European Union: The Impact On Franchising Of The New European Directive For The Protection Of Trade Secrets

Last Updated: 19 May 2016
Article by Babette Märzheuser-Wood and Robyn Chatwood

On 14 April 2016, after a lengthy gestation period, the European Parliament finally approved a new European Union Trade Secrets Directive.  This will be the basis for new harmonised laws to protect secret and valuable business information – known as "trade secrets" – in the European Union.  The new law will be of great interest to most franchisors and licensors as, traditionally, their trade secrets and confidential information form the basis of much of their franchised systems licensed to third parties.  And this is notoriously difficult to protect.  Below is an overview of the new law and a discussion of some of the issues with it.  

WHAT IS A TRADE SECRET?

The new Directive seeks to harmonise the laws in the European Union, and Member States have two years to enact their legislation implementing it.  It introduces a standard definition for "trade secret" (Article 2 of the Directive).  A trade secret is information that meets all of three criteria:

  1. Secret: It must be "secret in the sense that it is not ... generally known among, or readily accessible to, persons within circles that normally deal with the kind of information in question".
  2. Valuable: It must have "commercial value because it is secret".
  3. Protected: It must have been "subject to reasonable steps ... to keep it secret".

This definition for trade secret is wider than what would normally be the case in some parts of Europe at present. For example, courts in the United Kingdom consider the type of information when assessing if it is a trade secret which can be protected. The Directive's definition might mean that some information can now be protected where it may not have been previously. Generally, this will be good news for franchisors – as they will need only to focus on meeting the above three criteria to protect their valuable know-how. 

However, there are inherently practical difficulties with the definition, and therefore some thorny issues which may mean that information which is presently protected may no longer be under common law, for example: 

  • The new Directive gives no guidance as to who "persons within circles that normally deal with the kind of information in question" would be.  
  • Also unclear is how valuable the "commercial value" must be before it qualifies for protection.  Perhaps some older information (which still may be sensitive but of little commercial value, such as old lists of prospective franchisees) may not be protected under the new Directive.
  • Finally, there is little guidance on what steps must be taken by a franchisor to protect the trade secret in question in order to meet the threshold of being "reasonable" and so sufficient.

WHAT IS LAWFUL OR UNLAWFUL USE OF A TRADE SECRET?

The new Directive sets out (in Articles 2a, 3 and 4) what is lawful and unlawful use of a trade secret.

Lawful use

There are six main situations where use of a trade secret by someone other than the authorised licensee, franchisee or their employees or other users will be considered lawful.

  1. Independent discovery or creation, disassembly or testing of a product: It will be lawful to disassemble or test any product or object which is available to the public or lawfully in the dissembler's or tester's possession.  Lawful acts also include any honest independent discovery or reverse engineering of a trade secret.  This is an exception to infringement of a trade secret in the new Directive and it generally does not represent any major change to intellectual property laws in force at present in the European Union.
  2. Workers and unions exercising their rights: The new Directive aims, however, to clearly protect union and workers' rights.  In doing so, it sets out that it is lawful to use a trade secret if this is in the exercise of workers' or union rights to information and consultation in accordance with European laws "or practices".  Clearly this is a very wide loophole.  The new Directive does not seek to limit this exemption to use of the trade secret only for those purposes and only to the extent necessary for those purposes.  The text of the Directive thus gives franchisors' and franchisees' employees rights to disclose valuable confidential information to trade unions – a protection for workers and unions that may go beyond any current whistleblowing protections.  A worker could disclose a trade secret for any grievance.
  3. Honest commercial practices: Another broad category of lawful use of a trade secret is where "under the circumstances" the use is "in conformity with honest commercial practices".  The concept of "honest commercial practices" originates from the World Trade Organization's Agreement on Trade-related Aspects of Intellectual Property Rights (TRIPS), which is a global trade agreement dealing with intellectual property rights.  But it is likely that the term will need litigation in the European courts before its meaning is clear.  As an interim guide, the following would be contrary to honest commercial practices:

