Virginia Court Limits Reach of Preemption Provision of Uniform Trade Secrets Act

Does the Virginia Trade Secrets Act preempt all related business tort claims? Not necessarily, according to a recent unfair business practices case from the Eastern District of Virginia. In E.I. DuPont de Nemours and Co.v. Kolon Industries, Inc., 2009 U.S. Dist. LEXIS 76795, 2009-2 Trade Cas. (CCH) P76,728 (E.D. Va. August 27, 2009), click here, DuPont alleged that the defendant, Kolon, had hired one of its former employees, Michael Mitchell, and enticed him to reveal DuPont’s trade secrets not only relating to the development of KEVLAR aramid fiber, but also as to DuPont’s pricing and rebate practices. In addition, it alleged that Kolon had recruited other DuPont employees who possessed knowledge regarding the aramid fiber manufacturing process. And Kolon allegedly had solicited DuPont’s long-standing customers by using confidential pricing and rebate information and informing the customers that Kolon had hired former DuPont employees who had assisted Kolon in making significant improvements to its product.

DuPont included six counts in its complaint: (1) violation of the Virginia Trade Secrets Act, Va. Code §59.1-341; (2) statutory business conspiracy, Va. Code §18.2-499 et seq.; (3) tortious interference with contract; (4) tortious interference with business expectancy; (5) conversion; and (6) civil conspiracy. Kolon moved to dismiss the complaint in its entirety.

First, Kolon argued that the preemption provision of the Trade Secrets Act required dismissal of all counts in the complaint other than the one alleging a violation of the Act itself because all of the counts were based entirely upon a misappropriation of trade secrets theory. The court rejected this argument pointing out that Kolon disputed that the information at issue was a trade secret. As the court noted: “unless it can be clearly discerned that the information in question constitutes a trade secret, the Court cannot dismiss alternative theories of relief as preempted by the VUTSA,” quoting Stone Castle Fin., Inc. v. Friedman, Billings, Ramsey & Co., 191 F. Supp.2d 652, 659 (E.D. Va. 2002). Thus, as long as Kolon contended that the information at issue was not a trade secret the court could not consider the preemptive effect of the Trade Secrets Act based upon the pleadings alone.

Next, Kolon argued that, under the statute, all claims arising from the same nucleus of facts as the misappropriation of trade secrets claim were preempted by the Trade Secrets Act. The court rejected this argument also, holding that, under the prevailing interpretation in the Eastern District of Virginia, the preemption provision does not bar all claims that could arise out of factual circumstances that may involve a trade secret. Instead, preemption would apply only to claims that were predicated “entirely” upon the misappropriation of trade secrets.

Applying these principles to the separate counts for tortious interference with contract and business expectancy the court found that DuPont had pled facts separate from the trade secrets allegations in support of those counts. Notably DuPont alleged that Kolon had “used DuPont’s confidential information and trade secrets.” Because the allegations were phrased in the conjunctive and were not predicated solely upon the misappropriation of trade secrets, the court refused to dismiss those counts. Likewise, it denied the motion to dismiss the conspiracy counts on the basis that the concerted action included allegations separate from misappropriation of trade secrets.

Finally, Kolon argued, unsuccessfully, that the conversion count was subject to dismissal because conversion could not apply to the taking of electronic copies of a document, only to the original. The court, again, sided with DuPont, finding that even though Virginia courts have not addressed whether the possession of “copies” of documents can constitute conversion, the courts have “demonstrated a distinct willingness to expand the scope of the doctrine of conversion in light of advancing technology.” Thus, it held that “the purloining of copies of documents would constitute conversion because such action is an act of ‘dominion’ inconsistent with the true owner’s property rights.”

Private Regulation of Business Competition Through State Statutes and Common Law Theories

The news lately is peppered by the federal governments' (lack of?) regulation of businesses, but how do state statutes and the common law regulate businesses? That is the question addressed in the article The Use of State Statutes and Common Law Tort Theories to Regulate Business Conduct which can be found here.

The article "examine[s] how differences in state law can shape and influence what constitutes the appropriate bounds of business competition in a particular state." It focuses on the common law claims of intentional interference with contract or business expectancy and certain state statutory private rights of actions, such as the Massachusetts' Unfair and Deceptive Trade Practices Statute, North Carolina's unfair methods of competition statute or "little FTC act", and Virginia's statutory business conspiracy statute.

