March 01, 2012

On September 16, 2011, President Obama signed into law the Leahy-Smith America Invents Act (“AIA”), a piece of historic patent reform legislation that impacted 71 existing sections of the U.S. patent statute. Aside from the most fundamental change in the statute, moving the U.S. from a first-to-invent (“FTI”) system to a first-inventor-to-file (“FITF”) system, the AIA also incorporated a prior user rights provision and a post-grant review system. While numerous articles have been written decrying the potential weakening effect on patents of these provisions, inventors may have a secret weapon at their disposal – trade secrets.

New AIA Provisions

Under the prior user rights provision of the AIA (Section 5) that are codified in 35 U.S.C. § 273, an accused patent infringer may present as a defense clear and convincing evidence that it had engaged in commercial use of the patented subject matter at least one year prior to the patent’s effective filing date (see 35 U.S.C. § 273(b)). In the presence of such evidence, the “prior user” would be allowed free and clear historical and future use of that patented subject matter. As a simple example, assume that Company A invents “X”, but decides for economic or strategic reasons not to seek patent protection for “X”; instead, Company A elects to protect the invention as a trade secret. Independently, Company B invents “X” and elects to file and prosecute a patent application, which results in a patent for “X”. Under prior law, Company B could sue Company A for patent infringement and potentially win liability and damages. Under the AIA, if Company A can demonstrate that it engaged in good faith commercial use of “X” at least one year prior to the earlier of Company B’s effective filing date for the “X” patent or the date on which “X” was disclosed to the public in a manner that qualified for the exception from prior art under 35 U.S.C. §102(b), Company A may continue to use “X”.

The AIA also established a Patent Trial and Appeal Board (PTAB) (see Section 7) to oversee a post-grant review system (see Section 6), which allows any third party to challenge the validity of a patent for any unpatentability reason within nine months of the patent grant or issuance of a reissue patent. While this provision may seem innocuous at face value, it may provide further opportunities for competitors and potential infringers to lay in the weeds and sit on potential prior art as a patent goes through the prosecution process and then challenge patent validity post-issuance.

Due to public disclosure requirements inherent in the patent system, the above “after the fact” challenge provisions of the AIA would appear to weaken enforcement options available to patent owners. The historical reward for laying open one’s patent claims was the exclusive right to prevent others from using those inventions. With more weapons available to challenge the validity or exclusivity of patents, inventors may become more gun-shy in their willingness to publicly disclose inventions.

Trade Secrets to the Rescue

Fortunately, a potential solution exists: increased reliance on trade secret protection. Trade secrets do not require public disclosure; in fact, public disclosure destroys trade secret value. Under the Uniform Trade Secrets Act (“UTSA”), a trade secret is defined as information, including a formula, pattern, compilation, program, device, method, technique, or process, that 1) derives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use, and 2) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy. Trade secrets can include technical information (the Coca-Cola recipe, a manufacturing method, a product or screen design prototype, an apparatus design, technical specifications) or non-technical information (a customer list, cost structure of a particular product, customer complaint logs, identity of parts suppliers, a marketing plan), as well as negative know-how. For instance, in the case of WD-40, the name “WD-40” represents the 40th try by scientists in 1953 to come up with a “water displacement” formula to use as a rust-prevention solvent and degreaser in the aerospace industry. Here, not only was the formula a trade secret, but also the formulas and work that went into disproving the other 39 attempts to solve this problem. If a competitor only learned about the failed attempts, it would still save that company the time and expense of developing and evaluating those formulas.

Under the AIA, as long as convincing records of commercial use are maintained (and such use occurs at least one year prior to the effective filing date of a third party’s patent application), a trade secret owner may be permitted to use that trade secret as long as desired, without publicly disclosing the scope and boundaries of those rights and providing a roadmap to potential infringers as to designing around those boundaries.

Furthermore, while the life cycle of a trade secret depends on secrecy, there may be other potential reasons to reconsider the use of trade secret protection instead of patent protection. A patent has a fixed life and a known expiration date; a trade secret may remain in force indefinitely. If Coca-Cola had patented its famous formula, the intellectual property protection would have been lost forever upon patent expiration. Similar considerations exist in the licensing world. Trade secrets, unlike patents, can be licensed forever. A trade secret licensee can be obligated to continue paying royalties for the trade secret license even after the information has entered the public domain. The right to obtain royalties for a patent generally ends upon the expiration of the patent.

Patent v. Trade Secret Damages Differences

Concurrent with the debate over patent reform legislation, it has become increasingly more difficult for patent owners to prove patent infringement damages through the federal court system. Numerous cases have been decided during the past several years that address such damages issues as the Entire Market Value Rule (“EMVR”), apportionment, irreparable harm, and the 25% Rule. In particular, the courts in Lucent v. Gateway, 580 F.3d 1301 (Fed. Cir. 2009) and Cornell v. Hewlett-Packard, 609 F.Supp.2d 279 (N.D.N.Y. 2009), amongst others, have required rigorous economic review of whether and how the alleged infringing components reflect the basis for customer demand for an entire machine or for sub-assemblies thereof. In Cornell v. Hewlett-Packard, the Court determined that royalties could not be determined as a percentage of computer server sales (large base), or as a percentage of printed circuit board sales (smaller base), or even as a percentage of CPU brick sales (even smaller base), but rather as a percentage of processor sales, which the Court determined was “the smallest saleable infringing unit with close relation to the claimed invention.”

