In recent years, the Texas Supreme Court has revisited the requirements for establishing damages in trade secret misappropriation cases. The current trend of Texas law clarifies the need to present some concrete or objective evidence to support damage awards.
In Southwestern Energy Production Co. v. Berry-Helfand, the Texas Supreme Court outlined the flexible options available to prove trade secret misappropriation damages under the most common theories, but emphasized that “sheer speculation” is inappropriate to support damages in any lost profits case. Soon after, in Horizon Health Corp. v. Acadia Healthcare Co., Inc., the Texas Supreme Court applied Berry-Helfand and vacated a multi-million-dollar jury verdict awarded on the grounds of impermissibly speculative evidence. Cases following Berry-Helfand reveal that Texas’s “flexible and imaginative” approach to valuationempowers parties to tailor damage theories to fit their individual needs, but also that damage awards cannot stray too far from the evidence presented.
This article examines these cases and seeks to predict how the trends they exemplify will influence future claims for trade secret misappropriation in Texas.
Berry-Helfand reaffirms that Texas’s “imaginative approach” to trade secret valuation must be grounded in evidence.
In Berry-Helfand, an engineer named Toby Berry-Helfand developed a system which significantly reduced development costs in the East-Texas James Lime formation by identifying “sweet spots” for potential wells. She previewed her system to SEPCO, which retained Berry-Helfand’s data in its files in violation of a confidentiality agreement and used her work to develop mineral leases in the James Lime.
Berry-Helfand sued SEPCO for trade secret misappropriation and other claims. A jury awarded a total verdict of over $40 million, including nearly $11.5 million for trade secret misappropriation. The Texas Supreme Court reversed, holding there was legally insufficient evidence to support the damage award. It primarily disagreed with how Berry-Helfand’s expert arrived at the damages figure presented to the jury.
Berry-Helfand’s expert presented valuations based on the “reasonable royalty” model, which estimates “the amount that a person desiring to use the trade secret would be willing to pay for its use.” Because the value of a “reasonable royalty” can be proven by an example contract, Berry-Helfand’s expert presented an actual contract executed between Berry-Helfand and Petrohawk to substantiate a hypothetical “reasonable royalty” with SEPCO. The Petrohawk contract contained a “sliding-scale” overriding-royalty interest, which reduced Berry-Helfand’s overriding royalty down to zero depending on the overall royalty burden of specific wells. However, based on Berry Helfand’s testimony that she averaged a three percent overriding royalty on the Petrohawk contract, her expert applied a flat three percent royalty to the $381.5 million earned in “past production revenue generated by [SEPCO’s] wells.”
The Texas Supreme Court rejected this approach, reasoning that the expert should have applied the terms of the Petrohawk contract on a well-by-well basis, just as if the contract was the byproduct of negotiations with SEPCO. Because he did not, the Court concluded the expert “paint[ed] an incomplete and misleading picture about the royalty terms a willing buyer and seller would negotiate,” and remanded for a new trial on damages.
By doing so, the Court clarified that while “a measure of uncertainty is tolerated, and to an extent, unavoidable,” assertions made by damages experts must be substantiated: “relying on imagination is not justified when objective evidence is available.”
Horizon Health reiterates the importance of properly supported damage awards.
One year later, the Texas Supreme Court reiterated the importance of properly supported trade secret misappropriation damage awards in Horizon Health Corp v. Acadia Healthcare Co.In Horizon Health, the plaintiff, Horizon, claimed trade secret misappropriation when former executives left to create a new company, Acadia, and took with them “massive” amounts of confidential information, a secret client list, and Horizon’s best salesperson. Horizon sued for trade secret misappropriation and sought past and future lost profits, winning a $6.9 million jury verdict.
The Texas Supreme Court vacated Horizon’s trade secret misappropriation damage award for lost profits on the ground that the evidence was legally insufficient. The Court concluded Horizon failed to prove future lost profits for a business venture stolen from Horizon by Acadia because its evidence only showed that Acadia would not have won the contract without the misappropriation – not that Horizon would have won the contract instead. Horizon similarly failed to prove lost future profits based on contracts expected to be won by the salesperson induced to join Acadia, because Horizon only provided evidence of the expected number of contracts. Without evidence of the expected profits for the future contracts, Horizon’s evidence of projected future earnings was legally insufficient.
Recent cases applying Berry-Helfand’s standards provide guidance for litigants seeking to prove trade secret damages.
Berry-Helfand and Horizon Health also provide guidance to litigants by identifying the primary means to prove trade secret damages at trial: (1) plaintiff’s lost profits, (2) benefit to defendant, (3) value of trade secret to a reasonably prudent investor, (4) development costs avoided by the misappropriation, and (5) the value of a reasonable royalty. These methods are described here, along with Texas and Federal cases examining and applying them.
