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| [1] | UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT |
| [2] | No. 84-1773 |
| [3] | 1986.C05.41130 <http://www.versuslaw.com>;
790 F.2d 1195 |
| [4] | June 2, 1986 |
| [5] | METALLURGICAL INDUSTRIES INC., PLAINTIFF-APPELLANT, v. FOURTEK, INC., IRVING BIELEFELDT, NORMAN MONTESINO, GARY BOEHM, MICHAEL SARVADI & SMITH INTERNATIONAL, INC., DEFENDANTS-APPELLEES |
| [6] | Appeal from the United States District Court for the Northern District
of Texas, A. Joe Fish, District Judge, Presiding. |
| [7] | John Feather, HUBBARD, THURMAN, TURNER & TUCKER, 2100 One (word illegible)
Tower, Dallas, TX; John N. Bain, Richard E. Kummer, CARELLA, BYRNE, BAIN
& GILFILLAN, 6 Becker Farm Road, Roseland, NJ 07068; Gerald P. Urbach,
GEARY, STAHL & SPENCER, 2800 One Main Place, Dallas, TX 75250, Attorneys
for Appellant/Petitioner. |
| [8] | Richard D. Seibel, E. Roderick Cline, CHRISTIE, PARKER & HALE, P.O.
Box 7068, Pasadena, CA, Attorneys for Appellee for Smith International;
V. Bryan Medlock, Jr., Martin Korn, RICHARDS, HARRIS & MEDLOCK, 2900
One Main Place, Dallas, TX 75250, Attorneys for Appellee. |
| [9] | John Booth, Monty L. Ross, CRUTSINGER & BOOTH, 1000 Thanksgiving Square,
Dallas, TX 75201, Attorneys for Appellee for Bielefeldt; William Frank Carroll,
STINSON, MAG & FIZZELL, 3745 InterFirst Two, Dallas, TX 75270, Attorneys
for Appellee. |
| [10] | James L. Schutza, VERNON, McKINLEY & LYBRAND, One Energy Square, Ste.
1325, Dallas, TX 75206, Attorneys for Appellee for Montesino, Boehm &
Sarvadi. |
| [11] | Author: Gee |
| [12] | Before: Thomas Gibbs Gee, Carolyn Dineen Randall and Will Garwood, Circuit
Judges. |
| [13] | THOMAS GIBBS GEE, Circuit Judge: |
| [14] | Today's case requires us to review Texas law on the misappropriation of
trade secrets. Having done so, we conclude that the district court misconceived
the nature and elements of this cause of action, a misconception that led
it to direct a verdict erroneously in favor of appellee Bielefeldt. We also
conclude that the court abused its discretion in excluding certain evidence.
Accordingly, we affirm in part, reverse in part, and remand the case for
a new trial. |
| [15] | I. FACTS OF THE CASE |
| [16] | We commence with a brief description of the scientific process concerned.
Tungsten carbide is a metallic compound of great value in certain industrial
processes. Combined with the metal cobalt, it forms an extremely hard alloy
known as "cemented tungsten carbide"*fn1
used in oil drills, tools for manufacturing metals, and wear-resistent coatings.
Because of its great value, reclamation of carbide from scrap metals is
feasible. For a long time, however, the alloy's extreme resistance to machining
made reclamation difficult. In the late 1960's and early 1970's, a new solution
-- known as the zinc recovery process -- was devised, a solution based on
carbide's reaction with zinc at high temperatures. In the crucibles of a
furnace, molten zinc will react with the cobalt in the carbide to cause
swelling and cracking of the scrap metal. After this has occurred, the zinc
is distilled from the crucible, leaving the scrap in a more brittle state.
The carbide is then ground into a powder, usable in new products as an alternative
to virgin carbide. This process is the generally recognized modern method
of carbide reclamation. |
| [17] | Metallurgical Industries has been in the business of reclaiming carbide
since 1976, using the more primitive "cold-stream process." In
the mid-1970's, Metallurgical began to consider using the zinc recovery
process. In that connection, it came to know appellee Irvin Bielefeldt,
a representative of Therm-O-Vac Engineering & Manufacturing Company
)Therm-O-Vac). Negotiations led to a contract authorizing Therm-O-Vac to
design and construct two zinc recovery furnaces, the purchase order for
the first being executed in July 1976. |
| [18] | The furnace arrived in April 1977. Dissatisfied with its performance,
Metallurgical modified it extensively. First, it inserted chill plates in
one part of the furnace to create a better temperature differential for
distilling the zinc. Second, Metallurgical replaced the one large crucible
then in place with several smaller crucibles to prevent the zinc from dispersing
in the furnace. Third, it replaced segmented heating elements which had
caused electric arcing with unitary graphite heating elements. Last, it
installed a filter in the furnace's vacuum-pumps, which zinc particles had
continually clogged. These efforts proved successful and the modified furnace
soon began commercial operation. |
| [19] | In the market for a second furnace in mid-1978, Metallurgical provided
to Consarc, another furnace manufacturer, all its hard-won information about
zinc-recovery furnace design. Apparently allowed to watch the first furnace
operate, Consarc employees learned of its modifications. Because Consarc
proved unwilling or unable to build what Metallurgical wanted, however,
the agreement fell through, and Metallurgical returned to Therm-O-Vac for
its second furnace. A purchase order was signed in January 1979, and the
furnace arrived that July. Further modifications again had to be made, but
commercial production was allegedly achieved in January 1980. |
| [20] | In 1980, after Therm-O-Vac went bankrupt, Bielefeldt and three other former
Therm-O-Vac employees -- Norman Montesino, Gary Boehm, and Michael Sarvadi
-- formed Fourtek, Incorporated. Soon thereafter, Fourtek agreed to build
a zinc recovery furnace for appellee Smith International, Incorporated (Smith).
