It seemed like such a good idea at the time. Quicken Loans affiliate Title Source had signed an agreement with start-up HouseCanary to build specialty software. The relationship deteriorated, and Title Source sued to avoid the $5 million fee it had agreed to pay. To underscore its determination, it served the lawsuit personally on HouseCanary executives at their trade show booth, right in front of their customers.
Commercial litigation often starts with this sort of bravado, and Title Source apparently felt it had been seriously wronged. But less than two years later, in March 2018, a jury disagreed. It decided that Title Source had used HouseCanary’s secret data to build a competing product and slapped it with a verdict for $706 million.
The back story of this turnabout case provides some important lessons, grounded in the special nature of trade secret disputes. But first let’s understand how a hopeful software development deal turned so ugly.
Real estate appraisals traditionally rely on a physical inspection by a trained professional. But much of the data they collect about a house is already available online, or can be extrapolated. So just like many other industries, this one is undergoing disruption through automation, as firms develop Automated Valuation Models, or AVMs.
Title Source, one of the country’s largest title insurance and real estate valuation companies, signed a contract with software start-up HouseCanary to develop an AVM. The product would be licensed to Title Source for an annual fee of $5 million, but HouseCanary would maintain ownership and rights in its own data. The relationship began to break down over requested changes, and Title Source decided that it wasn’t getting what it bargained for. In the meantime, HouseCanary had shared its secret information with Title Source engineers.
Those same engineers were tasked with building their own AVM. From the perspective of Title Source, this project was necessary in order to cover for HouseCanary’s failures and to mitigate the damage it was suffering. When the time came to pay the $5 million fee, Title Source decided that an aggressive litigation strategy would best serve its needs and reflect its frustration.
This is where the drama begins its teaching. Title Source believed its own narrative, in which it was a victim of HouseCanary’s breach. Its commitment to that narrative masked the possibility that hidden in the records of the two companies’ dealings lurked a massive potential liability. When emails were produced as part of the litigation, it appeared that the engineers tasked with building Title Source’s AVM had used HouseCanary’s confidential information to do it. (One email exhorted colleagues to “think big and wide about how to maximize the value of the HouseCanary data to our business.”)
Some of this evidence was ambiguous, and Title Source argued that what it did was within its rights. But it was looking through its own lens, and didn’t fully appreciate the risk that HouseCanary’s alternative narrative of deliberate misappropriation would be accepted.
Why didn’t Title Source see the potential disaster when deciding whether to sue? The answer almost certainly lies in the emotional content of disputes where information has been shared between companies. The relationship starts, as it must, with declarations of trust on both sides. So when things start to go downhill, disappointment morphs into loathing and a sense of victimhood. Each side, anxious to see its own behavior as fully justified, develops a committed perspective.
Here, the miscalculation had very serious consequences. HouseCanary, having convinced the jury that its information had been misused, was able to present a simple and compelling damage model. It argued – again, using its adversary’s own records – that Title Source planned to save a certain amount of money on each AVM that it sold. Assuming that it would have taken two years to develop that product legitimately, and using internal projections of likely use, the benefit to Title Source worked out to be over $201 million.
The jury accepted that calculation, and added HouseCanary’s lost profits of almost $34 million. Then, because it had embraced HouseCanary’s narrative of a deliberate misappropriation, the damages were tripled, for a total of $706 million.
The first lesson we can extract from this story is cautionary: assessment of risk in potential litigation requires a sober, objective analysis of the evidence, with plenty of “devil’s advocate” scenario planning. This means resisting the kind of confirmation bias that can interfere with management’s ability to appreciate how the same facts can be interpreted in different ways.
Second, and closely related to the first point, we need to be aware that trade secret cases often spring from facts learned in unrelated litigation. In one case I worked on, a patent infringement claim led to the production of records showing that a misappropriation had occurred more than fifteen years earlier. Because the statute of limitations runs from the time of discovery, the accumulated damage claim was massive, and immediately the trade secret claim eclipsed the patent dispute.
Third, the HouseCanary verdict provides a reminder of the flexible and often generous way that damages are calculated in trade secret cases. The aggrieved party can collect not only for the damage it has suffered, but also can recover the perceived benefit received by the defendant, even if it hasn’t produced any profits or even any products.
Finally, this case suggests that companies engaged in collaborative development of technology need to manage the process very carefully to reduce the risk of later disputes. Clear protocols and careful record keeping around the receipt and use of confidential information will go a long way to prevent problems.
And a bit of training in how to draft emails wouldn’t hurt.
In the wake of Uber’s blockbuster trade secrets lawsuit, prompted by its hiring of the manager of a competitor’s self-driving car program, one of the company’s lawyers published an articlecomplaining about the law that protects “negative information” stored in a person’s head. It was crazy, he argued, to force employees to feign amnesia and to deliberately repeat mistakes made in their last job, in the name of protecting confidential information.
As you may recall, a few months ago I wrote positively about negative trade secrets, invoking Edison’s string of failed experiments that led him to a working light bulb. That kind of information in the hands of a competitor would allow it to catch up without the effort, investment and risk faced by the original innovator. So it makes a lot of sense that the law protects against disclosure of the failures, mistakes and dead ends of research.
But how can we provide that protection in fast-growing industries where employees often leave to work for the competition? How can they be expected to apply their well-earned skill but to remain silent when they see their new team going down what they know is a hopeless path? And even if they are careful never to signal with an eye roll or grimace, won’t the former employer sue them anyway once it sees a competing product? Wouldn’t it be more fair – and more efficient – to just allow them to use whatever “negative” information they remember, so long as they don’t take records with them?
I don’t think so. Protecting knowledge of failed experiments encourages companies to invest in deep, long-term and risky research, since they know others can’t easily catch up. And there is other social value in the “inefficiency” of requiring competitors to do their own homework. That’s because they probably won’t follow the same path. What the first company considered a “failure,” when encountered by the second company, may provoke a new and unique insight. Indeed, this is how a lot of innovation happens, and it’s why some organizations deliberately set up competing teams to pursue identical objectives.
The same principle that recognizes value in redundancy of effort can apply to individuals as well as companies. Rather than lamenting the prospect of wasted re-work, departing employees can look forward to a new environment to apply their skills. They can challenge the assumption of past “failures” by taking a fresh look at the process of discovery, searching for new ways to tackle old problems.
But while that sounds fine in the abstract, the practical challenge remains: how does someone take his or her accumulated experience to a competitor without getting sued? And from another perspective, how do you hire someone with experience and skill, to make sure that’s all you’re getting? Here are a few suggestions.
First, recognize the risk that is wrapped inside the opportunity. Is this new position likely to put the employee in an ethical hot seat? If everyone has asked the right questions in the interviews and has been honest about what challenges the new company is facing, you can also identify the risk of having addressed the same or similar problems for the competitor. If so, are these issues critical to the expected work assignment, or merely incidental?
