MEMORANDUM OVERVIEW OF THE UNIFORM TRADE SECRETS ACT

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1 To: New Jersey Law Revision Commission From: Staff Re: Uniform Trade Secrets Act Date: March 10, 2008 MEMORANDUM As directed by the Commission at its January meeting, this memorandum examines the Uniform Trade Secrets Act (UTSA) and whether the Commission should support the adoption of the UTSA by the New Jersey legislature. 1 OVERVIEW OF THE UNIFORM TRADE SECRETS ACT As early as 1969, the United States National Conference of Commissioners on Uniform State Laws ( NCCUSL ) organized a committee to develop a uniform trade secrets act, relying heavily upon the definition of trade secret from the Restatement of Torts (First) in formulating their own definition. The impetus for creating a uniform act generated with the patent law bar that sought to resolve the conflict between then current state statutes, which protected trade secrets while keeping innovations secret, and the federal patent policy, which was generally designed to encourage public disclosure of innovations. The committee that drafted what would become the UTSA, although beset with a period of inactivity and the death of its original chairman, eventually prevailed in creating what appears to be a successful uniform act. As its own comments indicate, NCCUSL eventually adopted a definition of trade secret that is broader than the Restatement of Torts (First) definition. The Restatement definition required that a trade secret be continuously used in one s business. The comment notes that the UTSA definition extends protection to a plaintiff who has not yet had an opportunity or acquired the means to put a trade secret to use. With the broader definition of trade secret and clear parameters set for the proper and improper means of obtaining such proprietary information, the Uniform Trade Secrets Act (UTSA) was released in 1979 and amended in Since that time, 47 jurisdictions (the District of Columbia and every State but New Jersey, New York, Massachusetts 2 and Texas) 1 The UTSA is one of five Uniform State Laws identified by the National Conference of Commissioners on Uniform state Laws as priorities for Other Uniform State Laws will be addressed in separate memoranda. 2 Some jurisdictions had adopted the UTSA before the 1985 amendments and then subsequently also adopted the amendments. New York and New Jersey have introduced bills adopting UTSA as will be noted in the text. Texas has a well-developed common law tradition, also derived from the Restatement of Torts (First), but no civil statute. As for Massachusetts Chapter 93, Sections 42 and 42A of the General Laws of Massachusetts regulate the embezzlement, stealing and unlawful taking, carrying away, copying or obtaining by fraud or deception of any trade secret. The statutory penalties are damages resulting from the tort, which may be increased to double the amount, as well as appropriate injunctive relief, including preliminary injunctive relief in an action by an employer against a former employee.

2 have enacted it into law, the most recent being Wyoming, which enacted it in The UTSA is pending in New York, having been introduced in both its State Senate and State Assembly as recently as January A bill based on the UTSA has been introduced in the New Jersey State Assembly in each successive legislative session since 2000, with its most recent introduction in 2007 (A2352 introduced by Assemblyman Richard A. Merkt (District 25 Morris). 3 No comparable bill appears to have been introduced in the New Jersey State Senate. The language of A2352 is virtually identical to the UTSA, unlike the enacted versions of the UTSA in some other states which deviate from the uniform version in small but significant ways, sometimes favorably so, as will be discussed below. A SUMMARY OF KEY PROVISIONS OF THE UTSA The uniform act prohibits actual or threatened misappropriation of trade secrets, imposing both injunctive relief and damages. Misappropriation under the UTSA includes acquisition of a trade secret of another by a person who knows or has reason to know the trade secret was acquired by improper means. It also includes disclosure or use of a trade secret of another without express or implied consent by a person who (a) used improper means to acquire the secret or (b) before a material change of position, knew or had reason to know that the trade secret was secret and that knowledge of it had been acquired by accident or mistake or (c) at the time of disclosure, knew or had reason to know that his knowledge of the secret was (i) derived from or through a person who had used improper means to acquire it or (ii) derived from or through a person who owed a duty to the person seeking relief to maintain the secrecy or (iii) acquired under