Trading Secrets : Trade Secrets Lawyers & Attorneys : Seyfarth Shaw Law Firm : Computer Fraud, Confidentiality Agreements, Corporate Espionage

Where hearsay and speculation form the sole basis for a complaint, summary judgment and sanctions against counsel will be the result, according to a recent decision of the Third Circuit. In Brubaker Kitchens, Inc. v. Brown, 2008 WL 2123327 (3d Cir. 2008), the Court granted defendants summary judgment and sanctioned plaintiff’s counsel because non-competition allegations against a defendant lacked reasonable foundation.

Brubaker Kitchens manufactures custom cabinetry. In 2005, both the general manager and plant manager of Brubaker resigned from their positions to form a competing cabinet company. During their time at Brubaker, the two managers had become friendly with defendant Mark Schibanoff, one of the principals of Kitchen Consultants, a sales and marketing company that had done work with Brubaker. On highly tenuous hearsay and speculation, Brubaker’s president suspected that Schibanoff had been inappropriately involved with the formation of the managers’ competing company. Regardless, however, Brubaker brought a series of claims again Schibanoff, including tortious interference claims, in response to which defendant filed a motion for summary judgment and a request for sanctions under Rule 11. The District Court granted summary judgment in favor of Schibanoff on all claims and also imposed direct sanctions against Brubaker’s counsel for submitting the frivolous claims.

The Third Circuit upheld the judgment of the District Court, agreeing that Brubaker had failed to substantiate its allegations with sufficient factual support to satisfy the essential elements of the claims against Schibanoff. Since the only significant evidence of Schibanoff’s involvement with the competing company was an informal dinner discussion and a single innocuous reference letter, the claims were deemed frivolous.

Although the Third Circuit unanimously affirmed the grant of summary judgment in favor of Schibanoff, Judges Jordan and Sloviter were split regarding the standard of review on the issue of sanctions. Judge Jordan, writing for the majority, found that the District Court did not abuse its discretion in imposing sanctions against Brubaker’s counsel where its lawsuit consisted solely of a “vague belief based on bad feelings and a stray comment that the accused was ‘involved,’” while Judge Sloviter believed the District Court incorrectly had relied on an earlier version of Rule 11 that stated the imposition of sanctions was mandatory rather than discretionary and had abused its discretion in this instance.

This case serves as a reminder to employers that they must have concrete evidence of improper competition and cannot rely simply on guesswork in bringing claims of tortious interference. In addition, counsel should also exercise careful judgment when deciding whether or not to proceed with a case, as the courts will not hesitate to impose sanctions if they believe claims lack a factual basis.

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A 49-year-old Missouri woman is being tried in Federal Court in Los Angeles for posing as a young boy and taunting a 13-year-old girl on the social networking site MySpace, leading the girl to hang herself. The woman was charged with conspiracy and violations of the Computer Fraud and Abuse Act (CFAA). This case is the first time the CFAA is being used in a social networking case.

Prosecutors say Lori Drew created a fake MySpace under the name of “Josh Evans” and initiated a fake friendship with Megan Meier. Drew later used the account to send cruel messages to Meier, culminating in an October 2006 message stating “the world would be a better place without you.” After receiving the message, Meier hanged herself and died the following day.

MySpace prohibits the use of fraudulent registration information, the use of accounts to obtain personal information about juvenile users, the use of the site to harass, abuse, or harm other users, and the promotion of false or misleading information.

Drew pleaded not guilty at trial. If found guilty, she could serve up to 5 years for the conspiracy count and up to five years for each of the three CFAA charges. Since the news of Drew’s alleged actions became public, she has been the victim of cyberbullying.

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United States v. Meng, No. CR 04-20216 JF (U.S.D.C. N.D. Calif.).

Judge Jeremy Fogel of the U.S. District Court for the Northern District of California in San Jose today imposed a 24-month prison sentence on Xiaodong Sheldon Meng, who pleaded guilty to possessing night vision software for pilots belonging to Quantum3D, his former employer, and using that information in a sales demonstration to Chinese naval officials.

According to the indictment, Meng was employed by Quantum3D in various systems engineering and analysis positions, and later as a consultant to Quantum3D. In that capacity, he had access to various trade secrets belonging to Quantum3D, a producer of hardware and software components for simulation systems for commercial and military customers. Among the products to which Meng had access were “Mantis,” a product used to visually simulate motions and three-dimensional scenes for training and other purposes, and “viXsen,” a visual simulation software program using for training military fighter pilots using thermal imaging (night vision) equipment. As part of his employment, Meng signed an “Employee Proprietary Information Agreement” acknowledging his obligation to return Quantum3D’s information, documents and other property to the company at the end of his employment.

