Trade secrets have long been essential to successful energy exploration and production, and the development and protection of proprietary information has become a critical part of midstream business. The shale revolution resulting from hydraulic fracturing and horizontal drilling has spurred an even greater need for midstream infrastructure. Advances in technology have helped exploit more oil and gas, and they are now being utilized to more effectively gather, process, transport and store these resources.
Success today requires applying real-time information to drive business processes and day-to-day decision-making. But this evolution also requires a plan to protect proprietary technology and confidential business information from competitors hungry to use them.
Midstream trade secrets
A trade secret is confidential business information that is economically valuable because it is not known by competitors. Unlike patents, trade secrets are valuable because they are a secret. To qualify as a trade secret, the business information must not be generally known or readily ascertainable, and the owner of a trade secret must take reasonable efforts to maintain its secrecy.
Areas in midstream business where protecting trade secrets is crucial include:
- Gathering, processing, compression and regasification facilities;
- Mergers and acquisitions;
- Joint ventures;
- Operations data; and
- Regulatory response and compliance.
Many midstream businesses have developed proprietary software and business processes that use analytics to capture, interpret and apply real-time data. These tools are being used to monitor equipment and schedule maintenance, including the identification of pipeline sections that should be prioritized for repair. They are also being used for predictive price and capacity modeling, fuel cost management, volume and pressure monitoring, supply and demand forecasting, capex budgeting and optimal route and transport strategy.
The presence of analytics in midstream business will intensify as demand for midstream infrastructure escalates.
The Wellogix case
The Wellogix decision highlights the importance of protecting proprietary analytic tools. In this case, the Fifth Circuit Court of Appeals in New Orleans affirmed a $44.4 million judgment in favor of a software developer that created an online platform for procuring oil and gas services and later sued its marketing consultant for trade secret misappropriation.
The developer shared the source code with the marketing consultant subject to confidentiality agreements and as part of the marketing services that the developer purchased. Later, without notifying the developer, the marketing consultant used the source code to create its own software and then competed against the developer on a new project.
The Fifth Circuit concluded that the source code in Wellogix’s software was a trade secret, that Wellogix maintained its secrecy by implementing a firewall and sharing its software subject to confidentiality agreements, and that the consultant misappropriated the trade secret by using the source code to create competing software.
Confidential business information pertaining to the design, operation and marketing of gas gathering and processing facilities—as well as compressor stations and LNG regasification terminals—is also ripe for trade secret protection and enforcement. In one notable case, the Texas Supreme Court held that a lower Texas court had jurisdiction over a Russian company that was sued by a Texas-based midstream company for allegedly misappropriating trade secrets about the design and marketing plan for a regasification facility to be built in Texas.
Mergers and acquisitions
Protecting confidential business information in mergers and acquisitions is also important, especially for potential sellers who are not in bankruptcy. Early in the deal process, the potential seller should obtain a confidentiality and non-disclosure agreement. This agreement should include the following protections:
- The buyer knows the seller considers the confidential information provided to be a trade secret;
- The buyer agrees the information is a secret and to maintain its secrecy;
- The buyer will examine the confidential information solely to evaluate whether to close the deal;
- The parties specify the scope of authorized use;
- Prohibition of reverse engineering;
- Prohibition of unauthorized disclosure and use by the buyer and its affiliates; and
- Remedies for breach, including injunctive relief and damages as well as attorneys’ fees, and identify the venue and choice of law that will govern any dispute.
Many joint ventures (JV) in midstream, especially pipeline projects, consist of direct competitors that decide to partner on a project. Joint venturing means sharing confidential business information, which in turn increases the risk of trade secret disclosure and misappropriation.
During JV negotiations, the parties should agree in writing how confidential business information will be identified and protected. This agreement should include the following components:
- Identify the information each party believes is a trade secret without divulging the trade secret itself;
- Stipulate that the identified information is a secret possessing economic value;
- Formulate actions to maintain secrecy and to minimize the risk of improper disclosure, including protocols for securing computers and data, and confidentiality agreements for employees and contractors;
- Provide instructions on what will happen to trade secret information when the JV concludes—be sure to include that trade secret information will be returned or destroyed, and that confidentiality obligations shall continue after the JV ends;
- Specifies that trade secret protection will continue if a change in control occurs; and
- Clarifies that the joint venturers’ obligations apply to all affiliates, subsidiaries, investors, and new companies.
