Trade Secrets: Made for TV--Former director owes royalty for stealing source code

by Kirton McConkie PC
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Utah Employment Law Letter - May 2014

Acrimony, anger, revenge, piracy, and a legal battle—these are often the ingredients of a prime-time television drama. But in this case, they are not the makings of a plot found on cable, Netflix, or DVD. Instead, they are the facts of a real-life Utah lawsuit.

An employee became angry about the way his colleagues at the software company where he was a director had been treating him. In a retaliatory stroke, he stole his former employer’s primary trade secret—its software product source code—and then freely handed it over to a major competitor. When the company sued and obtained a multimillion-dollar judgment against him, he complained that the jury awarded too much in damages. Read on to find out why this case might make good reality television.

Anger management

StorageCraft Technology Corporation is a computer software company. Its software developers spent a substantial number of hours creating and developing the source code on which StorageCraft’s software products were based. The company considered the source code a trade secret that it withheld from public dissemination and, more important, from its competitors.

James Kirby helped create StorageCraft, helped manage the company, and then helped himself to its source code. Kirby was part of the group that started StorageCraft and served as a director of the company. He worked numerous hours over the course of 15 to 20 months to develop the source code.

At some point, Kirby had a dispute or “falling out” with his coworkers. The nature of the dispute is unclear from the case, but Kirby apparently felt that his colleagues were not treating him well, and he became angry about it.

Revenge

Kirby decided to retaliate, so he copied and stole the source code on which StorageCraft’s products depend.There is no indication that he used the source code for personal profit or gain. Rather, it appears that he took the code out of spite.

But Kirby’s revenge was not yet complete: He next delivered the source code to one of StorageCraft’s primary competitors, NetJapan. The competitor soon introduced what the court called a “coincidentally timed” software product similar to StorageCraft’s.

Who wants to be a millionaire?

StorageCraft sued Kirby under Utah’s Uniform Trade Secrets Act (UTSA), alleging he had misappropriated the source code, which it deemed a trade secret. A jury trial was held on StorageCraft’s claims.

At trial, StorageCraft was allowed to present evidence for a “reasonable royalty” damages theory. The company argued to the jury that by taking the source code, Kirby had effectively assumed for himself a license to reveal the trade secret to a competitor. StorageCraft further argued that the disclosure diminished the value of the trade secret and the software products based on it.

Under the damages theory, the company argued that Kirby should be required to pay it a royalty equivalent to the amount it would have received if it had given him a license to disclose the trade secret. StorageCraft offered testimony from a damages expert who opined that the amount of the royalty should be $2.92 million.

After the parties presented their evidence, the jury apparently accepted the damages amount offered by StorageCraft’s expert and awarded $2.92 million to the company. Kirby appealed the jury’s verdict to the U.S. 10th Circuit Court of Appeals (whose rulings apply to all Utah employers).

Profit

On appeal, Kirby did not dispute that he had stolen or disclosed the source code. Instead, he focused only on the damages, claiming the award was too high. Specifically, he attacked StorageCraft’s royalty damages theory. He argued that the company could not be awarded a “reasonable royalty” as damages unless it first proved that either he or NetJapan made commercial use of or turned a profit on the trade secret—in this case, the source code. According to him, merely disclosing the trade secret was not enough for royalty damages to apply.

Kirby argued that royalty damages were unavailable as applied in this case because he did not use the source code he stole for personal profit or gain. Apparently revenge, not profit, was his motive. And because he did not use the source code for profit, the damages award was improper. He also argued that StorageCraft did not try to prove that NetJapan used the source code commercially. His argument did not get far with the 10th Circuit.

The UTSA provides for three different damages measures: (1) the amount of the defendant’s unjust enrichment, (2) the actual loss sustained by the plaintiff, or (3) a reasonable royalty. The 10th Circuit recognized that “Utah’s trade secret statute . . . expressly allows a reasonable royalty measure of damages when the misappropriator uses or discloses the trade secret” (emphasis in original). In other words, royalty damages are not limited to cases where the trade secret was used commercially; such damages are also available under the statute in cases of trade secret disclosure. Accordingly, the court focused on the fact that Kirby had disclosed the source code, not on his motives for doing so or what he received for disclosing the information.

