As I mentioned in a prior post on real estate investment vehicles’ use of intellectual property, the real estate industry is not immune from legal disputes arising from that “other” type of property: intellectual property – specifically trade secrets.

A recent case involving Zillow in the federal Northern District of California illustrates the point. In that case, Zillow, one of the nation’s most recognizable online real estate information marketplaces, was accused of trade secret misappropriation by Top Agent Network, Inc., a competing online real estate information dissemination service.

Score the early rounds of this battle to Zillow.

The complaint

Top Agent is a private online community and web application available to the top ten percent of real estate agents in certain local markets, focusing on “Upcoming Listings” – properties for sale that do not yet appear on the Multiple Listing Service (MLS), which is available to all registered real estate agents.

Top Agent’s complaint accused Zillow of misappropriating Top Agent’s trade secrets. According to the complaint, executives from Top Agent and Zillow began communicating in early 2014. Top Agent expressed interest in Zillow’s potential investment in the company. Zillow’s executive verbally assured Top Agent that all information provided by Top Agent would be kept confidential and used solely to evaluate a potential investment, but no non-disclosure agreement (NDA) was signed.

Top Agent set up an account for Zillow’s executive, allowing him to access Top Agent’s member-only content, including its “Upcoming Listings,” and the executives discussed Top Agent’s features, membership model, and business strategy. Through its account access, Zillow viewed dozens of pages within Top Agent’s private web application and opened more than a hundred member posts.

But Zillow eventually informed Top Agent that it would not be investing in the company. Soon after, Zillow launched its own “Upcoming Listings” product, which Top Agent alleged  contained all of the core features of Top Agent’s service.

In addition to trade secret misappropriation, Top Agent also asserted claims under the federal Computer Fraud and Abuse Act, California’s Computer Data Access and Fraud Act, and an assortment of other claims.

The District Court’s Order

On Zillow’s motion, the District Court dismissed all but one claim – breach of oral contract.

Top Agent’s complaint failed to state a trade secret misappropriation claim, the court held, because Top Agent failed to adequately identify the alleged trade secrets.

The court started with the familiar statutory definition of a trade secret under the California Uniform Trade Secrets Act:

1. information, including a formula, pattern, compilation, program, device, method, technique, or process, that
2. derives independent economic value, actual or potential, from not being generally known to the public or to other persons who could obtain economic value from its disclosure or use, and
3. is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

The court found that Top Agent only described its alleged trade secrets in “broad strokes,” without sufficient detail. Top Agent’s complaint alluded to the manner in which its “Coming Soon” feature was developed and implemented, the strategy behind the feature, and the identity of Top Agent member agents who made listing posts. Nothing in the complaint, the court held, showed how Top Agent’s information amounted to more than non-protectable ideas, features, and functions of design and operation (as opposed to protectable facts or “empirical data”). The court also held the complaint failed to describe Top Agent’s reasonable efforts to maintain the secrecy of its web content.

The court dismissed the Computer Fraud and Abuse Act claim on the ground that Top Agent had plainly given Zillow “authorization” to access its site (noting that how Zillow used information gained from that access was beyond the scope of the statute). The court likewise dismissed the Computer Data Access and Fraud Act because Zillow had “permission” to access Top Agent’s site.

The court dismissed all the remaining claims (other than breach of oral agreement) on the grounds of preemption, since they were all based on “the same nucleus of facts” as the trade secret claim.

Moving forward

The court’s dismissal order was “with leave” to amend, meaning Top Agent will have a chance to amend its complaint to more specifically describe its trade secrets and to show how its other claims arise from rights separate from trade secret law.

This early victory for Zillow, however, reinforces two lessons:

• Companies should have a very clear understanding of their trade secret inventory, and should be able to articulate how the information meets the statutory requirement of a trade secret as well as the reasonable efforts undertaken to protect them. There is a lot of “gray” in this area of the law, and it helps to have clarity before dealing with potential business partners or adversaries.
• Companies possessing trade secrets should always enter into a written NDA before sharing trade secrets with an outsider as part of any business relationship. Failing to obtain an NDA might constitute a per se failure use reasonable efforts to protect the trade secrets.

Nike recently sued three of its former shoe designers who defected to Adidas, claiming the trio brought trade secrets with them, including Nike’s strategic development plans, design drawings, and other information “tied” to several of its shoe lines.

What do shoes have to do with trade secrets?

The common perception of trade secrets usually revolves around customer information, vendor or “key contact” information, product pricing, or some combination thereof. Mention “Nike” and “intellectual property” in the same sentence, and odds are you’re talking about trademark protection for the famous swoosh.

