Wednesday, June 12, 2019

Theft of Trade Secrets Does Not Always Equate to the Non-dischargeability of a Debt in Bankruptcy

By Bill Siegel

TCK Aerospace Inc. v. Muhs (In re Muhs), 18-1372 (4th Cir. May 8, 2019)
 
Things do not always seem to be what they appear to be.  A judgment was entered against the debtor for misappropriation of trade secrets under the Uniform Trade Secrets Act (“UTSA”).  Yet, the Fourth Circuit Court of Appeals refused to apply collateral estoppel and reversed the U.S. District Court ruling that the debtor was collaterally estopped, i.e. precluded, from relitigating whether his actions were willful and malicious when he misappropriated trade secrets of his former employer, the judgment creditor.  The net effect of said reversal was to require the judgment creditor to re-try a 40-day trial in Arizona in order to object to the dischargeability of its claim against the debtor.
 
For background, the debtor quit his job at TCK Aerospace (“TCK”) to work for a competitor.  Even though he had contractually agreed not to disclose trade secrets, he so did anyway.  His former employer sued the competitor in state court in Arizona under Arizona’s version of the USTA, and sued the debtor in Federal Court in Alaska under Alaska’s version of the USTA.  The Alaskan Court stayed the matter until the Arizona matter had concluded.  A judgment was entered against the debtor's new employer for more than $20 million, of which about $13 million constituted punitive damages, with a finding that the new employer "willfully and maliciously misappropriated" trade secrets. As soon as the judgment was entered, the Alaskan court granted summary judgment for more than $20 million, which also included punitive damages, against the debtor for violating Alaska's version of the USTA. The judgment included the same amount of exemplary damages.
 
The debtor then filed Chapter 7 bankruptcy. As expected, the judgment creditor objected to the dischargeability of the judgment under Section 523(a)(6) of the Bankruptcy Code.  There, the bankruptcy court denied the judgment creditor’s motion for summary judgment refusing to apply collateral estoppel (Issue Preclusion). The district court reversed, finding the debtor’s actions constituted willful and malicious injury.
 
In reversing the District Court, the Fourth Circuit first focused on the Supreme Court Case, Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998).  There the Supreme Court declared that nondischargeability under Section 532(a)(6) of the Bankruptcy Code requires "a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury."  The Fourth Circuit then focused on one of its 2006 decisions, In re Duncan, 448 F.3d 725 (4th Cir. 2006), where it found that a “conscious disregard or reckless indifference” standard for punitive damages did not rise “to the level of intent to injure required by Geiger.” Id. at 730.
 
The court then analyzed the Arizona and Alaskan Courts’ decisions and noted that it was not enough to find an intentional and purposeful misappropriation to preclude the debtor from arguing that he did not intend to injure his former employer/the judgment creditor when he misappropriated trade secrets.   
 
The Fourth Circuit further found that the Alaskan Court never really decided whether the debtor intended to injure his former employer/the judgment creditor.  The Arizona court had ruled against the debtor’s new employer, but the debtor was never a party to said action.  The Alaskan court had only applied collateral estoppel against the debtor by ruling that the debtor was in privity with his new employer. The Alaskan court never found that that the debtor intended to injure even though the debtor’s actions were intentional.  Thus, the Alaskan Court’s ruling had no real effect on whether the debtor intended to harm his former employer.
 
The effect of reversing the District Court and affirming Bankruptcy Court was to require the judgment creditor/former employer to retry the case. 
 
Even though Texas is in the Fifth Circuit and the Fifth Circuit may take a different position, it perhaps is wise that when seeking punitive damages, eliciting testimony that the defendant intended to injure could preclude the defendant, and later, a debtor in bankruptcy, from getting a second bite at the apple, i.e. forcing a judgment creditor to retry a matter in which it had already succeeded.  

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