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Bad Faith Trade Secret Claims and Attorney Fee Awards

Posted in Trade Secrets

by James Kachmar

On June 15, 2009, the Court of Appeal for the Second District issued its ruling in FLIR Systems, Inc. v. Parrish and affirmed an award of attorneys fees and costs in the amount of $1.6 million to a defendant in a trade secrets misappropriation case. The FLIR Systems ruling demonstrates that a trial court has wide discretion to award sanctions against a plaintiff who brings a trade secrets misappropriation claim in bad faith.

Plaintiffs manufactured and sold microbolometers, which is a device used in connection with infrared cameras, night vision and thermal imaging. The defendants were former employees of plaintiffs and at least one defendant was responsible for creating a significant portion of plaintiff’s technology.

In 2005, the defendants decided to start a new company (“Thermicon”) which would mass produce bolometers and gave notice that their employment would end in January 2006. One of the defendants, Fitzgibbson, had developed a business plan in 1998/99 when he was self employed and the two defendants used that business plan to create Thermicon. 

Before their employment terminated, defendants offered plaintiffs an opportunity to participate in Thermicon. Plaintiffs were unhappy that they were only being offered a non-controlling interest in the new company and declined the offer.

 

The defendants then entered into negotiations with Raytheon Company to acquire licensing, technology and manufacturing facilities for Thermicon. They assured their former employer that they would not misappropriate any trade secrets and that the new company would use an intellectual property filter similar to the one used by plaintiffs.

 

Plaintiffs grew concerned that defendants’ new business would undermine their market share and so, plaintiffs filed an action for injunctive relief and damages in June 2006. The action was premised on a trade secret misappropriation claim that defendants could not mass produce low cost microbolometers without misappropriating their former employer’s trade secrets. Upon learning the filing of the lawsuit, Raytheon terminated its business discussions with defendants and in August 2006, defendants advised plaintiffs that they were not going forward with the new business.

 

Plaintiffs dismissed their claims for monetary damages against defendants and proceeded to trial for a permanent injunction to enjoin defendants from allegedly misappropriating their trade secrets. The Court heard eight days of testimony and then issued its ruling that no misappropriation or threatened misappropriation of trade secrets had occurred. The Court found that it was uncontroverted that defendants did not receive any funding for their new company, did not start the new business, had no employees or customers, did not lease any facilities or develop technology, and did not design, produce, sell or offer to sell any infrared products. The Court continued by finding that plaintiffs’ trade secret claims had been brought in bad faith since they were based on a theory of “inevitable disclosure,” a doctrine that has been rejected by California courts because it contravenes a strong public policy of employee mobility to permit ex-employees to start new entrepreneurial endeavors. As a result, the trial court ordered plaintiffs to pay defendants more than $1.6 million in attorneys fees and costs.

 

The plaintiffs appealed this decision arguing that the trial court had abused its discretion. The appellate court began reviewing section 3426.4 of the California Civil Code which provides, “If a claim of misappropriation is made in bad faith . . . the [trial] court may award reasonable attorneys fees and costs to the prevailing party.” Although the “bad faith” standard its not defined in the statute, California courts have established a two-prong test for awarding attorneys fees: (1) the objective speciousness of the claim; and (2) the subjective bad faith in bringing or maintaining the action, i.e., for an improper purpose. Section 3426.4 authorizes a trial court to award attorneys fees “as a deterrent to specious trade secret claims.” Furthermore, the trial court “has broad discretion in awarding fees.” 

 

As to the first prong, the appellate court recognized that “objective speciousness exists where the action superficially appears to have merit but there is a complete lack of evidence to support the claim.” The trial court had found that plaintiffs’ misappropriation claim was objectively specious “because appellants suffered no economic harm and there was no misappropriation or threatened misappropriation of trade secrets.” The court further found that the claim was objectively specious because it was established by evidence that plaintiffs had filed the lawsuit with a “anti-competitive motive.” For instance, plaintiff’s CEO testified that the company could not “tolerate a direct competitive threat” by defendants. He further testified that he had no evidence of any wrongdoing by defendants but was worried by their plan to compete with plaintiffs in the future.

 

Plaintiffs also argued that an attorneys fees award may not be upheld unless the action was “frivolous”. The appellate court rejected this argument finding that the word “frivolous” does not appear in section 3426.4 and thus would not impose this standard.

 

In further finding that the claim was objectively specious, the court found it significant that the complaint had alleged that plaintiffs had suffered “actual damages,” however, the evidence clearly showed that there were no damages whatsoever. Furthermore, the court concluded that since the claim was based on the rejected doctrine of “inevitable disclosure,” the claim had been brought in violation of public policy favoring employee mobility. The court further reasoned that “speculation that a departing employee may misappropriate and use a trade secret in a start up business will not support an injunction.” Thus, the Court found that the trial court had properly found that plaintiffs’ trade secret misappropriation claim was objectively specious.

 

Turning to the prong of subjective bad faith, the Court recognized that “subjective bad faith may be inferred by evidence that appellants tended to cause unnecessary delay, filed the action to harass respondents or harbored an improper motive.” The Court also recognized that the timing of the lawsuit could also raise an inference of bad faith.

 

The appellate court held that the trial court had found that plaintiffs had filed their claims for an anti-competitive motive in reliance on the rejected doctrine of “inevitable disclosure.” Furthermore, plaintiffs alleged that defendants had misappropriated their trade secrets because one of the defendants had downloaded computer information so that they could work at home. Plaintiff argued that this was sufficient evidence to support its claim for trade secret misappropriation. However, the appellate court rejected this argument finding that “under [plaintiff’s] construction of the law, an employer can bring a trade secret action after an employee downloads a company document and deletes the document from his or her laptop computer at home. A similar action can be brought where company messages are left on the employee’s email or phone answering machine and deleted after the employee changes jobs.” The court recognized that the California Uniform Trade Secrets Act requires an “actual or threatened misappropriation” and that “mere possession of trade secrets by a departing employee is not enough for an injunction.”

 

The appellate court further found that subjective bad faith had been established by the contradictory testimony of plaintiffs’ executives “who did not want to take responsibility for initiating and maintaining the action.” The appellate court held that the trial court had properly concluded that there had been subjective bad faith by examining plaintiffs’ settlement tactics. The trial court ruled that plaintiffs had engaged in improper settlement tactics by making bad faith settlement demands that “were inflammatory, violated public policy, and were made in bad faith.” The Court found that these improper settlement tactics further supported a finding of subjective bad faith.

 

Finally, plaintiffs argued that the action was not in subjective bad faith because it had survived defendants’ summary judgment motions. The appellate court rejected this argument and found that plaintiffs’ “cite no California authority that the denial of a summary judgment motion in a trade secret case precludes the trial court from finding, after it has heard all the evidence, that the action was brought or maintained in bad faith.” The appellate court recognized that “if the rule was otherwise, a trade secrets plaintiff could file sham declarations to successfully oppose a summary judgment motion and immunize itself from sanctions.” 

 

As a final word of caution, the appellate court held that it was not the mere filing of a trade secret claim that could be found to be in bad faith, but also maintaining a trade secret misappropriation claim after the prosecuting attorney is made award of facts that the trade secret claim has no merit. The appellate court ruled that “bad faith may be inferred where the specific short comings of the case are identified by opposing counsel and the decision is made to go forward despite the inability to respond to the arguments raised.” 

 

The FLIR Systems ruling is another reminder of the possible pitfalls in bringing a trade secret misappropriation claim. The penalties can be quite severe if the defendant is to successfully prevail and show that the trade secret misappropriation claims were found to have been brought in bad faith.