Protecting trade secrets using non-disclosure agreements

Recent US case law has raised the possibility that the common practice of including an expiry date in a non-disclosure agreement (also known as a confidentiality agreement) may lead to an inadvertent loss of trade secret protection.

Parties to a contract will typically enter into a non-disclosure agreement to protect valuable information that is to be disclosed by one party to the other. A non-disclosure agreement restricts the covenantor’s ability to disclose or use information that has been defined as confidential by the covenantee. The confidential information protected by the non-disclosure agreement can include trade secret information. A 'trade secret' is a type of confidential information that has exceptional value to a business and is subject to special efforts to maintain its secrecy. 

However, non-disclosure agreements may be deemed void if they are seen as a restraint of trade. A ‘restraint of trade’ occurs if the covenantor’s future liberty to carry on trade with other individuals or businesses that are not part of the contract is restricted (Stephens v Gulf Oil Canada Ltd, 11 OR (2d) 129, 25 CPR (2d) 64, 65 DLR (3d) 193 at 24). Being contrary to public policy, a restraint of trade is considered prima facie void and can be rebutted only by proof that the restraint is reasonable. The onus of proving reasonableness lies on the covenantee, who must demonstrate that the restraint is in the public interest and the contracting parties. The covenantee must also demonstrate that the restraint is not excessive or wider than necessary to protect their interest (Canadian Vapotred Ltd v Leonard, 1972 CarswellOnt 1041, 6 CPR (2d) 45 at 43). The common use of expiry dates in non-disclosure agreements limits the scope of the restraint and provides some protection against a finding that a non-disclosure agreement is void because it constitutes a restraint of trade.

In Canada, the issue of whether a non-disclosure agreement may be an unenforceable restraint of trade has been explored in the context of employment law. However, there has been little discussion of whether a non-disclosure agreement could be considered a restraint of trade in transactions between two or more businesses. There has also been little discussion of the distinction between trade secrets and ordinary confidential information. As such, US case law may provide some guidance.

US case law
The US Uniform Law Commission defines 'trade secrets' under the Uniform Trade Secrets Act 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" (Uniform Trade Secrets Act, Section 1 ‘Definitions’).

Recent US case law has held that where a trade secret is disclosed under a non-disclosure agreement that expires after a specific time period, the obligation to protect the trade secret also expires after that time period, thereby vitiating trade secret protection. At least two US courts have essentially held that because the trade secret was disclosed under a time-limited (as opposed to perpetual) obligation to keep it confidential, it was not the subject of reasonable efforts to maintain its secrecy and therefore ceased to be a trade secret entitled to protection.

In DB Riley Inc v AB Engineering Corp (977 F Supp 84 (D Mass 1997)) the plaintiff claimed that the defendant had acquired the plaintiff’s trade secret information and used it to provide itself with a competitive advantage, despite an existing contractual agreement with the plaintiff that restricted disclosure (Ibid at 86-89). The US District Court for the District of Massachusetts held that the information acquired by the defendant was trade secret information (Ibid at 89-90). Despite that finding, the court held that the trade secrets were not adequately protected by the plaintiff because the plaintiff was unable to demonstrate that reasonable steps were taken to preserve secrecy (Ibid at 90-91). In support of this ruling, the court noted that the plaintiff obtained a time-limited confidentiality agreement to maintain its trade secrets. As a result, the plaintiff could not prove ‘eternal vigilance’ over its trade secrets (Ibid at 91).

Since the plaintiff was unable to demonstrate a likelihood of success on the merits of its claim for trade secret misappropriation, the court could not award the preliminary injunction sought by the plaintiff (Ibid at 92-93).

A year later the US District Court for the District of California explored a similar question in Silicon Image Inc v Analogk Semiconductor Inc (977 F Supp 84 (ND Cal 1998)). The plaintiff claimed that the defendant wrongfully misappropriated the plaintiff’s trade secrets and sought to prevent the defendant from producing or selling copies of its work (Ibid at 1-2).

According to the court, in California information will qualify as a trade secret only if reasonable efforts have been made to protect its secrecy:

“Reasonable efforts to maintain secrecy have been held to include advising employees of the existence of a trade secret, limiting access to a trade secret on ‘need to know basis,’ and controlling plant access” (Ibid at 16 citing Courtesy Temp Services, Inc v Camacho, 222 Cal App 3d 1278 (1990)).

Extreme and unduly expensive measures do not need to be taken to protect trade secrets. However, disclosure of trade secret information under a non-disclosure agreement with a limited duration has resulted in previous denials of trade secret protection (Ibid at 17).

In light of the evidence provided, the court held that it could not conclude that the plaintiff had a high probability of success on its claim for trade secret misappropriation (Ibid).

