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.

Forro Precision, Inc. v. IBM Corp.

673 F.2d 1045, 215 U.S.P.Q. (BNA) 299 (9th Cir. 1982)


Before Trask and Fletcher, Circuit Judges, and Muecke*, District Judge.

      * Hon. C. A. Muecke, Chief United States District Judge for the District of Arizona, sitting by designation.  

Fletcher, J.:  [*1049]

This action arises from a series of events in 1972 and 1973 that culminated in the search of the business premises of Forro Precision, Inc. (Forro) by the San Jose police, who were accompanied by and aided in the search by employees of the International Business Machines Corp. (IBM).(1)  Forro brought suit against IBM on the basis of its participation in the search and other conduct damaging to Forro.  IBM, in turn, counterclaimed against Forro.

After extensive pretrial proceedings, the claims by Forro were narrowed to contentions that IBM had intentionally interfered with prospective business advantage under California law and had monopolized and attempted to monopolize in violation of section 2 of the Sherman Act.  15 U.S.C. 2 (1976).  IBM's contentions were narrowed to a counterclaim under California law that Forro had misappropriated its trade secrets.  A jury found in favor of Forro on the intentional interference claim and awarded actual damages in the amount of $ 2,739,010.  It found in favor of IBM on the misappropriation claim and awarded actual damages in the sum of $ 260,777, but deadlocked on the antitrust claims and on both parties' claims for punitive damages.

The trial judge initially declared a mistrial on Forro's Sherman Act section 2 claims, but later entered judgment in favor of IBM on this aspect of the case.  The trial judge further ordered that neither party recover punitive damages.

I

FACTS

IBM designs, manufactures, and markets a complete line of electronic data-processing equipment.  This lawsuit concerns disk drives and disk packs, which are one portion of the line.  The function of disk drives and packs is to provide rapid storage and retrieval of data.  The devices are components separate from the "main frame" of a computer, and, along with other modular equipment, are known as "peripheral equipment."  Peripheral equipment designed to work with a manufacturer's main frame computer is termed "plug compatible."  Companies other than IBM that manufacture such components are known as plug-compatible manufacturers, or "PCM's."

Forro is not a PCM, but rather is a manufacturer of precision metal parts purchased by PCM's for incorporation in peripheral equipment.  Forro ordinarily manufactures components in accordance with drawings and specifications provided by its PCM customers.  Forro has on occasion, however, offered parts manufactured under Forro's own "FP" designation.

During the late 1960's and early 1970's, IBM was developing a disk storage device called the 3330, or "Merlin."  IBM announced the Merlin to the trade in June, 1970.  The first customer shipment of the Merlin was set for August, 1971.  Forro offered Merlin parts, under its own FP designation, in mid-1971, prior to IBM's shipment date.  The date of shipment is significant because it is the first date upon which the devices could be acquired legitimately
[*1050] and "reverse engineered."  Prior to that time, detailed technical specifications would necessarily originate in IBM's shop.

In late 1970 and early 1971, IBM became aware of rumors that its security had been breached and that its new Merlin design was "out."  These rumors were substantiated on two occasions, when companies in the industry voluntarily turned over to IBM Merlin drawings that had come into their possession.  At about the same time, during discovery in a trade secret lawsuit brought by IBM against Memorex Corporation, IBM acquired information that led it to suspect that Forro had supplied to Memorex parts manufactured from Merlin designs.

Subsequently, in December, 1971, as part of its discovery in the Memorex lawsuit, IBM deposed Forro's president, Fowler, and its general sales manager, Knisely. At these depositions, Fowler and Knisely produced drawings of Merlin parts.  They testified at the depositions in the Memorex case, and later at trial in this case, that Forro acquired the drawings in May of 1971 from a Mr. Shinn, an employee of another company, Sigma Technology.  Shinn had submitted the drawings, which bore the Sigma Technology logo, to Forro as part of a request for a quote on the machining of certain of the parts.  After verifying that the documents were authentic Merlin drawings, Forro intentionally submitted a very high bid and lost the Sigma Technology business.  Forro copied the drawings prior to returning them to Shinn, and changed the Sigma Technology logo to a Forro logo.  Forro subsequently offered for sale under its own FP designation Merlin parts manufactured from these drawings.

