NY Startup Law

A businesslaw blog for New York entrepreneurs by Marc Law Associates PLLC

PROTECTING AND ENFORCING YOUR TRADE SECRETS IN NEW YORK

What do the formula for Coca-Cola, Colonel Sanders’ recipe for Kentucky Fried Chicken, and IBM’s customer list have in common? They are all business secrets that are valuable so long as they are never revealed. This makes them trade secrets.

Today’s topic is centered on trade secrets, which some consider a form of intellectual property. However,  unlike a  trademark, copyright, or patent, the owner of a trade secret  can’t register it  with any government agency. Why you ask? Because the basic premise of anything in your company being a trade secret is that you must keep it a secret. Once the information becomes available to an outsider,  its value as a trade secret is lost.

All states have their own laws regarding trade secrets. However, the National Commissioners of Uniform State Law enacted the Uniform Trade Secrets Act (“USTA”) to facilitate regulating trade secrets involving interstate commerce and protecting the same from theft. To date, 48 states have adopted the USTA. However, New York is one of a handful of states that hasn’t adopted the USTA.

The USTA definition of a trade secret includes a formula, device, pattern, technique or process that derives independent value and retains this value by its owner taking reasonable measures to protect its secrecy. Using these principles, the USTA defines misappropriation of a trade secret as  acquiring the trade secret through “improper means”,  the disclosure of the  trade secret by a person who obtained it by  improper means, or had a duty to keep it secret. One important note is that reverse engineering a trade secret, the process of replicating an invention by analyzing the finished product and working backwards, does not equate to misappropriation. In contrast, reverse engineering  a patented invention is not permitted, and is clearly patent infringement.  In sum, reverse engineering is a proper means of acquiring a trade secret, and any discovery on your own of a trade secret is not considered misappropriation.

THE NEW YORK VERSION (COMMON LAW)

As I previously mentioned, New York hasn’t adopted the USTA. New York basically relies on common law principles to regulate trade secret misappropriation. Specifically, trade secret misappropriation, much like common law trademark protection in New York, falls under the umbrella of  torts, specifically, Unfair Competition. The relevant body of law (not a statute) in New York  is the Third Restatement of Unfair Competition.

New York relies on two common law definitions of trade secrets. One  common law definition of trade secrets  is derived from what is known in legal circles as the Third Restatement of Unfair Competition. Verbatim it’s “A trade secret is any information that can be used in the operation of a business or other enterprise and that is sufficiently valuable and secret to afford an actual or potential economic advantage to others.

The other common law definition comes from Section 757 of the First Restatement of Torts. This restatement specifies that a trade secret “may be a chemical formula, manufacturing process, a system for treating or preserving materials, a machine pattern or a consumer list”. The Restatement also specifies that trade secrets don’t apply to information concerning a single event. Information or processes will only be considered a trade secret if it applies to continuous use in the operation of an ongoing business. I’m guessing that you can’t try to protect the methods used in a one time marketing campaign, but the customer list is a trade secret since it’s something a business will rely on continuously.

Section 40 of the same Restatement defines misappropriation of trade secrets as the act of acquiring a trade secret through improper means or acquiring or disclosing the trade secret to a third party under one of the following conditions:

  • the person acquired the trade secret under a duty of confidence
  • the person acquired the trade secret by improper means
  • the person acquired the trade secret from someone that she knows acquired the information through improper means or breached a duty of confidence
  • the person knowingly acquired the trade secret through an accident or mistake, provided that the owner took reasonable precautions to keep the information secret.

The duty of confidence principle is most relevant in the employer/employee relationship. The duty of confidence is most often established through employment  agreements, the most prominent being the non disclosure and non-compete agreements. However, the duty can exist without a written contract under an implied duty theory. If the employee knew or had reason to know that the information the employer disclosed was a trade secret, and conversely if the employer reasonably inferred that the employee consented to an obligation to keep the information secret, the employees disclosure may be treated as the misappropriation of a trade secret. I personally advise anyone reading this not to rely on this implied theory and memorialize the duty of confidence in an express written agreement.

THE ELEMENTS OF A MISAPPROPRIATION CLAIM IN NEW YORK

Much like the USTA, in order to prevail in a New York court on a misappropriation claim a suing party must allege 1) that the information is indeed a trade secret, and  2) that the defendant acquired the information through improper means.