Plaintiff’s lost profits
The “lost profit” model of trade secret misappropriation damages can be a difficult theory to support, as it turns on objective evidence of loss to plaintiff. As noted in Berry-Helfand, recovery under this category is usually contingent on the requesting party introducing “objective facts, figures, or data from which the amount of lost profits can be ascertained.” Unlike some other damages theories appearing in trade secret misappropriation cases, “reasonable certainty is required to prove lost profits.” Because “lost profits” seeks to identify the profits the requesting party would have earned “but for” the misappropriation, it is also known as the “but for” model. However, evidence showing projected earnings based on a defendant’s profits from misappropriation is insufficient to show plaintiff’s lost profits.
Because “lost profits” seeks to prove how much a plaintiff would profit from the trade secret, Texas courts will accept evidence of market conditions, business posture and competitive pressures to demonstrate the plaintiff’s profitability as compared to defendant. For example, in Matter of Mandel, a $1 million award was upheld because plaintiff’s expert testified about many different market factors which would influence the expected profits for companies similar to plaintiff, and provided a damages range based on these factors. Ultimately, the Fifth Circuit upheld a damages award at the low end of that spectrum, after considering “the significant rate of failures of comparable companies, the dysfunctional executive team of [plaintiff company], the lack of a functional product, [the competing company’s] abandonment of its efforts to create its own search engine, and the lack of profits by [both companies].”
In sum, since “lost profits” requires proving the value a plaintiff would have gained if the misappropriation never occurred, this theory is most likely to be successful if there is a clear record reflecting expected or actual profits.
Defendant’s profits from the trade secret
According to Berry-Helfand, damages in a trade secrets case can also be proven by evidence showing “defendant’s actual profits resulting from the use or disclosure of the trade secret.” This “benefit to defendant” may be measured by, among other things, evidence of market capitalization, evidence of profits, and evidence of revenue. Because “benefit to defendant” seeks to measure the total gain defendant realized from the misappropriation, it can be shown by evidence demonstrating costs saved by defendant. As a result, evidence supporting a defendant’s “actual profits” will sometimes overlap with evidence of “development costs avoided,” another commonly-used damages theory.
Revenue and market capitalization statistics are usually considered the best evidence of actual profit. However raw financial data can also be bolstered by other evidence. In Quantlab Techologies. v. Kuharsky, a multi-million dollar “actual profits” verdict was supported by both plaintiff’s testimony analyzing defendants’ financial records and defendant’s claim to investors that “his strategies [based on the misappropriated data] had led to $150,000-200,000 per day in trading revenues in 2011.”
“Benefit to defendant” also permits a fair deal of uncertainty. In GlobeRanger v. Software AG United States of America, the Fifth Circuit upheld a $15 million jury award (which was far greater than the $860,000defendant had earned from its misappropriation) after recognizing that “plaintiffs are not limited to damages based on the misappropriator’s profit,” but can identify what the “value of the misappropriated secret would be to a defendant who believes he can utilize it to his advantage” – regardless of a short-sighted defendant’s actual use of the product. Avoided development costs are another “benefit” a defendant can reap from misappropriation. In GlobeRanger, the “amount [plaintiff] spent on research and development … between 1999 and 2009” substantiated damages under both the “benefit to defendant” theory and the “defendant’s costs avoided” theory (discussed later in this article) because the avoidance of development costs directly benefitted defendant.
In sum, “benefit to defendant” is a more permissive theory than “lost profits,” allowing plaintiffs’ more flexibility to prove damages.
The value a reasonably prudent investor would have paid for the trade secret
A party may prove the value of a trade secret by showing what a reasonably prudent investor would pay for the trade secret. To do so, according to Berry-Helfand, a “plaintiff need only demonstrate the extent of damages as a matter of just and reasonable inference.” It can be shown “even if the extent is only an approximation.”
This category is often shown by the actual value of investor funds acquired by the misappropriating party. In Mandel, “investor value” was determined by analyzing proposed investor offerings for the misappropriated technology, specifically evidence showing defendant raised “approximately $2.5 million from investors before abandoning its attempt to create its own search engine … indicat[ing] a value of $1,375,000 attributable to [the misappropriator’s] 55% interest.”
Defendant’s avoided development costs
Another method listed in Berry-Helfand for establishing trade secret damages is by showing “development costs avoided” by a defendant. Like “defendant’s actual profits” and “plaintiff’s lost profits,” this theory relies on objective evidence. However, according to GlobeRanger, a plaintiff does not need to show with certainty the actual costs a defendant avoided. Rather, a plaintiff can rely on its own development costs as an approximation of expenses the defendant bypassed. Additionally, because avoiding development costs can result in a “benefit to defendant,” evidence supporting this theory can overlap with evidence of “defendant’s actual profits.”
