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How Should Litigators Establish Evidence in Trade Secret Cases? Part Two: Damages

How Should Litigators Establish Evidence in Trade Secret Cases? Part Two: Damages

By Varant Yegparian

As discussed in part one of this series, trade secret litigation presents a minefield of evidentiary challenges. But while the act of misappropriation is often simple enough to demonstrate, calculating the precise value of damages can be extremely difficult. Lawyers must be able to articulate the different cognizable forms of damage available to their client, supported by the requisite forms of evidence.

A “flexible and imaginative” approach is applied to the calculation of damages in misappropriation of trade secrets cases. Sw. Energy Prod. Co., 491 S.W.3d 699, 710 (Tex. 2016) (citing Univ. Computing Co. v. Lykes–Youngstown Corp., 504 F.2d 518, 538 (5th Cir.1974)). Each case is controlled by its own peculiar facts and circumstances.” Id. The Texas courts note that while damages may be ascertained with precision in some cases, lack of certainty will not preclude recovery. Id. Indeed, these courts note that where “the damages are uncertain, however, we do not feel that the uncertainty should preclude recovery; the plaintiff should be afforded every opportunity to prove damages once the misappropriation is shown.” Id.

At common law, damages in misappropriation cases could take several forms. Sw. Energy Prod. Co., 491 S.W.3d at 710 (“Damages in misappropriation  cases can therefore take several forms, including the value of the plaintiff’s lost profits, the defendant’s actual profits from the use of the secret, the value a reasonably prudent investor would have paid for the trade secret, the development costs the defendant avoided by the misappropriation, and a reasonable royalty.”).

TUTSA simplifies things (to an extent). Under the statute, a successful plaintiff can obtain injunctive relief and damages, which can include the actual loss caused by the misappropriation and the unjust enrichment to the defendant that is not taken into account in computing actual loss. Tex. Civ. Prac. & Rem. Code  § 134A.004(a). Alternatively, and in lieu of damages measured by the other methods, damages may be measured by imposition of a reasonable royalty on the defendant. Id. Furthermore, exemplary damages in an amount capped at two-times actual damages may be awarded to a plaintiff who proves willful and malicious misappropriation by clear and convincing evidence. Id. 134A.004(b).[1] Under TUTSA, a plaintiff is only required to show an injury if it seeks damages in addition to injunctive relief. Clements Fluids, 589 S.W.3d at 191. Relatedly, the burden of proof on damages for misappropriation of trade secrets is liberal. Id.

Nevertheless, as with the liability prong of the statute, courts look to pre-TUTSA cases in considering damages. See e.g., Sw. Energy Prod. Co., 491 S.W.3d at 710 (citing Lykes-Youngstown Corp., 504 F.2d at 539); TMRJ Holdings, Inc. v. Inhance Techs., LLC, 540 S.W.3d 202, 210 (Tex. App.—Houston [1st Dist.] 2018, no pet.) (same); 360 Mortgage Group, LLC v. Homebridge Fin. Services, Inc., 2016 WL 6075566, at *2 (W.D. Tex. Apr. 22, 2016) (same).

A. Plaintiff’s Lost Value

Loss of value to the plaintiff is usually measured by lost profits. Sw. Energy Prod. Co., 491 S.W.3d at 711 (Tex. 2016) (citing Jackson v. Fontaine’s Clinics, Inc.,  499 S.W.2d 87, 89–90 (Tex.1973)). To recover lost profits, a party must introduce “objective facts, figures, or data from which the amount of lost profits can be ascertained.”  Id. (citing Holt Atherton Indus., Inc. v. Heine,  835 S.W.2d 80, 84 (Tex.1992)). Reasonable certainty is required to prove lost profits.  Id. (citing  Miga v. Jensen,  96 S.W.3d 207, 213 (Tex.2002)).

In proving lost profits, evidence showing the defendant’s actual profits resulting from the misappropriation are required. StoneCoat of Tex., LLC v. ProCal Stone Design, LLC, 426 F. Supp. 3d 311, 351 (E.D. Tex. 2019) (“[A]lthough a defendant’s profits are a ‘proper element [ ] of damages in a case involving the wrongful use of a trade secret,” a plaintiff cannot recover damages without offering evidence “to show the actual profit made by [defendant].'”) (citing Elcor Chem. Corp. v. Agri–Sul, Inc.,  494 S.W.2d 204 (Tex. Civ. App.—Dallas 1973, writ ref’d n.r.e.)); see also, Carbo Ceramics, Inc. v. Keefe,  166 Fed. Appx. 714, 723 (5th Cir. 2006) (interpreting Texas law to permit a plaintiff to “seek damages measured by the defendant’s actual profits resulting from the use or disclosure of the trade secret”).

