I’ve Got a Secret . . . and I’m Willing to Use It! Franchisors, Franchisees, and Trade SecretsJune 15, 2017 – Articles Franchise Law Journal
Trade secrets are important assets of many franchise systems. They provide value to franchisors and franchisees, whose decision to become a franchisee may be based on the perceived value of the trade secrets and know-how the franchisor will impart to the franchisee. A trade secret can be as amorphous as a business method or process, or as precise as proprietary software, a recipe, or a formula. The key, as set forth in most state enactments of the Uniform Trade Secrets Act (UTSA), is that the trade secret "derives independent economic value, actual or potential, from not being generally known to, and not be readily ascertainable by proper means by ... other persons" and "is the subject of efforts that are reasonable under the circumstances to maintain its secrecy."1
But depending on the jurisdiction in which the UTSA's application may be tested, the same "thing" may or may not meet the definition of a "trade secret." And some states may be willing to grant temporary or preliminary injunctive relief quickly to prevent the misappropriation or unauthorized use of a trade secret, although others may not. Remedies may also vary from state to state: enhanced damages may not be available, attorney fees may not be recoverable, and permanent injunctive relief may or may not be an accepted remedy. There is also no specifically authorized seizure remedy. Both franchisor and franchisee operate in a fog-covered landscape.
Enter the Defend Trade Secrets Act (DTSA), enacted as an amendment to the Economic Espionage Act (EEA), 18 U.S.C. §§ 1831, et seq., which became effective on May 11, 2016. Several sections that create a federal civil cause of action for trade secret misappropriation or disclosure complete with rapidly deployable actions to halt ongoing violations and enhanced remedies for injured parties were added to EEA's pre-existing criminal sanctions for criminal economic espionage. Although the importance of a uniform federal cause of action for trade secret misappropriation (and jurisdiction in federal court) should not be underestimated, the DTSA does not preempt state UTSAs, inviting conflict not only among the various states, but between the DTSA and state versions of the UTSA.
This article explores the DTSA, reviews the limited case law under the Act, addresses nascent issues that may inform emerging DTSA jurisprudence, and offers practice tips to franchise lawyers.
I. The Statute
In 1996, the Economic Espionage Act2 created a federal criminal cause of action for economic espionage, specifically providing in 18 U.S.C. § 1831(a):
Whoever, intending or knowing that the offense will benefit any foreign government, foreign instrumentality, or foreign agent, knowingly—
- steals, or without authorization appropriates takes, carries away, or conceals, or by fraud, artifice, or deception obtains a trade secret;
- without authorization copies, duplicates, sketches, draws, photographs, downloads, uploads, alters, destroys, photographs, replicates, transmits, delivers, sends, mails, communicates, or conveys a trade secret;
- receives, buys or possesses a trade secret, knowing the same to have been stolen or appropriated, obtained, or converted without authorization;
- attempts to commit any offense described in any of paragraphs (1) through (3); or
- conspires with one or more other persons to commit any offense described in any of paragraphs (1) through (3), and one or more of such persons do any act to effect the object of the conspiracy,
Shall . . . be fined not more than $5,000,000 or imprisoned not more than 15 years, or both.
The EEA created a uniform federal means to protect trade secrets with all the attendant force of federal criminal enforcement. But it did not provide a correlative private cause of action. Variations of the UTSA formed a patchwork of protection for trade secrets, and decades of case development had fleshed out the scope of those statutes.3 Although each state's version of the UTSA creates a cause of action for claims arising out of the misappropriation or wrongful use of a trade secret, consistency among the states as to their scope and application varies—sometimes drastically so.
The efficacy of a private federal civil cause of action for trade secret misappropriation was the subject of a long-running debate that intensified in 2012, when federal civil trade secret legislation was introduced in the Senate, then amended and reintroduced in 2014.4 On the other side of the Hill, the Trade Secrets Protection Act of 2014 was introduced in the House. Finally, in 2016, S. 1890, incorporating features from both the earlier House and Senate proposals, became law.5 The goals of the DTSA mirrored those of the EEA, albeit in a civil, rather than criminal, format: a federal cause of action for misappropriation or disclosure of trade secrets with enforcement teeth. Thus, the DTSA provides federal jurisdiction, includes enhanced remedies for violations, and provides a basis for expedited actions. It does not preempt state trade secret laws, however.
Much of the language of the DTSA mirrors that of the UTSA, with numerous nearly identical provisions. Both the UTSA and the DTSA provide that a claim for misappropriation must be brought within three years after the misappropriation has been discovered or should have been discovered through reasonable diligence.6 The two acts also offer a trade secret owner similar civil damage recoveries. If a trade secret owner proves misappropriation, civil recovery may include actual damages as well as damages for any unjust enrichment caused by the misappropriation that is not addressed in any actual loss computation.7 An alternative remedy available under both the UTSA and the DTSA allows a trade secret owner to collect damages measured by a reasonable royalty for unauthorized misappropriation.8 Both the UTSA and the DTSA provide that, if the misappropriation is willful and malicious, a court may award exemplary damages of no more than two times the compensatory damages awarded.9 Finally, both the UTSA and the DTSA permit the recovery of reasonable attorney fees in cases of willful and malicious misappropriation.10
Notwithstanding the similarities, however, the DTSA is not a mere federal enactment of the UTSA.
A. Federal/State Interaction
Although the scope of the DTSA has yet to be explored, some of the statutory differences may prove more significant than a comparison with the UTSA may suggest, particularly as early DTSA cases in federal court reflect litigants piggybacking DTSA and state UTSA claims.11 Some DTSA remedies differ from those typically available under state UTSAs, and even the definition of "trade secret" differs, as a Washington district court observed in Earthbound Corp. v. MiTek USA, Inc. without further exegesis.12 The DTSA defines a trade secret as:
[A]ll forms and types of financial, business, scientific, technical, economic, or engineering information, including patterns, plans, compilations, programs, devices, formulas, designs, prototypes, methods, techniques, processes, or codes, whether tangible or intangible, and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing if— the owner thereof has taken reasonable measures to keep such information secret and (B) the information derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable through proper means by, another person who can obtain economic value from the disclosure or use of the information.13
By contrast, the UTSA, including the 1985 amendments, defines a "trade secret" as:
[I]nformation, including a formula, pattern, compilation, program, device, method, technique or process, that (i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.