Second, discuss the nature of the risk at a high level, without getting into the specifics of the previous assignment, but identifying the areas where there may be some concern about applying prior knowledge of what doesn’t work. You should both agree that no one will ask for, or provide direction from, that learning. But if the discussion leads to real anxiety about whether confidentiality can be managed this way, it may make sense to temporarily steer clear of any project that looks like it will cover the same ground as the previous job. In any event, you should establish an understanding that all of the work to be done will be firmly grounded on general knowledge and skill.
Third, you should directly address what is that knowledge and skill, and how you expect it to add value in the new position. To be especially safe, the employee might also want to prepare by brushing up on the state of the art in the relevant field of work, so that they can think, speak and act comfortably from that platform.
Even in highly competitive industries we can enjoy the benefits of labor mobility while still respecting the value of “negative” trade secrets. All it takes is a healthy respect for risk and a willingness to start over in the pursuit of something better.
Here in the U.S. we have a litigation system for pre-trial “discovery” that allows access to virtually every email and every record a company owns. It costs businesses more than $40 billion every year. Foreign countries, where there is no “discovery,” sneer at this self-inflicted injury, and foreign companies do all they can to avoid getting involved in it.
Except when we give them a free pass to visit and try it out.
What would you think if I told you that anyone from France or China or Brazil that was just thinking about some legal action in their country could come here and easily force discovery from a U.S. company, even though they couldn’t dream of getting the same information through their home courts? Crazy, right? That is exactly what has resulted from a law that’s so obscure it doesn’t even have a name, so we call it by its legal citation: 28 U.S.C. Section 1782.
Congress put Section 1782 on the books decades ago, motivated by the generous impulse to help foreign courts and litigants get information they needed, and to encourage foreign countries to pass similar laws that would give our citizens the same kind of access. On the first objective, the law has been a resounding success. In recent years petitions under Section 1782 have grown to over sixty per year.
On the second one, here’s a quick quiz: how many countries do you think have enacted laws inviting our litigants to come and get discovery from their corporations? Sorry, no prize for guessing the correct answer, zero. In fact, a number of countries have responded rather rudely by passing laws that prohibit any use inside their borders of otherwise reliable information, just because it is the product of the U.S. discovery system.
But we have forged ahead anyway with our unilateral offer, nursing the hope that someone will emulate our generosity. What exactly is the offer? Under Section 1782, any “interested person” can petition a U.S. federal court to force someone “found” here to produce documents and testimony for use in a foreign “proceeding.”
It used to be that everyone assumed that getting an order like this would be at least modestly difficult. Naturally the discovery would have to be really helpful, and so you would have to show at least that the information would be admissible in the foreign court. And of course it had to be a court that wanted it, to help inform a proceeding that was, well, proceeding. And the petitioner, you would assume, would have to be a party to that foreign proceeding.
All of these were reasonable assumptions, but they all turned out to be wrong. About 15 years ago AMD tried to use Section 1782 to get discovery from Intel that it could then turn over to the European Commission, which it hoped would begin antitrust enforcement against its competitor. The federal district court denied the petition: no proceedings were underway, only “contemplated.” No foreign court was involved, only a government agency. AMD was not a party. And if the information had been located in Europe it would not have been accessible to the Commission.
The U.S. Supreme Court reversed, holding that the statute was broadly worded, and if Congress wanted to put limitations on it, it had to say so. Needless to say, this ruling caused a lot of lawyers to dust off their statute books and take another look at Section 1782, causing a dramatic uptick in filings. In fact, some law firms are now marketing this law to foreign companies as a way to collect information that they couldn’t get in their home courts.
Congress has taken notice, and the House Judiciary Committee recently held a hearing at which I was invited to testify. There I described the Section 1782 process as a “one way street for the acquisition and export of U.S. information.”
But I wasn’t there to focus on the asymmetry of this law. My concern was rooted in the fact that it includes no safeguards to ensure that the discovery material — which often can include very sensitive trade secrets — is protected against disclosure or misuse once it lands in the foreign court (or agency).
This is not an abstract problem, I explained. While U.S. courts regularly issue “protective orders” closely guarding information exchanged in litigation, foreign courts and governments often don’t have any similar tools. In fact, most countries’ laws are insufficient to protect trade secret rights in general, and even less so when information is in the hands of courts that have to guarantee public access. Even the European Commission, in proposing the EU Trade Secrets Directive to its member states, recognized that Europe had a serious problem, saying that the “main factor that hinders enforcement of trade secrets in Court derives from the lack of adequate measures to avoid trade secrets leakage in legal proceedings.”
So if we really want to help our sister courts in other countries, we should send them sensitive information only when we have first wrapped it up in limited use restrictions. That is why I suggested in my testimony to Congress that an important “fix” to Section 1782 would be to require that federal judges consider the risk to U.S. trade secrets when ruling on these petitions. And if they allow the discovery, it should come with serious, specific requirements on how it can be used in the foreign “proceeding” to avoid loss or damage.
Let’s hope that closing this loophole is something that both political parties can agree on.
You can read my formal remarks here and watch the entire hearing here.
In a boat out on the lake, the little boy says, “Grandpa, why are we holding our poles out here?” I say, “Because that’s where I think the fish are.” “Will we catch any?” “I don’t know. Let’s wait and see.”
To anyone familiar with the discovery process in U.S. litigation, involving production of millions of emails and other electronic records, and dozens of pre-trial depositions of witnesses, it may be surprising to learn that less than a century ago we allowed none of that. Trial was the place where documents were introduced and testimony taken. The idea of getting early access to the other side’s evidence was widely derided as a fishing expedition, casting about for something you weren’t sure existed.
It took over twenty years of fierce infighting within the American Bar Association before the idea of requiring disclosure to an adversary was embraced and reflected in the 1938 Federal Rules of Evidence. Within a decade, the Supreme Court declared the corner fully turned: “No longer can the time-honored cry of ‘fishing expedition’ serve to preclude a party from inquiring into the facts underlying the opponent’s case. Mutual knowledge of all the relevant facts gathered by both parties is essential to proper litigation.” Hickman v. Taylor, 329 U.S. 495, 507 (1947)
Unfortunately, old taboos tend to linger. The first major revision to the Federal Rules issued in 1970, liberalizing the framework to make discovery easier. Objections were still framed as encouraging “fishing expeditions,” or sometimes the more dramatic “draining the swamp” of evidence. (Of course we no longer use that metaphor, since it’s been usurped by people who want politicians out of Washington.)
Broad discovery can be critical in trade secret cases, where the plaintiff may not know which of its secrets have been taken or misused. Misappropriation rarely happens in broad daylight. Although forensics can sometimes show that information has been copied or accessed improperly, often the alleged victim can only provide an educated guess as to what happened. Here in the U.S. the basic rule allows a plaintiff to file its case based on reasonable suspicion, and to use the discovery process to fill in the gaps.
Of course, modern discovery can be quite disruptive and expensive. Recognizing that there is a particular danger of abuse in trade secret cases, where defendants are often individuals or vulnerable start-ups, courts long ago began to manage this risk by requiring plaintiffs to identify the relevant secrets with “reasonable particularity.” In 1985, California decided to reinforce that requirement with a statute that prohibits a plaintiff from taking any discovery until it has complied.
