Recent Developments in Trade Secret Law

With New Jersey’s recent adoption of a variation of the Uniform Trade Secret Act (“UTSA”), all but four states (Massachusetts, New York, North Carolina and Texas) have implemented some form of the UTSA. However, courts in some of the states adopting versions of the UTSA are still drawing the limits of their statutory liability for misappropriation of trade secrets. Most recently, courts in California and Virginia have handed down key decisions clarifying statutory application.

New Jersey Joins the Ranks of the UTSA

On January 9, 2012, Governor Chris Christie signed into law the New Jersey Trade Secrets Act (S-2456/A921), which covers issues of trade secret misappropriation previously dealt with under common law. The statute aligns closely with the UTSA but differs in some significant ways. First, the statute specifically incorporates the protections of the common law stating that application of the statute shall not “be construed to deny, abrogate or impair any common law . . . right, remedy or prohibition.” One interpretation of the statute predicts that application of this section of the statute will protect proprietary and/or confidential information that does not meet the statutory requirements of trade secret, but was none the less protected under common law.

Second, the statute demands that New Jersey courts “shall preserve the secrecy of an alleged trade secret by reasonable means” including sealing of court records and allowing for in-camera hearings. This provision of the New Jersey statute runs counter to the public interest in access to court records put forth by the Supreme Court in Nixon v. Warner Communs., Inc., 435 U.S. 589, 597 (1978), that has led some litigators to promote arbitration. In Nixon, the Court stated that the judiciary recognizes “a general right to inspect . . . public records and documents, including judicial records and documents” although the Court explained that this right could be denied “where court files might have become a vehicle for improper purposes.” This right to inspect public records seems to directly clash with the New Jersey statute’s favoring of record sealing to protect what secrecy remains as to the alleged trade secrets. However, New Jersey courts may find that court records revealing a trade secret constitute a “vehicle for improper purposes” such that the courts may deem record sealing appropriate.

On the whole, New Jersey’s new statute parallels the UTSA and furthers the UTSA’s promotion of uniform trade secret protection from one state to the next. Time will tell if the statute’s unique variations limit the nationwide uniformity the UTSA intended.

California— Reverse Engineering With a EULA Not “Improper Means”

Across the country, a Federal District Court recently handed down a convincing interpretation of California’s own version of the UTSA, Cal. Civ. Code § 3426.1, in Aqua Connect, Inc. v. Code Rebel, LLC, No. CV 11-5764-RSWL (C.D. Cal. Feb. 13, 2012). While a ruling by the Federal District Court is not binding as to interpretation of state trade secret law, the California state courts may nevertheless find the court’s ruling to be persuasive authority in future cases.

In Aqua Connect, the court addressed whether Code Rebel violated the California trade secret statute when the company downloaded a trial version of Aqua Connect, Inc.’s software and reversed engineered to software to sell a version of its own in violation of the End User License Agreement (“EULA”). Reverse engineering is commonly defined, including by New Jersey’s recent UTSA adaption, as “starting with the known product and working backward to find the method by which it was developed.” Specifically the court had to determine whether Code Rebel’s actions constituted “misappropriation” by deciding whether the statute’s requirement of use of the “plaintiff’s trade secret through improper means” had been met.

Although the California statute finds that reverse engineering by itself, cannon constitute “improper means,” the court had to determine if breach of a EULA could convert reverse engineering into an “improper means” such that Code Rebel would be liable for misappropriation.

The Aqua Connect court found that mere presence of a EULA did not convert reverse engineering into an “improper means.” Instead, the court suggested that “reverse engineering must be combined with some other improper action in order for it to form the basis of a cognizable misappropriation claim.” Accordingly the court held that Aqua Connect had failed to state a claim because it did “not allege that the [] trial software was obtained through unfair or dishonest means” as the software had been provided to Code Rebel by Aqua Connect itself.

Aqua Connect also argued that the EULA created a “duty to maintain secrecy” that Code Rebel had breached thus opening itself to liability under the California statute. The court rejected this argument because California courts have refused to find that such a duty arises from a form license agreement. Having rejected both of Aqua Connect’s arguments, the court dismissed the claim without leave to amend — “find[ing] that no additional facts can be alleged to support a legally cognizable misappropriation of trade secret claim.

This decision reinforces the California statute’s rejection of reverse engineering as an “improper means” of acquiring a trade secret. However the case suggests that should foul play be involved in how the product or software is acquired by a defendant, reverse engineering might be converted into an improper means warranting liability under the statute. The decision also suggests that companies implementing EULAs as a means of trade secret protection should think twice as the agreement likely does not create liability on its own.

Virginia Supreme Court — Trade Secret Misappropriation Regardless of Competition

Virginia — another state having adopted the UTSA, Va. Code. §§ 59.1-336 — recently addressed the issue of whether or not a trade secret must be used by a competitor of the trade secret holder in order to be liable for misappropriation. The Virginia Supreme Court in Collelo v. Geographic Services, Inc., Nos. 101411, 101421 (Va. Jan. 13, 2012) held that the Virginia statute does not require proof that trade secrets were used for competition against the trade secret holder.

In Collelo, Mr. Collelo left his old employer (GSI) to work for a company (Boeing) that had been and continued to purchase services from GSI. Collelo performed the same work for Boeing that he had when Boeing had been a client of GSI. As a result, Boeing relied on GSI less for the services Collelo had provided. The trial court had reasoned GSI could not bring a claim against Boeing because Boeing “is not doing and has not been doing the same work as” GSI.

The Virginia Supreme Court looked to the wording of the statute — materially similar to the UTSA — finding that it only requires: (1) proof of a trade secret, (2) misappropriation of the trade secret by someone who had reason to know that the secret was acquired by improper means, and (3) proof of actual damages caused by the misappropriation. In particular, the court held that a non-competitor to the plaintiff’s market for the trade secret could meet these requirements as long as the secret was acquired by improper means and use of the secret caused actual damages to the plaintiff. The court held that a party which does not compete with the trade secret holder can meet these requirements. Boeing had utilized the trade secret to reduce its need for GSI’s services, thus potentially causing actual damages through its use of the trade secret. As such, GSI could succeed on its trade secret claim as long it could actually prove that it sustained damages through this reduction in services.

Although trade secret misappropriation generally involves a competitor discovering and implementing an originator’s trade secret, this decision suggests that the UTSA applies more broadly than traditionally thought. As long as harm can be attributed to use of a trade secret gathered by improper means, a strict reading of the language of the UTSA provides for misappropriation liability and recovery for a trade secret holder.

Broader Implications of These Progresses

Trade secrets have thus far lacked the nationwide protection awarded to other areas of intellectual property law — patents by 35 U.S.C. §§ 101-05, copyrights by 17 U.S.C. §§ 101-22, and trademarks under the Lanham Act. The UTSA and its state-by-state adaptations attempt to overcome the lack of federal protection for trade secrets and limit forum shopping. Consequently, decisions by the forty-six states that have adopted some form of the UTSA tend to influence the application by the other states so long as the state has not varied its UTSA adaptation too much from the original.

Accordingly, the California and Virginia decisions discussed above will likely have implications outside of the state whose law the court applied. As a result of the Virginia Supreme Court’s decision in Collelo, other states might see an influx of non-traditional trade secret cases involving use by non-competitors. However, this sort of influx seems unlikely as most companies in the position of GSI would likely have employees such as Mr. Collelo sign non-compete consulting agreements to prevent similar defections.  Furthermore, software and other companies across the country that traditionally rely on EULAs to prevent trade secret misappropriation during beta testing must consider the California district court’s ruling in Aqua Connect.