On May 17, 2013, a Pennsylvania appellate court, with one of its judges dissenting, ordered that the trial court award attorneys’ fees to a married couple whose neighbors wrongfully accused them of trade secret misappropriation regarding flagstone artwork. Krafft v. Downey, Pa. Sup. Ct. No. 476 WDA 2012 (Donohue, J.).

According to the majority, plaintiffs Jack and Linda Krafft must have known that they did not have protectable trade secrets in their flagstone imaging processes when they alleged that their neighbors, Larry and Jane Downey, violated the Pennsylvania Uniform Trade Secrets Act (PUTSA) by using those processes in their own business. Thus, the court held, the trial court should have made the Kraffts pay the Downeys’ attorneys’ fees spent in defending against the Kraffts’ PUTSA claims for which, by making them, the Kraffts engaged in “subjective misconduct.”

The facts and the trial court’s decision. Between 1995 and 2004, Linda Krafft learned how to transfer artwork images onto flagstone, and refined that process through extensive trial-and-error. In 2004, the Kraffts signed a license agreement with their neighbors, the Downeys, under which the Kraffts taught the Downeys the flagstone imaging process and licensed to them the “Framing on Stone” name. In exchange, the Downeys paid the Kraffts $20,000, and also agreed to pay 10% of the net sales. The agreement prohibited the Downeys from disclosing the imaging process. After the Downeys stopped paying commissions in 2007 and coined their own imaging brand (“Rock of Ages”), the Kraffts sued the Downers in December 2007 in Pennsylvania state court for breach of contract.

In February 2008, the trial court denied the Kraffts preliminary injunction motion, which apparently hinged on whether the Kraffts’ imaging process was confidential. In its written order, the court said that the Kraffts’ process was not secret, was in the public domain, and “is not new or unique to” the Kraffts. The Downeys presented extensive evidence during the injunction proceedings showing that prior flagstone imaging patents had expired, and that a number of books and articles available on the internet described the flagstone imaging process.

Undeterred, the Kraffts subsequently filed an amended complaint, including a PUTSA misappropriation claim. The Downeys filed a counterclaim shortly thereafter under PUTSA section 5(1) for the Kraffts having made a bad-faith claim in light of the court’s prior order. Just under two years later, not long after the Downeys filed a motion for summary judgment on their PUTSA claim, the Kraffts agreed to withdraw it. Nevertheless, the Downeys asked the trial court to award them their attorneys’ fees for having to defend against the PUTSA claim, which the Kraffts knew had no merit. The trial court denied that initial request. The Downeys later renewed that request after the Kraffts obtained a jury verdict against the Downeys for breach of contract (I could not locate the amount of that verdict). The court refused, holding that the Kraffts did not subjectively know they had no viable trade secrets, apparently relying on the two-prong bad-faith test of “objective speciousness” and “subjective misconduct” first used in California federal court in Stilwell Dev. Inc. v. Chen, 1989 WL 418783 (C.D. Cal. Apr. 25, 1989) and applied by a number of federal courts since.

The appeal, majority decision, and dissent. On appeal, the appellate court majority refused to adopt that two-pronged approach. The court pointed out that except for California, the few other UTSA state courts which interpreted bad faith under section 5(1) (Oklahoma, Alabama, and Maryland) had not applied the two-pronged test, but instead looked to their own internal law for guidance. Because there was no ‘uniform’ test for that section, the court would not adopt the test for the P[‘Uniform’]TSA.

Even so, the court applied the two-prong test to the Downeys’ counterclaim, because apparently it made no difference. The Kraffts could not have in good faith believed, in light of the trial court’s prior injunction-denial order, that their PUTSA claims had any merit. The court sent the case back to the trial court to determine the appropriate fee award.

Appellate Judge Strassburger dissented. He wrote that under the appropriate standard of review, which requires in part that the appellate court give significant deference to the trial court’s first-hand observations of the party’s conduct and credibility, the appellate court should have upheld the denial of PUTSA Section 5(1) attorneys’ fees. The trial judge was in the best position to determine the Kraffts’ subjective intent regarding their PUTSA claim, and just because they lost their preliminary injunction motion early in the case did not necessarily mean they would lose on their PUTSA claim at trial. Indeed, the Krafft’s succeeded at trial on their breach of contract claim, so the trial court’s finding that the PUTSA claim was not brought in bad faith, Judge Strassburger wrote, did not contradict the evidence so much so as to require the appellate court’s reversal.

What this means. The majority opinion did not resolve anything. It extensively examined the two-pronged test, refused to adopt it, but nevertheless applied it. Perhaps the Kraffts will ask the Pennsylvania Supreme Court to review. Or maybe they will settle the case and walk away from their verdict.