Upon ending both his employment and consulting relationship with Quantum3D, Meng took a position with Orad, a direct competitor of Quantum3D in China. The government charged that Meng then traveled to China and made a presentation and demonstration to various foreign governments and officials, including the Royal Thai Air Force, the Royal Malaysian Air Force, and government entities and military contractors of the People’s Republic of China, using Quantum3D’s products, modified to seem like they belonged to Orad.

The United States government charged Meng with misappropriating Quantum3D’s trade secrets without authorization and attempting to export them from the United States to China in violation of various federal laws including, among others, the Economic Espionage Act (18 U.S.C. § 1831), the Trade Secrets Act (18 U.S.C. § 1832), and the Arms Export Control Act (22 U.S.C. § 2778). Although the statutory maximum for the economic espionage count to which he pleaded guilty is 15 years in prison, Meng’s plea agreement with the government, in which he pleaded guilty to 2 of the 36 counts of the indictment, recommended a maximum sentence of 24 months’ imprisonment.

At the sentencing hearing, Judge Fogel imposed the 24-month maximum under the plea deal, emphasizing the need to deter others who would consider stealing and selling American technology and jeopardizing national security. In doing so, Judge Fogel became the first judge in the country to sentence a defendant convicted under the rarely-used Economic Espionage Act.

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Tracy v. Winfrey, et al., No. 07-1630 (1st Cir. June 11, 2008).

The U.S. Court of Appeals for the First Circuit has affirmed the dismissal of Darlene Tracy’s copyright infringement and trade secret misappropriation suit against Oprah Winfrey, Harpo Productions, and ABC Television.

In a pro se complaint filed in federal district court in Boston, Tracy alleged that she came up with the idea that eventually became the hit reality TV show “Oprah’s Big Give.” In the show, which recently completed its run, Winfrey gave money to ten contestants, who then competed to make the biggest impact on the lives of complete strangers by giving the money away. Tracy alleged that she conceived of the idea for a show entitled “The Philanthropist,” and submitted a proposal to an executive producer for The Oprah Winfrey Show. She claims that a second producer told her the proposal was under review, but that the producers stopped returning her phone calls and ignored her requests to return her proposal. The complaint asserts that more than a year later, Winfrey announced at the end of her daily talk show that she was giving $1,000 to audience members to use for a charitable purpose in their communities. Shortly thereafter, Winfrey and ABC announced a new program with the working title “The Big Give,” which Tracy alleged mirrored her concept for “The Philanthropist.”

The district court dismissed the complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) for failing to allege facts sufficient to support her claims. Tracy, now represented by counsel, appealed to the First Circuit. But the First Circuit affirmed the dismissal, concluding that “neither copyright nor misappropriation of trade secrets are apt legal theories for the facts as pled by Tracy, which, even construed in her favor, reveal that Tracy voluntarily and without reservation submitted her material to the defendants.”

While the lawsuit was pending, it garnered widespread media coverage, which was rumored to cause at least one large publishing house to back out of discussions concerning a possible companion “Big Give” book out of fear that it, too, might be named in the suit.

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The recent California appellate decision, Cypress Semiconductor Corp. v. Superior Court, is instructive not just on the issue of when the statute of limitations begins to run in a trade secret matter, but also contains important language with respect to the obligations of the trade secret owner to notify good faith, third-party users of the alleged misappropriation of trade secrets.

In Cypress, Silvaco Data Systems had developed and licensed electronic design automation software (“EDA”). This software was used by Silvaco’s customers to design their own products. One of Silvaco’s EDA products was known as Smart Spice, and Silvaco maintained the source code for SmartSpice as a trade secret. In late 1998, a former Silvaco employee began working for Circuit Systems, Inc. (“CSI”) and incorporated the SmartSpice trade secrets into a CSI product known as DynaSpice. Silvaco first suspected the trade secrets misappropriation in 2000 and sued its former employee and CSI at that time. Silvaco did not directly notify or take any action against CSI customers who had licensed DynaSpice. In August 2003, Silvaco and CSI entered into a settlement agreement and a stipulated judgment. The judgment included an express finding that Silvaco’s trade secrets had been incorporated into DynaSpice. The judgment also required CSI to discontinue licensing DynaSpice, as well as notify DynaSpice license holders that the software contained Silvaco trade secrets and to encourage customers to discontinue using DynaSpice.

