Is a Padlock Better than a Patent? Trade Secrets vs. Patents

• Avoiding Trade Secret Misappropriation
• Qualifying Information as a Trade Secret

By Mimi C. Goller

Editor's Note: To view Wisconsin statutory materials referenced in this article you must have and/or install Adobe Acrobat Reader on your computer.

In today's extremely competitive corporate environment, know-how and technology are key factors in the commercial success of a business, and businesses must determine whether to protect this valuable information under a patent or a trade secret. Making the wrong decision regarding which type of intellectual property protection to use could cost a company thousands or millions of dollars, and a competitive advantage. Therefore, a business must make a detailed analysis to determine the appropriate form of protection. This article reviews the various advantages and disadvantages with trade secrets and patents, and provides some important factors to consider when determining which form of protection to use.

Trade secrets

A trade secret is defined as any formula, pattern, device, or compilation of information that is used in one's business that gives it an advantage over competitors who do not know or use it.¹ There are many advantages and disadvantages with trade secret law.

Advantages. Unlike patent protection, which has a limited term, trade secret protection can be of unlimited duration. For example, Kentucky Fried Chicken's blend of 11 herbs and spices has been a well-kept trade secret for more than 37 years² and Coca-Cola's soda formula has been a valuable trade secret during the 100 years since its original formulation.³

Then, there is cost: Trade secret information can be relatively inexpensive. For example, there are no government fees associated with a trade secret. In addition, there are no attorney fees for drafting and prosecuting a trade secret, unlike for a patent application. However, various secrecy protection measures, such as computer security measures, employee nondisclosure agreements, employee exit interviews, secured/encrypted electronic communications, external audits, access restrictions, photocopying restrictions, and employee education programs, necessary to maintain trade secret status can be costly.

Further, a trade secret does not have to meet the high patentability standards of utility, novelty, and nonobviousness. As a result, the subject matter protectable as a trade secret is extremely broad and can include chemical formulas, recipes, algorithms, internal pricing, methods of doing business, customer lists, special customer needs, codes for determining discounts, customer credit ratings, architectural plans, manufacturing techniques, marketing and advertising plans, product development information, personnel information, and computer software. Even the genetic content of seeds⁴ and "negative know-how" (that is, knowledge that a certain approach to a problem does not work) have been found legitimate trade secret subject matter.

Additionally, trade secret misappropriation, unlike patent infringement, now can be prosecuted under criminal statutes. A new statute, 18 U.S.C. 1832, dubbed the Economic Espionage Act of 1996 (the Act), was signed into law on Oct. 11, 1996. The Act makes theft of trade secret information a federal criminal offense and gives the Department of Justice authority to prosecute trade secret theft whether it occurs in the United States or abroad.⁵ The penalties under the Act are severe. Violators of section 1832 can be imprisoned for up to 10 years and fined up to $500,000. A corporation or other organization can be fined up to $5 million.⁶

The Act punishes the individual who misappropriated the trade secret and makes it a federal criminal offense to receive, possess, or buy the trade secret information knowing that such information was obtained or stolen without the trade secret owner's authorization. Criminal forfeiture provisions allow forfeiture of any property constituting or derived from the proceeds of Act violations.

Two basic elements are required to prove theft of a trade secret under the Act. First, federal prosecutors must prove that the individual accused of misappropriating the trade secret did so knowingly. Second, the law requires proof of intent to injure the trade secret owner. This second element has drawn sharp criticism due to the difficulty in obtaining evidence proving an intent to cause injury; therefore, this law may be challenging to enforce.⁷

In the past, trade secrets were exclusively under state jurisdiction. Under the Act, federal courts have exclusive original jurisdiction, but the law states that it shall not be construed to preempt or displace any other remedies, civil or criminal, relating to the misappropriation or theft of a trade secret.

Wisconsin has a specific statute, section 134.90, that governs trade secret misappropriation.⁸ When examining an alleged violation of section 134.90, three questions must be answered. 1) Is the material at issue a trade secret under the definition in section 134.90(1)(c)? The definition requires that the "information derives independent economic value, actual or potential, from not being generally known to and not readily ascertainable by a proper means, by others who can obtain economic value from its disclosure or use." The definition also dictates that the information be subject to secrecy efforts.

