Trade Secret Preemption: Possible Defense To Trade Secrets Claim?
Two recent decisions by the Fifth Circuit Court of Appeals clarify the intersection between federal copyright law and state trade secret law. In GlobeRanger Corp. v. Software AG United States of America, Inc., 836 F.3d 477 (5th Cir. Sep. 7, 2016), the Fifth Circuit rejected an appeal in which the defendant argued that a plaintiff’s trade secret misappropriation claim was preempted by federal copyright law. Just four months later, in Ultraflo Corp. v. Pelican Tank Parts, Inc., No. 15-20084, 2017 U.S. App. LEXIS 509 (5th Cir. Jan. 11, 2017), the Fifth Circuit upheld a district court’s dismissal of a plaintiff’s state law claim of unfair competition by misappropriation, holding that the state law claim was preempted by federal copyright law. What accounts for these seemingly inconsistent conclusions over two strikingly similar state law claims? The difference lies in the elements needed to establish each state law claim.
In its September 2016 GlobeRanger decision, the Fifth Circuit heard an appeal after a jury awarded plaintiff GlobeRanger a $15 million jury verdict following a trial in the United States District Court for the Northern District of Texas on its state trade secret misappropriation claim. The central allegation in that case was that competitor Software AG misappropriated GlobeRanger’s radio frequency identification (RFID) technology – most commonly used in electronic readers in tollbooths, like EZ-Pass – after it had taken over Software AG’s subcontract with the U.S. Navy to implement the technology. Following the verdict, Software AG appealed, contending that federal copyright law preempted GlobeRanger’s state trade secret claim.
The Fifth Circuit explained in GlobeRanger that the different spheres of intellectual property can sometimes overlap and, as the software code at issue illustrates, the same intellectual property can be protectable under copyright laws or subject to trade secret protection. If the creator of the IP seeks copyright protection, it obtains the exclusive right to make copies of the work for decades but must publicly register the work before enforcing that right through a lawsuit. The supremacy of federal copyright law means, however, that state protection of copyrightable subject matter must sometimes defer to its federal counterpart. As the Fifth Circuit explained, two conditions must be met in order for the Copyright Act to preempt a state law claim. First, “the work in which the right is asserted must come within the subject matter of copyright.” Second, “the right that the author seeks to protect . . . [is] equivalent to any of the exclusive rights within the general scope of copyright.” This inquiry asks whether the state law is protecting the same rights that the Copyright Act seeks to vindicate or against other types of interference. “If state law offers the same protection, then the state law claim is preempted and must be dismissed.”
Applying this articulated two-part test to the facts in GlobeRanger, the Fifth Circuit found that the first condition was satisfied (because Software AG conceded its software code was copyrightable) but the second condition was not. This is because while federal copyright law and Texas trade secret misappropriation both involve copying, trade secret misappropriation involves an extra element: the state law prevents any improper acquisition through a breach of a confidential relationship or improper means. Accordingly, the Fifth Circuit ruled that GlobeRanger’s trade secret claim was not preempted because it was required to establish an “extra element” in order to establish a copyright violation: that its “protected information was taken via improper means or breach of a confidential relationship.” Significantly, the Fifth Circuit noted, ten other circuit courts that have considered this issue agreed that trade secret misappropriation claims are not preempted by the Copyright Act for this same reason.
Revisiting the issue of preemption just four months later in Ultraflo, the Fifth Circuit reached the opposite result when faced with a different state law cause of action. In this case, Ultraflo asserted an unfair competition by misappropriation claim under Texas law alleging that competitor Pelican stole its drawings showing how to design butterfly valves used in the transportation industry and then used them to make duplicate valves. The United States District Court for the Southern District of Texas dismissed Ultraflo’s Texas state law claim, finding that the general scope of federal copyright law preempts the claim. Ultraflo appealed, challenging the ruling. As it did in GlobeRanger, the Fifth Circuit utilized the two-part test to determine whether the Copyright Act preempted the state law cause of action. First, it found that Ultraflo’s design drawings were “undoubtedly” within the scope of federal copyright, as were the valve designs themselves even though they were not actually protectable under the Copyright Act. Second, unlike in GlobeRanger, the Fifth Circuit found that the second condition was met because Texas’s unfair competition by misappropriation cause of action does not afford protection materially different from federal copyright law. The elements of Texas’s unfair competition by misappropriation claim are: (1) the creation by a plaintiff of a product through extensive time, labor, skill, and money; (2) the use of that product by defendant in competition with plaintiff; and (3) commercial damage to the plaintiff. In other words, unlike the traditional trade secret misappropriation claim asserted in GlobeRanger, the unfair competition by misappropriation claim asserted in Ultraflo lacks the “extra element” necessary to bring it out of the general scope of copyright. Therefore, the claim was preempted.
These two Fifth Circuit decisions demonstrate that parties should pay attention to the possible application of copyright preemption to claims involving alleged theft of information or unfair competition. While most such claims will not be preempted, Ultraflo illustrates that some will be.