TRADE SECRETS, CONFIDENTIAL INFORMATION AND
THE EMPLOYMENT RELATIONSHI
P

by
Michael G. Horan
Fraser Milner Casgrain
&
Ian D. Werker
Barrister & Solicitor

TABLE OF CONTENTS
INTRODUCTION
PART I - DEFINITIONS AND POLICY
PART II - OBLIGATIONS
PART III - CONSIDERATIONS
CONCLUSION


INTRODUCTION


The recent decision of the British Columbia Court of Appeal in 57134 Manitoba Ltd v. Smith Paper Limited et al (1989) May 9, 1989, is a reminder to both employers and employees about some of the pitfalls in dealing with trade secrets or confidential information.

The employer in Smith Paper successfully sued a former employee and the new employer over both the unauthorized use of confidential price lists and solicitation of its customers. The employee was not considered by the Court of Appeal to be "top management." Nevertheless, he was bound by the general duty of good faith owed by an employee to his employer. The former employee,

clearly breached the most plainly recognized
obligations [of employment] and used the
information gained thereby in his
solicitation. Without regard to the question
whether he was a fiduciary, he thus rendered
himself liable for the damage which he thereby
caused to his former employer.

The Court assumed the new employer was ignorant of the employee's actions, but found it liable to pay damages based on the general principle that employers are vicariously liable for the actions of their employees.

Although such disputes are not novel, the Smith Paper case has created renewed interest in this area of law. This paper will attempt to examine the obligations of employers and employees in relation to trade secrets and confidential information.

Part I will look briefly at the definitions of trade secrets and confidential information in the context of employment cases. It also deals with the competing policy goals which Courts try to balance and which make the protection of employers' trade secrets and confidential information such a murky area.

Part II reviews the legal foundation for the non-statutory obligations of employees, officers and directors in the area of trade secrets and confidential information.

Part III highlights some factors which the Courts have considered when deciding whether there has been a breach of these obligations.


PART I - DEFINITIONS AND POLICY


1. TRADE SECRETS AND CONFIDENTIAL INFORMATION DEFINED

The definition of a trade secret has been discussed above in Professor Vaver's paper and we do not intend to duplicate his efforts. In the context of employment cases, the Courts in Ontario have defined trade secrets to include:

A process, tool, mechanism or compound known only to its
owner and those of his employees to whom it is necessary to
confide it.

Or,

Any formula, pattern, device, or compilation
of information which is used in one's
business, and which gives [one] an opportunity
to obtain an advantage over competitors who do
not know and use it.

The definitions apply to computer software, databases and related materials. They may also be wide enough to include price lists or customer lists. However, the latter type of information, is more frequently referred to under the rubric, "confidential information."

In most Canadian cases, one finds the expression "trade secrets" and "confidential information" used interchangeably. A recent English Court of Appeal however decision seems to have created a distinction which is important to employers seeking to protect commercial information such as price lists and customer profiles.

In Faccenda Chicken Ltd. v. Fowler et al, [1986] 1 All E.R. 617 (C.A.), the English Court of Appeal distinguished between trade secrets and two degrees of confidential information: "highly confidential information" which will be protected after the termination of the employment relationship and "less confidential information" which will not.

The dispute in Faccenda Chicken centred upon the characterization of sales information in relation to a business which essentially involved the distribution of fresh chicken from vans. The information related to prices, customers, and orders. The Court of Appeal confirmed the opinion of the trial judge who had held that there were three classes of confidential information: 1. trade secrets, 2. highly confidential information and 3. confidential information. It concluded by saying that,

In our judgment the information will only be
protected if it can properly be classed as a
trade secret or as material which, while not
properly described as a trade secret, is in
all the circumstances of such a highly
confidential nature as to require the same
protection as a trade secret eo nomine.
(emphasis added)

In the rest of the judgment, the Court refers to "trade secrets or their
equivalent."

On the facts of that case, the Court held that sales information was not "highly confidential" and not otherwise protectable. It went on to say that in other circumstances sales information could be of great importance and highly confidential. Depending on the facts any genre of information could fall into this "highly confidential" category.

Faccenda Chicken has been cited with approval in a number of Canadian decisions. One recently released Ontario decision, Quantum Management Services Limited v. Hann et al, distinguished between trade secrets and confidential information. In that case, the defendants were former employees of a personnel agency who had left the plaintiff's employ and set up a competing business. In doing so, they took advantage of their knowledge of their former employer's important clients whom they later solicited. (The names of the clients had been committed to memory.) Even though the Court found that the former employees had exploited confidential information, and found them responsible for damages, it held that the law pertaining to trade secrets did not apply. Rightly or wrongly, like the English Court of Appeal in Faccenda Chicken, the OntarioSupreme Court clearly saw a distinction between trade secrets and confidential information.

