MANAGING TRADE SECRETS IN A FRANCHISING ARRANGEMENT Guriqbal Singh Jaiya Director, SMEs Division, WIPO [email protected]

MANAGING TRADE SECRETS IN A FRANCHISING ARRANGEMENT

Guriqbal Singh JaiyaDirector, SMEs Division, WIPOwww.wipo.int/[email protected]

Outline of Presentation

What are Trade Secrets Protecting Trade SecretsLegal protection for trade secrets

and remedies for their misappropriation

Trade Secrets and Franchise

Intellectual property rights are inherent to a franchise. Without IP there can be no franchise

IP Trademarks Designs Patents Copyright Trade Secret

What are Trade Secrets

A trade secret is any confidential information that has:

(a) commercial value,(b) by virtue of being kept secret,

and(c) reasonable steps have been

taken to keep it secret/confidential.

Economic Espionage Act of 1996, 18 U.S.C. § 1839 (3)- def of a trade secret

“All forms and types of financial, business, scientific, technical, economic, or engineering information, including patterns, plans, compilations, programmed devices, formulas, designs, prototypes, methods, techniques, processes, procedures, programs, or codes, whether tangible or intangible, and whether or how stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing.”

Trade Secrets: Six General Factors Used by courts and franchisors to determine whether a

particular information constitutes a trade secret: To what extent is the information in question known outside the

franchisor’s business? What, if any part of the information, is in the public domain?

To what extent is the information known by the franchisor’s employees and/or members of the franchisor’s network? Franchisees, master franchisors, sub-franchisors, developers and employees at all levels of the franchise network should be made aware of the issue of confidentiality. Any information which the franchisor considers secret should be clearly pointed out to such persons.

What measures has the franchisor taken to guard the secrecy of the information?

How much time and investment of resources has the franchisor expended in developing and compiling the information?

What is the value of the information to the franchisor and to the franchisor’s competitors?

How easily can the information be obtained by people outside or leaving the franchise network?

Trade Secrets in a Franchise

Financial, technical, structural, marketing, engineering, distribution techniques/documents, recipes, business formats and plans, operations manuals, and pricing techniques are all candidates for protection as trade secrets.

Often franchisors develop, use and license confidential and proprietary computer software in their system.

In some franchise systems, customer lists are extremely important.

The franchisor should also anticipate the possibility that the franchisee may develop improvements or enhancements to the business, generate valuable data, and the franchise agreement should address the ownership and confidentiality of, and the right to use, such know-how and information.

IPRs and Franchising Agreement

The agreement should provide that any intellectual property, whether developed by the franchisor, the franchisee, or its employees is to remain the property of the franchisor at all times and that the franchisee may not disclose or infringe the franchisor’s intellectual property rights.

Protecting Trade Secrets: Who’s Responsibility?

Given the importance of trade secrets to a franchise system, and the potential for loss as a result of a single person associated with the franchise not exercising reasonable precautions to maintain their secrecy, it is critical that franchisors and franchisees take actions to protect the franchise system's trade secrets.

Importance of Education

Of all the methods available to the franchisor, one of the most effective is also the simplest: education.

Franchisors need to educate their franchisees as to what constitutes confidential trade secrets. Franchisors should ensure that their staff know when they are handling restricted information.

Need for a Comprehensive Framework for Safeguarding Trade Secrets Most businesses do not provide a comprehensive

framework for safeguarding trade secrets. Instead, in most businesses the responsibility for

trade secrets protection "if, indeed, responsibility has been assigned at all" is split between the legal department, the human relations department, the information technology function, and sometimes even physical plant security.

Divided responsibility is a recipe for problems. The most common problem is that a divided responsibility becomes no one's responsibility. For most companies, this is a recipe for disaster.

Need for a Comprehensive Framework for Safeguarding Trade Secrets Contd… There are many ways that a franchise business can leak confidential

information, including valuable trade secrets. While many European countries, including France and Germany, have followed the US’s lead and have introduced either specific legislation or criminal offences relating to the unauthorized disclosure of trade secrets, no such sanctions exist in the UK. Trade secrets do not even constitute “property” for the purposes of the Theft Act 1968.

