United States: Ninth Circuit Leaves Open Whether Trade Secret Liability May Be Predicated On An Implied Theory Of Confidentiality

In a recent decision, Direct Technologies, LLC v. Electronic Arts, Inc., the United States Court of Appeals for the Ninth Circuit called into question, but did not definitively resolve, whether trade secret liability could be predicated solely on an implied obligation of confidentiality under California law. The litigation arose in the context of a vendor dispute involving the design and manufacture of promotional USB flash drives. Defendant Electronic Arts (EA) was releasing one of its new video games, The Sims 3, and decided to order USB flash drives as a promotional trinket to be sold with the game. Plaintiff Direct Technologies (DT) was contracted to design and produce a prototype of the flash drive. Without DT's knowledge, DT's prototype was sent to a Chinese company that offered to manufacture the USB drives at a discounted rate. After learning that it had lost the project, DT sued in the United States District Court for the Central District of California for copyright infringement and trade secret misappropriation. EA moved for summary judgment on both claims and won.

Upon review, as to the copyright infringement claim, the Ninth Circuit reversed, holding that there was a genuine issue of material fact as to whether DT's cutaway design for removing the flash device merits copyright protection. With respect to the trade secrets claim, the Ninth Circuit affirmed summary judgment, but on alternative grounds. Originally, the district court held that no reasonable jury could find that Plaintiff took reasonable efforts to maintain the secrecy of its prototype. It was undisputed that there was no written nondisclosure agreement (NDA) in place or any express obligation of confidentiality in the vendor agreement entered into by the parties. In addition, Plaintiff had placed no limitations on what could be done with the prototype flash drive and did not mark or label the prototype as confidential.

Despite expressly acknowledging that the manufacturer "did not do much, if anything, to explicitly protect its prototype design," the Ninth Circuit in Direct Technologies refused to affirm on that basis. As the Court in Direct Technologies explained, "a confidential relationship may reasonably be implied," citing an older Ninth Circuit decision, Pachmayr Gun Works, Inc. v. Olin Mathieson Chemical Corp., issued before the California Uniform Trade Secrets Act (CUTSA) had been enacted.

In the end, the Ninth Circuit in Direct Technologies affirmed summary judgment in favor of the defense, but on alternative grounds — namely, that the USB prototype design did not qualify as a trade secret because it did not "[d]erive[] independent economic value from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use." See Cal. Civ. Code § 3426.1(d)(1); see Altavion, Inc. v. Konica Minolta Sys. Lab. Inc.

In its ruling, the Ninth Circuit declined to address whether the CUTSA statute preempts its pre-CUTSA decision, Pachmayr. The question therefore remains whether a common law implied duty of confidentiality still exists after enactment of CUTSA and whether additional efforts to maintain secrecy of a purported trade secret are required to satisfy the "reasonable efforts" requirement in CUTSA.

This unresolved issue creates practical implications for businesses handling information shared between potential partners. Business principals should be keenly aware that even in the absence of an NDA, courts may determine that a rational jury could find that the requirement that reasonable efforts be made to maintain secrecy of information purported to be trade secret is satisfied through an implied confidential relationship. They should take appropriate steps to ensure clear designations of what is — and what is not — considered confidential by the disclosing party. Drawing this distinction is particularly important with respect to disclosures during exploratory discussions, as parties conduct their diligence on whether they want to enter into a joint venture, partnership, investment or vendor agreement. Without such early and clear understandings, a party will be vulnerable to claims of trade secret misappropriation, which often involves expensive and intrusive discovery and protracted litigation.

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