Quantum Management also raised issues arising out of the employees' fiduciary duties - a significant difference from the situation in Faccenda. It would appear that liability was based more on the breach of those duties than a breach of confidentiality. It is the mixing of such legal principles in employment cases that make the law difficult to rationalize.


2. COMPETING POLICY GOALS


In creating the trichotomy of "trade secrets," "highly confidential information," and "less confidential information," the Court in Faccenda Chicken was wrestling with two competing interests in employment cases where disputes arise after the termination of employment.

From the employee's perspective, the question is, "What can I do when I go to work for a new employer or into business for myself?" From the employer's view point, the question is, "Can I prevent my former employee from using my trade secrets or confidential information?" This problem often arises when the former employee is competing directly with his former employer. Underlying the answers to these basic questions are two competing policy considerations which the Courts must attempt to balance. On the one hand, employees should be free to use their general skills and knowledge freely for themselves or for employers of their choice. In the absence of the misuse of confidential information or breach of a fiduciary duty, employees should be able to compete with their former employers.

On the other hand, employers should be able to protect their business assets, tangible or intangible, from being used without authorization and/or to their disadvantage. Employers should not be made to suffer from unfair competition from former employees who may either be in business for themselves or employed by a competitor.

These two considerations are easily stated but difficult to reconcile on the facts of any particular case. In Canavest House Ltd. v. Lett (1984), 4 C.I.P.R. 103 (Ont. H.C.), the employer was seeking an interim injunction to prevent a former programmer from competing, disclosing details of computer software, and seeking return of copies of research notes and working materials in connection with the software. Mr. Justice Callon, in dealing with the issues, remarked:

One would expect that research notes and
copies of previous programs would indeed
assist a programmer in creating completely new
programs. They are, in a sense, what a hammer
and saw are to a carpenter.

To the extent that information can be likened to a tool of the trade, it will probably not be considered confidential or a trade secret. In any given factual situation, it can be difficult to find where an employee's general knowledge ends and where the employer's confidential information begins. Perhaps this difficulty is the reason that the Courts have not defined, except in very general terms, what they will or will not protect.

In Canada there is no statute law specifically governing trade secrets or confidential information. Obligations pertaining to trade secrets or confidential information flow from both the common law and equity both of which will be discussed in the next section.


PART II - OBLIGATIONS


1. DURING EMPLOYMENT

In addition to any contractual obligation, all employees, regardless of rank, owe a duty of good faith and loyalty to their employers. Unless enlarged by express terms in the employment contract, this duty requires respect for the employer's trade secrets and confidentiality of customer lists. Employees, because of this duty of fidelity, may not use their general skills to the detriment of their employer while they are employed. This general obligation does not prevent an employee from planning, on his own time, to go into business for himself.

2. AFTER TERMINATION OF EMPLOYMENT

a) Overview

Employees may use general skills and knowledge anywhere following the termination of employment. They may not use or divulge their employer's trade secrets or confidential information. The two types of knowledge are difficult to separate. As noted in Faccenda Chicken,

The obligation does not extend [after
termination], however, to cover all
information which is given to or acquired by
the employee while in his employment, and in
particular may not cover information which is
only 'confidential' in the sense that an
unauthorized disclosure of such information to
a third party while the employment subsisted
would be a clear breach of the duty of good
faith.

Assuming that the information would be considered a trade secret or "highly confidential", there are three bases upon which employers generally seek protection.

Firstly, trade secrets and confidential information are protected by the equitable principles applicable to breaches of confidence. Namely,

[Protection of trade secrets] depends on the
broad principle of equity that he who has
received information in confidence shall not
take unfair advantage of it. He must not make
use of it to the prejudice of him who gave it
without obtaining his consent.

In actions of breach of confidence, the Courts will assess whether the information in question was,

1. confidential,
2. disclosed so that the recipient knew it was confidential, and
3. used by the recipient without permission to the
detriment of the party who disclosed the confidence.

Secondly, in employment cases, trade secrets and confidential information are protected by express or implied contractual obligations.

Thirdly, in situations involving high ranking employees and company officers, there are fiduciary obligations which protect an employer's trade secrets or confidential information.

