It is late Friday afternoon and your top salesperson asks to talk to you. She tells you that she is resigning to take a similar job with your major competitor. How should you react and what should you do next? Apart from the decision as to whether to make a counter-offer, what other decisions do you need to make? What other concerns should you have?
One possible concern would be what to do if she tries to take the customers with whom she has a successful relationship with her? Also, is there proprietary information she has about your products or services that would be detrimental to your business if shared with a competitor? Does she understand the new business-process software you have developed well enough to describe how it works to a programmer at the new company? If the answer to any of these – or related — concerns is “yes,” do you have any recourse?
As is true of so many things, the answer is, “It depends.” This article addresses the legal issues involved in protecting trade secrets, and it identifies steps you can take to protect your company from losing confidential and proprietary information when an employee leaves to join a competitor or to start a competing business.
Courts considering cases involving trade secrets encounter two significant competing interests : (1) the rights of individuals to start competing businesses or to continue to work in their chosen occupations — even when this includes leaving an employer to accept a position with a competitor; and (2) the rights of the existing business to protect the confidential and proprietary information in which it has invested significant resources, not only to develop, but also to protect. It is critical for the firm to know how it can protect its trade secrets, and how it can recover damages if its trade secrets are misappropriated by its former employees.
The Uniform Trade Secrets Act
In 1984 states began enacting the Uniform Trade Secrets Act, which was based on a compilation of numerous court decisions that had considered issues relating to confidential and proprietary information. As of this date, forty-one states have enacted it in its entirety or in some limited form.[1] (California’s code is a good example of this legislation.) The Uniform Trade Secrets Act defines a trade secret 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.”[2]
What Constitutes a Trade Secret?
Customer Lists: Is a customer list or a software program a trade secret? The answer requires analysis. A customer list will most likely be considered a trade secret if it possesses potential economic value by allowing a competitor to direct sales efforts to third parties who have already shown a predisposition to purchase the item which is for sale. Courts are reluctant to protect customer lists to the extent that they embody information which is readily ascertainable through public sources such as the yellow pages or business directories and contain mere identities and locations of customers that anyone can easily identify as potential customers. However, where the employer has expended time and effort identifying customers with particular needs or characteristics, courts will probably prohibit former employees from using this information to capture a share of the market. These lists will be distinguished from directories or other publications. As a general rule, the more difficult the information is to obtain, and the more time and resources spent by an employer in gathering it, the more likely a court will conclude that such information satisfies that requirement of the Uniform Trade Secrets Act.
A customer list possesses economic value when the secrecy of that information provides the owner of the customer list with a substantial business advantage. Therefore, a court will likely find that a customer list has economic value when its disclosure would allow a competitor to direct its sales efforts to those customers who have already shown a willingness to use a unique type of service or product as opposed to a list of people who only might be interested.
Software: Software developed by a company for its own benefit can also be treated as a trade secret. A company is typically able to establish that the software has independent economic value by showing that it invested time and money to develop and benefit from the software. Moreover, since the company is normally able to establish that the software contains unique features for the company’s welfare, the software should be considered a trade secret.
Reasonable Efforts: A claim under the Uniform Trade Secrets Act will not be actionable unless reasonable efforts have been made to ensure the secrecy of the alleged trade secret. The more the preventative measures taken to ensure the secrecy of the trade secret, the more likely that a court will find that this element of the Uniform Trade Secrets Act has been satisfied.[3]
Difference between Trade Secrets and Patents and Trademarks: A trade secret is not a patent or a trademark. Both patents and trademarks are matters of public record, while a trade secret is confidential and proprietary. Patent and trademark infringement actions are typically enforced in federal court while trade secret lawsuits are usually filed in state court. Patents are issued for the purpose of protecting the rights of inventors, while trade secrets cover information that includes formulas, patterns, compilations, programs, devices, methods, techniques or processes.
Misappropriation of a Trade Secret
The Uniform Trade Secrets Act prohibits the misappropriation of a trade secret. A misappropriation of a trade secret does not occur when a former employee announces a new affiliation even to clients of a former employer whose identity would be considered a trade secret. Courts consider simply announcing a new affiliation as basic to an individual’s right to engage in fair competition. However, misappropriation occurs if information from a customer database is used to solicit customers. For example, an individual or that individual’s new employer cannot send letters or otherwise contact actual or potential customers of the former employer seeking to obtain their business. Anything more than an announcement of a change of employment will most likely be considered a misappropriation under the Uniform Trade Secrets Act.[4]
The type of relief that a company claiming a trade secret violation can obtain includes an order from the court preventing the former employee and his new employer from doing business with any customer who switched their business from the company claiming the trade secret violation to the former employee’s new company. Also, the company complaining about a trade secrets violation may be able to recover monetary damages for the actual loss caused by the misappropriation. If the monetary damages sought by the complaining party are not provable, then a court may order that a reasonable royalty be paid for no longer than the period of time the use of the trade secret could have reasonably been prohibited.
