Friday, July 20, 2018

The Trade Secret-Contract Interface

Deepa Varadarajan's new article, The Trade Secret-Contract Interface, published in the Iowa Law Review, explores the role of contracts in trade secret law. This article returns to an issue that remained unresolved following rich exchanges between Robert Bone and other scholars such as Michael Risch and Mark Lemley. Varadarajan's article is a welcome follow up.

The Prior Debate: Does Trade Secret Law Have An Independent Justification?

Prior scholarship probed whether trade secret law is justified separate and apart from contract law. Contract law operates on the notion that parties who enter into an enforceable agreement with one another can sue a counter-party who breaches and obtain damages in an amount that approximates the benefit of the bargain. In contrast, the owner of a "trade secret"—information that is not generally known and has been the subject of reasonable efforts to maintain its secrecy—can sue another who misappropriates the trade secret, regardless of whether they are in a contractual relationship. The trade secret owner can obtain an injunction to protect the sanctity of the secret, not just money damages.

In his 1998 article, A New Look at Trade Secret Law: Doctrine in Search of Justification, Robert Bone argued that trade secret law lacks a theoretical justification distinct from other legal theories, in particular contract law. When trade secret law reaches beyond contractual liability, Bone wrote, trade secret law subsists in a "normative vacuum that continues to remain unfilled." Within that vacuum, judges "view trade secret law as a relatively open-ended delegation of authority to police the morality of commercial relationships." (Bone, 245).

In the wake of Bone's bombshell, several academics sought to justify trade secret law. Two of the most oft-cited papers seeking to do so were those of Michael Risch (2007) and Mark Lemley (2008).

Several justifications for trade secret law emerged from these discussions. The seeds of most of them can also be found in the Supreme Court's crucial holding in Kewanee Oil Co. v. Bicron Corp. (1974), where the Court held Ohio's trade secret statute was not preempted by federal patent law.

(1) Promoting Innovation Beyond Patents
First, trade secret protection, like patent protection, serves to promote innovation, including patentable as well as unpatentable innovation. As the Court put it in Kewanee, "[t]rade secret law encourages the development and exploitation of those items of lesser or different invention than might be accorded protection under the patent laws, but which items still have an important part to play in the technological and scientific advancement of the Nation."

(2) Promoting "Disclosure"
Second, trade secret law, like patent law, promotes disclosure of information. But while patent law encourages public disclosure in patent specifications, trade secret law encourages "disclosure" within firms (between employers and their employees and between employees) and between firms (especially between licensors and licensees of protected information). As the Court explained in Kewanee, without trade secret protection,
"[t]he holder of a trade secret would not likely share his secret with a manufacturer who cannot be placed under binding legal obligation to pay a license fee or to protect the secret. The result would be to hoard rather than disseminate knowledge."
(3) Limiting Expenditures On Costly Precautions
Third, trade secret law reduces the costs of self-help. In Risch's words, trade secret law provides "incentives for businesses to spend less money protecting secret information or attempting to appropriate secret information." (Risch, 44).  Back in 2007, Risch gave a helpful "real world example" from his law practice.
"A client proudly told me about how his company’s new development center in China was set up to protect trade secrecy: fingerprint scanners, almost no Internet access, expensive network filtering appliances to scan outgoing email, special locks on the computers... and so forth. These expensive and potentially efficiency-reducing measures are not installed in the United States (though here there are other more “standard” precautions). The only difference in the client’s decision making is the perceived inability to enforce trade secret rights in China."
(Risch, 44). While hardly empirically bulletproof, Risch's example suggests that a contract-only regime does a sufficiently worse job at protecting information as to make a difference in companies' expenditures on precautions.  (Douglas Lichtman also wrote a paper on the self-help issue in 2004).

(4) Channelling Subject Matter Into, And Out Of, The Patent System
Lastly, trade secret law, in Lemley's telling, helps to "channel" subject matter between the domains of trade secret protection, which requires retaining near-absolute secrecy, and patent protection, which requires near-total public disclosure. Lemley implied that channelling can only effectively occur if trade secret law is conceived as a property-like regime with strict subject matter restrictions, including first and foremost, secrecy.

But none of this convinced Bone. In his 2014 follow-on article, The (Still) Shaky Foundations of Trade Secret Law, Bone remained convinced of the fundamental soundness of his earlier critique, writing:
"I have learned much from this work. But it does not convince me that broad legal protection for trade secrets is justifiable. I remain skeptical that there is a normative basis for a freestanding trade secret law that is not parasitic on other legal norms."
(Bone 2014, 1804).