For franchisors who supply their technical operating manuals and the full workings of their system to a large number of persons at varying levels of the franchise chain, it is important to protect confidential information at all levels of the franchise network both during the term of agreement and post-termination.

With the ever-present threat of today’s franchisees becoming tomorrow’s competitors, it is important for franchisors to have policies in place regarding the use and disclosure of trade secrets by its franchisees and sub-franchisors particularly for the use of email where confidential information can be disclosed inadvertently.

A well-drafted franchise agreement together with the continuing education of franchisees and employees as to what constitutes trade secret information can help protect the franchisor’s trade secrets and so prevent the adverse consequences of their use by competitors and by third parties.

Camp Creek : A franchisee lost trade secrets

Camp Creek established and operated a Sheraton Inn franchise (the "Inn") close to the Atlanta airport. It had disclosed to Sheraton confidential information such as occupancy levels, average daily rates, discounting policies, rate levels, long-term contracts, marketing plans and operating expenses in a confidential context with the expectation that it would be kept confidential and used for limited purposes. Such information were closely guarded in the hotel industry. Thereafter, Sheraton purchased another hotel close by. The manager of the new hotel used the information described above to its advantage and to the detriment of Camp Creek. Held that the information qualified as trade secrets and were used in violation of the confidentiality agreement

Naturalawn

An ex-franchisee of a lawn care franchise was found to have violated trade secret law by using the franchisor's carefully guarded customer lists and by using the franchisor’s specially designed computer software.

Increasing vulnerability of trade secrets In franchising, the franchisor has to transfer

all of the information relevant to the way of doing his business to the franchisee.

If a franchisor is not careful, its products and method of doing business can be copied by employees or franchisees who can use the information to start competing companies. Advances in technology - the speed and ease with which

information can be moved has made businesses information more vulnerable to loss

Employee mobility and shifting allegiance

Trade Secrets: Extremely Vulnerable

Trade secrets are extremely vulnerable. Franchisees, master franchisors, developers, sub-franchisors, and their employees --- all enjoy a full working knowledge of the franchisor’s trade secrets. They are all, therefore, in an excellent position to compete for the franchisor’s market share. Sometimes even prospective franchisees acquire a good deal of valuable information.

If any such persons leave the franchisor’s network, unless the franchisor’s trade secrets are adequately protected, they can become its strongest competitor.

Indeed, there are many examples of franchises that have been established by former franchisees of a rival brand.

Steps for Trade Secret Protection

First Step - identify potential trade secrets (Trade secret audit)

Second Step - Take measures to protect them By identifying and protecting prevent their

loss Difficult to prove to a court that the

information is worthy of protection if steps had not been taken to identify and protect them in the first place

Identify

Prepare list of information that you think needs to be kept secretTechnical and scientific informationFinancial, legal and HR informationCommercial information

Note date of creation, place of storage/use and other key information

Franchisor must identify the trade secrets that exist within his business as a prerequisite for protecting them

Franchisor must identify the trade secrets licensed to a franchisee so that he is informed and takes the appropriate steps to protect them

Technical and Scientific Information

Product information technical composition of a product (medicine,

paint, recipe for a sauce), data about product performance, product design information

Manufacturing information manufacturing methods and processes (weaving

technique, device process), production costs, refinery processes, raw materials, machinery

know-how necessary to perform a particular operation

Financial, Legal and HR Information

Pricing informationSalary and compensation plans

Employee evaluation

Commercial Information

marketing strategy/researchcustomer buying

preferences and requirements

consumer profiles sales methods

Information protected in decided cases Access card control

information Project information Pricing information/sales

forecasts Financial information Computer source code Test material/ prototypes/

design specifications

Customer business info Engineering plans and

drawings Formulas Research Blueprints/diagrams Software Implementation

methodology Technical records Biomedical research Sales forecasts

Provisions in the Franchise Agreement

Franchisee acknowledges that the franchisor is the owner of all proprietary rights in and to the system and manual(s) and any changes or supplements to the manual(s); franchisee acknowledges that all of the information contained in the manual(s) is proprietary and confidential and franchisee shall use all reasonable efforts to maintain such information as confidential.