The furnace Fourtek provided incorporated the modifications Metallurgical
had made in its furnaces; chilling systems, pump filters, multiple crucibles,
and unitary heating elements. Smith has been unable to use this furnace
commercially, however, because a current shortage of carbide scrap prevents
its economically feasible operation. |
| [21] | Metallurgical nevertheless brought a diversity action against Smith, Bielefeldt,
Montesino, Boehm, and Sarvadi in November 1981.*fn2
In its complaint, Metallurgical charged the defendants with misappropriating
its trade secrets. Other causes of action, not brought forward on appeal,
were breach of contract, interference with business relations, conversion,
and unfair competition. Trial began on June 4, 1984, and Metallurgical spent
the next ten days presenting its case in chief. During this time, testimony
indicated Metallurgical's frequent notices to Bielefeldt that the process
was a secret and that the disclosures to him were made in confidence. Another
witness recounted meetings in which the modifications were agreed to Bielefeldt
was allegedly unconvinced about the efficacy of these changes and contributed
little to the discussion. Metallurgical also presented evidence that it
had expended considerable time, effort, and money to modify the furnaces. |
| [22] | Such evidence apparently did not impress the trial court; at the close
of Metallurgical's case, it granted the defendants' motions for directed
verdicts. Ruling from the bench, the court provided an array of reasons
for its order. The principal reason advanced was the court's conclusion
that no trade secret is involved. At trial, Metallurgical acknowledged that
the individual changes, by themselves, are not secrets; chill plates and
pump filters, for example, are well-known. Metallurgical's position instead
was that the process, taken as a whole, is a trade secret in the carbide
business. The court, however, refused to recognize any protection Texas
law provides to a modification process. It also concluded that the information
Bielefeldt obtained from working with Metallurgical is too general to be
legally protected. Finally, it ruled that "negative know-how"
-- the knowledge of what not to do -- is unprotected. All these findings
seem to have coalesced into a general conclusion by the court that this
case involves no trade secret. The trade court went on to provide further
rationales for its decision; it ruled that there was evidence of neither
Bielefeldt's improper use nor disclosure of any secret, nor of Metallurgical's
having been damaged by any improper misappropriation. Metallurgical appeals
all these conclusions against Bielefeldt and Smith only. It also contends
that the court erred in excluding certain evidence. |
| [23] | II. RULES OF REVIEW |
| [24] | We begin our discussion by noting the applicable standard of review. In
Boeing Co. v. Shipman,
411 F.2d 365,
374 (5th Cir. 1969) (en banc), we enounced the standard for deciding whether
a directed verdict is proper: |
| [25] | The [trial] court should consider all of the evidence - not just that
evidence which supports the non-mover's case - but in the light and with
all reasonable inferences most favorable to the party opposed to the motion.
If the facts and inferences point so strongly and overwhelmingly in favor
of one party that the Court believes that reasonable men could not arrive
at a contrary verdict, granting of the motions is proper. On the other hand,
if there is substantial evidence opposed to the motions, that is, evidence
of such quality and weight that reasonable and fair-minded men in the exercise
of impartial judgment might reach different conclusions, the motions should
be denied, and the case submitted to the jury. |
| [26] | The standard of review on appeal is the same. See, e.g., Bobb v. Modern
Products, Inc.,
648 F.2d 1051,
1057 (5th Cir. 1981). We must therefore consider all evidence and inferences
most favorably to Metallurgical. |
| [27] | Because the district court provided so many reasons for its order, we
feel compelled to discuss the law of trade secrets in detail. Our discussion
concentrates on Texas law, despite a clause in both purchase order agreements
that their interpretation is to be made under New Jersey law. This stems
from the nature of this case; as will be explained below, we are dealing
with a cause of action sounding in tort, not one based on contract. |
| [28] | Individual attention to the various elements of this tort is necessary
to provide an easily-understood analysis, but we can here briefly summarize
the discussion. A plaintiff must certainly show that a "trade secret"
is involved; the definition of this term is therefore crucial and must be
based on several factors. If the trial court concludes that a trade secret
exists, it then must determine whether the defendant committed any wrongdoing.
One who breaches the confidence reposed in him by the holder of a trade
secret and one who obtains the secret can be held accountable. No defendant
may be liable, however, unless he has "disclosed" or "used"
the secret improperly; again, defining these terms is required. These considerations
are the sum and substance of the cause of action involved. After expounding
the substantive law, we then turn to issues regarding the district court's
evidentiary rulings and the relief available to Metallurgical. |
| [29] | III. DEFINING A "TRADE SECRET" |
| [30] | We begin by reviewing the legal definition of a trade secret. Of course,
to qualify as one, the subject matter involved must, in fact, be a secret;
"matters of general knowledge in an industry cannot be appropriated
by one as his secret." Wissman v. Boucher, 150 Tex. 326, 240 S.W.2d
278, 280 (Tex. 1951); see also Zoecon Industries v. American Stockman Tag
Co.,
713 F.2d 1174,
1179 (5th Cir. 1983) ("a customer list of readily ascertainable names
and addresses will not be protected as a trade secret"). Smith emphasizes
the absence of any secret because the basic zinc recovery process has been
publicized in the trade. Acknowledging the publicity of the zinc recovery
process, however, we nevertheless conclude that Metallurgical's particular
modification efforts can be as yet unknown to the industry. A general description
of the zinc recovery process reveals nothing about the benefits unitary
heating elements and vacuum pump filters can provide to that procedure.
That the scientific principles involved are generally known does not necessarily
refute Metallurgical's claim of trade secrets. |
| [31] | Metallurgical, furthermore, presented evidence to back up its claim. One
of its main witnesses was Arnold Blum, a consultant very influential in
the decisions to modify the furnaces. Blum testified as to his belief that
Metallurgical's changes were unknown in the carbide reclamation industry.
