6 minute read | October.02.2015
In a fifteen-year tale of how not to protect your emerging company’s trade secrets when dealing with the big fish, on September 16, 2015, a California trial court denied a company’s bid for royalties for technology misappropriated by E*Trade in the early days of wireless trading. With multiple trials and trips to the court of appeals, and servers containing evidence being smashed with a hammer, the case underscores the importance of robust non-disclosure agreements and of thoroughly documenting your trade secrets.
The history of this case can be traced back to the early dot-com days of the late 1990s, when E*Trade was looking to make inroads into wireless access and trading. Enter the cleverly named Advanced Java Architecture for Extensible Objects company, or Ajaxo, Inc. In 1999, Ajaxo had a team of just six, headed by its sole shareholder, founder Sing Koo. Sing’s wife Connie, also director of marketing, actually sent an unsolicited email to E*Trade, and E*Trade responded with a non-disclosure agreement and a lot of questions.
Indeed, the record shows that E*Trade asked Ajaxo for a technical paper, live demonstrations, that Sing Koo even used his personal E*Trade account to demonstrate the technology, that Ajaxo made changes to the application at E*Trade’s request, that E*Trade’s engineers peppered Ajaxo with questions, and that an E*Trade senior engineer, Dan Baca, even made a copy of Ajaxo’s technical binder. E*Trade went so far as to send Ajaxo a draft letter of intent—with everything but the dollar amount filled in. Two weeks later, instead of a final letter of intent, Ajaxo was sent home with nothing and told they were too small to be an E*Trade partner.
In a cautionary tale for any emerging company dealing with a large corporation, Ajaxo would later learn that, during their technical meetings with E*Trade, E*Trade was also meeting with a company called Everypath. The month after E*Trade declined to hire Ajaxo, it sent Everypath a letter of intent for Everypath to be E*Trade’s wireless vendor. A week after E*Trade sent Everypath the letter of intent, Dan Baca (the E*Trade engineer who met with Ajaxo) started work at Everypath.
At trial, Ajaxo’s expert testified that Ajaxo’s software and Everypath’s software were “basically the same” and “almost identical.” On top of that, the E*Trade-turned Everypath engineer, Dan Baca, authored a patent application for Everypath which Ajaxo’s expert testified contained the same information communicated between Ajaxo and Baca while Baca still worked for E*Trade. Following a seven-week trial on Ajaxo’s claims for breach of the NDA and misappropriation of trade secrets, a jury awarded $1.3 million on the NDA breach and nothing for misappropriation.
Both parties appealed, and the court of appeals remanded in 2005 for a new trial on damages concerning Ajaxo’s misappropriation claim. On remand, Ajaxo pursued damages for unjust enrichment and lost. Not ready to give up, Ajaxo asked the trial court for another trial, this time on its alternative request for a reasonable royalty. The trial court denied this request, Ajaxo appealed, and the court of appeals remanded with directions to have a trial on royalties. Fast forward to the present.
In holding that Ajaxo was not entitled to royalties, the court made an extensive review of trade secrets damages as established by the evidentiary record in this case, which included destroyed evidence and discredited testimony. The questions for the court were whether Ajaxo was entitled to royalties and if so, how much. The answers were no and none.
In the trade secrets damages context, a royalty is typically determined by modeling a hypothetical negotiation between a willing trade secret owner and a willing trade secret user at the time the infringement began. For this, experts are needed. Ajaxo’s sole expert was its founder, Sing Koo, and the court didn’t believe him or credit his “Value-Added Developer Distribution” model. Under the model, Ajaxo argued that the court should assess E*Trade a royalty equivalent to (i) the price of a developer’s license for Everypath’s use of Ajaxo’s trade secrets in Everypath’s software, plus (ii) the price of license fees for Everypath’s customers (Ajaxo alleged 92 such customers).
The trial court rejected Ajaxo’s proposed royalties model, but even assuming royalties are appropriate, there’s still the matter of time. As in, the time-period in question. A royalty payment period may not be for any longer than the period of time the use could have been prohibited. This is known as the “head start” rule. Under this rule, once a defendant has discovered or would have discovered the trade secret or its equivalent without the misappropriation, any financial consequences from that time-period forward are deemed not to have been caused by the defendant’s wrongful act. The court found that E*Trade could have independently developed a competitive product on its own in six months with one qualified engineer dedicated to the task.
Finally, the court also found that Ajaxo had made a fair evaluation of its royalty model impossible because it destroyed critical evidence. In yet another cautionary note to come from this case, Ajaxo had not preserved actual evidence of the trade secrets themselves. To the contrary, all copies of the software were erased, lost, or destroyed, and all printed copies of the source code were destroyed no later than 2007. Curiously (and yet another caution), even the 2003 trial testimony and exhibits did not define the trade secret, at least not in a way that would allow the court to calculate royalties. The court also noted that many of Ajaxo’s excuses were simply not credible and actually showed bad faith, including the fact that Ajaxo destroyed a development server with a hammer.
The opinion is useful for its extensive (33 pages) analysis of damages in the misappropriation context, but also for its lessons. First, do absolutely be clear on the contours of your NDA and whether and how much your potential partner needs to know. Here, Ajaxo shared its trade secrets and documentation before it even got a draft letter of intent. Clearly, E*Trade (as the first jury found) breached the NDA, but Ajaxo could have done more to protect itself. Second, document your technology. This case lasted some fifteen years, but it turns out that Ajaxo destroyed everything by 2007. And finally, develop a good record at trial, because one never knows how long an appeal will take. Here, the trial record didn’t provide enough information concerning the trade secrets to help the court determine a royalty. In the end, Ajaxo was left with its original $1.3 million award from 2003 balanced against the cost of litigation including 12 years of appeals.