Monday, September 21, 2015

The Inevitable Disclosure Rule and Commercial Transactions

Claims for trade secrets misappropriation normally arise out two types of transactions: a fractured employment relationship or a failed business strategic transaction (such as a merger or joint venture).

One way to prove threatened misappropriation (and therefore secure injunctive relief) is to claim that improper use or disclosure of a secret is "inevitable." This inevitability theory is disfavored and not even viable in some jurisdictions. However, it continues to spur litigation and debate.

In the employment context, claims of inevitable disclosure normally must meet a certain standard, though the standard is necessarily flexible and case-specific:

  1. The old and new employer must be direct competitors.
  2. The employee's new position must overlap with the old one.
  3. The new employer must fail to take some reasonable step to guard against the employee's use or disclosure of trade secrets.
  4. The employee's departure conduct must suggest the possibility of misuse (e.g., misleading the employer as to plans, suspiciously accessing proprietary data).
If the inevitability theory works in employment cases, it does so because the employee's objectively perceived value to the new employer tends to derive from her prior work experience. Put another way, the employee normally does not bring some unrelated, free-standing value apart from this job history. So (again, in theory) it's at least plausible that even well-intentioned employees will disclose something that they shouldn't.

In a failed business transaction, this rationale is absent. Businesses may combine because of synergies that are unrelated to their status as market competitors. Therefore, it is dangerous to presume that erstwhile joint venture partners, for instance, will will have any incentive to incorporate the others' trade secrets.

The Appellate Court of Illinois' decision in Destiny Health, Inc. v. Cigna Corp., 2015 IL App (1st) 142530, notes this important distinction in applying the inevitable disclosure theory and rejecting it to a failed joint venture. Destiny Health discusses the leading case involving a failed acquisition and the attempted use of the inevitability theory, Omnitech Int'l v. Clorox Co., 11 F.3d 1316 (5th Cir. 1994). Both cases expound upon the difficulty in establishing trade secrets misappropriation through the inevitable disclosure theory.

Omnitech and Destiny Health both emphasize the danger associated with inferring trade secret misappropriation after a failed transaction. This leads to one of two perverse results: (1) if a company evaluates one potential target, and then declines to acquire it, the company effectively would be precluded from evaluating other targets; or (2) the company would have to evaluate potential targets without evaluating their trade secrets. 

Ultimately, I believe that contracts should set the parameters for the inevitable disclosure rule. In commercial transactions, a simple non-disclosure agreement (signed as a condition of evaluating a business transaction) should determine any future restrictions. If, as in Destiny Health, the agreement is silent on a party's ability to develop certain products, explore certain targets, or contracting with certain vendors, then the "inevitable disclosure" theory should be unavailable.

Similarly, in the employment context, I believe that the inevitable disclosure rule only should be applied to demonstrate the employer's protectable interest in enforcing a non-compete agreement. In other words, the employer should not have to wait for the ex-employee to disclose something before seeking enforcement. As long as the employer can show extensive access to company secrets, then this should support enforcement of a non-compete - assuming of course, the terms are reasonable and the agreement carries proper consideration.

The Destiny Health case illustrates the potential misuse and overapplication of the inevitable disclosure rule. Right now, it's operating as an uncontrolled extension of trade secrets law. The rule needs standards, but few courts seem willing to apply them with regularity.

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