FALL 2010

Trade Secrets


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

ID No. 85737 & 85736

Time:  W 6:30 - 9:30 p.m.
Room:  W-215
Professor Jay Dratler, Jr.
Room Across from 231D (IP Alcove)
Home: 330-835-4537
Copyright © 2000, 2002, 2003, 2006, 2008, 2010   Jay Dratler, Jr.   For permission, see CMI.

Forest Laboratories, Inc. v. Pillsbury Co.

452 F.2d 621, 171 U.S.P.Q. (BNA) 731 (7th Cir. 1971),
affirming in part and reversing in part 299 F. Supp. 202, 161 U.S.P.Q. (BNA) 622 (E.D. Wis. 1969)

Before Duffy, Senior Circuit Judge, and Cummings and Pell, Circuit Judges.  

[*623] CUMMINGS, Circuit Judge.  

Plaintiff, a corporation engaged in producing and packaging effervescent sweetener tablets, sued defendant Pillsbury Company, the well-known manufacturer of food products, alleging that Pillsbury had purloined certain Forest trade secrets.(1)  Apart from an antitrust count that was subsequently dismissed, the complaint was based on diversity of citizenship, and the parties are in accord that Wisconsin law is governing.(2)

After hearing the testimony of various witnesses and considering the exhibits, the district court agreed with plaintiff that it had successfully developed a process for packing effervescent sweetener tablets so as to lengthen their shelf life[.]  One step of this packaging procedure was adjudged to be plaintiff's confidential trade secret.  That step was described as follows: "Before packaging, the tablets are to be tempered in a room having 40% or less relative humidity for a period of between 24 to 48 hours."  

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[This court agreed with the district court that the tempering step was a trade secret.]

The evidence which was discussed in the district court's opinion and will not be reiterated here satisfied the district court and satisfies us that the[] criteria [for trade secrecy] were met by plaintiff until it had obtained a patent on March 16, 1965, disclosing the tablet tempering step.  Since the element of secrecy evaporated with the issuance of the patent, the district court properly held that Pillsbury should not be held liable after the issuance of the patent.

Even though it allegedly started using Forest's trade secret in Omaha, [*625] Nebraska, commencing in January 1964, Pillsbury advances several contentions against liability.  First, Pillsbury relies on the fact that its tempering was done in closed containers, whereas Forest's method utilized open containers.  However, there was testimony that the tablets would still equilibrate in closed containers, and might do so in a day or two if the container were only in a dry environment.  In any event, the user of another's trade secret is liable even "if he uses it with modifications or improvements upon it effected by his own efforts," as long as the substance of the process used by the actor is derived from the other's secret.   [Restatement of Torts, § 757, comment (c), page 9.]  The purpose of Forest's and Pillsbury's tablet tempering was to place the tablets in an ambient condition.  In our opinion, there was insufficient difference in the two methods to absolve Pillsbury from liability.  

Pillsbury purchased the assets of Tidy House Corporation on June 1, 1960.  The district court found that the trade secret had been divulged by Forest to Tidy House on a confidential basis and that as Tidy House's successor, Pillsbury was bound by the confidential disclosure to Tidy House.  On the state of this record(3) we cannot sustain the district court's conclusion.  The well settled rule of American jurisdictions, including Wisconsin, is that a corporation which purchases the assets of another corporation does not, by reason of succeeding to the ownership of property, assume the obligations of the transferor corporation.  Exceptions to this rule exist where (a) the purchasing corporation expressly or impliedly agrees to assume the liabilities of the seller, (b) the transaction amounts to a consolidation or merger of the two companies, (c) the purchasing corporation is merely a continuation of the selling corporation, or (d) the transaction is entered into fraudulently to escape liability.

There is no evidence that Pillsbury expressly agreed to assume all the liabilities and obligations of Tidy House, and in the absence of the purchase agreement or any evidence of conduct or representations by Pillsbury that could support it, we cannot find an implied assumption of liabilities.

