Downstream Liability in Trade Secret Litigation After Silvaco

Last year, for the first time, the issue of downstream liability surfaced in the law of trade secret misappropriation. In 2010, a California appellate court held that a software licensee did not know or acquire the secret source code the manufacturer used to make the product and, as a matter of law, it could not be liable for trade secret misappropriation. See Silvaco Data Sys. v. Intel Corp., 184 Cal. App. 4th 210, 216 (Cal. Ct. App. 2010).

Silvaco Data Systems (“Silvaco”) sued several chip makers, including Intel Corp. (“Intel”), which licensed SmartSpice, a chip-testing software developed by Circuit Semantics, Inc. (“CSI”), after CSI allegedly misappropriated the source code of the software from Silvaco and after Silvaco won an injunction barring CSI from using the disputed source code.

The court rested its holding mainly on the finding that Intel never possessed the secret source code connected with SmartSpice and thus, Intel could not be said to have used the trade secret. Id. at 226. Rather, Intel licensed only the object code software, which was not the same thing as the source code. The court explained that Silvaco's accusations were akin to accusing customers who ate pie at a diner of theft, because the diner's chef allegedly stole another's secret pie recipe. Id. at 224.

The court also stressed that public policy considerations “reinforce the common sense conclusion that using a product does not constitute a 'use' of trade secrets employed in its manufacture.” Id. at 224. The court further emphasized the public policy implications of a contrary holding by noting that qualifying Intel's conduct as misappropriation would require “any end user of a software application [to] desist from its use ['] the moment anyone claims that the application was compiled from stolen source code.” Id. at 230. (emphasis in original) Such a result, the court noted, would suppress technological innovation and business activity to an extent beyond the purposes of trade secret law. Id.

The Question Likely to Surface in Future Trade Secret Litigation

The ruling in Silvaco left unanswered a question that is likely to surface in future trade secret litigation: Even if the trade secret is incorporated in the end product, should liability extend to a party who had no knowledge of the trade secret at issue but merely received the end product under a contract with a party accused of trade secret misappropriation? In this scenario, both parties could advance powerful arguments and competing policy reasons to persuade the court that their respective positions better fit with the purposes of the Uniform Trade Secrets Act (the “UTSA,” adopted in most states).

The plaintiff's chief position would be that downstream liability should attach regardless of the defendant's state of mind. The premise is that because the secret is incorporated in the end product, the defendant possesses the secret and thus Silvaco should not apply. One of the plaintiff's strongest arguments is that an injunction is necessary to prevent the defendant from further disseminating or disclosing the secret in order to prevent augmenting the plaintiff's losses or even destroying the trade secret altogether. Usually, once disclosed, whether intentionally or by mistake, a trade secret is no longer a secret.

Moreover, in cases where the plaintiff's secret is not yet implemented in its own products, the plaintiff could argue that further use by the defendant of the product would inevitably disclose and therefore destroy the trade secret incorporated in it before the plaintiff even had the chance of exploiting the secret to obtain a return on the investment in time and resources exerted in its development. In many instances, a company's trade secrets constitute the majority of its assets. Thus, to further justify protection of the trade secret in the hands of an innocent third party, the plaintiff could ground its argument on a property theory by stressing that the value of its trade secret as an asset is diminished by its disclosure, whether or not the person acquiring it did so with knowledge of the trade secret, or with intent to misappropriate it, and whether or not the person acquiring it uses it competitively.

Furthermore, the plaintiff could point to public policy considerations and argue that imposition of liability on the innocent defendant better advances the purposes of the UTSA because, in addition to protecting trade secrets, it encourages investment in innovation by offering certainty that the secrets will be protected even in the hands of third parties who did not participate in their misappropriation.

In turn, the defendant could advance several arguments that its position better fits the scope and purposes of the UTSA. First, because the defendant had no knowledge of the alleged trade secret when it acquired the product incorporating it and had no intent to misappropriate it, the defendant did not knowingly use or acquire the trade secret in the UTSA sense, and therefore, could not be liable for trade secret misappropriation.

Misappropriation of trade secrets is an intentional tort. See, e.g., PMC, Inc. v. Kadisha, 78 Cal. App. 4th 1368, 93 Cal. Rptr. 2d 663, 673 (2000) (citing Cal. Civ. Code ' 3426.1). The UTSA (adopted in most states) provides in relevant part that “misappropriation” means:

(1) Acquisition of a secret of another by a person who knows or has reason to know that the secret was acquired by improper means; or (2) Disclosure or use of a secret of another without express or implied consent by a person who: (A) Used improper means to acquire knowledge of the secret; or (B) At the time of disclosure or use, knew or had reason to know that his or her knowledge of the secret was: (i) Derived from or through a person who had utilized improper means to acquire it; (ii) Acquired under circumstances giving rise to a duty to maintain its secrecy or limit its use; or (iii) Derived from or through a person who owed a duty to the person seeking relief to maintain its secrecy or limit its use; or (C) Before a material change of his or her position, knew or had reason to know that it was a secret and that knowledge of it had been acquired by accident or mistake.

