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

In August, federal prosecutors charged Biswamohan Pani, a former Intel Corp. engineer, with theft of trade secrets from his former employer, Intel.  This week, a Massachusetts grand jury added four new counts of wire fraud.  If convicted, Pani could serve up to 10 years in prison for the theft of trade secrets count, and up to 20 years on each count of wire fraud.

Federal prosecutors in Massachusetts allege that after Pani resigned from Intel in May 2008, he downloaded confidential documents and trade secrets worth $1 billion, including new microprocessor chip designs. Pani accessed the internal Intel network via his Intel-issued laptop, downloading "mission-critical" documents.

It is reported that Pani told his supervisors that he was leaving Intel to work for a hedge fund, but in reality he had accepted a job months earlier with Intel’s main competitor, Advanced Micro Devices, Inc., and began working there days after his resignation from Intel, but while still employed by Intel.  For a brief period, Pani was on both AMD’s and Intel’s payrolls due to accrued, unused vacation time at Intel.  Intel owns 80% of the worldwide market for microprocessors, and AMD owns the rest.

An FBI search of Pani’s home recovered eight Intel documents classified as “secret,” “top secret,” and “confidential.” Pani told FBI investigators that he planned to give the information to his wife, who also works for Intel. AMD is not accused of any misconduct, and there is no evidence that AMD had any involvement in or awareness of Pani’s actions.  Pani, of course, is no longer employed by AMD. 

 

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 By James McNairy & Robert Milligan

A new Ninth Circuit case, Asset Marketing Systems, Inc. v. Gagnon, 2008 WL 4138181 (Sept. 9, 2008), acknowledges (at least in dicta) that there is a trade secrets exception to Business and Professions Code Section 16600.

In the case, Gagnon, an independent contractor who developed computer programs for AMS, a field marketing organization, alleged, among other things that AMS had misappropriated his trade secrets that were contained in the programs’ source code.

The Ninth Circuit rejected Gagnon’s claims that AMS misappropriated his trade secrets.  The Ninth Circuit affirmed the district court’s determination that Gagnon had granted AMS an implied, unlimited license to retain, use, and modify the software, thus destroying any trade secret status the code might have had.

In rejecting Gagnon’s trade secret claim, the Court affirmed the district court’s holding that the noncompetition agreements signed by Gagnon’s employees were invalid. Gagnon contended that even if AMS obtained an implied license, it still misappropriated his trade secrets that were contained in the programs’ source code by hiring away his employees in violation of their employment agreements. One of the provisions in the employees’ agreements was an agreement not to engage in any employment or personal contractual agreement for AMS for twenty-four months without written consent from Gagnon.

Citing the California Supreme Court’s recent decision in Edwards v. Arthur Andersen LLP, 189 P.3d. 285, 288 (2008), the Ninth Circuit stated (arguably in dicta) that noncompetition agreements in California are invalid unless necessary to protect an employer’s trade secrets. The California Supreme Court in Edwards, however, specifically did not address what it called the so-called trade secret exception to Bus. & Prof. Code § 16600 and rejected the Ninth Circuit’s narrow restraint exception to section 16600 (the “narrow restraint” exception interpreted section 16600 to allow noncompetition agreements where departing employees were barred from pursuing only a small or limited part of a business, trade or profession). According to the Ninth Circuit, the non-competition agreements that Gagnon had his employees execute “were no longer enforceable” because they were no longer necessary to protect Gagnon’s trade secrets against AMS.

In this first post-Edwards published Ninth Circuit decision regarding section 16600, the Court did not provide any specific analysis concerning the nature of the trade secrets exception and what one must show to make defensible use of it. The Court’s dicta appears to suggest that non-competition agreements executed “to protect” an employer’s trade secrets will be enforceable. But as with most things legal, with trade secrets, the devil is in the details. What exactly the Court meant by a non-competition agreement to protect trade secrets is unclear. Further, mere assertions in employee/employer noncompetition agreements that the agreement has been executed “to protect” trade secrets without more is unlikely to withstand challenge.

 

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The Sixth Circuit Court of Appeals recently held that whether a trade secret is a protectable interest is an equitable question not affected by the lack of a written instrument. Niemi v. NHK Spring Company, --- F.3d ---, 2008 WL 4273123 (6th Cir. Sept. 19, 2008).

Richard Niemi is an individual engineer who provides various automobile company manufacturers with designs related to stabilizer bars for automobiles. In the early 1990s, Niemi had an idea for a new method of stabilizer-bar manufacturing, which interested his long term client, New Mather Metals (a subsidiary of Defendant NHK Spring Co.) Although the purchase order through which New Mather ordered the manufacturing tooling, which Niemi claimed to be a “trade secret,” included the clause that “no other or different terms or conditions shall apply to this order unless specifically agreed to in writing. . .”, Niemi claimed that he had assurances that his new method would be kept “confidential.” In order to protect itself from Niemi’s selling his designs to its competitors, New Mather requested that Niemi enter into a “exclusivity agreement,” which Niemi described as “reciprocal” despite any language in the instrument to that effect. “No further writing was needed, in Niemi’s estimation, because New Mather’s obligation represented a continuation of an arrangement that had been in place for 25 or 30 years . . . .” 

