Damages, Misappropriation, Trade Secrets, Unfair Competition
What damages may a business recover when its trade secrets are stolen and used by a competitor? Traditionally, courts have allowed businesses to recover actual losses caused by the trade secret theft – such as lost opportunities for profit. Are there other potential avenues of recovery? For example, can a business recover the amount of costs the competitor avoided by not having to develop the stolen trade secret? After all, the competitor avoided potentially onerous costs associated with years of research, development, trial and error by simply stealing the trade secret. Recently, the appellate Federal court covering New York State asked New York State’s highest court, the Court of Appeals, this exact question – and the Court of Appeals said “no.”
The misappropriation of trade secrets occurs when a competitor improperly obtains and uses another’s formula, pattern, device or compilation of confidential business information that provides a competitive advantage. In essence, it is a type of “unfair competition.” E.J. Brooks Company v Cambridge Security Seals, 858 F3d 744 (2d Cir 2017), presented a quintessential theft of trade secrets claim. Plaintiff manufactures plastic security seals (as seen here). Several of plaintiff’s employees jumped ship to defendant, a direct competitor, and brought with them plaintiff’s confidential, fully-automated plastic seal manufacturing process, which defendant immediately began to use. Plaintiff sued defendant for, among other things, misappropriation of trade secrets. After trial, the jury found defendant liable to plaintiff for $3.9 million, which represented the amount of costs defendant “avoided” by stealing the manufacturing process rather than developing it. Following an appeal of the award, the United States Court of Appeals for the Second Circuit asked the New York Court of Appeals whether, under New York law, “avoided costs” were an available form of damages for unfair competition claims.
In addressing the question in E.J. Brooks Co. v. Cambridge Sec. Seals, 2018 N.Y. Slip Op. 03171 (May 3, 2018), the Court of Appeals noted that the “fundamental purpose” of compensatory damages is to “make the victim whole” – in other words, to restore the injured party to the position it would have been in but for the misconduct. The Court reiterated the long-standing rule that a victim of trade secret misappropriation is not entitled to recover the revenue or profits actually received by a defendant. While those amounts might be relevant in determining plaintiff’s losses (e.g. “I would have earned what defendant earned”), the Court cautioned that there is “no presumption of law or of fact” that defendant’s profits, revenues, cost savings, etc. will approximate plaintiff’s losses. Rather, plaintiff’s actual damages must be measured by plaintiff’s actual losses, like lost opportunity for profit and the loss of investment to develop the confidential trade secret. The Court held a defendant’s “avoided costs” are not an available form of damages because they have no bearing on plaintiff’s lost profits. The Court further held that while plaintiff’s investment costs in developing a trade secret can show the value plaintiff placed on the secret, defendant’s avoided costs are “wholly unsubstantial and imaginary” (maybe defendant would have been really efficient in developing the stolen secret) and not an adequate approximation of plaintiff’s investment losses.
If you have any questions about theft of trade secrets or other unfair competition that have affected you, please do not hesitate to contact us.
Breach of Contract, Contracts, Modification, UCC
Oftentimes businesspeople sign a contract and put it in a drawer never to see the light of day again – unless a dispute arises. Especially with long-term contracts, trying to informally work things out might be efficient from a business perspective at the time, but it can lead to waiver of important legal rights in the end.
A 2017 decision by a New York appellate court, Kamco Supply Corp. v. On the Right Track, LLC , 149 A.D.3d 275, 49 N.Y.S.3d 721 (2d Dep’t 2017), certainly provided a wake-up call to anyone who believed in the casual administration of a contract. Kamco Supply Corp.concerned disputes arising out an approximately 18 month long distribution agreement. The intermediate appellate court held that the seller, by accommodating the underperforming purchaser, waived the right to enforce minimum purchase requirements for the construction product under the contract. The parties entered into the distribution agreement in mid-2005. The agreement required the purchase of 15 million feet of the product during the remainder of 2005 and ramped up dramatically to require purchase of 164 million feet in 2006 with a monthly minimum of 8 million feet. The purchaser agreed to use its “best efforts” to market, sell and distribute the product.