But the recent Nike case highlights that the definition of a “trade secret” can include a broad array of information. Yes, even including shoes, and shoe-related information.

(For other examples of the far reach of trade secret law, see my earlier posts regarding technology design concepts and real estate investment vehicles.)

Designs, Drawings, and Business Plans

The Complaint (filed in Oregon state court) is novel-like, weighing in at 50 pages – without exhibits – and includes many claims other than trade secret misappropriation (breach of a non-compete clause, breach of duty of loyalty, and tortious interference, among others).  But most of the case value – alleged by Nike to be at least $10 million – will likely hinge on the strength of the trade secret claim, given the possibility for punitive damages and attorney fees under the Oregon Uniform Trade Secrets Act.

Here are the trade secrets Nike claims were stolen by the former designers:

• future strategic development plans and product offerings/launches
• unreleased product design drawings and models
• unreleased product technology
• product financial performance information
• marketing campaign materials
• virtual testing methodologies
• blueprints for product launches

In a mild surprise and departure from the norm in a trade secrets case, Nike named only the three former designers as defendants, not their new employer Adidas.  (Not yet, at least ….)

 “Standard Playbook” Electronic Evidence

No trade secrets case would be complete without allegations that the former employees engaged in electronic misdeeds, and the Nike lawsuit is no exception.  Often, this type of evidence will make or break a case.

Nike claims that prior to leaving Nike, one defendant extracted proprietary documents from his company-issued laptop regarding Nike’s soccer footwear product line, and also sent an email from his work email account to his personal email account attaching confidential design drawings for an unreleased shoe designed for one of Nike’s sponsored athletes.

The defendants also allegedly erased incriminating emails, text messages, and other files.

Trade Secrets Rise

Trade secret law used to be the Rodney Dangerfield of intellectual property, getting far less respect and attention than its I.P. brethren – patents, copyrights and trademarks.  But in this “knowledge economy,” trade secret law provides a vital role in protecting the confidential information that drives profits (including shoe designs and a broad array of other items).

Until recently, trade secrets have been mostly overlooked by federal lawmakers.  While federal laws govern patents, trademarks, and copyrights, trade secret protection has been left primarily to the states, most of which have enacted some variation of the Uniform Trade Secrets Act (which, itself, provides for no federal civil remedies).

But differences among state trade secret laws remain substantial (and often difficult to predict), and recent high profile examples of trade secret theft and economic espionage (see below) have illustrated the increasingly national scope of trade secret issues.

At the same time, intellectual property owners have become increasingly aware that trade secret laws sometimes offer more meaningful protection for valuable company information than patent and other laws.  Put simply, trade secret protection can include more diverse types of information than patent law, does not require the disclosure of sensitive information in connection with any registration process, and doesn’t expire after an arbitrary time.

Trade secrets now have the attention of federal lawmakers, as demonstrated by two pending bills.

Proposed 2014 Federal Trade Secret Legislation: And Then There Were Two

My partner Josh Cohen previously published a post detailing the first proposed federal trade secret legislation, the Defend Trade Secrets Act of 2014 (S. 2267), which was introduced in April.

In July, a second bill was introduced in the House — the Trade Secrets Protection Act of 2014 (H.R. 5233).

Both pending bills seek to create a federal civil remedy for trade secret theft.  The bills are similar: both would permit a trade secret owner to bring a federal civil action seeking redress for trade secret theft relating to a product or service that is used in, or intended for use in, interstate or foreign commerce.  Both bills also contain similar provisions regarding available remedies, which include damages, injunctive relief, potential fee shifting, and potential treble damages.

The Senate bill (the Defend Trade Secrets Act of 2014) would also allow for a trade secret owner to apply to the district court for an ex parte order for preservation of evidence and seizure of property used to commit trade secret theft.  The House bill (the Trade Secrets Protection Act of 2014) includes a similar mechanism, but imposes slightly higher procedural requirements before a seizure order can issue (including a showing of likely success on the merits of the trade secret claim).

Economic Espionage Act Roots

Both pending federal bills are technically amendments to the 1996 Economic Espionage Act, which was an early step toward increased federal  attention to the topic of trade secrets.  That Act criminalized acts of trade secret theft by foreign parties or governments, or by domestic parties if the trade secret relates to interstate commerce.

The concerns giving rise to the Economic Espionage Act have made some headlines recently.  In March, a man was found guilty of stealing DuPont’s trade secrets and selling them to a Chinese chemical company, and was later sentenced to 15 years in prison.  In May, an indictment was issued against five Chinese military officers, accusing them of stealing trade secrets of five companies specializing in solar panels, metals, and nuclear power plants.  New stories like this seem to emerge almost every week.

