Fee award for bad faith in federal trade secrets case is a first

The U.S. District Court for the Northern District of California in Swarmify, Inc. v. Cloudflare, Inc., C 17-06957 WHA (Sept. 28, 2018), recently awarded attorney fees against a plaintiff who maintained its trade secret claims in bad faith under the Defend Trade Secrets Act. Plaintiffs suing for trade secret misappropriation under the California Uniform Trade Secrets Act have long been deterred from bringing frivolous claims due to state courts' willingness to award attorney fees for "bad faith" actions. Now, federal trade secret plaintiffs should also tread carefully to ensure their claims under the DTSA are brought in good faith, and not for improper purposes.

The language of the DTSA provides: "if a claim of misappropriation is made in bad faith, which may be established by circumstantial evidence, [... the court may ...] award reasonable attorney's fees to the prevailing party." However, no court has awarded fees for "bad faith" actions under the DTSA, which may embolden trade secret plaintiffs to pursue their claims in federal court rather than state court to reduce the risk of a fee award against them. The court's decision in Swarmify casts doubt on this tactic.

Plaintiff Swarmify alleged that Cloudflare stole video-streaming technology that Cloudflare allegedly learned of through the course of failed acquisition and licensing discussions with Swarmify. Cloudflare communicated to Swarmify throughout discovery and initial negotiations that it had proof of complete defenses to Swarmify's claims, but did not produce any such proof until mediation. At mediation, Cloudflare produced evidence that "unquestionably rendered Swarmify's misappropriation claim objectively specious," which Swarmify admitted. Swarmify continued to attempt to negotiate a settlement, but Cloudlflare refused. Swarmify ultimately voluntarily dismissed its claims with prejudice.

Cloudlfare then moved for attorney fees it incurred through the entire lawsuit. The court granted Cloudflare's motion in part for the fees and costs incurred from the time of mediation until dismissal of the action. Because the DTSA does not define "bad faith," the court applied the two-pronged "bad faith" standard used under the CUTSA, under which moving parties must show: (1) the objective speciousness of the claim, and (2) the subjective bad faith in bringing or maintaining the claims." Under this standard, the court determined that Swarmify should have voluntarily dismissed the case after the parties' mediation.

The court focused on Swarmify's decision to maintain the action after it learned at mediation that its claims could not succeed. The court cited a California appellate court in noting "the absence of evidence alone, even after discovery [...] does not support a finding of subjective bad faith." However, Swarmify was ethically obligated to drop its misappropriation claim once Cloudflare proved its defense," "a defense which indisputably rendered Swarmify's misappropriation claim objectively specious." After learning its claims could not prevail, Swarmify instead attempted to settle before it offered to dismiss its case voluntarily. At that point, Swarmify's failure to dismiss immediately was "sufficient to infer subjective bad faith."

Defendants can now move for fees against plaintiffs for bringing frivolous trade secret actions in federal court, confident that at least some courts will entertain such fee awards. Now that one federal court has adopted the two-pronged "bad faith" analysis used by state courts, litigants might expect other federal courts to follow suit. Of course, the Swarmify court's ruling was limited, and establishes a high bar to show "bad faith." Had Swarmify demonstrated any doubts as to the validity of Cloudlink's defenses, it likely could have maintained its action.

Likewise, for several years in California, a party's settlement discussions, which are ordinarily privileged, can form the basis for an award of "bad faith" attorney fees under California's Uniform Trade Secrets Act. Flir Systems, Inc. v. Parrish, 174 Cal. App. 4th 1270, 1282 (2009) (in awarding bad faith attorney fees under CUTSA, a court "may consider dilatory tactics and bad faith settlement demands in maintaining the action.").

Thus, lawyers handling trade secrets claims in both state and federal court should proceed with caution, particularly where the facts are shown not to support the trade secret misappropriation claim.