Court Permits An Opposing Party's Lawyers to Interview a Company's Current Employees Outside the Presence of the Company's Lawyers

When an unfair business practices case arises, like in other types of cases, a company wants to know as much as possible about the adverse company's prior internal discussions and processes that resulted in the unfair business practice. But lawyers have been sensitive to the line between properly investigating a case and improper discussions with the adverse company's employees and agents.

A recent court opinion, however, allows one party's lawyers to interview the current employees of an adverse party provided that those employees are not senior enough or otherwise in a position to bind the corporation with their statements. The lawyers are even permitted to call the employees at their workplace during working hours.

This opinion is important because companies involved in a dispute may want to consider whether they should alert their employees to the potential for litigation and inform them that the opposing attorneys may call them. Companies should also consult with their attorneys about what they should say to their employees about the possibility of being contacted by the opposing party's attorney.

The case is Smith v. United Salt Corp., 2009 U.S. Dist. Lexis 82685 (W.D.Va. 2009), and can be found here. In that case, the plaintiffs brought a sexual harassment claim against their employer. Their lawyers sought to interview the employer's current employees outside the presence of the employer's lawyers. The plaintiffs argued that "it is important to speak with these employees because during the workday and while present on United Salt's premises, other employees may have learned of information relevant to the plaintiffs' allegations that defendant Foster sexually harassed them at work and that United Salt is liable for the sexual harassment."

"However, the plaintiffs contend that their intent in seeking ex parte communications with current employees of United Salt is not to obtain admissions imputable to the corporation. Instead, they state that they are merely attempting to gather information relevant to the incidents of sexual harassment that occurred on the premises of United Salt."

The court first considered Rule 4.2 of the Virginia Rules of Professional Conduct, which provides:

"In representing a client, a lawyer shall not communicate about the subject of the representation with a person the lawyer knows to be represented by another lawyer in the matter, unless the lawyer has the consent of the other lawyer or is authorized by law to do so."

Citing Rules of Supreme Court of Virginia Pt. 6, § II, Rule 4.2 (2000).

The court then looked to the opinion in Lewis v. CSX Transp., Inc., 202 F.R.D. 464 (W.D. Va. 2001), which recognized that "'[t]he general prohibition against an attorney having ex parte contact with a represented party is based on several rationales[,]' including 'preventing an attorney from circumventing opposing counsel to obtain unwise statements from an adverse party.'" "The court in Lewis found that, given this rationale, a represented corporate party retains an interest in 'preventing an opposing attorney from eliciting un-counseled statements from its employees, since such statements could affect the corporation's potential liability.'

"This court in Lewis held that when one of the parties is a corporation, as is the case here, Rule 4.2 prohibits ex parte communication with:

'(1) persons having managerial responsibility for the corporate party; (2) any other person whose act or omission in connection with that matter may be imputed to the corporate party for purposes of civil or criminal liability; or (3) any other person whose statement may constitute an admission on the part of the corporate party.'"

The court in United Salt then stated that "[i]t is important to note that, in Lewis, the employees with whom the plaintiff's counsel had ex parte contact were the very employees who used and maintained the piece of equipment at issue. In such a case, an admission by any of these co-workers stating that he knew the equipment was defective and that he had taken no action to cure the defect or warn his co-workers would, in fact, be an admission of liability imputable to the employer."

"Such is not the case in this matter. In a Title VII sexual harassment case, the employer is subject to vicarious liability only for acts of supervisory employees." "That being the case, only an admission by a supervisory employee stating that he took a 'tangible employment action' against a plaintiff or that he created a hostile work environment due to her gender would impute liability on the employer. While statements from co-workers regarding the actions of supervisory personnel could be used as evidence to prove that sexual harassment had occurred, those statements, from nonsupervisory personnel, would not be an admission imposing liability on the employer. With this distinction in mind, it appears that the rationale for the Lewis decision — to prevent an attorney from circumventing opposing counsel to obtain statements from employees which could be used to impute liability on the employer — is not present in this case."

"For all of the above-stated reasons, the court finds that Rule 801(d)(2)(D) in conjunction with Rule 4.2 of the Virginia Rules of Professional Conduct do not prohibit ex parte contact by plaintiffs' counsel with plaintiffs' co-workers, whose statements could not be used to impute liability upon the employee. The same rules, however, do prohibit ex parte contact in this context with any supervisory or managerial employees."