The pending federal bills would provide federal civil remedies in addition to the criminal penalties available under the Economic Espionage Act.

What about trade secret claims based on state law?

Neither of the pending federal bills would preempt the patchwork of existing state trade secret laws, so trade secret owners can continue to rely on state law even if one of the federal bills is enacted.  But for companies conducting business across several states, the new federal proposals may offer greater stability and predictability for pursuing trade secret thieves.

While the term “trade secret” generally makes people think of Coca-Cola’s secret formula, software source codes, or company client lists, trade secret law has evolved to include everything from proprietary formulae to abstract ideas.  It may not come as a surprise then, that the “trade secret” claim is now being used in a variety of different contexts to broadly shield companies, including non-profit organizations, from disclosing sensitive financial information.

After coming under fire for its purported lack of transparency with regard to the way it used Hurricane Sandy donations, the Red Cross fueled the flames by invoking the trade secret exemption under New York’s Freedom of Information Law to prevent disclosure of “confidential proprietary data” in response to a public records request.  Can the Red Cross, a self-described “nonprofit, tax-exempt, charitable institution” with the legal status of “a federal instrumentality,” use the trade secret exemption? And even if it can, should it?

Under expansive trade secret laws, non-profits may be able to invoke trade secret protections to prevent disclosure of certain sensitive information.  Although its primary objective is not to seek financial returns for its members, a non-profit competes with other organizations for funding and donations to support a cause.  In that sense, non-profits are competitive businesses just like for-profit companies or corporations.  Just as a for-profit company may refuse to disclose certain sensitive financial or other proprietary information that may put it at an economic disadvantage in relation to other companies involved in the same trade, a non-profit may also do so if disclosure of certain information would put it at a competitive disadvantage with other similar organizations by reducing the amount of donations it receives.

However, unlike a for-profit company, which generates revenue by providing some tangible good or service, a non-profit relies mostly on external funding sources for financial support (e.g. the government and donors) to achieve its goals.  This means that a non-profit is particularly dependent on its public image in ways that a for-profit company might not be.  Just because non-profits may claim broad trade secret protections over their financial information doesn’t mean they should.  Any indication that a non-profit is being less than forthright with the public (i.e. its donor base) may undercut the organization’s image – and its donations – and may ultimately negate any benefit of keeping certain information a secret.  This is especially true in the Red Cross’s case, which touts its special relationship with the federal government as a source of legitimacy, and therefore, may be held to a higher standard of public accountability, fairly or unfairly.

The Red Cross subsequently released additional information about its general spending allocations voluntarily, while keeping other, more-detailed information secret.   Arguably, if it had taken this more considered approach in the first place rather than stonewalling the public records request, the Red Cross could have avoided further criticism about its lack of transparency and whatever deleterious effect it might have on its future donations.

Just because something is legal doesn’t mean it makes business sense.  Like other businesses, non-profits should be able to invoke trade secret for confidential or sensitive proprietary information.  While it makes sense for a non-profit to keep its donor lists a secret to prevent other organizations from poaching and diverting donations, it makes less sense for an organization dedicated to disaster relief to refuse to disclose to its donors if and how their money was distributed in response to a natural disaster.  As businesses that exist for the public good and by virtue of public support, non-profit organizations in particular should remain mindful of public perception when invoking trade secret protections.

Conventional wisdom holds that software algorithms and source code can be protected as trade secrets, but broader technology “design concepts” can only be safeguarded by registering for patent protection.  But that conventional wisdom is bending as more and more courts grapple with the boundaries between trade secret and patent law.  In one of the more interesting California trade secret cases from the second quarter of 2014 — Altavion, Inc. v. Konica Minolta Systems Laboratory Inc. — the court of appeal confirmed that technology design concepts can be trade secrets.

Altavion’s Digital Stamping Technology (DST)

The plaintiff, Altavion, was a small company that invented a process for self-authenticating documents through the use of barcodes containing encrypted data about the contents of the original documents, otherwise known as digital stamping technology or DST.  Altavion alleged that several aspects of its DST process constituted trade secrets and that the defendant, Konica, stole those trade secrets.  Altavion and Konica had entered negotiations, subject to a nondisclosure agreement, aimed at embedding Altavion’s DST in Konica’s multifunction printers.  After those negotiations failed, Altavion discovered that Konica had secretly filed for patents encompassing Altavion’s DST process.

