FALL 2008

Trade Secrets


Course No. 9200-704 (and 804)-801

ID No. 16545

MW 3:00 - 4:30 p.m.
Room L-134
Professor Jay Dratler, Jr.
Room 231D (IP Alcove)
(330) 972-7972
Copyright © 2000, 2002, 2003, 2006, 2008   Jay Dratler, Jr.   For permission, see CMI.

Questions and Notes on Lykes-Youngstown Corp. and USM Corp.

1.  These two cases illustrate how courts calculate monetary relief in trade secret cases.  Before analyzing them, take another look at Section 3 of the UTSA.

Subject to one exception, Section 3 says that a plaintiff who succeeds in proving liability "is entitled to recover damages for misappropriation."  Does this mean that a court has discretion whether or not to award damages, or does it mean that any plaintiff who proves damages has the right to recover them?  Must a court award damages in all cases, or only if there is adequate proof of the fact and the amount of damage?  If there is proof of the fact of injury but only inexact proof of the amount of damages, what rules apply?  Should trade-secret courts follow the rule of Bigelow and give the injured plaintiff the benefit of the doubt?

What about the exception in Section 3(a)?  Take another look at UTSA § 1(2)(ii))C), the provision defining "third-party misappropriation" in cases where the defendant claims to have had no knowledge of the tainted character of the information received.  What is the relationship between this provision and the exception in the first sentence of Section 3(a)?  Are the two provisions redundant?  Do they address the same factual scenarios?  Does the exception apply in the ordinary case in which the defendant knows full well that the information is protected when he acquires it?

2.  Section 3's second salient feature is providing two kinds of monetary relief.  The statute speaks of both "actual damages" and "unjust enrichment."  What do these two terms mean, and how do they differ?  Can you imagine a circumstance in which a plaintiff might have no proof of "actual damages" but the defendant might have been vastly and unjustly enriched?   Why does the law provide for both types of relief?  The obvious purpose of allowing a plaintiff to recover actual damages is compensation, but what is the purpose of forcing a defendant to disgorge unjust gains from trade-secret misappropriation?  Does disgorgement compensate the plaintiff for a loss or serve some other purpose?  Does it put the plaintiff in the "rightful position"?

In providing for both kinds of relief, the UTSA follows the general pattern of copyright and trademark law, but not patent law.  Both copyright and trademark law allow a successful plaintiff to recover both the plaintiff's own losses and the defendant's profits from the infringement—in each case without double counting of the same element of relief.  See 17 U.S.C. § 504 (copyright); Lanham Act § 35(a), 15 U.S.C. § 1117(a) (trademarks and federal unfair competition).  Although patent law once followed the same pattern, Congress eliminated profits recoveries in utility and plant patent cases in 1946 in order to simplify patent litigation.  See 35 U.S.C. § 284; General Motors Corp. v. Devex Corp., 461 U.S. 648, 654-655, 103 S.Ct. 2058, 76 L.Ed.2d 211 (1983) (discussing history of and reasons for 1946 change in case involving issue of prejudgment interest).  Profits recoveries remain possible in design patent cases.  See 35 U.S.C. § 289.

Thus, except for utility- and plant-patent law, virtually all of intellectual property law allows successful plaintiffs to recover both their own losses and the defendant's profits. Can you think of any good reason why this is so?  If a plaintiff has no losses but the defendant unlawfully uses the plaintiff's intellectual property to great profit, does a profits recovery give the plaintiff a windfall or serve some other useful policy purpose?

3.  Section 3's third salient feature appears in subsection (b), which allows, but does not require, courts to award "exemplary damages in an amount not exceeding twice any award made under subsection (a)" in cases of "willful and malicious misappropriation[.]"  What does this language mean?

First of all, what is "willful and malicious misappropriation"?  If the defendant knows that the information was someone else's trade secret when acquired, is that alone enough, or is more required for exemplary damages?

