United States: Tattletales Beware: Whistleblowing May Result In Trade Secret Misappropriation Liability

Last Updated: March 17 2014
Article by Jacob M. Heath

In the Brady Bunch episode "Stop Tattling," Mike Brady (the father) gives Cindy (youngest of the clan) a stern warning after her tattling lands Alice (the Brady caretaker) in hot water with Sam (the Brady's butcher and Alice's date to the dance).  Mike Brady explains the pitfalls of tattling during this scolding and warns: "You have to learn when to keep quiet."

The case of J-M Manufacturing Co., Inc. v. Phillips & Cohen LLP, et al., Case No. L79214 (Superior Court of New Jersey, Middlesex County, filed Feb. 10), highlights the "when to keep quiet" dilemma facing modern-day tattletales—i.e., whistleblowers.  These individuals must decide whether to keep quiet about suspected corporate malfeasance or to come clean, disclose potential trade secrets in the name of public welfare, and face potential liability for doing so.  Last month, J-M sued John Hendrix, a former J-M engineer, and the law firm of Phillips & Cohen LLP ("P&C"), alleging trade secret misappropriation, breach of fiduciary duty, breach of contract, computer-related offenses, conspiracy, and racketeering stemming from Hendrix's 2005 whistleblower False Claims Act lawsuit against J-M in a federal court in California.

As background, the False Claims Act (31 U.S.C. §§ 3729-3733) imposes civil liability on any person who knowingly uses a false record or statement to get a false or fraudulent claim paid or approved by the government.  It allows a private individuals (called "relators" under the law) to bring a "qui tam" action on the government's behalf to hold a defendant —e.g. federal contractors—liable for defrauding the government.   The relator, in many cases, is a whistleblower, such as a current or former employee with knowledge of the alleged fraud.  The United States, after an investigation, can intervene in the action, dismiss the action, or settle it over the relator's objections.  (That is how, after initially declining to prosecute, the federal government finally involved itself in legal action against Lance Armstrong, joining the FCA lawsuit filed by former Armstrong teammate Floyd Landis.)  When initially filed, qui tam complaints are placed under seal to allow the government to determine whether to assume control of the litigation.  As an incentive to bring qui tam suits, relators such as Landis can receive between 15-25 percent of the proceeds of an action or settlement if the government intervenes and between 25-30 percent if the government does not intervene.

Hendrix, whom J-M hired in 2002, filed the False Claims Act lawsuit against J-M and Formosa Plastics Corp. USA (J-M's previous owner).  Hendrix alleged that J-M and Formosa Plastics knew the PVC pipes J-M manufactured and sold to its customers for water and sewer systems failed to meet government standards, that they lied about the quality of the pipes, and that they failed to make improvements despite knowledge that the pipes did not meet government standards.  Hendrix also alleged that the J-M pipes were used throughout the country and that given the substandard materials and manufacturing process, the pipes would rupture substantially earlier than expected.  In September 2013, Formosa Plastics settled the qui tam against it for $23 million.  In November 2013, in the qui tam action against J-M, a California federal jury found that J-M knowingly misrepresented the quality of its PVC pipes used to build those water and sewer systems.

In the present suit, J-M alleges that it learned of Hendrix's and P&C's unlawful conduct when Hendrix's qui tam complaint was unsealed in 2010.  J-M contends that Hendrix breached his employee secrecy agreement ("ESA") and conspired with P&C to pursue the False Claims Act lawsuit against J-M by, among other things, misappropriating J-M's confidential and proprietary documents:

When he was hired by J-M in 2002, Hendrix executed J-M's Employee Secrecy Agreement. ... Thus, Hendrix was fully aware that his acts of purloining J-M's confidential and trade secret documents and information for P&C's review and use was unlawful and in clear contravention of his ESA with J-M.

J-M further alleges that P&C played an active role in Hendrix's unlawful conduct by encouraging and facilitating Hendrix's "act of theft and deception":

P&C's conduct in directing, encouraging and facilitating Hendrix's act of theft and deception cannot be mistaken for, or excused as, simple "legal advice."  Rather, P&C was actively engaged in this pilfering scheme.  Over a period of four months, P&C directed Hendrix's unlawful conduct by, among other things, supplying Hendrix with specific search terms to use while searching through J-M's proprietary AS400 computer database, and requesting that Hendrix purloin original and other documents from J-M, and send them to P&C's offices for review, duplication and eventual disclosure by P&C to end-users of J-M's products, all of which was designed to intentionally harm J-M.  P&C's actions and directors enabled Hendrix not only to purloin the documents specifically requested by P&C, but to place the originals of those documents back in J-M's files undetected so that Hendrix could continue his theft of valuable trade secret and proprietary information from J-M.