The evidence also shows Metallurgical's efforts to keep secret its modifications.
Blum testified that he noted security measures taken to conceal the furnaces
from all but authorized personnel. The furnaces were in areas hidden from
public view, while signs warned all about restricted access. Company policy,
moreover, required everyone authorized to see the furnace to sign a non-disclosure
agreement. These measures constitute evidence probative of the existence
of secrets. One's subjective belief of a secret's existence suggests that
the secret exists. Security measures, after all, cost money; a manufacturer
therefore presumably would not incur these costs if it believed its competitors
already knew about the information involved. In University Computing Co.
v. Lykes-Youngstown Corp.,
504 F.2d 518,
535 (5th Cir. 1974), we regarded subjective belief as a factor to consider
in determining whether secrecy exists. Because evidence of security measures
is relevant, that shown here helps us conclude that a reasonable jury could
have found the existence of the requisite secrecy. |
| [32] | Smith argues, however, that Metallurgical's disclosure to other parties
vitiated the secrecy required to obtain legal protection. As mentioned before,
Metallurgical revealed its information to Consarc Corporation in 1978; it
also disclosed information in 1980 to La Floridienne, its European licensee
of carbide reclamation technology. Because both these disclosures occurred
before Bielefeldt allegedly misappropriated the knowledge of modifications,
others knew of the information when the Smith furnace was built. This being
so, Smith argues, no trade secret in fact existed. |
| [33] | Although the law requires secrecy, it need not be absolute. Public revelation
would, of course, dispel all secrecy, but the holder of a secret need not
remain totally silent: |
| [34] | He may, without losing his protection, communicate to employees involved
in its use. He may likewise communicate it to others pledged to secrecy
. . . . Nevertheless, a substantial element of secrecy must exist, so that
except by the use of improper means, there would be difficulty in acquiring
the information. |
| [35] | Restatement of Torts, § 757 Comment b (1939). We conclude that a holder
may divulge his information to a limited extent without destroying its status
as a trade secret. To hold otherwise would greatly limit the holder's ability
to profit from his secret. If disclosure to others is made to further the
holder's economic interests, it should, in appropriate circumstances, be
considered a limited disclosure that does not destroy the requisite secrecy.
The only question is whether we are dealing with a limited disclosure here. |
| [36] | Prior caselaw provides no guidance on what constitutes limited disclosure.
Metallurgical cites Hyde Corp. v. Huffines, 158 Tex. 566, 314 S.W.2d 763,
117 U.S.P.Q. (BNA) 466 (Tex.), cert. denied,
358 U.S. 898,
79 S. Ct. 223,
3 L. Ed. 2d 148
(1958), and Sikes v. McGraw Edison Co.,
665 F.2d 731
(5th Cir.), cert. denied
458 U.S. 1108,
73 L. Ed. 2d 1369,
102 S. Ct. 3488
(1982), in contending that subsequent disclosure of a trade secret does
not free one from the constraint of a prior confidential disclosure. In
both of these cases, however, publication of the trade secret by its holder
followed an improper use by one in whom the holder had confided. This factual
difference renders these case inapposite. |
| [37] | Looking instead to the policy considerations involved, we glean two reasons
why Metallurgical's disclosures to others are limited and therefore insufficient
to extinguish the secrecy Metallurgical's other evidence has suggested.
First, the disclosures were not public announcements; rather, Metallurgical
divulged its information to only two businesses with whom it was dealing.
This case thus differs from Luccous v. J.C. Kinley Co., 376 S.W.2d 336 (Tex.
1964), in which the court concluded that the design of a device could not
be a trade secret because it had been patented -- and thus revealed to all
the world -- before any dealing between the parties. Second, the disclosures
were made to further Metallurgical's economic interests. Disclosure to Consarc
was made with the hope that Consarc could build the second furnace. A long-standing
agreement gave La Floridienne the right, as a licensee, to the information
in exchange for royalty payments. Metallurgical therefore revealed its discoveries
as part of business transactions by which it expected to profit. |
| [38] | Metallurgical's case would have been stronger had it also presented evidence
of confidential relationships with these two companies, but we are unwilling
to regard this failure as conclusively disproving the limited nature of
the disclosures. Smith correctly points out that Metallurgical bears the
burden of showing the existence of confidential relationships. Contrary
to Smith's assertion, however, confidentiality is not a requisite; it is
only a factor to consider. Whether a disclosure is limited is an issue the
resolution of which depends on weighing many facts. The inferences from
those facts, construed favorably to Metallurgical, is that it wished only
to profit from its secrets to the public. We therefore are unpersuaded by
Smith's argument. |
| [39] | Existing law, however, emphasizes other requisites for legal recognition
of a trade secret. In Huffines, 158 Tex. 566, 314 S.W.2d 763, 117 U.S.P.Q.
(BNA) 466, a seminal case of trade secret law, Texas adopted the widely-recognized
pronouncements of the American Law Institute's Restatement of the Law. The
Texas Supreme Court quoted the Restatement's definition of a trade secret: |
| [40] | A trade secret may consist of any formula, pattern, device, or compilation
of information which is used in one's business, and which gives him an opportunity
to obtain an advantage over competitors who do not know it. It may be a
chemical compound, a process of manufacturing, treating or preserving materials,
a pattern for a machine or other device or a list of customers. |
| [41] | Id. at 776, quoting Restatement of Torts, § 757 Comment b (1939). From
this the criterion of value to the holder of the alleged secret arises,
a criterion we have noted before. In Zoecon Industries,
713 F.2d at 1179,
we concluded that a customer list was a trade secret in part because the
list gave to its owner an advantage "over competitors who did not have
this information." See also Lykes-Youngstown Corp.,
504 F.2d at 535
("evidence was adduced at trial that [the product in question] had
unique capabilities and features which made it a valuable competitive product"). |
| [42] | Metallurgical met the burden of showing the value of its modifications.