The Fowler and Knisely depositions in the Memorex litigation were taken under a stipulation that the depositions would be subject to a protective order and that the originals of all documents produced pursuant to subpoena would be returned to Forro.  Within a week of the taking of the depositions, IBM returned the Merlin documents to Forro without restriction.

IBM became convinced that leaks of the Merlin drawings came from its San Jose laboratory.  IBM initiated an investigation in 1972.  In the course of this investigation, an informant told IBM that he had heard a rumor that Forro had technical information on the 3340, or "Winchester," Data Module.  The first shipment of the Winchester device was not scheduled until November, 1973.  IBM persuaded the informant to visit Forro and attempt to confirm the rumor. The informant contacted Forro but was unable to verify the rumor.

At trial, IBM introduced testimony of Fritz Damm, the former general manager of Damm and Zoon, a Dutch precision machine firm that produced Winchester parts for IBM.  Damm testified that Fowler had contacted him several times in late 1972 and early 1973, attempting to acquire Winchester drawings and specifications from Damm.  Fowler implied that Forro was already making certain Winchester parts.  Although Damm testified at trial that he had delivered Winchester drawings to Fowler two weeks before the search of Forro, none of the drawings were uncovered in the search.

Forro began selling FP Winchester parts shortly after IBM's first shipment in November, 1973.  Fowler testified that the specifications for Forro's FP Winchester parts were acquired through reverse engineering that took place immediately after the Winchester's first shipment date, and that he had not acquired any proprietary Winchester information through Damm.  Fowler's testimony was belied by testimony of Forro's general sales manager, Knisely, that he had seen a copy of the Winchester specifications in Fowler's office almost a year before the alleged reverse engineering could have taken place.  Fowler's testimony was also placed in question by the fact that one of Forro's parts exhibited characteristics peculiar to the European-made versions of the part.  The European version of the Winchester parts were not shipped until after the date of the drawing that Fowler claimed was created by reverse engineering.

By March, 1973, IBM had arranged through an undercover agent to buy from a man named Steckel an entire set of illicit [*1051] Winchester drawings for $ 75,000.  At that time, IBM had still not discovered the source within IBM.  IBM decided to seek the aid of local Santa Clara County law enforcement officials in order "to find the path back into the lab, and also to produce a thunderclap" of adverse publicity for the firms implicated in the illicit trade.

In late March and early April, 1973, IBM officials met with representatives of the California Attorney General's office and Santa Clara County law enforcement officials to discuss what actions to take to discourage trade secret thievery.  The San Jose Police Department, with the involvement and consent of the Santa Clara County District Attorney, agreed to take over the investigation.  The investigation thenceforth became a cooperative effort between the police and IBM.  An IBM undercover agent continued his work under police supervision.  Funding for the investigation came from IBM in the form of cash payments totalling $ 24,300.

In June, 1973, warrants were issued for the search of eight locations, including the Forro facility.  Probable cause to search Forro's place of business was predicated on the suspected presence of unlawfully acquired Merlin drawings. The police affidavits offered in support of the warrants were based in part on the 1971 Memorex depositions of Fowler and Knisely, and on IBM assertions that the documents produced by Forro had been IBM documents.  IBM neglected to tell the police that IBM had returned the documents to Forro after the depositions.

Forro's Los Angeles plant was searched on June 29, 1973.  The search lasted approximately twelve hours.  Five IBM employees accompanied the police to aid in examining the seized material to see that it matched that described in the warrant.  About four hundred drawings were seized, as well as price lists, correspondence, cost documents, and purchase orders.  During the course of the search, Fowler and his son hid documents in a false ceiling and in a car, allegedly out of fear that a seizure of all documents would put Forro out of business.