' a formulation that arguably supports the proposition that in order to prevail, the trade secret plaintiff should prove that the defendant knows or has reason to know that the information in its possession is a secret. See, e.g., Cal. Civ. Code ' 3426.1 (California UTSA) (emphasis added); Silvaco Data Sys., 184 Cal. App. 4th at 225.

Thus, the defendant would likely be able to distinguish this scenario from the approach to downstream liability involving other intellectual property rights. Unlike trade secret misappropriation, direct infringement of patents and copyrights is a strict liability offense with no requirement of proving the infringer's state of mind. See 35 U.S.C. ' 271(a); 17 U.S.C. ' 504(a). In direct patent infringement cases, the analysis ends once it is shown that the defendant's product satisfies all the claim limitations. If a device is capable of being operated in an infringing mode, the patentee does not have to show that the customers were told how to do it, or even that they were told it was possible. See, e.g., Intel Corp. v. United States ITC, 946 F.2d 821, 20 USPQ2d 1161, 1171 (Fed. Cir. 1991). In direct copyright infringement cases, a plaintiff need only prove ownership of the asserted copyright and copying of protectable expression; thus, even an innocent infringer is liable. See, e.g., Atari Games Corp. v. Nintendo of Am. Inc., 975 F.2d 832, 24 USPQ2d 1015 (Fed. Cir. 1992); Playboy Enterprises, Inc. v. Frena, 839 F. Supp. 1552 (M.D. Fla. 1193). Because the UTSA contains a “knowledge” requirement and because misappropriation of trade secrets is considered an intentional tort, the defendant would argue that the patent and copyright downstream liability approach is inapposite here.

Second, the defendant could highlight the serious public policy implications flowing from a ruling in the plaintiff's favor. Specifically, a contrary holding attaching liability to a party who merely receives an end product under a contract with a party accused of trade secret misappropriation would draw a wide circle of third-party distributors, vendors, and licensees into every trade secret misappropriation case, and thus radically extend liability to parties who never could have engaged in misappropriation. Moreover, a holding that extends liability to innocent parties would suppress further technological development and impair business transactions beyond the scope and purposes of the UTSA. It would also trigger uncertainty and litigation of virtually unlimited scope. Thus, like the court in Silvaco, courts should draw an important line by limiting liability to those entities actually involved in misappropriation, excluding from liability distributors or customers who purchase end products on the open market.

However, the plaintiff may attempt to subvert the defendant's contention that it did not knowingly acquire or use the trade secret, by arguing that the defendant nevertheless received either constructive or actual notice of the trade secret when the plaintiff notified the public at large or the defendant itself, respectively, that the end product contains a trade secret. Arguably, after the notice, any subsequent use of the end product by the defendant amounts to an actionable use of the trade secret incorporated therein.

In turn, the defendant may counter that liability should not attach for use of the alleged trade secret both before and after the notice. Specifically, the defendant's conduct before the notice lacked the requisite knowledge to constitute actionable acquisition or use under the UTSA. The defendant's use after the notice should nonetheless be exempt from liability for several reasons. First, because the defendant is more like a bona fide purchaser for value, an imposition of a duty not to use the secret after notice of its improper disclosure would be inequitable; thus, the plaintiff's recourse should be limited to the “initial misappropriator.” In some cases, the defendant may also be able to argue that it has materially changed its position by using the trade secret before it received notice of its existence. For instance, the defendant might have incorporated the end product containing the secret into another product to use for its own purposes, incurring substantial expenses in product development. Second, the defendant may argue that once disclosed by the misappropriator, the trade secret is no longer a secret ' an additional reason to limit the plaintiff's recourse to the misappropriator. Third, extension of liability to innocent parties would implicate the very public policy complications the court in Silvaco tried to avert.

Conclusion

On balance, the defendant's arguments have the potential to prevent parties alleging misappropriation from gaining unwarranted power in the marketplace, especially in the absence of contrary policy reasons. It seems reasonable that one who does not knowingly acquire, use, or possess the trade secret incorporated into an end product should not be liable for trade secret misappropriation. In some cases, however, the nature of the trade secret and the potential of further disclosure might warrant an injunction limited in temporal and substantive scope to allow the plaintiff to recoup its investment in the development of the secret.

Corina I. Cacovean is an associate at Wilson Sonsini Goodrich & Rosati in San Francisco.