2) Has misappropriation of the trade secret occurred? "Misappropriation" under section 134.90(2) includes not only actualmisappropriation but a mere threat to misappropriate a trade secret.

If both of the above requirements are met, the next question is: 3) What is the proper remedy under section 134.90(3) or 134.90(4)? The remedy can include injunctive relief and monetary damages. Further, anyone who misappropriates a trade secret in Wisconsin may be guilty of a Class E felony.⁹

Disadvantages. A trade secret is not necessarily exclusive and may be lost through independent discovery or reverse engineering by a third party, both of which are legal, unless prohibited by contract. Further, mere inadvertence by the trade secret holder may result in the loss of trade secret protection. It is not uncommon for an overzealous employee to inadvertently disclose confidential trade secret information at a trade show, during the bid-making process, or at industry seminars.

Trade secret information also is frequently exploited by former employees due to malice toward the former employer or the profitability of corporate espionage, or both. The House of Representatives' Subcommittee on Crime estimates that economic espionage costs U.S. businesses up to $50 billion a year.¹⁰ Although a business may take legal action against individuals who misappropriate trade secrets, as a practical matter the individuals often are without sufficient assets to pay the assessed damages, and imprisonment does not replace the company's lost competitive advantage.

The particular industry of a business may determine whether trade secret protection is beneficial. For instance, in the biotechnology industry, proprietary materials often are alive, microscopic, and able to reproduce themselves even when removed from a former employer's facility, making trade secret protection difficult.¹¹

The loss of trade secret protection also can be relatively easy and quick due to advances in computer technology. For example, an employee can download trade secret information from a company's computer onto a diskette, transfer the information to a home computer, and then upload it onto the Internet where it can be transmitted worldwide within minutes. Within hours, a company can lose complete control over its trade secret rights forever.¹²

Trade secret protection requires stringent secrecy protocols to protect trade secret status. These protocols, as mentioned above, may be quite expensive and difficult, depending upon the industry the company is in, the company's size, and its long-term strategy or goals.

In addition, advanced technology companies, such as those in the computer software or biotech industries, typically have high employee mobility which endangers trade secret preservation. This is especially troublesome since it often is difficult to determine whether an alleged trade secret constitutes the "general knowledge, skills or experience" of the former employee (which the employee has the right to take from the old employer and use for the new one) or the valid "trade secret" information of the former employer. An employee is free to use general skills or knowledge acquired during previous employment; and, as a general rule, courts tend to favor the employee in instances regarding trade secret versus general employee knowledge.¹³

Patents

A United States patent gives an owner the right to exclude others from making, using, or selling the invention covered by the patent. Every invention must have utility, novelty, and nonobviousness in view of the prior art in order to be patentable.

Advantages. Patent protection is exclusive during the entire life of the patent, which now is 20 years from the date of filing the patent application. If a competitor independently invents or reverse engineers what is covered by one's patent, the patent holder still retains exclusive rights to the invention, unlike trade secret protection.

Further, because there are no secrecy limitations surrounding issued patents, business transactions involving patents are easier to structure than those involving trade secrets because trade secrets are in increased danger of being lost through license agreements, joint developments, and consulting arrangements if certain precautions are not taken. Specifically, documents involving these transactions must include language ensuring strict confidentiality, enactment of proper trade secret protocols, and the like.

A patent also can generate revenue through licensing or assignment to third parties without the possibility of secrecy loss. Licensing allows companies to generate formerly untapped revenue from other corporations, ideally in unrelated industries that do not compete with the licensor. Some large companies, such as Texas Instruments, license their patents for sums approaching one billion dollars annually.¹⁴

Patents also can block competitors, who then must design around the patent claims, if possible. Therefore, companies can exploit and dominate niche areas and maintain an increased market share. Patents even can force competitors out of entire markets. In 1991 the Eastman-Kodak Company paid $925 million to the Polaroid Company to settle charges that it had infringed Polaroid's patent for instant photography processes. The settlement agreement also called for Eastman-Kodak to withdraw entirely from the instant photography market.¹⁵

For some businesses a corporation's patents are its only line of defense against competitors, especially for small start-up companies. For instance, a federal jury found that Microsoft's DOS 6 and DOS 6.2 operating systems infringed on patents held by Stac Electronics Inc., a small California company. The jury awarded Stac $120 million, which was more than Stac's entire sales since its 1983 founding.¹⁶ Eventually, Microsoft settled the case upon losing its appeal and agreed to pay Stac $43 million in royalties and to buy a $40 million stake in the tiny company.

