After 20 years of employment, Rowena Cheung quit her job with Fada International, an importer of jewelry and precious stones. She not only left the company with trade experience, but also an extensive rolodex of client contacts which she used to launch her own jewelry business. However, Cheung had signed a non-disclosure agreement (NDA) before leaving the company, in which she had promised not to disclose the customer information. Her former employer, in an effort to maintain its position in the competitive jewelry import business, then filed a lawsuit against Cheung claiming that she had misappropriated customer information.

Even though an NDA had been signed, an appeals court in December 2008 dismissed Fada International’s claim and held that Cheung did not steal the information. According to the ruling, trade secret protection did not apply since the customers were “readily ascertainable outside the employer’s business as prospective users … of the employee’s services or products.” Moreover, the court refused to interpret the NDA in a way that would keep Cheung from competing against her former employer. The court noted that Cheung had signed a confidentiality agreement, rather than a non-compete agreement that could her conduct on behalf of a new employer or in a new venture. The story of Rowena Cheung’s departure is a familiar one to business owners, who contend with the perils of sharing confidential information whenever they hire an employee or work with an independent consultant or external business. It is common for employees to break away and join the ranks of another venture in the same industry or even found a new competing venture. Most business owners are aware of the hazards and protect sensitive internal information by having employees, consultants, third-party business sign confidentiality agreements.

The NDA or confidentiality agreement is a set of promises that facilitates the disclosure of trade secrets. Typically, the NDA binds one or both parties to treat specific information as confidential. The NDA can take a variety of forms, including a separately executed agreement or a clause in another agreement, such as an employment contract. What an NDA typically protects is information of a secret, private or confidential nature that pertains to the company’s financial state, business dealings or technology. The document may either limit disclosure of the information to certain third parties on a need-to-know basis only (e.g., executives, attorneys, employees), or prohibit disclosure entirely. At the bare minimum, an NDA will usually cover the term of confidentiality, the manner in which the information must be held confidential, and the definition of what information will and will not be held secret. Sometimes companies that lack in-house counsel opt, in the rush to move transactions forward, for boilerplate language taken from other deals or from the Internet. This approach may jeopardize the protection of intellectual property, a costly stake for businesses that invest heavily in research and development.

The non-disclosure of confidential information, whether through NDA or other measures, is critical to the protection of proprietary information under United States trade secret law. The Uniform Trade Secrets Act (UTSA), which has been adopted by 42 of the states, defines a trade secret as “information, including a formula, pattern, compilation, program device, method, technique, or process, that: (i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.” Information classified as a trade secret is not only protected by state statute, but also by federal trade secret provisions under 18 U.S.C. 1832, which provides criminal penalties for the theft of certain secrets involving federal employees or federal liabilities. However, protection of trade secrets under state and federal laws evaporates when the information is disclosed to third parties and no longer considered “secret”, regardless of how the information was disclosed. Thus, the consequence of a poorly-drafted NDA may be the permanent loss of trade secret protection.

Despite the importance of the NDA in maintaining trade secret protection, confidential information may still be vulnerable to disclosure in a variety of ways. The dismissal of Fada International’s case against its former employee-turned-competitor demonstrates that certain categories of information fall outside the protection of an NDA. Moreover, the case illustrates the risks of litigating trade secrets in open court, where disclosure is a necessity and enforcement can be uncertain. An NDA may not help or may even hinder trade secret protection in the following areas:

• Common industry knowledge. Trade secret law is intended to protect information that derives economic value from not being generally known. Information that is common knowledge, either to the public at large or to individuals working in a particular sector, will not be protected as a trade secret. As the court in Fada International Corp. v. Rowena Cheung affirmed, client lists will not be considered confidential information in a competitive industry where the clients are commonly known entities within the industry.
• Ideas and general concepts. These fall under the umbrella of copyright and patent law protection, not trademark law. For example, the idea of creating a device that could play MP3 files was never a trade secret. The technologies behind the idea were, however, eventually protected under several different patents.
• Residual clauses. Some confidentiality agreements include residual clauses that exclude from the NDA any information that is retained in employees’ memories, such as general skills and knowledge. Residual clauses can render an NDA ineffectual by severely limiting the scope of confidential information covered by the agreement.
• Court discovery. If the NDA becomes relevant to litigation, a court-approved subpoena would supersede the confidentiality agreement and could require the disclosure of the information. It would then be necessary to obtain a protective order from the court to preserve secrecy.
• Parties in quiet breach. There is a consensus among legal practitioners that the enforcement of confidentiality agreements is often impractical. It is difficult to ascertain whether a consultant or former employee has disclosed the information after having left the company.
• Parties in open breach. Moreover, even when it is possible to prove that there has been a disclosure, litigation is costly and often ineffective when the defendant is judgment-proof and the secret has been exposed to the public. For example, in 2008 case Master Mech. Corp. v Macaluso, a New York heating, ventilation and air-conditioning firm sued an employee who had been hired to bring in new business, but then left the company to start his own business. The employee had been bound by agreement not to disclose confidential trade secrets and not to do business with the company’s customers for two years after termination. However, by the time the appellate court issued a ruling on the preliminary injunction against the employee, the two year term was over. In spite of the NDA and non-compete clause, the employee was ultimately free to engage in business with the firm’s clients.

In light of cases like Fada International Corp. v. Rowena Cheung, it is important to note that no NDA is bulletproof and that there are gray areas that fall outside of the protection of trade secret law. It may be helpful to consult with an intellectual property attorney to develop a strategy for optimizing the protection of confidential information.

- By Dava Casoni, Annie Lin