Second, what does Section 3(b)'s language require in terms of the amount of an exemplary award?  Is the statutory limit on the total award twice the amount otherwise made, or three times?  Finally, does this sort of exemplary award under Section 3 replace or supplement awards of punitive damages under state law?  Can a plaintiff receive both augmented damages under Section 3(b) and a separate (and possibly unlimited) award of punitive damages under the general principles of state law?  (Recall Mason v. Jack Daniel Distillery, where the court upheld and award of punitive damages based upon general principles of Alabama law.)

4.  A fourth salient feature of Section 3 appears in the last sentence of Section 3(a), which provides for recovery of "a reasonable royalty" in "lieu of damages measured by any other methods[.]"  Does the "in lieu of" language mean that a plaintiff who elects to recover a "reasonable royalty" cannot recover either actual losses or the defendant's profits from the misappropriation?

5.  As the Fifth Circuit's opinion in University Computing Co. v. Lykes-Youngstown Corp. suggests, the general legal standard for a "reasonable royalty" is the "willing buyer-willing seller" rule.  This rule is used to estimate "market value" in many areas of the law, including proceedings for public condemnation of land under Fifth Amendment's "just compensation" clause.  The usual formulation of the rule is what a willing buyer would pay a willing seller, if both were reasonably trying the reach agreement and neither were under a compulsion to buy or sell.

Is this rule conceptually appropriate in a case in which the plaintiff made clear by its behavior that it never intended to license the trade secret to anyone?  Does the willing buyer-willing seller rule, which hypothesizes the willingness of the trade secret owner to deal, properly take account of the value of the trade secret owner's right not to deal but to keep the secret to himself?  Does the willing buyer-willing seller rule provide precise and/or useful guidelines for calculating the amount of damages?  Is it realistic to speak of a hypothetical reasonable bargain when the facts of the case suggest that one party was unwilling to deal and the other took that party's property unfairly?

6.  More fundamentally, does the willing buyer-willing seller rule invite the parties to present useful evidence on the question of the value of what was taken?  Consider the colloquy between defendant's counsel and the plaintiff's expert witness, Josephson, quoted in the court's opinion.  When the defense lawyer got the witness to say that he had not based his opinion of value entirely on what someone else would pay, the lawyer could hardly believe his ears.  He thought he had scored a big point.  Had he?  Was the court right in saying that the jury had been properly instructed and it was up to the jury to sort out the various bits of evidence?  Or was defense counsel right in saying the witness' testimony should be excluded as not responsive to the substantive legal rule?  Should the willing buyer-willing seller rule be applied literally?

7.  Besides wrestling with the willing buyer-willing seller rule, the Lykes-Youngstown decisions provides a veritable mini-treatise on the calculation and proof of damages in patent and trade-secret cases.  Skim over the court's discussion of how courts calculate the plaintiff's losses and a "reasonable royalty" again.  Is the procedure formulaic?  Is it cut and dried?  Or are there numerous possibilities for creative legal argument, not only on the numbers, but also on how the numbers are calculated?  If you try a case like this, should you simply hire accountants and other experts and leave the numbers up to them, or should you work with accountants and other experts to make the best legal arguments possible, using the best numbers for your client?  Would University Computing Co. have been satisfied, after the egregious misappropriation it had suffered and all the years spent in litigation, with a nominal or minimal recovery?  (Even in the 1970s, the attorneys' fees for such a hard-fought case alone probably ran into at least the mid-five-figure range.)

8.  Lykes-Youngstown Corp. is an interesting case in other respects as well.  The court ultimately allows the jury to base its estimate of the value of UCC's software system, and therefore the "reasonable royalty," on Josephson's testimony about an unaccepted offer.  As the court itself notes, unaccepted offers are not proper evidence in land condemnation proceedings.  Is this a good rule generally?  Why or why not?  Does an unaccepted offer really say anything definitive about market value?  As a matter of evidence, are unaccepted offers subject to manipulation and fraud?  Was the court here nevertheless justified in accepting the testimony in this case?  Or did the court stretch the law out of shape in its rush to provide a good remedy for egregious misappropriation?