Often, in actions over trade secrets or confidential information, parties base their claims on a combination of all three of these bases. However, it is the second and third categories which have the most bearing upon employment cases. For the purpose of this paper we will look at these in turn.

b) Contract of Employment

i) Express Terms

Where there are express terms of an employment contract governing disclosure and use of trade secrets and confidential information, the Courts will enforce such clauses provided they are not in restraint of trade.

ii) Implied Terms

In the absence of express terms, the Courts will imply terms into the contract of employment in order to restrict employees, regardless of rank, from using trade secrets and "highly confidential" information after the termination of their employment.

Monarch Messenger Services Ltd. Houlding (1984), 2 C.P.R. (3d) 235
(Alta Q.B.) provides a good example of the application of this
general duty of fidelity where the employee is not bound by terms
of a written contract of employment. In that case the defendant
had been employed as a driver for the plaintiff's messenger
service. After three years of employment, he went into business
for himself and attracted two of the plaintiff's major customers.
At the time that he was hired, he had not been asked to sign a
contract restraining him from going into business for himself. In
the course of his employment he played a part in obtaining two
major clients and became responsible for servicing their courier
needs. There was no evidence that he had carried away any original
or copied price lists. In the absence of written contractual
obligations, the Court relied on the common law duties of employees
as follows:

The duty of the employee to look after and
preserve the employer's property extends to
the employer's physical property and also to
his intangible property such as his trade
secrets, lists of customers and secret
processes. The obligation exists while the
employee is employed and continues after the
employment has terminated.

The Court found:

It is also clear that the information entitled
to protection for the benefit of the ex-
employer need not be contained in a document
or other tangible or physical form. It may
include information committed to memory by the
ex-employee.

The Court concluded that:

If the information in question can fairly be
regarded as a separate part of the employee's
stock of knowledge which a man of ordinary
honesty and intelligence would recognize, to
be the property of his old employer and not
his own..., then the Court, if it thinks there
is a danger of the information being used or
disclosed by the ex-employee to the detriment
of the old employer, will do what it can to
prevent that result...

An employee can be in breach of his duty of good faith if he makes copies or memorizes a list of his employer's clients for use after the termination of employment. The important factor is that the Courts continue to imply the duty with respect to trade secrets and truly confidential information after the termination of the employment relationship.

c) Fiduciary Obligations

In addition to the general duty of fidelity, high ranking employees officers and directors (apart from statutory obligations) owe their employer fiduciary duties that forbid them from deriving personal benefit from business opportunities which arise through their employment. Like other employees, they may not disclose or use trade secrets and highly confidential information belonging to their former employer. In addition, they may be prevented from using or disclosing less confidential information - that a low ranking employee could otherwise take advantage of - if doing so would put them in breach of their fiduciary duties.

As fiduciaries, senior employees may not directly solicit clients of their former employers, unless this solicitation is part of a general solicitation which is permissible. This restriction has particular relevance to "confidential" information concerning customer lists which Faccenda Chicken would not prevent a "mere employee" from using. In the words of the Court in Alberts v. Mountjoy (1977) 16 O.R. (2d) 682 (H.C) at page 689:

Thus we have a principle with a principle to
the effect that the ex-employee [fiduciary] is
not entitled to make "an unfair use" of
information acquired in the course of his
employment, nor may he use confidential
information so acquired to advance his own
business at the expense of that of his former
employer. (emphasis added)

Courts apply Alberts v. Mountjoy in situations where the ex- employee is of sufficient rank and where the nature of the business makes the employer particularly vulnerable. For example, this occurs where a large portion of business flows from repeat business or policy renewals and where there is an emphasis on the personal relationship between the client and the employees who service them. In such cases, it is not necessary for the ex-employee to have physically removed documents containing the sensitive information which is a factor that Courts will examine in cases dealing with "regular employees".

Fiduciary obligations apply to directors, officers and "top employees" with respect to all degrees of confidential information. They may also apply to less senior employees in a particular position of trust. It is, of course, a question of fact whether an employee will be considered a "top employee" with fiduciary duties.

In Ontario, Alberts v. Mountjoy was recently distinguished in, a R.W. Hamilton Ltd. v. Aeroquip Corp. et al. (1988), 22 C.P.R (3d) 135 (H.C.). The Court found that, although the defendant employees had been "managers" in a business of selling hydraulic hose, they were not fiduciaries since they did not guide the affairs of their employer. Consequently, they were free to establish a competing business in the same geographical area. The decision contains an interesting observation by Mr. Justice Smith, underlining the difference between "top management" and "mere employees".

