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?
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:
All parties must understand the damages and the role a damages expert plays in these cases.
The court may grant three possible remedies to the plaintiff:
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.
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:
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 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:
When calculating unjust enrichment in trade secrets cases, the goal is to expel any monetary or business gains from the defendant, such as:
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.
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.
©All Rights Reserved. August, 2021. DailyDACTM, LLC d/b/a/ Financial PoiseTM
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…
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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