circumstances giving rise to a duty to maintain its secrecy. Improper means is defined as theft, bribery, misrepresentation, breach or inducement of a breach of a duty to maintain secrecy, or espionage through electronic or other means. The definition of proper means does not appear in the text of the uniform act but does appear in the comment to the act. The definition of trade secret is information that derives independent economic value from its proprietary nature and is the subject of reasonable efforts to maintain its secrecy. It includes a formula, pattern, compilation, program, device, method, technique or process. The economic value may be actual or potential. Misappropriation of trade secrets may be enjoined, whether actual or threatened, and the injunction may be continued for a reasonable time in order to eliminate the commercial advantage that otherwise would be derived from the misappropriation. Damages recoverable may include both actual loss caused by misappropriation and the unjust enrichment caused by misappropriation that is not taken into account in computing 3 A2352 was also introduced by Richard Merkt in February 2006; A2188 was introduced by Mr. Merkt in February 2004; A2237 was introduced by Mr. Merkt in May 2002; A2352 was introduced by LeRoy J. Jones (District 27-Essex) in May All versions of this bill appear to be identical. 2

3 actual loss. Damages may not be recovered, however, if a material and prejudicial change of position prior to acquiring knowledge or reason to know of the misappropriation renders a monetary award inequitable. In lieu of damages measured by these methods, damages may be measured by imposition of liability for a reasonable royalty for a misappropriator s unauthorized disclosure or use of a trade secret. The comment in the uniform act explains that this royalty may be imposed as an alternative to all other methods of measuring damages caused by a misappropriator s past conduct but must be based upon a demonstrably reasonable royalty. The comment also distinguishes such a royalty from the kind of royalty that may accompany injunctive relief. In exceptional circumstances, an injunction may condition future use upon payment of a royalty for no longer than the period of time for which the use could have been prohibited. Punitive damages are also available for willful and malicious misappropriation in an amount not exceeding twice any damage award. Attorney s fees are recoverable in cases involving willful and malicious misappropriation, or if a claim of misappropriation is made in bad faith, or if a motion for injunctive relief is made or opposed in bad faith. The statute also permits the court to grant protective orders in connection with discovery proceedings, holding in-camera hearings, sealing records and ordering litigants not to disclose alleged trade secrets without prior court approval. An action for misappropriation must be brought within three years after the discovery of the misappropriation (or within three years after, with reasonable due diligence, the misappropriation should have been discovered.) The act takes effect immediately and does not apply to misappropriation occurring prior to its effective date or to a continuing misappropriation that was begun prior to the effective date but continues thereafter. The act, except as noted, expressly displaces any conflicting tort, restitutionary and other state law providing civil remedies for trade secret misappropriation. As proposed in New Jersey, any action for such misappropriation against a public entity or employee, however, is expressly governed by the New Jersey Tort Claims Act, which expressly supersedes the act. CURRENT STATE OF NEW JERSEY MISAPPROPRIATION OF TRADE SECRETS LAW The current state of the trade secrets misappropriation law in New Jersey dates back to the early 1900 s with Stone v. Goss, 65 N.J. Eq. 756 (E. & A ) Resolving a dispute between an employer and its former employee not to reveal the secrets of its manufacture of depilatories (compounds to remove hair and wool from skins and hides), the court found that an express contract between the parties prohibited the disclosure of the employer s secret process because [t]he right of a manufacturer, whose goods are made by an unpatented secret process, to protection by injunction against the divulging of 3