Some courts outside of California have embraced this approach as sensible case management, explaining that it prevents unbounded rummaging through the defendant’s own secrets. But a few have gone further, posing the issue as not just potential harassment of the defendant but also the risk that the plaintiff, once given access to the defendant’s files, will – in the words of the judge who presided over the Waymo v. Uber case – “cleverly specify whatever happens to be there as having been trade secrets stolen from plaintiff.”
The problem with this observation is that it is unsupported by empirical evidence. And logically, one would expect – and courts can insist – that a plaintiff will be able to prove its own trade secrets by pre-existing records, eliminating the abstract concern about copying.
Naturally, discovery in trade secret cases can be abused. It’s part of a court’s job to avoid deliberate damage to a party inflicted by the cost of litigation. But in an information economy, disputes over trade secrets require access to information. We should allow all parties to a case to be properly informed by giving them access to the facts, in a way that is reasonably managed.
It’s important that trade secret owners consider this tension before filing litigation, especially in cases involving departing employees, where the relative burdens of litigation can affect how the court handles discovery.
Here are some tips to help keep your case from being stalled by aggressive demands for details about your secrets.
The overall objective is to get the discovery process moving while demonstrating that you have given careful thought to the court’s and the defendant’s need to know what you are claiming as trade secrets. Getting that issue out of the way will make it more likely that you can use discovery in the way it was intended, to “discover” facts that are important to your case.
That a plaintiff seems to be fishing is no reason by itself to view its discovery as unreasonable. In trade secret cases, just like when we’re out on the water, we go to where we think the fish are, and then we wait and see.
As I explain to my grandchildren, if we knew we would always succeed, we’d call it catching, not fishing.
There are many lessons to be drawn from Waymo v. Uber litigation. This is perhaps the most important. Lawsuits are about history, while business is about the future.
By the standards of most litigation, the suit by Waymo (a Google company) against Uber was fast-tracked, getting to trial within a year after it was filed. And what a year that was. Waymo started the case with forensic evidence showing that Anthony Levandowski, its former head of self-driving cars, had helped himself to 14,000 confidential files as he was leaving to form a start-up that Uber later acquired.
Then things started going downhill for Uber. Levandowski asserted his constitutional right not to testify. And the evidence extracted from Uber looked pretty damning. Motivated by what he called an “existential” need for autonomous vehicle technology, Uber’s CEO Travis Kalanick had secretly agreed in advance to buy Levandowski’s new company for $680 million and to give Levandowski $250 million in stock. He also agreed to indemnify Levandowski against his prior “Bad Acts” and even some future mischief. (For more details on this very unusual transaction, see my earlier article, The Most Dangerous Hire.)
The federal judge overseeing the case, William Alsup, told Waymo “You have one of the strongest records I have ever seen in a long time of anybody doing something that bad.” He issued a preliminary injunction against Uber, and he referred the case to the U.S. Attorney for investigation of criminal trade secret theft.
But Uber punched back, demonstrating that nothing from the Levandowski files had made its way into the company, and challenging Waymo’s trade secrets. Judge Alsup joined in, requiring Waymo to describe its claims with patent-like precision, and forcing the company to pick only 10 of 131 secrets to take to trial. Later, he disqualified Waymo’s damages expert and limited the damages it could claim.
While all this was going on, Uber replaced Kalanick, who had come under fire for other executive misbehavior. But each company, represented by some of the best lawyers and PR firms in the country, kept slugging it out in the courtroom and in the press. Then, just before trial, the court found that Uber suppressed an employee’s letter that seemed to confirm Waymo’s allegations of trade secret theft.
The lawsuit had all the earmarks of a classic trade secret fight, with each side emotionally invested in proving that the other was morally wrong, if not corrupt. The difference here was scale: two Silicon Valley giants acting out a riveting, continuous public drama about the next innovation wave in an already disrupted industry. So when it came to the trial, it was the hottest ticket in San Francisco.
And then at the end of the first week, to the surprise of hundreds of spectators, the case suddenly settled. Waymo would get Uber stock nominally work $245 million, and Uber’s new CEO would express contrition for having bungled the recruitment of Levandowski. An inspector would ensure that Uber’s autonomous vehicle program was uncontaminated with Waymo information. The civil case would be dismissed, leaving Levandowski without a job and under investigation for criminal trade secret theft.
What happened here? Is there anything useful we can learn from it? I think so.
Most trade secret litigation is fueled by emotional reactions to perceived wrongs. Plaintiffs feel betrayed and abandoned, and defendants feel blamed and misunderstood. Each side wants to fight in order to validate its perspective. So the lawsuit begins with great energy. But over time, new facts emerge, and the parties begin to reconsider the cost/benefit analysis of continuing the struggle.
Well before trial, Waymo had managed to achieve most of its basic objectives. Levandowski was gone from the scene. Uber in its defense had erected strong barriers against the migration of any Waymo secrets, and this prophylactic was reinforced by the judge with a pre-trial injunction. Uber had also undergone a profound shakeup at the top, and its new leaders had no attachment to the posturing of their predecessors.
Still, the lawsuit ground on for months, pushed by the momentum of early (if fleeting) victories coupled with competing hopes for a meaningfully favorable outcome. Presumably the executives of each company knew they had better things to do. But it can be hard to come to agreement when each team is engaged mostly among themselves, preparing for battle. Sometimes it takes the transparency of a public trial, where everyone sees the same facts unfolding before them, to get to yes.
The leadership of these two companies, together with their teams of advisors, have demonstrated that it is possible to recalibrate once rock-hard positions, and to shift attention to future opportunities instead of past disappointments. We should all take note.
When the auctioneer’s hammer went down, the violin sold for almost $16 million. It was one of the masterpieces of Cremona, the small northern Italian town that was the 18th-century center of violin-making. Ever since, the world’s best violinists have insisted that instruments made by Antonio Stradivari and his colleagues demonstrate a uniquely wide dynamic range and subtle tonal quality. So why can’t we make them like that now? Nobody really knows.
To begin with, the masters left no instructions. Some critics of trade secret law have cited Cremona as an example of progress “lost” because it was buried instead of published through a patent application. There are several reasons why that argument fails, but for today let’s consider the possibility that the violin makers couldn’t have passed on their secrets if they wanted to, simply because they didn’t know what made their violins sound so good.
Maybe they thought it was just their extraordinary skill. Stradivari, who worked until he was 92 and is credited with creating over 1,100 instruments, was not shy about promoting both his talents and his violins to royal buyers. His friend Guarneri was almost as commercially successful, and the Cremona luthiers as a group did nothing to dispel everyone’s assumption that the beautiful sounds were a product of nothing more than their superior individual craftsmanship. In any event, it was the result that mattered, even if no one could say what produced it.
