The Defend Trade Secrets Act (DTSA) was signed into law on May 11, 2016, establishing a federal cause of action for trade secret misappropriation and establishing appropriate damage remedies. While the damage remedies outlined by the DTSA have been, and continue to be, the standard under state law, the advent of the DTSA reinforces the need for an awareness of the possible damage remedies available in trade secret misappropriation cases.
Before the DTSA, trade secret damages were defined most commonly in accordance with the Uniform Trade Secrets Act (UTSA). Created by the Uniform Law Commission in 1979, and amended in 1985, the UTSA was “the first comprehensive effort to codify the law of trade secrets protection.”1 Since its introduction, the UTSA has been adopted by 47 states; it was introduced in the legislatures of Massachusetts and New York in 2016, and it has not been enacted in North Carolina.2 The UTSA, Section 3(a), defines damages as follows:
Damages can include both the actual loss caused by misappropriation and the unjust enrichment caused by misappropriation that is not taken into account in computing actual loss. In lieu of damages measured by any other methods, the damages caused by misappropriation may be measured by imposition of liability for a reasonable royalty for a misappropriator’s unauthorized disclosure or use of a trade secret.3
The DTSA defines damages awards for unauthorized disclosure or use of trade secrets in a similar manner to the UTSA, stating that awards can be calculated either as actual loss plus any unjust enrichment that is not addressed in computing damages for actual loss, or by imposition of a reasonable royalty.4 Both the UTSA and the DTSA also include a provision for exemplary damages of up to two times the awards discussed above in cases of willful and malicious misappropriation.5
An award of lost profits in any dispute — trade secret or otherwise — is recoverable if the wrongful act is the proximate cause of the loss. According to the American Institute of Certified Public Accountants (AICPA), “[p]roximate cause is an act from which an injury results as a natural, direct, uninterrupted consequence and without which the injury would not have occurred.”6 Although calculation of damages in the form of lost profits does not require precision, to be recoverable the loss should not be speculative in nature.
A calculation of lost revenues serves as the starting point for measuring lost profits. In a trade secret misappropriation, lost revenues may result from lost sales associated with a product or service protected by the trade secret, as well as lost sales of complementary products and services, commonly referred to as “convoyed sales.” Often these lost revenues are determined by comparing the plaintiff’s sales before the misappropriation to the sales following the misappropriation, a comparison referred to as a “but for” analysis (i.e., but for the defendant’s misappropriation of the trade secret, the plaintiff would have realized a certain amount of revenues).7 Other intervening factors, such as a downturn in the economy or changes in consumer demand, can impact lost revenues and should also be considered.
Following the calculation of lost revenues, a calculation of the costs associated with those revenues is required, which ultimately results in a determination of the incremental operating profit associated with the misappropriation or theft of the trade secret. Incremental or avoided costs are those that would have been incurred only if the lost sales had been realized. A thorough understanding of a company’s cost structure — and, specifically, of the product or service generating the revenue — is needed in order to properly determine the incremental costs associated with lost sales. Interviews of company personnel, deposition testimonies, reviews of internal and external financial statements, and any publicly available information regarding the company and its industry can inform this understanding, which should include whether costs are fixed or variable and whether they vary based on sales volume. The lost profits associated with the trade secret misappropriation are ultimately determined by deducting the incremental costs from the lost revenues.
As noted in Agilent Technologies v. Kirkland, “[D]amages in actions for trade secret misappropriation…are generally determined by ‘the difference between the plaintiff’s position before and after the misappropriation of his secret.’ The loss suffered by the plaintiff, such as lost profits, is the usual indicator of damage.”8 Further, the “method of determining lost profits based on a market share is an acceptable approach [for] demonstrating the causal relationship between misappropriation and lost profits.”9
Courts have accepted methods other than lost profits to calculate actual loss. One such method is a calculation of actual loss based on the investment value of the trade secret. In the case of Precision Plating & Metal Finishing, Inc. v. Martin-Marietta Corp., an established market did not exist, so the trial court determined the value of the trade secret by taking into account the information available at the time of the misappropriation and looking at what an investor would have paid to own the trade secret process at issue.10
Another accepted method for determining actual loss is based on the loss of business value resulting from the trade secret misappropriation. In the case of Wellogix, Inc. v. Accenture, LLP, Wellogix brought claims of trade secret misappropriation (under Texas common law) and trade secret theft (under the Texas Theft Liability Act). The jury returned a verdict on both counts. As its measure of damages, Wellogix did not seek lost profits but rather lost business value. The company’s financial expert testified as to the value of Wellogix just prior to the misappropriation while their technical expert testified that, based on his experience in the software industry, the value of Wellogix dropped to zero after the misappropriation. In the opinion of the appeals court, “[r]easonable jurors could find that this testimony established the ‘market value of the business immediately before and after’ the alleged misappropriation.”11
Under the theory of unjust enrichment, a plaintiff can recover any gains made by the defendant related to the misappropriation of trade secrets. In University Computing Co. v. Lykes-Youngstown Corp., the Fifth Circuit stated, “[T]he appropriate measure of damages, by analogy to patent infringement, is not what [the] plaintiff lost, but rather the benefits, profits, or advantages gained by the defendant in the use of the trade secret.”12
Traditionally, unjust enrichment is measured through an accounting of the defendant’s actual profits earned by using the misappropriated trade secrets, whether generated from increased revenue due to the use of the trade secret or reduced production costs due to the use of the trade secret, or a combination of both. A calculation of the defendant’s profits is normally used only when such a figure can be proved, and it is not appropriate when profits can be established using only “wholly speculative expectations of profits.”13 Although the UTSA and the DTSA do not specify how the calculation of the defendant’s profits should be completed, copyright law and trademark law can be reviewed for guidance.14
Both copyright law and trademark law state that the plaintiff is required to prove first the defendant’s gross sales. The defendant is then required to provide proof of any deductible expenses. The calculation of deductible expenses is often a highly contested issue, and case law on the topic is inconsistent between jurisdictions. Based on the jurisdiction, expenses can be calculated as incremental costs (i.e., those directly related to the sale of the accused product), direct costs (e.g., variable and overhead costs directly related to the trade secrets) or fully absorbed costs (e.g., portions of all general business expenses). Calculation of this form of unjust enrichment should include an examination of the case law in the applicable venue.