Contrary to the district[*626] court's statement, what evidence there was indicated that not all the assets of Tidy House were sold to Pillsbury.  Apparently Tidy House, Inc. continued its corporate existence after the sale and leased to Pillsbury the buildings housing the facilities it had sold.  There is no indication of the financial situation or the extent of the corporate activity of Tidy House following the transaction.  Consequently, again on the strength of this record, we cannot conclude that the sale of assets amounted to a merger.   Pillsbury can hardly be said to be a mere continuation of Tidy House since the transfer of assets was not a part of a reorganization.  And finally there is no suggestion whatever that Pillsbury was acting in bad faith when it purchased the Tidy House business.  In sum, we are not convinced that Pillsbury subjected itself to the obligation of secrecy as Tidy House's "successor."  Moreover, the knowledge of Tidy House's employees cannot properly be imputed to Pillsbury just because they went to work for Pillsbury.

Section 757(b) of the Restatement of Torts provides:
    "One who discloses or uses another's trade secret, without a privilege to do so, is liable to the other if
      * * *  "(b) his disclosure or use constitutes a breach [**11] of confidence reposed in him by the other in disclosing the secret to him * * *."
Since Pillsbury does not stand in the shoes of Tidy House, plaintiff's confidant, Pillsbury's use of the secret does not come within the confines of 757(b).  

Nevertheless, even though Pillsbury is not liable under 757(b) of the Restatement of Torts for using Forest's trade secret as Tidy House's successor, the evidence shows that Pillsbury acquired actual knowledge of the confidentiality of the disclosure made by Forest to Tidy House.  Thus Mr. Richard Egan, a former employee of Tidy House and of Pillsbury, and considered by the trial judge to be a credible witness, testified that he communicated the trade secret to Dr. Julian Stein, Fred McCarne, and possibly others employed by Pillsbury at a meeting in the middle of 1962.  He also told them that the Forest process had been received in confidence by Tidy House.  

Section 758(b) of the Restatement states:
    "One who learns another's trade secret from a third person without notice that it is secret and that the third person's disclosure is a breach of his duty to the other, or who learns the secret through a mistake without notice of the secrecy and the mistake,
    * * *
      "(b) is liable to the other for a disclosure or use of the secret after the receipt of such notice unless prior thereto he has in good faith paid value for the secret or has so changed his position that to subject him to liability would be inequitable."
Thus under 758(b) of the Restatement of Torts, Pillsbury would be liable for its use of the secret after receipt of the notice unless prior thereto it had in good faith paid value for the secret.  To satisfy this exception, Pillsbury argues that it purchased the trade secret when it acquired Tidy House's assets, and that Mr. Egan's communications did not occur until well after the acquisition.  However, the record does not show that Pillsbury paid anything specifically for the trade secret.  For all that appears on [*627] the record, Pillsbury's purchase of Tidy House assets at most involved only the purchase of its packaging facilities as part of the existing marketing structure, which included plaintiff as supplier.  Nothing has been brought to our attention which would show that Pillsbury actually gave value for Tidy House's tempering expertise with a view toward independently exploiting that know-how for its intrinsic value.

Comment (e) to 758(b) of the Restatement states that "not every change of position prevents the recipient of a trade secret from being subjected to the duty not to disclose or use the secret after notice.  The issue is whether the imposition of the duty would be inequitable under the circumstances."  The mere possibility that some arbitrary portion of the purchase price could ex post facto be ascribed to the potential of the trade secret for Pillsbury's later independent use does not demonstrate a change of position which it would be inequitable not to protect under the circumstances.  The purpose of Restatement 758(b) is to protect bona fide purchasers and reasonable reliance, but it may operate harshly on those who have expended substantial sums in development of their trade secrets.  For this reason, we require a specific showing that Pillsbury in good faith paid value for Forest's trade secret at that time, and since there is a dearth of such proof, under 758(b) of the Restatement, it remained liable to Forest for using the trade secret after the receipt of notice.  

Pillsbury next asserts that the special master's assessment of damages in the amount of $75,000 as approved by the district court was erroneous.  Both parties agree that the "reasonable royalty" method of computing damages was properly invoked.  According to that method, the primary inquiry in fixing a reasonable royalty is "what the parties would have agreed upon, if both were reasonably trying to reach an agreement."  Egry Register Co. v. Standard Register Co., 23 F.2d 438, 443 (6th Cir. 1928); see Union Carbide Corp. v. Graver Tank and Mfg. Co., 282 F.2d 653 (7th Cir. 1960).  Forest contends that under this method it was entitled to damages in excess of $1,000,000, while Pillsbury contends that the damages should be in the neighborhood of $7500.