Within the last century, as the remaining instruments were collected and prices began soaring, the search was on to re-discover the secrets of Cremona. For years, many credited the varnish. Recently, scientists discovered a particular bacterium had infested logs floating down river from the alpine forests, munching away enough of the interior of each cell to create an unusual resonance when the wood was dried and fashioned into a violin body.
So can you have a trade secret just because it produces results, if you don’t know how it works? The answer is yes; the law doesn’t require that you fully understand the mechanism that generates the effect. This is a good thing, since otherwise we might spend an inordinate amount of time peeling back the onion layers of causation in the search for the “ultimate” explanation.
In medicine, we long have used natural materials or drugs that are correlated with improvement or cure without knowing exactly how they work. Even when we think we know it, the human body’s systems, being almost infinitely complex and interdependent, laugh at us.
That doesn’t mean that the search for causation is a fool’s errand. Frequently, in trying to understand how we get good outcomes, we stumble on a related discovery that proves very helpful. This is what happened with the Cremona violins. On the heels of the revelation about cellulose-eating bacteria, researchers identified two types of fungus that perform roughly the same feat, after the fact. Applied to existing violins of lesser quality, these fungi do just enough of the right kind of damage to help the instruments approach the sublime quality of a Stradivarius.
A child, by trial and error, learns to ride a bike, but ask her how she does it and she can’t really explain. It has something to do with balance, but what is that? How many adjustments per second does she have to make? What role does speed play? (If you’re thinking none, then just compete with other family members to see who can ride the slowest without falling over.)
Machine learning, a kind of artificial intelligence, allows us to recognize patterns and establish correlations but not necessarily causation. Instead, multiple variables breed multiple hypotheses, and these become multiple opportunities for mining useful insights. A pattern extracted from big data can be applied by itself to improve the functioning of some systems, but it can also point us toward deeper understanding and even greater advantage. Discovering a secret often begs many questions, and leads to the discovery of more.
One lesson is that, when it comes to outputs, the assumptions we make about causation can sometimes mislead us, preventing us from using information about the phenomenon to developing new innovations. While we don’t have to know how our valuable trade secrets work, it usually pays to keep looking while we’re exploiting the advantages they provide. In fact, there may be some nuggets waiting to be uncovered by reverse engineering the good results produced by others. That is one of the ways that secrecy incentivizes innovation every bit as well as patenting.
We can enjoy the music at the same time that we try to understand how it’s made and why it moves us.
When Thomas Edison was asked about his years of searching for a long-lasting light bulb filament, he said, “I haven’t failed; I’ve just found ten thousand ways that won’t work.” Experimenting with materials ranging from platinum to beard hair, he eventually zeroed in on carbonized thread, and later, bamboo. At that point, he had two important trade secrets. The first, obviously, was the identity of the best material. But the second was the identity of all the others he had tried. Why should that collection of failures qualify as a trade secret? Because any would-be competitor would love to avoid having to put in the effort and take the risk that Edison did.
This same notion – that information about what doesn’t work, or works less well, is valuable and protectable – applies equally to modern research-based industries like pharmaceuticals and biotech, where thousands or even millions of compounds may be tested in order to arrive at a successful new drug or treatment.
The law didn’t always treat R&D with the same respect as its outputs. Back in Edison’s day, trade secrets were limited to information that was “in continuous use” in a business. If you wanted to protect the records of how you got there, you had to keep them locked up. (Edison was obsessive about keeping people out of his lab.) But by the middle of the twentieth century, just in time for the information economy, rules on trade secrets had relaxed, so that even data with “potential value” could be protected.
In the old days, a lot of confidential information was said not to “rise to the level of a trade secret.” Now, although we still occasionally see this phrase, it’s become virtually meaningless, since the bar is so low: any information qualifies as a trade secret if it’s not generally known and has even the slightest competitive value.
And this is how we get to include so-called “negative know-how” in the asset base of modern enterprises. The trial-and-error method of innovation produces lots of trials and lots of errors, and often requires enormous and risky investments. The ultimate successful product is only the very small tip of a large R&D iceberg.
For the law, dealing with negative data isn’t easy. It can be confused with an employee’s personal skill, which is not protectable as a trade secret. When a dispute goes to court, judges want the secrets specifically defined, and they can get frustrated when referred to gigabytes of experimental data. But this is the reality of developing complex products, where proving that a particular compound or technique doesn’t work can itself be an extremely valuable breakthrough.
Negative information is most commonly put at risk not by theft of the records of R&D, but by departing employees who are familiar with how a particular technical solution was created or optimized. Eager to help their new colleagues, a recent arrival may wince at a suggested development path and blurt out a warning not to go there. Even very general pointers about an engineering direction to try or to avoid can help a competitor reduce risk and shorten development time. That is why hiring someone who has worked on a similar project for a competitor can lead to trouble. See The Most Dangerous Hire.
Closely related to the concept of “negative information” is the idea that you can be guilty of trade secret theft even though your product looks very different, or you made significant investments in your own research. When a company’s work is informed by a competitor’s proprietary R&D, the courts refer to this as indirect misappropriation, using labels like “springboard,” “cornerstone,” or “accelerant” to describe the unfair advantage. In effect, it is enough if information from the first project substantially influences the second.
Proving indirect misappropriation can be a challenge, especially where there is no trail of purloined documents to link the accused derivative work to the original. But even in cases where the information has traveled in the mind of a departing employee, you can sometimes demonstrate an anomaly in the records of the second company’s development. The absence of experiments or research behind an important engineering decision, particularly if coincident with hiring from a competitor, might be an indication that someone directed the choice because they already knew what way to go (or not to go).
For companies that want to compete fairly and avoid litigation, this area can be difficult to manage. There are very few hermetically sealed industrial labs where no one has worked for a competitor. And the problem is particularly acute in fast-growing organizations, or where the industry relies on a rapidly mobile workforce. But in this as in other areas of trade secret loss or contamination, those who pay attention and manage to reduce risks are way ahead of the game.
Recently a client asked me for advice on setting up a reverse engineering project. The company had just hired a senior engineer from a competitor that had pulled ahead of them the year before with the release of a next generation product. They needed to respond soon. The new employee was “clean,” they assured me, having come over without any documents or files. So they proposed to get him going with a small technical team and some samples of the competitor’s product. He no longer had access to any trade secrets of his former employer; what could possibly go wrong?
In the world of trade secrets, reverse engineering is universally embraced as acceptable. It involves starting with a publicly available product or set of information and taking it apart to discover how it was created. Why does anyone do this? To discover, legitimately, a path already taken:
In most circumstances, there is nothing wrong with reverse engineering. The recently-enacted Defend Trade Secrets Act declares that it cannot be an “improper means” of acquiring information. (In fact, if you properly reverse engineer a product, the information you discover can be held by you as your own trade secret.) The reason behind the rule is apparent when you consider the limits of trade secret protection: selling a product that reveals the design and method of its manufacture means the secret is imperiled. If it is very easy to discern, then the secret is lost immediately. If it might take some time to figure out, then that’s called reverse engineering, and anyone is allowed to do it.