Prior to eBay v. MercExchange, 547 U.S. 388 (2006), patentees generally had a rather low hurdle to clear in order to obtain an injunction against adjudicated patent infringers. However, in the eBay decision, the Supreme Court ruled that patentees were required to prove the traditional four-factor test – irreparable harm, adequacy of legal remedies, balance of hardships, and public interest – in order to obtain injunctive relief. As a result, it has become more difficult for patentees, particularly those that are non-practicing entities (“NPEs”), to obtain post-trial injunctions.

In Uniloc USA v. Microsoft, 2011 U.S. App. LEXIS 11, * (Fed. Cir. 2011), the Federal Circuit specifically ruled that, “Evidence relying upon the 25% rule of thumb is … inadmissible under Daubert and the Federal Rules of Evidence...” The 25% Rule had previously been an oft-criticized shortcut damages methodology for determining a reasonable royalty rate in patent litigation by applying a 25% factor to the profits of a product made under the patented invention. Here again, the Court indicated that it was looking for more rigorous economic analysis of the relative importance, or contribution, of the patented invention to the demand for the patented or infringing product.

The net result of the above-described series of cases has been a set of increasingly higher hurdles to achieving patent damages success.

Trade secret damages, on the other hand, do not have as many case law hurdles or analytical requirements. First of all, most trade secret misappropriation cases are governed by individual state laws. While there is some variation amongst states, under the UTSA, general damages remedies for trade secret misappropriation include: actual loss to the plaintiff and unjust enrichment caused by misappropriation (that is not taken into account in computing actual loss), or, alternatively, reasonable royalty.

While some trade secret cases have referenced patent damages theories, an important distinction is that, unlike patent infringement damages, a trade secret plaintiff is entitled to seek defendant’s profits as a component of damages under the unjust enrichment provisions of the UTSA. Generally, it is the burden of the trade secret owner to demonstrate only defendant’s gross sales of products that incorporate the misappropriated trade secrets. The defendant is responsible for proving deductible expenses as well as any apportionment factors that it would like the Court to consider. As a result, trade secret damages may offer additional, and easier to demonstrate, opportunities to obtain monetary relief than patent infringement damages.

Our Secrets For Protecting Yours

In order to effectively employ a trade secret enforcement strategy, it is necessary to make sure you have a trade secret protection strategy. Not every company can lock its trade secrets in a vault, as with WD-40 and Coca-Cola. There is no silver bullet for trade secret protection, no hardware widget or software program or canned process that you can buy to make you safe. But the basic solution is simple: You must use your employees to protect your secrets. And, since you already pay them, you incur no additional out-of-pocket cost. Employees are the foundation of an effective trade secret protection program.

A successful strategy requires that all employees participate and that management unambiguously and explicitly expound a trade secret culture. You can’t just name a few employees as a trade secret protection group, or install some new security product, while the rest of the employees continue business as usual. You must enlist the support of every company employee to work toward a culture of full trade secret awareness.

Cultural awareness is much more effective than mere employee training, especially new-employee training, for a single learning experience fades from memory over time while a healthy trade secret culture reinforces itself. But if the C-Suite often doesn’t understand trade secrets, employees are even more confused. For a trade secret culture to be effective, management must very effectively convey its goals to employees. This requires much more than “Here is the new proprietary information policy – read it, sign here, and return it.”

Senior managers need to work to make sure employees understand what the company’s trade secrets are and what their responsibilities for them are. They need to know that risks to the company’s secret information are risks to its revenues, earnings, and share price, and ultimately to their own jobs. Management’s efforts to protect the company’s trade secrets are efforts to protect the employees’ jobs, their stock options, and their pensions. Employees have to know that.

They also need to be reminded that any type of company information can be a trade secret, including supplier identities, upcoming price changes, R&D activities and corporate policies – anything that can help a competitor compete against the company. In this era of high technology, employees also need to understand that any unsecured emails may be intercepted, any conversation may be overheard, and any computer screen in a public place may be read. Diligence and common sense must be part of the trade secret culture. Once a secret is divulged, no matter the reason, it is lost forever.

If employees understand their part in an unambiguous and committed trade secret culture, company information security policies will more likely be accepted and followed. Without that understanding, all the company policy manuals and policy communications in the world will be worthless. Embodiment of the culture at every level of management will help employees understand your expectations. Not every CEO needs to ride into Times Square on the back of a horse in a suit of armor with his trade secret formula safely in hand – as did Garry Ridge, president and CEO of WD-40, on his company’s 50th birthday. But it sure doesn’t hurt.

Also a contributing author:

R. Mark Halligan, Esq.