Bone's response (and thanks to Jeanne Fromer for reminding me to read it!) is particularly relevant as we move into a new world of federal civil trade secret law under Title 18. A few of Bone's key critiques are worth highlighting, as they could prove useful areas for empirical study:
  • "[I]t is not clear how much additional incentive trade secrecy adds [as an incentive to innovate], given that patent law already provides indirect incentives for nonpatentable inventions ... and .... firms already have market incentives to develop nontechnological, commercial information."  (1812). 
  • "[Trade secret protection] diverts investment away from patentable inventions by enhancing the private value of nonpatentable ones...[and] frustrates the disclosure goals of the patent system when firms opt for trade secrecy to protect patentable inventions." (1813) 
  • "[Contrary to what the Supreme Court stated in Kewanee,] trade secrecy does not publicly disclose inventions. It discloses to a contracting party but only under confidentiality constraints. That party learns the invention and might profit from the general knowledge in future work. But it cannot teach the information to others." (1814). 
  • "Defenders of trade secret law continue to insist that trade secrecy can be justified by its salutary effect on the precaution-stealing arms race. However, none of the more recent arguments add all that much to the analysis. Indeed, some treatments simply reassert the benefit without addressing any of the detection or litigation-cost problems [i.e. that the option to sue for trade secret misappropriation comes with its own costs.]."
All of these critiques remain subjects of controversy. If Bone is (still) right that trade secret law is not justified except as a "parasite" on other legal norms, or at least not quite enough to justify the costs of introducing it, then the new federal trade secret law subsists in a "normative vacuum" too.

Varadarajan: Maybe Contracts Are The Boogeyman, Not Trade Secrets

And now we come to Varadarajan's new article, The Trade Secret-Contract Interface. It's not exactly a "bombshell," but it does pry open a very important sliding door that hopefully others will enter.  (Forgive the metaphors; it's been a hot summer).

The subject of the prior debate was whether trade secret law is justified independently from more traditional legal regimes like contract. In her new article, Varadarajan builds on this scholarship. But she enters the discussion from a different angle. Whereas Bone and the others debated how to justify trade secret law apart from contract law, Varadarajan's purpose is to probe, and ultimately criticize, the pervasive role of contracts within, and around, trade secret law.

As mentioned above, contract law can be far weaker than trade secret law. This is because trade secret law acts in places where no contract exists, and provides a far blunter remedy. "Efficient breach" is not possible in trade secret; courts may impose injunctions even in cases where this leaves the trade secret owner with more than she bargained for. (To give one example, courts, including in my state of Ohio, may impose lengthy "headstart" injunctions "in order to eliminate commercial advantage that otherwise would be derived from the misappropriation.").

Take the example of the high profile Waymo/Uber lawsuit, in which Waymo sued Uber in order to stop Uber from acquiring and using trade secrets that Uber employee Anthony Levandowski allegedly obtained while working for Waymo. (The case subsequently settled.) Waymo never got Levandowski to sign a non-compete agreement and could not have done so given the California ban on non-competes, but using trade secret law Waymo might have obtained a permanent injunction preventing Levandowski from working at other firms like Uber, or even from working on self-driving cars period. Waymo never entered a contract with Uber at all; they were not in privity. Yet under trade secret law, Waymo could reasonably argue that Uber misappropriated trade secrets by hiring away Levandowski with knowledge that he came onboard with "14,000 highly confidential and proprietary files" containing Waymo information. If Waymo had succeeded at trial, it could potentially have enjoined Uber's entire self-driving car operation for years into the future.

Try doing that through contract law.

Yet at the same time, contract law can offer stronger protection for information than trade secret law. A principle reason is that contract protects a broader scope of information than trade secret law does. Waymo, for instance, could have accomplished a good deal using contracts. What if the information Levandowski took wasn't really a trade secret? Waymo still could have sued Levandowski for breach of contract with respect to "confidential," if not actually "trade secret," information he obtained while working at Waymo. Even without the ability to make Levandowski sign a non-compete agreement, Waymo could, and presumably did, have Levandowski enter a variety of contracts as a precondition to employment, ranging from non-disclosure to non-solicitation agreements. (On this point, see Jonathan Barnett and Ted Sichelman's working paper, arguing that companies in states that don't enforce non-competes have plentiful alternatives for limiting post-employment competition.) In addition, Waymo could have contracted with Uber and other competitors to agree not to "poach" each others' employees. True, the legality of anti-poaching agreements is seriously questioned. But the New York Times just reported that until recently major fast food companies like Arby's, Carl's Jr., and McDonald's used controversial "no-poach" clauses all the time, at least among franchises.