J-M further alleges that Hendrix and P&C lured "unwitting" employees and secretly recorded their conversations, fabricated records, and then disclosed this material to recruit parties for the qui tam lawsuit.  J-M is seeking compensatory damages, punitive damages, exemplary damages, and attorneys' fees, claiming that:

As a direct and proximate result of P&C's nationwide campaign to meet with various end-users and recruit these entities as plaintiffs for their qui tam action, and P&C's improper use of the stolen records and data, end-users removed J-M products from their approved products lists.

J-M's lawsuit highlights two sets of competing interests.  On the one hand are the public policy interests in encouraging qui tam actions where whistleblowers have a legitimate concern about corporate wrongdoing and investigate and report the suspected fraud.  On the other hand are the interests in safeguarding trade secrets and preventing irreparable harm if a corporation's trade secrets or confidential proprietary information is disclosed during a qui tam action—notwithstanding the merits of the qui tam litigation.

The False Claims Act provides some protections for both qui tam plaintiffs and defendants.  Section 3730(h), for example, prevents employer retaliation against a qui tam plaintiff who investigates and supplies information concerning fraudulent practices of an employer.  Section 3730(d)(4) allows courts to provide reasonable attorney's fees and expenses if the defendant prevails in a qui tam action and the action was brought in bad faith.  Section 3730(d)(3), moreover, limits the awards for qui tam plaintiffs who have been found to be wrongdoers.

Courts have recognized that the False Claims Act might not fully compensate a defendant whose trade secrets and confidential information might have been disclosed during a qui tam action.  Nor do the False Claims Act's protections address the dilemma the J-M lawsuit presents—i.e., whether a defendant, found liable in the qui tam action, can pursue claims against a qui tam plaintiff who appropriated the defendant's trade secrets to establish liability.

Case law provides three rules that guide this discussion.  First, qui tam defendants do not have a right to contribution or indemnification against whistleblowers, as the False Claims Act "in no way intended to ameliorate the liability of wrongdoers by providing defendants with a remedy against a qui tam plaintiff with 'unclean hands.'"  Mortgages, Inc. v. United States Dist. Court, 934 F.2d 209, 213 (9th Cir. 1991).  Nor can a qui tam defendant pursue claims that would essentially result in contribution or indemnification for liability stemming from the underlying qui tam action.  Simply put, a qui tam defendant cannot seek indemnification from its whistle-blowing employee.

Second, a qui tam defendant can pursue claims against a whistleblower where the alleged conduct is distinct from the conduct underlying the False Claims Act lawsuit, even when there is a close factual nexus between the two, as long as there is a distinction between the facts supporting liability against the whistleblower and facts supporting liability against the qui tam defendant.  Accordingly, a qui tam defendant could pursue claims against a whistleblower who gathered and disclosed trade secrets well beyond what is necessary to investigate and to maintain a qui tam action; for instance, the Ninth Circuit held that the False Claims Act would not protect a qui tam plaintiff from "her vast and indiscriminate appropriation" of a qui tam defendant's files.

Third, a qui tam defendant can pursue an action against a whistleblower where the qui tam defendants are bound up in the facts of the qui tam suit but the defendant was not found to be liable in the qui tam suit.  Essentially, a qui tam defendant could sue a whistleblower for trade secret misappropriation if the defendant succeeds in the underlying qui tam suit.  Apparent from all three principles is balancing of the public policy of encouraging qui tam actions while protecting qui tam defendants' rights to seek compensation.

The question remains how the New Jersey state court will apply this juggling act to the J-M lawsuit where there exist (1) a qui tam defendant who has been found liable under the False Claims Act and (2) allegations that Hendrix and P&C engaged in unlawful conduct to obtain that victory.  If the court adopts federal case law's analysis, J-M's claims may turn not just on the success of the Hendrix qui tam action, but on whether Hendrix's and P&C's conduct—appropriation of trade secrets—was unreasonably broad when investigating and maintaining the qui tam action.

Unlike Mike Brady's warning, the J-M case may be less about refraining from tattling and more about not overstepping your bounds when doing so. The lawsuit, however, is still in its infancy.  J-M is challenging the federal court's finding in the underlying qui tam action.  Hendrix and Phillips & Cohen have yet to respond to J-M's complaint.

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