Trading secrets Featured

8:00pm EDT May 26, 2008

Trade secrets are those “proprietary and confidential” processes, formulas or technical details that give businesses a competitive edge. Most successful companies invest significant amounts of time and money in creating these market differentiators.

“When you’re buying or selling a business, it’s critical to find out whether legally protected trade secrets actually exist,” says Gary Blackman, a partner with the Chicago law firm of Levenfeld Pearlstein LLC. “Otherwise, a seller is at risk of representing it owns something it doesn’t and a buyer is at risk of paying for something that doesn’t exist.”

Smart Business learned more from Blackman about how both buyers and sellers of businesses can confirm the existence and value of trade secrets and protect themselves throughout the process.

What is the legal definition of a trade secret?

Most states define a ‘trade secret’ as something that is sufficiently secret with some economic value. This could include a formula, device, method, technique, drawing, process, financial data, or even a list of actual or potential customers or suppliers. In other words, your business is worth more because your competitors don’t know what you know, and you’ve taken the necessary steps to prevent others from acquiring or using the information.

These steps could include: creating a confidentiality policy; maintaining trade secrets on computers and identifying them with warning screens that require passwords from those who access them; labeling documents as ‘Confidential Trade Secret. Do Not Copy. Do Not Distribute’; storing trade secrets in a secure area, such as a locked file cabinet, drawer or safe; and requiring your employees to sign confidentiality agreements that specifically identify the trade secrets.

How do trade secrets differ from patents, trademarks and copyrights?

Trade secrets operate outside the framework of copyright, patent and trademark law so there is no recognized registration processes. Though most states have adopted some form of trade secret legislation, the statutes only provide guidance. Trade secrets are a bit like mercury — both static and ever-changing. One day something can be a trade secret and another day it is not, depending on the owner’s actions. Unfortunately, the courts ultimately make determinations on trade secrets, which is why they are often difficult to identify, value and buy or sell.

Why are trade secrets an important issue in mergers and acquisitions?

In the context of a merger or acquisition, trade secrets are often assets that contribute to the value of an entity being bought or sold. Not unexpectedly, this is often more important to the buyer who is paying for that value than the seller. No one wants to pay for something that doesn’t exist or can’t be legally protected. In some cases, a buyer will significantly rely on the existence of a trade secret, in other cases it will not.

It really depends on the nature of the business and each side’s expectations and risk/benefit analysis. A buyer primarily concerned with a ‘proprietary and confidential’ process or customer list will want to spend more time on this issue than someone more interested in buying patents, trademarks and copyrights. A seller, on the other hand, should be concerned with whether it is representing that it ‘owns’ something of value that it does not, which can possibly subject it to post closing legal liability.

How can both sides protect themselves during negotiations?

A good seller’s lawyer will want to limit a seller’s trade secret representations, requiring instead that the buyer does its own due diligence, as opposed to relying on the seller’s opinion.

Conversely, a good buyer’s counsel will require that the seller specifically identify the trade secrets and make affirmative representations as to what was done to create and maintain the trade secret. This is important because inadvertent disclosure or the failure to keep something confidential can turn something that once was trade secret into something that can no longer be legally protected. Where possible, a buyer should: obtain an assignment of the seller’s rights under employee trade secret agreements for employees knowledgeable about the acquired trade secrets, identifying such agreements both by category and specific listing; seek an assignment of all other rights, contractual or otherwise, necessary to protect the buyer’s rights in acquired intellectual property assets; try to ensure that no records — or other material aides to reconstruction of the acquired trade secrets — are left behind with seller employees; and require the seller to instruct employees to surrender such records and materials.

A buyer may want to provide himself or herself with various legal remedies in the event that something that the seller represented as a trade secret is not one. This could include the seller paying back the value of this intellectual property.

GARY BLACKMAN is a litigation partner at Levenfeld Pearlstein LLC. Reach him at (312) 476-7536 or gblackman@lplegal.com.