements claimed it had a confidential method for salt systems that gave it a competitive advantage. Its vice president signed an affidavit stating that Clements invested millions of dollars for almost 33 years on research, development, training, and testing of its salt systems, that its system was not available through any outside source, that the system was not available outside the company, and that the system had made Clements the industry leader. The Court of Appeals concluded this was sufficient “clear and specific” evidence of a trade secret.[11]

Whether the employees misappropriated the trade secrets was a closer call. The defendants argued that Clements failed to prove misappropriation because it did not show the employees actually used the trade secrets. The employees signed affidavits denying that Clements provided them with any training they did not have before working for Clements, and denying they shared any Clements information with any third party.[12]

But the court found that Clements offered sufficient evidence of misappropriation to avoid dismissal. Specifically, Clements established:

(1) The employees had no experience in salt systems before working for Clements.

(2) Clements trained the employees to perform salt systems and disclosed its proprietary formula to them.

(3) The employees left Clements to go to a company, Greenwall, that was not doing salt systems.

(4) Shortly after that, Greenwell launched a salt systems business, announcing it in a website post authored by one of the employees.

(5) Greenwell then performed a salt systems job for Pioneer, one of Clements’ customers.

“Given Clements’ description of the time, money, and effort dedicated to the development of its salt systems,” the court said, “it is reasonable to conclude from the totality of the circumstantial evidence that [the employees] used Clements’ proprietary and confidential information in concert with Greenwell to launch its salt systems business.”[13]

Finally, Clements had to offer evidence it was injured by the trade secrets misappropriation. “The burden of proof on damages for misappropriation of trade secrets is liberal,” the court said, “and is satisfied by showing the misappropriation, the defendant’s subsequent commercial use, and evidence by which the jury can value the rights the defendant obtained.” The Texas Supreme Court does not require the plaintiff to establish a specific amount of damages in response to a TCPA motion. Clements was only required to offer evidence supporting a “rational inference as the existence of damages, not their amount or constituent parts.”[14]

The defendants argued that Clements failed to link its loss of the Pioneer job to the alleged misappropriation of trade secrets, but the court disagreed. Greenwell did not previously do salt systems jobs, it performed a salt systems job for Pioneer shortly after the Clements employees joined, and Clements had previously performed all of Pioneer’s salt systems jobs. This was sufficient circumstantial evidence to link the alleged misappropriation to Clements’ loss of Pioneer’s business, establishing an injury to Clements.[15]

The Morgan case teaches us that, while speculation and assumption are not evidence of trade secret misappropriation, you don’t need surveillance camera footage of the employee handing over the secret formula either. It’s enough to offer circumstantial evidence creating a reasonable inference that an employee has used the information to help a competitor take business from the plaintiff.

But Morgan was somewhat unusual. The plaintiff had actual evidence of a secret method that other competitors (allegedly) did not know or practice.

Most trade secrets cases don’t have this. The typical case involves “soft” trade secrets like customer lists, prices, and customer information. And usually the two competitors both do the same kind of non-confidential business before and after the employee changes jobs. In these cases, the fact that a customer follows an employee from one company to another doesn’t necessarily prove the employee used any confidential information. It could just mean the employee has a good relationship with the customer.

So plaintiffs in soft trade secrets cases beware. You will probably need “something more” than losing a customer to defeat a TCPA motion. At least until the legislature fixes the monster it created.

*Update: See also McDonald Oilfield Operations, LLC v. 3B Inspection, LLC, No. 01-18-00118-CV, 2018 WL 6377432 (Tex. App.–Houston [1st Dist.] Dec. 6, 2018) (reversing trial court’s denial of TCPA motion to dismiss in departing employee case involving competitors in the pipeline monitoring business). 

*Further Update: The legislature later amended the TCPA to exempt trade secret claims. See how the story ends at Shrinkage: TX Legislature and 5th Circuit Cut the TCPA Down to Size.

___________________________________________________________________

IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Most of his posts don’t have so many footnotes.

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] Tex. Civ. Prac. & Rem. Code § 27.011(b) (“This chapter shall be construed liberally to effectuate its purpose and intent fully”).

[2] Hawxhurst v. Austin’s Boat Tours, 550 S.W.3d 220, 233-35 (Tex. App.—Austin 2018, no pet.).