4 his secret in a proper case, is now established by a well-considered line of cases in England and in several states. In Sun Dial Corp. v. Rideout, 16 N.J. 252 (1954), also frequently cited by recent courts, no written agreement existed between the parties that expressly prohibited the use of the plaintiff s alleged secret trade process. The Sun Dial plaintiff manufactured precision dials and panels and sought to enjoin its former employees from using and disclosing a secret process for the making of their dials. The court defined a trade secret, adopted from the Restatement of Torts (First), as consisting of a formula, process, device or compilation which one uses in his business and which gives him an opportunity to obtain an advantage over competitors who do not know or use it. 16 N.J. 252, 257. Notably, the plaintiff had not entered into any written agreement with the individual defendants restraining their use of plaintiff s process after defendants left plaintiff s employ. The court determined such express agreement was unnecessary to entitle the plaintiff to relief so long as plaintiff could demonstrate that the employees learned the trade secret in confidence and, in violation of that confidence, either used or disclosed the trade secret after termination of their employment. Upholding the Appellate Division, the Sun Dial court determined that the defendants did just that--they well knew during their employment that the plaintiff s process was to remain secret in nature and they therefore could not disclose it to the detriment of plaintiff after their employment ended. The Sun Dial court made clear that the secrecy of the trade secret need not be absolute and disclosure to employees involved in its use would not necessarily result in the loss of the employer s trade secret protection. Yet the protected information must not be a matter of public knowledge or of general industry knowledge, although the fact that an ingredient may be publicly known is not controlling so long as the method of combining known ingredients, thus producing an enhanced or superior product, is proprietary information. The New Jersey law protecting trade secrets has continued to develop. It is now generally accepted that, a New Jersey plaintiff must establish six elements to support a claim of misappropriation of trade secrets. They are: (1) the existence of the trade secret; (2) that the secret information was communicated in confidence; (3) that the secret information was disclosed in breach of such confidence; (4) that the secret information was acquired by a competitor with knowledge of the breach of confidence; (5) that the secret information was used by a competitor to the detriment of plaintiff; and (6) that the plaintiff took precautions to maintain the secrecy of the trade secret. Thomas & Betts Corp. v. Richards Mfg. Co., WL (D. N.J. 2007); Rycoline Products v. Walsh, 334 N.J. Super. 62 (App Div. 2000). See also Rohm and Haas Company v. Adco Chemical Company, 689 F.2d 424 (3 rd Cir. 1982). To first determine the existence of a trade secret, New Jersey courts have looked to the Restatement of Torts definition as articulated in the Sun Dial case. Thus, the plaintiff must establish that there is a formula, pattern, device or compilation of information that is not a matter of general industry knowledge and is used in plaintiff s 4

5 business, giving plaintiff an advantage over competitors who do not know or use the information. See Thomas & Betts Corp. v. Richards Mfg. Co., WL (D. N.J. 2007) and also Ingersoll-Rand Co. v. Ciavatta, 110 N.J. 609, (1988), in which the court articulates additional considerations, referred to in the Restatement, that may help a court determine whether challenged information is a trade secret, such as, inter alia, the extent to which the information is known outside of the business and the extent of measures taken by the owner to guard the secrecy of the information. 4 As to remedies, New Jersey law permits injunctive relief only where money damages are inadequate and preliminary injunctive relief only when necessary to prevent substantial immediate and irreparable harm. When monetary damages are awarded, the courts appear generally to award successful plaintiffs compensation equal to the defendants profits or the plaintiffs actual losses, but not both. See Consolidated Boiler Corp. v. Bogue Elec. Co., 58 A.2d 759, 761 (Ch. Div. 1948). The awards are decided on the particular facts and circumstances in each case. Punitive damages may be permissible. See Epcon Group, Inc. v. Danburry Farms, Inc. WL (3 rd Cir. 2002) (applying Pennsylvania law, however.) 5 ADOPTION OF THE UTSA IN NEW JERSEY AND SUGGESTED MODIFICATIONS New Jersey misappropriations of trade secret law, as that of many other states who have since adopted the UTSA, is derived primarily from Restatement of Torts (First) concepts, as is the UTSA itself. New Jersey s law is also derived from the Restatement 4 At least one court, Platinum Management v. Dahms, 285 N.J. Super 274 (Law Div. 1995) relied upon the definition of trade secrets found in the Restatement (Third) of Unfair Compeition in determining that a customer list warranted protection notwithstanding the fact that the customers names could be pulled from trade directories. Notably, customer lists are not items specifically included in the definition of a trade secret in the New Jersey bill although other states do specifically include customer lists in the statutory definition. See below. 