As shown, lucrative judgments are available from patent infringers. Upon a finding of infringement, a court can assess lost profits, or at the very least, reasonable royalties. A patent holder does not need to prove that it lost sales due to the infringement or that it manufactured a product made in accordance with the patent in order to receive a substantial damage award. For instance, Honeywell Corporation received more than $300 million from various camera manufacturers for patent infringement even though Honeywell had never used its patented auto-focus technology in its own products.¹⁷

If a competitor willfully infringes a patent, a court may award treble damages, possibly increasing the jury award by thousands or millions of dollars.¹⁸ A court also may award attorney fees to the prevailing party in "exceptional" cases to deter willful infringement.¹⁹

Another advantage of patent protection is notice, which places the burden of avoiding infringement on all who have actual knowledge of the patent. Where a potential infringer actually has knowledge of another's patent, he or she has an affirmative duty of due care. If this duty is neglected or ignored, trebled damages often result.

Patent owners also may invoke the aid of the U.S. Customs Service (U.S.C.S.). If an owner of a U.S. patent believes that infringing merchandise is being imported into the United States, the owner may apply for a survey to assist him or her in taking appropriate action. The survey provides the patent owner with names and addresses of importers of merchandise that appear to infringe the issued patent.²⁰ Patent holders can use the survey results to institute court proceedings or administrative proceedings at the International Trade Commission (I.T.C.). If the I.T.C. or a court issues an exclusion order, the U.S.C.S. has the authority to prevent importation of infringing products. The U.S.C.S. will enforce the exclusion order and deny entry of imports in violation of the order and seize imports from repetitive violators.

Disadvantages. Patent protection can be relatively expensive, requiring fees for drafting patent drawings, government filing fees, attorney fees for drafting the initial application and prosecuting the application through the Patent & Trademark Office (PTO),and assisting in the prosecution through foreign patent offices. Maintenance fees also must be paid to the PTO at various intervals throughout the life of the patent, which become increasingly more expensive as the patent approaches its twentieth year.

Filing a patent application does not guarantee that a patent will eventually issue. It also does not guarantee that if a patent does issue, it will have the scope the inventor desires, since the scope of protection can be affected by necessary amendments made to the patent application during prosecution through the PTO. Additionally, when a patent eventually issues, it is limited to only 20 years of protection, unlike a trade secret, which potentially can offer indefinite protection.

Publication is a further disadvantage with a patent. In the U.S., once a patent issues it is published, allowing the patent holder's competitors a chance to analyze the invention. Filing in certain foreign countries results in publication of the patent application at 18 months from the filing date, even if a patent never eventually issues from the application.

It is possible to use patent protection in conjunction with trade secret protection. For instance, one may file a patent application on the confidential technology and at the same time use trade secret protocols. If patent prosecution proceeds poorly, the application may be abandoned and the confidential technology may enjoy trade secret protection, provided the application is not referenced in a subsequent U.S. patent. Under U.S. law, patent applications are kept confidential until issuance, unless referred to in a U.S. patent, wherein the abandoned application then is available to any member of the public, thereby destroying trade secret protection. If the individual proceeds with prosecution and a patent does eventually issue (and is thereby publicly disclosed), trade secret protection also is lost.

There are several factors to consider in determining whether patent protection is available. One factor is the type of subject matter at issue. Utility patents may cover machines, articles of manufacture, compositions of matter, and processes. ²¹ While patentable subject matter is not as broad as trade secret subject matter, it is quite far reaching. For example, patentable subject matter could include inventions ranging from methods of producing cortisone to commercial package configurations, ²² to fishing lures, and to diagnostic X-ray systems. Transgenic animals, fungi, viral strains, and bacteria also have received patent protection.

