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Just What We Need – Another Federal Law. Or Does The Defend Trade Secrets Act Of 2016 Actually Make Businesses Stronger?

Posted on May 05, 2016

Those who read my blogs know I’m no fan of the federal government messing with people who run businesses. A few days ago, Congress passed the Defend Trade Secrets Act of 2016 and Obama says he will sign it – so apparently they can agree on something.  The law itself is nothing new, 48 out of 50 states already have laws on their books that protect a business’s bona fide trade secrets from misappropriation, disclosure or misuse by employees or competitors who might come to possess them.  The feds are late to the game once again, so the question is, “Do we really need this law or do the states have it covered?”

Let’s start with the concept of trade secrets. The classic example of an actual trade secret is the formula for Coca-Cola.  This is something universally recognized as a business secret, that the owner developed using its time, resources and diligence, and, because of it, the owner has a competitive advantage in the market place.   If a disgruntled employee decided to make off with that formula and start his own cola company, or a competitor decided that it was easier to steal the formula than invent its own, then the law kicks in and gives the owner specific legal rights to block its use, to get it back, and to recover damages for its misuse.  But trade secret law applies to more than just the formula for Coke.  It can apply to any business secret that has independent economic value, or is a secret that gives its owner a competitive advantage.  It can include compilations of customer data, business methods, recipes, production techniques, and just about anything else the owner can prove is: (1) an actual secret; and (2) has independent economic value.

State laws governing these issues have been around a long time, and since the state statutes were all derived from a Uniform Act, they are all relatively the same. While there are some notable differences in how the individual state courts have applied them, for the most part, we already have a fairly consistent set of trade secret protection rules in place.  The state laws already give the owner a right to sue for an injunction to block misuse, to recover possession, and receive damages and win attorney fees.  So why do we need a federal law to do what 48 States have already done?  It’s a pretty good question actually, so we will just focus on that.

For starters, a company whose trade secrets have been taken can now sue in federal court. The company could do that before, but only if there was diversity jurisdiction – which allows residents of different states to file lawsuits in federal court.  When the dispute was between companies in the same state, they were limited to state court lawsuits.  Many companies would prefer federal court over a state court, so now they have a choice.  I consider that an improvement over the old laws.

Second, the federal law allows a judge to seize the trade secret and any related property in an ex parte procedure – this is not part of any state laws. Ex parte means the defendant doesn’t get notice of the order, or an opportunity to oppose it, until after it has been issued.  The idea here is that if the thief had notice, he could hide or destroy the evidence before it could be found and returned.  The trade secret owner has a high burden to obtain such an extraordinary remedy – given that we still follow notions of due process and fair play in our judicial system – but the remedy is new and potentially very powerful, maybe too powerful.

If the trade secret owner gets an ex parte order and it’s later determined it wasn’t legally entitled to do so, the defendant can sue for wrongful seizure under the statute and recover its damages and attorney’s fees for having its property wrongfully seized and its business interfered with. This of course assumes the defendant survives the attack, hasn’t gone bankrupt from legal fees, or wasn’t forced to into a settlement to avoid bankruptcy.

Now for the dark side of trade secret law. Too many businesses are using trade secret lawsuits as an anticompetitive device to restrain their employees from leaving and going to work for a competitor – essentially using them to block ordinary competition among lawful competitors.  Here’s how it works – a skilled employee without any non-compete or other employment contract decides to switch jobs, and goes to work for a competitor.  The former employer is worried it might lose customer accounts, talent, deals or sales, and, with no employment contract to enforce, decides to sue the former employee and his new employer for misappropriation of trade secrets.  The claim is that the employee “knows” all the former employer’s “secrets,” and will necessarily and inevitably use them to compete unfairly, and unless a judge blocks that employee from going to work for a competitor, the former employer will be irreparably harmed.

