Trade Secret Misappropriation: Methods for Measuring Damages and Seeking Relief

How to Assess Trade Secret Value in Litigation

Trade secret theft continues to rise, posing significant challenges for businesses seeking relief. Determining what qualifies as a trade secret and accurately assessing its value can be complex and multifaceted.

Trade secrets are broadly defined as confidential information that gives a business a competitive edge. They can include anything from formulas and designs to processes and techniques, encompassing a wide range of intellectual property.

Trade secret misappropriation occurs when a trade secret is used or disclosed without authorization, provided the trade secret is not in the public domain and the business has taken reasonable measures to protect it.

In 2023 alone, 1,203 trade secret cases were filed in federal district courts, reflecting the growing importance of intellectual property protection. For example, high-profile incidents like the alleged theft of trade secrets by a former Garrett Popcorn employee and an ex-GE engineer for use in China underscore the ongoing risks.

These cases, coupled with rising geopolitical tensions, have heightened awareness of the economic impact of trade secret theft. In response, governments and businesses have placed increased emphasis on protecting intellectual property to combat these challenges through actions like increased tariffs for imported goods.

As trade secret cases grow more frequent and complex, plaintiffs face critical questions: What legal options are available, and how can damages be accurately assessed to ensure justice is served?

The Complexity of Trade Secret Theft

The rise in trade secret misappropriation can be attributed to several factors, including the rapid pace of technological disruption, evolving trade secret theft laws like the Defense of Trade Secrets Act of 2016, and the often ambiguous nature of what qualifies as a trade secret. Together, these elements create a challenging landscape for businesses to navigate.

Adding to the complexity, trade secret cases often involve multiple overlapping legal claims, such as:

• 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

Given this complexity, understanding the damage at stake and the critical role of a forensic accountant is essential for all parties involved in these cases. A forensic accountant helps untangle these intertwined legal claims and provides clarity on the implications of financial damages.

Real-World Example: Motorola Trade Secret Misappropriation Case

A high-profile example of trade secret misappropriation involves Motorola, which was targeted by a hacking operation linked to the Chinese military. This case highlights the global and geopolitical dimensions of trade secret theft, where cyberattacks are employed to obtain confidential information. Such incidents underscore the importance of robust cybersecurity measures and international cooperation in combating trade secret theft.

While details of the economic impact and damages are not fully disclosed, the Motorola case serves as a cautionary tale for businesses to safeguard their intellectual property and take proactive measures against potential threats.

Options for Judicial Relief

When a plaintiff pursues legal action in a trade secret misappropriation case, the court may provide remedies to address the harm caused and deter further misconduct. These remedies fall into three primary categories:

• Equitable Relief: This type of judicial relief can come in the form of preliminary or permanent injunctions. Essentially, the court can order a party to either cease or refrain from a specific action temporarily before a final decision is made permanently.
• Monetary Damages: Compensatory damages focus on analyzing the plaintiff’s actual losses and the defendant’s unjust gains resulting from the wrongful conduct. In cases of willful and malicious misappropriation, exemplary (or punitive) damages of up to twice the compensatory amount may be awarded. For civil RICO claims, these damages can triple, along with attorney’s fees.
• Legal Fees: Courts may grant compensation for the plaintiff’s legal expenses incurred during litigation, adding further financial relief.

Since damages provisions vary across federal and state statutes, it’s crucial for a forensic accountant to assess the unique aspects of each case and disaggregate damages among trade secrets and other legal claims to ensure an accurate evaluation.

Measuring Actual Loss

The primary goal in estimating actual loss is to restore the plaintiff to the financial position they were in before the trade secret misappropriation occurred. This process aims to make the plaintiff whole by compensating for the economic harm caused by the misappropriation.