Cypress Semiconductor Corporation (“Cypress”), which was one of CSI’s customers, learned of the judgment in late August 2003. After judgment was entered, Silvaco also directly notified CSI customers that DynaSpice contained misappropriated trade secrets from Silvaco. Silvaco contacted Cypress in September 2003 and demanded that Cypress cease using Silvaco’s trade secrets. Silvaco claimed that despite this notice, Cypress continued to use the DynaSpice program, and thus continued to use Silvaco’s trade secrets. Silvaco brought suit against Cypress in May 2004.

The central issue decided by the California Sixth Appellate District in Cypress involved the statute of limitations of Silvaco’s claims against Cypress. However, the decision also contains important language regarding the obligations of a trade secret holder with respect to third parties who are using the holder’s trade secrets.

The Cypress court stated that “a cause of action for misappropriation against a third-party defendant accrues with the plaintiff’s discovery of that defendant’s misappropriation.” The Cypress court also noted that trade secret owners have an incentive under the California Uniform Trade Secrets Act (“CUTSA”) to put good-faith third parties on notice. According to Section 3426.1(d) of the CUTSA, “a trade secret loses its protected status if the owner does not undertake reasonable efforts to keep it secret.” Also, according to Section 3426.1(b)(2)(C) of the CUTSA, good faith acquirers of trade secrets who do not receive notice before materially relying upon the trade secrets may not be liable for misappropriation at all. Therefore, according to the Cypress decision, “the failure of the trade secret owner to take prompt action to protect its trade secrets or to alert good-faith acquirers to the existence of its trade secret claims can serve as a defense in the event the trade secret owner eventually decides to pursue a misappropriation claim against the third party.” (emphasis added).

A trade secret owner, therefore, must promptly investigate instances of possible misappropriation and seek to notify any third parties who may have acquired the owner’s trade secrets. Failure to act promptly, under the CUTSA and the Cypress decision, can give rise to statute of limitations defenses, as well as the possibility that the Court may find that the claimed trade secrets are no longer protected trade secrets at all.

The full text of the Court's decision can be accessed here http://www.courtinfo.ca.gov/opinions/documents/H032114.PDF.

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A California appellate court recently held that the statute of limitations for trade secret misappropriation claims against third parties who receive stolen trade secrets from others begins when the plaintiff, not the third party, suspects a misappropriation of trade secrets.

The Court stated: "We conclude that with respect to the element of knowledge, the statute of limitations on a cause of action for misappropriation begins to run when the plaintiff has any reason to suspect that the third party knows or reasonably should know that the information is a trade secret. The third party’s actual state of mind does not affect the running of the statute."

The Court indicated that the trade secret holder's failure to take "prompt action" in notifying the third party about the purported misappropriation may diminish the holder's trade secret misappropriation claim.

Justice Eugene M. Premo, the author of the court decision, stated "A trade secret loses its protected status if the owner does not undertake reasonable efforts to keep it secret."

The Court's opinion is significant because the decision demonstrates that trade secret holders need to take "prompt action" once they suspect a misappropriation of trade secrets, including investigating potential misuses of their secrets.

A trade secret audit can be an invaluable part of protecting a company's trade secrets before and after a company's trade secrets have been compromised. For more information on Seyfarth Shaw LLP's trade secret audit capabilities, click here.

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The California Courts of Appeal recently concluded that a former employee could not have breached a duty of loyalty to his employer where he entered into competition with the employer only after leaving the company. Primetech Corp. v. Cohen, 2008 WL 1899976 (Cal. App. 4 Dist. April 30, 2008).

The plaintiff, Primetech Corporation, a supplier of aircraft parts to the military and civilian industry, hired defendant Jonathan Cohen to help produce a database of aircraft parts. A year after Cohen started, the United States Air Force suspended Primetech and “debarred” many of its principals from any government contracting because of allegations that the company had knowingly delivered counterfeit parts to the Department of Defense. Around this time, Cohen, and another employee of Primetech, formed Air Sonic, an aircraft parts business, where they continued to use Primetech’s database. Cohen ultimately separated from Primetech in July 2005, taking several computers with him, as well as a database program containing Primetech’s financial information.

