Apportionment as a growing guide rail on trade secrets damages

For the past twenty years, courts have worked hard to address what seemed to be out-of-control damages estimates in patent cases. The Federal Circuit became active on such issues and defined rules of smallest saleable unit, apportionment, and set boundaries on the concept of a hypothetical negotiation.

During all of this development, trade secrets damages were neglected and doctrinal development of damages were unclear. Trade secrets themselves were inherently squishy and the scope of available damages were considerably larger than damages in patent cases. Indeed damages in trade secret misappropriation cases more closely resembled the Wild West until very recently. A 2016 study found that from 2001-2015, the median compensatory damage in a state trade secret misappropriation action was just over $200,000, compared to a median value of approximately $74,000 over the previous 50 years. John E. Elmore, A Quantitative Analysis of Damages in Trade Secrets Litigation, Forensic Analysis Insights (Spring 2016). Yet just as the rise of barbed wire to enclose plots of land helped close the frontier, recent trends in trade secret law have fortified restrictions on damages and are signaling an end to the once boundless field.

Damages under the California Uniform Trade Secrets Act

The California Uniform Trade Secrets Act (CUTSA) provides for several methods of calculating damages in trade secret misappropriation cases. California Civil Code § 3426.3(a) permits a complainant to recover actual losses and unjust enrichment caused by misappropriation of trade secrets. If the aggrieved party cannot prove lost profits or unjust enrichment, "court[s] may order payment of a reasonable royalty for no longer than the period of time the use could have been prohibited." Id. at § 3426.3(b). If a determination has been made that the misappropriation was willful and malicious, a court may award exemplary damages totaling no more than twice the amount of the compensatory damages for the misappropriation. Id. at § 3426.3(c). Straightforward on its face, prevailing plaintiffs and their experts have been able to secure massive compensatory damage rewards or royalty payments in the absence of limiting case law.

New case law is beginning to reign in damages available in trade secrets cases. After all, compensatory damages under CUTSA are limited to those resulting from the misappropriation itself and generally, while "[t]he law requires only that some reasonable basis of computation of damages be used[,]" California courts prohibit compensatory damages, such as lost profits, that are purely "uncertain, hypothetical and entirely speculative." Sargon Enterprises, Inc. v. Univ. of S. California, 55 Cal. 4th 747, 774-75 (2012) (internal citations and quotation marks omitted).

Apportionment in Patent Law: A framework for trade secrets damages

If you buy into the analogy of trade secret law and the wild west, then patent law can be considered a centuries-old metropolis. In fact, some of the very guide rails currently prevailing in patent law - apportionment and the entire market value rule - can trace their origin as far back as 1884. In Garretson v. Clark, the Supreme Court, quoting and affirming the lower court's decision, established:

"The patentee ... must in every case give evidence tending to separate or apportion the defendant's profits and the patentee's damages between the patented feature and the unpatented features, and such evidence must be reliable and tangible, and not conjectural or speculative; or he must show, by equally reliable and satisfactory evidence, that the profits and damages are to be calculated on the whole machine, for the reason that the entire value of the whole machine, as a marketable article, is properly and legally attributable to the patented feature." 111 U.S. 120, 121 (1884).

Here, Garretson is describing one of the most basic rules in determining damages from patent infringement: apportionment. "[W] here the patent creates only part of the profits, damages are limited to that part of the profits, which must be apportioned as between those created by the patent and those not so created." Velo-Bind, Inc. v. Minnesota Min. & Mfg. Co., 647 F.2d 965, 973 (9th Cir. 1981). In the same passage above, Garretson also articulated a major exception to the apportionment requirement known as the entire market value rule (EMVR). The EMVR "relieves a patentee from apportioning its damages only when the patentee can show that the patent-related feature is the basis for customer demand." Rite-Hite Corp. v. Kelley Co., 56 F.3d 1538, 1549 (Fed. Cir. 1995) (internal citation and quotation marks omitted).

Patent case law governing the reasonable royalties measurement of damages similarly dates back decades and also contains an apportionment requirement. Now commonly known as the Georgia- Pacific factors, when determining the amount of a reasonable royalty for a patent license, courts are to look at a non-exclusive set of factors, including "[t]he portion of the profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer." Georgia-Pac. Corp. v. U.S. Plywood Corp., 318 F. Supp. 1116, 1128 (S.D.N.Y. 1970).

Apportionment in trade secrets cases: taking a lesson from the patent playbook

The first major California trade secrets case applying an apportionment requirement is only about 20 years old. In 02 Micro Int'l Ltd. v. Monolithic Power Sys., Inc., the Northern District of California found that the plaintiff failed to prove unjust enrichment damages for misappropriation of a particular trade secret when its expert failed to "provide a reasonable basis for the jury to apportion damages." 399 F. Supp. 2d 1064, 1076-77 (N.D. Cal. 2005). Further, the court in 02 Micro used the Georgia-Pacific factors to determine the reasonable royalty award once unjust enrichment damages were denied.

Following 02 Micro, there has been somewhat of a lull of guiding CUTSA damages cases until 2020, when Ajaxo, Inc. v. E*Trade Fin. Corp. was decided by California's Sixth District Court of Appeals. 48 Cal. App. 5th 129 (2020). Here, the court affirmed the trial court's emphasis on apportionment in attempting - and failing - to determine a reasonable royalty award: "[w]e find nothing erroneous or contradictory in the trial court's application of apportionment principles to the reasonable royalty analysis." Id. at 169 (internal citations and quotation marks omitted).

Relying in part on the Georgia-Pacific factors used in patent cases, the Ajaxo court went one step further:

"We find that apportionment, even where not explicitly discussed, is implicit in the reasonable royalty. That is, where actual apportionment of profits cannot be shown, the reasonable royalty on a defendant's sales has the effect of creating an apportionment of profits based on an approximation of the actual value of the infringed device to the defendant. Analogizing from the patent context, this applies equally where the misappropriated trade secret informs some but not all of a defendant's commercial process or product." Id. at 170.

The most recent trade secret case regarding apportionment of damages under CUTSA was the Ninth Circuit's decision in Bladeroom Grp. Ltd. v. Emerson Elec. Co. in late 2021. 20 F.4th 1231 (9th Cir. 2021). Here, the Ninth Circuit vacated the trial court's judgment and remanded for a new trial on the basis that the lower court misinterpreted the non-disclosure agreement at the heart of the action for breach of contract and misappropriation of trade secrets. Id. at 1242-46. In doing so, both the majority opinion and the concurrence addressed the trial court's failure to distinguish damages attributable to the breach of contract claim versus the CUTSA claim. Citing to both 02 and Ajaxo, Circuit Judge Rawlinson, concurring, stated that, in the event that the jury on retrial "imposes liability on [defendant] for unjust enrichment ... [i]t is not sufficient for the damages expert to attribute the entire value of the sale of [defendant's] division to the misappropriation of [plaintiff's] trade secret despite admitting that the ... division had business and value that did not involve the use of the misappropriated trade secret." Id. at 1250.

Conclusion and Practice Tips

As damage awards for trade secret misappropriation under CUTSA face increased scrutiny and stricter requirements, trade secret law may not be the gold mine it was once perceived to be. Prevailing plaintiffs must now be cognizant of the growing adaptation of apportionment requirements and ensure their experts offer greater detail and disambiguation in their calculations of damages. Otherwise, they may find themselves caught in the barbed wire.