United States: Fiduciary Duties With Respect To Trade Secrets For Dual Or Multiple Directors

As a special feature of our blog—guest postings by experts, clients, and other professionals—please enjoy this blog entry from Donal O'Connell, Managing Director of Chawton Innovation Services Ltd.

Introduction

The purpose of this short paper is to ‘join the dots’ between a director’s fiduciary duties and especially a person holding dual or multiple directorships and trade secrets.

I was prompted to write this short paper by a) the clear lack of education and training provided to directors on the subject of trade secrets and trade secret asset management and b) some recent trade secret disputes involving dual or multiple directors.

Corporate governance is the system by which companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place.

It is no exaggeration to say that nearly all businesses have trade secrets. Quite often they are material to the company's value. Occasionally, trade secrets comprise the company's crown jewels.

Given the growing importance of corporate governance as well as the increasing value of trade secrets within organizations, I trust that you find this short paper of interest and of value.

Fiduciary Duties

While the precise outlines of company directors' obligations differ from country to country and by entity type, generally speaking, all directors must:

  • Exercise their duties as would a reasonable and prudent person (the ‘duty of care’)
  • Act in good faith for the benefit of the company and its shareholders (the ‘duty of loyalty’).

Directors’ Fiduciary Duties with Respect to IP

Generally, courts treat IP assets like any other corporate asset, which means directors must approach IP with the same due care as they would any other asset.

Such IP related duties for directors may include:

  • Appreciating the value of their IP assets
  • Ensuring implementation of necessary best practices and internal controls to protect company IP assets
  • Refrain from misappropriating IP and ensuring the company not misappropriate or utilize misappropriated IP

IP here includes patents, trademarks, copyright, designs, and trade secrets.

Trade Secrets

As indicated above, IP includes trade secrets.

While the laws governing trade secrets differ slightly from country to country, common among nearly all these laws is that a trade secret is any information that is:

  • Not generally known to the relevant business circles or to the public. The information should also not be readily accessible.
  • Confers some sort of economic benefit on its owner. This benefit must derive specifically from the fact that it is not generally known and not just from the value of the information itself. It must have commercial value because it is a secret. Commercial value encompasses potential as well as actual value.
  • It must have been subject to reasonable steps by the rightful holder of the information to keep it secret. What is reasonable can vary depending on the specific circumstances.

A trade secret continues for as long as the information is maintained as a trade secret. However, information may no longer be considered a trade secret once it becomes easily accessible, is no longer properly protected, or has no commercial value.

Broadly speaking, any confidential business information which provides an enterprise a competitive edge may be considered a trade secret.

Examples of Trade Secrets

A trade secret can be a formula, practice, process, design, instrument, pattern, commercial method, or compilation of information which is not generally known or reasonably ascertainable by others and by which a business can obtain an economic advantage over competitors or customers.

The subject matter of trade secrets is defined in very broad terms and includes sales methods, distribution methods, consumer profiles, marketing plans, supplier lists, client details, and manufacturing processes. Trade secrets may encompass manufacturing or industrial secrets and commercial secrets.

Trade secrets may exist in any of the three key business dimensions of operational excellence, customer intimacy, and product leadership.

Broadly, any confidential business information which provides a business with a competitive edge may be considered as a trade secret.

Trade secrets can even protect negative know-how, for example the results of failed experiments.

Directors’ Fiduciary Duties with Respect to Trade Secrets:

Director’s fiduciary duties with respect to trade secrets entail:

  • Directors should appreciate the value of their trade secret assets.
  • Directors should implement the necessary internal controls to protect their corporation's trade secret assets.
  • Directors must refrain from misappropriating trade secrets or utilizing misappropriated trade secrets.

Persons Sitting on More than One Corporate Board

In the modem business world, it is not unusual for a person to sit on more than one corporate board of directors.

Such individuals are known as dual or multiple directors, depending on the number of boards upon which they serve. The fiduciary duties for such individuals when it comes to trade secrets and trade secret asset management pose some interesting challenges, especially as it relates to refraining from misappropriating trade secrets or utilizing misappropriated trade secrets. The challenge arises as such persons holding dual or multiple directorships may most likely have access to the trade secrets of two or more organizations.

It is important to note that there is no dilution of fiduciary obligations when a person holds dual or multiple directorships. As a consequence, a person who acts in a dual or multiple capacity as a director of two or more companies owes the same duty of good management to all of the companies in question.

What does that mean in practice? A person holding dual or multiple directorships may not utilize the trade secret belonging to one organization to benefit another. He or she may not share the trade secret of one organization with another. He or she may not take steps to weaken or endanger the trade secret of one organization to benefit another.

The Growing Importance of Trade Secrets

Why do directors, but especially those dual or multiple directors, need to pay much closer attention to their fiduciary duties in relation to trade secrets?

Historically, trade secrets' significance has been under appreciated, but that situation is fast changing. There are various forces at play increasing the importance of trade secrets.

Firstly, the law has been changing.

  • The Defend Trade Secrets Act passed in the USA in May 2016
  • The EU Directive on Trade Secrets is enacted by member states on 9 June 2018
  • China explicitly included trade secrets in its 2018 revisions to the Anti Unfair Competition Law

Changes in the eligibility requirements and enforcement mechanisms of patent laws around the world, but especially those in the US—and especially as they relate to software and business method—make trade secrets an attractive mechanism to protect a company's competitive advantages

Cyber-criminals—whether competitors or State actors—are working overtime to trying to steal trade secrets from organizations

More and more companies are embracing open and outsourced innovation models which necessarily requires sharing and collaborating on trade secrets with others.

Changes in employment models are leading to a highly mobile and transitory workforce where companies now have increased risk their employees will walk out the door with their valuable trade secrets.

There is growing interest in trade secrets by the tax authorities.

  • OECD BEPS Guidelines include trade secrets as an intangible asset requiring proper management
  • Patent Box Tax Regimes in several jurisdictions now allowing trade secrets as qualifying IP
  • The US Government is encouraging US companies to repatriate their IP back to the US

Trade wars are linked by some to trade secret theft concerns.

Last, but not least, there is an increase in trade secret litigation especially for US companies but not exclusively so.

Steal a Trade Secret and Possibly Go to Jail

It is no exaggeration to say that nearly all businesses have trade secrets. Quite often they are material to the company's value. Occasionally, trade secrets comprise the company's crown jewels.

Directors, but especially those with dual or multiple directorships, must understand that they may be personally liable for breach of their duties of care and/or loyalty with respect to trade secrets, and where their actions fail the business judgment rule.

Intentional illegal acts, such as trade secret theft, are typically not covered under Directors & Offices liability insurance policies.

There are no exceptions built into the US Defend Trade Secrets Act, the EU Directive on Trade Secrets, or the Chinese Anti Unfair Competition Law that allow dual or multiple directors to misappropriate trade secrets.

Steal a trade secret and possibly go to jail!

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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