Course No. 9200-704 (and 804)-801
ID No. 16545
MW 3:00 - 4:30 p.m.
Room 231D (IP Alcove)
|Copyright © 2000, 2002, 2003, 2006, 2008 Jay Dratler, Jr. For permission, see CMI.|
Metallurgical Industries Inc. v. Fourtek, Inc.790 F.2d 1195, 229 U.S.P.Q. (BNA) 945 (5th Cir. 1986)
Before Thomas Gibbs Gee, Carolyn Dineen Randall and Will Garwood, Circuit Judges.
[*1197] Thomas Gibbs Gee, Circuit Judge:
Today's case requires us to review Texas law on the misappropriation of trade secrets. Having done so, we conclude that the district court misconceived the nature and elements of this cause of action, a misconception that led it to direct a verdict erroneously in favor of appellee Bielefeldt. We also conclude that the court abused its discretion in excluding certain evidence. Accordingly, we affirm in part, reverse in part, and remand the case for a new trial.
We commence with a brief description of the scientific process concerned. Tungsten carbide is a metallic compound of great value in certain industrial processes. Combined with the metal cobalt, it forms an extremely hard alloy known as "cemented tungsten carbide" [or "carbide"] used in oil drills, tools for manufacturing metals, and wear-resistant coatings. Because of its great value, reclamation of carbide from scrap metals is feasible. For a long time, however, the alloy's extreme resistance to machining made reclamation difficult. In the late 1960's and early 1970's, a new solutionknown as the zinc recovery processwas devised, a solution based on carbide's reaction with zinc at high temperatures. In the crucibles of a furnace, molten zinc will react with the cobalt in the carbide to cause swelling and cracking of the scrap metal. After this has occurred, the zinc is distilled from the crucible, leaving the scrap in a more brittle state. The carbide is then ground into a powder, usable in new products as an alternative to virgin carbide. This process is the generally recognized modern method of carbide reclamation.
Metallurgical Industries has been in the business of reclaiming carbide since 1967, using the more primitive "cold-stream process." In the mid-1970's, Metallurgical began to consider using the zinc recovery process. In that connection, it came to know appellee Irvin Bielefeldt, a representative of Therm-O-Vac Engineering & Manufacturing Company (Therm-O-Vac). Negotiations led to a contract authorizing Therm-O-Vac to design and construct two zinc recovery furnaces, the purchase order for the first being executed in July 1976.
The furnace arrived in April 1977. Dissatisfied with its performance, Metallurgical modified it extensively. First, it inserted chill plates in one part of the furnace to create a better temperature differential for distilling the zinc. Second, Metallurgical replaced the one large crucible then in place with several smaller crucibles to prevent the zinc from dispersing in the furnace. Third, it replaced segmented heating elements which had caused electric arcing with unitary graphite heating elements. Last, it installed a filter in the furnace's vacuum-pumps, which zinc particles had continually clogged. These efforts proved successful and the modified furnace soon began commercial operation.
In the market for a second furnace in mid-1978, Metallurgical provided to Consarc, another furnace manufacturer, all its hard-won information about zinc-recovery furnace design. Apparently allowed to watch the first furnace operate, Consarc employees learned of its modifications. Because Consarc proved unwilling or unable to build what Metallurgical wanted, however, the agreement fell through, and Metallurgical returned to Therm-O-Vac for its second furnace. A purchase order was signed in January 1979, and the furnace arrived that July. Further modifications again had to be made, but commercial production [*1198] was allegedly achieved in January 1980.
In 1980, after Therm-O-Vac went bankrupt, Bielefeldt and three other former Therm-O-Vac employeesNorman Montesino, Gary Boehm, and Michael Sarvadiformed Fourtek, Incorporated. Soon thereafter, Fourtek agreed to build a zinc recovery furnace for appellee Smith International, Incorporated (Smith). The furnace Fourtek provided incorporated the modifications Metallurgical had made in its furnaces; chilling systems, pump filters, multiple crucibles, and unitary heating elements. Smith has been unable to use this furnace commercially, however, because a current shortage of carbide scrap prevents its economically feasible operation. Metallurgical nevertheless brought a diversity action against Smith, Bielefeldt, Montesino, Boehm, and Sarvadi in November 1981. In its complaint, Metallurgical charged the defendants with misappropriating its trade secrets. * * *
Because the district court provided so many reasons for its order, we feel compelled to discuss the law of trade secrets in detail. Our discussion concentrates on Texas law, despite a clause in both purchase order agreements that their interpretation is to be made under New Jersey law. This stems from the nature of this case; as will be explained below, we are dealing with a cause of action sounding in tort, not one based on contract.