In my view the approach of the Courts has
struck a balance between the need for
compelling persons who occupy such high
positions in the business or corporate world
that the law should prevent the few who could
easily succumb to the temptation of serving
two masters from so doing, and freedom of
trade. They should be made to conform to a
high standard of ethical behaviour even if by
doing so the Courts may appear to be
encroaching upon the requirements of freedom
of trade. Not all managerial positions should
lead to the imposition of the very high duty
of a trustee lest the law commit a high
proportion of employees in this province to
slavery.

Employers are protected from the faithless
actions of top management by the law of trusts
and, failing that, in respect of lower level
employees by certain elementary rules of
decency that will prevent theft of
confidential information and of customer
lists. Beyond this the law dare not go,
preferring that the business community rely on
contractual arrangements.

In Coin-A-Matic (Pacific ) Ltd. v. Saibil et al (1986), 13 C.C.E.L. 59 (B.C.S.C.), the defendant employee had been the Western Region Vice President in the plaintiff's coin-operated machine business. After leaving the plaintiff's employ the defendant did not take any documents but did retain copies of leases and other contracts. He then set up a competing business and solicited a number of his ex-employer's clients. There had been no breach of his duty of fidelity as neither customer information nor standard form contracts which the defendant used were confidential according to the tests in Faccenda Chicken. Then, following White Oaks Welding Supplies v. Tapp (1983), 42 O.R. (2d) 445 (H.C.), the Court held, that while there had been a solicitation of the ex-employer's clients, this solicitation was part of a permissible general solicitation. In the result there had been no breach of the defendant's fiduciary obligation.

The foregoing cases show that there is a limit to how far the fiduciary principle can be stretched. Employers will resort to fiduciary duties to prevent a former employee from using information acquired during employment - information that would not be considered a trade secret in the strictest sense. However, if the information is a trade secret or "highly confidential", it will be protected by the general obligations owed by all employees.


PART III - CONSIDERATIONS


1. THE ONUS OF PROOF

An employer seeking to protect information has the onus of proving its secret or confidential nature. As indicated previously anemployer's ability to protect a trade secret or confidential information will depend on the circumstances of the particular case.

In employment related cases, the Courts consider whether,

a. the employer possesses a trade secret,
b. the employee knew it was a secret,
c. the employee acquired knowledge of the
secret during his employment, and
d. the employee has, after the termination
of his employment, made improper use of
his knowledge.

Looking at each of these four elements will provide the factual backdrop against which one can measure the extent of the obligations of employers and employees obligations in this area.



2. THE FOUR CRITERIA

a) Possession of a Trade Secret

i) Existence of a Secret

Assuming there is no doubt over the "ownership" of the information in question, Courts will consider a number of factors when deciding whether information is confidential or a trade secret. These include:

the extent to which the information is
known outside the business;
the extent to which it is known by
employees and others involved in the business;
the extent of measures taken to guard the
secrecy of the information;
the value of the information to both the
holder of the secret, and to his competitors;
the amount of effort or money expended in
developing the information;
the ease or difficulty with which the
information can be properly acquired or
duplicated by others; and
whether the holder of the secret and the
taker treat the information as secret.

Probably the most important of these considerations concerns the employer's ability to satisfy the Court that it took positive steps to maintain the secrecy of the information in question.

For example, in Robin Nodwell Mfg. Ltd. v. Foremost Developments Ltd. and Nodwell (1966), 52 C.P.R. 244 (Alta S.C.) Annotated, the defendant, Nodwell, assisted the plaintiff in the development of a four track vehicle which he later perfected while working for another employer, Foremost Developments Ltd. Since there was no written contract of employment, the plaintiff sought an injunction on the grounds that Nodwell had breached an implied term of his employment contract not to disclose trade secrets. The Court found that the vehicle was not a trade secret because it was not developed in secrecy.

By that I do not mean to say that he was
running out and telling his competitors from
the housetops but he was not running a very
tight security proposition and this he
continued while in the employ of the
plaintiff...[It] is significant that no
documentary warnings were went out to anyone
as to any change in policy and I am satisfied
on the evidence that during the course of the
development, there were, notwithstanding
restrictions, a large number of people who
would come into the shop an see the [vehicle]
in various stages of development.