 

Niemi learned a few years later that New Mather had disclosed his stabilizer manufacturing trade secret to other designers, and he brought an action against New Mather and its parent companies for misappropriation of trade secrets, as well as for other claims. The district court ultimately granted summary judgment to Defendants on the trade secrets claim, finding that Niemi had not taken sufficient steps to keep his designs secret. 

 

In reviewing Niemi’s appeal of judgment against his trade secrets claim, the Sixth Circuit considered Ohio’s adopted Uniform Trade Secrets Act, particularly focusing on the factor requiring “reasonable” efforts to maintain secrecy. Ultimately, it concluded that there were direct, disputed material facts sufficient to warrant reversal of the district court.

 

The decision is most significant, however, for the reasoning underlying its rejection of one of Defendants’ arguments; namely, that Niemi’s “oral reciprocal exclusivity agreement” was barred by the statute of frauds. In rejecting that argument, the court quoted Ohio law in noting that “protection afforded by trade secret laws is not a function of property interests or contract rights, but of ‘equitable principles of good faith applicable to confidential relationships.’” In other words, whether there is a contract or property interest in the trade secrets is “irrelevant” because trade secret protection derives from equity.

 

The progenitor of the principle quoted by the Sixth Circuit was Justice Oliver Wendell Holmes’ opinion in Masland, where he observed that, in “explaining the nature of a trade secret . . . trade secret laws are not those of property but the equitable principles of good faith applicable to confidential relationships.” Valco Cincinnati v. N & D Machining Service, Inc., 492 N.E.2d 814, 817 (Ohio 1986) (citing E.I. Du pont de Nemours Powder Co. v. Masland, 244 U.S. 100 (1917) (Holmes, J.)). 

 

In any event, although the fundamental character of a trade secret may be one of confidence protected by equity, there is some dispute among the states regarding whether a trade secret is a property right. Compare Envirotech Corp. v. Callahan, 872 P.2d 487, 494 (Utah App. 1994) (trade secret is a property right) with ConFold Pacific, Inc. v. Polaris Industries, Inc., 433 F.3d 952, 959 (7th Cir. 2006) (holding that, under Wisconsin law, a trade secret is not a property right but instead an interest protectable by contract).

 

The Sixth Circuit is correct that the lack of a written instrument does not itself negate a claim under the Uniform Trade Secrets Act. Certainly, if the existence of a written agreement – such as the “oral” mutual exclusivity and confidentiality agreement present in Niemi – would tend to increase the likelihood of a protectable trade secret, then its absence should mitigate against it.  But the Sixth Circuit seemed to go a step further in concluding that because a trade secret’s nature is one of equity, the lack of a contractual or property claim renders wholly “irrelevant” the lack of a written instrument. 

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 By Robert Milligan, Kurt Kappes and James McNairy

The California Supreme Court released its highly anticipated decision in Edwards v. Arthur Andersen LLP  today and held that employee non-competition agreements are invalid, even if narrowly drawn, unless the agreement falls within a statutory exception. 

In doing so, the Court rejected the Ninth Circuit’s narrow restraint exception, which excepted the prohibition contained in Business and Professions section 16600 on non-competition agreements where one was barred from pursuing only a small part or limited part of the business, trade or profession.

In its decision, the Court limited its review to two issues:

1)      To what extent does Business and Professions Code section 16600 prohibit employee non-competition agreements;

2)      Is a contract provision requiring an employee to release “any and all” claims unlawful because it encompasses nonwaivable statutory protections, such as the employee indemnity protection of Labor Code section 2802.

The Court concluded that Business and Professions Section 16600 prohibits employee non-competition agreements unless the agreement falls within the applicable statutory exceptions of sections 16601, 16602, or 16602.5. The Court also held that a contract provision whereby an employee releases “any and all” claims does not encompass nonwaivable statutory protections, such as the employee indemnity protection of Labor Code section 2802.

On the first issue, the Court found that California state courts have consistently affirmed that section 16600 evinces a settled legislative policy in favor of open competition and employee mobility. Section 16660 states: “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” (emphasis added) The chapter excepts non-competition agreements in the sale or dissolution of corporations (§ 16601), partnerships (§ 16602), and limited liability corporations (§ 16602.5). 

The Court noted that it had previously invalidated an otherwise narrowly tailored agreement as an improper restraint under section 16600 because it required a former employee to forfeit his pension rights on commencing work for a competitor (citing Muggill v. Reuben H. Donnelley Corp. (1965) 62 Cal.2d 239, 242-243). The Court, quoting Muggill, stated section 16600 invalidates provisions in employment contracts and retirement pension plans that prohibit “an employee from working for a competitor after completion of his employment or imposing a penalty if he does so unless they are necessary to protect the employer’s trade secrets.”

