Recoverable Damages in Trade Secret and Unfair Competition Claims
New York Law Journal
On May 3, New York’s highest court issued a decision clarifying the state’s common law on the extent of damages recoverable in cases asserting claims of misappropriated trade secrets, unfair competition and unjust enrichment. The Court of Appeals split 4-3. A frothy dissenting opinion bristles with evocative echoes of classical judicial skirmishes of long ago. Though the holding is important enough on the merits for litigators to digest, there is also some “entertainment” value in seeing how the jurists marshal their arguments. The subject matter is not easy but it is quite relevant in today’s litigious, technological world.
The decision is E.J. Brooks Co. v. Cambridge Security Seals, 2018 N.Y. LEXIS 1080 (N.Y. Ct. App, May 3, 2018). The court was responding to questions of law certified to it by the U.S. Court of Appeals for the Second Circuit. The federal appellate court was wrestling with an appeal filed from a federal district court judgment totaling $3.9 million in favor of a plaintiff (E.J. Brooks Co.) that sued defendant (Cambridge) for the latter’s misappropriation of a trade secret, unfair competition and unjust enrichment.
The pivotal damages issue upon which the Second Circuit sought guidance was whether, under New York law, a plaintiff in such cases “can recover damages that are measured by the costs the defendant avoided due to its unlawful activity.” The question sounds kind of technical but, in context, it is significant. So, let’s focus on the basic facts and issues but eschew elaborative detail in order to keep things simple.
Plaintiff is the largest U.S. manufacturer of “plastic indicative security seals.” They are called “indicative” because they have features that can “indicate” whether a seal has been tampered with, opened or damaged. Plaintiff had earlier acquired a company with a fully-automated process for manufacturing the seals. However, some employees defected to the defendant Cambridge, a rival manufacturer. Those employees brought the confidential, automated process with them and defendant used it to make the rival products.
Plaintiff sued defendant and the former employees in federal court in 2012 gaining a jury verdict of $1.3 million on each of the causes of action. Thus, the total damage award amounted to $3.9 million. The jury, however, rejected a claim for punitive damages. At trial, plaintiff sought to measure its damages by the costs defendant Cambridge had “avoided” when it misappropriated the trade secret.
In other words, according to an expert, Cambridge would have had to incur some $6 million to $12 million to develop the manufacturing process for its first generation machines, had it not used plaintiff’s trade secret. Thus, plaintiff’s claimed damages focused on defendant’s benefit from the tortious misconduct. But plaintiff did not proffer evidence of the losses it actually suffered or would likely suffer in the near future from the defendant’s use of the trade secret. Rather, the premise was that plaintiff’s actual losses approximated the costs defendant had avoided.
Defendant’s appeal to the Second Circuit questioned the propriety of using “avoided costs” by defendant as a measure of plaintiff’s damages rather than the losses actually sustained by plaintiff. The tensions, in part, inhere in classic notions of “compensatory” damages, i.e., an award of damages incurred that make the injured party “whole” after the wrongful behavior—as opposed to a kind of “disgorgement” of the defendant’s ill-gotten benefits from stealing the trade secret. The latter notion appears equitable in nature and suggests that the wrongdoer should not profit from his misbehavior even though the plaintiff victim’s actual losses might be lower than the development costs defendant inappropriately avoided. Those considerations are particularly apt in trade secret, unfair competition and unjust enrichment claims.
Both core rationales, as one can imagine, are policy-laden. Generally speaking, recoverable damages properly should be “compensatory,” rather than a windfall opportunity that would encourage a “roll of the dice” litigation whenever arguably wrongful behavior might be alleged. On the other hand, the law arguably shouldn’t encourage commercial piracy of trade secrets and acts of unfair competition where the victim’s actual losses will be modest but the defendant’s gain will be gargantuan.
In such cases, the enormous advantages of misbehavior can be so great that a trial limited to a plaintiff’s actual “compensatory” losses will be “worth” the misbehavior. Without a kind of “disgorgement” approach—for example allowing a plaintiff’s recovery of the defendant’s “avoided costs” that would have been incurred in developing the misappropriated process—would the law somehow be encouraging tortious commercial conduct?
Further, where the plaintiff’s actual losses from the stolen trade secret are modest, or where the victim of the theft is small or not wealthy, the mere filing of a lawsuit against a large, wealthy, well-lawyered-up “pirate” company may be daunting, if not impractical. A singular focus on actual “compensatory” harm arguably might overlook the potential future value of the trade secret itself, a value that might sky-rocket or bear highly profitable fruits during some future time frame—possibly well beyond the phase of defendant’s tortious conduct. Does “compensatory actual loss,” from a perspective of public policy, embrace full value of the trade secret?