This is not as cut and dry as it sounds. The court’s analysis will focus on whether the information was actually a secret in the first place. This will depend on a few things;

  • Whether the owner took reasonable steps to keep the information secret
  • Whether the information is a matter of public knowledge or can be discovered independently through reverse engineering or some other means of independent discovery

So if your company is lax in protecting its trade secrets or a competitor can recreate your “secret” by reading a few things and recreating it on its own, then any court action regarding the “secret” will likely be a waste of time and resources.

New York courts recognize three main categories of misappropriation:

  • independent improper means of acquisition without any confidential or implied confidential relationship between the parties including acquisition by theft or fraud
  •  Acquisition where a confidential relationship exists  whether expressly written in a contract or implied by a fiduciary relationship (former employees, suppliers regularly doing business have an implied duty)
  • Where the defendant has notice of the information being a trade secret she has an implied obligation to keep it secret. This applies to employers hiring a former employee.

Possible defenses to misappropriation include the following:

  • consent or permission to disclose
  • the trade secret was not in fact secret
  • independent development (also a defense to copyright infringement)
  • that the owner failed to take reasonable measures to protect keep the trade secret a secret

PROTECTING TRADE SECRETS

There are a few measures a company can take to protect its trade secrets. The most prevalent being through contractual agreements to commit to secrecy in writing. Companies wishing to protect their trade secrets should use this method of protection with employees and B2B partners, vendors, etc.  NDAs and invention agreements are common examples of such agreements. Salespersons are particularly important, because of their propensity to change employers and their knowledge of customer lists. However, all employees should sign agreements that contain some type of confidentiality provision.

A written agreement is particularly important if your company has to take someone to court for misappropriation, since the agreement itself establishes that you took reasonable measures to protect the secrecy of the info.  If a vendor refuses to sign the agreement, I suggest looking for another one. There are likely plenty of other vendors willing to fill the shoes of the non compliant party.

The managing body and human resources division of all startups and established companies alike should pay special attention to protecting its trade secrets, especially in light of the fact that unlike other forms of intellectual property, one can’t register trade secrets with any state or federal agency. In New York,unlike the majority of other states, there is no statutory protection of trade secrets under the USTA. It’s all based on common law principles which you will have to argue in court, at a considerable expense. Another method is to provide periodic reminders that the employees are privy to confidential information, and have the employee acknowledge the review by signing a confirmation. Exit interviews are also an effective way of finding out what confidential info the employee has retained. Make sure to have the employee return any written material that contains trade secrets.

To protect yourself from violating another company’s trade secrets, have every employee sign an agreement  containing a representation that the employee was not privy to knowledge of the former employer’s trade secrets or won’t disclose any of their former employers’ trade secrets.  Additionally you’ll want to include a statement  that you are hiring the employee based on her skills. Additionally the agreement should state that the employee is not bound by a non-compete that would prevent you from hiring her. I personally include these representations in the employee offer letter. This is especially necessary if hiring an employee from a competitor.

As I previously mentioned, NDAs provide written protection. This is important when negotiating deals with other companies, especially competitors, and in negotiating mergers and acquisitions. It’s worth mentioning that a startups looking for venture capital will lose any opportunity for investment if asking a venture capitalist (VC) to sign an NDA. VCs will usually ignore your material if asked to sign an NDA.  How does one get around this? My answer is that if you end up in court against a VC for misappropriation, you may prevail against the VC under the aforementioned principle of  implied knowledge. A startup can argue that the VC should have known that the information conveyed was confidential.

Other methods revolve around keeping the information secret from a physical perspective. A company should keep all trade secrets in a safe place that only certain employees have access to. Sign in sheets, employee ID, or an escort are methods of protecting the physical space. Only a select few that need access to perform their jobs should have access. Destruction of confidential information through shredding is another method.

Then there’s the protection of digital trade secrets. Cyber-theft is probably the easiest and most prevalent method of misappropriating trade secrets. Companies should pay special attention to data security measures (I’ll address this in a separate post) to prevent hackers from exposing mobile devices, social media, email, and cloud based storage of trade secrets.

Lastly, remember that you can take all the measures I’ve described and more, but if someone can access the same information through public channels, or reverse engineering, you no longer have a trade secret. Additionally you must take reasonable measures to protect your trade secrets or else you won’t be able to protect yourself through the court system. Trade secrets are among a company’s most valuable assets, so every measure must be taken to protect them from theft.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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