Like most rules, this one has its limitations. You can’t use the reverse-engineering process to “discover” and duplicate a patented invention. That is one of the advantages inherent in using patent protection instead of trade secrets. Also, if you haven’t simply purchased the product on the open market, but have acquired it by some form of limited license or other contract that restricts your rights to reverse engineer, the courts normally will enforce those restrictions. Finally, you can’t through reverse engineering simply duplicate a product that is protected by a trademark or otherwise market a product so identical that the public would be confused about its source. Indeed, that conduct deserves the derisive label “knocking off.”
But to appreciate the potential of reverse engineering, consider the case of Chicago Lock Co. v. Fanberg. For fifty years the Chicago Lock Company had marketed its special “Tubular Ace” lock, frequently seen on vending machines where maximum security is required. In order to achieve that level of security, the manufacturer would provide a duplicate key only to an owner registered with the company. The codes necessary to duplicate the keys were strictly controlled. Lost keys could only be replaced by the manufacturer or by a locksmith who could “pick” the lock to discover the appropriate configuration and grind a duplicate tubular key.
Locksmiths typically would record the relevant “key code” along with the serial number of the customer’s lock, to be able to duplicate the key if it was lost again. Fanberg, a locksmith himself, advertised for other locksmiths to provide him with correlations they had recorded over the years. He then compiled all of the correlation codes into a manual and offered it for sale. Chicago Lock Company, understandably upset that its security system was jeopardized, filed a lawsuit.
The court directed judgment for Fanberg. Whatever claims the owners of the locks might have had against their locksmiths for divulging the codes, the manufacturer had sacrificed its products to the possibility of exactly the kind of reverse engineering that occurred. The court explained:
“It is well recognized that a trade secret does not offer protection against discovery by fair and honest means such as by independent invention, accidental disclosure, or by so-called reverse engineering, that is, starting with the known product and working backward to divine the process, Thus, it is the employment of improper means to procure the trade secret, rather than mere copying or use, which is the basis of liability.”
If you intend to reverse-engineer a product, however, be careful how you do it. Acquire the product through a simple purchase. Make sure that there are no conditions attached to the purchase that might prohibit you from reverse engineering. In addition, beware of documentation that is provided as part of the sale that may itself contain confidentiality restrictions. This situation occurs frequently with sophisticated equipment accompanied by maintenance manuals or circuit diagrams with restrictive legends. It also comes up in the disassembly of software acquired under license agreements, where issues of copyright infringement may require special legal advice.
Carefully choose the team that will perform the reverse-engineering tasks. Use only those who have had no exposure to the way it was originally designed and made, and be sure that the team does not have access to any confidential material of the original manufacturer. Maintain detailed records of the entire process, so that it can be demonstrated – to the satisfaction of someone with a technical background – that the process was accomplished “from scratch” and without reference to any restricted information.
As for my client who hired the competitor’s engineer, they agreed they were asking for trouble by involving someone who had previously worked on this technology. Since he was already on board, and as extra insurance against a later claim, they abandoned their internal project and contracted with an outside vendor to perform the work in a “clean room” environment (a term borrowed from semiconductor processing, where particle contamination is strictly controlled), with nothing to refer to but the product itself. Reverse engineering may sound good, but as in so many other areas of trade secret law, the right answer isn’t found in a phrase, but in practical risk management.
Patenting and secrecy are the two major methods of protecting technology that supports competitive advantage.[1] While this has been true for decades, the legal landscape in which businesses must choose between them has changed dramatically in recent years, mainly as a result of two forces. The first of these was a series of court rulings that collectively have narrowed the scope of patentable subject matter and have made patents more difficult to enforce. The second was the America Invents Act of 2011 (the “AIA”), which effectively eliminated or reduced certain risks of choosing secrecy, while providing new ways to challenge patents in administrative proceedings. Considered together, these forces require innovators to reconsider their cost/benefit models for evaluating protection mechanisms. This article discusses risk factors counsel should weigh when advising clients on these issues. I do not advocate one method over the other, but instead suggest that decisions should be guided by clients’ business needs and priorities rather than by patent eligibility alone.
More than forty years ago the U.S. Supreme Court rejected the idea that state common law on trade secrets should be preempted by the federal patent statute. In Kewanee Oil Co. v. Bicron Corp., [2] the Court explained that anyone whose invention clearly qualified under the patent laws would always choose patenting over secrecy. [3] While this was a dubious assumption, a concurring opinion pointed out that Congress had repeatedly amended the patent law without ever questioning its coherence with trade secrets. Nevertheless, popular wisdom among intellectual property lawyers since Kewanee has continued generally to hold that patents are strong, secrets are weak, and unless there are good reasons to elect secrecy (such as the difficulty of proving infringement of process inventions), patenting is the preferred method when it is available.
Over the years, a fairly sophisticated approach to the issue emerged and began to dictate inventors’ preferences. This business-oriented analysis started with the issue of patentability and added more factors to the calculus, including:
I have already noted the two major forces that have combined to challenge the traditional patent/trade secret calculus: judicial decisions making patents more difficult to obtain and enforce, and legislation that has reduced the risk of employing secrecy while arguably reducing the value of patents in general by making their enforceability less reliable. The new calculus takes into account these tectonic shifts in a larger context, in which secrecy has achieved an unprecedented level of attention and importance. We therefore begin our analysis with a brief review of that context.
New Global Emphasis on Secrecy Issues
Establishment of the TRIPS Agreement in 1995 brought trade secret protection to the international stage. [8] The current wave of business globalization had already begun, and TRIPS made clear that industry could count on some level of respect for trade secret rights in cross-border transactions. The next year the Economic Espionage Act became law. [9] More recently, the U.S. government, partly motivated by reports of high profile cyberhacking and other forms of espionage against American companies, issued a number of reports, strategic plans, and executive orders reflecting a heightened interest by the administration in trade secret enforcement. [10] Naturally, this attitude has been reflected in the major bilateral and regional free trade negotiations to which the United States has been a party. [11] In 2016, Congress passed with almost unanimous support the Defend Trade Secrets Act, providing for the first time a civil misappropriation remedy under federal law. [12] Meanwhile, the European Union has issued a new Trade Secrets Directive that is expected to lead to a certain level of harmonization among the member states on major issues of definitions and frameworks for civil enforcement. [13] This interest by governments is consistent with industry surveys that show an increased reliance on secrecy over patenting as a means of protecting competitive advantage. [14]
Of course, enforcement activity in actual transactions is at least as important as policy pronouncements, and here the indications are also encouraging for trade secret owners. In TianRui Group Co. v. ITC, [15] a case involving trade secret misappropriation occurring entirely in a foreign country, the Federal Circuit held that the International Trade Commission properly exercised its authority under 19 U.S.C. § 1337 to bar importation of products manufactured abroad using the misappropriated secret information. A dissenting opinion by Judge Moore objected to what she viewed as an unjustified exercise in extraterritorial application of U.S. law. Although her analysis focused on whether the statute evidenced a congressional intent to apply extraterritorially, it is notable as well for its prediction that the panel’s holding would provide “an additional incentive to inventors to keep their innovation secret,” which she felt would in turn “den[y] society the benefits of disclosure stemming from the patent system, which are anathema to trade secrets.” [16] While I agree with Judge Moore that robust domestic remedies for foreign theft of secrets can provide some additional encouragement to rely on secrecy, I see that as fully consistent with the Supreme Court’s holding in Kewanee that trade secret law is complementary, not contrary, to the patent system. After all, the policy goal of the patent law is not disclosure itself but encouragement of invention, [17] and that is also a primary policy behind trade secret law .[18]
Trade Secret Anxiety and Risk Reduced by the AIA
Before passage of the AIA, decisions about secrecy versus patenting could involve some risk relative to patent law. The most obvious of these was the requirement (imposed uniquely in the U.S.) that the applicant disclose the “best mode” of implementing the claimed invention. [19] A failure to comply could result in the patent being held invalid, and so the best mode defense became a common feature of discovery in patent litigation, with the defendant searching for indications that the inventor’s thinking had been more precise than was revealed in the application. In effect, the patent applicant had to weigh the disadvantages of too much or too little disclosure, and whatever the decision there would always remain a risk either of facing a best mode defense in litigation, or publication of secrets that could properly have been maintained, or both. This risk was for the most part eliminated by the AIA, which maintains the best mode requirement but declares that it cannot be raised as a defense against infringement. Whatever one might say about the lack of elegance or consistency in this approach to patent reform, these special risks and costs of keeping as secrets certain patent-related information have for most practical purposes disappeared.