The trial court found that Altavion’s DST concepts were trade secrets, that Konica gained all of its knowledge of DST through the confidential negotiations with Altavion, and that Konica misappropriated Altavion’s DST trade secrets.  The court of appeal affirmed.

Can a patentable idea also be a trade secret?

On appeal, Konica argued that “[g]eneralized ideas and inventions are protectable by patents and thus cannot be trade secrets.”  The court of appeal disagreed, holding that “it is clear that if a patentable idea is kept secret, the idea itself can constitute information protectable by trade secret law.”  The court noted the different aims of patent law (shielding a publicly disclosed idea from infringement) and trade secret law (the right to control the dissemination of secret information), and observed that due to concerns regarding patent validity many businesses now choose to protect commercially valuable information through trade secret protection.

The court distinguished between the various components of Altavion’s DST technology.  At one end of the spectrum was Altavion’s “general idea” for a barcode allowing for self-authentication of documents, which was not a trade secret because it had been disclosed to several companies without a nondisclosure agreement.  At the other end of the spectrum was Altavion’s “algorithms and source code,” which was the most specific and secret level of information, and unquestionably a trade secret.  In the middle of this spectrum, and the focus of the lawsuit, were the “design concepts” underlying Altavion’s DST concepts.

Design concepts are protectable as trade secrets

The court held that Altavion’s design concepts were protectable trade secrets because they had independent economic value, were created through Altavion’s substantial investment of time and effort, were not readily ascertainable by competitors, and had not been previously disclosed.  The last part — “not previously disclosed” — was key to the court’s decision.  The court recognized that some earlier decisions had ruled that software design concepts were not trade secrets where those concepts were already “disclosed and evident to the end user.”  According to those prior cases, “plans, flows, inputs, outputs, rules of operation, priorities of operation, and the like are not trade secrets to the extent they are manifest in the way a program works.”

But here, the court ruled that Altavion’s design concepts maintained trade secret protection because they had not yet been disclosed in any finished product.  Altavion and Konica merely anticipated that the concepts would be disclosed later if and when the finished product containing the concepts was placed on sale.  The parties never reached that point, however, because negotiations ended and Konica pursued its secret patent applications covering Altavion’s concepts.

Takeaway

Trade secrets are not just for formulas, algorithms, and customer information.  An idea or design concept that might otherwise be patentable can also constitute a trade secret if it has independent economic value, is not readily ascertainable, and the owner diligently keeps it confidential.  Given recent concerns over heightened standards for patent validity and the high stakes of disclosing inventions in patent applications that might be rejected, expect more companies to rely on trade secret protection for their design ideas.

The terms “intellectual property” and “real estate” are rarely found in the same sentence.  Real estate industry veterans generally view “property” as an asset comprised at least partly of dirt.  But real estate investment vehicles – including REITs, private equity real estate firms, and private lending/investment entities – often have valuable intellectual property worth fighting over, most often in the form of trade secrets.

KBS v. ARC

Allegations of trade secret theft are at the center of ongoing litigation between two major sponsors of nontraded REITs (American Realty Capital Advisors and KBS Capital Advisors), a dispute that also includes the sponsors’ broker-dealers (Realty Capital Securities and KBS Capital Markets Group).  And this is no small skirmish.  The battle is being waged on two fronts – a Financial Industry Regulatory Authority (FINRA) arbitration, which was initiated in 2009, and an Orange County Superior Court action, filed in 2011, which is scheduled for a jury trial on March 9, 2015.

A “trade secret” is defined as information that derives independent economic value from not being generally known to the public or competitors, and which is the subject of reasonable efforts to maintain its secrecy.  Trade secret theft (or “misappropriation”) occurs when a person acquires another’s trade secret by improper means or uses or discloses another’s trade secret without consent.  If the information is generally known by the public or those within the industry, or if the information is readily ascertainable (i.e., via the internet), then it’s not a trade secret.

In the litigation between KBS and ARC, KBS claims that three of its former broker-dealer employees misappropriated trade secrets by downloading KBS information and using it to compete against KBS after they joined ARC.  Specifically, KBS claims that one former employee, on the day that he resigned, emailed to ARC a large spreadsheet containing a record of all KBS sales.  KBS also claims that two other former employees downloaded confidential information from KBS’ proprietary sales database, including contact information for registered dealers who sold the company’s REITs, and KBS’ former employees used that information after joining ARC.  That information could have value because nontraded REITS are sold almost exclusively through independent broker-dealers.

Who will win?