Thus, a time-limited term of confidentiality resulted in a loss of trade secret protection in at least two US cases. While imposing a perpetual or indefinite term of confidentiality seems to be the obvious solution, in some US states, such indefinite durations are viewed as unreasonable restraints of trade. If an indefinite or perpetual term non-disclosure agreement is in or governed by the law of one of these states, it will be deemed unenforceable because of a perceived unreasonable restraint of trade and offer no protection to any form of confidential information (The Securities Edge, “Keeping your Trade Secrets Safe: When NDAs can Backfire”). There is a risk of similar findings in Canada.

Canadian context
In the United States, 45 states and the District of Columbia have adopted the Uniform Trade Secrets Act. However, legislators in Canada have not enacted a similar statute (Christopher Heer, “Employees and Trade Secrets: How the Concept of Inevitable Disclosure May Fit into Canadian Common Law”, 19 IPJ 323).

While no singular definition has been adopted by the Canadian courts, they have identified several characteristics of a trade secret. A ‘trade secret’ includes a technique, process, tool, mechanism, compound, formula, pattern, device or compilation of information that is used in one’s business, only known to its owner and the employees that assisted in making it, which gives the business a competitive advantage. Most importantly, the trade secret must be kept secret (Ontario Realty Corp, Re (2007) OIPC No 171 at 18-19; Di Giacomo v Di Giacomo Canada Inc, 28 CPR (3d) 77 at 97-104). The constituent elements of a process may be known, but where the combination is unique and arrived at by using great time, effort and money, it should be legally protected as a trade secret (Di Giacomo, 28 CPR (3d) 77 at 107).

The Supreme Court of Canada in Merck Frosst Canada Ltée c Canada (Ministre de la Santé) recognised that common law typically makes no clear distinction between a trade secret and the broader category of confidential information (2012 SCC 3 at 105; 2012 SCJ No 3). While ‘trade secret’ is a “technical legal term, it does not have a comprehensive definition (Ibid at 104). When analysing Section 20(1) of the Access to Information Act, the court defined a ‘trade secret’ as having the following requirements:

• The information must be secret in an absolute or relative sense (ie, is known only by one or relatively few people).
• The possessor of the information must demonstrate that he or she has acted with the intention to treat the information as secret.
• The information must be capable of industrial or commercial application.
• The possessor must have an interest (eg, an economic interest) worthy of legal protection (Ibid at 109).

A trade secret is therefore distinct from a broader category of confidential commercial information (Ibid at 110-111).

While this case defines trade secrets only in the context of the Access to Information Act, it demonstrates that Canadian common law has recognised trade secrets as a special category of confidential information.

Managing risks
How might a Canadian lawyer balance the risk that a non-disclosure agreement may be found to be an unenforceable restraint of trade against the risk of losing trade secret protection by providing for a definite expiry of the confidentiality obligations? The solution is to distinguish between trade secrets and ordinary confidential information, both by definition and in terms of the duration of the protection obligation.

The first step is to clarify that the parties consider trade secrets to be a special category of confidential information. The current practice of defining ‘confidential information’ broadly (ie, to encompass as much information as possible) can continue, but ‘trade secrets’ should be carved out. If a client plans to disclose specific information, then the information he or she considers to be a trade secret should be expressly defined. For example, if a client has a secret formula they wish to protect in the non-disclosure agreement, then the drafter of the agreement should use clear and concise language to define that formula as a trade secret. Language such as ‘whether or not a trade secret’ may be used in or in association with the definition of ‘confidential information’ (this approach can be helpful when it is not known in advance which trade secrets, if any, are to be disclosed).

The second step is to specify separate protection durations for confidential information and trade secrets. The use of a distinct, different term of protection for trade secrets (as opposed to ordinary confidential information) provides for indefinite protection of trade secret information while reducing the risk that the non-disclosure agreement could be found to be an unreasonable restraint of trade. The following is an example of language that could be included in a non-disclosure agreement:

• Duration of obligations:
  • for confidential information that is not a trade secret, recipient’s obligations hereunder shall continue for the shorter of:
    • perpetually; and
    • such maximum duration as permitted by applicable statute or common law; and;
  • for confidential information that is a trade secret, recipient’s obligations hereunder shall be perpetual (Derived from Parker Poe Adams & Berstein LLP, “Time Limits in Confidentiality Agreements: Traps for the Unwary”).

Although it goes without saying, one should use an appropriate governing law clause to ensure that Ontario law governs the non-disclosure agreement. If the other party insists on another jurisdiction, seek advice from a lawyer who is qualified in that jurisdiction to confirm that the above approach would be effective under that jurisdiction’s law.