Trade secrets: An economic damages case

A recent circuit court case, Carbo Ceramics Inc. v. Keefe, provides a framework for developing economic damage theories in trade secret misappropriation cases. The case suggests the reasonable royalty method is the preferred approach when trade secret misappropriation is imminent but no actual damages have occurred.

Some background - After terminating his employment with Carbo Ceramics Inc. in May 2001, Terry Keefe planned to open his own proppant (an industrial lubricant) manufacturing plant. Although his plant was not yet operational, Keefe projected the new venture would generate roughly $238.5 million in revenues over a ten-year period.

Carbo alleged that Keefe breached his fiduciary duty as an officer of the company and his confidentiality agreement with Standard Oil (Carbo’s predecessor-in-interest). Carbo also charged Keefe with misappropriating trade secrets, including information related to Carbo’s proppant manufacturing process, business plans and pricing strategies.

Valuation-related issues - Carbo, the plaintiff, had the burden to prove lost profits. Accordingly, it hired a valuation expert to estimate the value of its manufacturing trade secrets to Keefe (rather than to Carbo).

The appraiser used the “profit-split method.” This method involves splitting a portion of the gross profit between the company using the trade secrets (Keefe) and the company owning the trade secrets (Carbo). Based on Keefe’s own financial projections, the valuator estimated lost profits from trade secret misappropriation at $3.9 million.

The court’s findings - Carbo appealed a summary judgment issued by the district court that denied it any economic damages for misappropriated trade secrets or breach of confidentiality. Based on relevant case law, the Fifth Circuit outlined four theories for estimating lost profits:

1. To what extent did the defendant actually profit from the use or disclosure of the trade secret?
2. How much would a reasonably prudent investor pay for the use of the trade secret?
3. How much did the defendant save — typically in terms of developmental costs — by misappropriating trade secrets?
4. What price would a willing buyer and seller negotiate for “reasonable royalties” for use of the trade secret?

In cases such as Carbo, where the trade secret has not actually been destroyed and the plaintiff is unable to prove specific injury, legal precedent suggests that the reasonable royalty method is the appropriate measure of damages. When quantifying royalties, courts consider resulting and foreseeable changes in the parties’ competitive posture, prices paid by licensees in the past, the total value of secrets to the plaintiff (including the plaintiff’s development costs and the importance of the secret to the plaintiff’s overall business), the nature and extent of the defendant’s intended use of the secret, and other case-specific factors affected by the parties’ agreement.

The plaintiff’s expert didn’t use any of the damage theories the court outlined. Moreover, Carbo’s “split-profit” damage theory was based on speculative revenues and operating profit from an unbuilt plant. With no evidence of recoverable actual damages, the Fifth Circuit affirmed the district court’s decision to deny Carbo economic damages under its trade secret misappropriation and breach of confidentiality claims. Furthermore, the court remanded the issue of permanent injunction to the lower court for reconsideration.

Lessons learned - Carbo underscores the importance of collaboration between attorneys and valuators to ensure experts choose the appropriate methodology based on relevant case law. When an expert’s analysis contradicts legal precedent, it can mean the difference between winning and losing the case