Lawrence Lorman, the company's vice president, testified that the zinc recovery
process gave Metallurgical an advantage over its two competitors by aiding
in the production of the highest quality reclaimed carbide powder. The quality
of the powder, in fact, makes it an alternative to the more costly virgin
carbide. Lorman testified that customers regarded Metallurgical's zinc reclaimed
powder as a better product that that reclaimed by the coldstream process
used by others. This evidence clearly indicates that the modifications that
led to the commercial operation of the zinc recovery furnace provided a
clear advantage over the competition. |
| [43] | Another requisite is the cost of developing the secret device or process.
In Huffines' companion case, K&G Oil, Tool & Service Co. v. G&G
Fishing Tool Service, 158 Tex. 594, 314 S.W.2d 782, 790, 117 U.S.P.Q. (BNA)
471 (Tex. 1958), the court recognized the cost involved in developing the
device in questions; "the record shows . . . that much work and ingenuity
have been applied to the development of a practical and successful device."
See also Zoecon Industries,
713 F.2d at 1179
("even if the names and addresses were readily ascertainable through
trade journals as the defendants allege, the other information could be
compiled only at considerable expense"). No question exists that Metallurgical
expended much time, effort, and money to make the necessary changes. It
clearly has met the burden of demonstrating the effort involved in making
a complex manufacturing process work. |
| [44] | That the cost of devising the secret and the value the secret provides
are criteria in the legal formulation of a trade secret shows the equitable
underpinnings of this area of the law. It seems only fair that one should
be able to keep and enjoy the fruits of his labor. If a businessman has
worked hard, has used his imagination, and has taken bold steps to gain
an advantage over his competitors, he should be able to profit from his
efforts. Because a commercial advantage can vanish once the competition
learns of it, the law should protect the businessman's efforts to keep his
achievements secret. As is discussed below, this is an area of law in which
simple fairness still plays a large role. |
| [45] | We do not say, however, that all these factors need exist in every case.
Because each case must turn on its own facts, no standard formula for weighing
the factors can be devised. Secrecy is always required, of course, but beyond
that there are no universal requirements. In a future case, for example,
should the defendant's breach of confidence be particularly egregious, the
injured party might still seek redress in court despite the possibility
that the subject matter was discovered at little or not cost or that the
object or secrecy is not of great value to him. The definition of "trade
secret" will therefore be determined by weighing all equitable considerations.
it is easy to recognize the possibility of a trade secret here, however,
because Metallurgical presented evidence of all three factors discussed
above. |
| [46] | Appellees posit two other reasons why Metallurgical's modification process
cannot be defined as a trade secret. The first is premised on characterizing
the process in question as the installation of various devices all well
known to modern manufacturing. This being so, the argument runs, the process
itself can be no secret, either. The technologies of chill plate, multiple
crucibles, pump filters, and unitary graphite heating elements are all said
to be public knowledge. This may well be so, but it does not prevent Metallurgical
from seeking legal protection. Ventura Manufacturing Co. v. Locke, 454 S.W.2d
431 (Tex.Civ.App. 1970), involved a process of finding and cleaning small
yet valuable titanium scraps lost during the manufacturing of airplanes.
Appellee Locke refined a previously unsuccessful process by implementing
new procedures, none of which was innovative. The court nevertheless found
that his efforts could constitute a trade secret: |
| [47] | Obviously, the basic proposition involved in the cleaning of dirty parts
by commercial detergents involves no trade secret. Also, the use of production
line techniques as such must be considered as a matter of general knowledge.
On the other hand, we cannot say that the details of the procedure followed
in the cleaning of these fasteners are matters of general knowledge. To
the contrary, the record demonstrates that such details as the type and
amounts of chemicals to be used and the times and temperatures for cleaning
the fasteners were developed by Ventura through extensive trial and error
and at considerable expense. |
| [48] | Id. at 434. Similarly, in Sikes,
665 F.2d 731,
736, we quoted with approval the following passage from Water Services,
Inc. v. Tesco Chemicals,
410 F.2d 163,
173 (5th Cir. 1969).*fn3 |
| [49] | It is clear that the theory of the Treat-A-Matic was not new to the industry.
The court also found that the design was apparent from inspection, and that
the system had been sold and advertised without restriction. These findings
are supported by the evidence. But these findings are not conclusive. The
trade secret here was the application of known techniques and the assembly
of available components to create the first successful system in the industry
. . . . As the Second Circuit stated in Imperial Cleaners, Ltd. v. National
Distillers & Chemical Corp. (2 Cir. 1965)
342 F.2d 737,
742 "a trade secret can exist in a combination of characteristics and
components each of which, by itself, as in the public domain, but the unified
process, design and operation of which in unique combination, affords a
competitive advantage and is a protectible secret." |
| [50] | We believe these cases cogently refute appellees' assertions to the contrary. |
| [51] | The second defense advances a supposed concept of "negative know
how" in reliance on one sentence from Hurst v. Hughes Tool Co.,
634 F.2d 895
(5th Cir.) cert. denied
454 U.S. 829,
70 L. Ed. 2d 105,
102 S. Ct. 123
(1981). The court there ruled that Hughes Tool Company did not really use
the information Hurst provided; "Hurst's information, while of some
benefit, provided only negative, 'what not to do,' input to Hughes."
Id. at 899. Both the district court and Smith interpret this to mean that
negative know-how cannot constitute a trade secret. The sentence in Hurst,
however, has nothing to do with whether the information was a trade secret.