The AIA also appears to have benefited trade secret holders by abrogating the so-called “forfeiture doctrine” originally described by Judge Learned Hand in the Metallizing Engineering case. [20] The doctrine barred patenting when the inventor had profited from commercial use of the invention for longer than the one-year grace period before filing, even where the use was secret, such that no one could gain access to the invention by inspection of a marketed product. Confirmed in later opinions of the Federal Circuit, this category of “secret prior art” is no longer present in the AIA’s amended § 102(a)(1), which lists the novelty-destroying types of prior art as: matter which was either patented, described in a printed publication, in pubic use, on sale, “or otherwise available to the public.” The clear implication of the latter phrase, according to most commentators, is that the prior art itself, and not just the things made with it, must be “available to the public.” [21]
Finally, the AIA dramatically broadened the prior user rights defense, which under the American Inventors Protection Act of 1999 had been provided only for business methods, by expanding its application to all technologies. [22] So long as the use began before the filing of the relevant patent application (or before an earlier public disclosure by the applicant during the grace period), this defense will protect one who had made a decision to deploy the technology in secret rather than seek a patent. Although subject to certain limitations, [23] the prior user rights defense is now sufficiently comprehensive that a decision to use secrecy can be made in the comfort of knowing that the activity will almost certainly not be prohibited by virtue of a later-issued patent.
Patent Rights Diminished by Court Decisions and Post-Grant Proceedings
If trade secret interests are in the ascendancy, the feeling among the IP bar is that patents, if not directly under attack, have been weakened by a combination of a series of court decisions and the effects of the post-AIA procedures for challenging issued patents. First we should consider what the courts have done to the scope of patentability. KSR adjusted the standard for obviousness, generally making it easier to challenge validity.[24] Bilski made it more difficult to claim business methods. [25] Mayo constrained applications for medical dosing techniques. [26] Nautilus raised the bar for § 112 definiteness. [27] And Alice has called into question the patentability of software inventions. [28] As for enforcement of patent rights, eBay substantially reduced the likelihood of getting an injunction. [29] Sandisk made it easier to file declaratory relief challenges (and therefore more complicated to engage in licensing discussions). [30] Seagate raised the bar for willful infringement. [31] LaserDynamics limited application of the “entire market value” theory of damages .[32] Octane Fitness injected a much more serious risk of fee-shifting if the patentee turned out to be wrong. [33] Whatever your view about the merits of each of these decisions—or all of them as a group—it should be easy to understand how patent owners, looking back over the past decade or so of court opinions, might be feeling shocked.
And then there is the AIA, which introduced reforms to the patent system that have been widely embraced as increasing efficiency, transparency, predictability, and effectiveness of the nation’s innovation engine. [34] But one aspect of this profound reworking introduced the notion of easier public challenges to issued patents, reflected in the processes for post-grant review of the PTO’s decision to issue a patent. [35] While few would question the inefficiency of putting all validity issues in front of a lay jury for determination, the alternative of sending back patents for re-working to the Patent Trial and Appeal Board—which applies a lower standard of proof and seems to be invalidating many more claims than it sustains—has stirred controversy over whether we have turned the system over to “patent death squads.”[36] Putting aside the rhetoric, we should not be surprised that patent owners feel that the traditional grants of “quiet title” in their inventions have been seriously disturbed, and the value of (at least some of) their patents has been reduced. And this is before considering some of the current proposals for further reform. [37]
I do not believe that the patent system is in existential crisis. Any transition to accommodate fundamental reforms will be (and especially will feel to rights holders) profoundly disruptive. But pendulums swing, and systems operating in tension usually return to stability. It should be no surprise, for example, that early PTAB decisions were statistically slanted towards invalidity, because the structural change suddenly addressed a backed-up inventory of questionable claims that previously could only have been challenged in federal courts. We should be patient and allow the new framework to adapt.
That said, the cumulative effect of all of the recent changes is substantial and undeniable. Even though we are in the early stages of adaptation, innovators need to pause and consider the ways in which these shifts are likely to affect their immediate interests and their long-term strategies.
The first point to hold in mind is that the question is not binary. It is not so much “patents versus secrets,” but “patents and secrets.” Both systems can provide benefits to the enterprise looking to profit from its innovative work. Patents remain uniquely valuable as a way to protect the competitive advantage of innovation, including through their “signaling” function. And secrets, while clearly essential to the protection of recipes, processes and transient facts, remain, as the Kewanee court said they were, relatively weak and risky. Moreover, trade secret protection is not “free” just because there are no filing fees. Maintaining a program of secrecy includes significant overhead costs for managing confidential relationships with employees, customers, suppliers, and other partners.
Second, the process of choosing one method over the other is dynamic, not just because the law is in a state of flux, but primarily because of the business conditions that should influence the decision. These include the international aspects of intellectual property protection, the nature of the relevant assets (information-based assets like data analytics favor trade secret protection over invention-based assets), and the behavior of relevant markets (fast-moving markets may make it more difficult to recoup the cost of patenting and to justify teaching the competition). As in many other areas of modern business, breaking old habits and challenging assumptions can be very productive.
Third, there is at least one way to buy time to address inventions that do not obviously fit into a clear decision model for patenting or secrecy. So long as you can accept the constraint of patent protection only in the U.S., it may be advantageous to file a provisional application together with a certification of intent not to file for foreign protection, [38] which will allow the application (including any subsequent non-provisional) to remain unpublished during the examination process. This approach effectively returns the applicant to the situation that applied generally before eighteen-month publication was introduced in 1999, so that, if at any time before allowance it is determined that the matter would be more productively maintained as a trade secret, the application can be withdrawn.
