IBA/SBL Conference in Paris

Committee X

“International Franchising”

Sessions on 18 and 21 September 1995

KNOW- HOW AND TRADE SECRETS *

by Aldo Frignani

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(presentation by Prof.Avv.ALDO FRIGNANI
of Pesce, Frignani, Pastore & Ruben Torino, Milano, Vienna)


KNOW-HOW AND TRADE SECRETS


OUTLINE

1) Is there any difference between know-how and trade secrets?

2) What may be validly regarded as know-how.

3) The functional role of know-how in franchising contracts.

4) How to identify know-how as:

5) Is the condition that know-how be identified (in order to qualify for block exemption) sound?

6) The difference between “assignment” and “licence” of know-how.

7) How to transfer know-how in franchising contracts.

8) Clauses used to protect know-how:

9) Communication and protection of know-how in international franchising agreements.

10) Legal remedies:


1) Is there any difference between know-how and trade secrets ?

Many economists believe that the entire body of information that advantages the person who developed it or legitimately possesses it, and that its competitors would like to acquire and use, is of value and ought to be afforded legal protection. The development of this knowledge requires an investment by the enterprise, the incentive for such an investment is provided by its profitability, or advantage over competitors, and will continue to exist so long as one succeeds in protecting the secrecy of the knowledge from competitors.

This body of information is generally defined as "trade secrets".

A specific feature of “knowledge” or “secrets” is that their exploitation inevitably endangers their existence; in fact, even when the owner of an undertaking wants to use his secrets in his own business, he must necessarily disclose them to third parties (employees or other co-operators), consequently, the number of those who legitimately acquire knowledge of the secrets increases. If legislators do not provide legal obligations not to disclose the communicated knowledge (or use them for purposes other than those for which they had been communicated), or do not allow imposition of such obligations by appropriate contractual clauses, the knowledge so disclosed will perish in the same moment it is communicated. Measures for the protection of secrets can be set forth also by the owner of the undertaking himself (and in this case they will be of a “technical” or “organisational” kind). If legislative provisos are not sufficient to ensure an appropriate protection of secrets, the owner of the enterprise must use, of course, more complex measures. In any case, legal obligations cannot be completely replaced by the defensive measures set forth by the secrets’ owner, considering that their exploitation always takes place through third parties. (1)

The “undertaking” is an essential and unifying element of the economic and legal analysis of trade secrets because: They are formed in the carrying out of an undertaking (causal element); they are used for its management (teleological element); they belong to the owner of an undertaking (subjective element); and they are part of the assets of the undertaking (objective element).

"Know-how" is a kind of trade secret developed by the business community, first, in common language, and subsequently in legal drafting, particularly in international contracts, which led it to be considered as a category of its own, and, as a consequence, to the issuing, mainly in the EC, of specific disciplines. In fact, since know-how has begun to be considered as the subject matter of contracts, businessmen have tried to clarify its possible object and ways to protect it, as well as to distinguish between its assignment and its licence.

However, in some jurisdictions no difference is drawn between "know-how" and "trade secrets". In the USA, for example, know-how is undoubtedly considered as a trade secret, which includes, according to the Restatement of the Law of Torts, "any formula, device or compilation of information which is used in one's business, and which gives him an opportunity to obtain an advantage over competitors who do not know or use it." (2) Most of the American States have adopted the recently issued “Uniform Trade Secrets Act”, which defines trade secrets as “information, including a formula, pattern, compilation, program, device method, technique or process, that:

i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and

ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.” Moreover, while in some States the two concepts of “trade secrets” and “confidential information” are merged, in other States a distinction is drawn between the former and the latter categories; the latter including information that is “inherently short-lived in nature”, e.g. short-term plans, or ways to “improve” particular computer software. Confidential information is therefore less protected than trade secrets, particularly concerning the duration of non-disclosure contractual clauses. (3)

In Germany, know-how is unanimously considered as part of Unternehmengeheimnisse as well. (4)

In the EC, know-how is defined by art. 1.7.1 of Regulation Nr. 556/89 (block exemption for know-how licence agreements) as “a body of technical information that is secret, substantial and identified in any appropriate form.”

Regulation Nr. 4087/88 (block exemption for franchising agreements) defines know-how (of course “commercial” know-how, as opposed to “technical” know-how) as “a package of non-patented practical information, resulting from experience and testing by the franchisor, which is secret, substantial and identified” (art. 1.3.f).