It is not found in the section of the opinion dealing with the existence
of a trade secret; rather, we were determining whether Hughes Tool Company
could be found to have used commercially any secrets Hurst conveyed. |
| [52] | Regardless of this misreading, the argument that negative know-how is
involved here is unpersuasive. We do not understand how the changes that
we have described can be seen as only showing what not to do. Metallurgical's
evidence shows that it encountered many problems with the furnaces Therm-O-Vac
delivered. Striving to solve these problems, Metallurgical took several
steps to modify the furnaces. Installing unitary heating elements, chill
plates, multiple crucibles, and pump filters are all "positive"
steps resulting from conclusions on what to do. These changes allegedly
turned unusable furnaces into ones fit for commercial operation. One may
say, of course, that these actions result from realizations of what not
to do; but so does every human process; the selection of one action at a
given moment involves the rejection of every other conceivable one that
might have been chosen. Using multiple crucibles, for examples, stems from
the conclusion that a single large crucible should not be used. This characterization,
however, can always describe the invention or modification of a device.
Knowing what not to do often leads automatically to knowing what to do.
Although we decline to hold that this distinction will always be unavailing,
in this case at least we regard the distinction between "positive"
and "negative" knowledge to be unintelligible. Because this final
claim of Smith is unpersuasive, we conclude that the evidence which was
presented at trial could have led a reasonable jury to believe a trade secret
existed. |
| [53] | IV. EXISTENCE OF A CONFIDENTIAL RELATIONSHIP |
| [54] | Deciding whether a confidential relationship existed between Metallurgical
and Bielefeldt must naturally precede an inquiry into his possible breach
of Metallurgical's confidence. Once again, we look to the Restatement of
Torts as our starting point: |
| [55] | One who discloses or uses another's trade secrets, without a privilege
to do so, is liable to the other if . . . (b) his disclosure or use constitutes
a breach of confidence reposed in him by the other in disclosing the secret
to him. |
| [56] | A breach of confidence under the rule stated in this Clause may also be
a breach of contract which subjects the actor to liability . . . . But whether
or not there is a breach of contract, the rule stated in this Section subjects
the actor to liability if his disclosure or use of another's trade secret
is a breach of the confidence reposed in him by the other in disclosing
the secret to him. |
| [57] | Huffines, 314 S.W.2d at 769, quoting Restatement, § 757 and comment j.
In Huffines, the Texas Court cited several cases to emphasize this message.
Quoted at great length was Adolph Gottscho v. American Marking Corp., 18
N.J. 467, 114 A.2d 438, 105 U.S.P.Q. (BNA) 398 (1955). The Gottscho court
stressed the blameworthy conduct of the defendant as the basis of this tort: |
| [58] | [Defendants] now seek to appropriate these trade secrets to their own
use and profit by a violation of their contractual agreements and a betrayal
of the confidence reposed in them by plaintiff. This they may not do; such
conduct is abhorrent to our conception of ordinary honesty . . . . Jackson
learned the plaintiff's trade secrets in confidence and, in violation of
his fiduciary obligations, he disclosed and used them for purposes other
than his employer's benefit . . . . His conduct was grossly improper and
gave rise to the plaintiff's cause of action, based on long-settled equitable
principles and supported by the marked changes in the attitude of the law
towards the need for commercial morality. |
| [59] | 114 A.2d at 441-42, quoting Julius Hyman & Co. v. Velsicol Corp.,
123 Colo. 563, 233 P.2d 977, 999 (1952), cert. denied
342 U.S. 870,
96 L. Ed. 654,
72 S. Ct. 113
(1951). Our review of the evidence on the existence of a confidential relationship
is hampered to some degree by the district court's exclusion of several
items of evidence. As we discuss below, the exclusions were improper; but
regardless of the evidence excluded, the record contains testimony of Metallurgical's
president, Ira Friedman, that he informed Bielefeldt of the confidentiality
Metallurgical expected. Although these references are few, they would have
sufficed to allow a reasonable jury to have believed that a confidential
relationship existed between Metallurgical and Bielefeldt. |
| [60] | V. OBTAINING SECRETS FROM ANOTHER |
| [61] | At this point we must devote separate attention to Smith, which stands
in a different light from Bielefeldt. It had no significant dealings with
Metallurgical and apparently was not heavily involved in the design of the
furnace it purchased. The question therefore becomes whether Smith as purchaser,
and thus as beneficiary of Bielefeldt's alleged misappropriation, can also
be held liable for it. |
| [62] | The law imposes liability not only on those who wrongfully misappropriate
trade secrets by breach of confidence but also, in certain situations, on
others who might benefit from the breach: |
| [63] | One who discloses or uses another's trade secret, without a privilege
to do so, is liable to the other if . . . (c) he learned the secret from
a third person with notice of the facts that it was a secret and that the
third person's disclosure of it was otherwise a breach of his duty to the
other . . . . |
| [64] | One has notice of facts under the rule stated in this Section when he
knows of them or when he should know of them . . . . He should know of them
if, from the information which he has, a reasonable man would infer the
facts in question, of if, under the circumstances, a reasonable man would
be put on inquiry and an inquiry pursued with reasonable intelligence and
diligence would disclose the facts. |
| [65] | Restatement, § 757 & comment l. Under this standard, we believe a
reasonably jury could find that Smith should have inquired into the relationship
between Bielefeldt and Metallurgical. Testimony shows that, during negotiations
for the purchase of a furnace, Bielefeldt told Smith of his current involvement
in then-pending litigation with Metallurgical regarding trade secrets in
New Jersey. Smith learned that Metallurgical claimed ownership of the design
and manufacturing processes of the zinc recovery furnace, a furnace which
Smith wished Bielefeldt to build. Apparently satisfied by Bielefeldt's assertion
of the meritlessness of Metallurgical's claims, Smith eventually gave him
the go-ahead for construction of the furnace. There is no indication that
it ever investigated the danger that Bielefeldt was wrongfully misappropriating
the ideas of others. The evidence as it stood at the end of Metallurgical's
presentation thus suggests that Smith knew of possible problems and did
nothing but rely on Bielefeldt's dismissals. We think that this inattention
to possible wrongdoing, unless refuted, amounts to a failure to reasonably
inquire into the facts involved. Under § 757(c), Smith might therefore be
held accountable, provided it used any trade secrets conveyed. This brings
us to the next issue. |
| [66] | VI. DISCLOSURE OR USE OF A TRADE SECRET |
| [67] | Wrongful misappropriation occurs if one "discloses or uses another's
trade secret without a privilege to do so . . . ." Restatement § 757.
