In E.J. Brooks Company v. Cambridge Security Seals, the Court of Appeals of New York narrowed the scope of permissible damage claims plaintiffs can assert in trade secret actions under New York law. The ruling denies plaintiffs the ability to recover costs that defendants avoided through misappropriating trade secrets (known as “avoided costs” theory), making New York law less attractive to certain types of trade secret actions due to the state’s conservative approach in calculating damages.

E.J. Brooks Company d/b/a TydenBrooks (“TydenBrooks”), the largest manufacturer of plastic indicative security seals in the United States, brought an action in federal district court against rival manufacturer Cambridge Security Seals (“CSS”), asserting causes of action that included common law misappropriation of trade secrets, unfair competition and unjust enrichment. TydenBrooks alleged that former TydenBrooks employees misappropriated trade secrets after defecting to CSS and sought damages based on an “avoided costs” theory.

Under an “avoided costs” calculation, the plaintiff estimates damages based on the amount the defendant saved in research and development costs by unlawfully acquiring the plaintiff’s trade secrets. At trial, the jury found CSS liable under all three claims and awarded TydenBrooks a $3.9 million judgment based solely on the TydenBrooks’ avoided cost theory.

On appeal, the Second Circuit requested guidance from the New York State Court of Appeals on the issue of whether, under New York law, a plaintiff asserting claims of misappropriation of a trade secret, unfair competition, and unjust enrichment can recover damages measured by the costs the defendant avoided due to its unlawful activity. Prior New York precedent had not conclusively addressed whether a plaintiff could recover damages based solely on the cost avoidance of a defendant’s unlawful misappropriation of trade secrets.

In a 4-3 decision, the Court of Appeals held that a plaintiff may not elect to measure its damages by the defendant’s avoided costs in lieu of the plaintiff’s own losses. The majority went on to explain that the calculation of damages must be narrowly focused on the economic injuries incurred by the plaintiff. The minority noted that the decision departs from the predominant rule accepted by most states and may even encourage unlawful theft of trade secrets in circumstances where the unlawful actor’s benefit far exceeds the likely cost of defending against a trade secret action. Other jurisdictions, such as the Fifth, Tenth and Eleventh Circuits, have either allowed actions based solely on an “avoided cost” theory, or allowed a calculation of reasonable royalty^[1] in lieu of a calculation of the plaintiff’s own losses.

Companies should be aware of New York’s conservative approach to damage calculations when entering into litigation surrounding trade secrets. Plaintiffs should also pay special attention to choice of law and choice of forum provisions in their contractual dealings with employees and contractors, as these may have an impact on the type of calculations that can be used to assess damages.

It is also important to note that the federal government expanded protections for trade secrets in adopting the Defend Trade Secrets Act (“DTSA”) of 2016. DTSA claims were not at issue in this case, because it predated DTSA’s enactment, but are an important consideration given the current case law in New York.

This post was written with significant assistance from Eduardo J. Quiroga, a 2018 Summer Associate at Epstein Becker Green.

_{[1] A reasonable royalty is similar to “avoided costs” because it allows a plaintiff to recover damages in lieu of showing actual loss.}