During legislative consideration of the DTSA, commentators mentioned the increasing difficulty in applying the pre-electronic language of the UTSA in a sophisticated electronic, cyber-based marketplace in which information can be instantly and widely transferred around the world. UTSAs specifically address paper records, files, hard copy transmission, and physical archives— typical media in the pre-cyberworld. Whether the definitional difference between UTSAs and the DTSA will significantly impact the scope of assets protected under federal as opposed to state law remains to be seen.
This simple observation of the court in Earthbound illuminates a potential conundrum for courts interpreting and enforcing the DTSA—to what precedents might a court refer for guidance? Decades of well-developed jurisprudence under state UTSAs would seem a tempting point of reference, yet as the court in Earthbound observed, the DTSA is not identical to the UTSA. Further, the very fact that Congress enacted a federal civil remedy for trade secret misappropriation reflects congressional sentiment that a distinct federal law was needed.
As the U.S. District Court for the Middle District of Florida noted in Adams Arms, LLC v.Unifi Weapon Systems, Inc., the DTSA prohibits two kinds of misappropriation—acquisition of trade secrets and disclosure of trade secrets.14Although the definition of "misappropriation" under the UTSA and the DTSA are substantively similar, there are stylistic differences.15 One difference that may prove noteworthy involves the defi of "improper means" under each Act. "Improper means" under both the UTSA and DTSA include "theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means."16 The UTSA and DTSA may differ, however, in what types of acts are not considered "improper means." Under the UTSA, "improper means" is defined by negative implication; "proper means" is defined, leaving the "improper means" label available for other conduct. The UTSA defines "proper means" to include:
- Discovery by independent investigation;
- Discovery by ‘reverse engineering,' that is, by starting with the known product and working backward to find the method by which it was developed. The acquisition of the known product must, of course, also be by a fair and honest means, such as purchase of the item on the open market for reverse engineering to be lawful;
- Discovery under a license from the owner of the trade secret;
- Observation of the item in public use or on public display;
- Obtaining the trade secret from published literature.17
The DTSA operates from the opposite end of the defi ition without a definition of "proper means," but instead refers to what does notcomprise "improper means." Under the DTSA, improper means: "does not include reverse engineering, independent derivation, or any other lawful means of acquisition."18 By not limiting what constitutes "proper means" of obtaining information, a court applying the DTSA could declare methods as permissible (or impermissible) that might have been defined differently under a state UTSA.
Entirely unique to the DTSA are provisions that offer protection to whistleblowers who disclose trade secrets for the purpose of reporting a possible violation of law.19 These immunity provisions grant specific protection for an individual who discloses a trade secret to a government official, or even a private attorney, for the purpose of reporting a potentially unlawful act. The whistleblower cannot be held criminally or civilly liable under any federal or state statute if he discloses the trade secret in confidence to a permissible person so that the person may investigate the claim of unlawful activity, or if the disclosure is made in a court filing so long as the filing is made under seal. Whistleblower immunity is considered an affirmative defense, and individuals accused of misappropriation must provide evidence other than their own statements to support a claim for whistleblower protection.20
The DTSA requires employers to provide notice of the DTSA's whistleblower protections to employees, contractors, or consultants. The notice must appear "in any contract or agreement . . . that governs the use of a trade secret or other confidential information."21 If an employer does not provide the notice, the employer is prohibited from recovering either exemplary damages or attorney fees under the DTSA.22
Although the DTSA uses the word "employer," a franchisor may be subject to the notice requirement. The term "employee" to whom an employer must give notice, includes any individual performing work as a contractor or consultant for an employer.23 A court may view a franchisee as either a contractor or consultant for the franchisor; thus, a franchisor should consider providing a DTSA notice to franchisees in the franchise agreement.
The DTSA's seizure provisions were the most controversial aspects of the legislation.24 They have no statutory equivalent in the UTSA. For some, seizure represented a means to quickly halt the theft of trade secrets; for others, it suggested law enforcement personnel dressed in black with battering rams breaking into the homes of entrepreneurs and harassed employees. Legislators and commentators expressed concern over: (a) whether and how much force law enforcement should be permitted to use to effect seizure; (b) the unintended effects of seizure on hosts of cloud data storage and other innocent parties; (c) potential use of seizure to shut down entrepreneurial competitors or doom them in the press; (d) the danger of seizing innocent data (perhaps even the target's own trade secrets); and (e) the in terrorum effect of even a threat of seizure on employees and small business. The debate resulted in DTSA provisions that are designed to safeguard against what may broadly be defined as potential abuse. Whether those safeguards are balanced between rendering the DTSA ineffective and preventing abuse will have to wait for the case law to develop.
The DTSA defines a judicial inquiry on seizure in a manner that is similar to a preliminary injunction standard of proof, but on steroids. Ex parte seizure orders may issue only in "extraordinary circumstances."25 To support any seizure request, on notice or ex parte, the applicant/plaintiff must demonstrate by "clear" evidence: (a) immediate and irreparable harm, (b) the inadequacy of any alternate equitable relief, (c) a balance of harms that favors the plaintiff, and (d) a likelihood of success on the merits.26 In addition, the applicant must show that the defendant actually possesses the trade secrets; that absent seizure that person would "destroy, move, hide or otherwise make such matter inaccessible to the court"; and that "the applicant has not publicized the requested seizure."27 The seizure order must describe the objects for seizure "with particularity" and as narrowly as possible to achieve the purposes of seizure.28
Once ordered, the DTSA requires that the seizure be accomplished in "a manner that minimizes any interruption of the business operations of third parties and, to the extent possible, does not interrupt the legitimate business operations" of the defendant.29 The seized matter is to be "protect[ed] from disclosure by prohibiting access by either the applicant" or the defendant, and any access during litigation must be controlled by the court to minimize disclosure.30 The order must define the scope of law enforcement's seizure actions, including the hours during which seizure may be made and "whether force may be used to access locked areas."31 The applicant also must post security "for the payment of the damages that any person may be entitled to recover as a result of wrongful or excessive seizure or wrongful or excessive attempted seizure."32
The court must schedule a seizure hearing as soon as possible, but in all events not more than seven days after the order is signed,33 and during the interim the court must protect the defendant from publicity arising from the seizure.34 The burden of proof is on the plaintiff, the seizure will be dissolved or modified if the applicant fails to satisfy its burden, and expedited discovery is specifically authorized.35
II. Early Cases—What Do We Know?
Advocates and opponents of the DTSA naturally viewed its prospects differently. Would the DTSA be a uniform, accessible, effective, and appropriate weapon against the malicious misappropriation of trade secrets? Or would the DTSA become a cudgel used by big business against entrepreneurs and ex-employees to stifle competition? The debate prompted many alterations, in particular to the seizure remedy, to the DTSA before its enactment. But many aspects of the debate remain for clarification by the courts.