In France, a statutory reference can be found (though the words "savoir-faire" are used, as a tribute to the well known ostracism towards English expressions) in the Decree 21 January 1967, on the transfer of technology, but no definition of "know-how" is offered . (5)

In Spain, no statutory definition is given; but, a wide analysis of the subject has been developed by legal scholars after a definition was given by the Tribunal Supremo in the case Mayo v. Thomson Brandt . (6)

In Switzerland, no specific statute expressly concerning know-how or trade secrets exists, but various provisions on this subject are spread throughout several federal and cantonal statutes. (7)

In many other countries, where special laws concerning the transfer of technology (8) have been passed, statutory provisos use the words "know-how", or include “secret”, “technical”, and/or “commercial knowledge” within their definition of "technology". (9)

The definition of trade secrets offered by the Korean “Unfair Competition Prevention Act” of 1991, includes any information which is secret, has an economic value, is related to technology or management, which is useful for productive or commercial activities, and is the object of substantial efforts to maintain secrecy. (10)

In Italy, there is no statutory definition of trade secrets or of know-how, apart from a very broad reference in art. 623 of the Penal Code to "information, intended to remain secret, about discoveries or scientific inventions, or industrial applications." Some definitions of know-how can be found, however, in the case law of the Court of Cassation. For example, in Metallurgica Italiana v. Schreiber, (11) know-how was defined as "the body of knowledge which, in the field of industrial technology, is needed in order to produce a good, or to put in practice a productive process, and the body of rules of behaviour which, in the field of commercial technique, are inferred from studies and entrepreneurial management experiences, regarding the organisational sector, or the stricto sensu commercial one." As may be shown by these decisions, the distinction between trade secrets and know-how, in Italy, is not clearly defined.

Jurists who have studied the relationship between know-how and trade secrets have expressed three views: First, know-how has a broader content than trade secrets; second, know-how has a narrower content; and third, know-how is identical to such secrets. Considering that even those who most doggedly search for possible differences between the categories (12) recognise that the rules laid down for trade secrets are, to a large extent, also applicable to know-how, it seems to me that the third opinion should prevail. (13)

2) What may be validly regarded as know-how

The body of information which forms know-how may relate to any object; it may include patentable, although unpatented, and unpatentable inventions, for example, computer software, (14) formulas, product testing and quality control techniques, and so on.

Concerning the possible object of know-how, reference must first be made to "technical secrets". According to legal scholars, this definition encompasses any technical knowledge apt to provide solutions to technical problems that are encountered in industrial activity.

Know-how also includes "commercial secrets", which are defined as “rules of behaviour derived from experience in the management of an enterprise and pertaining to the sector of organisation and trade.” (15)

The American Restatement of Torts adheres to a very broad notion of “commercial secrets” by including in its definition “any compilation of information”.(16) It is obvious that this is an almost unlimited category, and therefore, it is necessary to fix a minimum threshold, considering that what is intended to be protected is “the amount of effort required to develop the information”. However, it seems to me that there are two necessary elements for a commercial secret to receive protection: First, that the knowledge provides a competitive advantage to the owner of the enterprise, which he did not have before; and second, that in order to obtain this knowledge the owner of a competing enterprise must make investments. As we have seen, similar criteria have been used by the American “Uniform Trade Secrets Act”, which, however, adds a third element consisting of efforts made by the owner to maintain secrecy. (17)

However, if this view is accepted, commercial know-how cannot claim the same level of protection enjoyed by industrial know-how and technical secrets.

According to the Italian Court of Cassation, (18) the information which may constitute valid know-how may be "the most varied, and consist of processes, formulas, training procedures and, generally speaking, information of industrial or commercial interest." Specifically regarding commercial know-how, this notion includes lists of clients or suppliers, management techniques, financial and technical rules, ways and forms of determining prices and discounts, and so forth.

3) The functional role of know-how in franchising contracts

Commercial know-how is an essential element of franchising, even if, taken alone, it would not constitute a franchise. This statement finds its legal support in art. 1.3 a) of EC Regulation n° 4087/88, which includes the communication of know-how among the three essential obligations for franchising contracts.

This rule recognises the basic economic role of know-how in franchising contracts.

Know-how is of fundamental importance for both the franchisor and the franchisee. For the franchisor because its communication to the franchisee and its implementation by the same, together with the licencing of trade-marks, patents, etc., assures uniform commercial behaviour in distribution franchising. The uniformity of the network is of the utmost importance for the franchisor because it enables him to maintain a consistent image in the minds of the final consumers.

For the franchisee, the communication of know-how is, of course, of great economic value, because it allows him to use unpatented technology or commercial techniques, developed by the franchisor, and it acts as valid consideration for the payment of royalties. (19)

4) How to identify know-how as:

4.1) secret

Both art. 1.7.1 of EC Regulation n° 556/89 (block exemption for know-how licence agreements) (20) and art. 1.3 f) of Regulation 4087/88 (block exemption for franchising agreements) (21) require that know-how, "technical", in the first case, and "commercial", in the second, must be "secret".

