Licensing trade secrets

Got an idea, but not enough time, experience, personnel or money to put it to work? It often takes a team of players to transform an idea into a marketable product or service.
Written by Susan P. Butler, Contributor

Got an idea, but not enough time, experience, personnel or money to put it to work? It often takes a team of players to transform an idea into a marketable product or service. One way to make it happen is to let another company use your idea to develop or distribute the end product.

Before you just give away your idea, however, make sure you know whether or not it has special value. If you spend time or money developing your idea into something rather novel, you may own a valuable trade secret.

When you are ready to discuss your secret with another company, using a nondisclosure agreement is a good start. Once you decide to make a deal to let someone use your trade secret, keep these tips in mind and talk them over with your lawyer before you sign that contract.

What is a trade secret?

Trade secrets are intellectual property. However, unlike patents, copyrights and trademarks which are usually governed by federal laws, trade secrets are protected by state laws. This means that one state might define a trade secret differently than another state.

Although the definition may vary, in general a trade secret is information, a formula, a pattern or a device with some degree of novelty, that:

  1. gives the owner the opportunity to obtain an economic advantage over competitors who do not know about it or use it;
  2. is kept secret (i.e., it is not a matter of public knowledge or of general knowledge in the industry); and
  3. is kept secret because the owner makes a reasonable effort to maintain its secrecy.

A mere idea or simple information is not usually viewed as a trade secret. In most states you must expend a certain amount of money and effort in obtaining and developing the information. It must also be the type of information that a competitor would have to spend quite a bit of time and expense to acquire on its own.

If you do own a trade secret, you own something of value.

Confidentiality and restrictive clauses

The owner of intellectual property, like an owner of personal property such as an automobile, may prevent others from using it and may charge money for the right to use it. A contract selling intellectual property is normally called an "assignment." A contract leasing the property is usually called a "license."

Trade secrets are often licensed rather than assigned. In return for allowing a company to lease or use a trade secret, the owner is often paid a royalty — normally, a percentage of some price received by the company for each product sold.

There will be many different clauses or paragraphs in the license. The paragraphs about confidentiality and restricting use of the trade secrets are very important. They will be the parts of the license that a court will carefully consider if you later claim the other party is using your trade secrets wrongfully.

At the very least, these paragraphs should include:

  • A definition of confidential information that includes the trade secret;
  • Instructions on protecting the secrecy of the confidential information;
  • How long the confidentiality will last;
  • Any limitations on using the confidential information or trade secret

The definition of "Confidential Information" should be specific enough so that everyone understands what is confidential and what is not confidential. You might want to include a requirement that anything considered confidential must be marked "confidential." Then make sure you actually mark all your stuff during the project!

Protecting the secrecy of the information is crucial. Once it is no longer "secret," the information can no longer be a "trade secret." You might require at least one of the following conditions:

  • the licensee (the person using your trade secret) to disclose the information only to employees or independent contractors who have signed a confidentiality agreement;
  • the licensee, its employees and its independent contractors to only disclose the information to people who must know it in order to work on the project;
  • the licensee to return all confidential information to you once the agreement or the project ends.

Be sure to describe how long the licensee must keep the information confidential. Normally they should keep it confidential even after the agreement ends. Some owners require licensees to maintain confidentiality until the information becomes part of the "public domain," i.e., until it's no longer secret or until it's free for anyone to use under the law.

Requiring the licensee to keep the information confidential for a certain amount of time is different than limiting "use" of the information. Some states allow the owner of a trade secret to restrict the licensee from ever using it with their products or services after the agreement ends, even if the trade secret becomes "known" or part of the public domain.

For instance, the creator (and his heirs) of a formula for mouthwash continued to receive royalties on all sales of the product even after the formula become public domain — because the contract required continued payment.

In another case, a gym equipment company who licensed a design (a trade secret) from the owner for a fixed period of time, couldn't use the design in its competing product after the license ended — even though the company learned the design from a different source. The license restricted use of the trade secret even after the contract ended.

Each contract will be interpreted according to each state's laws. Therefore, make sure your attorney understands how trade secret licenses are usually interpreted in your state.

Choice of law

If you're doing business with a company in another state, be aware of which state's laws will govern the contract. Often parties to a contract agree that the laws of a certain state will govern interpretation of the contract and include this statement in the agreement. Most courts will follow that agreement if it's reasonable to do so. This means that the particular state must have something to do with the contract (e.g., a party to the contract is performing the services in that state).

Why is this clause so important for trade secret licenses? State laws vary in the way they protect trade secret rights, enforce rights, and interpret contracts.

For example, some state laws allow the owner of a trade secret to receive attorney's fees and punitive damages to punish a particularly wrongful misappropriation of trade secrets. However, at least two state courts have denied protection of trade secrets under the states' statutes, since the parties agreed in their contracts to things that were inconsistent with the statutes. In other words, what you put in your contract could prevent you from receiving attorney's fees and punitive damages even if the state law grants you this right.

Also, some state laws prohibit certain provisions in contracts that restrict use of trade secrets for a long time. This could make part or all of your contract void. If one state prohibits the restriction and your state doesn't prohibit it, make sure your state's law governs the contract!

As you can see, it's important that you select a knowledgeable and experienced attorney if you're licensing trade secrets across state lines. Make sure your attorney not only reads those states' statutes, but also reviews pertinent court cases interpreting the law in those states. Although you may need to pay the lawyer for some specialized research, you shouldn't have to pay him/her for basic legal knowledge in this area. That's why you go to an experienced intellectual property attorney.

Patents and know-how

Keep in mind that a person can own both patent rights and trade secret rights in a single product — they are separate types of intellectual property.

There are special legal requirements that apply to these types of licenses. If they aren't handled very carefully, you could lose rights and money. In some international deals, governments also regulate these types of agreements. Some governments even require the parties to allow a governmental agency to review the contracts before they can be enforced.

If your product might involve both trade secret and patent rights, or if your trade secret is technology "know how," it is extremely important to find an experienced patent attorney who also negotiates licenses.

As with all intellectual property contracts, please have an experienced lawyer work with you. The money you spend up front could save you losing much more out back.

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