Amalgamated Industries Ltd. v. Tressa, Inc.

Citation: 69 F. App'x 255Docket: No. 01-5708

Court: Court of Appeals for the Sixth Circuit; June 13, 2003; Federal Appellate Court

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Tressa, Inc., a manufacturer and distributor of hair care products, appeals a district court judgment favoring Amalgamated Industries Ltd. (AIL) regarding a breach of a 1989 Licensing Agreement. The district court found Tressa liable for breach of contract and misappropriation of trade secrets after a three-day bench trial. Tressa contends that it cannot be held liable for breaching a contract that AIL had previously breached, citing res judicata and collateral estoppel. Tressa also argues that AIL's claim for misappropriation is barred by the statute of limitations.

The appellate court agrees that the Licensing Agreement was effectively terminated due to the prior suit but affirms the damages awarded to AIL based on Kentucky’s Uniform Trade Secrets Act, which allows for civil remedies outside of a contractual relationship. The court views AIL’s current complaint as part of a single claim of misappropriation linked to Tressa’s initial misappropriation, thus not barred by the statute of limitations.

The Licensing Agreement granted Tressa the exclusive non-transferable rights to manufacture and sell hair care products using AIL’s proprietary information. Tressa was to pay AIL a nonrefundable technical development fee of $100,000 and a licensing fee of 4% of net sales for as long as AIL's formulas and information were used. Tressa paid the development fee but modified AIL’s unstable formula, leading to the creation of a hair-coloring product line called Colourage. The court determined that 21 of the 35 shades marketed by Tressa were derived from AIL’s formulas without substantial alteration, while 14 were blends of those original shades.

Tressa failed to pay AIL the required royalties for hair color formulas, claiming it independently developed its Colourage line. Tressa filed a breach of contract complaint against AIL on August 10, 1990, initiating the 'prior litigation,' to which AIL counterclaimed for misappropriation of trade secrets. In a 1992 bench trial, the court found that AIL breached the Agreement by providing an unstable formula, while Tressa misappropriated AIL’s trade secrets in developing its products. The court ruled that AIL’s counterclaim was timely and awarded damages based on restitution rather than expectation damages, effectively rescinding the contract. AIL was granted a licensing fee of 1.68% on Colourage's net annual sales, which was a reduction from the original contract fee of 4%. Following the judgment, disputes arose over whether Tressa owed royalties on eight new shades developed post-trial. Tressa argued it developed these shades independently, while AIL contended that additional proof was needed to assess this claim, prompting the need to reopen the case. Tressa paid royalties for the original shades until February 1995, when it notified AIL of reformulated shades due to ingredient availability, leading to further disputes regarding payments. AIL requested an evaluation of the new formulas, which were found to be substantially derived from AIL’s originals. Efforts to resolve the matter included a 1997 conference call with counsel to consider reopening the previous litigation or initiating a new action.

Magistrate Judge Wehrman advised the parties on May 20, 1997, to file a motion in the original lawsuit, leading AIL to submit a motion on October 16, 1997, to enforce a previous final judgment. Subsequently, on October 29, 1997, the prior litigation was reopened, and a discovery schedule was established. During discovery, AIL found that Tressa had created two new hair-color products, Irresistible and Facets, which prompted AIL to file a new action claiming misappropriation of AIL's formulas. The parties agreed to consolidate this new action with the prior litigation on March 1, 1999, but on June 3, 1999, Judge Wehrman instructed AIL to pursue all claims in a new lawsuit instead.

A three-day bench trial was held by Judge Bertlesman starting December 4, 2000. Tressa moved to dismiss AIL's misappropriation claim as untimely after AIL's case concluded. AIL presented an affidavit from its counsel detailing pre-filing discovery efforts and the guidance from Magistrate Judge Wehrman. Tressa's response, filed nearly a month later, did not dispute AIL's facts.

On May 15, 2001, the district court determined that Tressa breached the Agreement by failing to pay royalties and improperly using AIL's formulas. Although AIL's claim regarding eight new shades was deemed untimely, the court found that the statute of limitations was equitably tolled for reformulated shades, with Tressa continuing to misappropriate AIL's trade secrets. AIL was awarded damages for unpaid royalties at 1.68% of net annual sales for both the eight new shades and the reformulated shades. AIL's claims regarding Tressa’s Facets and Irresistible lines were dismissed.

Tressa contended that AIL's breach of contract claim should fail under Kentucky law, which states a breaching party cannot enforce the contract. AIL argued Tressa waived this defense by not raising it at trial. However, Tressa had effectively presented this defense during the trial, asserting that AIL breached the contract and thus could not enforce it. The court agreed with Tressa, noting that AIL's undisputed initial material breach must be considered in assessing the contract's enforceability, referencing the case West Kentucky Coal v. Nourse.

In Webb v. Welcome Wagon, Inc., the Kentucky Supreme Court ruled that a company cannot enforce a noncompete clause against an employee if the company has breached a material provision of the contract. This principle applies to equitable relief and also holds in legal contexts, indicating that a party committing the first breach cannot later complain about a subsequent breach by the other party. The case of Daniel v. Ohio Casualty Insurance Co. further illustrates that Kentucky courts consider a first breach when evaluating contract enforcement.