Individual attention to the various elements of this tort is necessary to provide an easily-understood analysis, but we can here briefly summarize the discussion. A plaintiff must certainly show that a "trade secret" is involved; the definition of this term is therefore crucial and must be based on several factors. If the trial court concludes that a trade secret exists, it then must determine whether the defendant committed any wrongdoing. One who breaches the confidence reposed in him by the holder of a trade secret and one who obtains the secret can be held accountable. No defendant may be liable, however, unless he has "disclosed" or "used" the secret improperly; again, defining these terms is required. These considerations are the sum and substance of the cause of action involved. * * *
We begin by reviewing the legal definition of a trade secret. Of course, to qualify as one, the subject matter involved must, in fact, be a secret; matters of general knowledge in an industry cannot be appropriated by one as his secret. Smith emphasizes the absence of any secret because the basic zinc recovery process has been publicized in the trade. Acknowledging the publicity of the zinc recovery process, however, we nevertheless conclude that Metallurgical's particular modification efforts can be as yet unknown to the industry. A general description of the zinc recovery process reveals nothing about the benefits unitary heating elements and vacuum pump filters can provide to that procedure. That the scientific principles involved are generally known does not necessarily refute Metallurgical's claim of trade secrets.
Metallurgical, furthermore, presented evidence to back up its claim. One of its main witnesses was Arnold Blum, a consultant very influential in the decisions to modify the furnaces. Blum testified as to his belief that Metallurgical's changes were unknown in the carbide reclamation industry. The evidence also shows Metallurgical's efforts to keep secret its modifications. Blum testified that he noted security measures taken to conceal the furnaces from all but authorized personnel. The furnaces were in areas hidden from public view, while signs warned all about restricted access. Company policy, moreover, required everyone authorized to see the furnace to sign a non-disclosure agreement. These measures constitute evidence probative of the existence of secrets. One's subjective belief of a secret's existence suggests that the secret exists. Security measures, after all, cost money; a manufacturer therefore presumably would not incur these costs if it believed its competitors already knew about the information involved. In University Computing Co. v. Lykes-Youngstown Corp., 504 F.2d 518, 535 (5th Cir. 1974), we regarded subjective [*1200] belief as a factor to consider in determining whether secrecy exists. Because evidence of security measures is relevant, that shown here helps us conclude that a reasonable jury could have found the existence of the requisite secrecy.
Smith argues, however, that Metallurgical's disclosure to other parties vitiated the secrecy required to obtain legal protection. As mentioned before, Metallurgical revealed its information to Consarc Corporation in 1978; it also disclosed information in 1980 to La Floridienne, its European licensee of carbide reclamation technology. Because both these disclosures occurred before Bielefeldt allegedly misappropriated the knowledge of modifications, others knew of the information when the Smith furnace was built. This being so, Smith argues, no trade secret in fact existed.
Although the law requires secrecy, it need not be absolute. Public revelation would, of course, dispel all secrecy, but the holder of a secret need not remain totally silent:
Restatement of Torts, § 757 Comment b (1939). We conclude that
a holder may divulge his information to a limited extent without destroying
its status as a trade secret. To hold otherwise would greatly limit
the holder's ability to profit from his secret. If disclosure to
others is made to further the holder's economic interests, it should,
in appropriate circumstances, be considered a limited disclosure that
does not destroy the requisite secrecy. The only question is whether
we are dealing with a limited disclosure here. Prior case law provides
no guidance on what constitutes limited disclosure. Metallurgical cites
Hyde Corp. v. Huffines, 158 Tex. 566, 314 S.W.2d 763, 117 U.S.P.Q.
(BNA) 466 (Tex.), cert. denied, 358 U.S. 898 (1958), and [another
case] in contending that subsequent disclosure of a trade secret does
not free one from the constraint of a prior confidential disclosure. In
both of these cases, however, publication of the trade secret by its holder
followed an improper use by one in whom the holder had confided.
This factual difference renders these cases inapposite.