In some cases, the defendant may have little or no profit that can be disgorged to the plaintiff, or the defendant may not have actually used the trade secrets in the production of a product or service. In those circumstances, damages may be measured by the benefits gained by the defendant through the saved cost of development (i.e., the cost that the defendant would have incurred had it developed the misappropriated trade secrets independently. In Telex Corp., and Telex Computer Products, Inc. v. International Business Machines Corp., the Tenth Circuit upheld a decision that it was proper to measure unjust enrichment using the trade secret owner’s cost of development even though the misappropriator did not complete the relevant project.15
Finally, it should be noted that unjust enrichment damages can coincide with an actual loss calculation, provided only one form of damages is calculated for each sale.
Although both the UTSA as amended in 1985 and the DTSA specifically permit a reasonable royalty in lieu of actual loss or unjust enrichment damages,16 it is important to note that “no single accepted method exists for how a court must determine ‘reasonable royalty’ damages.”17 Reasonable royalties are an available remedy for a range of intellectual property assets, including patents, trademarks, copyrights and trade secrets. A variety of methods are used in determining reasonably royalties, including the use of established royalties, application of a hypothetical negotiation, use of the analytical method, and application of a discounted cash flow analysis.18
Established royalties are, according to the AICPA, the “amount paid by the parties for the intellectual property in suit.”19 Although an established royalty could exist, considering the nature of trade secrets and the fact that they are protected by the owner, this is unlikely. When an established royalty does not exist, a practitioner would need to calculate a reasonable royalty.
The hypothetical negotiation is between a willing licensee and a willing licensor at the time of infringement (or, in the case of trade secrets, at the time of the misappropriation).
A well-known and often-cited case regarding the determination of a reasonable royalty and the framework of a hypothetical negotiation is Georgia-Pacific Corp. v. U.S. Plywood Corp., which pertained to patent infringement.20 That case provided a series of 15 factors to consider in determining a reasonable royalty, and practitioners frequently apply these factors to patent and non-patent cases in what is often referred to as a “Georgia-Pacific analysis.”
Additional guidance specific to trade secret misappropriation was provided by the Court of Appeals for the Fifth Circuit in 1974, following the Georgia-Pacific ruling. In University Computing Co. v. Lykes-Youngstown Corp., the court stated:
Because the primary concern in most cases is to measure the value to the defendant of what he actually obtained from the plaintiff, the proper measure is to calculate what the parties would have agreed to as a fair price for licensing the defendant to put the trade secret to the use the defendant intended at the time the misappropriation took place. In calculating what a fair licensing price would have been had the parties agreed, the trier of fact should consider such factors as:
These factors have a striking resemblance to those in Georgia-Pacific.
According to the AICPA,
[t]he royalty calculation under this method is based on the infringer’s own internal profit projections for the infringing item at the time the infringement began. The analytical method is based on the premise that any rate of return in excess of a normal rate of return can be attributed to the patent. This method takes the profits of the infringer, subtracts the infringer’s normal profit, and awards some portion of the remainder to the patent owner.22
The Federal Circuit in TWM Manufacturing Co., Inc. v. Dura Corp., a patent infringement case, upheld the analytical method as an acceptable approach to determining a reasonable royalty, stating, “Dura has cited nothing which would limit the district court’s discretion in choosing the analytical approach to determine a reasonable royalty.”23
The discounted cash flow analysis is “a method of valuing an investment based on the estimated future cash flows, taking into consideration the time value of money.”24 In the Hallmark Cards, Inc. v. Monitor Clipper Partners, LLC trade secrets case, a discounted cash flow analysis was used to determine the reasonable royalty. The royalty served to measure the amount that the defendant “would have likely paid Hallmark for the use of Hallmark’s proprietary information.” Clipper had used proprietary information to “purchase and subsequently manage a competitor of Hallmark’s called Recycled Paper Greetings, Inc. (RPG).” The analysis involved the estimation of the “profits that Clipper expected to earn from acquiring, managing, and ultimately selling RPG.” The court stated that both the unjust enrichment calculation and the reasonable royalty calculations were dependent “on Clipper’s actual use of Hallmark’s trade secrets,” pointing out that, “had Clipper merely acquired Hallmark’s trade secrets for its own edification, both of the above damage calculations would have fallen to zero. Thus, both the determination of liability and the assessment of damages in this case depend crucially on Clipper’s use of Hallmark’s trade secrets.”25 The jury awarded $21.3 million in compensatory damages and $10 million in punitive damages, which the Court of Appeals for the Eighth Circuit affirmed.
Now that the DTSA has been signed into law, trade secret protection is available at both the federal and the state levels. Attorneys and experts alike should be mindful of the venue where the case is filed, the damage remedies available in that venue and the nuances of these calculations.