    1. breaches of contract;
    2. breaches of confidence;
    3. inducements to breach contracts which protect trade secrets or which contain confidentiality obligations; or 
    4. unlawfully obtaining trade secrets knowingly or negligently.
  4. Protecting a legitimate interest: The new Directive contains an exception for when the trade secret is used by a third party for "protecting a legitimate interest".  This is another potentially wide exception.  A legitimate interest could be wholly subjective.  The Directive does not limit it to legitimate interests of a person who is a defendant in legal proceedings.  The exception is likely to encourage franchisees who wish to use a franchisor's confidential information after termination of a franchise agreement.  The trade secret may not be protected if it could be successfully argued that the franchisee contributed in part to the valuable confidential information and so is protecting its own legitimate interest by using it.
  5. Use for revealing a misconduct, wrongdoing, or illegal activity: Another of the exceptions is that any use of a trade secret for "revealing a misconduct, wrongdoing, or illegal activity" will be lawful – although this protection is only provided if such action was taken for the purpose of "protecting the general public interest".  Superficially, this exception appears to cover the current whistleblowing protections in place in many European jurisdictions including the United Kingdom. However, the purpose of the disclosure need not be limited to the "general public interest" purpose and actions taken by former franchisees or their employees may go beyond what is strictly necessary to serve that interest. 
  6. Exercising rights to freedom of expression and information: The new Directive includes a right for users of a franchisor's or franchisee's trade secrets to exercise a right to freedom of expression and information.  This exception aims to accommodate the European Convention on Human Rights' principle of freedom of expression but many in business will be concerned about balance and proportionality.  There may be little to stop anyone from exercising a right of freedom of expression about a franchisor's culture or practices if it is exercised in good faith. 

Unlawful use

The acquisition or use of a trade secret without consent will be treated as unlawful whenever it is done intentionally, or with gross negligence, by any of the following means:

  1. Unauthorised access to, appropriation of, or copying:  The acquisition of a trade secret without consent will be unlawful when carried out by unauthorised access to, appropriation of, or copy of any documents, objects, materials, substances or electronic files lawfully under the control of the trade secret owner (such as the franchisor) which contain the trade secret or from which the trade secret can be deduced.
  2. Unlawful acquisition or breach of confidentiality: Also unlawful will be use or disclosure of a trade secret acquired unlawfully or in breach of a non-disclosure agreement or other duty not to disclose (such as a contractual obligation or duty to limit use or disclosure of the trade secret). Franchisors will need to be especially careful when recruiting new franchisees not to acquire in error a competitor's or third party's trade secrets from the prospective franchisee when negotiating.  It will be important to obtain warranties from franchisees (backed up by appropriate indemnities) that any information disclosed to the franchisor in the recruitment or negotiation process is not a trade secret belonging to a third party and which cannot be lawfully disclosed by the franchisee to the franchisor.
  3. Any other conduct which, under the circumstances, is considered contrary to honest commercial practice: Any other conduct which, under the circumstances, is considered contrary to honest commercial practice is also unlawful.  This category is potentially the area most fraught with risk in the new Directive. As noted above, it implies an element of bad faith or misconduct.  However, it is highly probable that, across the 28 Member States that will implement the new Directive into local laws, their national courts' interpretation of the term will vary widely. 
  4. Using when knowing use is unlawful: Acquisition of a trade secret will be unlawful where it is acquired from a third party and the acquirer knew or should have known that the third party was acting unlawfully.  
  5. Production, offering placing on the market infringing goods or importing, exporting them or storing them when you knew or should have known they used trade secrets unlawfully: "Infringing goods" are defined in the Directive as goods whose "design characteristics, functioning, manufacturing process or marketing significantly benefits from trade secrets unlawfully acquired, used or disclosed". Dealing in them is an infringing act and knowingly or negligently doing so is unlawful under the Directive.  This could be a powerful provision for many franchisors – especially those who have unique know-how which is not easily protected or which is not protected with formal registrations of intellectual property rights.  However, the definition for infringing goods in the Directive relies on "significant benefit" – that is, the extent to which the goods rely on use of the trade secrets. It is unclear how much reliance will suffice to meet the threshold of "significant benefit". 