Relatively few DTSA cases have been decided since the statute became effective. Complaints have been filed, but most of the sparring to date has been in the motion for temporary/preliminary injunction or dismissal stage. Thus, the opportunity for clarification—or for that matter, for the development of any significant DTSA jurisprudence—is extremely limited. Glimpses into potential development of the DTSA may be evident in these early cases, but the record is thus far silent on many controversial issues. For the franchise bar, it is notable that none of the reported cases involve franchising in any substantive way.36
A. DTSA Gatekeeping
The DTSA became effective on May 11, 2016. An early and obvious question of applicability arose in Adams Arms.37 The defendant moved to dismiss the plaintiff's DTSA claims, arguing that the alleged wrongful actions occurred before the effective date of the statute. Observing that the DTSA prohibits two kinds of misappropriation—acquisition of trade secrets and disclosure of trade secrets, the court concluded that although the claimed wrongful acquisition had occurred prior to the effective date of the DTSA, actionable disclosure, including as a continuing violation under 18 U.S.C. §1836(d), may have occurred subsequent to that date, Thus, the motion was denied.38 The court specifically declined to decide whether and to what extent an aggrieved plaintiff could recover for DTSA violations that began before the statute's effective date.39 The Adams Arms case highlights a fundamental— and for now unanswered—question: in the event of a continuing violation, can recovery be had for effects prior to the effective date of the DTSA, or would recovery be limited to effects suffered subsequent to the statute's effective date?
Two cases have addressed the issue of standing under the DTSA, both focusing on 18 U.S.C. § 1836(b)(1), which affords the "owner of a trade secret" a private cause of action for misappropriation. In HealthBanc International,LLC v. Synergy Worldwide, Inc., the plaintiff alleged that the defendant's printed product labels constituted a disclosure of licensed trade secrets.40 The court held that although it appeared the plaintiff may have been the licensor of the technology, it was not an owner and thus could not assert a claim under the DTSA.41 The court in Phyllis Schlafly Revocable Trust v.Cori reached a similar conclusion.42 The case involved misappropriation of a donor database by ex-employees; the existence of related litigation in other states complicated matters. On the plaintiff's motion for a temporary restraining order, the court launched the usual TRO test, but stalled at the "likelihood of success" prong. Considering both the case at bar and the other pending cases, whether the plaintiff was the "owner" of the alleged trade secrets was debatable,43 and the motion was denied.
These unremarkable cases highlight an issue that may be especially pertinent to franchisors. Holding companies or parent or affiliated entities often own the intellectual property employed in a franchise system and license it to the franchising entity. The franchisor then sublicenses rights to franchisees to exploit the intellectual property consistent with the terms of the franchise agreement. In that structure, it appears the actual owner of the trade secret, rather than the franchisor, will be required to bring any DTSA claim. By contrast, in many states, trade secret licensees/sub-licensors have standing to take action against misappropriation under UTSAs.44
B. Temporary/Preliminary Relief
Courts assessing motions for injunctive relief under UTSAs and the DTSA recite the same multipart test, namely likelihood of success on the merits, irreparable harm, balance of the equities, and public interest. In fact, many of the courts that have addressed such motions in a piggybacked case asserting both DTSA and state UTSA claims do not specifically associate the standard with one or the other statute.45 The DTSA does not specifically require any alternate test for the issuance of temporary or preliminary relief.46
In UTSA jurisprudence, each element of the TRO/PI test receives judicial attention. In early DTSA cases, however, several courts have cited the DTSA as grounds for truncating two elements: irreparable harm and public interest. In Engility Corp. v. Daniels, the court brushed over the "irreparable harm" inquiry, declaring that the element "automatically" weighs in the trade secret owner's favor because the DTSA "by statute provides injunctive relief to prevent . . . violations."47 And in Earthbound, the court suggested a self-proving "public interest" element, observing that
the Economic Espionage Act, as amended by the [DTSA] establishes criminal penalties for misappropriation of trade secrets . . . which demonstrates Congress's belief that such conduct is harmful not only to the individual or entity whose secrets are purloined, but also to the public. . . . Theft of trade secrets, and allowing the thieves to retain and use the confidential information they purloined, undermines business development and stability; preventing such conduct is in the public's interest.48
One may understandably wonder whether this approach is consistent with the U.S. Supreme Court's decision in eBay v. MercExchange, in which the Court declared, in the context of a patent infringement action, that the imposition of injunctive relief depends upon the application of the traditional four factor test and that harm may not be presumed.49 Regardless of the fate of the irreparable harm and public interest factors under the DTSA, its criminal roots may afford a trade secret owner a psychological advantage in any TRO/PI hearing. Note, for instance, the manner in which the court in Earthbounddescribed the DTSA as "the Economic Espionage Act, as amended by the Defend Trade Secrets Act."50
Remedies inconsistent with state law have already posed a potential problem to courts fashioning remedies under the DTSA. The DTSA addresses the issue, specifically barring injunctive relief that "conflict[s] with an applicable State law prohibiting restraints on the practice of a lawful profession, trade or business."51 The court in Engility Corp. deftly waltzed between the DTSA and the restraints of Colorado law in fashioning a remedy, ultimately devising one that appeared to the court to accomplish the purpose of the injunction while not running afoul of Colorado law.52 In particular, the court determined that a blanket requirement that the defendants refrain from competing against Engility was inconsistent with Colorado law and narrowed the restriction to specific customers.