The two clauses at issue in Edwards’ agreement with Andersen provided:

1)      If you leave the Firm, for eighteen months after release or resignation, you agree not to perform professional services of the type you provided for any client on which you worked during the eighteen months prior to release or resignation. This does not prohibit you from accepting employment with a client. 

2)      For twelve months after you leave the Firm, you agree not to solicit (to perform professional services of the type you provided) any client of the office(s) [Los Angeles] to which you were assigned during the eighteen months preceding release or resignation. 

Andersen argued that the Court should interpret the term “restrain” under section 16600 to mean simply to “prohibit,” so that only contracts that totally prohibit an employee from engaging in his or her profession, trade, or business are illegal. 

The Court rejected that argument and found that Andersen’s non-competition agreement was invalid because the two specific clauses at issue in the agreement restricted Edwards from performing work for Andersen’s Los Angeles clients and therefore restricted his ability to practice his accounting profession. 

Earlier in the decision, the Court expressly stated it did not address the applicability of the “so-called trade secret exception to section 16660.” Before the Supreme Court granted the petition for review in Edwards, the lower appellate court’s decision remanded the case to the trial court to determine if the trade secret exception applied, i.e. the non-competition agreement was necessary to protect trade secrets. The Court’s disposition indicates that the issue is closed though and that there will be no such remand to the trial court:

We hold that the noncompetition agreement here is invalid under section 16600, and we reject the narrow-restraint exception urged by Andersen. Noncompetition agreements are invalid under section 16600 in California even if narrowly drawn, unless they within the applicable statutory exceptions of sections 16601, 16602, or 16602.5

Andersen asked the Court to adopt the limited or “narrow-restraint” exception to section 16600. The Court noted that confusion over the Ninth Circuit’s application of section 16600 arose in a paragraph in the Ninth Circuit’s decision in Campbell v. Trustees of Leland Stanford Jr. Univ. (9^th Cir. 1987) 817 F.2d 499, in which the Ninth Circuit stated that some California state courts have excepted application of section 16600 “where one is barred from pursuing only a small or limited part of the business, trade or profession” (citing Boughton v. Socony Mobil Oil Co. (1964) 231 Cal.App.2d 188 and King v. Gerold (1952) 109 Cal.App.2d 316). The Court found that the reasoning in these state court cases does not provide persuasive support for adopting the narrow restraint exception because Boughton involved the use of land, not a restriction upon a plaintiff’s practice of a profession, and King relied upon a trade secret exception to the statutory rule. 

The Court acknowledged that recent Ninth Circuit cases have followed Campbell to create a narrow-restraint exception to section 16600 in federal court. The Court stated that California state courts have not embraced the Ninth Circuit’s narrow restraint exception and stated “no reported California state court decision has endorsed the Ninth Circuit’s reasoning, and we are of the view that California courts have been clear in their expression that section 16660 represents a strong public policy of the state which should not be diluted by judicial fiat” (citing Scott v. Snelling and Snelling, Inc. (N.D. Cal. 1990) 732 F. Supp. 1034, 1042).

In sum, while the Court’s decision clearly states California does not recognize a “narrow restraint” exception to the general rule that employee non-competition agreements are invalid, the Court did not specifically address when non-solicitation of customer and employee clauses are permissible to protect trade secrets. 

The San Francisco Chronicle also has posted an article about this case.

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           According to the California Supreme Court's website, the Court’s highly anticipated decision in Edwards v. Arthur Andersen, LLP will be available tomorrow, August 7, 2008 at 10:00 a.m. on the Court’s website.

            Trade secret and employment attorneys have been closely following the Edwards case after the Supreme Court granted review of the case on November 29, 2006. 

            In the lower court, the Court of Appeal for the Second Appellate District expressly rejected somewhat settled Ninth Circuit case law that provides an exception to the general rule in California that covenants not to compete are unlawful in the employment context pursuant to Business and Professions Code section 16600. The narrow restraint exception essentially provides that a noncompetition agreement is not unlawful where it leaves a substantial portion of the market open to the employee. The lower court expressly found that the narrow restraint exception was a “misapplication of California law when applied to an employee’s noncompetition agreement.” The court further stated “[i]n our view, section 16600 prohibits noncompetition agreements between employers and employees even where the restriction is narrowly drawn and leaves a substantial portion of the market available for the employee.”

            The lower court also found that the broadly worded release that Edwards allegedly was required to sign was unlawful because it purportedly waived Edwards’ Labor Code section 2802 rights. Labor Code section 2802, subdivision (a), provides: "An employer shall indemnify his or her employee for all necessary expenditures or losses incurred by the employee in direct consequence of the discharge of his or her duties . . ." The lower court held that “[b]ecause Labor Code section 2802's indemnity provisions implement public policy, requiring Edwards to waive indemnity rights as a condition of continued employment violated public policy and constituted an independently wrongful act for purposes of . . .[Edwards’] intentional interference with prospective economic advantage claim.”

