Trust Is No Way to Protect Your Trade Secrets

April 30, 2012

The United States Court of Appeals for the 7th Circuit recently issued a decision in a trade secrets case that should serve as a reminder to all businesses that trust is no substitute for having the appropriate protection in place to safeguard a company’s valuable business information.

The case involved Fail-Safe, LLC (FS) and A. O. Smith, Corp. (AOS). It began with on and off informal discussions between the companies about the development of a pump motor to prevent swimmers from being caught by the suction created by swimming pool drains. Eventually, the discussions became serious enough that the founder of FS wrote to AOS expressing an interest in AOS developing a pump for its application. He traveled to Milwaukee to meet with several AOS engineers at which point he signed a standard AOS confidentiality agreement that stated FS was a supplier of research consulting services to AOS. At no point prior to, during or after these discussions did anyone from FS mention its desire for confidential treatment of any information it was disclosing to AOS nor did FS require AOS to enter into a confidentiality agreement. This is despite FS having done so in a variety of other earlier business relationships.

Following the meeting, FS continued to work with AOS although at no point was there any formal agreement. During this time, FS disclosed information on certain technical standards and test results from a prior FS pump design. It also provided information to AOS concerning how to properly test a possible AOS motor with a special test stand. About six months after his meeting with the engineers, FS’s founder wrote to an upper level AOS executive with a proposal for an agreement to move forward on commercializing the motor they had been working on. No agreement resulted but even so FS announced to the industry that it had solved the pool safety problem through a joint development effort with AOS. AOS responded to the announcement by sending a letter to the same businesses that had received FS’s announcement indicating there was no joint relationship between AOS and FS. It also contacted FS accusing it of having breached AOS’s confidentiality agreement.

Several months later AOS introduced two pump motors that FS claimed incorporated FS’s trade secrets. FS subsequently filed a suit against AOS in federal court alleging misappropriation of trade secrets as well as unjust enrichment under Wisconsin law. The District Court granted summary judgment in favor of AOS on both claims. It found that the misappropriation claim was barred by the statute of limitations and in the alternative that FS failed to take reasonable steps to protect the security of its claimed trade secrets. It also found that FS’s voluntary disclosure of its information defeated its unjust enrichment claim.

FS appealed the District Court’s decision to the Seventh Circuit Court of Appeals. Every Circuit Court reviews a District Court’s judgment on the pleadings and the grant of summary judgment “de novo,” which is Latin for “beginning anew.” Basically it means that the court takes a fresh look at the evidence and gives the benefit of the doubt to the party that lost the motion for summary judgment. Even with this advantage, the Circuit Court agreed that FS failed to take reasonable precautions to protect its trade secrets and as a result its claim of trade secret misappropriation failed. Further, because FS provided information voluntarily to AOS without any contractual agreement for confidentiality or intellectual property protection, AOS could not profit unjustly as a result of the voluntarily disclosure and thus FS’s unjust enrichment claim also failed.

To qualify as a trade secret under Wisconsin law (and the law of most other states), the secret must be the “subject of efforts to maintain its secrecy that are reasonable under the circumstances.” Wis. Stat. § 134.90 (2011). The Circuit Court noted that in this particular situation, FS not only failed to take reasonable steps to maintain the required secrecy but in fact failed to take any steps to protect information and rather volunteered information and willingly cooperated with AOS.

Under Wisconsin law, an unjust enrichment claim requires a plaintiff to prove that: (1) a benefit was “conferred upon the defendant [AOS] by the plaintiff [FS]”; (2) there was an “appreciation by the defendant of the fact of such a benefit”; and (3) there was “acceptance and retention of the benefit by the defendant under circumstances such that it would be inequitable to retain the benefit without payment of the value thereof.” However under Wisconsin law, one cannot recover for unjust enrichment if all the defendant has done is to use an idea of the plaintiff that is not a trade secret. Here there was no trade secret and as the court stated, “[s]imply put, one cannot steal free advice.”

The Circuit Court agreed with the District Court that this case was an “extreme case” and that FS “courted its own disaster” by failing to take any protective measures.

While this is an extreme case, it illustrates the point that sometimes even smart business people who know better can become too casual with their company’s trade secret in their enthusiasm to work out a deal or to pursue a business opportunity. It is important to keep in mind that trade secrets are valuable because they are secret AND because they are subject to efforts to maintain their secrecy that are reasonable under the circumstances.

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