Texas Supreme Court Provides Guidance on Use of "Flexible and Imaginative" Damage Models in Trade Secrets Disputes

Updates

In this past term, the Texas Supreme Court continued to provide guidance to businesses, lawyers, and lower courts on the management, procedures, and remedies for trade secrets disputes. In two recent cases, the Court has literally addressed the bookends for these types of cases. First, on May 20, 2016, the Court provided guidance on how to conduct preliminary injunctive hearings at the outset of trade secrets cases, remanding the case for further proceedings. (See our update on this case here.) And more recently, on June 10, 2016, the Court closely examined damages findings totaling nearly $40 million in an oil-and-gas misappropriation—once again, remanding the case to the trial court for a new trial consistent with the Court’s conclusions on (i) the sufficiency of lost profits damages calculations, and (ii) the availability of equitable disgorgement of lost profits in a trade secrets misappropriation case.

Trial Court’s $40 Million Judgment

Tory Berry-Helfand and Gery Muncey brought misappropriation and theft of trade secrets, fraud, conversion, breach of fiduciary duty, and breach of contract claims against Southwestern Energy Production Company (“SEPCO”) relating to SEPCO’s use of drilling techniques and well locations formulated by Helfand and Muncey. These techniques and well locations related to the James Lime reservoir in East Texas and were referred to as the Pearson Prospects. In early 2005, Helfand and Muncey presented their methodology and geological profile to SEPCO pursuant to a confidentiality and noncompete agreement that “required SEPCO to maintain the information’s confidentiality, use it solely to evaluate the Pearson Prospects for purchase from or development with [Helfand and Muncey] and ‘promptly return or upon request by [Helfand and Muncey], destroy the original and all copies of the Confidential Information’ if the parties failed to reach a written agreement for SEPCO to purchase or develop the properties.”

After evaluating the information provided by Helfand and Muncey, SEPCO made no offer, purportedly because it failed SEPCO’s economic criteria. Helfand and Muncey then approached Petrohawk, who entered into a transaction for the Pearson Prospects on the following terms: (i) a $1.8 million payment, (ii) a sliding-scale overriding royalty interest (which averaged 3% on these leases), and (iii) a 6.25% after-payout working interest. While negotiations with Petrohawk were ongoing, SEPCO embarked on its own James Lime play. In fact, as early as March 11, 2005, SEPCO’s internal drilling documents identified the James Lime as a “primary” drilling objective. Ultimately, SEPCO acquired 1,888 leases and drilled more than 140 wells—88 of them James Lime horizontal wells—in areas clustered around the sweet spots Helfand and Muncey had identified. These wells had a 100% success rate and generated $381.5 million in revenue for SEPCO. Helfand and Muncey learned of SEPCO’s successful drilling program and sued the company.

At trial, the jury found SEPCO liable on all claims. With respect to damages, the jury rejected the majority of the damages calculations presented by Helfand and Muncey’s expert witness, finding instead that the value of the trade secrets was $11.445 million and that SEPCO’s benefits, profits, or advantages from the trade secrets also totaled $11.445 million in the past (and $0 in the future). The jury awarded this same $11.445 million for the breach-of-contract, breach-of-fiduciary duty, theft, and fraud claims. This damages figure was precisely 3% of the $381.5 million in revenue SEPCO made from the disputed wells. The trial court ordered an accounting and rendered judgment on the jury’s verdict, and awarded an additional $23.89 million in equitable disgorgement of profits. In total, the trial entered a judgment of over $40 million.

The Texas Supreme Court and Remedies for Trade Secrets Misappropriation

The Texas Supreme Court addressed two key damages issues—(1) the sufficiency of the evidence supporting the $11.445 million damages finding for misappropriation of trade secrets, and (2) the availability of equitable disgorgement of profits as a remedy. With respect to the former, the Court noted that “[a] ‘flexible and imaginative’ approach is applied to the calculation of damages in misappropriation-of-trade-secrets cases.” Those damages can take many forms, including (i) value of the plaintiff’s lost profits, (ii) the defendant’s actual profits from the use of the secret, (iii) the value a reasonably prudent person would have paid for the trade secret, (iv) the development costs the defendant avoided by the misappropriation, and (v) a reasonable royalty.

In this case, the $11.445 million figure was calculated by using the average 3% overriding royalty with Petrohawk. The Petrohawk deal involved the same trade secrets at issue and negotiations in the same general time frame as Helfand’s and Muncey’s dealings with SEPCO. The Petrohawk transaction also implicated the same geologic area and attributes and included three of the five counties encompassed in Helfand and Muncey’s research. Despite these similarities, the Court rejected the $11.445 million award because the expert’s simple use of the fixed 3% overriding royalty was in error.

While the 3% was an average figure based on the Petrohawk agreement and the track record under that agreement, the Petrohawk transaction actually employed a sliding scale for the overriding royalty. Under this sliding scale, the overriding royalty zeroed out at a specified threshold. The expert’s failure to consider the sliding-scale and apply it to the SEPCO wells was found by the Court to be a fatal flaw. Applying the 3% figure across the board resulted in an “incomplete and misleading picture”; in contrast, using the actual sliding scale would have resulted in a more certain result. The Court observed, “. . . relying on imagination is not justified when objective evidence is available.” While the Court found that there were damages suffered from SEPCO’s misappropriation, the case needed to be remanded for a new trial.

With respect to equitable disgorgement of profits, the Court noted that the jury did not make an award of disgorgement of profits—rather the trial court issued that award and the court of appeals rejected that award when it found no fiduciary existed between SEPCO and Helfand and Muncey. Again, the Court remanded the issue to the trial court, stating that “we have not expressly limited the remedy to fiduciary relationships nor foreclosed equitable relief for breach of trust in other types of confidential relationships.” Consequently, “whether disgorgement remains equitable must be determined anew on remand and in light of the liability and value determinations following a new trial.”

Lessons Learned

It is no surprise that the Texas Supreme Court closely scrutinized the work of a damages expert in an eight-figure judgment. What is interesting here is that Helfand’s and Muncey’s damages expert fared poorly both before the appellate courts and the jury. Indeed, the majority of the $40 million judgment came from the trial court’s equitable disgorgement accounting—which, if ultimately upheld as a permissible recovery, could prove to be an interesting post-trial saving grace for plaintiffs that fail to make their own damages case effectively to the jury.

For parties pursuing trade secrets claims, the damages part of the case should be given significant attention from the outset—both in offensive discovery (evidence and testimony on the benefit gained and calculated by the defendant) and in expert workup backed by well-supported methodologies. The Court warned that while parties can explore all of the “flexible and imaginative” damage models permitted under Texas law, they cannot ignore objective, comparable data that materially impacts the damage models.