5 In Kilbarr Corp. v. Business Systems, Inc., 679 F. Supp. 422 (D. N.J. 1988), aff d, 869 F. 2d 589 (3d Cir. 1989), the court was asked to determine, in the context of a summary judgment proceeding, whether the lead time valuation limitation is applicable to an award of monetary damages for trade secret misappropriation. This lead time valuation limitation, also known as the head start defense to the assessment of damages, would limit damages to that period of time in which others in the trade, and the defendant in particular, are likely through legitimate business procedures to have become aware of the misappropriated secrets, if at all. Because of prior false testimony, then the passage of time and finally the fact that enjoining the defendant would have shut down the operation of the defendant Dutch corporation, neither a preliminary nor permanent injunction had been issued to prevent the defendant typewriter manufacturer from knowingly misappropriating the plaintiff s proprietary know-how (both trade secret and copyrighted) and continuing to use it. Even more egregious to the court than the misappropriation itself, the defendant had not returned the misappropriated information, despite several court orders to do so. The Court felt that the appropriate remedy under the circumstances was an adequate and complete monetary award. The court thus did not limit plaintiff s damages by a lead time valuation. 5

6 of Unfair Competition and in some cases from the New Jersey Criminal Code 6. Although our common law is well-established, the UTSA clearly has advantages that can only benefit New Jersey. The UTSA is streamlined, straightforward, and contains improvements to our common law more protective of persons with trade secrets. For example, the New Jersey courts now consistently rely upon a more restrictive definition of trade secret than exists in the UTSA. The common law definition requires that the proprietary information be used in the person s business, giving an opportunity for a business advantage over competitors who do not know or use the secret. Under the UTSA, actual or potential benefit from the proprietary information is sufficient. The key is that the information be (i) not generally known, (ii) not readily ascertainable by proper means by others who can obtain economic value from its disclosure or use, and (iii) subject to reasonable efforts to keep it secret. In addition, the definition of misappropriation in the UTSA is very broad. It includes acquiring the trade secret with knowledge or the reason to know that the trade secret was acquired by improper means, or disclosing the trade secret under a variety of circumstances, including doing so without appropriate consent, by someone who acquired it by improper means or knew or had reason to know that it was acquired improperly, or disclosing it in breach of a duty to maintain its secrecy or from or through a person who had such a duty. Under the UTSA, even accidental or mistaken knowledge of the trade secret may be actionable. The remedies afforded by the UTSA are clear cut and enhanced. Attorney s fees are permitted as are both the actual loss caused by the misappropriation and the unjust enrichment not taken into account when computing the actual loss. Imposition of a reasonable royalty is also a possibility under certain circumstances. NCCUSL touts the UTSA as the first comprehensive effort to codify the law of trade secrets protection, incorporating the major common law principles while filling gaps left by the courts. Its purpose was simply to provide a person with redress, in equity and law, for trade secret misappropriation while addressing the concern that the common law of misappropriation had developed unevenly state to state, leading to forum shopping and uncertainty overall in the business community. We believe that the purpose of the UTSA makes sense and New Jersey would benefit from adopting it. However, we propose a few minor modifications to the current proposed bill that would further enhance it in significant ways. 6 See L. 1965, C. 52, 1-5, now repealed due to the consolidation of all theft offenses. A definition of trade secrets now appears in the Code of Criminal Justice at N.J.S. 2C:20-1i. It is there defined as the whole or any portion or phase of any scientific or technical information, design, process, procedure, formula or improvement which is secret and of value... At least one state, Colorado, has adopted a similar definition of trade secret in its version of the uniform act, as noted in the text below. 6