Because a plaintiff’s development costs are readily available to a plaintiff, defendant’s avoided development costs are typically substantiated with evidence of plaintiff’s development costs. In Quantlab, a multi-million “development costs avoided” verdict was substantiated by testimony from plaintiff’s CEO that it cost plaintiff approximately $55 million to develop the misappropriated secret, in addition to defendant’s testimony claiming he used plaintiff’s technology “to avoid his own development costs in other ventures.”
Similarly, in GlobeRanger, “development costs avoided” were shown through evidence of plaintiff’sdevelopment costs, including invoices detailing the millions plaintiff “spent on research and development . . . between 1999 and 2009.” There, plaintiff’s evidence was contradicted by defendant’s allegations that it could have developed the technology itself, for only $140,000. The Fifth Circuit ultimately upheld the higher award because the jury “did not blindly accept the number of [plaintiff]’s expert, indicat[ing] the award was not the product of passion or prejudice, but rather reasoned evaluation of competing evidence.”
Because this theory can be proven via evidence detailing the plaintiff’s actual costs, it is naturally easier to detail, subject to the caveat that, where there are low-development costs associated with the trade secret, the theory may not be particularly helpful.
The final path to establishing trade secret damages given in Berry-Helfand is the “reasonable royalty” theory. This requires the plaintiff to “calculate what the parties would have agreed to as a fair price for licensing.” To substantiate a “reasonable royalty,” a plaintiff must conduct a “fictional negotiation of what a willing licensor and licensee would have settled on as the value of the trade secret at the beginning of the infringement.” Thus, while this method is “a proxy for the value of what defendant appropriated,” it is not just “a percentage of defendant’s actual profits.”
According to TMRJ Holdings v. Inhance Technologies, evidence which can validate a “reasonable royalty” estimate includes (1) the actual or competitive posture of the parties; (2) amounts paid to purchase or license the trade secret in the past; (3) the total value of the trade secret to plaintiff (including development costs and its importance to the business); and (4) the extent to which misappropriator used the trade secret. In practice, the fictional negotiation is usually proven with evidence from an actual contract. In Berry-Helfand, the plaintiff modelled her negotiation on the Petrohawk contract. However, as the Court made clear in that case when it vacated the award because Berry-Helfand’s proposed royalty did not match up with the royalty in the contract, reasonable-royalty damages based on a preexisting contract must be consistent with the structure of that contract.
On the other hand, if a hypothetical negotiation does correspond to a previously negotiated contract, it is more likely to support a “reasonable royalty.” For example, in TMRJ Holdings the Court affirmed a $4 million trade secret misappropriation jury verdict based on a “reasonable royalty” which was extrapolated from documents detailing the amounts previously paid to purchase and license the trade secret. In examining the “hypothetical negotiation,” the Court noted that the jury considered other evidence, including market data, company-valuation reports, a joint-venture contract, development costs and evidence of defendant’s misappropriation, which ultimately confirmed that the “hypothetical negotiation” reflected “a fair price for the [d]efendants’ use or disclosure of the trade secret.”
Because it requires showing that a hypothetical negotiation would result in an agreement resembling prior ones (despite potential differences in size, market power, bargaining position and other factors), the “reasonable royalty” theory presents a higher hurdle than other approaches. However, as shown above in TMRJ Holdings,if a plaintiff can satisfy the “reasonable royalty” measure, the evidence will likely fit multiple categories for review.
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Under Berry-Helfand and its progeny, courts are most likely to uphold decisions that feature: (1) reasoned decision-making by the fact finder in determining damages; (2) multiple theories for proving damages; and (3) clear evidence supporting the relied upon theory. These cases also illustrate that some theories may be more useful to certain types of plaintiffs but not others. For example, a “lost profit” theory may be more valuable to an established company because “lost profits” can be proven by historical financial data. Similarly, “development costs avoided” may be more valuable for technology which took significant time and money to develop than for a technology developed quickly and cheaply by a start-up company. For a start-up, “investor value” may be a better choice. Or, if the start-up’s secret has been misappropriated by a well-established company, “benefit to defendant” damages may far outweigh any losses plaintiff actually suffered.
There is no “one size fits all” approach which works in every case—Texas law still supports an “imaginative and flexible” approach to calculating trade secret misappropriation damages. As a result, both plaintiffs and defendants should be aware of the methods described in Berry-Helfand to maximize success in bringing or defending trade secret misappropriation claims in a post-Berry-Helfand world.
Kevin T. Jacobs is the litigation department chair in Houston at Baker Botts. He focuses his practice on commercial disputes and arbitrations for clients in the energy, chemicals, transportation, and life sciences industries.
Nischay Bhan is a Houston-based associate in the litigation practice at Baker Botts. He represents clients in complex commercial litigation matters, including energy litigation and insurance litigation.
Cornelius M. Sweers is also an associate in the litigation practice at Baker Botts in Houston. He handles complex civil litigation matters, including energy litigation, class actions and construction litigation.