Two recent decisions by the U.S. Court of Appeals for the Third Circuit shed light on several recurrent issues that arise in trade secret litigation under the federal Defend Trade Secrets Act (DTSA) and related state acts.1 This post will summarize the guidance provided by the appellate court on each of these issues.
What Constitutes Sufficient Identification of the Trade Secret?
Whether the trade secret owner has sufficiently identified the alleged trade secret(s) is a frequent (often early) battleground in trade secret litigation. Previous posts on this blog (Nov. 20, 2018 and Feb. 7, 2019) have addressed this issue. The Third Circuit discussed this issue in two different contexts.
One decision addressed the sufficiency of a complaint to withstand a motion to dismiss. The court said that "information alleged to be a misappropriated trade secret must be identified with enough specificity to place a defendant on notice of the bases for the claim being made against it."2 The court acknowledged that this is a fact-specific question to be decided on a case-by-case basis and noted that resolution of this question can be difficult.
The court found that the complaint at issue, which had been amended several times to add details, identified the alleged trade secrets more than adequately. The plaintiff alleged its trade secrets to be the information laying out its design, research and development, test methods and results, manufacturing processes, quality assurance, marketing strategies and regulatory compliance related to its development of a microsphere system for drug delivery, as well as the variables that affect the development of the plaintiff's microsphere products. While these categories of information were broad, they were all tied to a specific set of products. Further, the complaint specifically identified a particular document that the plaintiff had disclosed to the defendant under a confidentiality agreement as containing trade secrets and attached other documents specifying in detail secrets that it accused the defendants of taking and using.3
In contrast, the other decision by the Third Circuit held that the plaintiff had failed to sufficiently identify the trade secrets in a case where the district court had granted a preliminary injunction to protect those alleged secrets. The court commented that "[w]e cannot evaluate whether a plaintiff is likely to succeed on any element of a trade secret misappropriation claim until the plaintiff has sufficiently described those trade secrets."4
In that case, there was substantial evidence that two of the plaintiff's senior employees had defected to defendant and taken trade secrets with them. The district court issued a preliminary injunction prohibiting use of 13 broad categories of the plaintiff's "protected materials" including its formulas, customer purchase orders demonstrating its pricing, identification of customers experiencing difficulty with its products, internal discussions of customers' preferences and complaints, identification of its supply source for product ingredients, and its internal manuals and procedures showing how its lab is operated. The Third Circuit noted that "[w]hile some information falling within those categories may very well include trade secrets, there is a fair probability that many of the categories – and perhaps all of them – also include information that does not qualify for trade secret protection."5 The plaintiff had not sufficiently identified what particular information it claimed as trade secrets, and so the court could not assess its likelihood of success in establishing that misappropriation had occurred.
The Third Circuit added that district courts must assess the sufficiency of the trade secret identification "in light of … the stage of litigation – whether that be a motion to dismiss, a discovery dispute, a motion to preliminarily enjoin a defendant from competing with the trade secret plaintiff, or a summary judgment motion."6 This suggests that a more lenient standard of specificity applies at the motion to dismiss stage than when injunctive relief is being sought or when the litigation has progressed further.
What Constitutes Sufficient Evidence of Misappropriation?
Trade secret plaintiffs often must prove their case with circumstantial evidence. Reliance on such evidence may be especially necessary at the outset of a case, before a plaintiff can learn through discovery exactly which of its secrets are being used by defendant or exactly how they are being used. But reliance on circumstantial evidence may generate a challenge about whether a plaintiff has sufficiently alleged an act of misappropriation by the defendant.
In one case, the district court had ruled that the plaintiff's allegations were inadequate to show misappropriation because they merely demonstrated that the defendant was developing a microsphere product that utilized the same two peptides as the plaintiff's trade secret microsphere products. The district court asserted that the allegations failed to specify which trade secrets were misappropriated to develop the defendant's product, to describe the product development, or to show that the plaintiff's trade secrets were the source from which the defendant was developing its microsphere product.
The Third Circuit found two flaws in the district court's analysis. The first was that it had limited misappropriation based on improper "use" of a trade secret to the replication or obvious incorporation of trade secret material in a competitor's product. The circuit court held that this was far too narrow a construction. Instead, "the 'use' of a trade secret encompasses all the ways one can take advantage of trade secret information to obtain an economic benefit, competitive advantage, or other commercial value, or to accomplish a similar exploitative purpose, such as 'assist[ing] or accelerat[ing] research or development.' "7
Second, the circuit court held that the defendant's improper use of the plaintiff's trade secrets could be readily inferred from the allegations in the complaint. It was alleged that one defendant had approached the plaintiff about collaborating on the plaintiff's microsphere products and, pursuant to a confidentiality agreement, had acquired some of the plaintiff's trade secret information related to those products. Then the defendant informed the plaintiff that it would not pursue the collaboration due to financial considerations, only to launch a competing project and hire away the plaintiff's vice president of product development, who had overseen its microsphere products. Despite its complete lack of experience and an investment of just $6 million, the defendant was representing to its investors less than a year later that it was already developing four microsphere products, whereas the plaintiff had labored for many years on its microsphere products and invested more than $130 million in them. These allegations were sufficient to state a plausible claim for misappropriation.
Further, the district court had faulted the plaintiff for failing to show that it had suffered any harm, reasoning that the defendants had not yet launched any products and that the plaintiff had not alleged any missed business or investment opportunities. The Third Circuit flatly rejected this analysis, noting that " [b]y statutory definition, trade secret misappropriation is harm,"8 and that the plaintiff "has lost the exclusive use of trade secret information, which is a real and redressable harm."9
Reverse Engineering as a Defense to Misappropriation
The DTSA excludes reverse engineering from the type of conduct it defines as misappropriation.10 Can the potential for reverse engineering be raised as a defense by a defendant who did not actually engage in reverse engineering to obtain a trade secret? The Third Circuit noted that the possibility that a trade secret might be reverse-engineered is not a defense and that a defendant cannot escape liability for unlawfully stealing trade secrets because someone else might have been able to discover them through reverse engineering. The court acknowledged that "[t]here may be situations in which reverse engineering is so straightforward that the distribution of a product is itself akin to a disclosure. … But short of that factual scenario, the mere potential for reverse engineering with unlimited resources does not foreclose the existence of a trade secret."11
The Bond Amount for a Preliminary Injunction
Finally, the Third Circuit addressed an important practical issue that appellate courts seldom comment on: the size of the bond that a trial court should require when it issues a preliminary injunction in a trade secret case. Federal Rule of Civil Procedure 65(c) requires a plaintiff to provide "security in an amount that the court considers proper to pay the costs and damages sustained by any party found to have been wrongfully enjoined or restrained." The circuit court noted that this bond is "the only recourse for a wrongfully enjoined party" and that "the consequences of wrongfully enjoining a defendant could be dire if a district court were to significantly underestimate the economic impact of an injunction it issues."12
The district court had required a bond of $500,000, reasoning that this amount was toward the high end of bonds imposed in similar cases, and rejected the defendants' request for a bond exceeding $21.5 million. The Third Circuit frowned on this approach. It emphasized that a district court must engage in a case-specific analysis, looking at potential harm from the injunction, and that considering the bond amounts in other cases was appropriate only if they are truly comparable. In short, there is no "going rate" for the amount of the bond in a trade secrets case.
Each of these issues recurs regularly in the course of trade secret litigation. Although the Third Circuit did not break new ground, its analyses are thoughtful applications of the law.