CHAPTER 4 DAMAGES VALUATIONS OF TRADE SECRETS
4.4 Principles of Damages and Dispute Valuation
4.4.1 Damages in Tort and Contract Law
Given that the origins of trade secrecy law lie in tort and contract law, and that much of the valuation methods used in EEA cases stem from civil cases (as noted in Smith (2002), it is useful to discuss damages in the context of tort and contract law.
Reliance and Expectation in Damages Measures
Further concepts in damages calculations can be found in the legal justification for their existence. Damages are traditionally separated into restitution (or reliance212) damages and expectations damages. Restitution damages return the victim to the state before the theft (i.e. make the victim whole but for the theft.) Expectations damages, on the other hand, compensate the victim for future losses (typically on the basis of a contractual relationship.) Put differently, by Hall and Lazear (1994), “damages are generally calculated under the expectation principle, where the compensation is intended to replace what the plaintiff would have gotten if the promise or bargain had been fulfilled.”213
Hall and Lazear (1994) provide a useful graphical representation of the division between damages before a trial and damages after a trial. As they note,
restitution and expectations damages can lie in both the damages before the trial and after the trial.
212 As Hall and Lazear (1994) note, restitution and reliance are related concepts. Restitution is used in cases of injury or theft (and is therefore relevant to the EEA cases.) Reliance is used in cases of fraud and is applicable to tort and contract law.
213 Hall and Lazear (1994) p. 481.
Table 4-2: Hall and Lazaer (1994) Depiction of Damages214
The EEA employs a mix of both restitution damages and expectations damages.
Under restitution damages, the victim is compensated for the theft on the basis that the stolen trade secret had value (past and future) that the victim would have benefitted from. This clearly applies to the damages valuation method of Actual Damages and Fair Market Value and is found in variations of other models. As Hall and Lazear (1994) note, the but-‐for analysis of damages valuations relies on restitution damages.
Under expectations damages, however, the relationship between the victim and the defendant comes into play. As many of the defendants are employees or contractors (see Chapter 3 for a discussion) engaged in the development of the trade secrets, the victim rightfully expected that the trade secret would have maintained its secrecy and perhaps been further developed. This is particularly so in cases in which the trade secret was related to primary research which had
214Reprinted from Hall and Lazaer (1994), p. 478.
yet to undergo commercial application.215 Furthermore, the argument of Reasonable Royalty comes into play under expectations damages in which the defendant could have engaged in a contractual relationship with the victim in order to license the trade secret. In these cases, the defendant violates a theoretical licensing agreement.
However, in application, the EEA cases demonstrate a mix of restitution and expectations damages. As noted in the next chapter, Chapter 5, the damages valuations in EEA cases vary significantly. In many cases, a wide range of estimates are found for the trade secrets. Furthermore, the actual legislation fails to show a clear preference for restitution or expectations damages. As discussed in Chapter 5, the principles of damages valuations in EEA cases are found in the USTSA216, which allows for the use of Actual Damages, Unjust Enrichment and Reasonable Royalty. Furthermore, the Sentencing Guidelines advocate the use of the Fair Market Value. Thus, neither the principles of restitution or expectations damages are preferred in the legal infrastructure surrounding EEA cases.
Furthermore, the mix of restitution and expectations damages in the EEA suggests that these principles can be manipulated to favour one party over another. For example, if the victim is in an unfavourable contract, the damages expectations based on expectations may exceed that of restitution. In this case, the use of restitution damages would favour the victim. Thus, the use of
restitution or expectation damages adds another layer of debate in the calculation of damages in EEA cases.
Pure Economic Loss
215 The EEA cases involving university research would appear to be obvious examples of this. See U.S. v. Zhu, Criminal case 1:05-‐cr-‐10153-‐GAO-‐1 (Massachusetts, filed on June 16, 2005) and U.S.
v. Okamoto, Criminal case 1:01-‐cr-‐00210-‐DDD-‐1 (Northern District of Ohio, filed on May 8, 2001).
216 See Uniform trade secrets act, available at http://nsi.org/Library/Espionage/usta.htm, accessed November 2008 and D.O.J., (2008), Prosecuting IP Crimes Manual, p. 267.
A controversial topic in tort law is that of pure economic loss and its relation to economic efficiency. Pure economic loss is financial loss and damages that are purely financial and independent of physical inputs. This differs from
consequential (or parasitic) losses, which involve a much narrower definition of all losses. As Bussani and Palmer (2003) define it, “consequential economic loss is recoverable because it presupposes the existence of physical injuries, whereas pure economic loss strikes the victim’s wallet and nothing else.”217
It is tempting to consider EEA damages calculations as pure economic losses in the sense that trade secrets are intangible assets. However, this would represent an overly simplistic interpretation of the delineation between pure and
consequential losses. Nonetheless, the damages calculations in EEA case are, in general, based on pure economic loss. The underlying principles of damages valuations in EEA cases are based on cash flow analysis, actual expenditures and market values. All of these concern the financial impact of the theft and not any physical injuries.
The debate amongst legal scholars over pure economic loss arises because, in some jurisdictions, pure economic losses are not recoverable.218 Furthermore, as Gregen (2006) notes, the whether pure economic losses act to deter or redress injury is the subject of debate. However, a sound theory can be found in Bishop (1982) in his argument that economic loss is not efficient in that it induces “too much avoidance activity by potential tortfeasors219.”220
Further criticism of the economic efficiency of pure economic loss can be found in reference to the insurance market221. Under pure economic loss, as Bishop (1982) notes, the cost of insurance for victims or tortfeasors would be
prohibitively high. As pure economic loss can be much more than losses associated with physical loss (e.g. the cost of fixing a broken leg is likely to be
217 Bussani and Palmer (2003) p. 6.
218 Bussani and Palmer (2003) p. 7.
219 A tortfeasor is someone who commits a tort.
220 Bishop (1982) p. 13.
221 Bishop (1982) notes that this is a commonly used rationale in the pure economic loss debate.
less than the lost wages as a result of an injury), an insurance market, which will include administrative costs, will be too expensive and suffer from moral
hazard222 issues. Additionally, pure economic loss could result in the bankruptcy of the tortfeasor (or, in our case, defendant) and render any judgement
unenforceable. Given that the EEA sought to extend the reach of punishment of the theft of trade secrets to judgement-‐proof defendants (as discussed in Chapter 3,) the use of pure economics loss presents challenges to enforcement of the act.
This debate over the role of pure economic losses in the context of the EEA adds yet more legal controversy over the criminalization of the theft of trade secrets.
The difference between the valuations of trade secrets argued during the course of the case and those used in sentencing (as discussed in Chapter 5) could
suggest, as Bishop (1982) notes in relation to the debate over economic loss that,
“courts in deciding cases have reached results that seem broadly efficient.”223 Thus, the evidence of difference of valuations used in sentencing and those discussed in this chapter suggests that, in EEA cases, the courts recognise the lack of economic efficiency found in the pure economic loss approach.