[3] Thoroughbred Ventures, LLC v. Disman, No. 4:18-CV-00318, 2018 WL 3472717, at *3 (E.D. Tex. July 19, 2018).

[4] Even if the TCPA is substantive, it may not apply in federal court because it conflicts with Federal Rules of Civil Procedure 12 and 56. Id. at *3.

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

[6] See Tex. Civ. Prac. & Rem. Code § 27.009(a)(1). A successful movant also has the right to recover sanctions sufficient to deter the plaintiff from filing similar lawsuits, see § 27.009(a)(2), but it will probably be a rare trade secrets case where the court finds such sanctions are needed in addition to attorneys’ fees.

[7] See Tex. Civ. Prac. & Rem. Code § 27.009(b) (“If the court finds that a motion to dismiss filed under this chapter is frivolous or solely intended to delay, the court may award court costs and reasonable attorney’s fees to the responding party”).

[8] Morgan v. Clements Fluids South Texas, Ltd., No. 12-18-00055-CV, 2018 WL 5796994, at *1 (Tex. App.—Tyler Nov. 5, 2018, no pet. h.).

[9] Id. at *3.

[10] Id. at *4 (citing In re Lipsky, 460 S.W.3d 579, 586 (Tex. 2015)).

[11] Id. at *5-6.

[12] Id. at *7.

[13] Id. at *8. However, as to a third employee, Laney, the court held that Clements did not meet its burden. Unlike the evidence concerning the first two employees, Clements offered no evidence, circumstantial or otherwise, that Laney disclosed or used the trade secrets at his subsequent employer, ChemCo. And there was no evidence of whether Chemco had performed salt systems before, or that Laney performed any salt systems jobs with ChemCo. Id.

[14] Id.

[15] Id. at *8-9.

When Is a Customer List a Trade Secret?

When Is a Customer List a Trade Secret?

Imagine if I said to every salesperson in Texas: I don’t care whether you signed a non-compete or not. If you quit your job and try to take your customers with you to a new company, your original employer can sue you in federal court and get an injunction to prevent you from contacting any of your customers.

That would amount to saying every salesperson has a de facto non-compete.

Surely this cannot be true, right? But here’s how you get there:

  1. Almost every salesperson has some kind of list of his own customers, even if it’s just contacts on a smartphone. The salesperson knows the identity of the customers, their contact information, what they buy, and the prices they pay.
  2. A customer list is a trade secret under both the Texas Uniform Trade Secrets Act (TUTSA) and the federal Defend Trade Secrets Act (DTSA).
  3. Under the DTSA, the employer can file a trade secrets claim in federal court.
  4. The court can enter a preliminary injunction barring the salesperson from contacting anyone on the customer list.
  5. If the salesperson can’t contact his customers, the effect is about the same as a reasonable non-compete.

Hey, you had a good run, sales people. But you’re stuck where you work now, unless your employer agrees you can leave.

Wait. Is it really that bad?

Not quite. Because I’ve overstated one step in the analysis above: Step no. 2. A sales person’s customer list can be a trade secret, but it’s not always a trade secret. It depends.

That gives judges an important role. It’s up to them to police the boundary between when a customer list is a trade secret and when it isn’t. If judges set the bar too low for giving trade secret protection to a customer list, the result will be what I said: de facto non-competes for all sales people.

The Austin Court of Appeals made this very point the Trilogy Software case: “[I]nformation that a firm compiles regarding its customers may enjoy trade secret status under Texas law. But this does not mean that trade secret status automatically attaches to any information that a company acquires regarding its customers; if it did, it would amount to a de facto common law non-compete prohibition.”[1]

So, preservation of American free enterprise as we know it depends on courts holding companies to their burden of proof when they claim that customer lists are trade secrets.

To prove the customer list is a trade secret, the company has to show three things:

(1) the customer list has “independent economic value”

(2) it is not “readily ascertainable” by competitors

(3) the employer took “reasonable measures” to keep it secret

It’s usually not that hard to establish element no. 3, reasonable measures. Did the company avoid sharing the information publicly, require employees to sign confidentiality agreements, and maintain password protection on company computers? Those things are typically enough.

What about element no. 1, “independent economic value”? That’s a harder one. But it’s usually going to follow from element no. 2. If the customer list is not readily ascertainable by a competitor, that’s a good sign it has independent economic value. If it was readily ascertainable, it wouldn’t have much value.

