Texas Trade Secret Law Expanded

Modern technology is making it much more difficult for businesses to protect their trade secrets. Long gone are the days when an unscrupulous company officer or employee would have to spend hours late at night at the copy machine to copy and steal valuable trade secrets like customer lists, plans or specifications.  In the digital age, this can be accomplished in a matter of minutes by downloading the data to a flash drive that fits on a key chain. Texas is doing its best to pass laws to protect businesses from trade secret theft.  As discussed in one of my previous articles, the Texas Uniform Trade Secrets Act was passed in 2013, making it easier for businesses to protect their trade secrets.  

This act has now been amended.  On May 19, 2017, the Texas Governor signed the bill into law clarifying the meaning of the act and expanding the definition of trade secrets that are protected.  The act as amended, effective as of Sept. 1, 2017, provides that ""trade secret" means all forms and types of information, including business, scientific, technical, economic, or engineering information, and any formula, design, prototype, pattern, plan, compilation, program device, program, code, device, method, technique, process, procedure, financial data, or list of actual or potential customers or suppliers, whether tangible or intangible and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing if....." 

The italicized language is the language that was added by the amendment.  As you can see, the amendment expands the definition of a trade secret so that a wider net is cast to make additional types of company information protectable as a trade secret. So for example, if you own an engineering firm and engineering information or plans are stolen, the act includes this information as a protectable trade secret.  Keep in mind, if your business has suffered a trade secret loss, time is of the essence and you should take immediate action. 

Texas Supreme Court Takes Permissive View on Trade Secret Damages

One area in Texas commercial litigation that continues to evolve is the cause of action for theft of trade secrets.  State and federal statutes have recently been enacted making it easier for businesses to protect their trade secrets.  This is becoming increasingly important in the digital age when large amounts of information including protected trade secrets can be downloaded in seconds or minutes.  

The Texas Supreme Court seems to be following the trend.  In its recent June 2016 opinion of  Southwestern Energy Production Co. v. Hefland, Opinion No. 13-0986, the court decides whether to uphold a verdict for trade secret theft of over $30 million.  The underlying allegations involve the alleged misappropriation of data identifying highly productive oil and gas formations. Although, the court remands the case for a new trial on the grounds the plaintiff proved up some but not all of the damages, the court cites legal precedent stating, "A "flexible and imaginative" approach is applied to the calculation of damages in misappropriation-of-trade secrets.”

The court discusses multiple ways to measure damages for trade secret theft leaving the door open for Plaintiff's to be creative in developing their damages models.  However, in reading the opinion one gets the impression that the Plaintiff may have been a little too creative and would have been better off taking more of a rifle rather than a shotgun approach to proving up damages.  For example, the court finds that the Plaintiff's expert provided no basis for valuing certain elements of the damages claimed and overstated other damages calculations.  The result is that at the end of the day the court remands the case to the trial court for a new trial. 

Lessons learned from this case are that Texas courts may take a liberal view on damages in trade secret theft cases.  Even so, plaintiffs must meet the technical requirements in offering probative expert testimony to support damages.  Otherwise, plaintiffs may find themselves retrying their cases after years of hard work, or, even worse, being completely reversed on appeal.

Texas Shareholder Derivative Actions Made Easier

Just when it looked like all was lost for minority shareholders of closely held Texas corporations after the Texas Supreme Court eliminated shareholder oppression as a cause of action, along came the Court's decision of Sneed v. Webre, 465 S.W.3d 169 (Tex. 2015).  In this fascinating decision, the Court found that shareholders of TX closely held corporations do not have to first make a formal written demand upon the board of directors as a prerequisite to filing a derivative lawsuit. (A closely held corporation is one with fewer than 35 shareholders).

A derivative lawsuit is a proceeding instituted by shareholders on behalf of the corporation when the board of directors fails to initiate the lawsuit.  This typically arises when one or more interested directors or officers has allegedly breached fiduciary duties owed to the corporation. Naturally, in these situations, even those directors who have done nothing wrong may be reluctant to file a lawsuit on behalf of the corporation against one of their fellow board members or officers. Thus, if the directors fail to act, the law provides a mechanism for the shareholders to file a derivative action on behalf of the corporation.

Generally, before the shareholders of a corporation may file a derivative action, they must first make a formal written demand upon the board of directors to institute the lawsuit. Only after the directors refuse to do so or fail to timely respond to the demand may the shareholders institute the lawsuit. However, the Texas Supreme Court held that the shareholders of Texas closely held corporations do not have to meet this demand requirement.  They may simply file the lawsuit. This saves time and money for the complaining shareholders.

