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Financial Poise
measuring the loss of trade secret theft

Case Assessment on Trade Secret Misappropriation

Estimating Economic Loss in Trade Secrets Cases

The number of civil and criminal trade secret cases filed have substantially increased in recent years. In April of 2019, a former Garrett Popcorn employee was accused of stealing trade secrets, and just days before, an ex-GE engineer reportedly stole trade secrets for China. The rise in trade secrets cases has led the Trump administration to threaten an increase in tariffs due to economic challenges resulting from Chinese companies that demand trade secrets in exchange for business.

The Complexity of Trade Secrets Cases

Many factors contribute to the growth in trade secret misappropriation including disruptive technology, recent trade secret theft laws (e.g. the Defense of Trade Secrets Act of 2016) and the sometimes ambiguous definition of trade secrets.

As of now, trade secrets are still defined as confidential information used by a business to maintain a competitive advantage. A trade secret could be anything from a formula or design to a process or technique—a rather wide scope for one type of intellectual property.

[Editor’s Note: Learn about the protection of other types of intellectual property in the article, “Intellectual Property, Cybersecurity and Creativity” by Meghan Nugent.]

In addition to these factors, trade secrets cases are made more complex by their numerous legal claims:

  • Unjust enrichment
  • Computer Fraud and Abuse Act (CFAA) and Stored Communications Act (SCA) violations
  • Unfair competition
  • Conversion
  • Breach of contract
  • Tortious interference
  • Breach of fiduciary duty
  • Copyright infringement
  • Patent infringement
  • Whistleblower allegations
  • Civil Racketeer Influenced and Corrupt Organizations Act (RICO) violations

All parties to these matters must understand the available damages remedies and the role that a damages expert plays in these cases.

Options for Judicial Relief

The court may grant three possible remedies to the plaintiff:

  • Equitable Relief – This type of judicial relief can come in the form of preliminary or permanent injunction. In other words, the court can prevent a party from continuing or not continuing a specific course of action, either permanently or before a final decision is made.
  • Monetary Damages – Compensatory relief generally includes analyzing the plaintiff’s actual loss and the defendant’s gains from the alleged wrongful conduct. Exemplary (or punitive) damages of up to two times the compensatory damages may be awarded in situations involving willful and malicious misappropriation. In cases with civil RICO legal claims, exemplary damages are three times compensatory damages and attorney’s fees.
  • Legal Fees – The plaintiff may be granted compensation of legal fees accrued during the litigation process.

Damages provisions of federal and state statutes may vary, so a damages expert should determine damages on a case-by-case basis and disaggregate them among trade secrets or other legal claims. Calculating actual loss, unjust enrichment and reasonable royalty, therefore, is an arduous task.

[Editor’s Note: Are you concerned about protecting intellectual property under Chapter 11? Learn about licensor relief and more in “The Intersection of IP and Bankruptcy.”]

Measuring Actual Loss

The goal in estimating actual loss is to make the plaintiff “whole”. Essentially, this would restore the plaintiff to their original position before a trade secret misappropriation took place.

  • Lost Profits are calculated first by estimating lost revenue and subtracting the hypothetical costs incurred to produce revenue. Lost revenue is calculated using one of four methods: the “before and after” method, the “yardstick” or benchmark method, the sales projection method or a method using the terms of an underlying agreement ( e.g. confidentiality, non-compete or non-disclosure agreement). With all methods, the calculation subtracts actual revenue from sales projection revenue during the loss period.
  • Fair Market Value is a valuation analysis that estimates the financial impact of the trade secret misappropriation on the plaintiff’s business. This analysis may include an analysis of the diminution of the fair market value of the plaintiff business. In simple terms, the trade secret, which is an intangible asset, is given a tangible, cash-equivalent valuation. This equivalency is based on the assumption that the property would change hands between a buyer and seller in an open market with knowledge of the facts.

Three common methods are used to calculate trade secret value:

  • Cost Approach: based on the economic principle of substitution, under which a prudent investor would pay no more for a trade secret than the cost necessary to replace and/or protect the trade secret.
  • Market Approach: based on an analysis of trade secret acquisition transactions or trade secret licenses to value the subject trade secret.
  • Income Approach: used to estimate the value of a trade secret if the trade secret produces any measure of either operating income or license income.

Measuring Unjust Enrichment

When calculating unjust enrichment in trade secrets cases, the goal is to attempt to expel any monetary or business gains from the defendant, such as

  • Sales profits connected to the trade secret;
  • Head-start damages that accelerated the defendant to market;
  • Increased business value from higher cash flows;
  • Saved research and development; and
  • The value of the trade secrets on the date of misappropriation.

Measuring Reasonable Royalty

Actual loss and unjust enrichment could not be accurately calculated. Now what? A less popular method is using the reasonable royalty method, in which the damages are calculated based on the royalty income that the plaintiff would have earned had it licensed the subject trade secrets to the defendant.

The reasonable royalty method calculates an amount based on the assumption of a third-party licensor paying a third-party licensee. This could be based on documentation between defendant and plaintiff or a rate comparison of similar licensing agreements.

A royalty rate is typically documented as a unit amount, lump sum or percentage of gross revenue, net revenue or cost savings. Trade secrets are generally licensed either on a stand-alone basis, or as part of a patent or broader IP license agreement. It is difficult to find relevant third-party trade secrets license agreements to rely upon to properly analyze reasonable royalty; therefore, this method is used less in analyzing trade secrets damages in comparison to the plaintiff’s actual loss or defendant’s unjust enrichment.

The Way Forward for Trade Secrets Cases

Damages experts can measure economic loss in numerous ways, but the most important factor in calculating damages is an adherence to the unique facts and circumstances of the individual trade secrets case as these cases continue to grow.

[Editor’s Note: To learn how more about keeping your company’s intellectual property safe, check out the webinar “Leveraging & Protecting Trade Secrets in the 21st Century.”]

 

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About Shawn Fox

Shawn Fox is the national managing director of forensic and valuation services practice at Sikich LLC, the country’s 28th largest Certified Public Accounting firm. He has 22 years of experience providing fraud and forensic accounting, dispute advisory, and valuation services to the business and legal community involved in high profile disputes and investigations. Shawn directs…

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About David Wharton

David Wharton, CPA, CFE, CFF, is a senior manager for dispute advisory services in the Kansas City offices of Sikich. He has more than 12 years of experience providing forensic accounting, dispute advisory and financial consulting services to the business and legal community. David’s experience covers a wide array of complex matters including: commercial litigation,…

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