Let’s say the inventor or holder of the trade secret manufacturing process wishes to hold it for a while, without implementing it, i.e., to “put it on the shelf” so to speak, perhaps for exploiting it at a “better” time or to sell it in the future to a buyer eager and willing to pay for it handsomely. If that secret process is wrongfully appropriated, what “actual losses” will “compensate” the victim? Arguably, in that scenario, the defendant’s “avoided costs” of developing the secret process at least provides some non-speculative measure of “loss.”
The foregoing equitable notions, though easy to hypothesize, don’t necessarily tell the entire story. There is a framework of trade secret, unfair competition and unjust enrichment litigation principles that has evolved over time. The “avoided costs” theory of recoverable damages is not the only means by which victims with only modest compensatory actual losses can be assuaged. Where the theft has resulted from a defendant’s intentional, willful or grossly tortious behavior, plaintiff can sue not only for compensation that makes it “whole” but also for punitive or exemplary damages. Though the latter may have to be proportional to the compensatory award (constitutionally speaking), a punitive award can be quite substantial. Indeed, in the E.J. Brooks case featured here, plaintiff did in fact sue for punitive damages but the jury rejected that claim.
Likewise, victims of trade secret thefts can sue for equitable remedies above and beyond compensatory damages. Thus, seeking restraining orders or preliminary and permanent injunctions is not uncommon in such cases. Thus, the victim who is informed or becomes aware that its trade secret was misappropriated can try to “freeze” the defendant’s misuse of the secret and limit the loss of value to the plaintiff or the ill-gotten gains of the wrongful defendant. Although injunction practice is not always easy, it is an early strategic option to “protect” the property and can set things “right” without the need for years-long trials and appeals. Indeed, an injunction preventing defendant from further using the stolen process can lead to a reasonable settlement, especially when the defendant needs to continue production.
Actually, though not mentioned in the court’s opinion (probably because that litigation predated new statutory developments), the framework for protecting trade secrets has been materially enhanced by adoption of the “Defend Trade Secrets Act” of 2016 (DTSA; 18 U.S.C. §1836, etc.). The federal law was enacted on May 11, 2016 and allows the owner of a trade secret to sue in federal court when its trade secrets have been misappropriated, Congress wished to align remedies with the Uniform Trade Secrets Act which had been adopted by many states. Technically, the DTSA extended the Economic Espionage Act of 1996 which criminalizes certain trade secret misappropriations. Notable in the DTSA is the legal immunity given to whistleblowers. The DTSA does not preempt state laws protecting trade secrets so the federal law adds to the framework of remedies when trade secrets are misappropriated (if the trade secret relates to a product or service used or intended to be used in interstate or foreign commerce).
I mention the DTSA here because it is a powerful option that complements state laws and has features providing guidance to litigants. For one thing, “misappropriation” is defined. Second, the DTSA provides a new civil seizure mechanism that can be used prior to a formal adjudication that there has been a misappropriation. The trade secret owner can apply ex parte for an order providing for seizure of property necessary to prevent the “propagation” or dissemination of the trade secret. This permits a U.S. company to act quickly to protect the secret. Following the seizure order, the court is to hold a hearing in which the trade secret owner has certain proof burdens.
The DTSA also permits a court to grant an injunction to prevent a threatened or actual misappropriation. The injunction may require certain actions to be taken by the defendant to protect the trade secret. The court can condition future use of the trade secret by defendant’s payment of a reasonable royalty. And so on.
The May 3 New York Court of Appeals decision focused on New York common law. The majority rejected the “avoided costs” theory of damages as inconsistent with its perception of New York precedents that project the primacy of “compensatory” damages, actual losses sustained by the plaintiff. In that precedential universe the “avoided cost” approach urged by plaintiff in the federal trial was inconsistent and, therefore, not sustainable under New York law. The bristling dissenting opinion criticized such a limitation upon recoverable damages, arguing that the state case law did not mandate such a restriction and, further, that this would place New York law outside the mainstream of the remedies available in other jurisdictions. New York, they urged, should be a “leader” in the modern technological era.
Clearly, such trade secret, unfair competition and unjust enrichment litigations present complex imbroglios that lawyers should master. The well-written majority and dissenting opinions in E.J. Brooks are resources for upgrading one’s knowledge. They also are interesting expositions of differing judicial approaches.
In this article, I tried to keep the discussion simple, avoiding much factual detail inherent in the underlying litigation. The importance of the court’s May 3 decision should also be viewed in the context of the DTSA federal legislation which has broadened remedies in the trade secret area. The May 3 decision, however, may be all-important in unfair competition and unjust enrichment contexts. So, read it!