The search of Forro's premises was widely publicized in industry trade journals.  Forro incurred out-of-pocket expenses in the amount of $ 79,000 as a result of the search, and allegedly suffered further losses in sales and profits as a result of the adverse publicity. Although the investigations led to ten indictments, no indictment was sought against Forro or any of its employees or principals.


II

INTENTIONAL INTERFERENCE WITH CONTRACT

The jury found for Forro on its claim that IBM intentionally interfered with Forro's contractual relationships.  Forro's theory is two-fold: first, that IBM orchestrated and participated in a police investigation of Forro in order to subject the company to a "thunderclap" of adverse publicity and thereby disrupt Forro's business relationships, and second, that IBM used deceitful means to persuade the police to cause the issuance of the search warrant for Forro's plant and then participated in the ensuing search and seizure of Forro's business records.

* * * We find . . . that IBM's communications to the authorities and participation in [*1052] the search were privileged, and therefore we reverse.

* * *

B.  Dismissal for Destruction of Evidence

IBM moved under rule 37 of the Federal Rules of Civil Procedure to dismiss Forro's intentional interference claim because Forro allegedly destroyed blueprints that would have allowed IBM to trace the incorporation of its trade secrets into Forro's products. [*1053]  The district court viewed the evidence as conflicting with regard to whether Forro had destroyed evidence, and denied the motion.

The decision to impose sanctions under rule 37 is in the trial court's discretion. . . .  We do not think that IBM so clearly demonstrated its right to sanctions that we could say that the district court abused its discretion.  We accordingly affirm the denial of the motion.


C.  Privilege for Communicating with and Assisting Authorities

IBM contends that its solicitation of police aid and its assistance in the search of Forro's premises are privileged under California law.  The trial court ruled against IBM on these points and refused to give IBM's jury instructions on privilege.  The judge instructed the jury,(2) however, that California's policy of encouraging citizens to report criminal activities to the authorities should be considered by it as a factor in determining whether IBM's conduct was justified.(3)


1.  IBM's participation in the search

In deciding whether the trial court erred in refusing to instruct that IBM's participation in the search was privileged, we must apply California law.  Our examination of the evidence adduced in this case and applicable California law leads us to conclude that the Supreme Court of California would hold that IBM's actions in assisting the police in making the search were privileged and could not serve as a basis for civil liability.(4)

The search of Forro's premises was conducted under authority of a validly issued search warrant. The police obtained the search warrant from a magistrate.  The police requested IBM's aid in conducting [*1054] the search because the search warrant required that technical documents be identified.  A layman would not have had the expertise to identify the drawings containing IBM product specifications.  Teams composed of police officers and IBM employees conducted the search.  The IBM employees were accompanied by an officer at all times and acted under direct police supervision.  The officer in charge of the search personally reviewed all materials to decide whether they should be seized.  Forro does not argue that the actions of either the police or the IBM personnel in conducting the search exceeded the authority conferred by the warrant.  Although Forro would have us view IBM as a puppeteer directing the actions of the police, our review of the record convinces us that the evidence provides no basis for inferring that the police were not in charge of obtaining the search warrant and the conduct of the search itself.

California allows officers to request the aid of citizens in executing search warrants. People v. Turner, 249 Cal.App.2d 909, 927, 57 Cal.Rptr. 854, 865, cert. denied, 389 U.S. 963 (1967); Cal.Penal Code 1530.  The California legislature has provided that a citizen aiding an officer has such powers as the supervising officer may delegate.  Cal. Penal Code 830.6(b).   The officer himself is immune from suit arising out of the execution of a valid warrant. . . .   Cal. Civ. Proc. Code 262.1.  The California legislature has not, however, expressly provided for such immunity for the citizen assisting a search.