That the cost of devising the secret and the value the secret provides are criteria in the legal formulation of a trade secret shows the equitable underpinnings of this area of the law. It seems only fair that one should be able to keep and enjoy the fruits of his labor. If a businessman has worked hard, has used his imagination, and has taken bold steps to gain an advantage over his competitors, he should be able to profit from his efforts. Because a commercial advantage can vanish once the competition learns of it, the law should protect the businessman's efforts to keep his achievements secret. As is discussed below, this is an area of law in which simple fairness still plays a large role.
We do not say, however, that all these factors need exist in every case. Because each case must turn on its own facts, no standard formula for weighing the factors can be devised. Secrecy is always required, of course, but beyond that there are [*1202] no universal requirements. In a future case, for example, should the defendant's breach of confidence be particularly egregious, the injured party might still seek redress in court despite the possibility that the subject matter was discovered at little or no cost or that the object of secrecy is not of great value to him. The definition of "trade secret" will therefore be determined by weighing all equitable considerations. It is easy to recognize the possibility of a trade secret here, however, because Metallurgical presented evidence of all three factors discussed above.
Appellees posit two other reasons why Metallurgical's modification process cannot be defined as a trade secret. The first is premised on characterizing the process in question as the installation of various devices all well known to modern manufacturing. This being so, the argument runs, the process itself can be no secret, either. The technologies of chill plates, multiple crucibles, pump filters, and unitary graphite heating elements are all said to be public knowledge. This may well be so, but it does not prevent Metallurgical from seeking legal protection. * * *
Deciding whether a confidential relationship existed between Metallurgical and Bielefeldt must naturally precede an inquiry into his possible breach of Metallurgical's confidence. Once again, we look to the Restatement of Torts as our starting point:
Our review of the evidence on the existence of a confidential relationship is hampered to some degree by the district court's exclusion of several items of evidence. As we discuss below, the exclusions were improper; but regardless of the evidence excluded, the record contains testimony of Metallurgical's president, Ira Friedman, that he informed Bielefeldt of the confidentiality Metallurgical expected. Although these references are few, they would have sufficed to allow a reasonable jury to have believed that a confidential relationship existed between Metallurgical and Bielefeldt.
At this point we must devote separate attention to Smith, which stands in a different light from Bielefeldt. It had no significant dealings with Metallurgical and apparently was not heavily involved in the design of the furnace it purchased. The question therefore becomes whether Smith as purchaser, and thus as beneficiary of Bielefeldt's alleged misappropriation, can also be held liable for it.
The law imposes liability not only on those who wrongfully misappropriate trade secrets by breach of confidence but also, in certain situations, on others who might benefit from the breach:
Wrongful misappropriation occurs if one "discloses or uses another's trade secret without a privilege to do so . . . ." Restatement, § 757. The district court directed verdict for appellees in part because it saw no evidence of Bielefeldt's actual use or disclosure of Metallurgical's secrets. In reviewing this conclusion, we keep in mind the [standard of review] by scouring the record for reasonable inferences favorable to Metallurgical. One fact jumps out from this review: in their original [*1205] form, the furnaces delivered to Metallurgical differed from those that Smith purchased. The former furnaces lacked the key features needed to achieve commercial operation, while the latter possessed those featuresfeatures that Metallurgical had devised by extensive and expensive trial and error. Bielefeldt himself testified that he did not look to public sources of information in designing the Smith furnace; he instead claimed that he relied on his memory. That his earlier efforts lacked the features at issue suggests that his "memories" may well have been of working with Metallurgical. This issue is therefore an inappropriate ground for a directed verdict.
Smith's liability can arise, however, only if it in turn used the secrets
gained from Bielefeldt. "Use," as it turns out, is not so easily
defined. Smith claims that it never used any secrets gained because
its inability to procure substantial quantities of scrap carbide prevented
commercial operation of the furnace Fourtek provided. Lykes-Youngstown,
504 F.2d 518, guides us in determining commercial use. We must first
recognize the unfortunate blurring of analyses in that case. The
Lykes-Youngstown court's discussion of commercial use was in the
context of inquiring whether damages might be available. It is preferable,
of course, to divorce these concepts. Commercial use is an element
of the tort as announced in § 757 of the Restatement; while the nature
of the use may be relevant in determining the proper extent of damages,
its existence must also be shown to establish wrongdoing in the first
place. Despite this confusion, Lykes-Youngstown provides
[The court next addressed the trial court's exclusion of written nondisclosure agreements between Metallurgical and Therm-O-Vac before any purchase agreement between them. The trial court had excluded these agreements because the later purchase agreements contained "integration" or "entire agreement" clauses.]
