MANAGING TRADE SECRETS IN A FRANCHISING ARRANGEMENT Guriqbal Singh Jaiya

MANAGING TRADE SECRETS IN A
FRANCHISING ARRANGEMENT
Guriqbal Singh Jaiya
Director, SMEs Division, WIPO
www.wipo.int/sme
[email protected]
Outline of Presentation
What are Trade Secrets
Protecting Trade Secrets
Legal 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 posttermination.
 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 secret
Technical and scientific information
Financial, legal and HR information
Commercial 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 information
Salary and
compensation plans
Employee evaluation
Commercial Information
marketing strategy/research
customer 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.
Protection
HR 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
employees
Exit interviews
Non 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 noncompetition 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 exfranchisee 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.
Naturalawn
After 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 contract
Implicit contract
Even in the absence of a
confidentiality agreement or clause
duty of confidentiality may be
implied.
Fiduciary duty
Practice in the trade
Employees stock of knowledge or
employers confidential information
Difficult 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 Fowler
Mr. 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
Confidentiality Provisions in
the Franchise Agreement
 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.
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 law
Where 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)
Remedies
Civil 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.
Recommendation No. 4
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.
Recommendation No. 5
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.
Recommendation No. 6
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.
Recommendation No. 7
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.
Recommendation No. 8
 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-toknow 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.
Recommendation No. 9
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.
Recommendation No. 9 Contd…
 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.
Recommendation No. 9 Contd…
 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.
Recommendation No. 9 Contd…
 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.
Recommendation No. 9 Contd…
 Franchisors should ensure that the franchise
agreement contains reasonable non-compete, nonsolicitation 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.
Recommendation No. 9 Contd…
 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 welldrafted 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.
Recommendation No. 10
 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.