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Trade Secret Misappropriation: Methods for Measuring Damages and Seeking Relief

How to Assess Trade Secret Value in Litigation

Trade secret theft is on the rise, and it’s no easy task for affected businesses to obtain relief. What constitutes a trade secret and its value can be complicated.

Trade secret misappropriation is the unauthorized use or disclosure of a trade secret where the trade secret is not part of public domain and its owner (i.e., the business) has taken measures to protect the trade secret.

Trade secrets are 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.

The number of civil and criminal trade secret cases filed have increased by 30% 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 secret theft led the Trump administration to threaten an increase in tariffs because of economic challenges caused by Chinese companies demanding trade secrets in exchange for business.

Trade secret cases are not cut and dry. So, how does a plaintiff in a misappropriation case determine its legal options and the amount owed in damages?

The Complexity of Trade Secret Theft

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.

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 or patent infringement
  • Whistleblower allegations
  • Civil Racketeer Influenced and Corrupt Organizations Act (RICO) violations

All parties must understand the damages and the role 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 twice 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.

Measuring Actual Loss

The goal in estimating actual loss is to make the plaintiff whole. This restores 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
  • 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

Fair market value is a valuation analysis that estimates the financial impact of the trade secret theft on the plaintiff’s business. This analysis may include an analysis of the diminution of the fair market value of the plaintiff business.

In simpler 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 is based on the economic principle of substitution under which a prudent investor pays no more for a trade secret than the cost necessary to replace and/or protect the trade secret.
  • Market Approach is the analysis of trade secret acquisition transactions or trade secret licenses to value the subject trade secret.
  • Income Approach estimates 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 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
  • The value of the trade secrets on the date of misappropriation

Measuring Reasonable Royalty

What if actual loss and unjust enrichment could not be accurately calculated? A less popular method is using the reasonable royalty method. The damages are calculated based on the royalty income 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 (a 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. That’s why this method isn’t usually used to analyze trade secrets damages in comparison to the plaintiff’s actual loss or defendant’s unjust enrichment.

The Way Forward for Trade Secret Misappropriation

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, especially since cases are increasing.

[Editors’ Note: To learn more about this and related topics, you may want to attend the following webinars: Leveraging & Protecting Trade Secrets in the 21st Century and Valuing Your Brand and Other “Soft” Assets.]

©All Rights Reserved. August, 2021.  DailyDACTM, LLC d/b/a/ Financial PoiseTM

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About Shawn Fox

Shawn Fox is managing director for dispute resolution services at Sikich LLP. He has more than 20 years of accounting and consulting experience, and has extensive proficiency providing forensic accounting and dispute advisory services to the business and legal community. Shawn directs forensic investigations and analysis across a wide range of areas, including complex damages, lost profits, intellectual…

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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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