Critically, the plaintiff must come forward with evidence of causation pinpointing the profits it lost as a result of the misappropriation; evidence of the defendant’s profits writ large, without connection to their misappropriation, is not sufficient. StoneCoat, 426 F. Supp. 3d at 351 (“Morrison also opines as to  lost  profits.  However, his opinions are not tied in any way to the portion, if any, of the  lost  profits  which may have been caused by Profanchik’s or ProCal Stone Design’s alleged misappropriation of the French formula, but instead extend globally to all of the Defendants’ allegedly actionable conduct.”); Hunter Bldgs. & Mfg., L.P. v. MBI Glob., L.L.C., 436 S.W.3d 9, 21 (Tex. App.—Houston [14th Dist.] 2014, pet. denied)) (“Based on his trial testimony, it appears that, in calculating Global’s lost profits, Spilker presumed that the Defendants engaged in all of the actionable conduct alleged in Global’s petition and then calculated lost profits as damages for this allegedly actionable conduct. Nonetheless, Spilker did not connect his calculation of lost profits to any defendant’s alleged misappropriation of trade secrets.”).

One court has suggested that differentiating a defendant’s actual profits from those, if any, they would have made had the misappropriation not occurred could be an acceptable method of calculating lost profits. Id. (“Spilker’s testimony does not reflect that he attempted to measure the difference between Global’s actual profits and the profits, if any, that Global would have made if Nickel and LeBlanc had left Global when they did, and the Defendants had competed against Global without any misappropriation of trade secrets.”)

Moreover, in cases where a single, large transaction has been lost to the defendant, a plaintiff will typically be able to come forward with evidence establishing a complete calculation of lost profits. In Snowhite, the defendant’s misappropriation of trade secreted information enabled them to secure a single contract for providing furniture, fixtures, and equipment to a hotel. Snowhite Textile & Furnishings, Inc. v. Innvision Hosp., Inc., No. 05-18-01447-CV, 2020 WL 7332677, at *2 (Tex. App.—Dallas Dec. 14, 2020, no pet.). The court held that this evidence sufficiently established lost profits under TUTSA. Id. at * 12 (“Since misappropriation damages can take the form of the defendant’s actual profits from the use of the secret, Kapadia testified to a single complete calculation of  lost  profits  when he testified that Snowhite earned $45,000.00 from the Odessa Project.”)

This approach has its limitations. First, the trade secret’s value to the plaintiff is an appropriate measure of damages “only when the defendant has in some way destroyed the value of the secret.” Lykes-Youngstown Corp., 504 F.2d at 535. Thus, where the plaintiff “retains the use of the secret” and where “there has been no effective disclosure of the secret,” the total value of the trade secret to the plaintiff is an inappropriate measure. Id. Second, unless some specific injury to the plaintiff can be established, such as lost sales, the loss of value to the plaintiff “is not a particularly helpful approach in assessing damages.” Id. at 536.

B. Defendant’s Gained Value

Value to the defendant may be measured by the defendant’s actual profits resulting from the use or disclosure of the trade secret (unjust enrichment), the value a reasonably prudent investor would have paid for the trade secret, or development costs that were saved. Sw. Energy Prod. Co., 491 S.W.3d at 711 (citing Lykes-Youngstown Corp., 504 F.2d at 538-9). This is usually the accepted approach where the secret has not been destroyed and where the plaintiff is unable to prove specific injury. Lykes-Youngstown Corp., 504 F.2d at 535. There are many variations in the way this benefit can be measured. Id.