Last year, for the first time, the issue of downstream liability surfaced in the law of trade secret misappropriation. In 2010, a California appellate court held that a software licensee did not know or acquire the secret source code the manufacturer used to make the product and, as a matter of law, it could not be liable for trade secret misappropriation. See Silvaco Data Sys. v. Intel Corp. , 184 Cal. App. 4th 210, 216 (Cal. Ct. App. 2010).

Silvaco Data Systems (“Silvaco”) sued several chip makers, including Intel Corp. (“Intel”), which licensed SmartSpice, a chip-testing software developed by Circuit Semantics, Inc. (“CSI”), after CSI allegedly misappropriated the source code of the software from Silvaco and after Silvaco won an injunction barring CSI from using the disputed source code.

The court rested its holding mainly on the finding that Intel never possessed the secret source code connected with SmartSpice and thus, Intel could not be said to have used the trade secret. Id. at 226. Rather, Intel licensed only the object code software, which was not the same thing as the source code. The court explained that Silvaco's accusations were akin to accusing customers who ate pie at a diner of theft, because the diner's chef allegedly stole another's secret pie recipe. Id. at 224.

The court also stressed that public policy considerations “reinforce the common sense conclusion that using a product does not constitute a 'use' of trade secrets employed in its manufacture.” Id. at 224. The court further emphasized the public policy implications of a contrary holding by noting that qualifying Intel's conduct as misappropriation would require “any end user of a software application [to] desist from its use ['] the moment anyone claims that the application was compiled from stolen source code.” Id. at 230. (emphasis in original) Such a result, the court noted, would suppress technological innovation and business activity to an extent beyond the purposes of trade secret law. Id.

The Question Likely to Surface in Future Trade Secret Litigation

The ruling in Silvaco left unanswered a question that is likely to surface in future trade secret litigation: Even if the trade secret is incorporated in the end product, should liability extend to a party who had no knowledge of the trade secret at issue but merely received the end product under a contract with a party accused of trade secret misappropriation? In this scenario, both parties could advance powerful arguments and competing policy reasons to persuade the court that their respective positions better fit with the purposes of the Uniform Trade Secrets Act (the “UTSA,” adopted in most states).

The plaintiff's chief position would be that downstream liability should attach regardless of the defendant's state of mind. The premise is that because the secret is incorporated in the end product, the defendant possesses the secret and thus Silvaco should not apply. One of the plaintiff's strongest arguments is that an injunction is necessary to prevent the defendant from further disseminating or disclosing the secret in order to prevent augmenting the plaintiff's losses or even destroying the trade secret altogether. Usually, once disclosed, whether intentionally or by mistake, a trade secret is no longer a secret.

Moreover, in cases where the plaintiff's secret is not yet implemented in its own products, the plaintiff could argue that further use by the defendant of the product would inevitably disclose and therefore destroy the trade secret incorporated in it before the plaintiff even had the chance of exploiting the secret to obtain a return on the investment in time and resources exerted in its development. In many instances, a company's trade secrets constitute the majority of its assets. Thus, to further justify protection of the trade secret in the hands of an innocent third party, the plaintiff could ground its argument on a property theory by stressing that the value of its trade secret as an asset is diminished by its disclosure, whether or not the person acquiring it did so with knowledge of the trade secret, or with intent to misappropriate it, and whether or not the person acquiring it uses it competitively.

Furthermore, the plaintiff could point to public policy considerations and argue that imposition of liability on the innocent defendant better advances the purposes of the UTSA because, in addition to protecting trade secrets, it encourages investment in innovation by offering certainty that the secrets will be protected even in the hands of third parties who did not participate in their misappropriation.

In turn, the defendant could advance several arguments that its position better fits the scope and purposes of the UTSA. First, because the defendant had no knowledge of the alleged trade secret when it acquired the product incorporating it and had no intent to misappropriate it, the defendant did not knowingly use or acquire the trade secret in the UTSA sense, and therefore, could not be liable for trade secret misappropriation.

Misappropriation of trade secrets is an intentional tort. See, e.g., PMC, Inc. v. Kadisha , 78 Cal. App. 4th 1368, 93 Cal. Rptr. 2d 663, 673 (2000) (citing Cal. Civ. Code ' 3426.1). The UTSA (adopted in most states) provides in relevant part that “misappropriation” means:

(1) Acquisition of a secret of another by a person who knows or has reason to know that the secret was acquired by improper means; or (2) Disclosure or use of a secret of another without express or implied consent by a person who: (A) Used improper means to acquire knowledge of the secret; or (B) At the time of disclosure or use, knew or had reason to know that his or her knowledge of the secret was: (i) Derived from or through a person who had utilized improper means to acquire it; (ii) Acquired under circumstances giving rise to a duty to maintain its secrecy or limit its use; or (iii) Derived from or through a person who owed a duty to the person seeking relief to maintain its secrecy or limit its use; or (C) Before a material change of his or her position, knew or had reason to know that it was a secret and that knowledge of it had been acquired by accident or mistake.