The district court directed verdict for appellees in part because it saw
no evidence of Bielefeldt's actual use or disclosure of Metallurgical's
secrets. In reviewing this conclusion, we keep in mind the rule of Boeing
Co. v. Shipman by scouring the record for reasonable inferences favorable
to Metallurgical. One fact jumps out from this review: in their original
form, the furnaces delivered to Metallurgical differed from those that Smith
purchased. The former furnaces lacked the key features needed to achieve
commercial operation, while the latter possessed those features -- features
that Metallurgical had devised by extensive and expensive trial and error.
Bielefeldt himself testified that he did not look to public sources of information
in designing the Smith furnace; he instead claimed that he relied on his
memory. That his earlier efforts lacked the features at issue suggests that
his "memories" may well have been of working with Metallurgical.
This issue is therefore an inappropriate ground for a directed verdict. |
| [68] | Smith's liability can arise, however, only if it in turn used the secrets
gained from Bielefeldt. "Use," as it turns out, is not so easily
defined. Smith claims that it never used any secrets gained because its
inability to procure substantial quantities of scrap carbide prevented commercial
operation of the furnace Fourtek provided. Lykes-Youngstown,
504 F.2d 518,
guides us in determining commercial use. We must first recognize the unfortunate
blurring of analyses in that case. The Lykes-Youngstown court's discussion
of commercial use was in the context of inquiring whether damages might
be available. It is preferable, of course, to divorce these concepts. Commercial
use is an element of the tort as enounced in § 757 of the Restatement; while
the nature of the use may be relevant in determining the proper extent of
damages, its existence must also be shown to establish wrongdoing in the
first place. Despite this confusion, Lykes-Youngstown provides useful analysis. |
| [69] | Metallurgical looked to that case in arguing that the law provides a liberal
definition of "commercial use." Lykes-Youngstown does indeed state
a broad definition; "any misappropriation, followed by an exercise
of control and dominion . . . must constitute a commercial use . . . ."
504 F.2d at 542.
Lykes-Youngstown differs from our case, however, in one very important respect.
It was a case in which "the trade secret itself was what was to be
sold . . . ." Id. at 540. The court there explicitly contrasted a case
like ours, "where the trade secret is used to improve manufacturing,
and subsequently manufactured items were sold at a profit . . . . "
Id. Although the court made this distinction in determining the proper method
of computing damages, we think it also applies logically to developing a
definition of "use." The discussion in Lykes-Youngstown following
this distinction is therefore inapposite to our case, for which we instead
employ the everyday meaning of the term. If Smith has not put the furnace
into commercial operation to produce carbide powder it can then use, then
no commercial use has occurred. Because Metallurgical failed to provide
any evidence that Smith has so far benefitted from any misappropriation,
directed verdict in Smith's favor was proper. Should it in future seek to
profit from use or sale of the furnace, a new fact situation will be presented. |
| [70] | VII. EVIDENTIARY MATTERS |
| [71] | We now turn our attention to certain evidentiary rulings the district
court made to exclude various documentary and testimonial items of evidence.
At trial, Metallurgical offered Exhibit 246 in evidence; entitled "Non-Disclosure
Agreement" and dated June 11, 1976, this document predates any purchase
agreement between Metallurgical and Thermo-O-Vac. In it, Bielefeldt agreed
to hold all information gained from Metallurgical in confidence, using or
disclosing this knowledge only with Metallurgical's approval.*fn4
On July 30, 1976, Metallurgical and Therm-O-Vac signed the purchase order
for the first furnace. Entered into evidence as Exhibit 826, the order form
contained two clauses of significance here: an integration clause*fn5
and one entitled "Property Interest."*fn6
An analogous pair of documents also surrounds the purchase of the second
furnace. Exhibits 247 and 247A are different copies of a Non-Disclosure
Agreement dated March 1, 1978. Also signed by Bielefeldt, this agreement
provided detailed recognition of the confidentiality involved and the expectation
of nondisclosure absent Metallurgical's permission.*fn7
On January 31, 1979, the parties signed the purchase order for the second
furnace; this document, received in evidence as Exhibit 57, contained integration
and non-disclosure provisions identical to those of Exhibit 826. |
| [72] | The district court eventually withdrew exhibits 246, 247, and 247A from
evidence because of Texas' parol evidence rule, holding that the integration
clauses of exhibits 826 and 57 "abrogated all prior agreements between
the parties." The Texas parol evidence rule bars evidence of a prior
or contemporaneous agreement that contradicts or changes the express terms
of an unambiguous written agreement. See, e.g., Caviness Packing Co., Inc.
v. Corbett, 587 S.W.2d 543, 545 (Tex.Civ.App. -- Amarillo 1979, write ref.
n.r.e.). If Metallurgical were suing only on the contract, then the parol
evidence rule unquestionably would bar evidence of prior agreements. This
is not the case, however, the cause of action we are addressing on appeal
is independent of any contract. See Huffines, 414 S.W.2d at 769. Even if
the parties had not executed the purchase agreements, Metallurgical could
have sued for misappropriation of its trade secrets. Exhibits 246, 247 and
247A are relevant in showing that this tort occurred. They were offered
to show the parties' recognition of the unique nature of the zinc recovery
process and the confidential relationship then existing; their purpose was
not to change or undermine the agreements embodied in the purchase order.