            The issues that the Supreme Court are expected to address in tomorrow’s decision are:

 (1) Is a non-competition agreement between an employer and an employee that prohibits the employee from performing services for former clients invalid under Business and Professions Code section 16600, unless it falls within the statutory or judicially-created trade secrets exceptions to the statute?

(2) Does a contract provision releasing "any and all" claims the employee might have against the employer encompass non-waivable statutory protections, such as the employee indemnity protection of Labor Code section 2802?

            We will provide a follow-up blog entry once the decision comes out.  

By Robert Milligan, James McNairy and Summer Associate Julia Brodsky

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  By Erik Weibust (Boston) 

          Illustrating the roadblocks that Taiwanese companies still must overcome to do business in mainland China (Taiwan split from China amid a civil war in 1949), Forbes.com is reporting that electronics giant Hon Hai Precision Industry Co. recently took out half-page ads in major Taiwanese newspapers complaining about delays in a Chinese court over the prosecution of a Chinese competitor for allegedly stealing its trade secrets. In 2006, Hon Hai, which employs approximately 500,000 Chinese workers, sued BYD Company Limited, a Chinese competitor, for allegedly “systematically looting its trade secrets.”   According to Hon Hai, in 2006, two of its former employees took secret information when they left to work for BYD. Although the two employees have since been convicted of infringement in a Chinese court, according to Hon Hai, that may only be the tip of the iceberg. Specifically, Hon Hai alleges that over the past 4 to 5 years, 400 of its employees have moved to BYD, many of whom are suspected of providing the company with Hon Hai’s trade secrets and proprietary information. 

            According to the newspaper ads, the head of BYD is a member of the powerful People’s Congress, which has “the power to remove members of the judiciary.”  This, Hon Hai alleges in its ads has “result[ed] in a certain degree of unwillingness among local judicial and police members to deal with the case.” Nevertheless, Hon Hai believes that its rights will be vindicated eventually, particularly given China’s senior leaders’ commitment to protecting the interests of Taiwanese businesses on the mainland. 

            The Forbes.com article

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Goodyear Tire & Rubber Co. v. Schalmo, 2008 Wl 2697248 (Fla. App. 2 Dist. July 11, 2008)

The District Court of Appeal for the Second District in Florida confirmed that, no matter how unpleasant the task, when faced with an issue regarding whether documents are covered by Florida's Sunshine in Litigation Act, § 69.081, the trial court must conduct an in camera inspection of the documents and cannot enter a blanket confidentiality order. 

In Goodyear, the tire company refused to produce confidential and trade secrets documents in connection with a products liability lawsuit filed against it by individuals injured when the tire (manufactured by Goodyear) of a motor home separated and caused an accident. Goodyear argued that the Act required the court to conduct an in camera inspection of each of the documents before entering a confidentiality order and requiring production. 

Under the Florida Sunshine in Litigation Act,

            Upon motion and good cause shown by a party attempting to prevent disclosure of information or materials which have not been previously been disclosed, including but not limited to alleged trade secrets, the court shall examine the disputed information or materials in camera. If the court finds that the information or materials or portions thereof consist of information concerning a public hazard or information which may be useful to members of the public in protecting themselves from injury which may result from a public hazard, the court shall allow disclosure of the information or materials. If allowing disclosure, the court shall allow disclosure of only that portion of the information or materials necessary or useful to the public regarding the public hazard.

Goodyear, 2008 WL 2697248, *2 (quoting Fla. Stat. § 69.081(7)). The trial court, concerned about the inability to review and understand voluminous technical documents, developed its own procedure by which it protected all confidential materials through a blanket order and directed the parties to resolve the other issues regarding what would be protected, bringing back to the court only those issues the parties themselves could not resolve. The appellate court found that this procedure violated the judge’s duties to act as the gatekeeper of the Act. Id. at *3.

The appellate court went on to recognize that, although a trial court may still prevent public disclosure of trade secrets, it cannot do so if those alleged trade secrets relate to a public hazard.  If the trade secret material is otherwise relevant and discoverable (but not relating to a public hazard), it can be protected by an appropriate confidentiality order. 

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United States v. Malhotra, No. 5:08-CR-00423-JF (N.D. Ca.)

Former Hewlett Packard vice president Atul Malhotra today pleaded guilty in federal district court in San Jose, California to one count of theft of trade secrets. In an information filed on June 27, 2008, the United States charged Malhotra with violating the Trade Secrets Act, 18 U.S.C. § 1832(a)(2), by disclosing to HP certain confidential pricing information he obtained while employed at IBM. Specifically, the government charged that in his capacity as director of sales and business development for output management services for IBM Global Services, Malhotra obtained trade secret information regarding the IBM Global Services “CC Calibration Metrics.” This information concerned products costs and materials that IBM used to compete in the marketplace for printers and other output devices. Accordingly the document was stamped “IBM Confidential” on each page.