Before contacting an adverse party's employee, however, a lawyer will have to carefully analyze whether that employee can bind the corporation. While opening the door for lawyers to conduct broader investigations in some instances, this opinion is not without its own set of potential pitfalls.

A Misrepresentation Made During a Contract Performance May Not Constitute Fraud

In a newly released opinion, the Virginia Supreme Court reaffirmed the Virginia rule that a fraud claim cannot be based upon one contracting party's false statements to another contracting party in absence of an independent common law duty. The opinion can be found here. This rule is designed to prevent ordinary breach of contract claims from turning into tort claims. The facts in the new case illustrate the principle neatly.

In Dunn Construction Company, Inc. v. Cloney, Cloney contracted with Dunn Construction to build Cloney a house. Dunn Construction improperly constructed the front foundation wall, and after the wall failed inspection, Dunn Construction agreed to repair the cinderblock wall with steel reinforcing bars referred to as "rebar". After a second inspection and further repairs, Dunn Construction presented Cloney a final invoice. Cloney disputed parts of the invoice and suggested putting the final payment in escrow, pending final inspection of the wall.

After a "heated exchange," Cloney gave Dunn a check for the invoice amount, and Dunn Construction gave Cloney a written statement "guaranteeing the wall's stability for ten years and averring that the wall had been repaired by placing rebar in every cell of the cinderblocks and filling the wall to its top with concrete."

Cloney then hired a structural engineer "who determined that the wall had not been filled with reinforced concrete or adequately reinforced with rebar, as Dunn had represented to [County inspector] and Cloney." Rather, "between one-third to one-half of the cells had no reinforcement" and the wall could not pass a building code inspection.

Cloney filed a complaint against Dunn Construction for breach of contract, negligence and fraud. In addition to seeking compensatory damages, "Cloney sought $100,000 in punitive damages for the alleged fraud." The jury returned a verdict for $25,000 in punitive damages.

On appeal, Dunn Construction "contended that the circuit court impermissibly permitted Cloney to convert his breach of contract action into a tort action."

The Court agreed with Dunn Construction, even though it did "not condone [Dunn Constructon's] misrepresentations":

"As a general rule, damages for breach of contracts are limited to the pecuniary loss sustained. However, a single act or occurrence can, in certain circumstances, support causes of action both for breach of contract and for breach of a duty arising in tort, thus permitting a plaintiff to recover both for the loss suffered as a result of the breach and traditional tort damages, including, where appropriate, punitive damages. To avoid turning every breach of contract into a tort, however, we have consistently adhered to the rule that, in order to recover in tort, the duty tortiously or negligently breached must be a common law duty, not one existing between the parties solely by virtue of the contract.

Cloney contends that the present case can be distinguished . . . because the guarantee given by Dunn in exchange for Cloney making the final payment on the contract was used to procure a novation to the original contract and the false statement in the guarantee that the foundation wall had been properly repaired constituted a fraudulent inducement violative of a common law duty separate and apart from any duty arising under the contract. We disagree.

Under the contract, Dunn had a duty to construct the foundation wall in a workmanlike manner according to standard practices. Clearly, the original wall was not constructed in accord with this duty, and Dunn was required to make repairs to bring the wall in compliance with the applicable building code under that same duty. Dunn’s false representation that he had made adequate repairs thus related to a duty that arose under the contract. The fact that the representation was made in order to obtain payment from Cloney does not take the fraud outside of the contract relationship, because the payment obtained was also due under the original terms of the contract.

Nonetheless, . . . we cannot permit turning every breach of contract into an actionable claim for fraud simply because of misrepresentations of the contractor entwined with a breach of the contract."

Intentional Misconduct Could Nullify Damages Limitations Clauses in Commercial Contracts

We recently published an article in the Potomac Techwire regarding damages limitations clauses in commercial contracts. In a recent decision from the United States District Court for the Western District of Virginia, All Business Solutions, Inc. v. Nationsline, Inc., 2009 U.S. Dist. LEXIS 54693 (W.D. Va. June 29, 2009), the court held clauses that limit the ability to recover indirect. consequential or punitive damages unenforceable to bar claims for intentional misconduct based upon public policy. This is an important case, as companies who are sued for misconduct frequently seek to hide behind such clauses in commercial contracts to escape liability. To read the entire article, click here.