One warning: there are still some Texas cases that say a readily ascertainable customer list can be a trade secret. This is a mistake, for reasons I explained in my longest-titled blog post ever, Customer List Confusion: The Pesky Persistence of the Brummerhop Rule in Texas Trade Secret Litigation.

No, a readily ascertainable customer list is not a trade secret. But how readily is “readily”? It is of course a matter of degree. If a competitor could compile the same list from spending a day running Google searches, that’s probably “readily” ascertainable. If it would be extremely difficult to compile the list from public sources, that’s not readily ascertainable. Most cases fall in the middle. It’s going to be a fact-intensive issue.

That means it will often be a fact question for either the jury (at trial) or the judge (at a temporary injunction hearing). In those cases, the jury verdict or judge’s ruling will hold up as long as there is at least a little evidence to support it.

For example, in Amway Corp. v. bHIP Global, Inc., there was testimony that the customer contacts and information the employee provided were his own contacts he had previously developed. This was sufficient evidence to support the jury’s conclusion that the information was not a trade secret.[2]

Conversely, in 360 Mortgage Group, LLC v. Homebridge Financial Services, Inc., No. A-14-CA-00847-SS, 2016 WL 900577, at *4 (W.D. Tex. Mar. 2, 2016), there was sufficient evidence that the customer list was a trade secret. The fact that the employee emailed herself a copy of the broker list was evidence the list was not readily available elsewhere. And the list provided more than simply names and addresses. It also included compensation rates that could be used to “undercut” the employer. (See also The Price Undercutting Theory in Trade Secrets Litigation.)

As these cases illustrate, whether a customer list is a trade secret often presents a fact issue. But in some cases, the undisputed facts will establish as a matter of law that the customer list is not a trade secret.

For example, in Alliantgroup, LP v. Feingold, the court granted summary judgment that a client list was not a trade secret. It was undisputed that the client list was very short (under 15 names), the information was limited, and the names were readily ascertainable.[3]

Parker Barber & Beauty Supply, Inc. v. Wella Corp. was a similar case involving, strangely enough, the barber and beauty supply industry. The court held that “basic customer contact and limited sales information” that the company provided about 39 of its customers was readily ascertainable and therefore not entitled to trade secret protection.[4]

In Numed, Inc. v. McNutt, Numed argued that its pricing structure, marketing research, customer lists, and renewal dates were trade secrets. But the court disagreed: “The evidence reflects much of the information Numed wishes to protect is not secret. Instead, it is contained in the contracts distributed to Numed’s customers, which in turn may be discovered by anyone.”[5] This was a pre-TUTSA case, but the principle should still apply.

Finally, Guy Carpenter & Co. v. Provenzale was a pre-TUTSA case where the federal district court denied the employer’s motion for a preliminary injunction, and the employer appealed. The Fifth Circuit, applying Texas law, noted that a “customer list of readily ascertainable names and addresses will not be protected as a trade secret,” citing numerous cases. The court then said:

. . . the district court implicitly found the customer lists were readily ascertainable. We agree. Evidence in the record indicates participants in the reinsurance market freely disclose the identity of their reinsurance broker and the nature of the reinsurance products they regularly consume. We also note that Provenzale’s list of customers was relatively short—it included only those companies he personally serviced while at Guy Carpenter. He could easily reconstitute this list even without the aid of a trade publication. Even though Guy Carpenter took steps to protect its customer list and Provenzale signed a contract stating the customer list was confidential, we conclude the customer list was not a trade secret because it was readily ascertainable.[6]

So, if the employee offers evidence like this, the court may reject trade-secret status of the customer list as a matter of law.

These cases suggest some good deposition questions to ask if you are the lawyer representing the employee:

  • How long is the employee’s customer list in comparison to the entire customer list for the company?
  • Does the company require all of its customers to keep their transactions with the company secret? If not, how is the identity of the customers a secret?
  • Do customers freely share the identity of companies they buy from?
  • Could the employee easily reconstruct her short customer list? If so, doesn’t that suggest the information is readily ascertainable?
  • Are you saying a competitor would pay real money for this customer list? If not, how can you say it has “independent economic value”?