Pillsbury argues that "the master merely plucked from the air the figure of $75,000 without any attempt to tie that figure to any objective criteria."  Citing Mercury Cleaning Systems, Inc. v. Manitowoc Engineering Co., 255 F.2d 318 (7th Cir. 1958), Pillsbury concludes the $75,000 award is too speculative and uncertain to stand.  That case involved damages based on straight loss of profits for breach of contract, and this Court held that the evidence had not clearly enough connected the loss of profits with the breach.  The basis for an award of damages should be as explicit as the method of calculating the damages permits, but the reasonable royalty method used in this case is not amenable to a completely mathematical articulation.  Here the master considered the factors of Forest's loss of profits, its profits prior to 1964, and its claimed cost of development, and to these factors he assigned values supported by ample evidence.  But the master also correctly considered other factors not susceptible of precise valuation, such as Forest's ability to continue in the tablet-producing business, the nature of the trade secret, its utility, and advantages and extent of use.  And, of course, the commercial posture of the parties must have entered into the master's picture.  See Egry Register Co., supra, 23 F.2d at 443. Because of the type of factors considered and the necessarily judgmental process involved in constructing a hypothetical business agreement, we cannot fault any lack of specificity in arriving at what must necessarily be a reasonable approximation.

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Finally, Pillsbury asserts that the district court improperly refused to entertain its patent invalidity claim.  Forest did not contend that Pillsbury had infringed Forest's patent,(4) and the parties stipulated to a judgment of noninfringement.  Therefore, Pillsbury's argument that it might not be able in the future to raise defenses against this patent is frivolous.  Since the previous charge of infringement was withdrawn, non-infringement was conceded, and no harassment or repeated charges of infringement appear, the district court was within its rights in deciding not to issue a declaratory judgment as to the validity of Forest's patent.

The additional arguments presented by the parties have been fully considered but are not sufficiently substantial to merit discussion.  We conclude that the district court's factual determinations were not clearly erroneous and that apart from the award of attorneys' fees, its judgment was correct.  Five-sixths of the costs shall be taxed against Pillsbury and one sixth against Forest.  

Affirmed in part; reversed in part.
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1.   [court's footnote 1]  Formulations, Inc., another producer of effervescent sweetener tablets, was originally also a defendant.  However, during the course of trial, Formulations was dismissed because it did not have notice of Forest's alleged trade secrets.  That dismissal is not urged as error here.

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2.   [court's footnote 2]  Since Forest claimed that Pillsbury used its trade secrets solely in Omaha, Nebraska, the law of that state would seem pertinent.  However, the parties do not challenge the district judge's choice of Wisconsin law, nor have they shown that Nebraska and Wisconsin law differ.  Therefore, we will also treat Wisconsin law as governing.

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3.   [court's footnote 6]  The only evidence relating to the nature of the transaction was the testimony of Mr. John S. Rapp, the former president of Tidy House.  He stated that the assets of Tidy House "were simply sold to The Pillsbury Company on an exchange of stock basis," that all the production facilities, patents, trademarks and attendant good will were included in the sale but the Tidy House real estate was not, that after the sale Tidy House leased the buildings housing the production facilities to Pillsbury for a term of five years with some kind of option, that Pillsbury operated the acquired business as its Tidy House Division, that all Tidy House's key personnel went over to Pillsbury, that there was no indebtedness for Pillsbury to assume, and that on approximately June 1, 1964, part of the assets involved in the sale, including all the Tidy House products except artificially sweetened items, were reacquired from Pillsbury.  The agreement of purchase was never introduced in evidence.  No testimony was taken as to which liabilities Pillsbury agreed to assume and which it excluded although Pillsbury's assertion that it excluded all unknown liabilities was not rebutted during argument.  There was no allusion to the financial status of Tidy House Inc. and its ability to pay creditors following the sale.

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4.   [court's footnote 12]  A previous action brought by plaintiff against Pillsbury in the Southern District of New York for patent infringement and unfair competition was voluntarily dismissed on the same date that plaintiff commenced the action below.

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