Intellectual property has often been contentious as legislators try to balance the rights of intellectual property owners against progress and innovation. There is a fine line between promoting innovation and propping up monopolies to the detriment of competition, and poorly written, executed, or interpreted laws can promote poor policy. Most notoriously, this is seen with the rise of patent trolls, who do not really produce anything, but amass portfolios of patents for the purpose of suing alleged infringers and demanding licensing fees to keep products on the market. While some studies suggest that trolling activity has declined in recent years, trade secrets have emerged as a new avenue for filing lawsuits and extracting revenue through the legal system rather than innovating and creating new products.
Trade secrets are a unique subset of intellectual property law and refer to confidentially held information that provides a company with a competitive advantage in the marketplace. It could be a formula (such as the recipe for Coca Cola), a process, a technique, or an algorithm. If a company takes steps to keep such information confidential but a third party misappropriates it, that is a trade secret violation. Importantly, courts can impose damages on a party found to be misappropriating a trade secret.
A case in Texas exemplifies the potential high costs that the growth in emergence of trade secret abuse can inflict on companies and markets. In this instance, Amrock (formerly Title Source) hired HouseCanary, a property services software firm, to develop an app for real estate appraisers along the lines of Zillow, or Realtor.com, to calculate real estate property values. These products function by using an automated valuation model (AVM) — essentially an algorithm — to determine a property’s value based on characteristics such as location, number of bedrooms and bathrooms, similar property sales figures, and other publically available data.
While HouseCanary claimed to have developed a revolutionary AVM, the company failed to deliver a functional mobile app to Amrock. After it became clear that HouseCanary was not going to follow through with their commitment to deliver a “revolutionary” app, or any app for that matter, which was to leverage their AVM, Amrock sued for breaching the contract and proceeded to develop their own AVM instead.
In response, HouseCanary countersued, claiming Amrock stole valuable trade secrets which it used to develop its own product. A jury in Texas agreed and awarded HouseCanary an incomprehensible $706 million award—later increased to almost $740 million to include attorneys’ fees and interest—despite the original contract between the two being valued at only $5 million per year for an app HouseCanary never actually delivered.
However, key facts came to light shortly after the case concluded. Several HouseCanary employee whistleblowers came forward confirming HouseCanary had no proprietary information to be stolen and no functional product – hence no app was delivered to Amrock. In fact, under oath the whistleblowers testified that HouseCanary relied on technology licensed from an entirely separate company. Further, the whistleblowers claimed that HouseCanary even offered hush money veiled as consulting contracts as a means to keep them from speaking out. These developments among other facts presented at the original trial are currently under review by the Texas Fourth Court of Appeals in San Antonio.
There is no rational explanation for awarding damages in excess of $700 million based on a $5 million dollar per year contract. This egregious verdict is not only anti-competitive, but also highlights a dangerous precedent should it be allowed to stand. It opens a new front for gaming intellectual property laws solely for exploiting the system for monetary rewards rather than protecting innovators. Speculative, hypothetical, or in this case perhaps entirely fabricated trade secrets must not be an accepted means to extract money, especially not at the scale of hundreds of millions of dollars. This award dampens the incentive to collaborate with potentially innovative startups and dissuades the kind of collaboration that fuels the success of our tech sector.
Given the relative slowdown of new claims during the COVID-19 crisis, it is possible that the Texas Fourth Court of Appeals will reach their decision on the case soon. Should this verdict survive on appeal, companies would justly be more wary of entering into any contracts with partners perceived as a heightened risk of pursuing future trade secrets claims. In fact, this type of litigation abuse poses a real threat to innovation: if a company risks liability for massively outsized damages, entrepreneurs and venture capitalists may shy away from investing in technologies and firms due to the greater risk and higher cost of litigation. Legitimate productive companies driving the next generation of innovation will find it more challenging to access the resources that fuel invention. For American entrepreneurs and defenders of innovation, all eyes are on the Texas Fourth Court of Appeals to see how the future of innovation and intellectual property law will be affected.
Wayne T. Brough is the president of the Innovation Defense Foundation.