These can be tough questions for the company. But the company’s lawyer always has the best comeback: if the customer list is readily ascertainable and doesn’t have any economic value, why did the employee take it?

*Update: In Marek Brother Systems, Inc. v. Enriquez, No. 3:19-CV-01082, 2019 WL 3322162, at *4 (N.D. Tex. July 24, 2019), the court applied Trilogy Software and held that the plaintiff failed to persuade court that customer information the employee sent to his personal email address was not readily ascertainable.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow him on Instagram at @zachwolfelaw to keep up with his latest shenanigans.

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] Trilogy Software, Inc. v. Callidus Software, Inc., 143 S.W.3d 452, 463 (Tex. App.—Austin 2004, pet. denied) (emphasis added).

[2] Amway Corp. v. bHIP Global, Inc., No. 4:10-CV-549, 2013 WL 2355083, at *2 (E.D. Tex. May 29, 2013).

[3] Alliantgroup, LP v. Feingold, 803 F.Supp.2d 610, 626 (S.D. Tex. 2011).

[4] Parker Barber & Beauty Supply, Inc. v. Wella Corp., No. 03-04-00623-CV, 2006 WL 2918571, at *17 (Tex. App.—Austin Oct. 11, 2006) (mem. op.).

[5] Numed, Inc. v. McNutt, 724 S.W.2d 432 (Tex. App.—Fort Worth Feb. 5, 1987, no writ).

[6] Guy Carpenter & Co. v. Provenzale, 334 F.3d 459 (5th Cir. 2003).

FBI Nabs Apple Trade Secrets Thief

FBI Nabs Apple Trade Secrets Thief

You may have heard about Xiaolang Zhang. He’s the Apple engineer who was about to board a plane to China before being arrested by FBI agents and charged with theft of trade secrets under Title 18, United States Code, Section 1832. His new employer, Xpeng Motors, denied any knowledge of trade secret theft.

Rather than recount the details reported by the press, this week on Five Minute Law we’re traveling into the future to hear opening statements in the civil lawsuit to be filed in federal court under the Defend Trade Secrets Act.

SCENE: Courtroom, Robert F. Peckham Federal Building & United States Courthouse, San Jose, California, USA.

THE COURT: Ok, we’re on the record on July 14, 2020, in Case No. 18-CV-78745, Apple, Inc. v. Xpeng Motors. Ladies and gentlemen of the jury, we are now going to hear opening statements from the lawyers. Ms. Cunningham, are you ready to proceed?

MS. CUNNINGHAM: Yes, Your Honor.

Ladies and gentlemen, this is a case about cheating. Not cheating at sports or cheating on your spouse, but cheating at business. Specifically, the business of self-driving car technology. You all know my client, Apple. It’s the best-known technology company in the world. It got there through hard work and innovation.

But some companies want to take shortcuts. Rather than doing the hard work to develop their own technology, they want to cheat and ride the coattails of others. The evidence will show that the defendant, Xpeng Motors, is one of those companies.

Xpeng was founded in 2014 in Guangzhou, China to develop electric self-driving vehicles. It is backed by some of the biggest Chinese companies in the world. It has a lot of smart people working for it, but in 2016 Xpeng decided that wasn’t enough. They needed a boost.

Now you all know about the iPhone and the MacBook, but that’s not all that Apple does. Apple also has a division working round the clock to develop software and hardware for autonomous vehicles. That means self-driving cars.

Back in 2016, Apple had made general statements to the press about self-driving car technology, but the details were a closely guarded secret. The code name was Project Golden Delicious.

This project involved thousands of engineers. One of those engineers was Mr. Xiaolang Zhang. Apple hired Mr. Zhang in December 2015 as a hardware engineer on the Compute Team, where he designed and tested circuit boards to analyze sensor data for the project.

Apple is very serious about making sure people like Mr. Zhang don’t publicize Apple’s secret technology and future product plans. The evidence will show that Apple takes extensive efforts to protect its trade secrets.

Before starting, corporate employees must sign an Intellectual Property Agreement that prohibits any unauthorized use or transmission of Apple’s intellectual property. Apple provides employees annual training on the importance of protecting its confidential information. Mr. Zhang signed one of these agreements and attended the annual training, so he was fully aware of his obligations to protect Apple’s intellectual property.