From the start, the purchaser failed to meet the 2005 purchase requirements, let alone the tenfold increased requirements in 2006. The seller did not default the purchaser, but instead tried to work with the purchaser. By May 2006, the purchaser opened discussions with the seller to end the relationship and, by July 2006, the seller recognized the purchaser would miss all purchase requirements. Regardless, the seller decided to stick with the purchaser as the seller’s best hope to increase sales of the product. By the end of 2006, in an act that surely stung, the nonperforming purchaser sued the seller for breach of contract in failing to refund $17,500. The seller countered with claims of breach of the purchase requirements seeking $71 million in damages.
The court focused on the importance of “course of performance” in “relational” contracts (i.e., contracts involving continuing relationships) in determining not only whether a party committed a retrospective waiver of a prior obligation, but also whether a party prospectively waived an executory, or future, obligation of the other party. The court held that where a contracting party waives an ongoing obligation, it may retract the waiver on reasonable notice and without undue prejudice to the counterparty. The case, involving the sale of goods, also triggered the Uniform Commercial Code, which recognizes the importance of course of performance in interpreting agreements and finding waiver of future rights. The court upheld the trial court’s finding that, despite an express “no waiver” provision in the contract prohibiting oral waivers, the seller by its conduct (i) waived the past due purchase requirements; (ii) made an election not to terminate the contract because of those breaches; and also (iii) waived the future purchase requirements because the seller failed to give timely notice withdrawing its waiver. The court dismissed the seller’s claims because the seller did not enforce the purchase requirements or make written reservations of rights and, instead, made accommodations to the purchaser in the hopes of increased sales.
The end result for the seller was that after 11 years of litigation (over seven times longer than the contract term), and after trial and appeal, the court granted the purchaser a $17,500 verdict on its breach of contract claim and dismissed the seller’s claims holding the seller waived the purchaser’s admitted breaches of every purchase requirement in the contract. This case provides a cautionary tale that contracting parties should avoid informal changes, and instead enforce their contracts and document amendments and new understandings.
While the above presents an extreme situation, you might face a less severe situation that could still result in a court later finding you waived your rights by failing to enforce your contract rights or by making oral changes without reservations of rights and proper documentation. If you have any questions about your contractual relationships and how you can best protect your business (whether to enforce or avoid a particular contract), please do not hesitate to contact us.
Employment Law, Non-Compete, Restrictive Covenants
Many employers and employees alike assume that a non-compete covenant in an employment agreement will be enforced without issue if an employee violates it. The reality, however, is far less certain. In New York, the general public policy favoring “robust and uninhibited competition” weighs “against sanctioning the loss of a man’s livelihood.” As such, New York courts will “rigorously examine” restrictive covenants and enforce them “only to the extent necessary to protect the employer from unfair competition.” If a restrictive covenant is reasonable in time and geographic scope (which is different for each case), a court will enforce a non-compete if it is necessary to protect 1) the employer’s trade secrets; 2) confidential customer information; 3) the employer’s client base; and 4) “irreparable harm” where the employee’s services are “unique or extraordinary” – such as a professional athlete or musician, or a broker, trader or salesperson who has a “unique relationship” with the employer’s clients.
Even if an employer can meet the rigorous test to demonstrate a restrictive covenant is necessary to protect it, the First Department Appellate Division (the appellate court that covers New York County and Bronx County) recently confirmed that an employer may not enforce a non-compete covenant against an employee terminated without cause. The court drew on prior cases that referred to the inherent unfairness of an employer seeking to prevent an employee from working when that employee did nothing to bring about her own discharge. The court confirmed that an employer’s “continued willingness to employ” the employee is a required part of enforcing a non-compete. New York courts simply will not prevent a laid off employee from trying to earn a living.
