Plaintiffs in trade secret litigation may not recover costs that defendants avoided through misappropriation, a split New York Court of Appeals has ruled, settling a novel issue for courts in the state.

The question of whether or not plaintiffs can assert damages under an “avoided costs” theory was certified to New York's high court last year by the U.S. Court of Appeals for the Second Circuit.

Writing for the majority in a 4-3 decision handed down on Thursday, Judge Paul Feinman said that compensatory damages for plaintiffs in trade secret cases must be based on how much the plaintiffs lose, not on an infringer's avoided development costs, which he said are “hypothetical.”  

Feinman was joined in the majority by Judges Janet DiFiore, Leslie Stein and Michael Garcia.

The dispute at the heart of the case involves competitors in the plastic security-seal business: TydenBrooks, the world's largest manufacturer of security seals, intended to prevent tampering with containers and other products, alleges that a breakaway group of employees who formed their own business, Cambridge Security Seals, stole trade secrets from their former employer.

TydenBrooks sued Cambridge Security in the U.S. District Court for the Southern District of New York for common-law misappropriation of trade secrets, unfair competition and unjust enrichment.

At trial, TydenBrooks' damages expert testified that, without the information allegedly taken from TydenBrooks, Cambridge Security would have incurred between $6.1 million and $12.2 million in additional costs to develop its first-generation machines.

Southern District Judge Loretta Preska, who presided over the case, charged a jury solely on an avoided costs theory and the jury awarded $3.9 million to the plaintiff on the three claims.

In New York, there's a dearth of case law on “avoided cost” damages: In coming to its decision to certify questions to New York's high court, the Second Circuit had to sift through 100 years of Court of Appeals case law to find bits of jurisprudence to guide its ruling.

The federal appeals court came across a 1905 case that appeared to support an award of avoided costs, but determined that the ruling did not fully answer the question, and said the Court of Appeals should weigh in.

Lawyers for TydenBrooks argued on appeal that, across the country, courts have recognized that a trade secrets plaintiff bringing an unjust enrichment claim is entitled to a defendant's avoided costs.

For example, they argue, in 2006, the Fifth Circuit found that, if damages for a trade secrets plaintiff cannot be calculated based on what the plaintiff has lost or what the defendant gained, the plaintiff is entitled to a “reasonably royalty.”

The Court of Appeals judges in the minority, Judges Rowan Wilson, Jenny Rivera and Eugene Fahey, appeared sympathetic to TydenBrooks' argument that New York might be out of step with other states on the avoided costs issue. 

Writing for the minority, Wilson said his colleagues in the majority are ignoring the law of other jurisdictions, and that a defendant's ill-gotten gains are available as an equitable remedy, which allows flexibility in damages awards that need not be tethered to a plaintiff's losses.   

“Not only does that approach produce an incorrect answer here, but it also forsakes New York's historic role at the vanguard,” Wilson said. “Where we should lead, we now refuse even to follow.”

Cambridge Security was represented by Kasowitz Benson Torres attorneys Daniel Fetterman, Howard Schub, Fria Kermani and Joshua Brown.

“We are pleased with the New York Court of Appeals opinion today which finally answers an important unresolved policy issue under New York law by stating a clear and appropriate measure of damages that will be used in trade secret misappropriation cases for a long time to come,” Fetterman said in a statement issued by a spokesperson.

Kramer Levin Naftalis & Frankel partner Daniel Goldman presented oral arguments on behalf of TydenBrooks, and the company's legal team also included Kramer Levin attorneys Kerri Ann Law, Claudia Pak and Sam Koch.

Goldman did not respond to requests for comment.