The Texas parol evidence rule bars evidence of a prior or contemporaneous agreement that contradicts or changes the express terms of an unambiguous written agreement. If Metallurgical were suing only on the contract, then the parol evidence rule unquestionably would bar evidence of prior agreements. This is not the case, however, the cause of action we are addressing on appeal is independent of any contract. See Huffines, 314 S.W.2d at 769. Even if the parties had not executed the purchase agreements, Metallurgical could have sued for misappropriation of its trade secrets. [The excluded exhibits] are relevant in showing that this tort occurred. They were offered to show the parties' recognition of the unique nature of the zinc recovery process and the confidential relationship then existing; their purpose was not to change or undermine the agreements embodied in the purchase order. We regard their significance as stemming from legal concepts completely independent of any contractual relationship,(1) their consequences, moreover, [*1207] do not impinge upon the legal effect of that relationship. We thus conclude that the exclusion of these exhibits was an abuse of the district court's discretion.
The district court also excluded certain testimony of Friedman, Bielefeldt, and Paul Durkin, a former employee of Metallurgical. Because these exclusions were also premised on the applicability of the parol evidence rule, they too were improper. On appeal, appellees argue that the testimony was cumulative anyway, but we are unconvinced. On retrial, therefore, testimony about the parties' understanding of confidentiality existing before the purchase order agreements should not be excluded because of the parol evidence rule.
We now come to the issue of remedies available to Metallurgical. The district court apparently found crucial Smith's inability to operate its furnace profitably. Because there was no commercial use, it concluded that damages were unavailable. We have already concluded that Smith did not "use" the alleged secrets Bielefeldt provided; to say that this circumstance precludes all remedies goes too far, however. The court failed to distinguish consideration of the individual appellees; Smith is out of the picture, but Bielefeldt remains. Should he be found liable on retrial, the appropriate damages should be based on the tenets of Lykes-Youngstown. We there adopted the concept of the "reasonable royalty." This does not mean a simple percentage of actual profits; instead, the trier of fact, should it find Bielefeldt liable, must determine "the actual value of what has been appropriated." We later expounded this concept:
We conclude by recognizing the other appellees in this case. Our decision has focused exclusively on Bielefeldt and Smith. Metallurgical, however, also named the other officers of Fourtek as appellees. It thereby forced Norman Montesino, Gary Boehm, and Michael Sarvadi to file an appellate brief. Only in their brief do we learn that Metallurgical itself moved to dismiss all counts against these three, a motion which the court granted. No evidence in the case was presented against them. Only in Metallurgical's reply brief, moreover, do we discover that "Metallurgical does not urge this appeal as to Montesino, Boehm, and Sarvadi . . . ." We regard the naming of these three as appellees, thus forcing them to submit a brief, as constituting a frivolous appeal. We therefore [*1209] award attorney's fees and single costs to Montesino, Boehm, and Sarvadi in accordance with Fed.R.App.P. 38. On remand, they are to submit their claims for fees to the district court.
AFFIRMED in part, REVERSED in part, and the cause is REMANDED.
1. [court's footnote 8] A possible
response to this argument is that, while the tort of misappropriating
a trade secret is theoretically distinct from a cause of action on the
contract, in this case the tort is swallowed by the subsequent contractual
agreements; therefore, the response would run, the parol evidence rule
remains applicable in governing the admissibility of evidence. To
accept this position, however, would require us to deny in the first place
to Metallurgical a cause of action based on breach of confidence. Because
the entire dispute would be contractual, duties imposed by tort law would
become irrelevant. This consequence is contrary to the Restatement's
philosophy that contractual duties are irrelevant in dealing with a breach
of confidence. As discussed earlier, the language of Huffines
strongly emphasizes the importance of providing tort liability as a way
of promoting business honesty and commercial fairness. Influenced
by such emphatic statements, we are unwilling to let this cause of action
die because of the presence of contracts. Instead, we acknowledge
the possible importance of any agreements in proving or disproving a requisite
element(s) of the tort and providing an independent basis for a contractual
cause of action.
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