We think that California Penal Code section 830.6(b) must be understood as according a citizen immunity that derives from the officer's own immunity. This result is supported by two California cases.

In Peterson v. Robison, 43 Cal.2d 690, 697, 277 P.2d 19, 24 (1954), the California Supreme Court held that a private citizen is not subject to an action for false imprisonment when he makes an arrest at a peace officer's request.  The court reasoned that it would be unfair to impose civil liability on a person when a California statute made it a misdemeanor to refuse an officer's request to aid in an arrest.

A more recent California Supreme Court case, Sokol v. Public Utilities Comm'n, 65 Cal.2d 247, 418 P.2d 265, 53 Cal.Rptr. 673 (1966), held that a public utility was not civilly liable for disconnecting the plaintiff's phone after receiving notification from the local police chief that the phone was being used for illegal purposes.  A state Public Utilities Commission regulation required the phone company to disconnect phone service whenever it had reasonable cause to believe that a subscriber was using the phone for an illegal purpose, and further provided that notice from a law enforcement officer of such usage was sufficient to constitute reasonable cause.  The court noted by reference to Peterson that it would be unfair to impose liability on a person for doing what the law requires, and stated further that "(a) contrary rule would not only be inequitable but would discourage cooperation with law enforcement agencies."

We conclude that the California courts would extend the reasoning of Peterson and Sokol to provide immunity to IBM.  An attempt to distinguish this case from Peterson and Sokol on the basis that no statute required IBM to assist the police in searching Forro's premises is unconvincing.  The principal basis for the holdings in the California cases is the policy of encouraging citizens to aid the police.  Police officers occasionally have need to seek help from private citizens in conducting valid searches.  Indeed, such assistance may be more necessary to the police in the context of a search, where technical knowledge may be wanting, than in the arrest context addressed in Peterson.  A citizen should not have to assess his potential civil liability when presented with a reasonable police request for assistance.  Otherwise, citizen cooperation might be deterred. [*1055]


2.  IBM's Communications to Authorities

IBM contends that all of its communications to the authorities were absolutely privileged under section 47(2) of the California Civil Code, which provides:
    "A privileged publication or broadcast is one made—* * *
      "2. In any (1) legislative or (2) judicial proceeding, or (3) in any other official proceeding authorized by law . . ."
At trial Forro tried to show that IBM secured the cooperation of the San Jose Police through misrepresentation and fraud.  Specifically, Forro asserted that IBM failed to inform the police that a protective order shielded the depositions on which the affidavit in support of the search warrant was based, failed to disclose that IBM's counsel had returned without restriction the Merlin drawings produced at the depositions, and misled the authorities into thinking the designs were trade secrets.

The privilege conferred by section 47(2) in defamation actions is absolute and unaffected by the presence of malice. . . .(5)  Underlying the privilege is the policy of encouraging freedom of communication between citizens and public authorities charged with investigating wrongdoing. . . .  Accordingly, the privilege applies to communications designed to prompt officials to initiate proceedings as well as to communications made during the course of proceedings.  Brody v. Montalbano, 87 Cal.App.3d 725, 151 Cal.Rptr. 206 (1978).  Although by its terms the section 47(2) privilege applies only to defamation actions, California courts have invoked the policies underlying the privilege to defeat liability for interference with business relations and related torts. . . .

Forro contends that the courts in Brody [and other decisions] provided immunity under the rubric of the doctrine of justification, and only by analogy to the section 47(2) privilege.  Forro asserts that the "justification defense" is not absolute and that it presents a question of fact to be decided on a case-by-case basis.  It defends the instruction to the jury that it must balance the utility of the defendant's conduct against the hardship it causes and contends that there was evidence from which the jury could decide in Forro's favor.