 Approximately two months after obtaining the confidential IBM information, Malhotra accepted a position as vice president of imaging and printing services at Hewlett Packard in Palo Alto, California. Shortly thereafter, the government alleges, Malhotra sent e-mails to two separate HP senior vice presidents entitled “For Your Eyes Only,” and attached the IBM Global Services CC Calibration Metrics.  An HP statement at the time indicated that HP conducted an internal investigation, terminated Malhotra’s employment, and reported the activity to law enforcement and to IBM.

Malhotra faces up to ten years in prison and a $250,000 fine on the single count of theft of trade secrets. Sentencing is scheduled for October 29, 2008, before District Judge Jeremy Fogel.

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A company's trade secrets may be some of its most important assets.  Recent headlines underscore their importance, and vulnerability:

1. Recently, an employee was arrested at the airport and over 1,000 company proprietary documents containing trade secrets were seized that the employee was attempting to transport with her to her new job.
   
2.  A national retailer recently was hit with a $21.5 million verdict after a jury found the retailer liable for stealing the design of a popular home improvement tool. 
   
3. A former employee recently pleaded guilty in a U.S. District Court in California to stealing proprietary technologies from his former employer and selling or offering them for sale to foreign governments and military contractors.

A survey of companies estimated that in just one year, companies likely were to have lost as much as $53 to $59 billion dollars in proprietary information and intellectual property through theft and misappropriation.  Seeking trade secret counseling and an audit can assist clients to determine best practices to help protect their most important assets.

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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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The Topps Company, maker of “Bazooka” bubble gum, licensed Stani to manufacture and distribute the gum in Argentina. The original license was entered into in 1957 and was to expire in 20 years. It provided that Topps would share its “know-how, formulae, processes and techniques” with Stani in exchange for royalties on Stani’s sales. In 1976, the parties entered into a new 10-year agreement, with Stani given an option to extend it for another 10 years. The new agreement provided for the parties sharing Topps’ “manufacturing technology, marketing concepts and techniques, … and trademark use” in exchange for Stani’s payment of a yearly license fee. In the 1976 agreement, Topps also gave Stani “the exclusive non-assignable right and license to manufacture ... and sell within the [relevant] Territory, during the continuance of this Agreement, Licensed Products utilizing TOPPS Technology.” Emphasis added. Four years later, the parties entered into two new contracts: a third license agreement, and an escrow agreement. The 1980 license agreement, which expired by its terms in April 1996, gave Stani the same “exclusive non-assignable right and license” that had been given in 1976 except that the corresponding 1980 provision ended with the words “Licensed Products” and did not include "utilizing TOPPS' technology." The escrow agreement (for which Stani paid $100,000) recited that, absent a default, upon expiration of the 1980 license agreement legal title to the registration in Argentina of the trademarks “Topps” and “Bazooka” would pass to Stani.

In 1999, three years after the 1980 license agreement expired, Topps sued Stani and its parent corporation, Cadbury (to whom Stani had assigned the trademarks), alleging that Stani was continuing to use Topps technology which constituted misappropriation of trade secrets. In its answer, Stani denied that it was using Topps’ formulae but argued that, in any event, it had the right under the parties’ agreements to do so. The district court granted summary judgment to Stani and its parent, reasoning that the 1976 and 1980 documents (including the assignment to Stani of the Argentina registration of the trademarks) necessarily gave Stani the right to continue using Topps’ chewing gum formulae after April 1996. The Second Circuit reversed on the ground that summary judgment was inappropriate because the agreements were ambiguous with regard to Stani’s rights after April 1996. Topps Co. v. Cadbury Stani S.A.I.C., No. 06-5316-cv (2d Cir., May 15, 2008).

The court of appeals said that, on the one hand, the 1980 license agreement provided that the “TOPPS Trademarks and the Topps Technology shall at all times remain the exclusive property of TOPPS or its assigns” and gave Stani the right to use TOPPS formulae only “during the continuance” of the agreement. Those provisions suggest that Stani had no post-April 1996 rights. On the other hand, the “during the continuance” provision might have been intended to refer solely to what was to happen if there was an early termination of the 1980 license for cause, and there was no provision expressly granting or expressly denying Stani the right to the formulae after April 1996. Moreover, the assignment of trademark registration gave Stani at least the right to make a substantially similar product if it could do so without using the Topps formulae and without deceiving customers. Therefore, the parties’ intent was a material disputed issue requiring a trial.

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Georgia’s Trade Secrets Act prohibits knowing misappropriation of trade secrets. See Ga. Code Ann. § 10-1-761. In a recent decision, the Eleventh Circuit briefly examined this principle in affirming a district court’s grant of dismissal and concluded that the Complaint must set forth facts from which the court could infer that any misappropriation of trade secrets was knowing. Southern Nuclear Operating Co., Inc. v. Electronic Data Systems Corp., 2008 WL 1700204 (11th Cir. Apr. 14, 2008).