Early applications for temporary or preliminary relief in DTSA cases suggest that: (1) the DTSA has been wielded against ex-employees, (2) preliminary relief has issued where the plaintiff has strong evidence and there are egregious facts, (3) courts have acted quickly, (4) seizure has not been granted, and (5) courts have carefully structured preliminary remedies. Although most of the early DTSA cases involve departing employees, two arise from relationships among competitors.
Henry Schein, Inc. v. Cook appears to be the first case filed under the DTSA.53 In round one, after the plaintiff tried to serve notice on the defendant, the court granted an ex parte TRO against the plaintiff's ex-employee Cook with remarkable speed on June 10, 2016. Cook had resigned and become an employee of a competitor. Plaintiff Henry Schein, Inc. (HSI) determined that as Cook left, she forwarded "a wide array of confidential and trade secret information," including "comprehensive, confidential HSI customer practice reports ... ," equipment inventory, price quotations, and proposals in process, from her work email to her personal email. She also logged into the HSI system that updated these items and did not return her laptop for two weeks. Additionally, she unsuccessfully tried to access the HSI system a day after she resigned. When she returned her computer to HSI, she had tried to erase the emails she sent to herself. In addition to taking this information, Cook attempted to divert HSI customers to her new employer before her departure, even visiting customers and removing some HSI information from their businesses. Applying the usual test for injunctive relief, the court readily granted the TRO.54
Round 2: a decision on whether a preliminary injunction should issue occurred on June 22, 2016, less than two weeks later.55 On the DTSA claim, the court found a likelihood of success on the merits and concluded that HSI's potential loss of relationships constituted irreparable injury. The exemployee argued that she did not intend to use HSI's information for personal gain, but the court held that her intent was irrelevant under both the DTSA and the state UTSA.56 The court continued the TRO as a preliminary injunction, but eliminated the portion of the TRO that prohibited Cook from soliciting HSI customers.57
The speed with which the judge acted in the Henry Schein case, and the exceedingly short set of deadlines he imposed on the parties and a third-party forensic expert who had yet to be retained, were remarkable. Seizure was neither requested nor specifically granted, but under the rubric of expedited discovery the court ordered devices to be turned over to the forensic expert for imaging, the collected images to be provided to defense counsel, and defense counsel to begin producing the images to the plaintiff's counsel within approximately two weeks. Written discovery responses and complete production were required about one week later, and a preliminary injunction hearing was scheduled for June 21, 2016, less than one month following issuance of the TRO.58
Another notable DTSA opinion is Getty Images v. Motamedi, in which the court granted the plaintiff's motion for a TRO, expedited discovery and issued a Hague Convention request a mere four days after the case was filed.59 Defendant Motamedi, a vice president at Getty Images, had signed a non-disclosure agreement and been apprised in writing of Getty's non-disclosure policies. Motamedi decided to join a former colleague in a new venture in the United Kingdom and compete against Getty. In preparation for her new venture, Motamedi emailed Getty confidential and trade secret data to the new company. Getty uncovered evidence of these transmissions and other questionable communications in the defendant's Getty email account and speculated that her non-Getty emails and her electronic devices would provide a "treasure trove" of damning information. As in other cases, the plaintiff's forensic evidence weighed heavily in the court's decision granting a TRO, expediting discovery and issuing the Hague Convention request.60
Engility Corp. demonstrates the value of pre-hearing factual development (particularly forensic evidence) and a well-conducted motion hearing.61 One can reasonably characterize the facts as egregious. The defendant exemployee's twists and turns, admissions, and denials in the face of Engility's evidence, prompting the court to frankly dismiss his testimony as incredible, played a major role in the outcome.62 Engility is a defense contractor that provides hi-tech communications solutions to the U.S. military. As the "face" of Engility to U.S. military officials, Daniels was privy to a wide range of highly confidential information and had signed a confidentiality agreement. While still working for Engility, Daniels set up another company, intending to compete for the same business. Daniels gave notice to Engility and returned his company computer and additional information on a flash drive. But Daniels (as he finally admitted) kept some Engility trade secrets, offering varying and increasingly less believable explanations for his behavior. Engility's forensic evidence, and the deposition of its forensic expert, belied the truth. Company emails and computer and flash drive metadata indicated modifications and erasures after his departure date. Surveillance tapes also confirmed Daniels' tardy return of some company property.
In palpable understatement, the court wrote: "[Daniel's changing] testimony somewhat reduced Daniels' credibility in the court's eyes, but a later admission had an even more damaging effect."63 Daniels finally admitted that he had not erased the hard drives and, therefore, had a complete copy of the flash drive even after he had supposedly returned everything. He nevertheless insisted that he had finally deleted everything and had given the drive to his lawyer.
On these facts and evidence, the court had no difficulty issuing an injunction, even applying a "clear and unequivocal" standard of proof because of the extraordinary nature of a preliminary injunction.64 The court made short shrift of the likelihood of success factor, expressing frank disbelief in any of Daniels' testimony.65 Nor were the balance of harms or public interest elements difficult.66 Irreparable harm was a different matter. Engility had not demonstrated irreparable harm with the specific factual support the court might have preferred. But, as noted above, the court concluded that DTSA's provision for injunctive relief in the face of a violation satisfied the irreparable injury element because the Tenth Circuit's test for injunctive relief "excuses irreparable harm . . . when the evidence shows that a defendant is or will soon be engaged in acts or practices prohibited by statute, and that statute itself provides for injunctive relief to prevent such violations."67 The DTSA, 18 U.S.C. § 1836(b)(3)(A), authorizes injunctive relief to prevent misuse of trade secrets, and the Colorado trade secrets act does likewise; the irreparable harm element of the test thus "automatically favor[ed] Engility."68
Engility had submitted a proposed preliminary injunction, which prohibited any use, disclosure, or destruction of Engility information and prohibited the defendants from accepting business from the affected Engility clients. The court agreed with the first two conditions, but found the non-compete provision worrisome. Could the injunction restrict competition by Daniels? The DTSA prohibits an injunction that prevents a person from entering into an employment relationship,69 but "employment relationship" does not encompass an outside contractor relationship. The DTSA also prohibits an injunction that would conflict with state non-compete laws.70 The court determined that Colorado presumptively invalidates non-competes, but exempts from that prohibition contracts for the protection of trade secrets, which are enforced in Colorado to the extent necessary to protect trade secrets. The court thoughtfully crafted a non-compete in the preliminary injunction that restricted the defendants' ability to compete for business from Engility's targeted customers only.71
Earthbound Corp. is one of two cases that apply the DTSA to business-to-business activities.72 In this case, however, the competitor relationship was coupled with an ex-employee's activities. Earthbound developed a proprietary Super-Template, which manipulates "engineering calculations on load pressures, deflection and elongation, design methodology, product selection, inventory and pricing" in support of its business providing "services and systems for earthquake tie-down and connections in building construction." Earthbound's sales arm was a third party, Intact Structural Supply, LLC (ISS). Personnel at ISS had broad access to Earthbound trade secret and confidential data, including the Super-Template, financial goals, strategic planning, sales projections, and customer list. None of the ISS employees who were included as defendants in the action had signed confidentiality or non-compete agreements with Earthbound or ISS.