It is true that the California courts have spoken in terms of "justification" rather than "privilege" when discussing why communications with officials may not serve as the basis of liability on a claim of intentional interference with a contractual relationship.  However, the California court's use of the term "justification" appears to be synonymous with "privilege"i.e., certain kinds of conduct are justified as a matter of law . . .  The Brody, [and other] courts apparently considered communications [*1056] with authorities to be justified under all circumstances.

Forro asserts alternatively that although privilege may exist for properly motivated communications, privilege does not provide a shield if the challenged communications are not intended to achieve the objectives of the official proceeding. . . .  Forro argues that IBM cannot claim privilege because its objective was to harm Forro and others by creating a "thunderclap" of publicity, rather than to report wrongdoing.

Forro points to the jury's rejection of IBM's justification defense as an indication that IBM's motives were improper.  The absolute privilege is not defeated, however, by the communicant's ulterior motives, Scott v. McDonnell Douglas Corp., 37 Cal.App.3d 277, 112 Cal.Rptr. 609 (1974). There is ample support in the record for IBM's position that the company's communications to the authorities were made for law enforcement purposes as well as for the purpose of creating publicity.(6)  Indeed the jury verdict for IBM on its claim for misappropriation of trade secrets could be read to indicate a view on the part of the jury that the communications to the authorities had in part a legitimate purpose.  A California court would resolve any doubts in favor of a finding of privilege. Twyford v. Twyford, 63 Cal.App.3d 916, 134 Cal.Rptr. 145 (1976).  We conclude that all of IBM's communications to the authorities were privileged.

Accordingly, we find that the trial court erred in failing to instruct the jury that IBM's communications with the authorities and its participation in the search were privileged under California law.  The evidence relating to these activities was such a major part of the proof adduced by Forro in support of its claim of intentional interference that its admission at all and certainly its admission without proper instruction was prejudicial to IBM's cause.

Accordingly, we reverse and remand for a new trial on this count.


III

MISAPPROPRIATION OF TRADE SECRETS

The jury awarded $ 260,777 to IBM on its claim of misappropriation of trade secrets.  Forro challenges both the sufficiency and the admissibility of the evidence supporting the claim.


A.  Sufficiency of the Evidence

* * *  [*1057]  * * *

We think the evidence was sufficient to permit the inference that Forro improperly acquired what it knew to be IBM's proprietary information.  There was ample testimony about the acquisition of Merlin drawings through Shinn of Sigma Technology.

The fact that Forro offered Merlin parts before the date of IBM's first shipment to customers suggests that the specifications used by Forro were IBM's work product rather than information acquired through reverse engineering.  Damm testified that Fowler solicited and acquired Winchester information.  The similarity of one of Forro's Winchester-compatible parts to the European-made version of the part corroborated IBM's assertion that the specifications were acquired through Damm, as opposed to Forro's assertion that it reverse engineered the part from a United States-made part it had lawfully acquired.  If Forro copied the European version of the part, it used confidential information, because its drawing was dated prior to the time it could have first acquired the European part legally.  Furthermore, although the drawings hidden by Fowler and his son on the day of the search were never identified at trial, the jury could have inferred from the activity that Fowler and his son were concealing secret IBM information.


B.  Admissibility of Certain Evidence

We likewise reject Forro's contentions that the trial court improperly admitted certain evidence.  The trial court admitted hearsay evidence relating to IBM's trade secrets investigation and the ensuing arrests, indictments, and convictions, for the limited purpose of showing IBM's state of mind when it requested help from the San Jose Police.  Forro contends that the probative value of the evidence was substantially outweighed by its prejudicial effect and that the jury inferred from the evidence that Forro must have been implicated in the theft of trade secrets. Fed. R. Evid. 403.

The trial court's ruling in this regard was within its discretion, . . . and we cannot say that it abused its discretion.  The evidence was central to IBM's defense to the intentional interference and antitrust claims.  In view of the limiting instruction given by the judge that the evidence be used only to show IBM's state of mind, we cannot say that its prejudicial effect "substantially outweighed" its probative value. [*1058]

Forro's remaining assertions of error relate to matters peculiarly within the trial court's discretion.  We find them without merit.  * * *

We accordingly affirm the judgment in favor of IBM on its claim of misappropriation of trade secrets.

