Malicious Theft of Trade Secrets Doesn’t Result in Nondischargeability, Circuit Says

Even though the actions were willful and malicious, a judgment for misappropriation of trade secrets under the Uniform Trade Secrets Act, or UTSA, is not automatically nondischargeable under Section 523(a)(6), because the UTSA only requires an intentional act, not an intent to injure, according to the Fourth Circuit.

The opinion means that egregious behavior does not result ineluctably in nondischargeability.

The Misappropriation

The debtor had been employed by an aerospace contractor, where he had access to his employer’s trade secrets used in upgrading aircraft. The employment contract forbade him from disclosing confidential information to third parties.

The debtor quit and took a job with a competitor of his former employer. Allegedly, he and his new employer used the former employer’s trade secrets to bid successfully on new aircraft maintenance jobs.

The former employer sued the competitor in Arizona state court and sued the debtor in federal district court in Alaska. The district judge in Alaska stayed the suit, waiting for the Arizona case to play out.

The Arizona court conducted a 40-day bench trial and entered judgment against the debtor’s former employer for more than $20 million under Arizona’s version of the UTSA. Finding that the former employer “willfully and maliciously misappropriated” trade secrets, the judgment by the Arizona court included about $13 million in exemplary damages.

The debtor was not a party to the Arizona action. The Arizona court made no finding that the debtor intended to injure his former employer.

Once the Arizona judgment came down, the Alaska district court soon granted summary judgment in favor of the plaintiff, finding that the debtor was collaterally estopped from relitigating issues raised in Arizona because he was in privity with his new employer.

The Alaska court entered judgment for more than $20 million against the debtor for violation of Alaska’s version of the USTA, among other things. The judgment included the same amount of exemplary damages.

The Bankruptcy

The debtor responded to the judgment by filing a chapter 7 petition in Virginia, where the plaintiff objected to dischargeability of the judgment under Section 523(a)(6). The bankruptcy judge denied a motion for summary judgment in favor of the plaintiff.

The district court in Virginia granted leave to appeal, reversed the bankruptcy court, and directed the bankruptcy court to enter judgment declaring that the debt was nondischargeable. The district judge said that a willful and malicious injury barred discharge.

Reversal in the Circuit

The debtor appealed and won a reversal and remand in a May 8 opinion by Fourth Circuit Judge Stephanie D. Thacker. In sum and substance, she ruled that neither the Arizona nor the Alaska court had found that the debtor intended to injure. The courts only found that his actions were intentional.

The appeal turned on Section 523(a)(6), which provides that a debt is nondischargeable in an individual’s chapter 7 case if the debt was “for willful and malicious injury by the debtor to another entity or to the property of another entity.”

The Rule from the Supreme Court

Judge Thacker began with Kawaauhau v. Geiger, 523 U.S. 57, 61 (1998), where the Supreme Court declared that nondischargeability under Section 532(a)(6) requires “a deliberate or intentional injury, not merely a deliberate or intentional act that leads to injury.” [Emphasis in original.]

Judge Thacker based her ruling in significant part on the Fourth Circuit’s only published authority on Section 523(a)(6), In re Duncan, 448 F.3d 725 (4th Cir. 2006), where a mother had been assessed punitive damages for the wrongful death of her adoptive daughter.

The Fourth Circuit held that the damages were dischargeable, Judge Thacker said, because the “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.

Applying the Law to the Facts

Turning to the case on appeal, Judge Thacker said that the standard for “willful and malicious” under the UTSA “fall[s] below the Geiger standard.” Further, she said that the Arizona and Alaska courts’ findings of an intentional and purposeful misappropriation “is still not enough.”

Judge Thacker reasoned that the judgment was dischargeable because the Alaska court did not determine that the debtor “intended for [the plaintiff] to be injured by that misappropriation.”

Judge Thacker had a second ground for her conclusion that collateral estoppel did not apply: The debtor’s intent to injure was not “actually decided” in Alaska.

True, the Arizona court had found that the new employer intended to injure the plaintiff. However, the Alaska court only applied collateral estoppel against the debtor by ruling that the debtor was in privity with his new employer.

Judge Thacker said that the Alaska court made no findings that the debtor intended to injure his former employer. She said that collateral estoppel did not apply because the debtor’s intent to injure “was neither actually decided in, nor essential to, the Alaska action.”

Judge Thacker reversed and remanded the case for further proceedings in bankruptcy court. The debtor is not out of the woods, though, because the plaintiff had other grounds for contending that the judgment should be nondischargeable. And, of course, the plaintiff could hold a trial in bankruptcy court and prove intent to injure under Section 523(a)(6).