The 10th Circuit therefore concluded that because there was no dispute that Kirby had at least disclosed the source code to NetJapan, StorageCraft could present evidence of, and the jury could award, a reasonable royalty as the measure of damages.The court reasoned: “When someone steals a trade secret and discloses it to a competitor, he effectively assumes for himself an unrestricted license in the trade secret.” Further, the court added that “where (as here) [a former employee] discloses a trade secret to a rival company in a fit of retaliatory pique without any desire for personal riches, the other two measures of damages may not always be entirely fit for the task.”

The price is right

Kirby did not stop there. He also argued that the damages award was still too high: He insisted that even if a reasonable royalty was an appropriate measure of damages, the amount of $2.92 million was unreasonable. The 10th Circuit therefore next addressed whether that amount would have been the correct amount of a royalty.

The court noted that the royalty measure of damages is intended to be “‘the price that would be set by a willing buyer and a willing seller’ for a license in the trade secret.” Many factors figure into determining the amount of a reasonable royalty for a license, including the duration, scope, and market royalty rates for similar licenses. Unlike the analysis above, the use to which a trade secret is put does matter in determining the scope of a license and the amount of the royalty that would be paid.

Kirby asked the court to equate him with a “hypothetical misappropriator who stole a trade secret and then disclosed it only to his long since retired, seriously aged, and tight-lipped great-grandfather, someone who didn’t and couldn’t make sure of the secret and who therefore couldn’t do serious damage to the trade secret or its rightful holder.” The 10th Circuit quickly shot that argument down, observing: “But those aren’t the facts of this case.” The court explained: “Instead, the evidence at trial showed that . . . Kirby took StorageCraft’s trade secret and intentionally disclosed it to NetJapan, aware that [it] was an able competitor, and . . . could well use the secret to compete with StorageCraft.”

Although StorageCraft may not have attempted to prove that NetJapan actually used its source code in the development of a product that was remarkably similar to its product, the facts allowed the jury to render an award based on any impact to the value of StorageCraft’s trade secret by its disclosure to a rival. Consequently, the court determined that the jury had reason to determine that the damages award—the royalty price for the license—was right.

Quantum leap?

Kirby also challenged the damages expert on appeal, arguing that the trial court failed to meet its obligation to ensure that the expert was reliable and relevant before allowing him to testify. Specifically, Kirby challenged assumptions made by the expert in quantifying the costs StorageCraft incurred in developing the source code. Although he did not argue that the expert should not have accounted for development costs in figuring the royalty amount, he attacked the expert’s estimation of the number of hours StorageCraft employees put in to develop the source code. The expert assumed that developers worked 40 hours per week for 15 to 20 months. Kirby posited that assumption was too high.

However, the 10th Circuit found that the expert’s assumptions were based on the evidence presented at trial. Indeed, the court pointed out that “Kirby’s own deposition testimony confirms that he and three other engineers devoted a very large number of hours to [the source code’s] creation over a 15 to 20 month period.” Consequently, the 10th Circuit rejected Kirby’s argument and concluded that the expert’s testimony was properly allowed at trial. The court affirmed the jury’s damages award. StorageCraft Technology Corporation v. James Kirby, 744 F.3d 1183 (10th Cir., Mar. 11, 2014).

Lessons learned

When an employee leaves a company, he may attempt to take confidential, proprietary, or trade secret information. If the stolen information meets the UTSA’s definition of a trade secret, the employer has a claim against the employee even if there is no nondisclosure agreement in place.

One method of calculating damages, as illustrated in this case, is to estimate royalty damages. This damages methodology requires the court to presume a fiction to make the injured employer whole: that the departing employee effectively has a license to use or disclose the trade secret. Such damages can be significant.

If a former employee takes trade secret information from your company, you may want to consult a lawyer about how to minimize the harm and whether you are entitled to any possible damages and remedies. Royalty damages are just one of the arrows you could have in your remedy quiver. Otherwise, your company may be significantly harmed, you may not be able to recover the damages to which you are entitled, and you may be left to see how the situation plays out as the plotline of a TV drama.

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