Varadarajan identifies two distinct functions that contracts play within trade secret law.

The Evidentiary Function of Contracts

The first function is evidentiary. When courts assess a trade secrecy claim, they use contracts as evidence to support two key elements. (Varadarajan, 1557-1559).

First, contracts provide evidence for whether or not the subject matter is protected. U.S. trade secret law requires the owner of a trade secret to take "reasonable measures to keep such information secret[.]" 18 U.S.C. § 1839(3). Contractual protections are often crucial for establishing reasonable secrecy precautions. As Varadarajan notes, citing studies by David Almeling and his colleagues, “confidentiality agreements with employees and business partners are the most important factors in the courts’ analysis of reasonable measures.” (1557) (citing David S. Almeling et al., A Statistical Analysis of Trade Secret Litigation in State Courts, 46 GONZ. L. REV. 57, 69 (2011)). Thus, when putative trade secret owners fail to use contracts to protect their information, by requiring non-disclosure agreements when exchanging information with manufacturers and by requiring confidentiality contracts when hiring employees, they are more likely to lose in court.

Second, contracts assist courts in determining whether the defendant was under a duty of confidentiality. U.S. trade secret law does not impose liability for disclosing or using another's information unless the person does so using "improper means" (e.g. breaking into a factory) or in breach of a "duty to maintain the secrecy of the trade secret."  18 U..S.C. § 1839(5). (There is also a claim based on mistaken disclosures). There is not always a written contract indicating that a person owes a duty to maintain the secrecy of given trade secrets. In those cases, courts may nonetheless "imply" a contract, either as a matter of fact ("implied in fact") or as a matter of law ("implied in law").  Varadarajan  argues courts are "wary" of implying contracts in the absence of good evidence, though, perhaps notably, she only cites a around five cases for this proposition, and one "but see." (1559-1560, nn. 88-89). This is important to her argument because if courts find "implied" duties to maintain secrecy everywhere, then contract isn't doing as much work as Varadarajan suggests in establishing liability.

This first part of the article (Parts I, II, and III) is largely descriptive. Varadarajan's contribution is simply to explain what trade secret lawyers and students already know: that in practice courts look to contracts as evidence that trade secrets exist and that defendant was under a duty with respect to those secrets. But Varadarajan also provides a simple explanation for contracts' utility in both establishing the existence of a trade secret and in establishing whether misconduct occurred. Drawing on her prior work, she argues that contracts, assuming they are clearly drafted and suitably represented to all relevant parties, provide "notice" as to what is protected, and what is not. "The pivotal evidentiary role of contracts in trade secret cases," she concludes, "stems largely from [contracts'] notice function." (1560).

Varadarajan is right to focus on notice. In patent law, patent disclosure and the claims in particular play an important notice function, alerting others, including potential infringers, of the patentee's rights and of the possibility of future litigation. See Nautilus, Inc. v. Biosig Instruments, Inc., 134 S.Ct. 2120, 2129 (2014) ("[A] patent must be precise enough to afford clear notice of what is claimed, thereby "`appris[ing] the public of what is still open to them.'") (citations removed). But in the trade secret context, the people who encounter trade secrets may not always know or even suspect that a trade secret exist.  "Unlike patent law," Varadarajan writes, "trade secret law does not require putative trade secret owners to formally apply for or describe the boundaries of asserted trade secrets." Thus, the trade secret defendant "does not even learn of the existence or precise boundaries of the trade secret she is alleged to have violated until she becomes the subject of litigation." (1560).

Her theory, in short, is that clear contracts "can help alert recipients of information about the existence and scope of claimed trade secrets[,]" (id.), thus avoiding the uncertainty and unfair surprise that comes with invisible boundaries. Interestingly, while Varadarajan does not appear to take a stance on the debate mentioned above about which legal norms best justify trade secret law, but her focus on notice as a sign of "possession" sounds more in property theory than in contract.

The "Evasive" Function of Contracts

The second function Varadarajan identifies for contracts is substantive rather than evidentiary. Along with serving as ex post evidence of a viable trade secret claim, contracts can be used by sophisticated parties to get around or "evade" the boundaries of trade secret protection. Varadarajan calls this (I think far too leadingly) contracts' "evasive" function.

