Reasonable Royalty Payments: a Third Bite at the Apple in CUTSA Cases

January 6th, 2011
By: Erich Schiefelbine, Stephens Friedland LLP
and Evan Rothman, Stephens Friedland LLP

Recently, in Ajaxo Inc. v. E*Trade Financial Corporation (2010) 187 Cal.App.4th 1295 (review denied November 10, 2010), the Sixth District Court of Appeal held that a reasonable royalty may be recovered by a plaintiff under the California Uniform Trade Secrets Act (Civ. Code §§ 3426-3426.11 (“CUTSA”)) even where a jury finds that the defendant did not profit from its misappropriation of trade secrets.  Under section 3426.3(b), if neither actual loss nor unjust enrichment is “provable,” the court has discretion to order payment of a reasonable royalty to the plaintiff.

Ajaxo sued E*Trade for misappropriation of trade secrets for its alleged use of technology information that E*Trade received while evaluating Ajaxo’s wireless stock-trading software.  At trial Ajaxo relied solely on unjust enrichment as the measure of damages.  The jury found for Ajaxo but accepted E*Trade’s evidence concerning damages.  This evidence showed that E*Trade had actually lost millions in its wireless stock trading activities.  The court rejected Ajaxo’s request for reasonable royalties because—while holding that unjust enrichment was provable—there was “no net amount in terms of actual damages.”

Multiple appeals followed.  On the second appeal, E*Trade argued that to be “unprovable” under section 3426.3(b), “a measure of damages must fail as a matter of law, as opposed to the situation here, where the measure was not proved as a matter of fact.”  Relying on the legislative history and public policy concerns, the Court held that “[s]ince CUTSA was intended to codify the common law, it is reasonable to assume that the Legislature intended the reasonable royalty amendment to track the common law practice of allowing for reasonable royalties when the plaintiff could not prove any loss and the defendant ‘made no actual profits.”

Under CUTSA, reasonable royalties are allowed in two situations: (1) when it would be unreasonable to enjoin future use of misappropriated trade secrets, or (2) if neither actual loss nor unjust enrichment is provable.  Under the common law, reasonable royalties as a measure of damages were “only appropriate where the defendant has made no actual profits and the plaintiff is unable to prove a specific loss.”  The common law did not distinguish between proving “defendant’s lack of profit as a matter of law rather than as a matter of disputed fact.”  Since CUTSA was intended to codify the common law “[t]here is no reason to believe that the Legislature intended the hairsplitting distinction” that E*Trade urged in this case.

The Court also pointed out that a misappropriating defendant may gain “any number of nonpecuniary benefits by stealing a trade secret.”  This would allow a defendant to benefit from the plaintiff’s ingenuity without having to compensate the plaintiff at all.  According to the Court, this result would seemingly be inconsistent with the public policies underlying trade secret laws.

Thus, “where a defendant has not realized a profit or other calculable benefit as a result of his or her misappropriation of a trade secret, unjust enrichment is not provable within the meaning of section 3426.3, subdivision (b), whether the lack of benefit is determined as a matter of law or as a matter of fact.  To hold otherwise would place the risk of loss on the wronged plaintiff, thereby discouraging innovation and potentially encouraging corporate thievery where anticipated profits might be minimal but other valuable nonmeasurable benefits might accrue.”

Ajaxo suggests that an evaluation of a misappropriation claim should, at a minimum, include the possibility of an award of a reasonable royalty.  Ajaxo did not answer, however, how a court would measure a royalty in the absence of actual damages.  Proving what is “reasonable” in this context may become a fourth bite at the apple . . .

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