MiTek had unsuccessfully tried twice to buy Earthbound and in each case signed confidentiality agreements. During discussions regarding a possible purchase transaction, Earthbound disclosed the names of key ISS personnel to MiTek, along with an explanation of their position, knowledge, and duties. The key ISS personnel subsequently decided to move to MiTek (after MiTek had offered them a signing bonus, which was paid while they were still employed). The employees did not give notice to Earthbound until several months later, and incredibly, each asked to stay at Earthbound to transfer work to successors, notwithstanding that they were already on MiTek's payroll. Unsurprisingly, Earthbound did not agree. Each employee returned laptops and company phones to Earthbound, but the phones had been returned to factory settings (wiped) and all data had been removed from laptops, etc. Wiping phones and laptops, together with the employees' odd request that they be allowed to remain at Earthbound while on MiTek's payroll, raised Earthbound's suspicions. However, a customer telling Earthbound that it had received an unsolicited bid from MiTek for a job that it had planned to award to Earthbound, at a lower price than Earthbound, likely turned suspicion into belief. Earthbound's lawyer sent a cease and desist to MiTek and the ex-employees, demanding, among other things, a return of everything, nonuse, etc. All of the defendants denied wrongdoing and refused to provide any information.
Earthbound engaged a forensic expert prior to filing its complaint. From Earthbound's records, she gathered a raft of information showing that one ex-employee in particular, both before and after giving notice to Earthbound, sent confidential information from his email to his wife's email, moved Earthbound files to his cloud storage or his DropBox account, inserted USBs on multiple occasions and downloaded files, and engaged in other questionable behavior. The description of the evidence she gathered was compelling. When confronted with these facts, the employees did not deny taking data, but instead argued that no one told them it was confidential or proprietary.
When Earthbound filed its complaint (asserting both a DTSA claim and a Washington UTSA claim) and motion for temporary restraining order, it already had substantial evidence of misappropriation. This proved critical to the court's decision to grant the TRO. Citing primarily the Washington version of the UTSA, the court devoted many pages to explaining the evidence provided by the forensic expert, brushed away a weak defense, and entered an aggressive TRO that required (1) the surrender of electronic storage means, hard drives, and devices for independent analysis by a third-party forensic expert; (2) nondisclosure, nonuse, and preservation of data; and (3) the defendants to give two-hour depositions prior to the PI hearing.73 The court observed that the misappropriation analysis would also support a violation of "the Economic Espionage Act, as amended by the Defend Trade Secrets Act" and that "[t]he EEA establishes criminal penalties for misappropriation of trade secrets . . . [which] demonstrates Congress's belief that such conduct is harmful not only to the individual or entity whose secrets are purloined, but also to the public."74
The final case of note in the infancy of the DTSA is Mission ManagementCorp. v. Blackbaud, Inc., which is unique among DTSA cases in that it involves only business-to-business misadventures.75 Mission Management and Microedge, a company purchased by Blackbaud, participated in a joint project to develop an analytical database to assess the utility and likely effects of social programs. The parties negotiated at least two agreements, but executed only a letter of intent. The plaintiff alleged that its proprietary "Outcomes Database" was subsumed into the "Outcomes" product offered by Blackbaud after it purchased Microedge. The plaintiff surmised, among other things, that one of Microedge's purposes was to boost its value in Blackbaud's purchase transaction based on the incipient release of the new joint database product. The defendant moved to dismiss the Illinois UTSA and DTSA claims asserted by the plaintiff. Of all the interesting issues that could be raised on a Rule 12(b)(6) motion based on these allegations, the only one that the court addressed was a fairly uninteresting one—whether the plaintiff adequately alleged the existence of trade secrets. Based on unsurprising prior Illinois UTSA cases, the court found that plaintiff had adequately alleged its trade secrets and denied the motion.76
C. Whistleblower Exemption
Thus far, only one defendant has attempted to rely on the DTSA's whistleblower exemption. In Unum Group v. Loftus, the court confronted a fact pattern in which one of Unum's employees, Loftus, was caught on camera on multiple occasions hauling documents in boxes out of its offices.77 He finally returned a laptop, but no documents.
Loftus moved to dismiss Unum's DTSA and UTSA claims, relying on the whistleblower protection provisions in the DTSA.78 But there was no indication that Loftus took any of the steps that a whistleblower would have taken; he admitted taking documents, but the only support for his whistleblower defense seemed to be his word. The court required Loftus to promptly turn over to the court all the documents, regardless of media, he had removed; all other copies of the documents, even those in Loftus' attorney's possession were ordered destroyed; no documents were to be provided to others; Loftus was required to mirror his computer hard drive and flash drive; and Loftus and his lawyer were required to sign affidavits attesting to the completion of these tasks.79 The court's comments on Loftus' whistleblower exemption criticize (and give small credence to) what appears to be a clumsy effort to apply the exemption.