In the current situation, the Agreement between AIL and Tressa was effectively rescinded due to prior litigation, even if the district court did not explicitly terminate it. The damages awarded aimed to restore the parties to their pre-contract positions, with all prospective damages calculated under the Kentucky Trade Secrets Act, as neither party adhered to the contract terms since then. Consequently, AIL's breach of contract claim fails, and Tressa's defenses of res judicata and collateral estoppel are moot.

Instead of a simple contract dispute, the case centers on Tressa's ongoing misappropriation of AIL's trade secrets obtained through the Licensing Agreement, which constitutes a single claim under the Act. AIL's original complaint was filed within the statute of limitations, making it valid, as the district court should have connected any further misappropriation to the prior litigation. The court's award of damages is upheld under the Trade Secrets Act rather than a contract claim. AIL's Information is acknowledged as a trade secret, with evidence showing Tressa's unauthorized use of AIL's formulas to develop new products, thus constituting trade secret misappropriation. A key point of contention remains the application of the statute of limitations, with ongoing debates over whether trade secret misappropriation should be treated as a continuing tort or a single tort at the time of the initial misappropriation.

The legal analysis compares two contrasting judicial interpretations of trade secret misappropriation: Underwater Storage, Inc. v. United States Rubber Company, which views misappropriation as a continuing tort allowing for multiple claims with each unauthorized use, and Monolith Portland Midwest Co. v. Kaiser Aluminum, which asserts that a claim accrues at the time of the first adverse use or disclosure, aligning with the 'confidential relationship' view. This divergence is rooted in differing theoretical foundations for trade secret protection, with the 'property' view allowing for ongoing claims versus the 'confidential relationship' view focusing on initial breaches. The Uniform Trade Secrets Act, endorsed in 1979 and adopted in Kentucky in 1990, rejects the continuing tort approach, stating in Section 365.890 that claims for misappropriation must be filed within three years of discovery or reasonable discovery. The Act treats continuing misappropriation as a single claim, with the limitation period starting upon discovery of the misappropriation. The comments to the Uniform Act emphasize the rejection of the continuing wrong doctrine and highlight the sufficiency of a three-year period for legal recourse. Section 365.894 mandates uniform application across states, encouraging consideration of interpretations from other jurisdictions, where courts have consistently ruled that misappropriation claims arise only at the initial act, guided by the discovery rule. This interpretation aligns with the ruling in Cadence Design Systems, affirming that continued misuse is classified under a single claim for statute of limitations purposes.

The court referenced several cases to clarify when the statute of limitations begins for trade secret misappropriation claims under various Uniform Trade Secrets Acts. In Read, Lundy, Inc. v. The Washington Trust Co. of Westerly, it was established that the statute of limitations is triggered when the plaintiff first becomes aware of the defendant’s misuse of confidential information, and subsequent acts of misappropriation do not create separate causes of action. Similarly, McLeod v. Northwest Alloys, Inc. confirmed that the limitation period starts with the unauthorized disclosure of a trade secret, not when it is used in operations. McCaffree Fin. Corp. v. Nunnink emphasized that the limitation period begins when the claimant discovers, or reasonably should have discovered, the misappropriation. The California Supreme Court in Cadence distinguished between acts of misappropriation and claims, stating that while misappropriation occurs with each wrongful disclosure, a claim arises only once at the time of the initial misappropriation, subject to a discovery rule.

In the current case, it was determined that if Tressa's actions regarding newly developed shades were treated as separate claims, AIL's complaint would be barred by the statute of limitations, as AIL was aware of these actions by 1993 and 1995. AIL filed a motion to enforce judgment in 1997 but did not file a new complaint until February 1999, exceeding the three-year limit. However, the initial act of misappropriation occurred when Tressa misappropriated AIL’s trade secrets in developing the Colourage line, which was discoverable in 1990. Thus, AIL's original complaint was timely filed within three years of this initial misappropriation. The court concluded that treating the new acts as separate claims would contradict the statutory purpose, and AIL's claim was preserved by its timely enforcement of the prior judgment.

Holding that AIL must initiate a new lawsuit for subsequent acts of misappropriation would prevent plaintiffs from pursuing claims related to new acts occurring more than three years after discovering an initial misuse, even if the plaintiffs acted diligently. If the first act of misappropriation by Tressa is considered the trigger, recognizing a new claim would result in it being barred by the statute of limitations, which is an inappropriate outcome. The district court should not have closed the previous litigation, and the current case should be viewed as part of that claim, which was filed within the statutory limitations period. 

Ruling otherwise contradicts the statute's intent to prevent splitting causes of action and would allow ongoing misappropriation without consequence beyond the three-year limit. Statutes of limitations are designed to prevent stale claims and promote diligence, and AIL's claim is neither stale nor reflective of a lack of diligence. AIL’s new claim arose due to procedural decisions by the district court rather than any delay in pursuing its rights.

The court affirmed the district court’s award of damages to AIL under Kentucky’s Uniform Trade Secrets Act. Tressa was entitled to recover $100,000 for technical development, deducting costs for producing shades based on AIL's formulas without a contract and Tressa’s expenses. The valuation was based on AIL's appropriated shades, totaling $42,000, indicating that AIL appropriated 42% of the product. From February 1995 to February 1999, Tressa paid royalties on net sales of shades not reformulated but stopped payments after February 1999 on all shades.