A critical component of this calculation is determining lost profits, which involves estimating lost revenue and subtracting the avoided costs the plaintiff would have incurred to generate that revenue. Lost revenue is typically calculated using one of four methods:

• The ‘Before and After’ Method: Compares the plaintiff’s financial performance before and after the misappropriation.
• The ‘Yardstick’ or Benchmark Method: Uses a comparable business or industry standard as a benchmark for expected performance.
• The Sales Projection Method: Relies on the plaintiff’s internal sales forecasts to estimate revenue loss.
• Agreement-Based Method: Uses the terms of underlying agreements, such as non-disclosure, non-compete, or licensing to guide calculations.

In all these methods, the calculation subtracts the plaintiff’s actual revenue during the loss period from their projected revenue, providing a clear picture of the economic impact of the misappropriation.

Fair Market Value

Determining the fair market value of a trade secret involves assessing its financial impact on the plaintiff’s business. This valuation assigns a tangible, cash-equivalent figure to an intangible asset, reflecting what the trade secret would be worth if exchanged between a willing buyer and seller in an open market with full knowledge of the facts.

Three widely used methods to help calculate the value of trade secrets include:

• Cost Approach: Based on the principle of substitution, this method assumes a prudent investor would not pay more for a trade secret than the alternative cost to replace or protect it.
• Market Approach: Relies on analyzing comparable transactions, such as trade secret acquisitions or licenses, to determine the value of the subject trade secret.
• Income Approach: Estimates the trade secret’s value by examining its ability to generate operating income or license income.

By applying these valuation methods, a valuation analyst can quantify the economic loss resulting from trade secret misappropriation with greater precision.

Measuring Unjust Enrichment

In trade secret misappropriation cases, the goal of calculating unjust enrichment is to strip the defendant of any financial or business benefits gained through the misappropriation. This ensures that the wrongdoer does not profit from the stolen trade secrets.

Key forms of unjust enrichment may include:

• Defendant’s Profits: Profits generated directly from the misappropriated trade secret.
• Head-Start Damages: Gains from accelerated market entry enabled by the stolen information.
• Increased Business Value: Enhanced cash flows or market position resulting from the misappropriation.
• Saved Research and Development Costs: Expenses avoided by using the plaintiff’s trade secrets.
• Trade Secret Value at Misappropriation Date: The immediate financial benefit derived from the theft.

By focusing on these elements, unjust enrichment calculations ensure that defendants are held accountable for any advantages obtained at the plaintiff’s expense.

Measuring Reasonable Royalty

What if actual loss and unjust enrichment cannot be accurately calculated?

When other methods of calculating damages prove challenging, such as actual loss or unjust enrichment, the reasonable royalty method offers an alternative approach. This method estimates the royalty income the plaintiff would have earned had the trade secrets been properly licensed to the defendant.

The reasonable royalty method determines damages by assuming a hypothetical agreement between a third-party licensor and licensee. This calculation may rely on documentation between the defendant and plaintiff or comparing rates from similar licensing agreements.

Typically, royalty rates are expressed as a lump sum or a percentage of gross revenue, net revenue, or cost savings. Trade secrets may be licensed independently or as part of a broader intellectual property agreement, such as a patent license. However, finding relevant third-party trade secret licensing agreements for analysis can be particularly difficult, making this method less commonly used compared to other approaches.

Despite its limitations, the reasonable royalty method remains a useful option in cases where more direct measures of damages are impractical.

The Way Forward for Trade Secret Misappropriation

As trade secret misappropriation cases continue to rise, the role of forensic accountants becomes increasingly vital. While there are numerous methods to measure economic loss, the key to accurately calculating damages lies in tailoring the approach to the unique facts and circumstances of each case. Every trade secret carries its own nuances, making a one-size-fits-all solution impractical.

By focusing on the specific details of the misappropriation, forensic accountants can ensure a fair and accurate assessment, providing clarity and justice in an ever-evolving landscape of intellectual property disputes.

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. How to Build and Implement your Company’s Information Security Program
2. Introduction to US Privacy and Data Security: Regulations and Requirements
3. Selecting the Right Valuation Expert

This is an updated version of an article originally published on August 21, 2021.]

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