* * *  [*1062]

[The court affirmed rejection of Forro's antitrust claims against IBM.]

The case is AFFIRMED in part, REVERSED in part, and REMANDED for proceedings consistent with this opinion.


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Footnotes

1.   [court's footnote 1]  This is the second case before this court involving the same course of events.  The plaintiff in Arnold v. International Business Machines Corp., 637 F.2d 1350 (9th Cir. 1981), was one of the persons implicated in the theft of IBM secrets.  He brought an action under 42 U.S.C. 1983 and 1985, on the theory that IBM violated his civil rights by giving false and misleading information to the San Jose Police that resulted in the search of his residence and in his arrest and subsequent indictment.

We there affirmed the trial court's grant of summary judgment to IBM because the plaintiff failed to show that IBM was the proximate cause of the search, arrest, and indictment.  On the record of that case, we found no facts that indicated that IBM ultimately controlled the decisions of the police, and therefore IBM's actions could not be said to be the legal cause of the police actions that injured plaintiff.

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2.   [court's footnote 3]  The trial court's instruction on IBM's justification defense was as follows:

Instruction Number 43
    "In addition to denying any wrongful or intentional interference with any prospective business advantage of the plaintiff, the defendant raises the defense that its conduct was justified under all of the circumstances shown by the evidence in the case.
    "The defendant has the burden of proof on this defense of justification.  If you find from a preponderance of the evidence that the defendant was justified in the acts of which the plaintiff complains, then you should find for the defendant and against the plaintiff on the claim of intentional interference with plaintiff's prospective business advantage.
    "The defendant claims by way of justification that it was motivated by its desire to protect its trade secrets or proprietary information.  Further, IBM claims justification based on the social duty of good citizens to aid in proper enforcement of the criminal laws.
    "I instruct you that a party has a right to take reasonable steps to protect its trade secrets and proprietary information from improper use by unauthorized persons.
    "I also instruct you that there is a strong public policy to encourage all citizens to assist law enforcement agencies by reporting criminal activities, and by cooperating with the duly authorized civil authorities in carrying out the law enforcement duties assigned to such authorities."
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3.   [court's footnote 4]  California recognizes justification as an affirmative defense to the torts of interference with a contractual relationship and interference with prospective advantage.  The defense was explained by the California Supreme Court as follows:

    "Whether an intentional interference by a third party is justifiable depends upon a balancing of the importance, social and private, of the objective advanced by the interference against the importance of the interest interfered with, considering all circumstances including the nature of the actor's conduct and the relationship between the parties."
Herron v. State Farm Mut. Ins. Co., 56 Cal.2d 202, 206-07, 363 P.2d 310, 312, 14 Cal.Rptr. 294, 296 (1961). . . .

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4.   [court's footnote 5]  We have found no California case directly in point on the question of whether a private citizen may be subjected to civil liability when, at a peace officer's request, he aids the officer in conducting a search.  Therefore, we must derive from a review of relevant California law the result the California Supreme Court would reach if presented with this case. . . .

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5.   [court's footnote 6]  In the intentional tort context, a privilege may be either "absolute" or "qualified."  Conduct that is absolutely privileged may not be a predicate for liability regardless of the motive or purpose of the actor.  A qualified privilege, however, in general only protects the actor where he can show that he acted reasonably and with proper motive.  See W. Prosser, Law of Torts 16 at 98-99 (4th ed. 1971).

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6.   [court's footnote 9]  IBM explains that its expressed aim to create a "thunderclap" of publicity reflected the hope of some IBM security officials that the publicity attending criminal prosecutions would have a deterrent effect on trafficking in its trade secrets.  Forro, on the other hand, says the desired effect was to discredit Forro in the eyes of its customers.


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