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Litigation Law Alert – New York Limits Damages Measured by “Avoided Costs”

By Joelle A. Milov

Decision

New York’s Court of Appeals recently issued a decision in response to a certified question posed to it by the United States Court of Appeals for the Second Circuit.  The decision will curtail “avoided costs” damage claims brought in New York in particular causes of action, including claims for common law misappropriation of trade secrets.

In E.J. Brooks Co. v. Cambridge Security Seals, No. 26, 2018 N.Y. LEXIS 1080 (May 3, 2018), the Court of Appeals, New York’s highest court, was asked by the Second Circuit, “[w]hether, under New York law, a plaintiff asserting claims of misappropriation of a trade secret, unfair competition, and unjust enrichment can recover damages that are measured by the costs the defendant avoided due to its unlawful activity.”  In response, a divided Court of Appeals held that “avoided costs” damages were not recoverable under such claims. 

Background

Plaintiff acquired non-party Stoffel Seals Corporation’s automated manufacturing process for plastic security seals.  Plaintiff claimed that various employees departed for a competitor, defendant Cambridge Security Seals, and brought with them its confidential manufacturing process.  In 2012, plaintiff sued Cambridge in the United States District Court for the Southern District of New York, asserting claims for, among other things, common law misappropriation of trade secrets, unfair competition, and unjust enrichment.  The case proceeded to a jury trial, and defendant was found liable on all of these counts.

On damages, plaintiff proffered an “avoided costs” theory that requested damages of “the difference between the costs [defendant] actually incurred in developing and using the [plaintiff’s] manufacturing process and the costs that [defendant] would have incurred had it not misappropriated [plaintiff’s] process.”  Critically, plaintiff did not argue that defendant’s avoided costs would approximate plaintiff’s losses.  The jury awarded plaintiff $1.3 million for each cause of action, for a total of $3.9 million in compensatory damages.

The parties filed post-judgment motions, with defendant arguing that avoided costs were not an appropriate measure of damages.  The trial court denied defendant’s motion, and defendant appealed.  Finding that the Second Circuit and New York State courts had not endorsed an “avoided costs” theory of damages in such cases, the Second Circuit certified the question, asking the State court to rule on this issue of State law.

Majority Opinion

  • Unfair Competition

The majority opinion of the Court of Appeals began its unfair competition analysis with the proposition that “[t]he ‘fundamental purpose’ of compensatory damages is to have the wrongdoer ‘make the victim whole.’”  It also noted that the rule for damages in unfair competition cases is that such damages should relate to plaintiff’s losses proximately caused by defendant’s actions.  In this case, defendant was liable to plaintiff for unfair competition based upon misappropriation, and “[t]he essence of the misappropriation theory is not just that the defendant has ‘reap[ed] where it has not sown,’ but that it has done so in an unethical way and thereby unfairly neutralized a commercial advantage that the plaintiff achieved through ‘honest labor.’”  The Court, therefore, found that damages should be based on “the loss of plaintiff’s commercial advantage, which may not correspond to what the defendant has wrongfully gained.”   Providing plaintiff with defendant’s gains “may be appropriate where a plaintiff’s actual losses cannot ‘be traced with even approximate precision.’”  Even if so, “it must first be shown that there is ‘some approximate relation of correspondence, a causal relation not wholly unsubstantial and imaginary, between the gains of the aggressor and those diverted from his [or her] victim.’”  If no “correspondence” is proved, a court will not presume that a defendant’s gain approximates plaintiff’s loss.  While the Court was opining solely on avoided costs damages, the majority’s discussion of a necessary “correspondence” between defendant’s wrongful profits and plaintiff’s loss may raise issues in future litigation where plaintiff seeks recovery of a defendant’s profits.

  • Trade Secret

As to claims of misappropriation of trade secrets, the Court cited the First Department’s decision in Hertz Corp. v. Avis, Inc., 106 A.D.2d 246 (1st Dep’t 1985) for the proposition that, in trade secret cases, damages cannot be calculated by an increase in defendant’s profits unless the profits were evidence of plaintiff’s losses.  Noting that New York State courts had largely followed Hertz, the Court of Appeals “agree[d] that damages in trade secret actions must be measured by the losses incurred by the plaintiff, and that damages may not be based on the infringer’s avoided development costs.”  The Court of Appeals noted that certain other courts allow the use of avoided costs damages to show defendant’s gains, but found that because such “calculation of damages . . . does not consider the effect of the misappropriation on the plaintiff,” such damages were impermissible.

  • Unjust Enrichment

Finally, as to unjust enrichment claims, relying on its prior decision in IDT Corp. v. Morgan Stanley Dean Witter & Co., 12 N.Y.3d 132 (2009), the State Court of Appeals found that “where a defendant saves, through its unlawful activities, costs and expenses that otherwise would have been payable to third parties, those avoided third-party payments do not constitute funds held by the defendant ‘at the expense of’ the plaintiff.”  Accordingly, the Court found that for unjust enrichment claims, a defendant’s avoided costs could not substitute for plaintiff’s losses as compensatory damages. 

In sum, the majority found that avoided costs damages were unavailable on all three claims that were the subject of the certified question. 

Dissenting Opinion

The dissent derided the majority’s misreading of cases and its narrow interpretation of damages to pertain only to those available at law and not those available in equity.  The dissent also disputed the majority’s approach to losses available to a trade secret plaintiff as being overly restrictive, noting that in trade secret cases, a defendant’s avoided costs are also proper calculations of damages because such avoided costs “are reasonably related to the value of the trade secret.”  On a more critical note, the dissent contended that the majority’s decision avoided the Court’s responsibility to shape common law that accomplishes State policies.

Conclusion

The Court’s decision will curtail avoided costs damage claims in common law misappropriation of trade secrets, unfair competition, and unjust enrichment claims.  Yet, the Court stopped short of saying that an avoided costs theory was never viable, as that theory appears to survive in certain unfair competition and misappropriation of trade secrets claims when there is a connection between defendant’s gain and plaintiff’s loss.  How close a connection will be required remains to be seen.

For more information, contact Joelle A. Milov or your CLL attorney.

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