' a formulation that arguably supports the proposition that in order to prevail, the trade secret plaintiff should prove that the defendant knows or has reason to know that the information in its possession is a secret. See, e.g., Cal. Civ. Code ' 3426.1 (California UTSA) (emphasis added); Silvaco Data Sys., 184 Cal. App. 4th at 225.

Thus, the defendant would likely be able to distinguish this scenario from the approach to downstream liability involving other intellectual property rights. Unlike trade secret misappropriation, direct infringement of patents and copyrights is a strict liability offense with no requirement of proving the infringer's state of mind. See 35 U.S.C. ' 271(a); 17 U.S.C. ' 504(a). In direct patent infringement cases, the analysis ends once it is shown that the defendant's product satisfies all the claim limitations. If a device is capable of being operated in an infringing mode, the patentee does not have to show that the customers were told how to do it, or even that they were told it was possible. See, e.g., Intel Corp. v. United States ITC , 946 F.2d 821, 20 USPQ2d 1161, 1171 (Fed. Cir. 1991). In direct copyright infringement cases, a plaintiff need only prove ownership of the asserted copyright and copying of protectable expression; thus, even an innocent infringer is liable. See, e.g., Atari Games Corp. v. Nintendo of Am. Inc. , 975 F.2d 832, 24 USPQ2d 1015 (Fed. Cir. 1992); Playboy Enterprises, Inc. v. Frena , 839 F. Supp. 1552 (M.D. Fla. 1193). Because the UTSA contains a “knowledge” requirement and because misappropriation of trade secrets is considered an intentional tort, the defendant would argue that the patent and copyright downstream liability approach is inapposite here.

Second, the defendant could highlight the serious public policy implications flowing from a ruling in the plaintiff's favor. Specifically, a contrary holding attaching liability to a party who merely receives an end product under a contract with a party accused of trade secret misappropriation would draw a wide circle of third-party distributors, vendors, and licensees into every trade secret misappropriation case, and thus radically extend liability to parties who never could have engaged in misappropriation. Moreover, a holding that extends liability to innocent parties would suppress further technological development and impair business transactions beyond the scope and purposes of the UTSA. It would also trigger uncertainty and litigation of virtually unlimited scope. Thus, like the court in Silvaco, courts should draw an important line by limiting liability to those entities actually involved in misappropriation, excluding from liability distributors or customers who purchase end products on the open market.

However, the plaintiff may attempt to subvert the defendant's contention that it did not knowingly acquire or use the trade secret, by arguing that the defendant nevertheless received either constructive or actual notice of the trade secret when the plaintiff notified the public at large or the defendant itself, respectively, that the end product contains a trade secret. Arguably, after the notice, any subsequent use of the end product by the defendant amounts to an actionable use of the trade secret incorporated therein.

In turn, the defendant may counter that liability should not attach for use of the alleged trade secret both before and after the notice. Specifically, the defendant's conduct before the notice lacked the requisite knowledge to constitute actionable acquisition or use under the UTSA. The defendant's use after the notice should nonetheless be exempt from liability for several reasons. First, because the defendant is more like a bona fide purchaser for value, an imposition of a duty not to use the secret after notice of its improper disclosure would be inequitable; thus, the plaintiff's recourse should be limited to the “initial misappropriator.” In some cases, the defendant may also be able to argue that it has materially changed its position by using the trade secret before it received notice of its existence. For instance, the defendant might have incorporated the end product containing the secret into another product to use for its own purposes, incurring substantial expenses in product development. Second, the defendant may argue that once disclosed by the misappropriator, the trade secret is no longer a secret ' an additional reason to limit the plaintiff's recourse to the misappropriator. Third, extension of liability to innocent parties would implicate the very public policy complications the court in Silvaco tried to avert.

Conclusion

On balance, the defendant's arguments have the potential to prevent parties alleging misappropriation from gaining unwarranted power in the marketplace, especially in the absence of contrary policy reasons. It seems reasonable that one who does not knowingly acquire, use, or possess the trade secret incorporated into an end product should not be liable for trade secret misappropriation. In some cases, however, the nature of the trade secret and the potential of further disclosure might warrant an injunction limited in temporal and substantive scope to allow the plaintiff to recoup its investment in the development of the secret.

Corina I. Cacovean is an associate at Wilson Sonsini Goodrich & Rosati in San Francisco.