Varadarajan's identifies several "evasive" uses of contract in the trade secret context, including:
  • use of contracts to expand the subject matter of protectable information beyond a legal trade secret; 
  • use of contracts to eliminate potential reverse engineering defenses, for instance by publicly selling software subject to a license containing an anti-reverse engineering clause; and  
  • use of contracts to prevent employees from working for competitors after they leave, i.e., non-compete agreements. 

If the prior part of the article is descriptive, this part (Part IV and V) is highly normative. Drawing on the work of others like Orly LobelPam Samuelson, and Rochelle Dreyfuss, Varadarajan asserts that contracts are being used to inappropriately "evade" the doctrinal limits of trade secret law. "While contracts can perform a valuable notice function in trade secret law," she writes, firms "use contracts strategically to evade trade secret law’s requirements and limitations." (1563). She thinks this is problematic because, in her words,
firms’ pervasive use of contracts to subvert trade secret law’s requirements and limitations can negatively impact cumulative innovation and employee mobility.
(1576) (emphasis added by me).

The most basic example of this problem (though, as I will explain, I am not sure it is a problem) is when firms use contracts to protect relatively confidential information that may not qualify as "secret."  Varadarajan asserts that "[p]utative trade secret owners use contract law to evade [the] ongoing 'secrecy' requirement and chill uses of non-secret information—in effect, enlarging the scope of protectable information." Quoting Lobel, she makes the semi-empirical claim that "'[c]ontractually, it has become standard to include broad and open-ended lists of confidential information that goes beyond the statutory definition of trade secrets.'" (1565) (quoting Lobel).

To be clear, Varadarajan does not contend that any use of contracts to protect information should be viewed with suspicion. Rather, she argues contracts should be scrutinized more or less strictly, depending on where they fall on the "negotiability spectrum." (1573-1574). On one end, are business-to-business contracts involving sophisticated parties; on the other end are corporation-to-user and employer-to-employee contracts, where one contracting party may have unequal levels of information and bargaining power.  (1574).

Since most contracts at issue in trade secret litigation are likely to fall on the latter end of this spectrum (primarily, contracts signed by employees), this stance would cast suspicion on many of the contracts courts currently see in trade secret disputes. For instance, non-compete agreements, which prevent employees from working for competitors for a set period following departure, would be more strictly scrutinized, even in states where they are not banned, by virtue of the fact that, as compared to licensing contracts, they involve parties with unequal bargaining power.  (1577) ("[C]ourts should be more skeptical of employee and consumer contracts that depart from trade secret default rules.").

Varadarajan discusses various doctrinal ways to weaken these contracts: preemption, misuse, and traditional non enforceability of contract. (1576-1590). Without going into these solutions, I'll just note that none of them appears to have much of a bark. (See, e.g., 1588) ("Even in the employment context, where employees often assent under conditions of information asymmetry and disparate bargaining power, unconscionability arguments have held little sway.").

From Contract To Trade Secrets To ... Contracts

I am not convinced that this boogeyman exists. The earlier debates surrounding Bone's 1998 article implied that, where there is a contract in place, a legal remedy is more justified than when no contract exists. Yet Varadarajan suggests that relying so heavily on contracts is problematic, and that now contracts need to be justified when they go beyond the confines of trade secret protection.

Like Varadarajan, I also see irony in the trajectory her article describes: trade secret law has its origins partly in contract law; yet now companies use the existence of trade secrets to justify broad enforceability of their contracts.
[F]irms try to legitimize non-competes by invoking their connection to trade secret law—yet ironically, non-competes enable firms to bypass trade secret law’s requirements and limitations altogether. ... Indeed, “courts across the country point to the protection of trade secrets as the primary justification for enforcing non-competition covenants.”
(1572) (quoting Charles Tait Graves' article in Rochelle Dreyfuss and Katherine Strandburg's outstanding handbook on trade secrecy).

But there still has to be more discussion of why using contracts instead of or on top of trade secret law is inefficient, immoral, or what be it. In deciding whether this problem really exists, it is useful to disaggregate the two scenarios identified above: the evidentiary function of contracts, on the one hand, and the substantive function, on the other (what Varadarajan calls their "evasive" function).

With respect to contracts' evidentiary function, I cannot see much of a problem with courts looking for a contract in deciding whether to impose trade secret liability. As Judge Posner famously observed in Rockwell, the more precautions a putative trade secret owner takes, whether physical or contractual, the more likely they 'deserve' legal protection, and the more likely the misappropriator was on notice that the information was to be protected. See Rockwell Graphic Systems, Inc. v. DEV Industries, Inc. (7th Cir. 1991) ("...the more the owner of the trade secret spends on preventing the secret from leaking out, the more he demonstrates that the secret has real value deserving of legal protection, that he really was hurt as a result of the misappropriation of it, and that there really was misappropriation.").