Source Code Sufficient to Prove Trade Secret

It is not uncommon for a business, whose former employee has joined or formed a competitor firm, to charge that the employee has misappropriated its trade secrets. Proving the charge is another story.

Under the Uniform Trade Secrets Act which has been adopted in Virginia, Maryland and the District of Columbia, a trade secret is defined as:
“information, including but not limited to a formula, pattern, compilation, program, device, method, technique, or process that:
1. 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
2. Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”

Virginia Code § 59.1-336.

A recent decision from the Fourth Circuit Court of Appeals addressed Virginia’s trade secrets law in the context of a computer model. Decision Insights, Inc. v. Sentia Group, Inc., 2009 U.S. App. LEXIS 2654 (4th Cir. 2009). In that case, the plaintiff had developed and marketed a software program used to prepare negotiating strategies and measure risks associated with various alternatives. Three of the defendants were employees of Decision Insights (“DII”) who had worked on modifications to the software and had access to its source code. While they were still employed by DII, the employees established Sentia Group, Inc. a competitor firm. When efforts to negotiate a license of the software program from DII failed, Sentia hired the same individual who had worked with the defendants at DII to develop its own software. The result was a program that allegedly used the same methods as those used in the software owned by DII.

When DII sued, the district court granted summary judgment in favor of the defendants and dismissed the case on the basis that the plaintiff had failed to meet its burden of proof as to the existence of any trade secrets. On appeal, the Fourth Circuit took a different view and reversed (in part) the decision of the district court granting summary judgment in favor of the defendants and remanded the case for further proceedings.

In its complaint, DII claimed that its computer model, as a total compilation, was a trade secret and that within that model were 12 specific functions that individually also qualified as trade secrets. The appellate court reversed the lower court for, among other things, the failure of the district judge to consider whether the software program as a total compilation qualified as a trade secret. Id. at *19.

The court noted that the most important characteristic of a trade secret is secrecy, Id. at *17, quoting Dionne v. Southeast Foam Converting & Packaging, Inc., 397 S.E.2d 110, 113 (Va. 1990), and that it may retain that characteristic even though it is shared with others, if that disclosure is in confidence, express or implied. Id. at * 17-18, quoting Dionne, 397 S.E.2d at 113. Under long established precedent in Virginia, a “working combination” of information, all of which individually may be in the public domain, can, when combined, be protected as a trade secret. Servo Corp. of Am. v. Con. Elec. Co., 393 F.2d 551, 554 (4th Cir. 1968).

The appellate court in Decision Insights acknowledged that DII could not produce the algorithms used in the creation of the program as it was over 15 years old. Nevertheless, the court held that the source code for the software in conjunction with a flow chart and narrative explaining the software program could be an acceptable method for identifying the trade secret at issue. Id. at *21-23. On remand it directed the district judge to examine the evidence to determine whether Decision Insights adequately identified its software compilation claim such that the claim could proceed to trial. In addition the district court was directed to individually consider the independent trade secret claims separate and apart from the compilation claim. Id. at *22-23.

The take-away: For companies that had developed software programs years ago that they want to protect as trade secrets, the source code may suffice to prove trade secret status, even if the original algorithms have been destroyed. In addition, companies should not forget that the common law also protects proprietary and confidential information from disclosure by a rogue employee to a competitor in those situations where it would be difficult to prove that the information is a trade secret.

Unfair Business Practices Government Contracts Webinar Download Available

Williams Mullen's Unfair Business Practices Team hosted its second webinar, entitled Beware the Government Contract: Protecting Your Company's Assets from the Government and Other Contractors.

Topics discussed in the webinar include:

(1) Identifying corporate assets that could be in jeopardy during the award and performance of a government contract;

(2) Practical considerations to protect assets from competitors, contracting partners, and the government; and

(3) Understanding critical contract clauses that can be negotiated to your company’s benefit, whether as a prime contractor or subcontractor.

The complete audio and powerpoint presentation can be downloaded by clicking here.

The Team's next webinar is entitled Intellectual Property: Building Your Castle Moat, How to protect your company's knowledge. It will be held on July 23, 2009. To register, click here.