Fourth, irrespective of the decision to use secrecy or patenting for a particular innovation, there is now a greater need to pay attention to how information assets are managed. As I have already noted, confidential information—including unpublished patent applications—constitutes the majority of most companies’ asset base. This is evanescent property and requires special management focus to protect its integrity, whether it is held as a secret or matures into a patent. Indeed, it is something of a dilemma that in the age of global collaborations and “open innovation” this extraordinarily valuable, vulnerable property must be shared with outsiders who are sometimes located in countries with less-than-robust intellectual property regimes. The security challenge grows with the complexity of a company’s sharing network, and now that we are in a first-to-file environment, it has become more important that organizations police their confidential relationships for leaks, maintain scrupulous records of invention activity, and monitor published patent applications by collaboration partners, to identify claims that may have been improperly derived from the collaboration.
Deciding whether to choose secrecy or patenting (or both) used to be a fairly straightforward exercise; or at least we all assumed it was. The framework has now shifted dramatically, not only because of changes in the law, but also because the global business environment is much more complex. The good news is that along with increased risks come new opportunities for developing creative strategies that can leverage the value of our clients’ most important assets.
[1] Trade secrets protect a wide range of confidential information, ranging from customer lists to strategic plans and business methods. See Pooley, Trade Secrets § 4.02[2] (Law Journal Press 2017, updated semiannually). This paper concerns only protection of technical information that could qualify as patentable subject matter, but which might also be protectable as a trade secret.
[2] Kewanee Oil Co. v. Bicron Corp., 416 U.S. 470, 492 (1974).
[3] Id. at 490 (“The possibility that an inventor who believes his invention meets the standards of patentability will sit back, rely on trade secret law, and after one year of use forfeit any right to patent protection . . . is remote indeed.”).
[4] Mark A. Lemley & Carl Shapiro, Probabilistic Patents, 19 J. Econ. Perspectives 75, 80 (2005) (“Between 55 and 67 percent of issued U.S. patents lapse for failure to pay maintenance fees before the end of their term . . . , which indicates that these patents are of little value to their owners.”).
[5] See F. Andrew Ubel, Who’s on First?—The Trade Secret Prior User or a Subsequent Patentee?, 76 J. Pat. & Trademark Off. Soc’y 401, 407 (1994).
[6] Andrew Beckerman-Rodau, The Choice between Patent Protection and Trade Secret Protection: A Legal and Business Decision, 84 J. Pat. & Trademark Off. Soc’y 371, 400-401 (2002).
[7] Sebastian Hoenen et al., The Diminishing Signaling Value of Patents between Early Rounds of Venture Cap ital Financing, 43 Res. Pol’y 956 (2014).
[8] TRIPS: Agreement on Trade-Related Aspects of Intellectual Property Rights, art. 39.
[9] 18 U.S.C. §§ 1830, 1831-1839.
[10] See, e.g., Office of the Nat’l Counterintelligence Exec., Foreign Spies Stealing U.S. Economic Secrets in Cyberspace: Report to Congress on Foreign Economic Collection and Industrial Espionage, 2009-2011 (2011), available at http://www.ncsc.gov/publications/reports/fecie_all/Foreign_Economic_Collection_2011.pdf; Victoria Espinel, Launch of the Administration’s Strategy to Mitigate the Theft of U.S. Trade Secrets, White House Blog (Feb. 20, 2013), https://www.whitehouse.gov/blog/2013/02/20/launch-administration-s-strategy-mitigate-theft-us-trade-secrets; U.S. Intell. Property Enforcement Coordinator, Exec. Office of the Pres. of the U.S., 2013 Joint Strategic Plan on Intellectual Property Enforcement (2013), available at https://www.whitehouse.gov/sites/default/files/omb/IPEC/2013-us-ipec-joint-strategic-plan.pdf.
[11] See, e.g., Article 18.78 of the draft Trans-Pacific Partnership agreement, available at https://ustr.gov/sites/default/files/TPP-Final-Text-Intellectual-Property.pdf.
[12] Pub. L. 114-153, effective May 11, 2016, codified as amendments to the Economic Espionage Act, 18 U.S. C. §§ 1831-1839.
[13] Directive (EU) 2016/943, available at http://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32016L0943&from=EN.
[14] See http://www.nsf.gov/statistics/infbrief/nsf12307/ (R&D-intensive companies reported secrecy as “very important” or “somewhat important” at a rate more than twice that of patenting).
[15] TianRui Grp. Co. v. Int’l Trade Comm’n, 661 F.3d 1322 (Fed. Cir. 2011).
[16] Id. at 1343 (Moore, J., dissenting).
[17] See Eldred v. Ashcroft, 537 U.S. 186, 190 (2003) (“[I]mmediate disclosure is not the objective of, but is exacted from, the patentee . . . .”).
[18] Kewanee, 416 U.S. at 493.
[19] 35 U.S.C. § 112.
[20] Metallizing Eng’g Co. v. Kenyon Bearing & Auto Parts Co., 153 F.2d 516, 519-20 (2d Cir. 1946).
[21] See, e.g., Robert R. Armitage, Understanding the America Invents Act and Its Implications for Patenting, 40 AIPLA Q.J. 1, 54 (2012), available at http://www.uspto.gov/sites/default/files/aia_implementation/armitage_pdf.pdf.
[22] See Report on the Prior User Rights Defense (2012), available at http://www.uspto.gov/sites/default/files/aia_implementation/20120113-pur_report.pdf.
[23] The right is personal and may not be transferred; it may be exercised only in the places where the technology was in use at the relevant time; and it does not apply to patents held by universities.
[24] KSR Int’l Co. v. Teleflex Inc., 550 U.S. 398 (2007).
[25] Bilski v. Kappos, 561 U.S. 593 (2010).
[26] Mayo Collaborative Servs. v. Prometheus Labs., Inc., 132 S. Ct. 1289 (2012).
[27] Nautilus, Inc. v. Biosig Instruments, Inc., 134 S. Ct. 2120 (2014).
[28] Alice Corp. Pty. v. CLS Bank Int’l, 134 S. Ct. 2347 (2014).
[29] eBay Inc. v. MercExchange, L.L.C., 547 U.S. 388 (2006).
[30] SanDisk Corp. v. STMicroelectronics, Inc., 480 F.3d 1372 (Fed. Cir. 2007).
[31] In re Seagate Tech., LLC, 497 F.3d 1360 (Fed. Cir. 2007).
[32] LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51 (Fed. Cir. 2012).
[33] Octane Fitness, LLC v. ICON Health & Fitness, Inc., 134 S. Ct. 1749 (2014).
[34] See Armitage, supra note 21, at 4-9.