Franchisee acknowledges, knows, and agrees that designated portions of the manuals are trade secrets known and treated as such by the franchisor.

ProtectionHR policy

Information is usually lost from within a company

Security procedures for paper documents, tangible material and for electronic information

Human Resource Policy – employees and franchisees

Awareness creation/strong enforcement of breaches Information week survey only 9% of companies

educate their employees on data security Should be part of training provided to the

franchisee

Confidential agreements/clauses Similar expectations vis-à-vis franchisee and its

employees

Staff manual Operational manual of the franchise

Human Resource Policy –Ex employeesExit interviewsNon compete agreements

Such agreements are enforceable where it is considered reasonable as to time, scope and geographical limitation necessary to protect the legitimate interests of the employer (or Franchisor); where they are not harmful to the public, and where they do not impose undue hardship on the employee (or franchisee)

Gold Messenger Plaintiff franchised his system for setting up and

operating an advertising circular business to the Defendant.

The franchisee received the Operations and Procedures Manual detailing how to set up and operate a GM franchise.

The agreement included a covenant not to compete (at termination, franchisee may not compete with GM for three years and within 50 miles of GM franchise territories).

After the franchisee failed to pay royalties, plaintiff terminated the agreement. Thereafter the Defendant began publishing a competing circular called "Penny Power."

Held that the defendant could not use the confidential information contained in the manual to compete unfairly with the franchisor

Servpro Franchise involved a cleaning company. A non-

competition clause in the agreement prevented an ex-franchisee from competing in the same kind of business covered by the franchise agreement for two years after termination within a ten mile radius of the area in which the franchisee rendered services.

The clause was not enforced because there was no evidence of misuse of confidential business. The ex-franchisee operated a competing business within the 10-mile radius but there was no evidence that any of the franchisor’s manuals, techniques or training manuals were used.

NaturalawnAfter the termination of a

franchise agreement for lawn care the ex-franchisee was prevented from running a competing business in the same area

Duty of Confidentiality

Explicit contractImplicit contract

Even in the absence of a confidentiality agreement or clause duty of confidentiality may be implied.

Fiduciary dutyPractice in the trade

Employees stock of knowledge or employers confidential informationDifficult question of fact as to

whether the information that has been used to the detriment of the employer is information of the employer or honestly acquired during employment by the employee

Faccenda v FowlerMr. Fowler left Faccenda where he had

worked for 8 years and set up his own business of delivering and selling fresh chicken

He took with him customer lists and their requirements, delivery routes and pricing information

This information was held not to be sufficiently confidential

Bingham Hill. v Morning Fresh

Bingham Hill was awarded $550,000 in damages for their stolen trade secrets.

Morning Fresh had hired the former cheese maker at Bingham Hill who had signed an agreement while at Bingham Hill stating he would not disclose their recipes or make their cheeses elsewhere.

He violated this agreement by not only disclosing their trade secrets but by using them to make duplicate cheeses at Morning Fresh.

Internal Security Documents under lock and key Password protection in computers Disclosure on a “need to know”basis Confidential documents marked “confidential” Registration at reception/visitor logs/escorts Use “keep out” “authorized personnel

only”signs Access controlled photocopiers, scanners,

computers. Use of shredders Nothing on the internet

“Confidential”“This document contains confidential and

proprietary information of [COMPANY] and is protected by copyright, trade secret and other national laws. Its receipt or possession does not convey any rights to reproduce, disclose its contents, or to manufacture, use or sell anything it may describe. Reproduction, disclosure, or use without specific written authorization of [COMPANY] is strictly forbidden”

Case Study – Old Country Buffet

OCB popular chain of buffet restaurants. Good food, décor, service and had solved a variety of problems in running a buffet (food spoilage, wastage, cost cutting)

Klinke got access to OCB’s manuals and recipes, copied them and replicated them in his competing buffet business

Held that OCB had not taken precautions to protect their recipes or their manuals and as such could not be protected as trade secrets

The trade secrets must be accorded maximum security consistent with franchisee’s need to make frequent reference to them;

franchisees shall strictly limit access to the manuals to employees who have a demonstrable and valid “need to know” the information contained therein in order to perform their position and strictly follow any provisions in the manuals regarding the care, storage, and use of the manuals and all related proprietary information;

the franchisor should reserve the right to designate which employees of the franchisee shall execute confidentiality agreements, in a form provided by the franchisor.

