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Confidentiality Agreement Traps & Trade Secret Destruction – Part 2

Confidentiality Agreement Traps & Trade Secret Destruction – Part 2

In the first part of this series on confidentiality agreement traps, we discussed how a “time duration” trap in a confidentiality agreement (CA) strips statutory protections from trade secrets. Failing to obtain signed confidentiality agreements from the recipient’s personnel sets up the second trap.

Personnel as Parties to the CA

Requiring the entity receiving confidential information (Receiving Entity) to sign a confidentiality agreement is beyond dispute. However, a Receiving Entity can act only through its officers, employees and other personnel. Accordingly, confidential information must be disclosed to these individuals for use on behalf of the Receiving Entity. Requesting signed confidentiality agreement from officers, employees and other personnel of the Receiving Entity can lead to contentious negotiations. Receiving Entities frequently claim that:

(1)     obtaining and tracking CAs with personnel is too burdensome; and

(2)     CAs with personnel are unnecessary since (if the CA is properly drafted) the Receiving Entity will be responsible for violations by its personnel.

In contrast, the disclosing party will claim that it needs the right to obtain injunctive relief and damages from personnel violating the confidentiality requirements. As a practical matter, most of the Receiving Entity’s personnel will have no knowledge of their company’s obligations under the CA without co-signing it.

The Second Trap

The “Second Trap” is highlighted in a recent judicial decision holding that the information’s confidentiality was lost and and the CA was unenforceable. In nClosures Inc. v. Block and Company, Inc., 770 F.3d 598 (7th Cir. 2014), after signing a confidentiality agreement the device designer provided confidential designs to a contract manufacturer. Six months after the first device was produced, the contract manufacturer developed its own competing device.

The federal district court ruled for the contract manufacturer when the designer sued for breach of the confidentiality agreement. On appeal, the Seventh Circuit Court of Appeals held that obtaining a confidentiality agreement only at the outset of the relationship was insufficient. Failing to obtain signed confidentiality agreements from each individual accessing confidential information was cited as a factor in the court’s ruling that:

(1)     the designer failed to keep its proprietary information confidential, and

(2)     the confidentiality agreement was unenforceable.

In reaching this decision, the Seventh Circuit referenced its previous holding that:

a federal court applying Illinois law “will enforce [confidentiality] agreements only when the information sought to be protected is actually confidential and reasonable efforts were made to keep it confidential.” Id. at 602.

Loss of Trade Secrets

As noted in the first part of this series, the Texas Uniform Trade Secrets Act (TUTSA) requires “efforts that are reasonable under the circumstances to maintain its secrecy.” Reasonable efforts to maintain secrecy generally include enforceable confidentiality agreements. Since an unenforceable confidentiality agreement is legally equivalent to no confidentiality agreement, nClosures would mean the “trade secret” owner failed to take reasonable efforts to maintain secrecy with a corresponding loss of the trade secret protections under TUTSA.

Effect on Business Value

Trade secrets add value to virtually all businesses. If trade secret protection is lost, the sale of the business may become impossible or possibly only at a drastically reduced valuation.

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.