Southern Nuclear Operating Company had retained Electronic Data Systems (“EDS”) to provide computer and software services. Southern Nuclear eventually terminated that agreement and hired Computer Technologies Solutions, Inc., (“CTS”) to perform the same functions. EDS requested that Southern Nuclear return EDS’s products and documentation or certify their destruction. Southern Nuclear never did so, and so EDS filed an action against Southern Nuclear and CTS for misappropriation of its trade secrets.

The only issue on appeal was whether the district court had erred in granting dismissal on the grounds that EDS did not allege that CTS knew or should have known at the time it was hired that it had misappropriated trade secrets of EDS. The court of appeals agreed with the district court and affirmed the dismissal in a very brief opinion because there was “nothing in the Complaint that provides facts from which the court could infer that CTS knew or should have known that it had misappropriated trade secrets of EDS.”

Nonetheless, service providers such as CTS should still be conscious of trade secrets issues when they enter into new agreements to provide services or products, ensuring that information used by the client and made available to the service provider is not a competitors’ trade secrets, particularly if there is some reason to suspect that the information may be protected.

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The Illinois Appellate Court affirmed a ruling granting summary judgment to American Family Mutual Insurance Company on its declaratory judgment action seeking a determination that it has no duty to defend the insured defendants in an underlying trade secret misappropriation action the company brought in federal court. American Family Mut. Ins. Co. v. Roth et al., No. 1-07-0526 (Ill. App., 2d Dist., Mar. 31, 2008).

American Family, a Wisconsin-based insurer, entered into written agency agreements with defendants Bonnie Roth and Connie Roth, owners of Roth & Roth Insurance, pursuant to which Bonnie and Connie worked as exclusive agents of American Family. The agency agreements provided that the policies, policyholder records, and other materials furnished by American Family to the defendants remained American Family’s property and that all originals and copies were to be returned to American Family within 10 days of termination of the agreements. The agreements also contained provisions, signed by the defendants, governing their access to American Family’s proprietary computer system, software and database, which included customer lists and confidential customer information. In addition, the agreements contained nonsolicitation agreements prohibiting the defendants from soliciting American Family policyholders for one year following termination of the agreements.

After terminating the agreements with Bonnie and Connie, American Family demanded the return of all of its property, including policyholder records, and reminded Bonnie and Connie that privacy laws and the agreements prohibited them from disclosing policyholder information to third parties. Nonetheless, the defendants solicited American Family customers, including sending a solicitation letter to at least one American Family customer that contained personal financial information Connie Roth obtained while an agent of American Family.

American Family sued the defendants in federal court alleging violations of the Wisconsin Uniform Trade Secrets Act, Wis. Stat. Ann. § 143.90(1)(c); federal law; and state common law for breach of contract and tortious interference. American Family also instituted a declaratory judgment action in the Illinois circuit court seeking a determination that it has no duty to defend the defendants in the federal court action pursuant to the terms and conditions of the business-owners’ package insurance policy it had issued to them as its agents. The circuit court granted summary judgment in favor of American Family.

On appeal, the defendants asserted that the circuit court erred because the underlying complaint contained factual allegations of “personal and advertising injury” that brought the action within the policy’s coverage. But the appellate court rejected this argument, finding that the defendants’ alleged retention and use of confidential information gleaned from American Family’s database and computer system amounted to trademark and trade secret infringement, thus bringing the action with the policy exclusion for injuries knowingly caused by the insured and arising out of such infringement. The appellate court also found that the defendants’ alleged retention of American Family’s information and use of that information to solicit American Family’s customers constituted a breach of the agency agreements, thus bringing the action within an exclusion to the policy’s coverage for injuries that arise from breach of contract. Accordingly, the court concluded that American Family did not owe a duty to defend its former agents in the underlying action.

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One of the nation’s large home builders recently filed suit against a former executive in federal court in Albuquerque, New Mexico for alleged misuse of the company’s trade secrets related to a highly confidential internal strategic plan.

Pulte Home Corporation filed suit against former executive Lynn Galindo, a former area vice president based out of Las Vegas, Nevada, in the United States District Court of New Mexico (Case 1:08-cv-00210-JB-LFG) alleging claims of trade secret misappropriation, conversion, breach of fiduciary duty, breach of contract, fraud, breach of implied covenant of good faith and fair dealing, and unjust enrichment.

The complaint alleges that shortly before Galindo’s departure from the company, she misappropriated an internal strategic plan related to the Albuquerque housing market and later used it to create a similar plan for a competitor.