One other interesting fact in this case was that the shareholders of the parent corporation were instituting the derivative action on behalf of the parent corporation's wholly owned subsidiary.  The court held that they were equitable shareholders of the subsidiary and therefore had standing to also bring the action on behalf of it.

Durable Power of Attorney Creates Fiduciary Relationship

A recent court of appeals discussed the significance of the fiduciary relationship created when someone signs a power of attorney authorizing another to act as their agent.  (Jordan v. Lyles, 485 S.W.3d 785 (Tex. App. - Tyler 2015)).  In this case, Bud executed a durable power of attorney appointing his stepdaughter as his agent. Subsequently, Bud, with the help of his stepdaughter, completed some forms making his stepdaughter the sole beneficiary of Bud's bank and annuity accounts.  As a result, when Bud died these accounts vested in the stepdaughter and did not become part of Bud's probated estate.

After Bud's death, the stepdaughter withdrew the money from the accounts and liquidated the annuities.  Bud's heirs sued the stepdaughter for breach of fiduciary duty.  The court held that the power of attorney created a fiduciary relationship between Bud and his stepdaughter as a matter of law. Even in the case of a gift between parties with a fiduciary relationship, the law presumes the gift to be unfair and invalid.  The recipient of the gift must prove that the transaction was fair and reasonable.

The jury found that Bud's stepdaughter breached her fiduciary duty, under the circumstances of this case, and awarded damages to the heirs. The court of appeals upheld the jury award.

Fiduciary Duties Owed by Members of Texas Limited Liability Companies

The Texas Supreme Court has made it clear in a recent opinion that majority shareholders do not owe formal fiduciary duties to minority shareholders, even in closely held corporations. Cardiac Perfusion Services, Inc. v. Hughes, 436 S.W.3d 790 (Tex. 2014). However, a recent Texas appellate court held that managing members of a limited liability company (LLC) may owe a fiduciary duty to the non-managing member when the company agreement vests sole control of the company in the managing members.  Guevara v. Lackner, 447 S.W.3d 566 (Tex. App.—Corpus Christi 2014), reh'g overruled (Dec. 11, 2014).

The moral of the story is that in forming an LLC, careful attention should be paid to drafting the company agreement that governs the operation of the LLC.

Construction Delay Damages

Owners often require general contractors they hire to perform construction services to agree to waive their rights to recover delay damages.  General contractors in turn require their subcontractors to agree to the same.  When a contractor's work is significantly delayed by others, this can result in catastrophic financial losses to the contractor.

Fortunately, the Texas Supreme Court recently held that there are exceptions to the enforceability of these no delay damages clauses.  The court held that the exceptions to their enforceability include when the opposing party causes the delay or hindrance by engaging in arbitrary and capricious conduct, active interference, bad faith or fraud. (See Zachry Const. Corp. v. Port of Houston Auth. of Harris County, 449 S.W.3d 98, 104 (Tex. 2014), reh'g denied (Dec. 19, 2014)).

Lessons learned are that if you are a contractor, you should avoid signing a contract that contains a blanket waiver of the right to recover delay damages.  However, even if you have agreed to this type of clause, all may not be lost if you sustain delay damages.  You will just have to submit proof that one of the common law exceptions applies to the enforceability of the clause.

Texas Corporate Fiduciary Duties Alive and Well

The last post discussed the Texas Supreme Court's recent decision in Ritchie v. Rupe eliminating shareholder oppression as a cause of action in Texas.  However, all is not lost for minority owners in small corporations or limited liability companies who are treated unfairly.  In fact, the same court made it clear that board of director members and officers continue to owe fiduciary duties to their corporations that can be enforced by shareholders through derivative actions.

Lessons that can be learned from this decision are:

1. The court favors that shareholders use shareholder agreements to govern their respective rights and obligations.  The court mentions the use of shareholder agreements multiple times throughout the opinion.  I anticipate corporate attorneys will utilize these agreements more frequently in forming corporations and representing minority investors.

2. Shareholders in closely held corporations (corporations with fewer than 35 shareholders) may file suit against directors or officers in control of a corporation who breach their fiduciary duties without jumping over all the procedural hurdles typically required in derivative actions.

3. A shareholder has statutory but not common law rights to inspect a corporation's books and records.

4. The directors of a corporation cannot refuse to pay dividends for an improper purpose such as devaluing the shares of the other shareholders.

5. In limited instances, if the controlling officers or directors terminate a minority shareholders employment, they may be liable for breach of fiduciary duty.

6. Officers and directors will continue to be held accountable to a corporation for misapplying corporate funds or diverting corporate opportunities.

7. If controlling directors or officers take action to deflate the value of a corporation's shares, "perhaps to allow the company or its shareholders to purchase a minority shareholder's shares for less than their true market value," the corporation may have a cause of action for breach of fiduciary duty.