05/16/2012 02:16 pm ET Updated Jul 16, 2012

Trade Secrets May Be Lost

A recent decision of the United States Court of Appeals for the Seventh Circuit is a reminder that a trade secret may be lost if the owner fails to take reasonable precautions to protect it (Fail-Safe, LLC v. A.O. Smith Corp.). Inventors, and other owners of intellectual property, must have a signed confidentiality agreement prior to disclosing proprietary or trade secret information in the course of business negotiations or transactions. As the Seventh Circuit began its opinion:

This case is about whether a plaintiff can sustain a trade secret or unjust enrichment claim when that plaintiff fails to take any protective measures to safeguard its proprietary information. Business relationships do not always develop under formulaic circumstances. But when one company fails to take any protective steps to shield its proprietary information, it cannot then expect the law to protect it when the relationship sours.

This case involved two companies discussing the development of a swimming pool pump motor. In the course of these interactions one company (Fail-Safe) described some test results and desirable features. The other company (A.O. Smith) had Fail-Safe sign a one-way confidentiality agreement identifying Fail-Safe as a supplier of research consulting services. Subsequently Fail-Safe asserted that A.O. Smith had designed its own pump that incorporated information disclosed in the interactions between them.

The Seventh Circuit noted that the plaintiff failed to take reasonable precautions to protect its trade secrets such as marking the information as confidential or requiring a reciprocal confidentiality agreement. Furthermore, the Court stated a "mere subjective belief that it had entered into a joint venture does not warrant protection." It is clear that conversations concerning business relationships must be formalized with signed documents.

The Uniform Trade Secrets Act, enacted by almost all state legislatures, broadly defines a trade secret:

information, including a formula, pattern, compilation, program, device, method, technique, or process, that: (i) derives independent economic value, actual or potential, from not being generally known to and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.

This definition contains two parts. First, economically valuable information must not be generally known. Second, the owner must take reasonable steps to keep it secret. Much litigation involves the information part of the definition. Many cases are concerned with customer lists and sales techniques. Frequently these are determined to be commonly known or readily ascertainable. The Seventh Circuit case under discussion, uncommon for an established company, involves the reasonable steps to maintain secrecy aspect.

As many commentators have noted, the owner of a trade secret must consider how it is being disclosed within and outside of the organization. Employees should, at a minimum, sign a Non-Disclosure Agreement and have access to trade secret information on a need-to-know basis. One cannot be too careful or continually vigilant that everyday conduct does not negate the initial precautions. This would be like purchasing a safe but failing to lock the door. Companies have discontinued factory tours due to trade secret disclosure concerns. Externally, Confidentiality Agreements are a must prior to disclosure to third parties. Again, thoughtful planning is critical.

Trade secrets may be lost due to ignorance of the law or careless conduct. This should not happen in our modern information based economy.