D. Protective Discovery and Seizure
The Unum case is also notable for its discussion of procedural aspects of the DTSA that were added to protect trade secrets during the litigation process. During legislative hearings on the DTSA, several commentators expressed concerns regarding the potential disclosure of trade secrets and reactions to those concerns found their way into the Act. Even prior to the DTSA, the Economic Espionage Act authorized courts to take "necessary and appropriate [action] to preserve confidentiality" and, in addition, imposed conditions on a court's ability to order disclosure of trade secrets in litigation.80 When the DTSA was adopted, additional protective measures were included in the context of civil seizure.81 Although the plaintiff did not request, nor did the court expressly grant, seizure in Unum, the court applied many of the protective measures specifically authorized in 18 U.S.C. § 1836(b)(2)(D), especially requiring that produced data be maintained by the court only, even to the exclusion of defense counsel.82
Interestingly, although seizure was not involved in any of the cases discussed above, the courts moved extremely quickly on plaintiffs' motions for temporary or preliminary relief. The Henry Schein and Getty Imagescases are particularly good examples of the sense of urgency that the DTSA imparts. The court in Getty Images granted the plaintiff's motion for TRO, expedited discovery, and issued a Hague Convention request four days after the case was filed and followed it up by ordering aggressive expedited discovery. In Henry Schein, the court granted an ex parte TRO against HSI's ex-employee one day after suit was filed and granted preliminary injunctive relief less than two weeks later.83
Although seizure under the DTSA has not been granted or analyzed in detail, it has been requested in at least one instance. In OOO BrunswickRail Management v. Sultanov,84 plaintiff OOO Brunswick requested the court enter a seizure order for the laptops and mobile phones in possession of a former employee.85 Rather than analyzing the DTSA's seizure requirements, the district court simply stated that seizure under the DTSA was unnecessary because it would order the former employee to deliver the devices to the court under Federal Rules of Civil Procedure Rule 65 at a scheduled hearing and ordered that the devices not be accessed or modified. Although the court mentions the DTSA's seizure remedy, it provides no guidance as to evidentiary requirements or other interpretation.
What little we can glean from the DTSA cases thus far suggests that, in applying the seizure remedy, courts will be inclined to act quickly, may force the parties to litigate on a fast track, and will be respectful of the trade secrets at issue. But does that answer the fears of commentators on either side of the legislative debate: will the DTSA have a chilling effect on exemployees/entrepreneurs (higher price of entry and litigation)? Is the weapon it provides to big business immense, while smaller entities will be discouraged (by price) from using it? Will the seizure remedy be abused? These questions obviously await resolution, but a look at an analogous civil seizure remedy may provide some hints.
The DTSA's seizure remedy was modeled after provisions in the Lanham Act, which allows seizures of counterfeit goods.86 Although generalization is dangerous, courts applying the Lanham Act seizure remedy have typically demanded strict compliance with the statutory requirements and have ordered seizure (rather than injunctive relief) only where there is evidence of the defendant's prior disobedience of court orders. In Lorillard Tobacco Co. Bisan Food Corp., for instance, the U.S. District Court for the District of New Jersey refused to issue a seizure order, observing that the statute "contains rock solid requirements that I find are not met here."87 In particular, the court found nothing to suggest prior disobedience on the part of the defendant. The Third Circuit affirmed, concluding that the plaintiff failed to demonstrate that "the person against whom seizure would be ordered . . . would destroy, move, hide or otherwise make such matter inaccessible to the court," the same language that appears in the DTSA.88 However, in Dell v. Belgiumdomains, LLC, a Florida district court came to a different conclusion and issued a seizure order against alleged cybersquatters.89 Notably, the evidence sought to be seized was primarily electronic (making it easy to destroy), cybersquatters have routinely ignored judicial proceedings, the defendants had no physical presence in Florida, and they used fictitious names and shell entities to shield their activities.
As in the DTSA, the Lanham Act seizure provision includes a penalty for bad faith or wrongful seizure. Where seizure has been implemented in bad faith or impermissibly against non-counterfeit goods, courts have awarded damages to the injured party. In Prince of Peace Enterprises, Inc. v. Top Quality Food Market, LLC, for example, a seizure order had issued and been executed.90 On a motion to dismiss, the court found the plaintiff did not have standing under the Lanham Act and much of the seized product was not counterfeit and awarded damages to the aggrieved defendant based on the wrongful seizure, referring the issue of amount to the magistrate.91 Waco International v. KHK Scaffolding Houston, Inc. also turned into a victory for the defendant.92 After a seizure that yielded many, perhaps mostly, non-infringing goods, the court dissolved the seizure order but entered a narrow injunction at the same time. The defendant's counterclaim for wrongful seizure was successful and the jury awarded damages in the form of attorney fees. The appellate court affirmed.93
III. What's a Lawyer to Do?
The only realistic conclusion at this moment in time is that there is no conclusion. The DTSA is an infant and its story is only beginning. Early cases may provide a clue to its development, but so many aspects of the statute remain untested that even an educated guess is chancy. How do we, as lawyers representing franchisors and franchisees, deal with the DTSA? Practice tips, some obvious and others less so, can be gleaned from the language of the DTSA, the early cases, and analogous statutes.
For preventive maintenance (transactional counsel):
- Consider adding the notice required by the DTSA in franchise agreements. A franchisee may qualify as a "contractor" under the statute, and the DTSA also mandates notice to "employees." It's worth considering whether the advantages of providing notice (recovery of enhanced damages and attorney fees) warrants any perceived risk that doing so may support an argument that the franchisee is the franchisor's employee.
- Nondisclosure provisions in franchise agreements should be supported by identifying the claimed trade secrets not only generally (as is usual in franchise agreements) but more specifically in the operations manual.
- Marking physical media containing claimed trade secrets as confidential may have added significance under DTSA, as may other methods of protection (e.g., password-protected online access only).
- Carefully consider ownership of trade secrets in the franchise corporate structure. Putting ownership of trade secrets in the franchising entity may not be desirable for many reasons (e.g., tax, income distribution, and exposure to third party claims). But if the owner of trade secrets is required to be a plaintiff in any DTSA action, are the business reasons for separate ownership still compelling?
For emergency responders (litigators):
- Weigh the risks of aggressive enforcement and strongly consider potential benefits (or adverse consequences) of federal jurisdiction. Aggression requires strong support and could backfire.
- Hire a forensic expert prior to filing and develop evidence of theft or disclosure.
- Avoid an ex parte motion for temporary restraining order if possible. Try serving notice on the defendant.
- Don't skimp on the hearing for a temporary restraining order/preliminary injunction—make it a compelling evidentiary hearing.