Apple was especially serious about protecting the secret technology it was developing in Project Golden Delicious.

Apple had several layers of access control for project information. First, Mr. Zhang had to log in to the company’s virtual private network, which they call the “VPN.” Next, another employee had to grant him disclosure rights for the project.

Then, Apple used an internal software tool to manage requests for project disclosure and maintain a record of all disclosures. For Mr. Zhang to get access to the project, another employee had to “sponsor” him and give a business justification. A manager had to review and approve that request. So, access was strictly on a “need to know” basis.

After granting Mr. Zhang general access to the project, Apple then gave him even higher access to the secret project database. He worked on the project for about a year and a half, learning about Apple’s secret autonomous vehicle technology the whole time.

This was a huge privilege for Mr. Zhang. Just imagine having the keys to the vault where you could find top-secret technology for the most cutting-edge industry in the world.

But what did Mr. Zhang do with this privilege? The evidence will show that he betrayed Apple. And he did not act alone.

Sometime prior to April 2018, Mr. Zhang got in touch with Xpeng Motors. We don’t know exactly when or where, because Mr. Zhang pled the Fifth.

MR. CROCKETT: Objection! Your Honor, may we approach? [bench conference ensues with animated body language]

MS. CUNNINGHAM: As I was saying, we know Mr. Zhang got in touch with Xpeng Motors at some time before April 2018. You see, Mr. Zhang took advantage of Apple’s generous paternity leave policy from April 1 to April 28, 2018. While on paternity leave, he traveled to China. Funny thing is, that’s where Xpeng Motors has its headquarters.

Then on April 30, 2018, shortly after returning from China, Mr. Zhang suddenly announced—these announcements are always “sudden”—that he was moving back to China to be with his mother who was in poor health. Oh, and one more thing. He told his immediate supervisor at Apple he was going to work for Xpeng Motors.

You can imagine the alarm bells this set off at Apple. Mr. Zhang’s supervisor called in Apple’s New Product Security Division, who met with Mr. Zhang and took custody of his two iPhones and his MacBook laptop. Apple then immediately disabled his access to Apple’s network and offices.

Apple did a forensic analysis of Mr. Zhang’s devices, and guess what they found? Just days before Mr. Zhang announced he was leaving, his Apple network activity increased exponentially. It included both bulk searches of the secret project database and targeted downloading of specific files.

These files included technical documents on Apple prototypes and prototype requirements, such as power requirements, low voltage requirements, battery system, and drivetrain suspension mounts. You will hear Apple’s expert witness testify that these secret technical documents would have great independent economic value for a competitor in the self-driving car field.

But that’s not all. You will see security camera video showing Mr. Zhang on Apple’s campus at 9:14 p.m. on the evening of Saturday, April 28, 2018. You’ll see him enter Apple’s autonomous vehicle software and hardware labs and leave the building less than an hour later carrying a computer keyboard, some cables, and a large box.

Was he just working late, burning the midnight oil? Keep in mind he was on paternity leave at this time, and he announced his resignation just two days later. The evidence will make it pretty obvious what he was doing.

But don’t take my word for it. You will hear testimony that Mr. Zhang was interviewed both by Apple security and the FBI. And he admitted it. He admitted pursuing employment with Xpeng Motors while still employed by Apple. After initially denying it, he admitted he was on the Apple campus on April 28. He admitted taking online data from the secret project database while on paternity leave.

It gets worse. Mr. Zhang admitted “air-dropping” the data he took from Apple’s system on to his wife’s laptop computer. When Apple examined that computer, it found that a folder titled “RECENT” contained 40 Gigabytes worth of data, and the laptop’s system event logs reflected “Air Drop” activity on April 29 and 30. And 60 percent of the data on the computer came from Apple.

One of the files Mr. Zhang put on his wife’s laptop was especially important. We call it the “X-File.” The X-File contained top-secret electrical schematics for one of the circuit boards Apple was developing for the project.

Now, why do you think Mr. Zhang was doing all this? Was he going to use all this secret technology by himself? That doesn’t make any sense.

The evidence will show that immediately after leaving Apple, Mr. Zhang went to work for Xpeng Motors at its headquarters in Palo Alto. Then on July 7, he bought a last-minute round-trip ticket to China. And he might have gotten away with it too, if FBI agents hadn’t arrested him just after he got through the security checkpoint at Terminal B.

