A few years after ruling that the Air Force violated the confidentiality clauses of contracts with a government contractor by disclosing its proprietary information relating to the manufacturing process for a conveyor used in assembling smart bombs weighing more than a ton each, the Court of Federal Claims recently determined the contractor’s damages. The court treated the controversy as involving a “lost asset” for which there is no known market, and not a “lost profits” case as the Government contended. Therefore, the appropriate measure of damages was an estimate of the amount a willing buyer would have paid a willing seller for the proprietary information. The proper methodology was to multiply the number of conveyor units the Air Force expected to purchase as of the date of the breach, times the contractor’s bid price, times a reasonable profit, and then to discount for the “risk that a potential buyer of [the] proprietary information would associate with realizing the profit stream deriving from the use of that asset.” Spectrum Sciences & Software, Inc. v. U.S., No. 04-1366C (Court of Fed. Claims, Feb. 14, 2011) (the court’s decision regarding liability is reported at 84 Fed. Cl. 716 (2008)).

Over the course of several decades beginning in the early 1970s, the Air Force developed and upgraded the conveyors. In 2000, Spectrum Sciences & Software (Spectrum) self-funded an effort, which ultimately failed, to become the principal supplier of new versions of the conveyor. However, Spectrum needed the Air Force’s cooperation in order to refine and test its products. So, the parties entered into a Cooperative Research and Development Agreement (CRADA) which prohibited disclosure by either of them of the other’s proprietary information. Since Spectrum’s confidential data was expressly identified in the CRADA, protection should have been assured. Moreover, when Spectrum thereafter submitted a proposal to build the conveyor and the proposal contained the data, the cover page of the submission “warned, inter alia, that ‘[t]he data in this proposal will not be disclosed outside the Government and will not be duplicated, used, or disclosed in whole or in part for any purpose other than to evaluate the proposal.’”

Ultimately, Spectrum’s proposal was rejected. However, it was not returned to Spectrum, and contrary to orders the contracting officer opened it and circulated it among a number of Air Force officials. Spectrum’s proprietary information then was used extensively by the Air Force procurement team and was incorporated in a subsequent RFP that was distributed to outside vendors, including Spectrum’s competitors.

The trial with respect to liability was bifurcated from the damages determination. With respect to liability, in 2008 the Court of Federal Claims held that “the Air Force repeatedly breached the CRADA in failing to protect adequately Spectrum’s proprietary information.” Spectrum, 84 Fed. Cir. at 744. At the subsequent trial on damages, each party presented an expert witness. Spectrum’s expert computed its damages as roughly four times the amount proposed by the Government. The final award was $1.2 million.

A significant reason for the difference between the two valuations resulted from Spectrum’s expert basing damages on the number of conveyor units the Air Force anticipated buying as of the date of the breach (2003) whereas the Government’s expert used the much smaller number that had actually been ordered on the date when the court’s liability ruling was issued (2008). The court observed that the number ultimately ordered was irrelevant because it was a function, in part, of the poor performance by Spectrum’s competitor that had been awarded the contract, something that could not have been known or anticipated several years before when the breach occurred.

With regard to the per unit price, Spectrum’s expert used the company’s initial bid. Although that bid had been rejected, and while “unaccepted offers to sell property, like other unconsummated transactions, generally represent poor barometers of value,” in this instance use of the bid price was appropriate. It was well below the Government’s pre-bid estimate, and it approximated Spectrum’s selling price to the United Kingdom for the same product. The Government’s expert, by contrast, suggested use of Spectrum’s bid for a similar product several years after the breach, but the court disagreed because that bid constituted “a last ditch effort by Spectrum to realize something from its efforts . . . [at a time it was competing] with firms that were being handed its intellectual property gratis.” Thus, that bid was “based upon a price cut triggered by the Air Force’s improper release of Spectrum’s proprietary information [and] would effectively reward defendant for the misconduct of its officers in a way that the law simply does not countenance.”

With respect to the appropriate profit margin, the court held that a reasonable expectation of profit was the 15% ceiling for federal procurement under a cost-plus-fixed-fee contract (even though this procurement involved simply a fixed-fee contract). Finally, the proper way to compute the discount rate was to take the risk-free interest rate (for short-term Treasuries) plus an equity risk premium, plus or minus factors reflecting the riskiness of investing in stock of a company in Spectrum’s industry, of a company Spectrum’s size, and of a company like Spectrum that had a key-customer dependence factor. Having decided that “defendant appropriated significant benefits for itself and inflicted significant harm on plaintiff by breaching the CRADA,” it is not surprising that substantial damages were awarded.

This opinion is significant for several reasons. First, it is a rare example of a court detailing the method of computing damages in a lawsuit involving misappropriation of proprietary information for which there is no known market. Second, the court clearly differentiated between the valuation of a lost asset and the computation of lost profits.