High-stakes trade secret cases are typically aggressively prosecuted. But plaintiffs (and their attorneys) who prosecute these claims face substantial risks if the evidence does not support the contention that a trade secret has been misappropriated. Even a plaintiff who may have initiated a misappropriation action in good faith risks attorneys’ fees and malicious prosecution liability by continuing to prosecute the matter after it learns that the case is not substantiated.

Section 4 of the Uniform Trade Secrets Act authorizes a court to award costs and attorneys’ fees if the court determines that a claim for misappropriation is made in bad faith, and most jurisdictions include this provision. For example, California Civil Code § 3426.4 provides that “[i]f a claim of misappropriation is made in bad faith, a motion to terminate an injunction is made or resisted in bad faith, or willful and malicious misappropriation exists, the court may award reasonable attorney’s fees and costs to the prevailing party.”

SASCO v. Rosendin Electric, Inc.

Several recent California cases highlight that the risk to employers (and the law firms representing them) is not simply in initiating actions for misappropriation but also for continuing to pursue them when the facts of the claim are not borne out in litigation.

In SASCO v. Rosendin Electric, Inc., 207 Cal.App.4th 837 (2012), the California Court of Appeal affirmed a trial court’s order awarding the defendants almost $485,000 in attorneys’ fees and costs pursuant to California Civil Code § 3426.4. SASCO sued Rosendin Electric, Inc.; another licensed electrical contractor; and three individual defendants for misappropriation of trade secrets, among other things. The trial court accepted for the sake of argument that SASCO’s computer program was a trade secret. The court concluded, however, that there was no evidence of misappropriation and that SASCO had sued the defendants based on the suspicion that they must have misappropriated trade secrets because the individual defendants went to work for a competitor, which subsequently secured a contract for which both companies were competing. The trial court concluded that the plaintiff engaged in bad faith pursuant to Section 3426.4, which consisted of both objective speciousness and subjective bad faith. The appellate court agreed with the trial court that continuing to prosecute the action without evidence of actual misappropriation constituted subjective bad faith.

FLIR Systems, Inc. v. Parrish

The risk to plaintiff employers (and their law firms) in pursuing claims in bad faith is not limited to attorneys’ fees and costs under the statute. On April 6, 2012, Latham & Watkins was sued for malicious prosecution in Los Angeles Superior Court. The plaintiffs, William Parrish and Timothy Fitzgibbons, were former officers and shareholders of Indigo Systems Corporation, which was purchased by FLIR Systems, Inc., in 2004. From 2004 to 2006, the plaintiffs worked for FLIR, leaving in 2006 to start their own business. FLIR retained Latham and sued the plaintiffs for, among other things, misappropriation of trade secrets. After a summary judgment motion was denied, the case proceeded to trial on FLIR’s claim for injunctive relief. The trial court denied FLIR’s request for a permanent injunction, found that FLIR brought the trade secrets action in bad faith, and awarded attorneys’ fees and costs of $1,641,216.78. The trial court’s decision was affirmed on appeal.[1]

In the subsequent malicious prosecution suit, Latham & Watkins filed a motion contending that the plaintiffs’ claims were barred by the statute of limitations and on their merits, contending that (i) a one-year statute of limitations applied to the plaintiffs’ claims and the claims were untimely under that limitations period and (ii) the trial court’s denial of summary judgment for the plaintiffs on the claims brought against them by FLIR established that the underlying action was brought with probable cause as a matter of law. The trial court granted Latham’s motion on statute of limitations grounds and did not expressly address Latham’s argument that the claims against the law firm were without probable cause.

On August 27, 2014, the Court of Appeal issued an opinion reversing the trial court. The Court of Appeal held that the applicable statute of limitations for malicious prosecution claims was not the one-year, but rather the two-year, limitation period set forth in Cal. Code Civ. Proc. Section 335.1.

The Court of Appeal then considered Latham’s argument disputing the merits of the plaintiffs’ malicious prosecution complaint. Key to Latham’s argument was the fact that the plaintiffs had moved for summary judgment in the underlying case and that motion had been denied. Latham argued that the “interim adverse judgment rule” applied, under which claims that have succeeded at a hearing on the merits are deemed not so lacking in potential merit to serve as the basis for a malicious prosecution claim (unless such ruling is obtained by fraud or perjury). Prior courts had routinely applied the interim adverse judgment rule to bar claims for malicious prosecution where there had been a denial of a defendant’s motion for summary judgment in the underlying action.

The Court of Appeal noted that the plaintiffs had evidence that:

  1. Latham filed a complaint alleging actual misappropriation of a business plan, disregarding a claim that the plaintiffs had created the business plan prior to their employment with FLIR;
  2. when plaintiffs presented that evidence to Latham, Latham changed the theory of the case to pursue a claim that the plaintiffs could not effectuate the business plan without inevitably using FLIR’s intellectual property;
  3. Latham knew that inevitable disclosure is not a viable legal theory in California and, therefore, knew that this theory lacked legal basis;
  4. the factual basis for Latham’s theory was expert testimony that considered only publicly available technology when Latham knew that the plaintiffs’ business plan would be using non-public technology obtained lawfully from third parties; and
  5. FLIR’s president testified that he had no factual basis to assert that the plaintiffs would use FLIR’s intellectual property, strongly implying that the claim against them was a preemptive strike.

Critically, the Court of Appeal found that Latham had “sought an obviously anti-competitive injunction based on the speculative possibility that the [plaintiffs’] product might violate its client’s trade secrets . . . .” The Court of Appeal held that these circumstances supported the conclusion that “no reasonable attorney would have believed [the] case had merit,” and it reinstated plaintiffs’ claim.

Latham filed a petition for re-hearing, which was denied on September 19, 2014, and then, on the court’s own motion, was granted on September 25, 2014. On June 26, 2015, the Court of Appeal issued its decision, this time, affirming the trial court’s order granting Latham’s motion on the ground that the “interim adverse judgment rule” established Latham had probable cause to bring the action. The court held that exceptions to the interim adverse judgment rule did not apply in this case because (i) the summary judgment motion was not denied on procedural or technical grounds and (ii) the summary judgment motion was not obtained by fraud or perjury.[2]

But this ruling did not conclude the matter. On October 14, 2015, the California Supreme Court granted the plaintiffs’ Petition for Review, and the case is pending.

Understand the Risk Before Prosecuting

There are substantial risks in pursuing trade secret actions if it appears that plaintiffs are using the Trade Secrets Act to mask an anti-competitive intent. If, during the course of the litigation, there is no evidence that a trade secret has been misappropriated or it does not look like a trade secret can be proven, plaintiffs and their attorneys must understand this risk in assessing whether, or to what extent, to continue to pursue the action.

A version of this article originally appeared in the Take 5 newsletter “Restrictive Covenants: Do Yours Meet a Changing Landscape?