A plaintiff can recover the defendant’s “actual profits resulting from the use or disclosure of the trade secret.” Carbo Ceramics, 166 Fed. Appx. at 722 (citing Elcor Chem. Corp. v. Agri–Sul, Inc.,  494 S.W.2d 204, 214 (Tex.App.-Dallas 1973, writ ref’d n.r.e.)). However, there is “little precedent under Texas law” on the quantum of proof required for a plaintiff to recover damages attributable to the defendant’s profits. MGE UPS Sys., Inc. v. GE Consumer & Indus., Inc., 622 F.3d 361, 369 (5th Cir. 2010). Given that this method requires proof of actual profits, plaintiffs routinely have difficulty establishing this measure of damages. For example, in Carbo Ceramics, the Fifth Circuit affirmed the trial court’s grant of summary judgment on damages because the plaintiff’s expert, who had projected the defendant’s profits, rendered an “inherently speculative” opinion based on projected, not actual, revenues. Carbo Ceramics, 166 Fed. Appx. at 724 (“However, the fundamental problem with Carbo’s theory of damages … is the starting point—Keefe’s projected revenues. It is undisputed that Keefe has neither built a plant nor produced a product. Hence, any damage model based on speculative revenues and operating profit from an unbuilt plant, is in and of itself, inherently speculative.”). Likewise, in MGE, the plaintiff’s expert based his opinion on the defendant’s total revenues, not actual profits. MGE, 622 F.3d at 369 (“MGE faces the same problems showing “actual profits resulting from the use or disclosure of the trade secret” as it did on its copyright claim. DX–37 demonstrated PMI’s  total revenue,  not “actual profits.” MGE has not presented evidence that provides any means of distinguishing revenue PMI gained from other sources from revenue gained through misappropriation of MGE’s trade secrets, let alone a calculation of profits from the relevant portion of revenue.”) The failure to put on evidence of actual profits required judgment as a matter of law in the defendant’s favor.

To avoid these problems, a plaintiff can seek damages measured by the costs saved by the defendant.  Carbo Ceramics, 166 Fed. Appx. at 723 (citing Lykes-Youngstown Corp., 504 F.2d at 538-9). This is typically shown through saved development costs.  Id.; see also Bourns, Inc. v. Raychem Corp.,  331 F.3d 704, 709–10 (9th Cir.2003) (affirming award of $9 million, measured by three years’ saved time at a “burn rate” of $3 million per year). Lykes-Youngstown Corp. elaborated on the proof that could be used to establish this damages model: “… the difference in costs to the defendant of developing the trade secret on his own, using the actual development costs of the plaintiff as the complete measure of damages.” 504 F.2d at 538. While this method has the benefit of being readily ascertainable and easy to establish (the plaintiff will be in control of all the information required to establish its actual development costs), this measure may be inadequate to fully compensate the plaintiff for the misappropriation. As Lykes-Youngstown Corp. noted, this “measure of damages simply uses the plaintiff’s actual costs, and in our view is frequently inadequate in that it fails to take into account the commercial context in which the misappropriation occurred.” Id.

C. Reasonable Royalty

The multitude of damage models used in trade secret cases is the best evidence of the challenges facing a plaintiff who has established misappropriation but must still quantify the harm resulting from that misappropriation. This challenge intensifies when a plaintiff cannot square the harm it suffered with the lost-profits or saved-costs approaches described above. These challenges are precisely why courts are encouraged to take a “flexible and imaginative” approach to the problem of damages—one that will be controlled by the “peculiar facts and circumstances” of each case. Id. To deal with situations where quantifying the plaintiff’s harm is difficult, TUTSA and the common law employ a “reasonable royalty” as an alternative measure of damages.

When imposing a reasonable royalty, a court is free to impose the royalty for a finite or indefinite amount of time because the award of the royalty is a form of equitable relief. Bianco v. Globus Med., Inc., 53 F. Supp. 3d 929, 934 (E.D. Tex. 2014) (“Because the award of an ongoing royalty is a form of equitable relief, Texas case law pertaining to injunctive relief in trade secret cases is relevant … a court may impose perpetual injunctive relief that continues even past the time when a trade secret is publicly disclosed. Such perpetual relief, however, is not mandated. A court is free to award equitable relief for a limited term if the circumstances warrant such relief.”) (internal citations omitted).

The reasonable royalty model is calculated based on what a willing buyer and seller would settle on as the value of the trade secret. Carbo Ceramics, 166 Fed. Appx. at 723 (citing Lykes-Youngstown Corp., 504 F.2d at 538-9). Because the precise value of a trade secret may be difficult to determine, the proper measure is to calculate what the parties would have agreed to as a fair price for licensing the defendant to put the trade secret to the use the defendant intended at the time the misappropriation took place. Sw. Energy Prod. Co., 491 S.W.3d at 711. This royalty is calculated based on a fictional negotiation of what a willing licensor and licensee would have settled on as the value of the trade secret at the beginning of the infringement. Id. Because the royalty is, in essence, a proxy for the value of what the defendant appropriated, it is not simply a percentage of the defendant’s actual profits. Id.