This written agreement should help prevent future disputes. It will also help refute possible attacks from the former joint venture asserting that it owns the trade secret, developed it independently, learned about it legally from a third party, and that the information is known industrywide.
The effort spent to set up operations and to secure the optimal combination of vendors for secondary logistics, including trucking, shipping, barge and rail, is likely subject to trade secret protection. One federal court has implied that a “vendor network”—the effort expended to develop a network of the best vendors—may constitute a trade secret. Another has held that operations data maintained on a confidential basis, including land and lease files, are trade secrets since the company “[learned] by experience” the solutions that work and that do not work.
Also, trade secret law protects “negative know-how.” This information is commercially valuable, because knowing what processes will not work brings a business closer to finding correct solutions.
Compliance and response
Midstream businesses should take care not to divulge trade secrets through the disclosures they make to federal, state and municipal regulatory authorities. This is especially true if the disclosures are available for public viewing or are subject to open-records laws.
In such situations, businesses should work with the regulatory authority to prevent or minimize the public disclosure of confidential business information. They should review the regulation to see if it contains a trade secret carve-out, seek protective orders when necessary and redact confidential information when possible. The same is true when midstream businesses must respond to lawsuits by environmental groups or information requests from them.
Case law addressing the protection of trade secrets from disclosure during regulatory compliance varies greatly, even though most states have a policy favoring trade secret protection.
Trade secret laws
Trade secrets are protected and enforced through two sources of law: first, the trade secret law of each state; and second, the federal Defend Trade Secrets Act (DTSA), effective May 11, 2016.
The trade secret laws of most states are similar but not uniform. Although 48 states, all but New York and Massachusetts, have enacted a version of the model Uniform Trade Secrets Act (UTSA), many states enacted slightly distinct versions.
By contrast, the DTSA equips trade secret owners with the same federal cause of action for trade secret misappropriation pursuable in any federal court nationwide. This matters for midstream businesses because many projects extend across state lines. A plaintiff can assert both a DTSA claim and a state law trade secret misappropriation claim through the same lawsuit in federal court.
A cause of action for trade secret misappropriation is established under both the DTSA and state trade secret law by showing that a trade secret exists, that the trade secret was acquired through improper means and that the trade secret was used without authorization.
There are some notable differences between the DTSA and UTSA. First, to pursue a trade secret misappropriation claim under the DTSA, the trade secret must be “related to a product or service used in, or intended for use in, interstate or foreign commerce.” Most trade secrets used in midstream business should qualify because they relate to systems that directly or indirectly assist the transport of oil or gas across state lines. Second, the DTSA provides immunity to whistleblowers under trade secret law who disclose a trade secret to “a federal, state, or local government official” or “to an attorney” and do so “solely for the purpose of reporting or investigating a suspected violation of law.”
Similarly, the DTSA provides immunity under trade secret law to persons who disclose a trade secret as part of a lawsuit “if such filing is made under seal.”
To be able to receive an award of exemplary damages and attorneys’ fees against an employee who violates the DTSA, the employer must first provide notice of these immunity provisions to the employee.
Unlike some state trade secret law, the DTSA permits a litigant to pursue additional claims based upon the conduct underlying the trade secret misappropriation claim, such as claims for conversion, unjust enrichment and civil theft liability. In addition, the DTSA provides an “extraordinary” remedy for the civil seizure of property. It also enables litigants to use federal courts to prevent misappropriation occurring in foreign countries if “an act in furtherance of the offense was committed in the United States.”
This provision is significant for midstream businesses that conduct operations in Canada or Mexico.
Midstream businesses should address trade secrets proactively so they can be best situated to protect and enforce them. First, they should identify the confidential business information that they believe are trade secrets. Second, they should develop a system for maintaining their secrecy. This includes measures to keep computers and data secure, the use of confidentiality agreements, non-disclosure agreements and noncompetition agreements covering employees with access to the trade secrets, and implementing a policy to protect trade secrets during regulatory compliance. Third, when required, they should seek an injunction and damages against competitors who attempt to misappropriate their trade secrets.
Businesses with a record of consistently protecting confidential information are more likely to establish that the information is in fact a trade secret. They are also more likely to prevail in pursuing trade secret misappropriation claims.
Jonathan R. Childers is a partner at Lynn Pinker Cox Hurst LLP, specializing in business trial and litigation law in the energy sector.
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