Thursday, September 2, 2010

California Court of Appeal Permits Royalty Damages Claim to Proceed Against E*Trade (Ajaxo v. E*Trade Financial)

In a long-running dispute involving E*Trade's unsuccessful attempt to develop wireless trading technology, a California Court of Appeals has allowed a wireless vendor to proceed against E*Trade on the theory of royalty damages.

E*Trade had previously been found liable for willfully misappropriating trade secrets related to wireless trading technology. However, E*Trade's jilted vendor - Ajaxo - had been unable to show either that (a) it suffered any lost profits from E*Trade's misappropriation of technology; or (b) E*Trade received some inequitable benefit. A California Superior Court refused to allow evidence of royalty damages to proceed, despite the lack of evidence of either lost profits or unjust enrichment damages. That, the appeals court, said was error.

The concept of royalty damages is not unique to trade secrets law, as it has been directly borrowed from patent law. This makes sense. Businesses often must decide whether they want to innovate and create a competitive advantage through secret information, or take the opposite approach and secure exclusive market rights through novel inventions. The common thread is the notion of exclusivity.

Royalty damages are most often applied when lost profits or improper gain cannot be proven by a preponderance of the evidence. This alternative theory is meant to reward a plaintiff's efforts at innovation, since it can hardly be punished if a trade secret is stolen but not deployed properly. This damages theory simply shifts risk to the misappropriator.

From the plaintiff's perspective, actual evidence of a reasonable royalty must be established, usually through experts. It cannot be presumed. A royalty is defined as a hypothetical, arms-length selling price between the trade secret developer and the misappropriator. Evidence of negotiations regarding license fees to use a secret (such as source code) certainly would be a starting point. Other factors tending to establish a royalty might be the value of the secret to the plaintiff's business or development costs associated with its creation. The evidence of royalties is likely to be very complex, depending on the nature of the secret taken and how important it is to the developer's core business.

From the trade secret plaintiff's perspective, counsel must be thinking about royalty damages from the outset of the case. The law on lost profits is often defense friendly, and an early halt to trade secrets misappopriation may mean that unjust enrichment simply is not provable.


Court: Court of Appeal of California, Sixth Appellate District
Opinion Date: 8/30/10
Cite: Ajaxo, Inc. v. E*Trade Financial Corp., 187 Cal. App. 4th 1295 (Cal. Ct. App. 6th Dist. 2010)
Favors: N/A
Law: California

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