March 21, 2007

Jerome Falk co-authors article "Disgorgement of Profits"

Arnold & Porter Article

By: Jerome B. Falk Jr. and Michael A. Jacobs

Daily Journal
March 21, 2007

Misappropriation of trade secrets cases are frequent visitors to California courtrooms and, because the plaintiff is entitled to claim damages (Civil Code Section 3426.3(a)), are regularly tried to a jury. In addition to damages, a successful plaintiff may obtain the disgorgement of profits so long as it does not duplicate the plaintiff's recovery of money damages.

Litigants and trial judges often submit the issue of unjust enrichment disgorgement of profits to the jury along with the issue of money damages. Should they? Or is the determination of the "profits" from the misappropriation that must be disgorged to avoid "unjust enrichment caused by misappropriation" an equitable issue for the court?

Whether a statutory remedy is triable to the court or to a jury turns on "whether there exists a counterpart in English practice or whether the nature of the remedy involved resembles more a traditional legal, rather than a traditional equitable, remedy." Canavin v. Pac. Southwest Airlines, 148 Cal.App.3d 512 (1983); see also Pac. W. Oil Co. v. Bern Oil Co., 13 Cal.2d 60 (1939) ('"[A] legal and equitable remedy may be sought in the same action; but each remedy must be governed by the same law that would apply to it if the other remedy had not also been asked for"'). In this situation, the plaintiff is entitled to a jury trial on the legal remedy, but there is no right to a jury trial on the equitable remedy. Estudillo v. Sec. Loan & Trust Co., 158 Cal. 66 (1910); McCarty v. Macy & Co., 153 Cal.App.2d 837 (1957).

Moreover, in California, where the plaintiff seeks both money damages and equitable relief, the defendant has a strong argument that the equitable claim should be tried to the court first. That is because, in California, when equitable and legal issues are presented, the preferred procedure is to try the equitable issues first even if the result will be to deprive the plaintiff of a jury trial on the legal issues. Raedeke v. Gibraltar Sav. & Loan Ass'n, 10 Cal.3d 665 (1974); Nwosu v. Uba, 122 Cal.App.4th 1229 (2004) ("trial of equitable issues first may promote judicial economy"); 7 B. Witkin, CALIFORNIA PROCEDURE, Trial Section163 (4th ed. 1997).

Accordingly, if disgorgement of profits is equitable, a defendant charged with misappropriation of trade secrets will have a strong argument that the claim for disgorgement should be tried first. If the court finds that no misappropriation occurred, or orders disgorgement of profits in an amount that exceeds the claim for damages, nothing will be left to submit to the jury.

This prospect of defeating a demand for jury in a trade secret misappropriation case (or at least limiting the jury's role to the assessment of money damages) has been overlooked.

Unjust enrichment "is based upon equitable principles." First Nationwide Sav. v. Perry, 11 Cal.App.4th 1657 (1992); Hirsch v. Bank of Am., 107 Cal.App.4th 708 (2003). Consequently, many cases have held that remedies for unjust enrichment, such as disgorgement of profits, accounting, restitution and constructive trust, are equitable and can be granted only by a court. De Guere v. Universal City Studios, Inc., 56 Cal.App.4th 482 (1997) (accounting of profits); Am. Motorists Ins. Co. v. Superior Court, 68 Cal.App.4th 864 (1998) (insurer's claim for equitable restitution of overpaid defense costs); Van de Kamp v. Bank of Am., 204 Cal.App.3d 819 (1988) (action challenging bank's use of customer funds for its own profit); Getty v. Getty, 187 Cal.App.3d 1159 (1986) (constructive trust imposed to prevent unjust enrichment).

Thus, the restitutionary disgorgement relief available to remedy unfair business practices under Business and Professions Code Sections 17200 and 17203 is equitable and is for the court, not a jury, to decide. Korea Supply Co. v. Lockheed Martin Corp., 29 Cal.4th 1134 (2003) (a "UCL action is equitable in nature ... '[P]revailing plaintiffs are generally limited to injunctive relief and restitution"').

