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 [email protected].