Chancery Court Rules that Investing in Competing Businesses Does Not Constitute Misappropriation of Trade Secrets When Permitted by Governing Documents

By: Jessica Pearlman and Corinne Smith

In Holdings, Inc. v. ABS Capital Partners, Inc., et al. (C.A. No. 2017-0583-JTL (Del. Ch. June 15, 2018), plaintiff, Inc. (“Alarm”) brought suit against defendants ABS Capital Partners, Inc., ABS Partners V, LLC, and ABS Partners VII, LLC (collectively “ABS”) asserting: (1) the misappropriation of trade secrets under the Delaware Uniform Trade Secrets Act (“DUTSA”), and (2) common law misappropriation of confidential information. Both claims related to ABS’s investments and board appointments in both Alarm and one of its direct competitors. The Delaware Court of Chancery dismissed both claims for failure to state a claim pursuant to Court of Chancery Rule 12(b)(6), ruling that (1) it was not reasonably conceivable that ABS engaged in misappropriation under DUTSA, and (2) DUTSA preempts Alarm’s common law claim because it is based on the same wrongful conduct as its trade secret claim.

In 2008, before investing in Alarm, ABS entered into a non-disclosure agreement with Alarm (“2008 NDA”) that expressly recognized that ABS might invest in Alarm’s competitors. ABS, Alarm, and Alarm’s other stockholders later entered into a stockholders agreement that allowed ABS to appoint a director to Alarm’s board of directors. Ralph Terkowitz, an ABS partner, regularly attended board meetings from 2008 to 2016 as an Alarm director and was involved in many of Alarm’s major business decisions. Alarm’s complaint alleged that Mr. Terkowitz passed confidential information about Alarm garnered from these meetings to ABS in oral and written reports.

After recapitalizing in 2012 and adopting an Amended and Restated Certificate of Incorporation (“Amended Charter”), Alarm and its stockholders entered into another stockholders agreement, again reiterating that ABS could invest in companies in competition with Alarm as long as ABS did not disclose or otherwise make use of Alarm’s proprietary or confidential information in connection with such investments. After Alarm completed its IPO in 2015, ABS acquired a significant ownership stake in Resolution Products, Inc. (“Resolution”), a direct competitor of Alarm. ABS appointed Phil Clough, one of its partners, to the Resolution board of directors.

Though Mr. Clough never served on the Alarm board and Mr. Terkowitz never served on the Resolution board, Alarm claimed ABS either had already misappropriated or inevitably would have misappropriated its trade secrets in violation of DUTSA. Alarm also claimed that, in the absence of any trade secret misappropriation, ABS had engaged or would have inevitably engaged in common law misappropriation of Alarm’s confidential information. ABS moved to dismiss Alarm’s complaint for failing to state a claim on which relief could be granted.
The court cited precedent in determining that to survive a motion to dismiss, Alarm’s complaint would have had to plead that (1) a trade secret existed; (2) the plaintiff communicated the trade secret to the defendant; (3) the communication was made pursuant to an express or implied understanding that the defendant would maintain the secrecy of the information; and (4) the trade secret has been misappropriated as defined in DUTSA. The court assumed for the sake of analysis that the first three requirements were met; therefore, Alarm only needed to demonstrate that trade secrets were misappropriated within DUTSA’s definition of “misappropriation.”

The court found that ABS’s investment in Resolution, made roughly a year after Terkowitz left Alarm’s board, did not successfully demonstrate such misappropriation, which DUTSA defines as “acquisition of a trade secret of another by a person who knows or has reason to know that the trade secret was acquired by improper means.” While ABS was not permitted to “make use of any proprietary or confidential information of the Company in connection with such activities,” the later stockholders agreement recognized that an investment in a competitor would not, on its own, violate such confidentiality terms. Similar understandings were evidenced in the 2008 NDA and the prior stockholders agreement.

Importantly, the court noted the Amended Charter included a provision exempting stockholders like ABS from “any duty not to pursue corporate opportunities that might arguably belong to Alarm.” The clear intent of this provision, the court found, was to waive any claim for breach of the duty of loyalty against ABS, permitting ABS to invest in competing companies like Resolution. The court found that these circumstances did not indicate ABS misappropriated or inevitably would have misappropriated Alarm’s trade secrets in violation of DUTSA, but only supported an inference that ABS invested in a company that competes with Alarm, which under various agreements both Alarm and ABS had agreed was permissible.

The court also dismissed Alarm’s common law misappropriation claim. DUTSA’s preemption provision states that DUTSA “displaces conflicting tort, restitutionary and other law of [Delaware] providing civil remedies for misappropriation of a trade secret.” (6 Del. C. § 2007). Common law claims based on the same alleged wrongful conduct as trade secret claims are precluded under this provision (Savor, Inc. v. FMR Corp., 812 A.2d 894, 898 (E.D. Pa. 1974)), though the provision does not apply to contractual, criminal, or non-trade secret related remedies.

Alarm argued that two prior cases—Beard Research, Inc. v. Kates, 8 A.3d 573 (Del. Ch. 2010), and Overdrive, Inc. v. Baker & Taylor, Inc., 2011 WL 2448209, at 4* (Del. Ch. June 17, 2011)¬—demonstrate that DUTSA does not have a preemptive effect on common law claims based on the same wrongful conduct as a trade secret claim. The Court of Chancery disagreed, distinguishing both cases from the facts presented before the court by Alarm: Beard Research does not apply because that case featured a fiduciary relationship not present in this case, and Overdrive related primarily to a conversion claim, not misappropriation of trade secrets.

Having failed to survive a motion to dismiss on either claim, Alarm sought to amend its pleading to describe the trade secrets that were allegedly misappropriated. The court denied its request, referencing an earlier opportunity given to Alarm to specify the misappropriated trade secrets. Holdings, Inc. v. ABS Capital Partners, Inc., et al. (C.A. No. 2017-0583-JTL (Del. Ch. June 15, 2018)

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