<span class="padlock_text"></span> v.21 #5: Legal Issues

by | Dec 1, 2009 | 0 comments

Section Editors:

Cases of Note — Trade Secrets – Nondisclosure Agreements – Non-compete Clauses
by Bruce Strauch (The Citadel) strauchb@citadel.edu

Decision Insights, Inc. v. Sentia Group, Inc., United States Court of Appeals for the Fourth Circuit, 2009 U.S. App. LEXIS 2654.

Decision Insights, Inc. (DII) developed software called a “Dynamic Expected Utility Model” (“EU Model”) which became the primary asset of the company. EU Model is an analytical tool used in preparing negotiating strategies. It assesses risk, compares different operating positions and trade-offs among the alternatives. Since 1989, DII has used the EU Model and owns the assets, copyright, and all proprietary rights.

Gary Slack and Dr. Bruce Mesquita developed the EU Model from scratch. Slack is on DII’s board; Mesquita is no longer with the company.

In 1998, Carol Alsharabati was hired to make modifications to the EU Model. She signed a confidentiality agreement. Curiously, she had absolutely no computer training, but admits gaining valuable experience while with the company.

Is it that easy? So why are we not software magnates?

Around 2001, Mark Abdollahian and three others — Kugler, Efird and Scott — who had worked with Alsharabati — left DII to form Sentia Group. All but Kugler had signed Trade Secret Nondisclosure Agreements (“Agreements”) and Efird’s had a non-compete clause.

Are you following all these players? It’s only semi-important in the case. Although the dynamics of folks jumping ship and going into competition holds its business interest.

The original plan was to obtain a software license from DII and operate in a separate territory. After all, one of them had signed a non-compete agreement. But Sentia could not reach agreement with DII.

Deciding to develop their own version of the software, Sentia sought legal counsel and were advised that no one who had had access to the DII code be involved in the task. If this was not possible, the new code should bear no resemblance whatsoever to the EU Model. And they had better document every step in the development process.

As so many clients do, Sentia ignored counsel’s advice and hired Alsharabati to do the work. And she did so in the record time of six weeks.

DII claimed the software is identical to the EU Model and sued for breach of contract, misappropriation of trade secrets and other theories not of interest to us here.

Litigation
So far so good. But then DII got sloppy in the discovery process and failed to identify its trade secrets with specificity or differentiate them from what is public knowledge. Sentia asked for sanctions, so DII scrambled about and identified its entire source code (i.e., mathematical equations) as a total compilation that was the big trade secret and twelve major components that were each secrets as well.

Sentia huffed and puffed about that, and DII was ordered to produce “all algorithms, block flow diagrams, narratives” associated with the development of EU Model. And Sentia was awarded attorney’s fees for its efforts in acquiring this information.

DII said the software was over fifteen years old and they didn’t have the algorithms. Reverse engineering would cost in the range of $100,000. The magistrate judge brought them all in again and said if the stuff didn’t exist, then it didn’t. And imposed sanctions of $13,256.25.

Ouch.

Sentia moved for summary judgment based on the failure of DII to meet the burden of establishing trade secrets. Sentia won this, and DII appealed.

The Appeal – Trade Secrets
The state of Virginia defines a “trade secret” as “information including but not limited to a formula, pattern, compilation, program, device, method, technique or process, that:

  1. Derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and 
  2. Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.” Va. Code. § 59.1-336.

The key is secrecy rather than novelty. Dionne v. Southeast Foam Converting & Packaging, Inc., 240 Va. 297, 397 S.E.2d 110,113 (Va. 1990). “Novelty in the patent law sense, is not required for a trade secret.” Trandes Corp. v. Guy F. Atkinson Co., 996 F.2d 655, 664 (4th Cir. 1993).

Thus the whole secrecy issue is fact-intensive and very much a jury question. Hoechst Diafoil Co. v. Nan Ya Plastics Corp., 174 F.3d 411, 419 (4th Cir. 1999). DII said its software is a compilation within which there are twelve specific functions, any or all of which are protected trade secrets. Which — see the requirements above — is a complex question of fact. The Fourth Circuit agreed and remanded to the district court.

Trade Secret Nondisclosure
Abdollahian and others signed agreements not to disclose DII’s proprietary information. They assigned work product to DII and agreed to return all confidential stuff when they left. The district court basically ignored this saying there was no evidence of breach because there was no evidence of any trade secrets.

Since the Fourth Circuit had sent the trade secret issue back for a jury trial, then this was reversed as well.

Kugler had never executed his nondisclosure agreement but a letter from him to DII stated he would never make improper use of confidential information. DII said they would never have shared anything with him without such an understanding.

The absence of a writing does not mean there was no binding agreement. It is a question of intent. If the parties have a meeting of the minds — and part of the understanding was that a written contract would be executed — then “…there results an obligatory contract which neither party is at liberty to repudiate.” Manss-Owens Co. v. H.S. Owens Son, 129 Va. 183, 105 S.E. 543, 547 (Va. 1921) (quoting Boisseau v. Fuller, 96 Va. 45, 30 E.E. 457 (Va. 1898).

 Well, those dates seem to make that established law. But the cases do distinguish this from a situation where no one intended to be bound until a formal execution of a written contract. At any rate, we certainly have a nice question of fact as to what their minds met upon.

Non-competition Clause
Efird entered into an agreement to not compete with DII’s “precise” business for a period of two years. Virginia law examines these contracts on a basis of (1) limiting the scope to what is reasonably necessary to protect legitimate business interests of the employer, and (2) not unduly oppressing the employee in his efforts to earn a living. Blue Ridge Anesthesia & Critical Care, Inc. v. Gidick, 239 Va. 369; 389 S.E.2d 467, 470 (Va. 1990).

These covenants are not favored as they are restraints on trade and are strictly construed against the employer including putting the burden of proof of reasonableness on him. See Grant v. Carotek, 737 F.2d 410, 411-412 (4th Cir. 1984).

The district court found the agreement was “broader than necessary” to protect DII’s legitimate interests. But this was premised upon the belief that DII had no trade secrets. “The possession of trade secrets and confidential information is an important consideration in testing the reasonableness of a restriction on competition.” Meissel v. Finley, 198 Va. 577, 95 W.E.2d 186, 191 (Va. Ct. App. 1956).

And the sanctions got vacated as the parties had a genuine dispute as to how to identify trade secrets, and the district court was muddled on the issue.

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