Confidentiality Provisions in the Franchise Agreement

Franchisee shall not at any time, without franchisor’s prior written consent, copy, duplicate, record, or otherwise reproduce in any manner any part of the manuals, updates, supplements, or related materials, in whole or in part, or otherwise make the same available to any unauthorized person.

The manuals at all times remain the sole property of franchisor; upon the expiration or termination, for any reason, of the franchise agreement, franchisee shall return to franchisor the manuals and all supplements thereto.

Confidentiality Provisions in the Franchise Agreement

Secret Recipes Kentucky fried chicken

The secret recipe of “11 herbs and spices” lies in a bank vault.

Few people know it, and they are contractually obligated to secrecy.

The ingredients are mixed by two different companies in two different locations and then combined elsewhere in a third, separate location. To mix the final formula, a computer processing system is used to blend the mixtures together and ensure that no one outside KFC has the complete recipe

Other Measures Carefully review advertising and promotional

materials and press releases to protect trade secrets

Monitor trade press and business journals for any news indicating a possible compromise and/or exploitation of your trade secrets by others.

Police the activities of suppliers, franchisees, etc

Include post-term obligations in employment agreements that impose a duty on the employees to keep his or her former employer aware of his or her whereabouts

Protecting Trade Secrets When information is held to be a trade secret, it

cannot legally be disclosed even when the legal relationship between the franchisor and the franchisee is at an end.

If a franchisee discloses or threatens to disclose a franchisor’s trade secrets, then the franchisor may bring an injunction to prevent disclosure and/or an action for damages against the franchisee.

These remedies may be in addition to any remedies that the franchisor has by virtue of the franchisee’s disclosure being in breach of the Franchise Agreement.

Protection for Trade Secrets Often no specific lawWhere there is a contract; employees with

express provisions in their contracts or an implied duty of confidentiality or those who have signed NDA or CA

Where there is no contract; information imparted in confidence and used in breach of that confidence or information obtained by unlawful or improper means (theft, industrial espionage, bribery)

RemediesCivil remedies based on breach of

contract or tort law; damages, injunctions, seizures and impoundment

Criminal remedies - rarely a criminal offense in its own right but could attract criminal liability by committing criminal offenses for procuring the information (theft, trespass, etc)

Recommendation No. 1

No. 1: Define the franchisor's trade secrets broadly in the franchise agreement, for example -- "As used herein, the term Trade Secrets mean, any information, including, but not limited to, any manuals, contracts, customer data, supplier data, financial data, price lists, know-how, methods, techniques, processes, compilations, formulas, programs or patterns relating to the operation of the franchise and the products or services thereof."

Recommendation No. 2 and 3

No. 2: Specifically state in the franchise agreement that any items embodying the franchisor's trade secrets are being licensed to the franchisee as opposed to being sold.

No. 3: Specifically state in the franchise agreement that the franchisee is prohibited from "reverse engineering," decompiling or disassembling any items embodying the licensed trade secrets.


No. 4: Require the franchisee to acknowledge that he or she is not violating any restrictions of former employees or other previously-owned franchises and that he or she will not disclose or use any trade secrets of any former employers or other previously-owned franchises in the operation of the present franchise.


No. 5: Stress the importance of maintaining secrecy of the system's trade secrets and specifically include a statement in the franchise agreement wherein the franchisee acknowledges that he or she may have access to the franchisor's trade secrets and that these trade secrets have substantial value that provide the franchisee with a competitive advantage.


No. 6: Include specific provisions in the franchise agreement that restrict unauthorized use and disclosure of the system's trade secrets and prohibit the franchisee from delivering any papers, or publishing any articles pertaining to the franchise or its activities until they are first reviewed and approved for publication by the franchisor.