WHAT ARE THE REMEDIES AVAILABLE TO FRANCHISORS FOR INFRINGEMENT OF THEIR TRADE SECRETS?

The new Directive sets out that civil redress against unlawful use of trade secrets will be available.  Owners of trade secrets will be able to apply across the European Union for a wide range of remedies, including injunctions and damages.  This is subject to a limitation period of six years for bringing a claim.  However, there is no "choice of law" provision in the Directive, which means that liability could depend on which national law applies in the European Union for the proceedings. Franchise agreements usually specify the governing law to be applied although this could be a jurisdiction outside the European Union.  

NEXT STEPS AND WHAT FRANCHISORS SHOULD DO AS A RESULT OF THE NEW DIRECTIVE

Member States in Europe now have two years in which to enact national laws which implement the new Directive.  In the meantime, confidentiality agreements and contractual rights will remain relevant and important – especially given the ambiguity in the new Directive as to the meaning of many of the fundamental concepts and the uncertainty as to whether the Directive will change the legal landscape for trade secrets or confidential information in any particular European country.  

Many confidentiality agreements generally impose greater obligations than the written and common law. Good non-disclosure provisions should not, for example, limit protection of a franchisor's know-how, confidential information and trade secrets to only that information which the franchisor has taken "reasonable steps" to protect, or limit protection to only that information which may be of a minimum commercial value.  In short, franchisors should not rely solely on the protection under the Trade Secrets Directive.  Contractual rights are crucial and provide a second cause of action to take against unlawful users of trade secrets as they can be sued additionally for breach of contract.

It goes without saying that franchisors should now be evaluating whether they do take "reasonable steps" to keep their valuable information secret.  Contracts and legislation are no substitute for practical measures such as:

  • staggering disclosure of confidential information when negotiating (that is, hold back the "crown jewels" such as the franchisor's operations manual until at an advanced stage);
  • circulating limited copies of confidential documents, numbering them, restricting access to them on a need-to-know basis and marking them as "confidential";
  • installing appropriate physical and electronic security such as firewalls, secure emails or encryption, restricting USB keys and bring-your-own-devices and auditing these; 
  • ensuring employee contracts are clear and there are firm-wide policies in place for dealing with know-how and the protection of intellectual property including trade secrets and data.  It is best to give employees practical guidance (such as on not discussing company business on public transport, on the use of laptops or mobile devices in public places, about meta-data in tracked documents etc.); and
  • reminding departing franchisees, employees and consultants of their confidentiality obligations and asking them to confirm in writing that they have returned all confidential information.

Given the importance of the "reasonable steps" qualification to attain protected status for trade secrets, franchisors should document their measures and retain evidence of them in case these are the subject of a challenge.

Further, franchisors need to clearly identify what are their valuable trade secrets and implement policies and procedures that are robust enough to qualify as "reasonable steps" to protect their trade secrets.  Steps to consider now include the following:

  • reviewing policies and procedures for protecting sensitive information given to franchisees and their employees or other third parties, including IT security;
  • ensuring franchisee and franchisee employee training adequately covers protection of the franchisor's confidential information;
  • revising existing franchise agreements to expressly deal with trade secret protection;
  • reviewing franchisee exit processes to ensure that all confidential information is returned and further use of the franchisor's trade secrets is appropriately restrained; and
  • in light of the potential defence for whistleblowers, ensuring compliance with such retaliation laws and developing training to implement best practices so as to reduce the potential for whistleblower retaliation and associated claims.

Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com.

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