Businesses Beware: Don’t Restrain Former Employees by Exaggerating Your Trade Secret Claims

Sunstein LLP

Employment contract

The First Circuit seldom delivers opinions on trade secret claims, so employers should pay extra-close attention to the lessons to be learned from the court’s recent decision in TLS Management v. Rodríguez-Toledo:

  • If you sue an ex-employee for walking off with your proprietary information, make sure it meets the legal standard for a trade secret: The information is not generally known, is not readily ascertainable, has independent value, and is protected by reasonable security measures.
  • Be prepared at the outset of the case to describe your trade secret as specifically as possible. If the supposed secrets remain amorphous late in the litigation, a court may conclude that you don’t really have any.
  • If your non-disclosure agreement (NDA) with an employee extends—even in part--to publicly available information, don’t expect the court to rewrite it to protect your company’s genuinely secret information. The court will throw the whole thing out.

The TLS Management opinion is not a bold extension of the law, just a rare synopsis of the strict requirements that employers must follow to assert trade secret claims. The First Circuit hears appeals from decisions from federal trial courts in Massachusetts, Rhode Island, New Hampshire, Maine and Puerto Rico. Although litigants in those jurisdictions are most directly affected by the TLS decision, businesses and their employees outside the First Circuit are subject to roughly similar applications of trade secret law.

Case Background

TLS Management and Marketing Services, a Puerto Rico-based tax planning firm, contended that two of the tax schemes it pitched to clients qualified as protectable trade secrets:

  1. A portion of its “Capital Preservation Report” (CPR) which contained recommendations specific to each client based on an analysis of applicable law; and
  2. Its “U.S. Possession Strategy,” which based tax avoidance advice on an arbitrage approach rooted in the fact that Puerto Rico tax rates are lower than federal rates. A client on the mainland could enjoy a lower tax rate on certain services by outsourcing them to TLS and buying its shares.

TLS alleged that Ricky Rodriguez, a former TLS director, used the Possession Strategy at his own consulting company and downloaded CPR documents without authorization. TLS sued for misappropriation of the two trade secrets and violation of a nondisclosure agreement.

The trial judge found in favor of TLS on both counts; Rodriguez and his company appealed. The First Circuit reversed, finding that TLS did not prove it had trade secrets.

Overbroad = Overbearing

Trade secret lawsuits are prone to abuse, the appeals court stated. Most other forms of intellectual property are defined in scope before their owner tries to enforce them. Patent rights, for example, cannot exceed the scope of the patent claims. And federal registration delineates the boundaries of a plaintiff’s copyright. For trademark claims, too, the federal registration and public use of the mark define the scope. On the other hand, the court observed:

Trade secrets are different. There is no requirement of registration and, by definition, there is no public knowledge of the trade secret in advance of litigation. Even the defendant is not necessarily on notice of the trade secret before litigation. This raises the possibility that the trade secret owner will tailor the scope of the trade secret in litigation to conform to the litigation strategy.

TLS’s lawsuit against its former employee fed the court’s instinctive suspicion of trade secret claims. TLS described its secrets with general references to “methods or techniques” for tax liability reduction, without detail. The concept of tax arbitrage based on Puerto Rico tax exemption laws “was hardly secret,” the court said, and TLS’s own CPR—one of its asserted secrets--acknowledged that it was well known that the combination of federal and Puerto Rico tax laws allowed a business to reduce its tax liability.

Which aspects of the reports or possession strategy were public and which were not? TLS never answered this essential question. The fatal flaw in TLS’s case was that it never disentangled secrets from publicly known information. TLS may have shown that some documents describing its tax scheme were not easy to acquire, but, the court said, it failed to establish that the “substance” of that scheme was not readily ascertainable.

By the same token, the court reversed the verdict that Rodriguez violated his nondisclosure agreement, finding that the agreement covered practically all information he obtained while working for TLS.

Applying Puerto Rico law, the court said that the NDA’s “astounding breadth and lack of any meaningful limitation” rendered it invalid for not one but three reasons: It extended to publicly available information; it unduly restrained Rodríguez’s freedom to compete; and, relatedly, it diminished the public’s freedom of choice.

Courts routinely scrutinize NDAs to make sure they protect only an employer’s legitimate competitive interests. TLS’s agreement was far broader than necessary to achieve this goal. The First Circuit declined to rewrite the NDA by excising the unreasonable portions; it rejected it in its entirety.

Concluding Words

Fifty years ago, courts may have been more deferential to businesses’ claims of misappropriated secrets. The law has long since evolved to weigh the concerns of labor: Are claims being inflated to restrain competition by a former employee and his new employer? This coincides with a general trend at the state level to limit the enforceable scope of non-compete agreements.

Employers must be humble about the scope of their trade secrets. If they try to bar employees from using information that is not demonstrably secret, they may end up with no protection at all.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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