A recent decision by California’s Fourth Appellate District Court of Appeals highlights the dangers of prosecuting a trade secret case that proves to be unsuccessful — namely, the possibility that a court may find that the action was brought in “bad faith” because one of the elements necessary for that trade secret claim was missing. While the July 11, 2012 decision, SASCO v. Rosendin Electric, Inc., is rooted in California’s version of the Uniform Trade Secret Act (UTSA), (Civ. Code, 3426.4), it is a sobering reminder that a company bringing a trade secrets claim in California may need to have actual evidence of misappropriation to support its claim. (A PDF copy of the opinion can be found below and a hat tip to Dan Westman of Morrison & Foerster for bringing this opinion to my attention).
Facts: SASCO had sued three former senior managers who joined a competitor, claiming that they had misappropriated trade secrets, including certain allegedly proprietary software, for an opportunity that was being pursued by SASCO called the Verizon Trustin Project. After a number of bruising discovery disputes, SASCO was unable to come forward with evidence that the former employees ever misappropriated any trade secrets and it dismissed its claims rather than respond to a motion for summary judgment by the former employees. The employees then sought their attorneys fees, claiming that the action had been brought in bad faith as part of a larger effort to wear them down through litigation.
Holding: The trial court found that SASCO had brought the case in bad faith under California’s version of the UTSA. The trial court explained that SASCO’s suspicions that its former employees had taken other trade secrets was an insufficient basis for asserting the claim and it faulted SASCO for not conducting a thorough investigation before filing the lawsuit. (SASCO’s cause was not helped by the fact that the trial court also believed that the allegedly proprietary software was an “off the shelf” computer program). In light of of the absence of any direct or forensic evidence and affidavits from the former employees that they did not misappropriate the trade secrets, the trial court granted the former employees’ motion for attorneys fees and costs, awarding a total of $484,943.46.
On appeal, the Court of Appeals agreed, holding that the trade secret claims were “objectively specious” which it defined as an action that superficially appears to have merit but for which there is a complete lack of evidence to support the claim. Rejecting SASCO’s interpretation that only “frivolous” claims warranted a bad faith finding, the Court of Appeals reasoned that there was also ample evidence of subjective of bad faith. Specifically, the Court of Appeals was also influenced by the fact that, in a related litigation between SASCO and one of the employees, a federal district court had awarded approximately $570,000 in attorneys fees and costs against SASCO because that litigation appeared to have been initiated as part of an attempt to wear down the former employees with duplicative and costly satellite litigation in two separate forums.
My Concerns: Misappropriation can be one of the tougher elements of a trade secret claim to prove and, as a result, other courts have generally found that circumstantial evidence of misappropriation is sufficient. Indeed, I would argue that circumstantial evidence is often critical in trade secret cases, which by their nature, involve stealth and concealment, making it doubly difficult to prove actual misappropriation. As was perhaps best explained by the U.S. Court of Appeals for the Sixth Circuit in its opinion in Stratienko v. Cordis Corp., 429 F.3d 532 (6th Cir. 2005): “Permitting an inference of use from evidence of access and similarity is sound because ‘misappropriation and misuse can rarely be proved by convincing direct evidence.’ Eden Hannon & Co., 914 F.2d at 561 (citing Greenberg v. Croydon Plastics Co., 378 F. Supp. 806, 814 (E.D. Pa.1974)). Presented with ‘defendants’ witnesses who directly deny everything,’ plaintiffs are often required to ‘construct a web of perhaps ambiguous circumstantial evidence from which the trier of fact may draw inferences which convince him that it is more probable than not that what the plaintiffs allege happened did in fact take place.’ Id. Thus, requiring direct evidence would foreclose most trade-secret claims from reaching the jury because corporations rarely keep direct evidence of their use ready for another party to discover.”
Consequently, to the extent that the Fourth District is imposing a duty of direct evidence of misappropriation in all cases, I think it may be imposing an impossible burden on some plaintiffs. If this is the standard, all that a defendant has to do is object or fail to disclose critical evidence and a plaintiff may find itself in a situation that it cannot produce that direct evidence, since evidence of misappropriation is frequently in the hands of the defendant.
The Takeaway? California plaintiffs need to do their homework and would be well served by making sure that they have some evidence of misappropriation before filing an action. While the Fourth District Court of Appeals acknowledges there may be situations where a plaintiff may bring an action in good faith if it reasonably believes discovery may reveal misappropriation, a forensic examination of any devices of departing employees and other proper investigation should be conducted before filing any action. While I am troubled that the Fourth District appears to be imposing an obligation to come forward with direct evidence given the special challenges of proving direct misappropriation, there does appear to be wiggle room in the opinion for future plaintiffs on this point.
Finally, it should be noted that the SASCO decision may be a bit of an outlier, given some of its unique facts (the dismissal of the claim by SASCO and the satellite litigation in federal court which resulted in a similar award of attorneys fees). However, there are a number of cases working there way through the courts involving claims or findings of bad faith against unsuccessful trade secret plaintiffs (see the recent case filed against Latham & Watkins, and most notably, the American Chemical Society v. Leadscope case currently being considered by the Ohio Supreme Court). Therefore, thinking through your trade secret claims and carefully considering the evidence in support of the elements of those claims before filing a lawsuit is more important than ever.