Recent trade secret case: Fail-Safe, LLC v. A.O. Smith Corporation

April 17, 2012

It is a common scenario: a trade show encounter or an article in a trade magazine piques the interest of an entrepreneur in a product made by another company. Representatives from the two companies have informal discussions about the synergy of their businesses, and the idea for a product of interest to both of them is born. Continued cooperation and concrete plans for the joint development of the product follow, details are shared, and no one mentions the idea that the information being exchanged is confidential. Engineers from the companies meet in person, and despite the fact that it has demanded confidentiality agreements in other business dealings, one of the parties neglects to require a confidentiality agreement from the other. Work continues, with the companies discussing technical standards and deadlines for their planned product. Eventually, things fall apart, and the two go their separate ways. In Fail-Safe, LLC v. A.O. Smith Corporation, decided by the Seventh Circuit Court of Appeals on March 29, 2012, the plaintiff was the party in this common scenario that did not insist upon a confidentiality agreement, and when the defendant developed and marketed a product allegedly incorporating Fail-Safe’s trade secrets, it had no claim for either appropriation of those trade secrets, or for unjust enrichment.

Enthusiasm about the potential for profitable fruits of a collaboration with another business and focus on the substance of the deal often lead the participants to forget or disregard the "legalities." This recent case is a reminder that a moment of awkwardness is a small price to pay to protect valuable information from exploitation by someone else. Fail-Safe was decided under Wisconsin state law, but the principles are broadly applicable. Like most other states, Wisconsin has adopted the Uniform Trade Secret Act, and adheres to the same fundamental concepts with respect to the protection of trade secrets. A trade secret is any information that gives a business a competitive advantage over others who do not know that information. In order to claim that such information has been wrongfully used or disclosed, its owner must be able to show that it took reasonable steps to protect its secrecy.

The court in Fail-Safe pointed to the following facts in concluding that A.O. Smith was entitled to summary judgment: 1) the plaintiff never mentioned confidentiality in its oral or written communications with the defendant; 2) the plaintiff didn’t require defendant to sign a confidentiality agreement, even though defendant had plaintiff sign one, and despite the fact that plaintiff had used confidentiality agreements in other situations; and 3) plaintiff didn’t designate as confidential any information provided. Since the plaintiff failed to take reasonable steps to protect its information, that information was not wrongfully taken from it, and further, since "the material conveyed to A.O. Smith was without any intellectual property protection or contractual agreement for confidentiality, A.O. Smith could not profit unjustly from the use of that voluntarily disclosed information," according to the court.

Businesses planning to work together should respect each other’s wisdom in insisting on a confidentiality agreement. The terms need not be one-sided; the agreement can be fair and reciprocal, and therefore should not be regarded as over-reaching. The time to address the issue of confidentiality is at the outset of discussions; there is no reason to wait for the drafting and execution of a "formal" agreement, since despite the bright prospects envisioned by the parties when their relationship begins, many deals fall apart before the parties manage to finalize a written agreement. Therefore, the best practice is to always identify confidential information with clear markings, keep it secure, and insist on a written agreement before disclosing it to anyone outside the company.

This alert is intended to be informative and should not be interpreted as legal counsel for any specific fact situation. The information contained herein is for informational purposes only and is not legal advice or a substitute for legal counsel. Readers should not act upon the information presented without consulting professional legal counsel. Pursuant to applicable rules of professional conduct, this communication may constitute Attorney Advertising. © 2012 MARSHALL, GERSTEIN & BORUN LLP, Chicago, Illinois. All rights reserved.