The problem is that, in most cases, the employee really didn’t know that much, and the company really didn’t have or rely on bona fide trade secrets to conduct its business; but, if the former employer can’t use the employee’s talents, then it’s going to make sure no one else can either. Rather than spend tens of thousands of dollars on a legal battle, it’s easier for the new employer to just fire the toxic employee and move on.  The former employer gets a de facto non-compete without having had to bargain for it, and competition has effectively been halted.  There are many variations on this theme, but the point is that as much as the bill’s sponsors tell you they were intending to protect one’s hard earned competitive advantages in the marketplace, what they did was further weaponize the slackers who use litigation to block competition rather than just provide a better product or service.

But wait – for those employees who signed non-compete agreements and those new employers who have hired them, this federal law now allows you to get sued in federal court to enforce the non-compete. Why?  Because with federal question jurisdiction over trade secret misappropriation, every related state law claim (e.g., breach of non-compete agreement), can also be joined in the federal lawsuit and decided by a federal judge.  The federal law helps here, because it prohibits a judge from granting an injunction that prevents someone from going to work for a competitor completely, and limits court ordered restrictions on competitive employment to those things that are based on actual evidence of threatened misappropriation rather than simply on evidence that the former employee knows stuff.  This means that it will be much harder, and more expensive, for the former employer to use litigation to get a non-compete by proxy.

Now for the irritating part. The federal law gives an employee “immunity” from liability – not just under the federal law, but also any state trade secret law – if the employee discloses a trade secret unlawfully, but to a government official or lawyer as part of a criminal or civil investigation.  It’s fine if the feds want to create immunities under their own laws, but it’s rather bold of them to create a sweeping immunity under the other 48 state statutes as well.  I doubt Congress checked with the state legislatures to see if that was OK with them – and we presume it wasn’t because if the States wanted that immunity, they are perfectly capable of passing their own bills creating it.

The other irritating part is that every employer is required to “notify” every employee of his immunity in any contract they have with that employee, and if there is no contract, then the employer has to make a written policy containing the immunity notice and publish it to employees in handbooks, on bulletin boards, or some other way. If the employer doesn’t give the required notice, then the employer can’t get exemplary damages or attorney fees from the employee even if the employee intentionally stole and misused an actual trade secret.

Do employees really need to be told they have immunity from trade secret liability if they tell the cops or their lawyer? Of course not, but don’t think for a minute that’s why it’s there.  Big companies with lots of human resources staff will easily comply with this technical rule.  It will give them all something to talk about for the next three months, and they will create lots of new policies, rules, and go to seminars and have a jolly good time lamenting the new federal burdens. But it’s the small business person who suffers.  Those that don’t have their own HR departments, or who don’t have staff dedicated to mining the Federal Register every two weeks for every new regulation or law the feds push out without really telling us about.  These are the businesses who won’t put this notice in their contracts or their handbooks, and when a disgruntled employee really does take a trade secret and move it to a competitor unfairly, that employee doesn’t have to worry about the extra punishment.  To the United States Congress on behalf of the small business owner – thanks for nothing.

Since the immunity is effective for state court claims too, the thieving employee gets a windfall whether the suit is under the new federal law or an older state law. Plus, the federal law defines employee to include “contractor,” and “consultant,” – so to those who use consulting agreements or contractors (think non-W2 independent contractors), this immunity applies to them also.

Does this new law really help? The U.S. Chamber of Commerce seems to think it will and they have supported it.  So let’s give it a chance and we will see – but I’m not that optimistic, because I think we will see it hurt more businesses than it helps.  I think you are going to see the large, well-funded companies use this as a weapon to restrain competition from smaller competitors who are less able to finance a defense to a federal lawsuit and will be forced to settle or give up.  This makes me think of patent trolls, but that’s another article for another day…

If you have questions regarding the Defend Trade Secrets Act, Ohio’s trade secret laws, any other aspect of Ohio business or employment law, please contact Todd Harpst or any of the other construction lawyers at Harpst Ross, Ltd. – Business Lawyers for the Construction Industry®, at (330) 983-9971.

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