We regard their significance as stemming from legal concepts completely
independent of any contractual relationship,*fn8
their consequences, moreover, do not impinge upon the legal effect of that
relationship. We thus conclude that the exclusion of these exhibits was
an abuse of the district court's discretion. |
| [73] | The district court also excluded certain testimony of Friedman, Bielefeldt,
and Paul Durkin, a former employee of Metallurgical. Because these exclusions
were also premised on the applicability of the parol evidence rule, they
too were improper. On appeal, appellees argue that the testimony was cumulative
anyway, but we are unconvinced. On retrial, therefore, testimony about the
parties' understanding of confidentiality existing before the purchase order
agreements should not be excluded because of the parol evidence rule. |
| [74] | We may not disturb the district court's exclusion of the evidence, however,
if that ruling can be upheld on other grounds, regardless of whether the
court relied on those grounds. Fed. R. Evid. 103 requires a finding of error
to be based on the exclusion of evidence only if "a substantial right
of the party is affected." If other grounds exist supporting the evidence's
exclusion, the district court's reliance on the parol evidence rule can
constitute only harmless error. See United Communications, Inc. v. American
Television & Communications Corp.,
536 F.2d 1310,
1318 n.6 (10th Cir. 1976); 11 Wright & Miller, Federal Practice and
Procedure: Civil § 2885 (1973). It is thus necessary to address the best
evidence rule and authentication challenges Bielefeldt raises regarding
exhibits 247 and 247A. At trial, the court expressed concern about whether
these exhibits satisfied the best evidence rule, but eventually did not
base their exclusion on the rule. Bielefeldt now maintains, as he maintained
at trial, that the exhibits' authenticity was insufficiently confirmed and
that the exhibits were inaccurate copies of the original, which has apparently
been lost. |
| [75] | Exhibit 247 is a poorly-xeroxed copy of the March 1, 1978 non-disclosure
agreement. Because parts of the copy were difficult to read, Metallurgical
introduced into evidence Exhibit 247A, a more legible reproduction. Both
copies have unintelligible markings on the lower left hand corner. The markings
do not cover the agreement's text or Bielefeldt's signature. Because they
do not appear to alter or modify the typed text of the agreement, it is
difficult, if not impossible, to see how their presence can affect the case
in any way. While these markings might distinguish the copies from the original
document, the alteration seems of a most trivial kind. The record therefore
reveals no genuine issue as to the authenticity of the copies' contents;
no suggestion of unfairness arises, moreover, by admitting the copies into
evidence. The copies should not be excluded because of some small, unintelligible
markings that apparently have nothing to do with the issues of this case.
Rather, these markings should go to only the weight attached to the exhibits.
See Greater Kansas City Laborers Pension Fund v. Thummel,
738 F.2d 926,
928 (8th Cir. 1984). |
| [76] | Authentication of Exhibit 247 came from the testimony of Ira Friedman,
who claimed to have been present when Bielefeldt signed the document. No
testimony, however, authenticated Exhibit 247A. That exhibit appears to
be a slightly enlarged and clearer copy of either the original or Exhibit
247. Authentication of Bielefeldt's signature can be made by comparing it
to that of Exhibit 247, already authenticated. Had the case gone to the
jury, it could have assumed this task. See Fed. R. Evid. 901(b)(3). We therefore
refuse to affirm the ruling excluding these exhibits' exclusion on any other
ground. |
| [77] | VIII. REMEDIES AND OTHER MATTERS |
| [78] | We now come to the issue of remedies available to Metallurgical. The district
court apparently found crucial Smith's inability to operate its furnace
profitably. Because there was no commercial use, it concluded that damages
were unavailable. We have already concluded that Smith did not "use"
the alleged secrets Bielefeldt provided; to say that this circumstance precludes
all remedies goes too far, however. The court failed to distinguish consideration
of the individual appellees; Smith is out of the picture, but Bielefeldt
remains. Should he be found liable on retrial, the appropriate damages should
be based on the tenets of Lykes-Youngstown. We there adopted the concept
of the "reasonable royalty." This does not mean a simple percentage
of actual profits; instead, the trier of fact, should it find Bielefeldt
liable, must determine "the actual value of what has been appropriated."
