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Court of Chancery Resolves Complex Dispute Regarding Trade Secrets and Claims of Fiduciary Duty Breach

In two related opinions totaling more than 100 pages from two separate trials involving overlapping parties, the Court of Chancery awarded approximately $5 million in damages for misappropriation of trade secrets, breach of fiduciary duty, aiding and abetting of the breach of fiduciary duty, and tortious interference with prospective business relations.  See Kates v. Beard Research, Inc., C.A. No. 1480-VCP (Del. Ch. Apr. 23, 2010); Beard Research v. Kates, C.A. No. 1316-VCP (Del. Ch. Apr. 23, 2010).  Read the shorter of the two opinions here and the longer opinion issued on the same day here.

Background and Key Players

Charles Beard Research & Development, Inc. (“CB”) and Beard Research, Inc. (“BR”) were owned by Dr. Charles D. Beard and his wife, Caroline.  CB was a chemistry-based contract research organization (“CRO”), which focused on “one-off and catalog work.”  Essentially, CB manufactured large amounts of chemical compounds. BR, on the other hand, provided full time equivalent chemists (“FTEs”) who were then hired by a CRO.

ASDI, Inc. (“ASDI”) is a shipper of chemical compounds.  Advanced Synthesis Group, Inc. (“ASG”) which was ultimately acquired by ASDI, previously funded ASDI.  Alan Blize managed Pfizer, Inc.’s (“Pfizer”) relationships with CB and BR.  Blize then became the CEO and part owner of ASDI, after being hired for his knowledge of custom synthesis operations.

Michael Kates was a chemist and Executive Vice President and Director of Marketing of CB.  He also became an owner, director, and officer of BR.  He did not have a non-compete agreement with either entity.  In February 2004, Kates departed from CB and BR to become ASG’s President.  Soon thereafter in April 2004, Garry Smith quit as CB’s Director of Chemistry to work at ASG, ultimately assuming the same role at ASDI.  Michael Wagaman, a former CB Senior Group Leader, and Stephen Jones, a former CB Senior Scientist and Group Leader, also transitioned to ASDI and ASG, respectively, in April 2004.

In Beard Research, Inc., et al v. Kates, et al., C.A. No. 1316, plaintiffs, BR and CB brought an action against a number of business competitors and former employees claiming they were the victim of a scheme to put them out of business.  CB and BR had hired Michael Kates in 1998 but by 2003, Kates began talking to Alan Blize, whose employer, ASDI was looking to set up a company that would compete with CB and BR.  Blize knew Kates from his previous job at Pfizer (CB and BR’s largest customer).  In early 2004, Kates and three other CB employees left and went to work for ASG, a company funded by ASDI.  Shortly thereafter,

Pfizer signed a contract with ASG and terminated a $22 million contract it had with CB.  At about the same time, CB and BR saw many of their compounds listed for sale in a new ASG catalog.  CB and BR filed suit against ASDI, ASG, Pfizer, Blize, Kates, and the three former employees Garry Smith, Steven Jones, and Michael Wagaman on May 4, 2005, asserting multiple claims against various combinations of these defendants including misappropriation of trade secrets, breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, tortious interference with contractual relations, and tortious interference with prospective business.

Kates v. Beard Research, Inc., C.A. No. 1480, involved the propriety of a $100,000 per month management fee (the “shared expenses fee”) that BR paid to CB.  In 2000, when BR employed four FTE chemists, Dr. Beard and Kates agreed that BR would pay CB a Shared Expenses Fee of $50,000 per month.  After a significant increase in the amount of work and the FTEs, BR began paying CB a shared expenses fee of $100,000 per month.  Kates filed this suit on July 7, 2005 alleging that the $50,000 per month increase in the shared expenses fee constituted corporate waste and a breach of Dr. Beard’s fiduciary duties.

ASDI/ASG’s Competition with CB/BR

In December 2002, Pfizer and CB entered into a $22 million nonexclusive contract that permitted termination in the event that Dr. Beard or Kates departed from CB. Blize participated in the negotiations of the contract with CB, despite having already accepted a job at ASDI.  In addition to its work for Pfizer, CB was very successful in its one-off custom synthesis work and its catalog business.  The catalog business, including the experiments used to create the catalog, were widely considered confidential by both CB chemists and Blize during his time at Pfizer.

In February 2003, talks between Kates and Blize culminated with Blize asking Kates whether he would have interest in creating a custom synthesis lab for ASDI.  As a result, in June 2003, Kates signed a mutual nondisclosure agreement with ASDI, which permitted the free flow of confidential information during the exploration of a potential business arrangement.  The byproduct of the discussions was that ASDI created ASG and Kates resigned from CB.

Smith then entered into a similar agreement with ASDI.  However, Smith actively recruited CB employees and tried to collect confidential CB information, including information related to CB’s experiments and customer information.  After Kates left CB, Pfizer and ASG entered into a contract for FTE and one-off work.  Despite considering terminating its contract with CB because of Kates’ departure, Pfizer ultimately entered an amended contract eliminating one-off work and decreasing the number of FTEs.  ASG then unveiled a catalog featuring many compounds similar to those found in CB’s catalog.  CB’s brand had been compromised and it sold its assets in 2005.

