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Failures are valuable IP: Protect your startup’s negative trade secrets

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Eugene Y. Mar

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Eugene Y. Mar is a partner with Farella Braun + Martel LLP in San Francisco, leading the firm’s Technology Industry Group.

Tech companies and startups are familiar with protecting their inventions with patents, and their secret formulas, source code and algorithms as trade secrets.

But they may not be aware of another powerful form of IP protection in California: “Negative trade secrets” are intended to protect a company’s secret know-how gained from extensive research investment about what does not work.

Consider Thomas Edison’s quote about his lightbulb experiments: “I haven’t failed, I’ve just found 10,000 ways that won’t work.” Imagine that Edison’s assistant quit and was hired by a competitor. The former assistant’s “negative know-how” from Edison’s 10,000 failed attempts would allow his new employer to start on attempt 10,001.

But while a trade secret is a company’s intellectual property, an employee’s general knowledge, skill and experience acquired in his or her former employment is not. Where does one draw this line? Does Edison’s former assistant really have to retry all 10,000 prior failures that he knows won’t work?

In a high-profile intellectual property case regarding self-driving technology (Waymo v. Uber), Judge William Alsup asked rhetorically, “Is an engineer really supposed to get a frontal lobotomy before they go to the next job?”

The answer to this question is obviously no, but companies have other ways to protect this information. Companies and employees should bear in mind some general best practices when protecting and navigating around negative trade secrets.

Define the breadth of negative trade secrets clearly

Courts sometimes scrutinize the breadth of alleged negative trade secrets to determine if they prevent others from competing in a particular field altogether. The broader the effect of the trade secret is and the greater its preemptive effect, the more likely a court will refuse to recognize that secret.

In one case, a court found that “Plaintiff’s designation of ‘technical know-how’ regarding what does and does not work in [ … ] digital media management software is simply too nebulous a category of information to qualify for trade secret protection.” The court criticized the plaintiff for failing to “identify any specific design routes,” and instead seeking to prevent the defendants from designing any software at all.

Any company seeking to protect this type of IP should sufficiently narrow the negative trade secret’s breadth so it doesn’t overlap with an entire field or industry.

Documentation can be used protectively

Negative trade secret claims most often succeed when a company can identify specific documents or data that included negative knowledge and were taken.

Such specificity is likely what allowed Genentech’s claims to go forward in a recent pharmaceutical case against JHL. Genentech included specific allegations that the defendants “downloaded and provided to JHL hundreds of confidential Genentech documents filled with proprietary negative know-how.”

JHL argued that its protocols differed from Genentech’s, but the court said this did not foreclose JHL’s possible use of Genentech’s negative trade secrets. This negative know-how “would confer JHL the benefit of steering clear of fruitless development pathways, thereby saving precious time and resources.”

So if a pharmaceutical manufacturer can identify data that was taken, which contained failed formulas, those failed formulas could be protectable negative trade secrets.

For software companies, claims for negative know-how misappropriation may require specific examples of the failed code that was taken.

Negative trade secrets can be the flip side of positive secrets

Companies should bear in mind that courts sometimes enforce a negative trade secret as the flip side of a positive trade secret.

In a case where a customer list was misappropriated, a court stated that “[i]f a customer list is acquired by lengthy and expensive efforts, which, from a negative viewpoint, indicate those entities that have not subscribed to plaintiff’s services, it deserves protection as a trade secret.”

The court meant that by acquiring a list of those who had purchased, defendants had “acquire[d] a list which has already screened out uninterested consumers and thereby saved ‘themselves comparable efforts in screening out those entities who declined [their] patronage…’”

In other words, the defendants acquired a customer list and could now avoid calling uninterested people, which the court characterized as a negative trade secret.

Below, we provide a list of general trade secret best practices as well as tips you can apply for negative trade secrets. Combining these lists can improve a company’s chances of maximizing their IP protection.

General trade secret tips

Treat it like a secret

Like the rules laid out by Tyler Durden in the movie “Fight Club,” the first and second rule of protecting a trade secret is: “You do not talk about [the trade secret].”

Keep it secret. Circulate trade-secret information only on a need-to-know basis among employees or internal teams. Avoid distributing the trade secret to anyone who doesn’t need to know about it, especially anyone outside the company.

Prepare an information security policy

Documenting basic policies regarding when employees may share confidential information outside the company and in what format. Define categories of information, such as public information, internal information, confidential information and strictly confidential information.

Protect against leaks using training

Conduct organized and formal training sessions with employees on the meaning of trade secrets, how the company protects them from public disclosure and how employees are obligated to help protect them.

It is best practice to do this when onboarding new employees and to provide periodic reminders (at least annually) either individually or in group settings. It is also good practice to provide documentation that the employees can sign to assert that they attended and understood the training.

Label documents clearly

Add “Confidential” or “Highly Confidential” legends on internal documents that describe or reference trade secrets. Do not overuse these labels on documents that don’t warrant them, as overuse may cause employees to ignore the label entirely and result in courts discounting their significance.

Secure access to your servers

Implement a companywide VPN network so employees can work with copies on company servers and can’t store anything on their own computers locally. VPNs also typically add a layer of encryption to transmission and can log access.

Log product development

Tech companies should use tools such as Github to log key developments of their product, including versions of their source code. Ideally, this information should include what those developments are, when they happened and who designed them.

Use the onboarding process to introduce policies to new employees

When onboarding employees, have employees certify that they are not bringing any trade secrets from their former employer. You should also train them in the company’s information security policies, which should usually include signing a non-disclosure agreement.

Implement a process of departing employees

Conduct exit interviews with employees who are leaving the company, ensuring that all their equipment and documentation has been returned and that access to company databases has been revoked.

Include a termination certification in employment agreements that are signed during the exit interview. The certification should state that the employee has not taken any confidential information or company devices and that personal devices have been reviewed and cleared of all company trade secrets and confidential information (although such information should never be on personal devices).

Be careful when exploring M&A or partnerships

If you’re considering a merger or partnership with another company, try to limit the initial information sharing to your financial information, and only provide sensitive technical information if the potential partnership has progressed significantly. Always use a well-written non-disclosure agreement.

Negative trade secret tips

Document successes and failures

Introduce a general practice of documenting all attempts so that failed formulas, code or implementations are documented along with successful ones. Also document who worked on something and why it failed. Ensure any such documentation is well protected within the company.

Delineate negative trade secrets in your NDAs

Include a clause regarding the protection of negative trade secrets in any non-disclosure agreement that your company signs, whether it’s with an onboarding employee or a potential partner company.

Explain what constitutes a negative trade secret

Explain the concept of negative trade secrets in training sessions so employees understand that their obligation to keep proprietary information secret extends not only to positive know-how but to negative know-how as well.

Define your trade secrets clearly

If litigation occurs, describe the negative trade secret in specific terms. It’s also a good idea to couple any negative trade secret with a positive formulation of the secret, if possible.

For example, if you’re trying to protect years of unproductive sales calls with potential customers who were not interested in your product, you should also choose to protect the list of customers who were interested in the product. If the court looks askance at the negative secret, the positive one can be a great alternative.

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