To that end, the Fifth Circuit has articulated a series of standards to be considered when putting on evidence to support a reasonable royalty:

  • The resulting and foreseeable changes in the parties’ competitive posture;
  • Prices past purchasers or licensees may have paid;
  • The total value of the secret to the plaintiff, including the plaintiff’s development costs and the importance of the secret to the plaintiff’s business;
  • The nature and extent of the use the defendant intended for the secret; and
  • Whatever other unique factors in the particular case which might have affected the parties’ agreement, such as the ready availability of alternative processes.

Lykes-Youngstown Corp., 504 F.2d at 539 (citing Hughes Tool Co. v. G. W. Murphy Industries, Inc., 491 F.2d 923, 931 (5th Cir. 1973)). Evidence of all these factors is not required. Sw. Energy Prod. Co., 491 S.W.3d at 712-13.

A party who presents evidence that tracks the Lykes-Youngstown factors will meet its evidentiary burden. For example, in Harper v. Wellbeing Genomics Pty Ltd., the plaintiff came forward with: evidence showing the parties’ different competitive positions resulting from the defendant’s misappropriation, an executed distributorship agreement that was probative of what a willing party would pay to license the trade secret, testimony regarding the time and costs spent in developing the trade secret, and proof that the trade secret had been used by the defendant to secure a patent. 2018 WL 6318876, at *9 (Tex. App.—Austin Dec. 4, 2018, pet. denied). The Austin Court of Appeals held this to be legally sufficient evidence for purposes of withstanding appeal. Id.

While “a measure of uncertainty is tolerated” in computing damages for trade secret cases, “when there is objective evidence from which more certainty can be gleaned, it is incumbent on the plaintiff to produce that evidence.” Sw. Energy Prod. Co., 491 S.W.3d at 720. In Sw. Energy Prod. Co., the Texas Supreme Court took issue with the evidence the plaintiff presented to establish a reasonable royalty. There, the plaintiff relied on expert testimony applying a flat 3% overriding royalty on a number of oil and gas leases. Id. The expert did so based on an agreement between the defendant and a third party. Id. The court took issue with this royalty as painting an incomplete and misleading picture because it did not comport with the actual method used to calculate the overriding royalty contained in the agreement upon which the plaintiff’s expert relied. Id. (“Under the Petrohawk agreement, evidence of production revenue is no evidence that a transaction qualifying for an overriding royalty even exists. If Helfand had sued Petrohawk to recover an overriding royalty on 140 wells drilled based on her recommendation, she would not automatically be entitled to a 3% overriding royalty even if her average on three other deals (or 3,000 other deals) was 3%.”). The calculation of the reasonable royalty required that the plaintiff actually show that the leases in question actually qualified for the 3% override calculated by the expert—something she did not do. Id. (“Though readily ascertainable, the record here does not contain any evidence of the per-prospect or average overriding royalty that would obtain if the Petrohawk compensation structure were applied to the disputed wells.”). More to the point, the evidence that the expert relied upon did not establish the value of the trade secret—instead, the evidence involved a transaction that involved the trade secret in an ancillary manner. Id. (“Thus, even though the compensation structure in the Petrohawk agreement is merely probative of the trade secret’s value, and not necessarily dispositive of a reasonable royalty, we cannot excuse the absence of objective evidence that places the compensation structure in context and bears directly on ‘the amount that a person desiring to use the trade secret would be willing to pay for its use.'”)

Put another way, the evidence used to calculate the reasonable royalty must be probative of the value a hypothetical buyer would place on the trade secret.

D. Evidence Establishing Damages

The following checklist provides a quick reference to the types of evidence needed to prove up in a trade secret case.

Plaintiff’s lost value:

  • Objective facts, figures, or data from which the amount of lost profits can be ascertained. Reasonable certainty required.
  • Causation is key: must attribute profits lost to the misappropriation.
  • Best used for single or definite number of transactions.

Defendant’s gained value:

  • Actual profits must be tied to the misappropriated secret; generalized evidence (revenues, overall net profits, etc.) insufficient.
  • Avoided costs include the costs to plaintiff to develop the trade secret; often are inadequate.

Reasonable royalty:

Lykes-Youngstown Factors

  • Changes in the parties’ competitive posture;
  • Prices past purchasers or licensees may have paid;
  • The total value of the secret
  • Nature and extent of defendant’s use; and
  • Other unique factors which might have affected the parties’ agreement.

Varant Yegparian is a partner at Hicks Johnson PLLC, a Houston-based trial law firm.

[1] Under TUTSA, “[w]illful and malicious misappropriation” means intentional misappropriation resulting from the conscious disregard of the rights of the owner of the trade secret. Tex. Civ. Prac. & Rem. Code  § 134A.002(7).