The only instance I'd see this evidentiary function as controversial is where the employer uses contracts in ways that, while virtually costless to them, do not really provide meaningful notice of what is off limits. (See discussion on page 1567). But under ordinary circumstances, when a court finds that contractual agreements to retain confidentiality abounded, and that the employee clearly signed and understood them, the justifications for imposing trace secrecy should be more, not less, robust.

Contracts' substantive/"evasive" function seems inherently easier to critique—at least in the way Varadarajan characterizes it. As noted above, Varadarajan asserts that the "use of contract law to subvert the limitations and requirements of trade secret law can negatively impact innovation, as well as employee mobility." (1576).  If true, this suggests that using contracts to tie up more information than is "not generally known or readily ascertainable" in the trade secrecy sense could be bad for innovation and welfare.

But is this true? The cases of non-compete agreements and anti-reverse engineering clauses are particularly controversial and have been critiqued by many. Notably, the non-compete case is especially controversial because it implicates external concerns—to quote Viva Moffat in the Akron Law Review, non-competes raise questions about "personal autonomy and liberty." Varadarajan relies heavily on these critiques, without proving they are true or addressing the counter-arguments with more than a "but see."

Leaving aside the non-compete and reverse engineering cases, Varadarajan does not provide any evidence to support that expanding protections through contract is bad for innovation or welfare generally. This is a problem because the onus is on her to show that contracts should be treated with suspicion.

The law and the norm at the state and now federal level is that contracts can be used to protect information that does not qualify as a trade secret. The UTSA does not preempt contractual remedies, "whether or not based upon misappropriation of a trade secret." As Varadarajan notes, this almost certainly does not change post-DTSA. (See discussion on pages 1580-1583). The DTSA does not preempt state law remedies and does not touch state law contracts. 18 U.S.C. § 1838.

It is possible to make a compelling argument that trade secret law's current 'anti-preemptive' stance on contracts is bad. Varadarajan notes briefly that some commentators have made this argument. Dreyfuss, for instance (channeling Lemley's channeling function), argued that when trade secret owners augment their rights with contracts, this upsets the balance between trade secrecy and patents; thus, these contracts should be vulnerable to preemption by federal patent law. (Varadarajan, 1579-1580).

But the reverse argument is strong.  As Varadarajan notes, "[f]or strong proponents of freedom of contract," contractual provisions that conflict with trade secret law should "essentially 'always'" be enforced, "constrained perhaps only by antitrust law." (1576).  We cannot simply forget Bone's bombshell when it suits us. His entire premise was that contracts lie on stronger normative footing than trade secret law. To quote his 2014 article:
"[W]hen trade secret law imposes liability for breach of a contractual duty of confidence, the policy reasons for doing so are simply those that support contract enforcement more generally." 
(Bone, 2014, 1806) (emphasis added).

On this reasoning, if parties agreed not to use or disclose certain information, the court should enforce the contract even if the information isn't a trade secret, especially if the party is seeking only contractual remedies.

The response to this point, of course, comes not from the contract field, but from the intellectual property field, where the Supreme Court has said over and over that protecting information outside the bounds of patent law has potential costs for innovation. This was (I think) Lemley's main reason for analyzing trade secrets as a branch of intellectual property. As he put it,
"[t]reating trade secret law as an IP right dependent on proof of secrecy highlights the policy stakes, and will encourage courts to preempt common law claims that threaten to undermine the balance trade secret law strikes."
This quote suggests that Lemley embraced trade secret-as-intellectual property due to intellectual property's limits, and close attention to information as a public good, more than its "property" aspect.

And yet. Contracts are still different.

Varadarajan briefly gives lip service to this debate between freedom of contract and freedom of information. (1576) ("While antitrust law can police some egregious forms of anticompetitive conduct [effectuated through contracts], it is not designed to address other IP policy concerns—for example, promoting innovation or protecting the public domain.").  But I did not see quite enough of this back and forth in her article. Instead, she relies heavily on the arguments of others such as Lobel, and reverts to the standard story of "more protection bad; less protection good"—but without explaining exactly why.


To conclude, and as can clearly be seen from the length of this post, Varadarajan's article is a tremendously enlightening read and a fantastic beginning. It does a lot of the leg work towards deepening understanding of an evolving area of law: the trade secret-contract interface.

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