7 1. Add the Recovery of Costs in Addition to Attorney s Fees For example, California s Uniform Trade Secrets Act (California Civil Code Section 3426) provides that if a claim for misappropriation is made in bad faith, or a motion to terminate an injunction is made or resisted in bad faith, or willful and malicious appropriation exists, then the court may award reasonable attorney s fees and costs to the prevailing party including a reasonable sum to cover the service of expert witnesses. The witnesses, however, cannot be regular employees of any party and the costs must be actually incurred and reasonably necessary in either or both preparation for trial or arbitration by the prevailing party. See Cal. Civ. Code, Sec The uniform law and New Jersey bill A2352 permits an award of attorney s fees but not costs. California s modification seems one worth emulating. 2. Define Bad Faith When Awarding Attorney s Fee The recently introduced versions of the UTSA in the New York legislature, S00162 and A02296, include a definition of bad faith in their attorney s fees provision which seems useful. The definition states: For purposes of this section, a claim of misappropriation is made or continued in bad faith or a motion to terminate an injunction is made or resisted or continued in bad faith if it is undertaken or continued solely to harass or maliciously injure another or to delay or prolong the resolution of the litigation; or it is undertaken or continued without any reasonable basis in fact or law and could not be supported by a good faith argument for an extension, modification or reversal of existing law. This appears to be an addition that could enhance New Jersey s current bill. 3. Modify the Trade Secret Definition Although not specifically delineated in the New Jersey bill, customer lists are specifically mentioned in the definition of trade secrets in the UTSA as adopted by Arkansas, Illinois, Colorado, and Connecticut. Connecticut includes drawing, cost data or customer list within the parameters of information that may be a trade secret. Illinois adds drawing and financial data to its definition, also adding a list of actual or potential customers or suppliers. Colorado rewrites the model act definition entirely. Instead, it defines trade secret as: the whole or any portion or phase of any scientific or technical information, design, process, procedure, formula, improvement, confidential business or financial information, listing of names, addresses, or telephone numbers, or other information relating to any business or profession which is secret and of value. New York s recently introduced bill s definition is: 7

8 any form and type of financial, business, scientific, technical, economic, or engineering information, including a pattern, plan, compilation, program device, formula, design, prototype, method, technique, process, procedure, program, or code, whether tangible or intangible, and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically or in writing.... We do not recommend Colorado s approach. New York s approach seems to exclude by trying to include too much. However, the Illinois or Connecticut approaches are more appealing. The inclusion of some reference to financial or cost data, drawings and a customer or supplier list are important. Such inclusion is also consistent with the Restatement of Torts (First). Georgia s definition states that at trade secret means information, without regard to form. The words without regard to form placed after the word information seems useful. Also important is the addition of the words but not limited to after the word including to make clear that the items noted in the definition are examples but not limitations. 4. Add a Definition of Proper Means as Described in the Comment to the Uniform Act In the comment to the definitions section of the uniform act, the drafters defined proper means to include a number of independent methods by which otherwise protected information could be ascertained without committing a misappropriation. Although no one piece of legislation can be all-inclusive, it seems that delineating the ways that proprietary information can be permissibly obtained would make even clearer the definition of misappropriation. CONCLUSION We have not been able to ascertain why New Jersey has thus failed to adopt any version of the UTSA. What does appear possible is that there is little incentive to adopt the UTSA because the New Jersey s common law of trade secret misappropriation is so long-standing and well-developed. However, we believe that the adoption in New Jersey of the uniform act would enhance our current law, benefit those with trade secrets to protect and fulfill the purpose of the UTSA as articulated by NCCUSL. We therefore recommend that the UTSA be adopted in New Jersey with minor modifications as already noted. 8