This case makes it clear that the employer has a responsibility to take active steps to guard what it views as its trade secrets or confidential information.

ii) Maintenance of Secrecy

The very nature of trade secrets and confidential information makes it difficult for an employer to satisfy the onus in litigation. Secrets will lose their special status once they have been revealed, a point well illustrated by R.L. Crain Limited v. Ashton and Ashton Press Manufacturing Company Limited, [1949] O.R. 303 (Ont. S.C.), aff'd [1950] O.R. 62. In that case, the defendant, Ashton, was the a former machine shop foreman of the plaintiff, Crain. Crain alleged that Ashton had become familiar with trade secrets and confidential information and used them to produce his own machine. Unlike in Nodwell, the Court was prepared to accept that the information had, for a while, been a trade secret. However, it held that the information had ceased being confidential by the time Ashton had left the plaintiff's employ. The Court refused to protect the information by granting an injunction to prevent Ashton from making and selling his own machines.

b) Employee Awareness

Where an employer has actively guarded its confidential information or trade secrets by restricting access to the sensitive work areas and warning employees of the confidential nature of the information, it should be able to prove that its former employees were aware of the confidential nature of particular information.

c) Acquired During Employment

The employer must also prove that the employee learned the secret during his employment - a question which touches on the skills and knowledge of the employee at the time his employment commences. It is in essence, a restatement of the first criterion concerning the employer's possession of a trade secret. This will be a problem in cases where the employee developed a trade secret before or after joining the employer. The case, Dyform Engineering Ltd. et al v. Ittup Hollowcore International Ltd. et al (1982), 71 C.P.R. (2d) 72 (B.C.S.C.) illustrates this point well.

In Dyform, the defendant, Putti worked for the plaintiff as plant superintendent. Before joining the plaintiff he had developed a concrete extruding machine for which he had obtained a patent. Putti later assigned the patent to the plaintiff. After leaving the plaintiff's employ, Putti developed an improvement to the machine. It was argued that he had an obligation, as a former employee, not to reveal the trade secret to his former employer's competitors. In dismissing the argument, the Court noted,

As to trade secrets disclosed..., there is no
evidence the...technology was acquired by
Putti during the term of his employment. It
would appear in the evidence he had formulated
the concept of the...technology [after the
termination of his employment]. To do so he
no doubt knew of certain secrets that were
exploited by him and resulted in a subsequent
patent application. But there is no evidence
that those secrets were acquired by him whilst
employed by the plaintiff...



d) Unauthorized Use

Assuming that the employer can satisfy the first three criteria, it still has to prove unauthorized use. It is not enough to prove only the possibility of misuse, even where the ex-employee has physically taken or copied secret or confidential documents, surreptitiously or otherwise.

Montour Ltee v. Jolicoeur (1988), 19 C.I.P.R. 25 (Que S.C.), concerned an employee whom the Court found had taken or copied commercial cooking recipes and used them with his new employer. The employee was a junior employee with no managerial responsibilities. There was no term of the employment contract restraining the employee from going to work for a competitor and no term on the non-disclosure of trade secrets or confidential information. Nevertheless, both the employee and his new employer were found jointly and severally liable in damages for theplaintiff's losses. The Court simply could not believe that the defendants could have developed so many products without using the plaintiff's recipes.

In Monarch Messenger Services Ltd. Houlding (1984), 2 C.P.R. (3d) 235 (Alta Q.B.), the plaintiff proved that its former employee had solicited customers for a new employer. The Court found that the confidential information related to identity of customers, the identity of key personnel employed by customers, pricing practices and a general knowledge of the former employer's business practices.

CONCLUSION

Trade secrets and confidential information raise difficult questions for employers and employees.

On one hand, employers need to ensure that their intangible business assets are protected. On the other hand, employees need to be free to use their skills without fear of being sued by former employers. In attempting to balance these competing policy interests, Court decisions have not precisely defined the type of information that will be protected - perhaps because of confusion over the the various applicable legal principles. The result is uncertainty for both employers and employees who, for their own purposes, may wish to assess the nature of particular information.

However, where information may be categorized as either a trade secret or highly confidential, then employees of all levels are bound by equitable and implied contractual obligations that prohibit them from using the information without authorization - even after the termination of employment. In addition, the law prevents employees with fiduciary obligations from using and benefitting from less confidential information derived from their positions.

This paper is for general information only. It is not intended to provide legal advice for any particular situation and should not be construed as doing so. If you have any specific legal questions you should contact a lawyer.