Trade Secrets and the Option Value of Involuntary Exchange

Abstract:     
A trade secret is proprietary but unpatented information that confers a competitive advantage on its owner. If someone impermissibly uses a trade secret, the owner of the secret is entitled to a remedy that may include, in addition to damages, an injunction that forbids the unauthorized user from manufacturing a product that employs the owner’s secret. Courts disagree, however, over whether such an injunction should continue after the trade secret becomes public knowledge - for example, through a patent application or marketing. Even when courts agree that the injunction should continue after the trade secret becomes public, they still disagree over whether the injunction should be perpetual or limited in duration. This article uses real option theory within a Schumpeterian framework of innovation and competition to clarify the conflict regarding the proper duration of an injunction to remedy the unauthorized use of trade secrets. The optimal duration of such an injunction should be proportional to the option value implicit in the unauthorized use of the trade secret, which in turn will increase with the extent of sunk costs associated with the trade secret and the level of risk associated with innovative activity in the relevant market. Furthermore, the unauthorized use of a secret process differs in economic effect from the unauthorized use of a secret product design, yet courts have failed to discern this distinction when fashioning injunctive relief in trade secret cases. The three conflicting common law rules, as well as the default rule under the Uniform Trade Secrets Act, all are flawed on economic grounds. However, because the option value of unauthorized use of a trade secret would be difficult for litigants to calculate and judges to evaluate in a given case, a reasonable proxy is the imposition of a perpetual injunction. Such an injunction would induce the innovator and unauthorized user to enter post-trial licensing negotiations under circumstances in which the unauthorized user had no bargaining power. As a consequence, the innovator would license the trade secret at its full opportunity cost, which would incorporate his best estimate of the option value associated with the unauthorized user’s knowledge and exploitation of the secret before its public disclosure.

Number of Pages in PDF File: 47

Keywords: Trade secrets, injunction, remedies, real option, involuntary exchange, Schumpeter, innovation, misappropriation, opportunity cost

JEL Classification: D31, K11, K20, K21, K42, L43

working papers series