Ten Steps for Protecting Trade Secrets
It is better not to wait for a situation to occur where trade secrets are in jeopardy before taking action. Preventive measures may decrease the likelihood that a former employee (or, indeed, a current employee) may disclose trade secrets.[5]And, if someone does disclose – or attempt to use – trade secrets, then proof that the employer did consider this information to be valuable and confidential and took steps to insure its confidentiality will be helpful. To help protect your business you should take the following steps:
- Have all employees, independent contractors and temporary personnel execute confidentiality agreements as a condition of new or continued employment. A confidentiality agreement should contain, among other terms, a definition of trade secrets, limitations of how employees can utilize trade secrets, and the types of monetary and injunctive relief that a company can recover if the employee breaches the agreement.
- Conduct regular meetings with employees, independent contractors and temporary personnel to remind them about what information the company considers confidential and the reasons why it wants to protect it.
- Identify any information that the company considers confidential as confidential and proprietary by either placing it in a separate file or stamping “confidential and proprietary” on it.
- Limit access to confidential information to only those persons who absolutely must see it. A company can place the information in a separate locked file cabinet or require selected employees to use a password to gain access to it.
- When establishing a new employment relationship, the company should inquire whether that person’s previous employer required him or her to sign a confidentiality agreement. A company should follow this policy, because it promotes awareness by the new employee that his future employer respects the confidential and proprietary information of that person’s former employer.
- If this is the case, advise other employees, independent contractors and temporary personnel that the company has been required to enforce a confidentiality agreement.
- Include confidentiality provisions in personnel manuals.
- Require vendors, suppliers and potential customers to sign non-disclosure agreements about the confidential and proprietary information made available to them, and make the company’s employees aware of that policy. A non-disclosure agreement is similar to a confidentiality agreement in that both seek to protect trade secrets. (Non-disclosure agreements are typically signed by vendors, suppliers and potential customers whereas confidentiality agreements are signed by employees.) A company’s employees will develop a better understanding that the company places a significant value upon its confidential and proprietary information if they see that third parties are being required to sign non-disclosure agreements.
- Create an understanding among employees, independent contractors and temporary personnel that any confidential information that they create on behalf of the company belongs to the company.
- Hold thorough exit interviews and require personnel who have terminated their relationship with the company to return all confidential information that had been in their possession, including any information that is on their office or home computer.
To Illustrate the Point…
To make these principles easier to understand, consider the following example which is based on an actual case handled by one of the authors. A parts distribution firm had a confidentiality agreement prepared for its employees to sign. All of them duly did so. One of the salesmen who signed the confidentiality agreement was also the brother-in-law of the firm’s president. A few months after signing the agreement, this brother-in-law quit the firm and started working in a similar capacity for one of the company’s major competitors. Despite the agreement, he began soliciting the firm’s customers for his new employer. (He justified the action on the grounds that he had been the person who had built many of these relationships in the first place, and they were relationships with him more than with the company. He also argued that he had a family to support and that forbidding him to solicit these customers was an infringement on his right to earn a living.)
The original employer took quick and decisive action to enforce the confidentiality agreement. The firm was located in a multi-state metropolitan area, which complicated matters somewhat. The company was located in one state, the brother-in-law resided in a second state, and his new employer was located in a third state. Since the parties were located in different states, a law suit was filed in federal court (rather than state court). On an ex-parte basis, the court issued a Temporary Restraining Order against both the brother-in-law and his new employer.
After negotiation, the parties eventually agreed to a settlement whereby the brother-in-law and his new employer were prevented from soliciting any of the firm’s clients for two years. Without a signed confidentiality agreement, this firm would have been unable to stop the former employee from soliciting its clients.
As this case shows, it is important for a firm to have all of its employees sign a confidentiality agreement since you never know who may breach confidentiality. By taking quick and decisive action, the firm sent a clear message to its current employees (and its competition) that it was serious about protecting its trade secrets.
Conclusion
The Uniform Trade Secrets Act was drafted so that business owners and their competitors, as well as current and former employees, would have a better understanding of their rights with respect to how a company’s trade secrets can be protected and utilized. A business owner or manager must understand that his or her rights to protect the company’s trade secrets are not automatic. Instead certain affirmative steps must be taken to limit other’s rights to use this confidential and proprietary information. If the business owner makes his current and former employees aware of these trade secrets and they still misappropriate them, he or she may then be able to obtain relief against them, including the possibility of an award of damages being entered against them.
[1] You should consult with a lawyer in your jurisdiction to learn of the extent that your state has enacted the Uniform Trade Secrets Act.
[2] California Civil Code, Section 3426.1 (d)
[3] For a more extended discussion of what is required to meet the test of secrecy and a listing of applicable court cases, click here for Stephen M. Westbrook and Carol L. Smith, Trade Secret Practice in California, Chapter. 4, Section 4.2.
[4] California Civil Code. Section 3426.1 (b) and 3426.2
[5] For a good discussion of preventive measures — as well as a demonstration that trade secrets laws extend beyond the United States legal code, see John Koch, Protecting Trade Secrets: Dealing with Departing and Departed Employees, The Continuing Legal Education Society of British Columbia.
