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Confidentiality Agreement Traps & Trade Secret Destruction

A nondisclosure or confidentiality agreement (CA) is frequently viewed as an unnecessary formality to be satisfied with an off-the-shelf “form” so the parties can move on to a business purchase and sale, joint venture, supply relationship, employment arrangement, service arrangement or other business. If properly drafted, a CA offers legal protection of confidential information. If not, catastrophic outcomes include forfeiture of trade secret protection, possible destruction of business value, and incentivizing competitors to pirate employees.

As a four part series, we will highlight unintended consequences of improperly prepared CAs and discuss possible solutions in the last part.

Trade Secrets Require Secrecy

Although every business develops trade secrets, few recognize that their information, processes and methods are protectible. Under the Texas Uniform Trade Secret Act (TUTSA), customer lists, supplier lists and even “negative information” (unproductive methods and techniques that a business wants its competitors to waste resources exploring) may be trade secrets if their secrecy is properly maintained. TUTSA defines a “trade secret” as “information, including a formula, pattern, compilation, program, device, method, technique, process, financial data, or list of actual or potential customers or suppliers, that:

(A) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use; and

(B) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

Trade secret owners may use TUTSA  to obtain injunctions, royalties and damages (including double those amounts for willful and malicious misappropriation), and recover attorneys’ fees.

The Duration Trap Trade Secret Destruction

Business brokers, private equity groups and venture capitalists commonly insist on a “duration clause” which terminates their confidentiality obligations after a stated time period (frequently two to four years). Proponents of pro-duration clauses argue the need to avoid: (1) claims of wrongful use/disclosure of confidential information when similar information is rightfully sourced elsewhere; and (2) being required to track the source of each item of confidential information across the multitude of  deals reviewed.

While these arguments are frequently persuasive, the more compelling argument is the irreparable “collateral damage” to the disclosing business. Trade secret protection exists only if reasonable efforts are exercised to maintain secrecy. An agreement allowing disclosure of trade secret information at a future time establishes abandonment by the business of reasonable efforts to maintain secrecy. Courts considering this issue agree that a duration clause terminates trade secret status and protection. A few cases on this point include:

  • Because of a two-year duration clause in a third party CA, a trade secret owner lost an injunction proceeding against its primary competitor for trade secret misappropriation. Silicon Image, Inc. v. Analogk Semiconductor, Inc., 642 F. Supp. 2d 957 (N.D. Cal. 2008).
  • A 10-year time duration clause in a business relationship CA blocked the trade secret owner’s effort to obtain a preliminary injunction. DB Riley, Inc. v. AB Engineering Corp., 977 F. Supp. 84 (D. Mass. 1997).
  • A former employer lost trade secret protection and could not prevent a former employee from taking the information after a 12-month CA expired. ECT International Inc. v. Zwerlein, 597 N.W.2d 479 (WI 1999).

A business owner whose trade secret protection may find that the business is no longer an attractive purchase or business partner. Acquirers might conclude that “green fielding” the business is less expensive than paying a premium for a business with compromised trade secrets/intellectual property. Potential joint venturers may bypass the business by absorbing the critical information directly into their services and products. Employees might learn that their personal marketability has dramatically increased by bringing proprietary knowledge to a competitor.

Different approaches  to resolving this issue will be explored in the last part of this series.

This blog does not establish an attorney-client relationship and does not constitute legal advice. Legal outcomes are based on the particular facts of a situation and the application of the law to those facts.  Anyone with issues described in this blog should hire an attorney for legal advice based on the relevant facts. The firm has no obligation to maintain the confidentiality of any information received by email or comments.

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