After you hear all the evidence, the inescapable conclusion will be that Mr. Zhang was working with Xpeng Motors to take Apple’s secret technology.

And that’s cheating. Thank you.

THE COURT: Thank you, Ms. Cunningham. Mr. Crockett, are you ready to proceed? . . . Mr. Crockett?

MR. CROCKETT: Oh, sorry. Yes, Your Honor.

Ladies and gentlemen of the jury, I’m impressed. That was quite an opening by Ms. Cunningham. I don’t know if I can compete with that. I mean, I didn’t go to Harvard like she did. I’m just an old trial lawyer.

But I tell you what. These old hearing aids still work pretty good, and I was using them while Ms. Cunningham was talkin’. And it’s not what I heard that’s important, it’s what I didn’t hear.

Let me give y’all an example. I didn’t hear her say anything about having any evidence that Xpeng Motors was in cahoots with Mr. Zhang when he did all that sneaky stuff during his paternity leave. Did you hear her say anything about any evidence that anybody at Xpeng Motors put Mr. Zhang up to it? I didn’t.

You know what else I didn’t hear? I didn’t hear anything about any evidence that Mr. Zhang ever—ever—gave any of those top-secret Apple documents to anyone at Xpeng Motors.

Now, when we get to the end of this trial, you’re going to get some papers from the judge that we call a charge. And that charge is going to have a lot of complicated instructions about stuff like “misappropriation.”

Now, back when I was flying helicopters in Vietnam, we didn’t use a lot of fancy words like “misappropriation,” but I know what stealing is. And that’s basically what misappropriation means: stealing. And I’ll make you a bet. I bet during this whole trial you won’t hear any evidence that my client, Xpeng Motors, stole anything from Apple.

You know what else you’re not going to hear? I’ll bet you dollars to donuts you won’t hear any evidence that Apple lost any money because of anything Xpeng Motors did. Now they’ve got this nice man with a Ph.D who’s going to come in and say there’s no way Xpeng could have developed its self-driving car technology without Apple’s schematics. So when they don’t have any real evidence, they’re going to rely on some professor getting paid $750 an hour. Well, we have a saying back in Texas where I grew up: that dog won’t hunt.

Now, I’ll level with you on something. You’re going to see some internal emails from Xpeng Motors talking about how they’re going to make their self-driving car technology more like Apple’s and beat Apple at its own game. But that’s not stealing, that’s competition. That’s the American way. If you can build a better mouse trap, you get the cheese.

Or the apple. [wink]

THE COURT: Thank you, Mr. Crockett. Ms. Cunningham, call your first witness.

*Update* You can read the indictment of Zhang here. As of June 2019, his criminal case has not yet gone to trial, and it appears that Apple has not yet brought any civil suit against XPeng. But XPeng is now involved in a similar trade secrets dispute with Tesla, as reported by The Verge here. In Tesla, Inc. v. Cao (N.D. Cal.), Tesla served a subpoena for documents on XMotors, XMotors filed this Motion to Quash, and Tesla filed this Response.

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IMG_4571

Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfe on Instagram to keep up with his latest shenanigans. 

He made up the names “Project Golden Delicious” and “X-File,” and the stuff about what Xpeng Motors did. The rest of the facts are taken from press reports and the FBI agent affidavit attached to the Criminal Complaint in U.S. v. Xiaolang Zhang, No. CR-18-70919, U.S. District Court for the Northern District of California.

 

The Price Undercutting Theory in Trade Secrets Litigation

The Price Undercutting Theory in Trade Secrets Litigation

You can’t take him anywhere: Five Minute Law goes to a cocktail party

[COVID-19 update: Five Minute Law goes to a Zoom hangout]

Hi, I’m Zach Wolfe.

Good to meet you Zach, I’m Travis Austin. So what do you do?

I’m a lawyer. I do business litigation.

Oh, my cousin’s a lawyer. I think he does corporate law. What kind of litigation do you do?

Mostly non-compete and trade secrets cases.

Trade secrets? That sounds interesting. Like patents?

Not really. [Wolfe pauses to think about whether he can explain without sounding pedantic.] Actually, a patent is kind of the opposite of a trade secret.

Oh, I didn’t know that.

Yeah, like if you file a patent on some new technology you invented, the patent filing makes it public to the world. 