It is important to note, however, that a termination must be without cause to render a non-compete covenant unenforceable. A federal district court in New York recently explained that a termination for cause will not affect the enforceability of a non-compete because of the perverse incentive it would create. Specifically, the court stated that “to hold otherwise would be to permit employees to avoid reasonable non-compete agreements simply by ‘creating’ cause for their dismissal.” Lest one think that scenario far-fetched, this exact scenario played out in an earlier case where the court found that a doctor “purposely engaged in a course of conduct that was designed to induce [his employer] to fire him” with the hope of rendering the doctor’s non-compete unenforceable. Because the court found the non-compete was necessary to protect the employer from unfair competition, the non-compete was enforceable against the scheming doctor.
If you are an employer or an employee with any questions about non-competes and other types of restrictive covenants, please do not hesitate to contact us.
Damages
In this electronic age, claims for conversion – the intentional and unauthorized exercise of control over another’s property that interferes with the owner’s right of possession – have become more complex. Decades ago, if someone broke into your safe and stole stock certificates representing your shares in a company, a conversion claim was straightforward: the thief, without authority, deliberately stole your stock certificates and you lost your right of possession. The analogous act today would be a thief improperly accessing your online brokerage account and transferring ownership of your shares to another account. The result is still the same – someone stole your property and you can no longer use it. Until 2007, however, New York law was unsettled as to whether a claim for conversion could even apply to electronic records and data.
In a 2007 advisory opinion, the New York Court of Appeals, in Thyroff v. Nationwide Mut. Ins. Co., 8 N.Y.3d 283, 832 N.Y.S.2d 873 (2007), held for the first time that intangible property, such as electronic data, is capable of being converted. In Thyroff, pursuant to an agent agreement, an insurance company provided an insurance agent with a computer, on which the agent saved personal data. The insurance company later terminated the agreement and repossessed the computer, depriving the agent of access to his electronically stored personal information. In the landmark opinion, the Court of Appeals held that even though the insurance company had the right to repossess the computer, it did not have the right to take the agent’s electronic data and the agent could have a claim against the insurer for conversion.
Recently, the Commercial Division of the New York County Supreme Court had to decide an “arguably unsettled question of law” – whether a claim for conversion exists where the owner still has electronic access to the stolen information. In MLB Advanced Media, L.P. v. Big League Analysis, 2017 NY Slip Op 32617(U), Major League Baseball entered into an agreement with Big League Analysis to develop a suite of online youth-oriented baseball services. The parties’ relationship deteriorated and, among other claims, Big League Analysis alleged MLB committed conversion by keeping copies of Big League Analysis’ information without authority. While Big League Analysis admittedly still had access to the subject information, it argued it could still maintain a conversion claim. Relying on Thyroff, the court disagreed and dismissed Big League Analysis’ conversion claim, holding Big League Analysis was not deprived of its use of the information. The court held that no claim for conversion lies where a party “wrongfully possesses a copy of documents when the originals are in [the owner’s] possession.” While the court held that Big League Analysis did not have a conversion claim because it still could access the stolen information, Big League Analysis still has other claims beyond the scope of this post that can protect its business information, data and documents.
If you have questions about conversion and misuse of business information, please do not hesitate to contact us.
Frydman LLC
Frydman LLC is pleased to announce that David Frydman has been selected to the 2019 America’s Top 100 Bet-The-Company Litigators list, an honor reserved for nation’s most exceptional trial lawyers for high stakes business litigation matters. Less than .5% of lawyers receive this honor. David’s selection recognizes his career long success representing clients in their high stakes business litigation. David’s selection is the result of third-party research or peer nominations by other elite attorneys and limited to the top 100 litigators in New York. Being named to the Bet-The-Company Litigators cements David’s position as a top New York business litigator.
Please do not hesitate to contact us to learn more about David’s practice and how Frydman LLC can help you in your business dispute.
