July 2010 / Volume 8, No. 2

PROTECTING TRADE SECRETS AND CONFIDENTIAL INFORMATION

Almost every business has information that it desires to keep confidential.  Unfortunately, there is no simple formula for knowing what information is protectable and for how long.  Moreover, some types of information are protected by law, while protecting other types of information requires a contract.

Information that rises to the level of a "trade secret" is protected by statute.  Most states have adopted a version of the Uniform Trade Secrets Act, which defines a "trade secret" as information that (a) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (b) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.  The Illinois Trade Secrets Act became effective January 1, 1988.

Under the Trade Secrets Act, a "trade secret" can include a formula, pattern, compilation, program, device, method, technique, or process, but the definition is nevertheless a vague one, and what may be a trade secret for one company may not be a trade secret for another. A company’s customer list, for example, may or may not be a trade secret.  If a business invests substantial time and money in developing and maintaining exclusive relationships with its customers, and if the identity of those customers is not generally known in the industry, and if the company takes steps to keep its customer list confidential, then its customer list may well constitute a trade secret.  If, however, a company solicits customers from a published industry list, and if its customers generally do business not only with the company but also with its competitors, then it is not likely that the company can protect its customer list as a trade secret.

The two-prong test for a trade secret requires efforts to maintain the secrecy of the information.  These efforts might include such steps as keeping the secret information in locked storage or as an encrypted document accessible only with a computer password; limiting access to certain key employees; marking the storage device as confidential; separating the information into two or more parts, so that no one employee has access to the entire formula; having each employee sign a confidentiality agreement; and taking other reasonable measures to ensure that the trade secret information remains a secret.

In addition to trade secrets, there is a much larger universe of information that businesses often wish to protect.  For example, privately held companies have no obligation to publically disclose their financial statements, and generally desire to keep these confidential.  It is unlikely, however, that financial statements rise to the level of a trade secret.  In this case, a recipient of a company’s financial statements will have an obligation to keep them confidential only if that obligation is imposed by contract.

Thus, companies routinely enter into Non-Disclosure Agreements ("NDA’s") to protect information which they desire to keep confidential.  An NDA allows a business to disclose confidential information that may or may not rise to the level of a trade secret, and to have some assurance that the recipient of such information will have an obligation to keep it confidential.  Nevertheless, an NDA is not a cure-all; it will protect information only if that information is indeed confidential.  Information that is known to the public or others in an industry does not become protectable as confidential information merely by claiming that it is confidential.

Moreover, while trade secrets may be protected for as long as the owner is capable of keeping them secret, information that is merely confidential probably does not enjoy the same level of protection.  Indeed, how long a company can protect confidential information likely depends on the nature of the recipient.  If it is disclosing information to a competitor which is contemplating buying the business, the company can expect greater protection under an NDA.  If, however, a company is seeking to restrict its employees from using confidential information following the termination of their employment, the company can expect that a court will give careful consideration to the nature of the information and the length of the restriction.

It has become a common practice, particularly in certain industries, for parties to routinely enter into NDA’s, and companies often sign them first, and seek legaladvice only when a problem arises later.  However, some NDA’s are much better suited for their intended purpose than others, and it usually requires much less legal time for an attorney to review an agreement before the parties sign it than it does to try to help clients fix problems after they arise.

By Leonard J. Gambino


USING LLCS FOR ASSET PROTECTION PURPOSES

While much attention in the business world is focused on accumulating wealth, not enough attention is given to protecting what has been accumulated.  With an increasingly litigious society, protecting assets from creditors should be an important consideration for high net worth individuals.  One useful asset protection strategy is creating and maintaining a limited liability company (“LLC”) to hold and shield assets from creditors.  A properly formed, properly funded and properly maintained LLC can present a major obstacle for creditors of LLC owners.

Generally, if a creditor secures a judgment against an individual, the creditor can place liens upon and ultimately gain control of a debtor’s assets such as bank accounts, securities and real estate.  However, it is much more difficult to attach and gain control of assets of a debtor held in an LLC.  Typically, the creditors of an LLC owner can obtain a charging order which requires the debtor to turn over to creditors any assets received by the debtor from the LLC.  When an LLC is owned by two or more persons and LLC distributions are not made to the debtor, the creditor may effectively be without a remedy since the creditor cannot directly attach the LLC’s assets.  Furthermore, if a person close to the debtor is an LLC member, such as the debtor’s spouse, the LLC, if properly structured, can make distributions to the debtor’s spouse without making distributions to the debtor and thereby permit the debtor to indirectly benefit from assets which are held in the LLC.

Careful attention must be paid to creating LLCs for asset protection purposes.  A critical step in creating the entity is selecting a jurisdiction which limits the remedies of creditors of LLC owners to obtaining a charging order so that there is no right to force the sale of the debtor’s LLC interest.  Laws are in a constant state of flux and, therefore, the preferred jurisdiction to maintain LLCs for asset protection purposes may vary from time to time.  Also, special consideration is required in preparing LLC operating agreements to ensure that the rights of creditors are limited to the greatest extent possible.  For example, an operating agreement which provides for pro rata distributions to LLC members in all cases would clearly not provide LLC owners with the appropriate shield for asset protection purposes.

Fraudulent conveyance laws prevent debtors from transferring assets in a manner which will impair the rights of their creditors.  For this reason, the best time to engage in asset protection planning, such as funding an LLC with investment assets, is not when an individual is about to be sued but rather when the individual has no or few creditors so that the asset transfers are less likely to be set aside.

Few, if any, asset protection strategies can be characterized as providing absolute protection from creditors in all cases.  The end result of asset protection planning is not to create impenetrable protection from creditors but rather to make it more cumbersome for a future creditor to attach a debtor’s assets.  A properly utilized asset protection device, if not providing complete protection from creditors may, nonetheless, present enough of a hindrance to permit a debtor to negotiate a beneficial resolution of a creditor’s claim.  Properly creating and utilizing an LLC to hold investment assets is one technique that can provide protection for those who desire to protect their assets from the claims of creditors.

By Bruce E. Bell


Schoenberg Finkel Newman & Rosenberg, LLC (312) 648-2300

This newsletter is not intended to be legal or tax advice and is not a substitute for obtaining legal or tax advice. This Newsletter is deemed to be advertising material by the Illinois Supreme Court.