504 F.2d at 537,
quoting Vitro Corp. v. Hall Chemical Co.,
292 F.2d 678,
683 (6th Cir. 1961). We later expounded this concept: |
| [79] | The proper measure is to calculate what the parties would have agreed
to as a fair price for licensing the defendant to put the trade secret to
the use the defendants intended at the time the misappropriation took place. |
| [80] | In calculating what a fair licensing price would have been had the parties
agreed, the trier of fact should consider such factors as the resulting
and foreseeable changes in the parties' competitive posture; the prices
past purchasers or licensees may have paid; the total value of the secret
to the plaintiff's business; the nature and extent of the use the defendant
intended for the secret, and finally whatever other unique factors in the
particular case might have been affected the parties' agreement, such as
the ready availability of alternative process. |
| [81] | Id. at 540. Estimation of damages, however, should not be based on sheer
speculation. If too few facts exist to permit the trier of fact to calculate
proper damages, then a reasonable remedy in law is unavailable. In that
instance, a permanent injunction is a proper remedy for the breach of a
confidential relationship. Zoecon Industries,
713 F.2d at 1180,
citing Huffines, 314 S.W.2d at 778. In this case, moreover, an injunction
against Bielefeldt in no way depends on whether Smith achieved commercial
use. Should Metallurgical prove its point on retrial, therefore, it has
a remedy available to right the wrong done it. |
| [82] | We emphasize the limited consequences of today's decision. In no way do
we pass judgment on whether Bielefeldt committed any wrong; that task is
for the trier of fact. We hold only that the opportunity for this determination
to be made must be given. It may be that on retrial Bielefeldt can successfully
show that his knowledge came from somewhere else or that the process of
modification was no secret. |
| [83] | We conclude by recognizing the other appellees in this case. Our decision
has focused exclusively on Bielefeldt and Smith. Metallurgical, however,
also named the other officers of Fourtek as appellees.*fn9
It thereby forced Norman Montesino, Gary Boehm, and Michael Sarvadi to file
an appellate brief. Only in their brief do we learn that Metallurgical itself
moved to dismiss all counts against these three, a motion which the court
granted. No evidence in the case was presented against them. Only in Metallurgical's
reply brief, moreover, do we discover that "Metallurgical does not
urge this appeal as to Montesino, Boehm, and Sarvadi . . . ." We regard
the naming of these three as appellees, thus forcing them to submit a brief,
as constituting a frivolous appeal. We therefore award attorney's fees and
single costs to Montesino, Boehm, and Sarvadi in accordance with Fed.R.App.P.
38.
On remand, they are to submit their claims for fees to the district court. |
| [84] | The district court's order is AFFIRMED in part, REVERSED in part, and
the cause is REMANDED. |
|
|
|
| Opinion Footnotes | |
|
|
|
| [85] | *fn1 Hereafter referred to simply as
"carbide". |
| [86] | *fn2 Metallurgical is a New Jersey corporation.
The individual appellees reside in Texas, and Fourtek is a Texas corporation.
Smith is a California corporation having a Texas office. |
| [87] | *fn3 Tesco, to be sure, concerns Georgia
law, but Georgia, like Texas, recognizes the Restatement definition of trade
secret; and we think our language there apposite here." Sikes,
665 F.2d at 736.
|
| [88] | *fn4 The document provides as follows:
The undersigned hereby agrees that what they [sic] witness and all information,
either written or orally received during visit to M.I., and relating to
Metallurgical International products, manufacturing procedures, or equipment
will be held in confidence, and will not be transmitted, used or disclosed
to, any person or organization without the express written approval of
Metallurgical International. |
| [89] | *fn5 Entitled "Other Understandings,"
this provision states in part:
All previous communication between the parties hereto, either oral or
written, with reference to this proposal, is hereby abrogated, it being
understood that there are no agreements, understandings or guarantees
whatever other than contained in this proposal and supplements thereto. |
| [90] | *fn6 This clause reads as follows:
It is understood that portions of the design of the equipment covered
by this proposal may be of proprietary nature to one or both parties.
It is agreed that neither PURCHASER nor Therm-O-Vac will disclose design
features of the equipment to third parties without prior written agreement. |
| [91] | *fn7 Recitation of the entire document
is necessary to show the extent of the parties' expectation:
WHEREAS, Therm-O-Vac Engineering and Manufacturing, Inc. has constructed
a zinc reclamation process for the recovery of tungsten carbide cobalt
for Metallurgical International, Inc., based on specifications developed
by the mutual efforts of Therm-O-Vac and Metallurgical; and WHEREAS, from
the date of the installation of the zinc reclamation process Metallurgical
has modified same based on the experience of Metallurgical with the use
of the zinc reclamation process; and WHEREAS, Metallurgical has purchased
the zinc reclamation process from Therm-O-Vac; NOW, THEREFORE, Therm-O-Vac
agrees with Metallurgical to hold all information concerning the zinc
reclamation process confidential and further agrees to refrain from manufacturing,
using or selling the zinc reclamation process or any information concerning
same which is in any way similar to the zinc reclamation process developed
and constructed for Metallurgical to any other person, firm or corporation
unless and until permission to do so is received in writing from Metallurgical
International, Inc. IN WITNESS WHEREOF, Therm-O-Vac Engineering and Manufacturing,
Inc. has caused these promises to be executed by its respective representative
and caused its respective signature to be affixed hereto. /s/ Irvin Bielefeldt |
| [92] | *fn8 A possible response to this argument
is that, while the tort of misappropriating a trade secret is theoretically
distinct from a cause of action of the contract, in this case the tort is
swallowed by the subsequent contractual agreements; therefore, the response
would run, the parol evidence rule remains applicable in governing the admissibility
of evidence. To accept this position, however, would require us to deny
in the first place to Metallurgical a cause of action based on breach of
confidence. Because the entire dispute would be contractual, duties imposed
by tort law would become irrelevant. This consequence is contrary to the
Restatement's philosophy that contractual duties are irrelevant in dealing
with a breach of confidence. Cf. Hendricks v. Wall, 277 S.W. 207 (Tex.Civ.App.
-- El Paso 1925, writ ref'd) (a contract intending or inducing a fiduciary's
breach of trust is void). As discussed earlier, the language of Huffines
strongly emphasizes the importance of providing tort liability as a way
of promoting business honestly and commercial fairness. Influenced by such
emphatic statements, we are unwilling to let this cause of action die because
of the presence of contracts. Instead, we acknowledge the possible importance
of any agreements in proving or disproving a requisite element(s) of the
tort and providing an independent basis for a contractual cause of action. |
| [93] | *fn9 Fourtek, Inc., was also named as
appellee but it has gone into bankruptcy. |
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