The German Trade Secret Act and the Implications for Business and Employment Contracts
Is the law clear enough?
09 December 2019
On 26 April 2019, the German Trade Secret Act (TSA) implementing Directive (EU) 2016/943 (Know-How Directive) came into force. While TSA created new possibilities for protection in this area, it presents certain challenges for companies looking to take advantage of this protection, in particular, regarding employment and business contracts.
This article discusses the changes in this area of the law and the associated challenges.
Concept of Trade Secrets
The TSA introduced a legal definition of trade secrets in into German law for the first time. Section 2 No. 1 of the TSA states, for information to be considered a trade secret, such information must be a) "neither in its entirety nor in the exact arrangement and composition of its components generally known or readily accessible to persons in the circles that normally handle this type of information and therefore be of economic value"; b) "subject to appropriate secrecy measures by its lawful owner;" and c) "subject to a legitimate interest in secrecy". However, terms such as "legitimate interest in secrecy" and "appropriate secrecy measures" create uncertainty and raise questions about the practical implementation of this law.
Interpretation of Appropriate Secrecy Measures
Unlike under the previous law, the owner of a trade secret must now actively take measures to protect information as he/she bears the burden of proof [of demonstrating that information is a trade secret]. Otherwise, the relevant information will not be subject to the new law. However, it is unclear yet how the demands imposed by TSA can be met. Some guidance is given in the explanatory memorandum to the TSA, which sets out seven guiding factors which include: (i) the value of the information and its development costs; (ii) the nature of the information; (iii) its significance for the company; (iv) the size of the company; (v) the usual standard of confidentiality; (vi) the way in which the information is labelled; and (vii) the scope of corresponding contractual arrangements with business partners
A prudent company should adopt the following strategy, bearing in mind that the law requires "reasonable" measures to be taken to protect trade secrets:
- comprehensive use of binding non-disclosure agreements both internally with employees and externally with contractual partners (best practices: contractual fine or right for preliminary injunction);
- agree procedures for the disclosure of trade secrets during transactions;
- notarial deposit of the most crucial trade secrets ("crown jewels");
- internal diversification regarding access to business secrets on a strict need-to-know basis;
- supplementary technical access restrictions in addition to existing physical barriers (buzzword: IT security).
It is important, given the burden of proof to demonstrate information is a trade secret, that the implementation of the actions above is documented carefully.
However, the TSA does not require owners of trade secrets to implement the best available secrecy measures. There is no perfect secrecy in business operations and the TSA does knowingly not impose unrealistic obligations on market participants.
One area of concern for companies (especially during corporate transactions) is the reverse engineering of products and the outflow of know-how during this process. Reverse engineering means the deconstruction or any other analysis of products (including software), objects or substances in order to derive the embodied know-how.
Reverse engineering was generally prohibited in Germany by the provisions of the German Unfair Competition Act. This prohibition has been eased by recent case law, which has focused on the necessary technical complexity of deconstruction. Reverse engineering is now generally permitted in order to obtain a trade secret under the TSA if the object at issue "has been made publicly available" or "is in the lawful possession of the actor".
However, there are some key differences between these two scenarios. In the latter case (lawful possession) the product in question "shall not be subject to any obligation to restrict the acquisition of the trade secret". This allows for the possibility of contractually excluding the application of TSA in cases of lawful possession, e.g. development agreements between companies. Additionally, a contractual penalty could be agreed in order to avoid difficulties in proving the amount of damages. The actual use of the know-how gained through reverse engineering will most likely already be prevented by corresponding confidentiality regulations.
As regards public availability (e.g. by the free sale of goods), it can be difficult to determine when the availability of a product is in the public domain. For example, is a machine that is only offered to certain companies in a niche industry and not to the world at large regarded as publicly available? The TSA lacks a possibility to exclude its application in such a scenario. An attempt to do so through, for example, a company's general terms and conditions may not be compatible with the TSA.
It remains to be seen how such a clause in a company's general terms and conditions, for example, could also be effective against the background of the German Civil Code which prohibits the deviation from essential principles of the underlying statutory provision. The essential principle of the TSA in this context is the general permissibility of reverse engineering. On the other hand, the overall principle of the underlying Know-How Directive is the EU-wide protection of trade secrets which gives companies the possibility of preventing reverse engineering. The German application of the Know-How Directive must not be stricter than in other countries that do not have a similar restriction of general terms and conditions in their Civil Code.