Ok, I see. So if you keep the technology inside the company, it can be a trade secret?

Exactly.

So is that the kind of trade secret litigation you do?

Well, not that much. [Wolfe pauses again to decide whether to explain or change the subject to something less boring.] Most of my trade secret cases involve things like customer lists and prices.

Really? I didn’t think prices were trade secrets.

[Wolfe smiles, sensing an opportunity] They can be. I actually just wrote a blog post about that.

Oh, you have a blog? . . . [now all is lost]

A typical price undercutting scenario

So what’s the answer? Are prices really trade secrets?

It depends. Let’s consider a hypothetical.

Paula Payne Windows orders windows from manufacturers and sells them to residential and commercial builders. The profit is the spread between the cost of buying and shipping the windows and the price charged to the customer.

Dawn Davis is the most experienced sales person at Paula Payne Windows. One day Dawn meets the owner of Real Cheap Windows for margaritas. A month later, Dawn suddenly announces to Paula Payne—these announcements are always “sudden”—that she’s leaving the company to go to work for Real Cheap.

And here’s the hard part for Paula Payne: Dawn never signed any non-compete. In fact, she never even signed a routine confidentiality agreement. “When Dawn started, our whole company was just a little office with three phones and some computers,” the founder of Paula Payne Windows explains. “The last thing I was thinking about was legal documents.”

A few weeks later, it becomes obvious that Dawn’s customers have stopped placing orders with Paula Payne. And that’s not all. Paula Payne discovers that the day before leaving, Dawn emailed herself an Excel spreadsheet containing all of her sales for the previous 90 days, including (1) the name of the customer contact, (2) the window model numbers, (3) the price paid to the manufacturer, (4) the shipping cost, and (5) the price charged to the customer.

Paula Payne Windows sues Dawn Davis and Real Cheap, claiming misappropriation of Paula Payne’s trade secrets under the federal Defend Trade Secrets Act and the state Uniform Trade Secrets Act.

Specifically, Paula Payne claims that after joining Real Cheap, Dawn started selling to her previous customers at prices slightly lower than what customers were paying Paula Payne. “Dawn Davis is using the confidential pricing information in the spreadsheet to undercut Plaintiff and steal its customers,” Paula Payne alleges.

This is the common “price undercutting” theory in trade secrets litigation. It is common because while not every company has secret technology or a “secret sauce,” every business has customers and prices.

So, even if a company doesn’t require its employees to sign non-competes, the company can use trade secret law to try to stop a departing employee from competing, as long as it has customers and prices that are arguably confidential.

When are prices trade secrets?

Returning to the initial question, is that kind of information actually a trade secret?

Like any kind of information, prices charged to customers can be trade secrets, if:

(1) the price information has “independent economic value”

(2) the prices are not “readily ascertainable” by competitors

(3) the company took “reasonable measures” to keep the prices secret

These are the three essential elements of a “trade secret” under both the Texas and federal statutes. Like any type of information, price information that meets these elements can be a trade secret.[1]

carrots-cooking-food-40790
Lower prices. They cut like a knife.

But prices are not just any kind of information. Price competition is at the core of the free competition the law should encourage. We want businesses to “undercut” their competitors on price. We just don’t want them to use another company’s trade secrets to do it.

So it’s important for judges to hold companies to their burden of proving their price information meets the three elements needed for trade secret protection.

Let’s apply this to the Paula Payne Windows case. Paula Payne would argue that the detailed price information in the spreadsheet has “independent economic value” because Dawn can use it to undercut Paula Payne.

But Paula Payne Windows also has to prove the price information is “not readily ascertainable.” In this case, the spreadsheet contains prices charged to Paula Payne and prices charge by Paula Payne. Is it really that hard for a competitor to find out those prices?

To show the information is not a trade secret, Dawn’s lawyer will want to establish that:

– Paula Payne Windows has no agreements with the window manufacturers requiring the manufacturer prices to be kept confidential

– Prices charged by the manufacturers are available in industry publications, on the Internet, or simply by asking the manufacturer

– Paula Payne Windows has no agreements with its own customers requiring its prices to be kept confidential

– Paula Payne’s customers are willing to tell other window companies how much Paula Payne is charging them

These questions go to the heart of the elements of a trade secret. If Paula Payne doesn’t require its customers to sign confidentiality agreements, has it really taken “reasonable measures” to keep the prices secret? If manufacturers and customers are willing to disclose their prices, isn’t the information “readily ascertainable”?