Who will win?  In trade secret cases, the ultimate outcome is so fact driven and there is so much “gray area” in the law that it is difficult to predict or handicap the final verdict.  For example, courts often hold that basic contact information of clients or key allies is not a trade secret, especially where that information is readily available on LinkedIn and other websites.  On the other hand, a trade secret finding is much more likely if contact information is mixed with more detailed (and less publicized) data such as pricing, ordering preferences, or other operational facts built up through research and experience.  If successful, trade secret claims can result in actual damages, recovery of unjust enrichment, imposition of a reasonable royalty on profits made through the trade secret theft, and (in cases of willful/malicious misappropriation) exemplary damages and attorney’s fees.

Just like other companies, real estate investment vehicles need to protect their valuable trade secrets, most typically by requiring employees to sign agreements acknowledging the company’s trade secrets, limiting and monitoring access to confidential information, with extra sensitivity during times of key employee departures.  Similarly, when hiring, great care should be taken to ensure that the new employees don’t bring their former firm’s stolen trade secrets with them.  Simple steps like these can avoid the courtroom and keep the focus on the “dirt-based” kind of property.

NEWSFLASH-Congress may actually do something.

There is talk of a bipartisan (you read that right, BIPARTISAN) bill to provide redress for trade secret theft in federal courts. Today trade secrets are the poor relations of patent, copyright and trademark, which all enjoy federal protection, but that may soon change.

Trade Secrets Sound Cool, Do I Have One?

A trade secret is confidential/proprietary information that (1) has economic value because it is not generally known and (2) is the subject of reasonable efforts to keep confidential/proprietary. KFC’s 11 herbs and spices, Coca Cola’s formula or perhaps your customer list (assuming you took reasonable steps and the list has economic value) are prime examples of trade secrets. On the other hand, if your competitor can hire a Gen-Xer or Gen-Yer to obtain the same information on Google, it’s not a trade secret.

Current Trade Secret Protection

Trade secret law evolved from the common law, law created over time by judges’ decisions, which was then codified by a group of intellectual property lawyers into the Uniform Trade Secrets Act (the “UTSA”). The UTSA has been adopted, at least in some form, by 48 states. Apparently New York and Massachusetts are holding out for a sweeter deal. For example, in California, a state where you can’t throw a cat without hitting a trade secret, the UTSA begins at section 3426 of the Civil Code. Today, there is no federal cause of action for trade secret theft, and victims are generally required to litigate in state court.

The Proposed Federal Trade Secret Legislation

The proposed federal “Defend Trade Secrets Act” would expand the Economic Espionage Act, set forth in 18 U.S.C. § 1831, to create a federal cause of action for trade secret theft. The Defend Trade Secrets Act generally mirrors existing state law under the UTSA, but the proposed federal law is limited to trade secret theft relating to “a product or service used in, or intended for use in, interstate of foreign commerce.” As with most state trade secret statutes, a victim can seek ex parte injunctions (emergency Court orders preventing the destruction, dissemination or use of alleged trade secrets, requiring the return of such information and, in some instances, prohibiting a former employee with such information from working for a competitor). It also authorizes awards of treble damages and/or attorneys’ fees for willful or malicious misappropriation. Under the proposed Defend Trade Secrets Act, the statute of limitations (deadline for filing a lawsuit) is five years, which is longer than the three-year deadline in California and many of the states that have adopted the UTSA.

Why Should I Care?

If the 48 civilized states have adopted the UTSA and the remedies are similar, why do we need a federal Defend Trade Secrets Act? First, if your trade secrets are stolen and the thief is using them in multiple states, you’ll have any easier time litigating the entire case in one federal court compared to suing in multiple state courts, which may have different rules and standards and might well require you to deploy a platoon of lawyers. Second, federal courts apply federal rules, which in many cases are more efficient than state rules. For instance, in federal court the parties are required to voluntarily exchange key documents and information at the outset of a case. Whereas in state court, parties usually must serve discovery requesting such documents and information and actually obtaining these can be like pulling teeth. Third, in many jurisdictions, federal courts are less impacted than state courts, so litigants are likely to get more attention and get relief sooner. Finally, the Defense of Trade Secrets Act may provide a good reason to ignore the idiom “don’t make a federal case out of it.” If you’re looking to protect your trade secrets, you might prefer to drag the thief in front of a federal judge, appointed for life and approved by the Senate, whom the thief might find little more intimidating than facing a local state judge, whose reelection signs can be seen on lawns and billboards every four years.

In most cases, those looking to protect their trade secret rights will benefit from the proposed Defense of Trade Secrets Act.