The provisions of Section 5 No. 2 of the TSA on permissible disclosures of trade secrets are of specific relevance in the context of criminal sanctions. This provision states that anyone who discloses a trade secret "for the protection of a legitimate interest", namely "for the disclosure of an unlawful act or professional or other misconduct", is justified and thus exempt from punishment.
Accordingly, whistleblowing, i.e. the disclosure of business secrets to criminal prosecution authorities or the media in order to prove the unlawful conduct of the employer, is to be exempt from punishment under certain circumstances. However, this whistleblowing should only be justified "if the acquisition, use or disclosure is suitable to protect the general public interest". Once again, this is broad and general wording of which case law will need to decide the scope. Firstly, it remains open what is to be considered to be in the public interest. Secondly, taken in the literal sense, any disclosure of even the slightest "misconduct" – not necessarily one of unlawful nature – could be declared legal. The extended explanatory memorandum of the TSA had demanded a "misconduct of some extent and weight" – a requirement unfortunately not implemented in the final wording.
The wording also does not expressly require any previous attempts by the whistleblower to resolve the matter in-house. Pursuant to Section 1 (3) No. 4 TSA, rights and obligations resulting from employment contracts also apply within the scope of the new Act. Thus, it follows from the loyalty obligations of the employee that he first needs to contact responsible authorities within the company. Despite that, it is preferable to include secondary obligations in employment contracts under which the employee is obliged to attempt to resolve the matter internally by following set practices set out in the contract. Likewise, the recitals of the Know-How Directive emphasise the aspect of proportionality of a whistleblower´s approach in this regard.
It remains to be seen whether the EU Directive on the Protection of Persons Reporting on Breaches of Union law (proposal COM (2018) 218/973471), which was also adopted in April 2019, can contribute to an overall whistleblowing protection system. Article 1 of the draft version provides that the directive´s material scope shall cover, among other things: product safety, road safety, environmental protection, radiation protection, animal welfare, food safety, public health, consumer protection, protection of privacy and personal data and the security of network and information systems.
A major concern of the Know-How Directive was the preservation of confidentiality during court proceedings. Owners of trade secrets should not be deterred from enforcing material claims due to the danger of excessive disclosure during these proceedings, which may even lead to a loss of rights according to the trade secret definition. Unfortunately, the new provisions do not completely resolve the dilemma of the trade secret owner.
Section 16 (1) TSA grants the court the possibility to classify information as "requiring secrecy" upon request of a party. If classified as such, section 16 (2) TSA states that the parties and other persons involved in the proceedings are obliged to treat the information confidentially and are prohibited to use and disclose the information outside of the proceedings. Infringements can be sanctioned by the court with an administrative fine of up to EUR 100,000 (or up to six months of detention) under section 17 TSA. This value, though, could still be too low for enormously valuable trade secrets, such as recipes for high-revenue products or specialized production know-how. Besides, this does not solve the core problem that the opposing party may gain actual knowledge of the secret - albeit subject to legal restrictions - at the latest during the process.
In addition, section 19 TSA gives the parties a right to request the restriction for the opponent's personnel to access documents or oral hearings (including protocols and recordings). However, in any case a natural person of each party and one of their (legal) representatives must be granted unlimited access.
Eventually, it should be noted that the TSA, unfortunately, does not follow the path of harmonization as regards local jurisdiction. Under section 15 (2) TSA, the (regional) court in whose district the defendant has his general place of jurisdiction has exclusive local jurisdiction, meaning that the owner of the secret – as customary in German intellectual property law - is barred from bringing an action at the place of the infringement in the event of the unlawful use of trade secrets.
Key Take-Away Points
- Newly inforced German Trade Secret Act requires companies to take active secrecy measures to ensure protection.
- The required adjustment of company policies and employment contracts is complicated by the various indefinite terms used in the legal wording of the new Law.
- Reverse engineering of shared products is of particular importance and should, unlike previously, be contractually excluded to the extent legally permitted.
- Another threat for companies must be seen in the possible loss of trade secrets through whistleblowing.
- Procedural changes aim to prevent the loss of rights during proceedings.