No. 7: Include specific provisions in the franchise agreement in the event of the franchisee's severance, including: requiring the immediate return of any of the franchisor's trade secret information and any items embodying those trade secrets; requiring acknowledgment that he or she has no ownership interest in the trade secrets or any items embodying the trade secrets.


A bulletproof operations manual describes which of the franchisor's processes and procedures are trade secrets, and attempts to explain why.

It confirms the importance of maintaining such trade secrets, and establishes policies and procedures such that users of the operations manual understand and agree to maintain such secrets.

The operations manual should even describe the circumstances under which the operations manual (or at least the part of the manual containing trade secrets) is maintained--for example, in the manager's office behind a locked door.

Recommendation No. 8 Contd…

No. 8: Include specific guidelines in the operating manuals for protecting the secrecy of the franchisor's trade secrets, including: limiting access to the trade secrets to only those franchise employees that have a need-to-know for the performance of their duties; requiring locking of all offices, file cabinets or storage rooms in which confidential information may be found; providing appropriate legending and treatment of all trade secrets; limiting access to copying and scanning equipment and computers; and password-protecting all computers and encrypting all electronic communications containing references to the trade secrets.


No. 9: Require the franchisee to have every employee who may have access to the franchisor's trade secrets execute an employment agreement having non-disclosure provisions, restrictive covenants, and notice requirements of subsequent employment.


The franchisor should require that the franchisee’s key/relevant employees enter into NDA/confidentiality agreements.

While many franchise agreements provide for this, many franchisors fail to enforce these undertakings or fail to ensure that their franchisees enforce them.

Franchisors, when meeting with their franchisees, should stress the importance of such undertakings being observed.


Virtually all franchise agreements have in-term covenants prohibiting the franchisee’s or its owners’ association with or interest in a competitive business. The definition of a competitive business varies among franchise systems. Ideally, it is broad enough to protect a franchisor and its proprietary information from possible leakage into related businesses and yet sufficiently narrow as to be enforceable by a court.

In-term covenants proscribe direct or indirect, controlling or non-controlling, legal or beneficial interests in competitive businesses; performing services as an officer, director, employee, manager, consultant, representative, agent, or in any other representative capacity for a competitive business; soliciting the franchisor’s or other franchisees’ employees; and other conduct that might divert business from the franchise system.


The nondisclosure provisions should define or identify the nature of franchisor’s trade secrets or other proprietary information, prohibit its disclosure and unauthorized use during and after the franchise agreement’s term, and require franchisees to obtain NDAs from managerial employees and others who have access to proprietary information.

While most franchisor’s believe that it is impractical to require a franchisee’s managerial employees to sign these NDAs as a condition for employment, failure to do so could eviscerate the franchisor’s later attempts to protect its proprietary information from improper disclosure and/or use.


Franchisors should ensure that the franchise agreement contains reasonable non-compete, non-solicitation of clients and customers of the franchise and non-poaching of franchisors’ and franchisees’ employees.

Additionally, the franchisor should ensure that in its and its franchisees’ employment contracts, the above post-termination restrictive covenants are included.

The courts will enforce post-termination covenants if they are necessary to protect the franchisor’s or franchisee’s legitimate business interests such as trade connections, customer base, and suppliers. Covenants must be reasonable with regard to duration and geographical location.


In addition to post-termination covenants and other restrictions, the agreement should expressly provide that upon termination, all rights in customer lists, marketing lists, and suppliers’ lists are to be assigned to the franchisor (if this is not provided for during the term of the agreement).

Whilst the franchise agreement is certainly the heavyweight in the franchisor’s armory, the arsenal should also include well-drafted non-disclosure agreements for discussions with potential franchisees and master franchisees, developers, and sub-franchisors.

It is particularly important when a franchisor is considering expanding into a new territory that any confidential trade secret information that is revealed with potential franchisees or master franchisees is imparted under a strict duty of confidence.


No. 10: Require the franchisee to conduct periodic meetings with the franchise employees to instruct them as to their responsibilities to maintain secrecy of the franchisor's trade secrets. The franchisee should also conduct severance interviews with any terminating employees in which they acknowledge in writing their post employment obligations to the franchise.