Misappropriation by acquisition cases are having a moment in the fashion/beauty space. On the heels of Olaplex landing a $66 million win in the trade secret suit it filed against L’Oreal in January 2017 (less than a year after the enactment of the federal Defend Trade Secrets Act), in which the haircare startup accused the beauty titan of pilfering confidential information about its products during potential M&A discussions, three similar suits have since been filed. Le Tote recently sued Urban Outfitters, alleging that the company has stolen its trade secret-protected business model under the alleged guise of a potential acquisition in order to create a rival fashion rental business, Nuuly.
Around the very same time, Seed Beauty – the Southern California-based company responsible for “creating, developing, manufacturing, storing, selling, and distributing” the products of the billion dollar beauty ventures of Kim Kardashian and Kylie Jenner – filed two separate trade secret lawsuits: one against Kardashian’s KKW Beauty, and another against Coty, Inc. and Kylie Jenner’s corporate entity, in connection with Coty’s acquisitions of stakes in the half-sisters’ buzzy brands.
In both of its newly-filed complaints, Seed alleges that as a result of the cutting-edge nature of its business model, the details of its “creative and logistical development services” and the terms of the “exclusive relationships [it has] with its beauty brand partners” amount to “highly sensitive, confidential and trade secret information.” Those “highly sensitive and confidential” elements of its business are at risk, Seed claims, due to Jenner and Kardashian’s respective deals with Coty.
Misappropriation by Acquisition
All four cases, despite the differing parties and facts, nonetheless, share a core commonality: they all fall within the realm of trade secret misappropriation by acquisition, a type of misappropriation of confidential business information – such as a formula, pattern, compilation, program, device, method, technique, or process that derives independent economic value from not being known to others – that usually occurs when such information is shared during the negotiation and/or due diligence phases of an M&A transaction, and is used inappropriately thereafter.
In order for companies to engage in acquisition discussions and share necessary, but often-confidential and competitive advantage-driving information with interested parties, these information-sharing phases inevitably involve the use of legal instruments, such as non-disclosure agreements (“NDAs”). At the heart of such NDAs – which are generally entered into when a competitor, partner company, or an employee is given access to protected information – is a formal agreement that the company and/or individual will limit its use of the information that they are provided access to.
In the case of acquisition discussions, for instance, permissible uses, as outlined in such legal instruments, tends to enable an individual to become apprised of the company’s inner-workings, such as its financials, technologies, and pending legal issues, etc., and in many cases, to determine the company’s value.
Despite the existence of such NDAs, however, this handful of new lawsuits proves that such situations and the mechanisms put in place to protect the parties are rarely straightforward. Matters are complicated in most situations by the fact that the NDAs at play rarely – if ever – explicitly prohibit companies/individuals from starting their own, similar companies and/or entering into acquisitions with competitors after having had access to such secret information. Instead, as the Financial Times’ Sujeet Indap stated recently in reference to the language in the NDA entered into by Le Tote and Urban, the terms of such agreements are far less clear cut, and tend to prohibit the parties from using such confidential information to “impair either party’s right to make, use, procure or market any products or services, now or in the future, which may be competitive with those offered or contemplated by the other party.”
In other words, the information-acquiring party (Urban Outfitters in the situation with Le Tote) “must thread a needle,” per Indap. “It is free to start its own competitor to Le Tote” – an NDA does not prohibit that – but at the same time, “it cannot use any of the [proprietary information from the] materials it reviewed” in connection with the potential acquisition discussions for a set period of time, thereby, raising the question of whether these NDAs are really serving as measures to protect confidential information or whether they are acting as quasi non-compete agreements for companies like Urban.
“Does [the] NDA [it signed] effectively mean that Urban Outfitters is precluded from building its own business for the 2-year duration of the agreement simply because, at one point, it was interested in buying Le Tote?,” Indap asks, acknowledging the murkiness that comes with such situations and the terms that parties sign off on in furtherance of a potential deal.
It is not difficult to see how such NDA terms and the resulting restrictions give rise to issues on both sides. In order to successfully make its trade secret misappropriation case, a plaintiff, such as Le Tote, will have to establish that Urban acquired valuable, confidental information from it and improperly used it to built the rival rental business. (In addition to asserting that it took reasonable steps to protect the information at issue, which is critical in a trade secret case, Le Tote claims that it provided Urban with access to the information subject to the terms of the NDA, and that there is no way that Urban could have started to build its own rental company and built it “so quickly” (i.e., in a matter of months) “without using the proprietary information that they learned from Le Tote.”).
Beyond proving access/acquisition of the information and subsequent misappropriation by Urban (the latter of which can be shown by evidence of physical documents or data being stolen, or by way of circumstantial evidence), Le Tote will then need to show by way of non-speculative evidence that it has been damaged as a result Urban’s alleged misappropriation.
It is similarly easy to see where defendants, such as Urban, make arguments in their defense. For example, independently developing information from one’s own pool of knowledge or the public domain is a complete defense to a claim of trade secret misappropriation. As noted by Justia, one of a defendant’s “best defenses” to trade secret misappropriation claims is independent development, which occurs when an individual or company “independently develops information from its own pool of knowledge or the public domain,” and not by way of information provided to it by plaintiff, thereby, serving as “a complete defense to a claim of trade secret misappropriation.” This is precisely what L’Oreal asserted in the Olaplex case, with the cosmetics/personal care company arguing during a week-long trial in August 2019 that it independently conceived of its version of the hair bonding products in August 2014, before it entered into M&A talks with Olaplaex.
The complexity of such cases, and the defenses at issue, is only heightened by the fact that it can be “a difficult task to convince a jury that a trade secret exists, that it has been stolen, and that the misappropriation caused harm,” according to DLA Piper’s Andrew Valentine, who points to the Huawei Technologies and Futurewei Technologies v. CNEX Labs and Yiren Ronnie Huang, and the Six Dimensions, Inc. v. Perficient Inc. cases, among others, as examples of this. More than merely convincing a jury, these matters are further muddied by the fact that quantifying the damages owed to the aggrieved party as a result of misappropriationcan be complicated, he says. This is often the case because dollar figures can be difficult to ascertain for things, such as know-how, manufacturing processes and business practices, for instance, thereby, making these cases complicated and expensive to litigate.
Ultimately, this recent bout of fashion/beauty-specific trade secret cases, as well as those that have popped up in other industries, which may only end up growing in number in light of the enduring industry consolidation that is being born from COVID-19 and the resulting market volatility, demonstrates that “the risk for acquiring companies” – or potentially acquiring companies – “might be higher than they think,” says Mark McCareins, a clinical professor of business law at Northwestern’s Kellogg School of Business. And this is true regardless of whether the deal actually comes into fruition (which was the case for the Kardashian/Jenner and Coty transactions) or not, the latter of which is clear from the Le Tote and L’Oreal cases.
This aspect of deal-making worth is paying particular attention to, especially as COVID-19 continues to put pressure on companies, with a couple of the side effects of that being the obvious strength of conglomerate-owned companies and the increased consolidation of existing companies, particularly independently-held ones, something that analysts expect will continue for the foreseeable future.
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