9.  Another important point of  Lykes-Youngstown Corp. is its take on the "commercial use" requirement for trade-secret misappropriation.  Where does this requirement come from?  Is is explicit in the UTSA or only implicit?  Is it related to the requirement of causation—that any plaintiff must prove that the wrong caused the alleged damages?

The defendant argued there was no use because it had never sold any licenses for the misappropriated software, although it had tried to do so.  The plaintiff argued there was "use" by virtue of the defendant unlawfully exercising dominion and control over the software, manipulating it on machines, and demonstrating it to prospective customers—all of which put the trade secrets beyond plaintiff's control and subjected them to risk of further disclosure and misuse.  Was the court right to hold that these activities constituted "use" at least for the purpose of awarding damages?  Or did the court stretch to provide a good remedy for an egregious wrong?

The court in Metallurgical Industries, Inc. v. Fourtek refused to follow this aspect of Lykes-Youngstown in ruling that Smith International had never used the misappropriated trade secrets because the furnace containing them had never been used to recover "carbide" for paying customers.  Not only did that court court deny damages for lack of use; it denied any remedy at all, although it kept open the possibility of a later remedy in the even of future use.  Are these two results reconcilable?  Can you distinguish the two case on their facts?  If not, which court had the better approach to the question of "use" and why?

10.  The case of USM Corp. v. Marson Fastener Corp. illustrates recovery of what the UTSA calls "unjust enrichment."  In many respects, the facts present a classic case for this remedy.  The opinion tells us little about the plaintiff, but both the dollar figures for profits (on little rivets, at that!) and the defendant's sales in Australia suggest that the defendant was a large, international company.

Just for fun, let us assume that plaintiff was a small, local firm making, marketing, and selling rivets to manufacturers in the Boston area only. Under that assumption, could the plaintiff prove that it had lost a sale for every sale that the defendant made, both nationally and internationally?  In order to prove causation, wouldn't the plaintiff have to show that it had the capability to market and sell rivets in all the markets in which defendant sold them illicitly?  If it could not, could it prove injury in fact with respect to all of defendant's illicit sales?  Does this analysis suggest why plaintiff did not even try to claim losses in this case?

Under these (assumed) circumstances, what policy function(s) does forcing the defendant to disgorge its illicit profits perform?  Does it serve to compensate plaintiff for a loss whose magnitude cannot be proven but is nevertheless real?  Does it also serve other purposes?  Suppose plaintiff had provable losses but they amounted only to three percent of defendant's illicit profits?  Wouldn't the defendant happily continue on its merry way, misappropriating the trade secrets, paying off plaintiff's provable losses as they occurred, and laughing all the way to the bank?

11.  The USM Corp. decision is also of interest because it provides a mini-treatise on many of the accounting issues that arises in unjust-enrichment cases.  Before your eyes glaze over at the mere mention of accounting minutiae, consider the following.

The table of defendant's profits in footnote 1 covers fifteen years.  Since few statutes of limitations (other than that for murder) last for anywhere near that long, this fact suggests that the litigation itself lasted for a decade or more.  It was a hard-fought and grueling battle.  No doubt the plaintiff's economic survival was at stake.  Under these circumstances, do you think that the plaintiff was interested in a mere declaration of right?  Would it have been satisfied if its lawyer had not squeezed every dime out of the misappropriator, no matter how brilliantly he or she proved liability for misappropriation?  Numbers do matter, especially when they represent a remedy for a lifetime of hard work stolen by a misappropriator.

12.  If you have little or no accounting background, make sure you understand the different meanings of the words "income," "revenue," "profits," "cost" and "expense."  Although related, each of these words has a separate and distinct meaning for accounting and general business purposes.  Look up all these words in the dictionary.

Generally speaking, "revenue" refers to a firm's gross income or receipts, such as the price charged buyers for each widget multiplied by the number of widgets sold.  "Cost" or "expense" refers to the money that the firm pays to others in making its products or providing its services. For a manufacturing firm, "costs" and "expenses" including such things as the wages paid to workers, the costs of raw materials, the price paid for equipment, expenses for utilities such as electricity and telephone service, and general expenses for marketing, legal advice, accounting, insurance, taxes etc.