Another factor to consider is public disclosure. If an item was sold, offered for sale, or displayed to the public, it may not be patentable due to statutory bars that require a U.S. patent application be filed no later than 12 months from the aforementioned activity. However, trade secret protection still may be an option, depending upon the specific circumstances.

Further, if an industry is one in which technology progresses rapidly, thereby making advancements obsolete in a short time, trade secret may be the most logical form of protection. This is due primarily to the cost of filing a patent application and the amount of time an application may spend during prosecution in the PTO, usually several years.

Conclusion

Trade secret and patent protection can be very effective tools in securing a company's intangible assets and competitive edge. However, a careful analysis must be conducted to determine which type of protection is best suited for a particular piece of information and the specific circumstances. As evidenced, a client's long-term goals, product line, and the specific industry the client is in must be reviewed carefully in making this determination.

Endnotes

¹ See generally, Milgrim on Trade Secrets, §1.01[1] at 1-20, (1993) (Matthew Bender).

²K.F.C. Corp. v. Marion-Kay, 620 F. Supp. 1160, 1172, 228 U.S.P.Q. (BNA) 545 (S.D. Ind. 1985).

³Coca-Cola Bottling Co. v. Coca-Cola Co., 107 F.R.D. 288, 289, 294, 227 U.S.P.Q. (BNA) 18 (D. Del. 1985).

⁴ Pioneer Hi-Bred Int'l. v. Holden Found. Seeds Inc., 35 F.3d 1226 (8th Cir. 1993).

⁵ See generally, R. Mark Haligan, The Recently Enacted Economic Espionage Act, Nat'l. L.J., Dec. 9, 1996.

⁶ If the trade secret theft benefits a foreign government, the penalties are even more severe, fining an individual up to $500,000 and a possible prison term of 15 years. A corporation may be fined up to $10 million. See 18 U.S.C. § 1831.

⁷ Stacey A. Barlow and Stasia L. Ogeden, After the Economic Espionage Act: Hiring, Firing, and Dealing in Corporate America, Intell. Prop. Today (1997).

⁸ See Minuteman Inc. v. Alexander, 147 Wis. 2d 842 (1989), for a general discussion of Wisconsin trade secret law.

⁹Wis. Stat. § 943. 205(3).

¹⁰ D. Goodin, "Busting Industrial Spies," The Recorder,American Lawyer Media, L.P., Sept. 25, 1996.

¹¹ Stephen A. Bent et al., Intellectual Rights in Biotechnology Worldwide, 346-47 (1987).

¹² Haligan, id. at note 5; see also Religious Tech. Ctr. v. Lerma, 908 F. Supp. 1362 (E.D. Va. 1995) (A disgruntled former member of the Church of Scientology posted various documents on the Internet that were deemed trade secret information by the Church of Scientology. A court held that because this information was posted on the Internet, it was effectively part of the public domain, impossible to retrieve, and a party who merely downloads Internet information cannot be liable for misappropriation of what was once a trade secret even though the individual who originally posted the trade secret information on the Internet may be liable for misappropriation.)

¹³ This general rule is derived from the strong public policy to encourage employees to use the general skills and knowledge they acquired during employment. This policy of favoring employee mobility and free competition puts a heavy burden on the employer. See Derek P. Martin, An Employer's Guide to Protecting Trade Secrets from Employee Misappropriation, BYU L. Rev., at 958 (1993); Lee T. Gesmer, Protection of Trade Secrets in the Computer Industry, LGU Tech. L. Bull. (January 1986).

¹⁴Arthur Wineburg, Reconciling IP Rights and Industrial Policy, Legal Times, Sept. 13, 1993.

¹⁵ Kevin Rivette and Orving Rappaport, Golden Opportunities, Legal Times, Dec. 19, 1994.

¹⁶ Id. at n.13.

¹⁷ Id.

¹⁸35 U.S.C. § 284.

¹⁹35 U.S.C. § 285.

²⁰ 19 C.F.R. § 12.39.

²¹ See generally, Chisum on Patents, chapter 1 (1996) (Matthew Bender).

²²U.S. Patent No. 2,435,355, "Package Construction" patented in 1948 by Edgar Ingram Sr. covers the White Castle box still used today.

Wisconsin Lawyer