Notably, this restitutionary disgorgement remedy authorized by the UCL (as contrasted with nonrestitutionary disgorgement of profits, which is not available under the statute (Korea Supply Co.)) in some sense includes an element of injury: A plaintiff is entitled to the return of money or property that was once in its possession or money or property in which he or she has a vested interest, but no more. It thus overlaps in some sense with the concept of damages.

Given the well-settled principle that restitutionary disgorgement is a form of equitable relief, it follows a fortiori that nonrestitutionary disgorgement, which is not related to any actual loss suffered by a plaintiff, is even more obviously equitable. It could not be anything else.

Yet scant appellate authority addresses the question in the context of disgorgement of profits from a misappropriated trade secret. In Klamath-Orleans Lumber, Inc. v. Miller, 87 Cal.App.3d 458 (1978), the plaintiff sought money damages based on its lost profits. It tried to prove its losses by looking at the defendants' profits from the accused products as a proxy for what it might have earned absent misappropriation. Justice Otto Kaus explained that, because the plaintiff's ultimate goal was to measure its own losses and not the defendants' profits, the remedy invoked was one at law that was properly tried to a jury. However, the court carefully distinguished this money damage remedy from a remedy seeking disgorgement of a defendant's profits, which the court said would be equitable: "The fact that [the plaintiff] opted for this entirely legitimate method of proving its damages did not change the nature of the jury trial phase of the case: It remained an action for damages and did not become one for an accounting. ... [The] [p]laintiff did not try an equitable action for an accounting which would have sought to disgorge defendants' actual profits from those sales."

Although limited California precedent is squarely on point, federal decisions strongly support the view that disgorgement of profits from misappropriated intellectual property is an equitable remedy. Sperry Rand Corp. v. ATO Inc., 447 F.2d 1387 (4th Cir. 1971) (trade secret recovery traditionally has included "the damages sustained by the victim (the traditional common law remedy)" or "the profits earned by the wrongdoer by the use of the misappropriated material (an equitable remedy which treats the wrongdoer as trustee ex maleficio for the victim of the wrongdoer's gains from his wrongdoing)"; see also Sheldon v. Metro-Goldwyn Pictures Corp., 309 U.S. 390 (1940) (before Copyright Act, recovery of profits available only in equity "to prevent an unjust enrichment by allowing injured complainants to claim 'that which, ex aequo et bono, is theirs'"); Braun Inc. v. Dynamics Corp. of Am., 975 F.2d 815 (Fed. Cir. 1992) (distinction between damages and profits as remedies under patent law evolved separately in courts of law and equity); Maier Brewing Co. v. Fleischmann Distilling Corp., 390 F.2d 117 (9th Cir. 1968) (award of infringer's profits under Lanham Act can be either "a means of compensating the plaintiff for sales which he has lost" or it can be based "on the equitable concepts of restitution and unjust enrichment").

A party that wishes to avoid a jury trial should raise this issue at the earliest appropriate time and seek a determination by the trial court that the claim for disgorgement of profits from misappropriation is an equitable issue that will be tried first to the court. A plaintiff that wishes to preserve its right to a trial by jury on the misappropriation cause of action and the damages remedy may find itself forced to choose between abandoning its claim for disgorgement of profits and its desire to have a jury decide the case.

Jerome B. Falk Jr. is a director with Howard Rice Nemerovski Canady Falk & Rabkin in San Francisco and a certified specialist in appellate law. Michael A. Jacobs is a partner in the San Francisco office of Morrison & Foerster whose practice focuses on litigation of high-technology and intellectual property matters.

Copyright 2007 Daily Journal Corp. Reprinted and/or posted with permission. This file cannot be downloaded from this page. The Daily Journal ' s definition of reprint and posting permission does not include the downloading, copying by third parties or any other type of transmission of any posted articles.

Subscribe Link

Email Disclaimer