Only when all these out-of-pocket costs and expenses are subtracted from revenue does the result represent the firm's "net income" or "profit."  This is what the sole proprietor lives on, or what the corporation uses to pay dividends to shareholders and provide for future expansion.  Profit is extremely important, for a firm that makes no profit will go out of business, and a sole proprietor who has not profit will starve (or go on welfare).  These terms can be summed up by the following equation:

profit (or "net income") = revenue (or "gross income") - expenses

When the law speaks of "unjust enrichment" and a defendant disgorging its illicit gains, which of these categories is at issue?  Does/should a defendant disgorge its revenue, expenses or profit?  Which makes sense in light of the purpose(s) of unjust-enrichment theory?

One nuance is worth mentioning.  Sometimes expenses are divided into general categories.  The most common of these are "cost of good sold," "marketing and promotion," "research and development," and "general and administrative" (also called "overhead").  The "cost of goods sold" is limited to costs directly and obviously allocable to the production of specific products, such as labor and raw materials.  The other expenses are categorized separately because they are not as obviously allocable to particular products.  For example, when IBM advertises its "e-business" services, the cost of that advertising is not allocable to any particular product or service IBM's, but presumably benefits sales of a wide range of products and services in a whole field of commerce.  Accountants therefore cannot allocate these costs to the manufacture of a specific product as they might for example, the cost of buying a disk drive that becomes a component of a specific computer system.  The same can be said of the other categories of expense—research and development and general and administrative. They are expenses of the business as a whole and generally hard to allocate to any particular product or service.

13.  The USM Corp. court begins by establishing an important rule.  Once the plaintiff has shown the defendant's gross revenue or sales receipts, the defendant has the burden of proving all deductions from gross revenue, as well as any part of gross revenue that is not properly apportionable to the misappropriation.  In this respect, trade-secret law follows the well-worn path of federal copyright and trademark law (and indeed of patent law before profits recoveries in utility- and plant-patent cases were disallowed).  See generally, Sheldon v. Metro-Goldwyn Pictures Corp., 309 US 390, 60 S.Ct. 681, 84 L.Ed. 825 (1940) (seminal decision on apportionment of profits in copyright litigation).

The federal copyright and trademark statutes are explicit on this point.  See 17 U.S.C. § 504(b) (in part: "In establishing the infringer's profits, the copyright owner is required to present proof only of the infringer's gross revenue, and the infringer is required to prove his or her deductible expenses and the elements of profit attributable to factors other than the copyrighted work"); Lanham Act § 35(a), 15 U.S.C. § 1117(a) (in part: "In assessing profits the plaintiff shall be required to prove defendant's sales only; defendant must prove all elements of cost or deduction claimed").  Is Section 3 of the UTSA similarly explicit?  If not, where does the court get the same rule for trade secrets?

Why is this rule universal in calculating profits recoveries in intellectual property law?  Is it fair to both parties?  Does it reflect certain realities of accounting and human proclivities?  What policies does it support?

14.  An important question that arises often in damage cases involves the apportionment of "general and administrative" or "overhead" expenses.  By definition, these are expenses that are not obviously allocable to any particular products or services but are costs of the business as a whole.  Examples are expenses for telephones, electricity, janitorial services, general taxes (such as property taxes) and legal and accounting services.  Taken together, these "overhead" expenses can be considerable, and some of them may be properly allocable to the illicit activities and therefore fairly deductible from "unjust enrichment."  But how much?

The defendant in USM Corp. argued for allocating expenses based upon gross revenue.  That is, it argued for apportioning overhead expenses to the illicit activities (the ones using the misappropriated trade secret) according to the ratio that the defendant's gross revenue from those activities bore to the defendant's gross revenue for the defendant's business as a whole.

Certainly that formula provides a reasonable approximation of the overhead allocable to the illicit activities, such as an accountant not involved in litigation might use.  What are the legal, fairness and policy arguments for and against allowing a defendant to use such a formula to deduct a substantial fraction of its overhead expenses from the "unjust enrichment" that it otherwise would have to disgorge?  How did the court rule on this issue?  Was the court's decision right?  Was its decision consistent with the principles of Bigelow?

