Early Dismissal of Trade Secret Lawsuit May Help Defeat Claim for Attorney’s Fees

By Zeb Anderson and Lauren Bradley

A lawsuit asserting intellectual property claims and violations of a non-competition and non-solicitation agreement played a dominant role in the second season of HBO’s comedy “Silicon Valley.” Throughout the season, it was clear that Hooli—the plaintiff and leading player in the relevant technology sector—was intent on using the lawsuit to punish a start-up competitor, Pied Piper, with high legal costs and to scare away its investors. Indeed, as the show acknowledged, the legal costs can be in the millions and the defense can be difficult to fund when the potential legal liability makes investors wary.

A trade secret lawsuit filed with the motive of harming a competitor would seem to be filed in bad faith, which provides a basis to seek attorney’s fees under North Carolina’s Trade Secrets Protection Act (N.C. Gen. Stat. § 66-154(d)) (the Act). However, based on a recent decision, it appears that the Business Court will apply an objective test to determine whether a trade secret claim was filed in bad faith. This may make it more difficult to recover attorney’s fees under the Act when a lawsuit is dismissed before discovery as to improper motives is conducted.

In a trade secrets lawsuit between software competitors, Judge James L. Gale denied the defendant’s motion for sanctions, including attorney’s fees under N.C. Gen. Stat. § 66-154(d), where the plaintiff undertook what the court found to be a reasonable investigation that supported a good faith belief in its trade secrets claim. Velocity Solutions, Inc. v. BSG, LLC, 2015 NCBC 51 (May 26, 2015). Erik Hoghaug worked for the plaintiff, Velocity Solutions, Inc. (Velocity), until he formed his own company and became a consultant for the defendant-competitor, BSG, LLC (BSG). Velocity sued BSG, alleging that Hoghaug brought Velocity’s trade secrets to BSG.

Velocity voluntarily dismissed its lawsuit without prejudice before conducting discovery in order to facilitate settlement discussions; however, BSG maintained from the inception of Velocity’s lawsuit that Velocity had failed to identify with specificity the allegedly misappropriated trade secrets and had failed to support its allegations of misappropriation. These two failures formed the basis for BSG’s motion for sanctions and attorney’s fees under N.C. Gen. Stat. § 66-154(d) (and Rule 11 of the North Carolina Rules of Civil Procedure) after Velocity voluntarily dismissed the suit. Section 66-154(d) allows a judge to award “reasonable attorneys’ fees” to the “prevailing party” if a trade secrets misappropriation claim is asserted in “bad faith.”

Judge Gale concluded that an improperly pleaded trade secrets claim does not inescapably lead to an award of attorney's fees. He cited recent decisions from his Business Court brethren, Judges Bledsoe and McGuire, and his own decision, Le Bleu Corp. v. B. Kelley Enterprises, Inc., 2014 NCBC LEXIS 66 (N.C. Super. Ct. Dec. 9, 2014), which this Website has previously highlighted, regarding the specificity requirements for pleading a trade secrets misappropriation claim and reaching the discovery stage on a trade secrets claim. According to Judge Gale, the foregoing decisions create a pleading standard under Rule 12 of the North Carolina Rules of Civil Procedure and a standard for whether the plaintiff is entitled to proceed with discovery under Rule 26, whereas § 66-154(d) requires that a different standard be applied to establish that the pleading was filed in bad faith.

Applying the foregoing, Judge Gale concluded that Velocity had an adequate factual and legal basis for its trade secrets claim based on its pre-suit investigation. Velocity’s pre-suit investigation, evidenced by affidavits of in-house and outside counsel, consisted of performing more than 20 interviews, scrutinizing publicly available information about BSG’s software, and consulting with counsel. Notably, Judge Gale specifically stated that his conclusion that Velocity should not be sanctioned did not mean that Velocity’s complaint would survive a motion to dismiss if re-filed.[1]

Based on Velocity, filing a vague trade secrets claim against a competitor that may not survive a motion to dismiss will not necessarily result in sanctions—even if the competitor suspects and contends that the lawsuit was filed for an improper motive, such as to gain leverage for an acquisition, which is the motive BSG imputed to Velocity,[2] or to put the competitor out of business. This precedent could encourage unscrupulous companies to initiate flimsy trade secrets lawsuits against competitors for improper motives, hoping that simply filing the lawsuit will provide them with a competitive advantage, while safely avoiding the risk of sanctions by dismissing the lawsuit before discovery can test their motives. While the Court in Velocity relied on the affidavit evidence of Velocity’s considerable pre-suit investigation efforts, BSG did not have the opportunity to challenge the legitimacy of these efforts through discovery.

This opinion also is noteworthy for at least two more reasons that are largely in the background of the opinion. First, Judge Gale aptly noted that our appellate courts have not conclusively stated whether the standard for bad faith is objective or subjective, but stated that it is more likely an objective standard, even though the application of a subjective standard would not change the outcome in this case. With the North Carolina Supreme Court now having appellate jurisdiction over final orders from the Business Court, it may be more likely that the North Carolina Supreme Court will speak to this issue in the future.[3]  Second, Judge Gale acknowledged that the inquiry under § 66-154 is “temporally broader and may extend beyond the pleadings,” whereas the Rule 11 analysis is confined to the pleadings and circumstances at the time the pleading was filed. Thus, an attorney’s fees claim under § 66-154(d) may allow a party to bring in more evidence than what is contained in the pleadings to support a finding of bad faith, as compared with limiting the evidence to the pleadings under Rule 11, although finding such evidence may be difficult if the lawsuit is dismissed before discovery. In future cases, one or both of these legal issues could come to the forefront as the courts, particularly the Business Courts, continue to provide more guidance on the standards applicable to trade secrets claims.

[1] Velocity, in fact, re-filed its complaint on March 30, 2015, and filed an amended complaint on June 26, 2015.

[2] See Defendants’ Brief in Support of Joint Motion for Attorney Fees Pursuant to NCGS
§ 66-154(d) and Sanctions Pursuant to N.C. Rule of Civ. P. 11, p. 2, 9.

[3] There appear to be no appellate cases regarding the final or interlocutory nature of an order regarding attorney’s fees under § 66-154(d), but the Court of Appeals has held that a grant or denial of attorney’s fees as a sanction for refusing to cooperate with discovery is a reviewable final order when the underlying suit is no longer pending. See Long v. Joyner, 155 N.C. App. 129, 134, 574 S.E.2d 171, 175 (2002) (“Ordinarily, defendants’ appeal from the sanction order would be dismissed as interlocutory. But here, the underlying legal issues in this case have been resolved by the parties in a settlement agreement. The trial court’s order appealed in this case constitutes the only unresolved issue in the case and therefore is appealable.”).


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