Primetech sued Cohen and his new aircraft parts company, Air Spectrum, which had replaced the earlier Air Sonic. After a bench trial, the trial court entered judgment for Cohen on most of the causes of action, rejecting Primetech’s claims for breach of loyalty, misappropriation of trade secrets, and unfair competition, among others. Primetech argued on appeal that the trial court had erred in denying its motion for a directed verdict (nonsuit) on its cause of action for breach of loyalty. Primetech alleged that Cohen had breached his duty of loyalty when he began operating his own aircraft parts company while still employed at Primetech. The trial court, however, concluded that Cohen was never an officer of the company and furthermore, he had started Air Sonic with the consent of Primetech’s vice president and had not actually decided to compete with Primetech until after he had separated from the company, which he was entitled to do since there was no non-compete clause in his employment contract. Reviewing the facts, the Courts of Appeal observed that while substantial evidence supported a determination that Cohen was an officer of Primetech when he set up a competing business using Primetech’s database, Primetech had failed to demonstrate that Cohen had directly harmed the company with his competing venture, so any error was not prejudicial and thus reversal was not warranted. As a result, the Courts of Appeal held that the trial court’s factual findings precluded Primetech from succeeding under a breach of loyalty theory.

This case should prompt companies to consider carefully the circumstances under which they separate from former executives. Although non-competition agreements can protect an employer, a company should not rely on breach of loyalty claims to protect against contemporaneous competition where there is any inference of an amicable split. Employers should also realize that to pursue a breach of loyalty claim successfully , they must demonstrate that the employee “formed the design to compete” while still employed with the company. Similarly, without adequate trade secrets counseling and preparation, even a company’s most valuable asset (in this case the airplane parts database) can be used by former employees in competing businesses if the proper protections are not in place.

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By Scott Krol, New York

The United States Court of Appeals for the Fourth Circuit recently upheld summary judgment holding that a former employee did not violate the Virginia Computer Crimes Act (“VCCA”) when the former company could not prove that they were unaware of employees’ use of company funds. Further, the employee did not violate the Virginia Uniform Trade Secrets Act (“VUTSA”) when the company could not show any evidence that the employee in fact used any of the otherwise protected trade secrets for his benefit.

The parties to this case are closely linked. Jerry Nims is an entrepreneur who obtained patents on many technologies used in making identification cards more difficult to temper with or counterfeit. Nims started Orasee which owned many of these patents.

In 2003, Nims formed EC4 Technologies Limited (“EC4 UK”), a wholly owned subsidiary of Orasee, to license the technologies.

In 2005, Nims set up Othentec Ltd. (“Othentec UK”) as a subsidiary of EC4 UK.

Nims’s son-in-law, Jeffrey Phelan, was appointed Managing Director of both EC4 UK and Othentec UK, and later was put in charge of better distributing the company’s product in the United States.

On March 17, 2005, Phelan formed EC4 Technologies, Incorporated (“EC4 USA”) and became that company’s CEO. He began to market and distribute Orasee technologies in the U.S. pursuant to a sublicense agreement between the EC4 UK and EC4 USA. In November 2005, another executive formed Othentec Limited (“Othentec USA”) for the same purpose as EC4 USA, this time as wholly owned by Othentec UK.

By early 2006, after a considerable amount of friction developed between the parties, Phelan was discharged from his positions at the UK companies, but continued to do business as EC4 USA. This gave rise to the case at hand, essentially Nims’ companies claimed that Phelan abused his position of power and trust to form EC 4 USA fraudulently and proceeded to use Othentec UK’s money and trade secrets to run the U.S. business successfully. Phelan moved for and won summary judgment against Othentec UK on all issues except whether Phelan breached his fiduciary duty to Othentec UK.

The district court explained that there are three elements of committing a violation of the VCCA: “(1) using a computer or computer network (2) without authority (3) intending to obtain, embezzle, or convert the property of another.” Va. Code Ann, §18.2-152.3.

The Court found that Phelan clearly was authorized to access Othentec UK bank account, Othentec UK was aware of the withdrawals, and Phelan did not directly withdraw the money using a computer. Instead, Phelan merely sent an email to the accountant asking for the withdrawal. Hence, there was no evidence of the unauthorized use of a computer to commit a crime. Othentec UK “produced no evidence outside of self-serving speculations that Phelan committed a violation. of the VCCA.”

The VUTSA makes it illegal for a person to misappropriate trade secrets from another. Othentec UK argued that Phelan, as Managing Director, was intimately familiar with the technology, “unless someone is foolish enough to believe that all that (EC4 USA’s technology) was developed in a clean-room environment without reference to, use of, or attempting to work around” Othentec UK’s proprietary and highly confidential software and manufacturing process, than Othentec UK had no basis for its argument. The Court agreed with the last part, ruling that these “allegations, speculations, and inference are not enough to survive summary judgment.” See Othentec Ltd. v. Phelan, --- F.3d ----, Case No. 06-2297, 2008 WL 2009740 (4th Cir. May 12, 2008) (emphasis added).

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