15.  Another accounting question that is complex but numerically significant is that of taxes.  Just like anyone else, a defendant must pay income taxes on its profits.  For accounting purposes, income taxes are a legitimate expense, falling under the "general and administrative" or "overhead" category.  Firms must pay their federal income taxes, or the federal authorities will come and attach their property, so taxes are hardly in illusory expense.

Should a defendant in an unjust enrichment case be allowed to deduct its federal income tax payments from its profits before disgorging them to the plaintiff?  What are the arguments pro and con allowing the deduction?  What if the tax rules allow the defendant to deduct damage payments (at least those in the form of profits disgorgement) from its income in computing its taxable income for federal tax purposes?  Suppose then the defendant pays taxes at a higher rate, pays unjust-enrichment damages to the plaintiff after deducting those taxes, and then, after making that payment, files an amended tax return, deducting the damage payments from its revenue to reduce its taxable income, and thereby obtains a tax refund?  Should the plaintiff get the tax refund?  If so, should the court retain jurisdiction of the case until limitations period for filing amended tax returns runs out to allow for this possibility?  How did the USM Corp. court solve these knotty problems, and did its solution make sense? from a theoretical perspective?  from a practical perspective or "rough justice"?

16.  Yet another accounting question that often arises involves prejudgment interest.  This is interest on the amount awarded as damages before the judgment is rendered.

In the case of the plaintiff's losses, the economic theory of prejudgment interest is simple.  By perpetrating the wrong, the defendant caused the plaintiff a monetary loss.  To the extent that the loss is "liquidated" (i.e., numerically determinable in amount), it is as if the plaintiff had taken an equivalent sum of money from the plaintiff.  Had the plaintiff had that money, she could have invested it in a insured bank account and earned interest.  If she needed the money while deprived of it, she would have had to borrow the same amount, at interest.  Either way, she "lost" the interest on the amount, and the "rightful position" principle requires that the defendant compensate her for the loss of interest, as well as the loss of principal.  The interest should run from the date of the loss (in this case the date of the misappropriation), but some states have it run from the date on which the lawsuit is filed.  (The question of interest after the judgment is rendered is conceptually similar.  That question, however, is regulated by special statutes in most states, which provide for "post-judgment interest at a specified rate.)

Difficulties occur, however, in translating this theory from damages measured by the plaintiff's losses to damages measured by the defendant's unjust enrichment.  Suppose some time has passed between defendant's receipt of illicit gains and the date of judgment. Can't one argue that the defendant could have invested those gains in a bank account and earned interest (or avoided taking a loan and paying interest) during that interval?

But what about timing?  In calculating interest on the amount of plaintiff's losses, one assumes that all those losses occurred at the date of misappropriation.  Isn't this assumption reasonable?  Yet is the same assumption appropriate for the defendant's profits?  Look at the fifteen-year table of defendant's illicit profits in footnote 1 of the USM Corp. decision.  Is it fair, for example, for defendant to pay interest on profits gleaned in 1980 for a period beginning in 1964, when the wrong occurred?  Or for a period beginning a some later date—but long before 1980—when the lawsuit was filed.  Wouldn't that force defendant to pay interest on profits before it had them?  How does the USM Corp. court resolves these questions, and is the resolution reasonable?  Would it be better for courts simply to admit expert testimony regarding the actual loss of interest, or do statutory and common-law principles preclude their doing so?

17.  A final issue raised by the USM Corp. decision is the question of punitive damages.  The court decides that augmentations of damages (under a statute apparently analogous to UTSA § 3(b) applies only to the plaintiff's losses, and not to the defendant's unjust enrichment.  Is that what UTSA § 3(b) says?  If not, should courts be eager to augment damages based upon unjust enrichment?  Should it make any difference whether the court has given the plaintiff the benefit of the doubt in many of the accounting calculations?

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