Misappropriation of Trade Secrets

The Court found that ASG, ASDI, Kates, and Smith misappropriated trade secrets under the Delaware Uniform Trade Secrets Act (“DUTSA”).  In the twenty plus pages of the Court’s opinion devoted to this count, the Court held that the CB’s catalog could be classified as a trade secret as it derives independent economic value, was not generally known, and was not readily ascertainable.

Breach of Fiduciary Duty

The Court found that Kates had breached his fiduciary duties as an officer and key managerial member of CB and as officer and director of BR.  In addition to other actions, Kates breached those duties by taking confidential information to his new job.  The Court also found that the breach claim was not preempted by the DUTSA, as different facts were required to establish the different causes of action.

The Court also found ASDI and Blize were liable for aiding and abetting Kates’ breaches because they knew or should have known that Kates was committing a breach.  Despite this knowledge, ASDI and Blize did not take “any meaningful steps to ensure that ASDI and ASG did not receive or use any confidential information.”  Unlike ASDI and Blize, ASG was not found to have aided and abetted as ASG did not begin operations until after Kates left CB (with the breaches occurring before Kates departed from CB).

Tortious Interference with Contractual Relations

The Court also found that the plaintiffs failed to prove their claim for tortious interference with contractual relations because Pfizer did not breach its contract with Plaintiffs.  Tortious interference with contractual relations requires “(1) a valid contract; (2) about which defendants knew; (3) an intentional act that is a significant factor in causing the breach of such contract; (4) without justification; (5) which causes injury.”  Because Pfizer was permitted to terminate its contract when Kates departed, plaintiffs could not prove the required breach.

Tortious Interference with Prospective Business Relations

However, plaintiffs were able to prove that defendants ASDI, ASG, Blize and Kates committed tortious interference with prospective business relations, specifically with plaintiffs’ Pfizer Contract and their one-off and catalogs.  This claim required plaintiffs to show “(1) a reasonable probability of a business opportunity; (2) intentional interference by a defendant with that opportunity; (3) proximate causation; and (4) damages.”  The Court held that “[t]he tortious interference with prospective business relations standard is arguably more favorable to a defendant than the tortious interference with contractual relations standard because, under the former standard, a court must consider the defendant’s privilege to compete or protect his business interests in a fair and lawful manner.”  While such a claim must be balanced against defendants’ “privilege to compete in a fair and lawful manner,” defendants did not do so and instead used proprietary information to take business from plaintiffs.

Damages

In considering plaintiffs’ claim for damages, the Court noted that they need only prove damages by a preponderance of the evidence as  “Delaware does not ‘require certainty in the award of damages where a wrong has been proven and injury established.'”  The Court considered plaintiffs’ loss of the value to their business and loss cash flow.  However, it did not consider the loss related to the Pfizer contract, as that was subsumed in the prior two factors.  Accordingly, the Court awarded Plaintiffs nearly $5 million in damages.

Court Dismisses Kates’ Claim for Waste and Breach of Fiduciary Duty

In Kates v. Beard Research, C.A. No. 1480, Kates’ brought a claim for waste based upon shared expense fees that CB charged BR.  Initially, CB required BR to pay $50,000 per month in consideration for CB’s coverage of BR’s overhead.  As the number of FTEs at BR quadrupled over time, CB doubled the shared expense fee, increasing it to $100,000. Kates argued that this amounted to waste and because Beard controlled both CB and BR, he stood on both sides of the payment thus this constituted a breach of fiduciary duty and thus his claim for waste should be assessed under the entire fairness standard.  The defendants asserted that the traditional waste standard applied to Kates’ claim.  After a discussion of the two different standards and the case law, the Court found that “Kates has failed to prove his case under either standard.”

As the standard for corporate waste is “onerous, stringent, extremely high, and very rarely satisfied,” Kates was unable to prove such a claim.  The Court found that Kates accepted the arrangement for $50,000 per month in shared expenses fees when BR employed four FTEs and that “one would expect the [s]hared [e]xpenses [f]ees ….to increase as the number of FTEs BR employed increased.”  Kates also agreed that one would expect the Shared Expenses Fee charged to BR to increase as the number of FTEs BR employed increased.  The Court found that “a business person of ordinary, sound judgment could conclude that CB’s carrying of the overhead associated with a tripling (from four to twelve) and, later, quadrupling (to sixteen) of the number of FTEs BR employed would represent adequate consideration for BR’s payment of twice the Shared Expenses Fee it paid when it had only four FTEs.”  Thus the evidence did not support allegation of waste.  In addition, the Court found that the increased share expenses fee CB charged BR was entirely fair.  The Court found that Kates knew of the basis for the increase of the fee from $50,000 to $100,000 and he approved it.  Thus, “there was nothing unfair about the process used to establish the amount of the increase.”

This summary was prepared by Kevin F. Brady and Ryan P. Newell.

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