According to the complaint, the plan, which cost in excess of $1 million dollars to produce, contained information that would allow a competitor at Pulte’s expense to make informative decisions regarding the “relative health of the market in terms of marco/micro economic and market forces; the size of the mobility of the population within the market; the organization of Pulte’s Target Consumer Groups; the location preferences by consumer group, price sensitivity, product preferences, over-and under-served consumers groups which indicates market opportunity; and the top performing communities in the market organized by Target Consumer Group.” The plan also contained Pulte’s analysis of this data, its strategy for increasing its presence in the market, an “identification of specific challenges of this market and Pulte’s proposed solutions to those challenges.”

According to Pulte’s complaint, “A knowledgeable person would be able to use Pulte’s . . . [strategic plan] to assess the viability of a specific location (or multiple locations), understand the best opportunities for targeting specific consumer groups in the locations under evaluation and be able to fine tune a product offering in terms of community layout, community design, community amenities, lot size and configuration, floor plan selection and specifications of homes.”

According to the suit, Pulte provided Galindo with notice of her termination in the spring of 2007 as part of a reduction in force. Galindo negotiated a lucrative severance package that paid her nearly $300,000 in severance pay, bonuses and other compensation. Pulte claims Galindo conspired to obtain the strategic plan while she was negotiating her severance from the company and that if it would have known she had obtained the highly confidential plan that it would not have entered the severance agreement. Galindo apparently obtained the plan by contacting a subordinate and induced the employee to send her a copy prior to her separation.

During Galindo’s employment and as part of her severance agreement, Galiando signed agreements to keep Pulte’s proprietary information, such as the strategic plan, confidential, according to the complaint. Pulte claims that Galindo agreed to provide a developer in the Albuquerque area with a marketing study and used material from Pulte's confidential strategic plan in the report.

The case has yet to be set for trial and has been assigned to District Judge James O. Browning and Magistrate Judge Lorenzo F. Garcia.

This case highlights the need for employers to review the activities of departing employees shortly before their departure to ensure that company confidential/trade secret information has not been compromised and that the employees understand their continued confidentiality obligations to the company. Employers should consider reviewing these employees’ e-mail activity and access to proprietary databases prior to their departure, as well as remind other employees to report any suspicious activities, to attempt to safeguard company secrets.

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A former software engineer for a Chicago-area telecommunications company has been indicted for allegedly misappropriating over 1,000 proprietary documents containing trade secrets which she was evidently attempting to transport with her to her new job in China. Neither company has been named.

The defendant, Hanjuan Jin, a naturalized citizen, took a medical leave of absence from the Chicago-based company (Company A) in February 2006. During her medical leave, she accepted a job with a company in China (Company B) where she was to develop communications software. She then informed Company A that she would return to work on February 26, 2007, without notifying the company that she had secured a job in China. After purchasing a one-way ticket to China for Feb. 28, 2007, Jin returned to Company A and allegedly downloaded hundreds of documents. She allegedly returned that night as well as the next night to copy more documents. These documents included descriptions of how Company A provides an interstate communication feature that cost the company hundreds of millions of dollars to develop, and federal authorities claim that had Jin succeeded in bringing them to China, Company A could have lost more than $600 million over the next three years.

Jin was arrested and the documents seized at O’Hare Airport on Feb. 28, 2007. She was charged with three counts of theft of trade secrets. If convicted, each count carries a maximum penalty of ten years in prison and a $250,000 fine.

For more information, see http://www.earthtimes.org/articles/show/suburban-chicago-woman-indicted-for,337647.shtml or http://www.chicagotribune.com/news/local/chi-trade-secrets-webapr03,1,1758307.story.

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The Eleventh Circuit Court of Appeals affirmed the sentence of a former Coca-Cola Company employee and one of her co-conspirators for conspiracy to commit theft of trade secrets in violation of 18 U.S.C. § 1832(a). In United States v. Williams, a jury convicted Joya Williams of taking trade secrets related to secret marketing materials from Coca-Cola and working with her co-conspirator, Edmund Duhaney to try to sell them to Pepsi Company through a third-party, Ibrahim Dimson. (Mr. Duhaney pleaded guilty.)

The facts under which Ms. Williams and Mr. Dimson were convicted and sentenced read like a serial clock-and-dagger television series. Ms. Williams snuck files (and even a product sample) out of her workplace, gave them to Mr. Duhaney (who testified against Ms. Williams and Mr. Dimson as part of his plea-bargain), who then contacted Mr. Dimson to act as the go-between with Pepsi Co. Mr. Dimson contacted Pepsi Co. by mailing an executive at Pepsi an offer to provide “very detailed and confidential information” about Coca-Cola he would provide “to the highest bidder.” Pepsi Co., of course, notified Coca-Cola, which then notified the FBI. An undercover agent with the FBI posed as a Pepsi executive and began the process of purchasing small confidential items with an aim towards one large purchase. After the terms of the large purchase were consummated, the FBI arrested each of the three conspirators.