[35] For a straightforward and concise description of the Inter Partes Review, Post Grant Review, and Covered Business Method programs, see U.S. Pat. & Trademark Office, Major Differences between IPR, PGR, and CBM, www.uspto.gov/sites/default/files/ip/boards/bpai/aia_trial_comparison_chart.pptx (last visited Oct. 9, 2015).
[36] See Peter J. Pitts, “Patent Death Squads” vs. Innovation, Wall St. J. (June 10, 2015), http://www.wsj.com/articles/patent-death-squads-vs-innovation-1433978591.
[37] See, e.g., PATENT Act—Protecting American Talent and Entrepreneurship Act of 2015, S. 1137, 114th Cong. (2015-2016) (requires more specific pleadings and disclosures); STRONG Patents Act of 2015, S.632, 114th Cong. (2015-2016); Shield Act—Saving High-Tech Innovators from Egregious Legal Disputes Act of 2013, H.R. 845, 113th Cong. (2013-2014) (if passed, would permit a patent defendant to move early in a lawsuit to designate a patentee a non-practicing entity and to stay civil discovery while the motion is resolved). See also Senator Grassley Introduces Major U.S. Patent Reform Bill Different from House Bill, Intell. Prop. Owners Ass’n (Apr. 30, 2015), https://www.ipo.org/index.php/daily_news/april-30-2015/ (reviewing the PATENT Act).
[38] See 35 U.S.C. § 122(b)(2)(B).
Every trade secret case is built around a story. Sure, the plaintiff’s story is different than the defendant’s, even though each draws on the same facts. For the rest of us that don’t have a dog in the fight, helpful lessons are available. But sometimes you have to look hard to find them. Here’s one.
When Waymo, the Google self-driving car company, filed its lawsuit against Uber earlier this year, the story was remarkable enough. Anthony Levandowski, the head of Waymo’s research team for several years, had left to start Otto, supposedly to make autonomous long-haul trucks. Six months later Uber had purchased the new company (for $680 million) and hired Levandowski ($250 million in Uber stock) to lead its own team. Thanks to an errant email, Waymo suspected Uber had accessed its secrets, and ultimately discovered that just before leaving Levandowski had downloaded over 14,000 confidential files.
The optics kept getting worse. It turned out that Uber had struck a deal with Levandowski immediately after he left, promising to buy the newly minted Otto months later. And because they knew that litigation was likely, they cloaked the transaction in a shared privilege. It looked like Otto had been just a cover to keep Waymo distracted, and that Uber may have known about the downloaded files.
When it came to the injunction hearing earlier this year, Uber made an impressive showing: 40 attorneys had interviewed 85 witnesses and reviewed over 300,000 documents, demonstrating beyond argument that none of the secret Waymo files had come over to Uber. But the judge persisted: what about conversations Levandowski might have had with the Uber team, making suggestions based on his knowledge of Waymo data? Levandowski wasn’t available to answer, since he had claimed a Fifth Amendment privilege.
But Uber had more to worry about than just Levandowski’s absence. Buried deep in the deal documents was an unusual provision that would illuminate and underscore the judge’s concern.
When the transactional records were released about a month later, they showed that Uber had agreed to indemnify Levandowski, promising to defend him and pay for any judgment based on trade secret misappropriation before the contract was signed. Presumably, this was mainly about the downloaded Waymo files. How could Uber justify taking on that responsibility? By tying the indemnity to a robust and independent investigation of what Levandowski had done. In that way, Uber would know exactly what it was getting into, and would be able to prove that none of the files were actually used at Uber.
It is unusual, but not rare, for a hiring company to indemnify a new employee against claims by a former employer. An indemnity commits the new employer to shared liability, although that risk might be reduced by careful investigation, as Uber apparently did here. And it can be evidence that both parties had something to worry about, and so can fit into a plaintiff’s narrative. A safer approach for the new employer is simply to require, in writing, that the recruit bring no information in any form, perhaps providing independent counsel to help ensure compliance. But where the risks can be managed, and when the perceived value of the new hire is great enough, companies occasionally give in to the demand for indemnity.
In its deal with Levandowski, Uber went further. Having indemnified him against past “Bad Acts” (yes, that was the unfortunate term they used in the documents), it excluded coverage for future misbehavior that was fraudulent or intentional, including misappropriation of trade secrets. But Uber agreed to a significant exception to this exclusion: there would be indemnity for any use of “information . . . retained in [his] unaided memory.” In other words, so long as Levandowski didn’t deliberately memorize something by referring to the Waymo documents, he would be covered for using whatever he happened to recall.
Let’s pause here to briefly address three important points. First, trade secret misappropriation applies to information carried in one’s head, just as if it were on paper or in an electronic file. Second, liability doesn’t depend on direct copying of the information; in this context that means, for example, that suggestions made to Uber’s team could be actionable if based on what Waymo had found didn’t work or worked less well. Third, the kind of exception Uber agreed to here, when used in a nondisclosure agreement between businesses, is called a “residuals clause,” because it carves out from protection the “residual” information that people exposed to the secrets might later remember.
For large companies looking at possible acquisition of a technology or business, the residuals clause makes sense, because it protects against claims over similar activities that they might be pursuing independently in another division or at a later time. But the disclosing party always sees the residuals clause as a red flag and resists it, because the risk of losing valuable secrets is obvious and unpredictable. I have frequently seen transactions fail on this single issue, the discloser claiming that the “residuals” exception swallows the rule on confidentiality.
In effect, Uber granted Levandowski a residuals exception on Waymo’s secrets. Of course, this doesn’t necessarily mean that he misused what he knew from Waymo while guiding the team at Uber. It is at least theoretically possible, for example, that the technology platform at Uber is so different than Waymo’s that nothing from Waymo could possibly be relevant to Uber’s project. But trade secret cases are driven by appearances, and Uber has given Waymo the appealing argument that Levandowski was incentivized to misappropriate.
As I pointed out at the beginning of this piece, the issue is not so much the particular story as it is the lesson we can draw from it. Here, we’re talking about onboarding of high-level talent from a competitor, and the most important lesson for management is to understand the hidden risks. They begin with a fact we too often ignore: those with responsibility for the recruitment are seized with cognitive dissonance. While we say we want them to respect third party IP and avoid contamination of our own information assets, we also know that the recruit with relevant experience at a direct competitor is the “perfect hire.” Sometimes there is too much emphasis on the latter and very little on the former, and the “perfect” hire becomes the dangerous hire.
As we see from the Uber example, this tendency to underestimate or ignore risk can be amplified by a sense of urgency, such as a need to catch up in an emerging market. Paying a lot of money for high-level talent can be justified by the size of the opportunity. But by agreeing to indemnify Levandowski for what he remembered, Uber raised the stakes with risk.
No one can say for sure whether the prize was worth the cost for Uber, not least because there’s been no trial, and perhaps Waymo won’t be able to prove that anything about its project leaked from Levandowski’s brain to Uber’s team. But still, this case is instructive for any business considering hiring an executive from a competitor: be aware that the cost of this recruitment might include the legal fees, disruption and liability risk of a trade secret claim. Manage accordingly.