- Don't rely on the DTSA to satisfy elements of the injunction standard of proof—eBay may intrude.
- Offer the court a proposed order that respects the limits of state law.
In the franchise industry, counselors must consider not only the effects of actions in a particular dispute, but the upstream and downstream effects throughout the system. The DTSA, for better or worse, offers the opportunity for consistent national protection of trade secrets. Predictability is highly valued, but an adverse outcome may unduly impact an entire franchise system. The DTSA increases potential rewards and potential risks.
- See, e.g., Washington's version of the Uniform Trade Secrets Act, WASH. REV. CODE§ 19.108.020(1).
- Amended in 2012 by the Foreign and Economic Espionage Penalty Enhancement Act of 2012, Pub. L. No. 112-269, 126 Stat. 2442, 2443 (codified at 18 U.S.C. §§ 1831, 3553; 28 U.S.C. § 994) (2012).
- Forty-eight states have adopted some version of the Uniform Trade Secrets Act. New York and Massachusetts have not.
- Protecting American Trade Secrets and Innovation Act of 2012, S. 3389, 112th Cong. (2nd Sess.) (2012).
- Legislative history of the DTSA includes a House Judiciary Committee Report, two hearings in 2014 (in the House and in the Senate), a Senate hearing in 2015, written statements submitted in connection with those hearings, and written responses to questions posed by legislators. Although a complete review of these documents is not within the scope of this article, a fair observation is that the concerns and views recited herein were expressed by legislators, witnesses, and commentators during the process of enacting the DTSA.
- UNIFORM TRADE SECRETS ACT § 6; 18 U.S.C. § 1836(d). Individual states may have different statutes of limitations for misappropriation actions.
- UNIFORM TRADE SECRETS ACT § 3; 18 U.S.C. § 1836(b)(3)(B).
- UNIFORM TRADE SECRETS ACT § 3; 18 U.S.C. § 1836(b)(3)(B).
- UNIFORM TRADE SECRETS ACT § 3; 18 U.S.C. § 1836(b)(3)(C).
- UNIFORM TRADE SECRETS ACT § 4; 18 U.S.C. § 1836(b)(3)(D).
- For reference, this article was mostly written in January 2017, although research and outlining preceded the writing.
- No. C16-1150, 2016 WL 4418013, at *10 (W.D. Wash. Aug. 19, 2016).
- 18 U.S.C. § 1839.
- No. 8:16-cv-503, 2016 WL 5391394, at *5 (M.D. Fla. Sept. 27, 2016).
- Compare UNIFORM TRADE SECRETS ACT § 1(2) with 18 U.S.C. § 1839(5).
- UNIFORM TRADE SECRETS ACT § 1(1); 18 U.S.C. § 1839(6)(A).
- Comment, UNIFORM TRADE SECRETS ACT § 1(1).
- 18 U.S.C. § 1839(6)(B).
- 18 U.S.C. § 1833(b)(1).
- 20 See Unum Group v. Loftus, No. 4:16-cv-40154, 2016 WL 7115967 (D. Mass. Dec. 6, 2016), discussed below.
- 18 U.S.C. § 1833(b)(3)(A).
- 18 U.S.C. § 1833(b)(3).
- 18 U.S.C. § 1833(b)(4).
- 18 U.S.C. § 1836(b)(2).
- 18 U.S.C. § 1836(b)((2)(A)(i).
- 18 U.S.C. § 1836(b)(2)(A)(ii)(I) through (III).
- 18 U.S.C. § 1836(b)(2)(A)(i)(V), (VII).
- 18 U.S.C. §§ 1836(b)(2)(A)(i)(VI), 1836(b)(2)(B)(ii).
- 18 U.S.C. § 1836(b)(2)(B)(ii).
- 18 U.S.C. § 1836(B) (iii).
- 18 U.S.C. § 1836(B)(iv).
- 18 U.S.C. § 1836(B)(vi).
- 18 U.S.C. § 1836(B)(v).
- 18 U.S.C. § 1836(C).
- 18 U.S.C. § 1836(F).
- Allstate Insurance Co. v. Rote, 3:16-cv-01432, 2016 WL 4191015 (D. Or. Aug. 7, 2016), involved enforcement of a non-compete and non-disclosure agreement against an ex-agent who did business exclusively under the Allstate brand. On a motion for preliminary injunction, the court did not prevent competition by the ex-agent, but required all confidential data to be returned to Allstate. Although Allstate's complaint alleged violations of both the Oregon version of the UTSA and the DTSA, the court did not appear to rely on the DTSA in fashioning preliminary relief. Despite its promising caption, Panera, LLC v. Nettles and Papa John's International, Inc., No. 4:16-cv-1181-JAR, 2016 WL 4124114 (E.D. Mo. Aug. 3, 2016), does not deal with a franchise-related issue, but with an IT specialist who wanted to jump to Panera from Papa John's.
- Adams Arms, LLC v. Unified Weapon Sys., Inc., No. 8:16-cv-503, 2016 WL 5391394, at *5 (M.D. Fla. Sept. 27, 2016).
- Id. at *6; see also Dazzle Software II, LLC v. Kinney, Case No. 16-cv-12191, 2016 WL 6248906 (E.D. Mich. Aug. 22, 2016) (without substantive analysis, the court granted a motion to dismiss, but with leave for plaintiff to amend after discovery into defendant's conduct subsequent to May 11, 2016).
- Id. at *6.
- No. 2:16-cv-00135, 2016 WL 5255163 (D. Utah Sept. 22, 2016).
- Id. at *6.
- No. 4:16-cv-01631, 2016 WL 6611133 (E.D. Mo. Nov. 9, 2016).
- Id. at *3–4.
- Unsurprisingly, whether a licensee has standing, and whether that standing extends to both exclusive and non-exclusive licensees, varies from state to state. See,e.g., DTM Research v. AT&T Corp., 245 F.3d 327 (4th Cir. 2001) (Maryland law; fee simple ownership not required for standing); Faveley Transp. USA, Inc. v. Wabtec Corp., 758 F. Supp. 2d 211 (S.D.N.Y. 2010) (exclusive licensee has standing to sue under New York law); Metso Minerals, Inc. v. FLSmidth-Excel, LLC, 733 F. Supp. 2d 969 (E.D. Wis. 2010) (licensee has standing to bring trade secret misappropriation claim).