As stated by the Court, the facts leave no doubt as to the validity of the underlying convictions, but Ms. Williams raised two constitutional challenges to her trial. First, she argued that the trial court’s limitation on her cross-examination of Mr. Duhaney violated her Sixth Amendment right of confrontation (the Eleventh Circuit disagreed). Second, she argued that the trial court denied her due process by striking her closing argument’s reasonable doubt analogy (again the Court of Appeals disagreed). And both Ms. Williams and Mr. Dimson appealed their sentences, arguing that the district court had placed too heavy an emphasis on the seriousness of the offense in going above the recommended sentencing guidelines for each of them. The Court of Appeals, however, held that the trial court had not abused its discretion in sentencing them.

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¹ Trial lawyers frequently have a series of “reasonable doubt” stories and analogies for use at closing argument, tailored to the case and whether they are the prosecutor or defense attorney. Ms. Williams’ attorney’s analogy is arguably one of the stranger ones: “Williams argues that her counsel properly explained the concept of reasonable doubt by comparing it to a patient's desire to seek a second opinion when told by a doctor ‘you know, I'm looking at you and I think you need to have both of your legs amputated.’”

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The Chemical Abstracts division of the American Chemical Society (ACS) sued three software developers who left ACS to start their own company, Leadscope. ACS sued for trade secret misappropriation, alleging that the software developers used ACS trade secrets to develop their own product. The filing of the lawsuit scuttled several pending (very promising) deals that Leadscope was about to close on. Leadscope counterclaimed for defamation, tortious interference, unfair competition and deceptive trade practices.

The lawsuit was filed in 2002 was hotly contested. Among other things, there was a dispute over insurance coverage, resulting in a court of appeals decision in favor of coverage, see Am. Chem. Soc. v. Leadscope, Inc. , 2005-Ohio-2557.

The trial lasted 2 months in the Franklin County Court of Common Pleas (Columbus, Ohio). On March 27, the jury returned a verdict ruling in favor of Leadscope (the defendant and counterclaimant), awarding counterclaim compensatory damages of $27 million.

In closing arguments, Leadscope's attorney argued, that ACS "destroyed the reputations of three dedicated scientists...They have ruined the financial position of LeadScope...These scientists did their own work. They didn't take anything from [ACS]". Much of the case focused on expert analysis of Leadscope's source code. Leadscope presented expert testimony that the source code of their own product was NOT copied.

Certainly, a cautionary tale for people filing trade secret lawsuits!

The Columbus Dispatch has reported on the verdict. See
http://www.columbusdispatch.com/live/content/business/stories/2008/03/28/LEADSCOPE.ART_ART_03-28-08_C12_HF9P1EG.html?sid=101

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Stanley Steemer licensed AAA Abachman to operate a carpet and upholstery cleaning business under the Stanley Steemer name. The franchise agreement gave Abachman “the sole right to use Stanley Steemer’s ‘trademarks, service marks, patents, and trade secrets’ in its carpet and upholstery cleaning business within its assigned territory.”

After Abachman had secured this right, however, Stanley Steemer licensed a second company to operate a “duct cleaning” business in an overlapping geographic area. Abachman complained to Stanley Steemer that this second license violated its exclusive rights in the area, and, after being rebuffed, sought a declaratory judgment that this was so. The parties’ cross summary judgment motions resulted in judgment for the defendant, Stanley Steemer, on the basis that the franchise agreement granted exclusive rights only as to “carpet” and “upholstery” cleaning, not “duct” cleaning. Abachman appealed to the 11th Circuit.

The central issue in the appeal was whether the contract between Abachman and Stanley Steemer afforded Abachman an exclusive right in Stanley Steemer’s mark generally, or only as to carpet and upholstery. The relevant portion of the agreement gave “Abachman the exclusive and perpetual rights ‘to own and operate a Stanley Steemer carpet and upholstery cleaning business (hereinafter referred to as a ‘Stanley Steemer Business’) in the ... ‘Franchisee’s Area’[ ] and to use the trademarks, services marks, patents, [and] trade secrets ... solely in a Stanley Steemer Business in that area and in no other manner.’”

The per curiam decision affirmed the district court, holding that this language provided an exclusive right to the Stanley Steemer mark only as to “carpet and upholstery.” Relying on the language “and in no other manner,” the Court held that this unambiguous language foreclosed any broader understanding of the contract, even a subsequent term requiring payment by Abachman to Stanley Steemer for “any additional sale resulting from or associated with the name Stanley Steemer.”

Although there was a weak, facial argument that the broad language “trademarks, services marks, patents and trade secrets” is broader than only “carpet and upholstery cleaning” if done under the Stanley Steemer name, it seems clear that the Court concluded from the contract language quoted in its opinion that such use is constrained to “Stanley Steemer Business,” a term defined as “a Stanley Steemer carpet and upholstery cleaning business.”

Although neither a trendsetting case nor a departure from black letter law, this case is a good reminder that clearly written, descriptive contract language is (still) critical and definitive in disputes. Here, Stanley Steemer did a good job of providing both the breadth necessary for Abachman to run a successful franchise and at the same time limiting that franchise strictly so as to enter into a separate agreement with another entity.

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