United States: Fiduciary Duty With Respect To Trade Secret Asset Management

As a special feature of our blog—guest postings by experts, clients, and other professionals—please enjoy this blog entry from Donal O'Connell, Managing Director of Chawton Innovation Services Ltd., and David Cohen. 

Trade Secret's New Found Prominence:

As we both have written previously, the changing nature of technology, product development and sales, and the patent enforcement landscape, have given trade secrets a new-found prominence.

Trade secrets are now becoming a much more significant part of a company's value. As a result, trade secret asset management is becoming (and if not, it should become) a regular part of company board discussions and review. 

Director's Duties:

While the precise outlines of company directors' obligations differ from country to country and by entity type, generally speaking, all directors must:

  • Exercise their duties as would a reasonable and prudent person (the "duty of care")

and

  • Act in good faith for the benefit of the company and its shareholders (the "duty of loyalty").

Business Judgement Rule:

Since it is easy to criticize but hard to really know if a director is really acting with good faith or loyalty, the so-called "business judgment rule" protects directors from personal liability if they acted:

  • on an informed basis,
  • in good faith,

and

  • in the honest belief that the action they took or decision the made was in the best interests of the company.

So, if a director is:

  • not "grossly negligent" in their duties;
  • stayed informed of the facts relevant to their responsibilities;
  • acted in good faith;

and

  • acted in the best interests of the company,

the director will be protected from personal liability for actions that harmed the business and led it to bankruptcy or other civil (and possibly criminal liability).

What Does this Have to do with Trade Secrets?

A lot.

We have found that few companies properly manage their trade secrets. In fact, we believe many company's sub-par practices put the continued existence of what the companies' believe to be their trade secrets at significant risk.

This state of affairs should be a major concern of company boards – especially, where a significant store of value comes from information they believe to be trade secrets.  This concern should arise not just out of concern for a company's well-being—but to protect the directors' own personal liability.

Director's Duties with Respect to IP:

Generally, courts treat IP assets like any other corporate asset, which means directors must approach IP with the same due care as they would any other asset.

Such IP related duties for directors may include:

  • Being informed of the value of their IP assets.
  • Ensuring implementation of necessary best practices and internal controls to protect company IP assets.
  • Refrain from misappropriating IP and ensuring the company not misappropriate or utilize misappropriated IP.

IP here includes patents, trademarks, copyright, designs, and trade secrets.

Trade secrets from Neglect to Prominence

A trade secret is any information that is:

  • Secret.
  • Has value.
  • Is reasonably protected.

Broadly speaking, any confidential business information which provides an enterprise a competitive edge may be considered a trade secret.

While in the past the proper management of trade secrets may have been neglected, this is slowly but surely changing for a variety of reasons:

  • Law changes (Defend Trade Secrets Act passed in May 2016 in the USA; The EU Directive on Trade Secret in Europe enacted by member states in June 2018; The Anti Unfair Competition Law updated in China at the beginning of 2018).
  • Increased trade secret litigation particularly involving US companies but not exclusively so.
  • Growing interest in trade secrets by the tax authorities (OECD BEPS, Patent Box Tax Regimes in certain jurisdictions).
  • Cyber criminals trying to steal trade secrets.
  • Companies embracing Open Innovation and sharing trade secrets.
  • The move to outsourcing many business activities (e.g. manufacturing, distribution, etc.).
  • The changing nature of employment – especially where a company hires a tech star who, unbeknownst to the company brings and utilizes in their job their former employer's trade secrets.
  • Pending trade wars being blamed by some on trade secret theft.
  • IP reform weakening some other forms of IP like patents.

We are not the only ones who have noticed the increasing significance of trade secrets. For example, Forbes Magazine labelled the 'Defend Trade Secrets Act' as the biggest IP development in years.

Few Companies Manage Trade Secrets Well:

Unfortunately, many companies are poor when it comes to trade secret asset management:

  • There is a lack of ownership.
  • Documentation is poor.
  • They are not addressed in company policies or procedures.
  • Physical, electronic, process and legal protection mechanisms are poor to non-existent.
  • There is no classification of the trade secrets.
  • Whether trade secrets were shared with third parties, let alone details on how, is missing.
  • Third parties with access to trade secrets have inadequate to no requirements to protect them.
  • Trade secrets are not properly addressed in employment and severance agreements, licenses, and other contracts.
  • There is little if any information on trade secrets shared between the Legal / IP function and the Accounts / Tax function.
  • There is no audit trail.

Recent reports such as the excellent Baker McKenzie report – "The Board Ultimatum – Preserve & Protect – The Rising Importance of Safeguarding Trade Secrets – 2017" highlight in our opinion a major disconnect between what companies say about trade secrets and trade secret asset management and what companies actually do about trade secrets and trade secret asset management.

Some Trade Secret Best Practices:

Those exceptional companies who have mastered trade secret asset management tend to have the following things in place

  1. A Trade Secret Policy
  2. Education of Employees about Trade Secrets
  3. Robust Fit for Purpose Trade Secret Process & Procedures
  4. A System to Underpin that Process
  5. Good quality trade secret metadata
  6. Trade Secret Governance

Trade Secret Risks for Company Directors:

As noted above, directors may be personally liable for breach of their duties of care and/or loyalty, and where their actions fail the business judgment rule.

Common claims seeking to hold directors personally liable include:

  • A failure to perform appropriate due diligence when making an acquisition.
  • Misrepresentations regarding the financial health of the organization.
  • Misstatements or omissions regarding potential future performance.
  • Careless management strategy that causes bankruptcy.
  • Breach of duties under applicable securities or other statutory laws.
  • Conflicts of interest.

We believe that all of these risks are impacted by trade secret asset management.

It is no exaggeration to say that nearly all businesses have trade secrets. Quite often they are material to the company's value. Occasionally, trade secrets comprise the company's crown jewels.

As a director it is, at least, negligent to fail to:

  • Know about the existence of, let alone ensuring proper management of, trade secret assets that may be material to the company's value.
  • Ensure that steps are taken to protect against trade secret misappropriation by rogue employees and third-party partners (such as OEMs or distributors).
  • Ensure the existence of reasonable physical and electronic for a company's trade secrets.
  • Ensure that anyone (employee or otherwise) that can access a company trade secret be informed of and obligated with respect to reasonable trade secret management policies.
  • Ensure that the company takes steps to minimize the risk that new hires infect the company with misappropriated trade secrets (from their former employers or third parties).

If a company becomes insolvent or (if public) has a declining share price, company directors may find themselves personally liable if a court finds that they failed to engage in or require from those they supervised reasonable trade secret asset management.

If only to protect their own liabilities, company directors should become more concerned about proper trade secret asset management.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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