- See, e.g., Earthbound Corp. v. MiTek USA, Inc., No. C16-1150, 2016 WL 4418013, at *10–11 (W.D. Wash. Aug. 19, 2016) (temporary restraining order); Henry Schein, Inc. v. Cook, No. 16-cv-03166, 2016 WL 3418537, at *3 (N.D. Cal. June 22, 2016) (preliminary injunctive relief).
- By contrast, as discussed in greater detail below, the DTSA's seizure remedy mandates a separate and more demanding standard.
- Engility Corp. v. Daniels, No. 16-cv-2473, 2016 WL 7034976, at *11 (D. Colo. Dec. 2, 2016). The court did not rely totally on the DTSA, however. It cited Tenth Circuit jurisprudence, which "excuses irreparable harm . . . when the evidence shows that a defendant is or will soon be engaged in acts or practices prohibited by statute, and that the statute itself provides for injunctive relief to prevent such violations." Id.
- Earthbound, 2016 WL 4418013, at *10. Likewise, in Getty Images v. Motamedi, No. 2:16- cv-1892, 2016 WL 7321133 (W.D. Wash. Dec. 16, 2016), the court relied exclusively on the DTSA itself for the public interest element.
- 547 U.S. 388, 392 (2006). Since its original pronouncement, the eBay holding has been applied to condemn "automatic" or presumptive grants of injunctive relief in many contexts. See, e.g., Monsanto Co. v. Geertson Seed Farms, 591 U.S. 139 (2010) (environmental case); Ferring Pharm., Inc. v. Watson Pharm., Inc., 765 F.3d 205 (3d Cir. 2014) (trademark case); Swarovski Aktiengesellschaft v. Building No. 19, Inc., 704 F.3d 44 (1st Cir. 2013) (trademark case); Novus Franchising, Inc. v. Dawson, 725 F.3d 885 (8th Cir. 2013) (franchise case); PBM Prods., LLC v. Mead Johnson & Co., 639 F.3d 111 (4th Cir. 2011) (trademark case); Perfect 10, Inc. v. Google, Inc., 653 F.3d 976 (9th Cir. 2011) (copyright case); Salinger v. Colting, 607 F.3d 68 (2d Cir. 2010) (copyright case); N. Am. Med. Corp. v. Axiom Worldwide, Inc., 522 F.3d 1211 (11th Cir. 2008) (trademark case).
- Earthbound, 2016 WL 4418013, at*10.
- 18 U.S.C. § 1836(b)(3)(A)(i)(II).
- Corp., 2016 WL 7034976, at *11.
- 191 F. Supp. 3d 1072 (N.D. Cal. 2016).
- Id. at 1079–80.
- Henry Schein, Inc. v. Cook, No. 16-cv-03166, 2016 WL 3418537 (N.D. Cal. June 22, 2016).
- Id. at 10.
- Although the court did not mention it, the elimination of the non-solicitation portion of the TRO appeared to be intended to comply with California's prohibition of non-competes. This juxtaposition of the DTSA with state statutes, especially in the area of remedies, appears more sharply drawn (and with far more analysis) in Engility Corp., discussed in greater detail below.
- It is worth noting that a different judge in the same court (Western District of Washington) handled an earlier DTSA case in exactly the same way, including authoring some of the language that appears in the plaintiff's motion for TRO in Getty Images, discussed below, without attribution. See detailed discussion of Earthbound, below.
- No. 2:16-cv-1892, 2016 WL 7321133, at *2–3 (W.D. Wash. Dec. 16, 2016).
- Id. at *1.
- Engility Corp. v. Daniels, No. 16-cv-2473, 2016 WL 7034976 (D. Colo. Dec. 2, 2016).
- Id. at 4–6.
- Engility Corp., 2016 WL 7034976, at *6.
- Id. at *7 (citing Greater Yellowstone Coal. v. Flowers, 321 F.3d 1250, 1256 (10th Cir. 2003)).
- Id. at *8.
- Id. at *11–12.
- Id. at *11.
- 18 U.S.C. § 1836(b)(3)(A)(i)(I).
- 18 U.S.C. § 1836(b)(3)(A)(i)(II).
- Engility Corp. v. Daniels, No. 16-cv-2473, 2016 WL 7034976, at *14 (D. Colo. Dec. 2, 2016).
- Earthbound Corp. v. MiTek USA, Inc., No. C16-1150, 2016 WL 4418013 (W.D. Wash. Aug. 19, 2016).
- Id. at *11–12.
- Id. at *10.
- No. 16 C 6003, 2016 WL 6277496 (N.D. Ill. Oct. 27, 2016).
- Id. at.*5–6.
- See Unum Group v. Loftus, No. 4:16-cv-40154, 2016 WL 7115967 (D. Mass. Dec. 6, 2016).
- 18 U.S.C. § 1833(b).
- Unum, 2016 WL 7115967, at *4.
- 18 U.S.C. § 1835(a).
- 18 U.S.C. § 1836(b)(2).
- Unum, 2016 WL 7115967, at *4.
- Henry Schein, Inc. v. Cook, No. 16-cv-03166, 2016 WL 3418537, at *10 (N.D. Cal. June 22, 2016)
- No. 5:17-cv-00017-EJD, 2017 WL 67119 (N.D. Cal. Jan. 6, 2017).
- Id. at *2.
- 15 U.S.C. § 1116(d).
- 377 F.3d 313, 317 (3d Cir. 2004).
- 18 U.S.C. § 1836(b)(2)(A)(ii)(V).
- No. Civ. 07-22674, 2007 WL 6862341, at *7–9 (S.D. Fla. Nov. 21, 2007).
- 760 F. Supp. 2d 384 (S.D.N.Y. 2011).
- Id. at 394, 396.
- 278 F.3d 523 (5th Cir. 2002).
- Id. at 536–37.
Article originally appeared in Volume 36-4 (Spring 2017) of the Franchise Law Journal. This information or any portion thereof may not be copied or disseminated in any form or by any means or downloaded or stored in an electronic database or retrieval system without the express written consent of the American Bar Association.
It also appeared in the September 2017 edition of The Licensing Journal.