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The New York Court Of Appeals, Answering A Certified Question From The United States Court Of Appeals For The Second Circuit, Rules On The Appropriate Measure Of Damages In New York Trade Secret, Unfair Competition And Unjust Enrichment Cases

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  • Posted on: May 4 2018

E.J.Brooks Company d/b/a TydenBrooks (“TydenBrooks” or “Plaintiff”) manufactures plastic security seals (“Seals”). When TydenBrooks acquired Stoffel Seals Corp. (“Stoffel”) it came to own Stoffel’s fully automated, and confidential, process for manufacturing Seals.  Some TydenBrooks employees “defected to a rival manufacturer, Cambridge Security Seals (“CSS”), and brought with them TydenBrooks’ confidential Seal manufacturing process.

TydenBrooks then commenced an action in the United States District Court for the Southern District of New York and asserted causes of action sounding in common law misappropriation of trade secrets, unfair competition, and unjust enrichment.  On the issue of damages:

TydenBrooks sought to measure its injury by the costs CSS avoided as a result of its unlawful activity.  Under this “avoided costs” theory, TydenBrooks sought monetary relief in an amount equal to the difference between the costs CSS actually incurred in developing and using the TydenBrooks’ manufacturing process and the costs that CSS would have incurred had it not misappropriated TydenBrooks’ process.

TydenBrooks presented CSS’ avoided costs as a measure of CSS’ benefit from the misappropriation, “which TydenBrooks asserted was its per se measure of damages.”  TydenBrooks failed to present evidence or argue that “CSS’ avoided costs could be a proxy for its own losses.”  Consistent with this position, TydenBrooks repeatedly urged that “its own financial losses were irrelevant to its “avoided costs” theory of damages.”  The Federal District Court’s jury charge was based on TydenBrooks’ theory of damages and the Court:

Reminded the jury that it “may award compensatory damages only for injuries that TydenBrooks proved were proximately caused by defendants’ allegedly wrongful conduct” and “only for those injuries that TydenBrooks has actually suffered or which it is reasonably likely to suffer in the near future.” However, the court did not explain how the jury cold make the inference that CSS’ avoided costs approximated the losses that TydenBrooks “actually suffered” or was reasonably likely to suffer in the near future (emphasis in original).

The jury returned a verdict in favor of TydenBrooks.  Among the post-judgment activity of the parties was a motion by CSS for various forms of relief based on “avoided cost” being an improper measure of damages.  In denying CSS’ motion, the court held that “the amount of damages recoverable in an action for misappropriation of trade secrets may be measured either by the plaintiff’s losses…or by profits unjustly received by the defendant” and that avoided costs “could either measure the defendant’s gain or, alternatively, the plaintiff’s losses.”

On CSS’ appeal from the District Court’s denial of its post-judgment motion, the Second Circuit Court of Appeals, certified, among another, the following question to the New York Court of Appeals: “Whether under New York law, a plaintiff asserting claims of misappropriation of trade secret, unfair competition, and unjust enrichment can recover damages that are measured by the costs the defendant avoided due to its unlawful activity.”  In so certifying its question, the Court recognized that “neither the Second Circuit nor the New York courts appear to have approved the specific type of award in this case.” (Internal brackets omitted.)

On May 3, 2018,  the Court of Appeals, in  E. J. Brooks Company v. Cambridge Security Seals, issued an opinion answering in the negative, the certified question of whether “avoided cost” analysis is the appropriate measure of damages in misappropriation of trade secret cases.  In reaching its conclusion, the Court of Appeals recognized that the “fundamental purpose of compensatory damages is to have the wrongdoer make the victim whole.”  (Citations and internal quotation marks omitted.)

As to Unfair Competition

The essence of TydenBrooks’ case was a misappropriation theory of unfair competition, which makes a party liable if they “exploit the skill, expenditures and labors of a competitor” (citations and internal quotation marks omitted), and was described by the Court as follows:

The essence of the misappropriation theory is not just that the defendant has reaped where he has not sown, but that it has done so in an unethical way and thereby unfairly neutralized a commercial advantage that the plaintiff achieved through honest labor (citations, brackets and internal quotation marks omitted).

The Court noted that the damages must be measured by plaintiff’s loss of commercial advantage, which “may not correspond to what the defendant has wrongfully gained.”  Thus, the Court recognized that while “courts may award a defendant’s unjust gains as a proxy for compensatory damages in an unfair competition case,” “the accounting for profits in such cases is not in lieu of damages but is the method of computing damages.” (Emphasis in original, citations and internal quotation marks omitted.)  Such calculations may be appropriate where plaintiff’s actual losses cannot be accurately traced, but there still must be some correlation between the defendant’s gains and the opportunities lost by the plaintiff.

As to Trade Secret

The Court then analyzed whether “avoided costs” may be awarded in trade secret cases, in which a plaintiff must prove that it “possessed a trade secret” and that the defendant “is using the trade secret in breach of an agreement, confidence, or duty, or as a result of discovery by improper means.” (Citations omitted.)  The Court too, concluded that “damages in trade secret actions must be measured by the losses incurred by the plaintiff, and that damages may not be based on the infringer’s avoided development costs” and that calculations tied to defendant’s gains, as opposed to plaintiff’s losses, are not “permissible measure[s] of damages.

This Blog recently addressed pleading requirements in trade secret cases [here].

As to Unjust Enrichment

Nor can “avoided costs” be a measure of compensatory damages in a claim for unjust enrichment, in which a plaintiff must show that: 1. the defendant was enriched; 2. at plaintiff’s expense; and, 3. that equity and good conscience should not permit the defendant to keep that which the plaintiff seeks to recover.

The Court held that “where a defendant saves, through its unlawful activities, costs and expenses that otherwise would have been payable to third parties, those avoided third-party payments do not constitute funds held by the defendant ‘at the expense of’ the plaintiff” and, accordingly, “a plaintiff bringing an unjust enrichment action may not recover as compensatory damages the costs that the defendant avoided due to its unlawful activity in lieu of the plaintiff’s own losses.”

It should be noted that a lengthy dissent, in which two justices concurred, is rather critical of the majority decision, in which three justices concurred.

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