Delaware Bankruptcy Court Finds Misappropriated Trade Secrets are Subject to Avoidance and Turnover
In Corporate Claims Management, Inc. v. Shapier, et al. (In re Patriot National Inc.), Adv. Pro. No. 18-50307 (Bankr. D. Del August 8, 2018), the Delaware Bankruptcy Court found that alleged misappropriation of trade secrets could constitute a violation of the automatic stay under section 362 of the Bankruptcy Code and be subject to turnover under section 542 of the Bankruptcy Code.
This case involved a typical fact pattern involving the misappropriation of trade secrets. An executive of one company (i.e., the debtor) is lured by an employment opportunity at a competing company. Because the executive was privy to confidential information about the debtor, she signed a noncompetition agreement preventing her from utilizing or disclosing confidential information and competing with the debtor in the event she ever obtained a new job.
After filing bankruptcy, the debtor sued its former executive and her new employer, alleging that the former executive, after leaving, had assisted her new employer in utilizing the debtor’s trade secrets, client lists and other confidential and proprietary information. This misappropriation of information apparently resulted in a loss of the debtor’s customers and employees. The debtor alleged that the resulting loss of customers negatively impacted its revenues by approximately $3.4 million annually.
In the first count of its complaint, the debtor alleged that the misappropriation of information constituted a willful violation of the automatic stay, pursuant to sections 362(a)(3) and 362(k) of the Bankruptcy Code. Section 362(a)(3) prohibits “any act to obtain possession of property of the estate or property from the estate or to exercise control over property of the estate.” 11 U.S.C. § 362(a)(3). A violation of section 362(a)(3) generally requires both (a) a post-petition act and (b) property of the estate. See Pardo v. Nylcare Health Plans, Inc. (In re APF Co.), 274 B.R. 408, 416 (Bankr. D. Del. 2001). Section 362(k) imposes punitive damages in certain cases where there is a willful violation of the automatic stay.
Responding to a motion to dismiss, the debtor argued that it sufficiently plead that the former executive and new employer continued to use trade secrets and confidential information of the debtor post-petition. The debtor argued that this continued use violated the automatic stay.
Judge Gross agreed with the debtor, finding that the debtor’s rights under the noncompetition agreement with its former executive as well as its customer lists were property of the debtor’s bankruptcy estate that merited being protected by the automatic stay. According to the Bankruptcy Court, if the former executive and new employer continued to use such information, this could constitute a violation of the stay.
In the second count of its complaint, the debtor claimed that it was entitled to a turnover of its property under section 542(a) of the Bankruptcy Code, which provides that “an entity . . . in possession, custody, or control, during the case, of property that the trustee [or debtor] may use, sell, or lease under section 363 . . . shall deliver to the trustee [or debtor], and account for, such property or the value of such property . . . .” 11 U.S.C. § 542(a).
To establish a turnover claim, the party seeking turnover must show (a) property in the possession of another entity, (b) the property could be used in accordance with section 363 of the Bankruptcy Code, and (c) the property has more than inconsequential value to the debtor’s estate. Zazzali v. Minert (Inre DBSI), 468 B.R. 663, 669 (Bankr. D. Del. 2011).
Based on the same rationale applicable to the stay violation count, the Bankruptcy Court found that there was little issue that the misappropriated trade secrets, client lists and other information could involve property of the estate in the hands of a third party and such property could have been used by the estate during the bankruptcy case, in accordance with section 363. The Court also found, based on the $3.4 million damages allegation, that the property would not be of inconsequential value to the estate.
The Bankruptcy Court therefore concluded that the debtor had alleged sufficient facts to state claims for stay violation and turnover.
While the Bankruptcy Court also reviewed other claims based on state and federal law, the Court’s conclusions with respect to these other claims presented a mixed result for the debtor. For example, the Bankruptcy Court found that under certain applicable state law (Missouri) governing misappropriation, a trade secret did not include a company’s client list. Thus, under Missouri law, neither the executive or new employer could be held liable for misappropriation of the debtor’s client list. The Court also found under other applicable state law (Florida) governing misappropriation, the new employer could not be held liable because it was not privy to the noncompetition agreement between the debtor and its former executive.
Nonetheless, under the Bankruptcy Code’s claims for an automatic stay violation and turnover, the Court had less issue with finding potential liability for both the former executive and its new employer. This demonstrates that the Bankruptcy Code can sometimes provide unique remedies that are broader and not otherwise affordable under state law.