Ethics Clawback Policy: Backstop to Lost Profits in a Trade Secret Fight

When an employee goes Benedict Arnold and defects with a jump drive (or DropBox account) full of your trade secrets, you know what you want – an injunction to stop him from using your secrets against you, along with money damages from both the ex-employee and his new employer.

But taking a court judgment for your lost profits isn’t always a lock. That’s one reason why ethics clawback policies deserve a close look.

One company found out about lost profits the hard way in Radiant Financial v. Bagby. Although the jury awarded the company over $900,000 for trade secret theft, the judge took it away and handed down a judgment for the defense. Lost profits, said the Dallas appeals court, hadn’t been proven well enough. Only $152,916 of the jury award was lost profits, but the lost profits were needed to support the remaining $600,000 for attorney’s fees and $150,000 for exemplary damages. (Yes, the company had spent $600,000 prosecuting the case to wind up empty-handed!)

Here’s the quick rundown. The company set up an independent financial advisor as an agent to pitch its fractional life insurance settlement products as investments. The advisor signed an agreement that had a non-disclosure provision. When the advisor brought the company 59 investors who’d deposited money in escrow for a closing on their investment, the company couldn’t close the deal. It didn’t have any life insurance policies that met the investors’ criteria – and had no direct leads to acquire satisfactory policies. The company’s expert witness on lost profits assumed that the company would eventually secure satisfactory policies because its management assured him they had “always been able to place policies” with investors.

The Dallas appeals court had a big problem with that. Texas courts are comfortable handing out awards for lost profits when they’re provided with “reasonable certainty.” Although company’s proof doesn’t have to be “exact,” it can’t be “speculative.” The court couldn’t stomach the company’s bold prediction that it would have satisfied the investors’ criteria – when it had nothing in hand. Lost profits tossed into the waste basket.

Think about the implications of this ruling for startup ventures or moves into new markets.

That’s one reason why some companies have implemented an ethics clawback policy. The policy says that when an employee violates the company’s serious ethical standards – like stealing trade secrets, bribing foreign officials or hauling off with a SOX violation – the company can claw back its incentive compensation. Everything from commissions, to signing bonuses, to retention bonuses, to stock options, to other incentive compensation can be subject to clawback.

Careful with state law, though. If a form of incentive compensation qualifies as earned wages under state law, it probably can’t be clawed back.

And frankly securing an injunction isn’t easy either, so we’ve written about that before in a Texas Lawyer article here.