Companies always want to say their prices are highly confidential and valuable, but that claim often doesn’t hold up to scrutiny.

And that’s not the only problem with the price undercutting theory.

Causation rears its ugly head

Let’s say Paula Payne Windows persuades a judge or a jury that the pricing information is a trade secret. That’s not the end of the story. Paula Payne also needs to prove that Dawn Davis used the information to make the sales to the customers. In other words, Paula Payne still has to prove causation.

Ah, causation. The bane of plaintiff’s lawyers everywhere.

You see, it’s not enough to prove the price information was a trade secret and that Dawn Davis sold windows to Paula Payne’s customers. Paula Payne must prove it was Davis’s use of the information—and not something else—that caused Paula Payne to lose the sales. See eCommission Solutions, LLC v. CTS Holdings Inc., No. 18-1672-cv, 2019 WL 2261457, at *2 (2d Cir. May 28, 2019) (while misuse of customer list can be unfair competition, there was no evidence that use of pricing info and customer list caused the plaintiff’s loss of customers).

This requires a counterfactual: imagine that Dawn Davis never took the spreadsheet with the prices. Would she have still made the sales?

To prove Dawn would have made the sales anyway, her lawyer will want to show:

– Dawn has longstanding personal relationships with her customers

– Dawn could have undercut Paula Payne Windows simply by asking the customers what Paula Payne Windows was charging them

– Price is not the only factor for the customers, or even the most important factor

– The customers ordered from Dawn because of their personal relationships

– Prices change daily or weekly, making the numbers in the spreadsheet quickly obsolete

– Dawn didn’t even look at the spreadsheet in making the sales

– In short, Dawn would have made the sales even if she hadn’t taken the spreadsheet.

Proving these points could negate the causation element of Paula Payne’s trade secrets claim.

Wait a minute, you might say. This isn’t fair. Dawn Davis developed goodwill with her customers on Paula Payne’s dime. That goodwill belongs to Paula Payne. Dawn shouldn’t be allowed to exploit it for the benefit of a competitor.

You would have a point. But goodwill is not a trade secret. See Am. Mortgage & Equity Consultants, Inc. v. Bowersock, No. 1:19-CV-492-RP, 2019 WL 2250170, at *5 (W.D. Tex. May 24, 2019) (customer relationships are not trade secrets). And there is really only one legal mechanism to protect goodwill: an enforceable non-compete.

But if there isn’t a non-compete, and the employee takes confidential information about the company’s prices, how do you sort out whether the employee made the sales because she had the price information, or because she had relationships with the customers?

Ask me next time you see me at a party.

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IMG_4571Zach Wolfe (zwolfe@fleckman.com) is a Texas trial lawyer who handles non-compete and trade secret litigation at his firm Fleckman & McGlynn, PLLC. Follow @zachwolfelaw on Instagram to keep up with his latest shenanigans.

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 Fox v. Tropical Warehouses, Inc., 121 S.W.3d 853, 859 (Tex. App.—Fort Worth 2003, no pet.) (a pre-TUTSA case citing price lists and customer lists as information entitled to trade secret protection until trial); T-N-T Motorsports, Inc. v. Hennessey Motorsports, Inc., 965 S.W.2d 18, 24 (Tex. App.—Houston [1st Dist.] 1998, pet dism’d) (same). See also SP Midtown, Ltd. v. Urban Storage, L.P., No. 14-07-00717-CV, 2008 WL 1991747, at *6 (Tex. App.—Houston [14th Dist.] May 8, 2008, pet. denied) (mem. op.) (evidence that customer and price information would allow competitors to slightly undercut plaintiff’s prices and take its business raised a fact issue on whether the information was a trade secret); In re Desa Heating, L.L.C., No. 2-06-088-CV, 2006 WL 1713489, at *2 (Tex. App.—Fort Worth June 22, 2006, orig. proceeding) (mem. op.) (affidavit testimony that competitors could use financial information to undercut company’s pricing to obtain its customers, while “somewhat conclusory and lacking in detail,” was sufficient to establish that information was entitled to trade secret protection in discovery).