Know-how is "secret", according to Reg. 556/89, when it is not generally known or easily accessible. Know-how need not be "absolutely" secret; it is sufficient that the information of which it is composed is not easily acquired. In other words, its transfer to the licensee must provide him with an economic benefit, allowing him to save time and money.

Moreover, it is not required that any single piece of information included in the licensed know-how is secret, being sufficient that the body of knowledge that forms know-how, taken as a whole, has such an economic value.

In so doing, EC law adheres to the s.c. theory of "relative secret", which was first developed by legal scholars with reference to trade secrets as a whole. (22)

In this connection, it must be emphasised that we can hardly imagine an absolute secret, unless one wants to attribute an impossible paradigmatic function to the hypothetical case of an owner of an undertaking, as a physical person, who alone has knowledge of the secret, and uses it by himself. Moreover, in the field of patentable inventions, the myth of absolute secrecy has disappeared, both because today research is made by teams, and because in the required testing phase several persons become familiar with the “secret”. This becomes even more apparent when one considers that in modern patent legislation, the required novelty corresponds to "non-availability to the public" (Art. 54.2 of the European Patent Convention, and thereafter introduced in all domestic legislations of the Member States).

Similar rules are contained in art. 1.3 g) of Reg. 4087/88, about franchising contracts, which state that "secret" "means that the know-how, as a body or in the precise configuration or assembly of its components, is not generally known or easily accessible, it is not limited in the narrow sense that each individual component of the know-how should be totally unknown or unobtainable outside the franchisor's business."

A variation of this approach has been adopted in the United States, where the parties may legally agree that the obligation to pay royalties will last indefinitely, regardless of whether the know-how may no longer be secret. (23) The Supreme Court has stated that this obligation is reasonable because of the competitive advantage granted to the licensee as the first company to sell the device.

4.2) substantial

Art. 1.7.1 of EC Regulation n° 556/89 requires know-how to be "substantial". The same requirement is included in art. 1.3 f) of Reg. n° 4087/88.

According to art. 1.7.3., "substantial" means "that the know-how includes information which is of importance for the whole or a significant part of (i) a manufacturing process, or (ii) a product or a service, or (iii) for the development thereof, and excludes information which is trivial. Such know-how must thus be useful, i.e. can reasonably be expected at the date of conclusion of the agreement to be capable of improving the competitive position of the licensee, for example by helping him to enter a new market or giving him an advantage in competition with other manufacturers or providers of services who do not have access to the licensed secret know-how or other comparable secret know-how."

According to art. 1.3 g) of Reg. 4087/88, "substantial" means "that the know-how includes information which is of importance for the sale of goods or the provision of services to end users, and in particular for the presentation of goods for sale, the processing of goods in connection with the provision of services, methods of dealing with customers, and administration and financial management; the know-how must be useful for the franchisee by being capable, at the date of conclusion of the agreement, of improving the competitive position of the franchisee, in particular by improving the franchisee's performance or helping it to enter a new market."

It is obvious that the two definitions are quite similar. The only difference being that the one given by Reg. 556/89 makes direct reference to "production" or "industrial" know-how, while the one included in Reg. 4087/88 is directly concerned with "commercial" know-how.

In both cases, the requirement of "substantiality" has to be considered under two points of view: Objective and subjective. The first pertains to the "inventive step" which, even if at a very low level, cannot be absent; therefore, "trivial information", according to Reg. 556/89, or "unimportant" information, according to Reg. 4087/88, disqualify an agreement from being exempted.

The other, subjective, refers to the practical utility that the information can grant to the licensee or to the franchisee. This requirement must be ascertained with reference to the actual position of the subjects at the date of the conclusion of the agreement.

Moreover, it must be noted that, according to Reg. 556/89, it is not necessary that know-how constitute a substantial portion of the manufacturing process, it is sufficient that it be important for only a "significant part" of the process. The same argument can be used for franchising: Know-how need not concern the whole commercial activity of the franchisee, it is sufficient that it includes "information which is of importance" for the carrying out of the same activity.

5) Is the condition that the know-how be "identified" (in order to qualify for block exemption) sound ?

Both Regulations 556/89 and 4087/88 require that know-how should be "identified" in order to qualify the agreement for a block exemption.

Art. 1.7.4 of Reg. 556/89 states that "the term ‘identified’ means that the know-how is described or recorded in such a manner as to make it possible to verify that it fulfils the criteria of secrecy and substantiality and to ensure that the licensee is not unduly restricted in his exploitation of his own technology. To be identified the know-how can either be set out in the licence agreement or in a separate document or recorded in any appropriate form at the latest when the know-how is transferred or shortly thereafter, provided that the separate document or other record can be made available if the need arises."

Art. 1.3. i) of Reg. 4087/88 similarly states: "‘identified’ means that the know-how must be described in a sufficiently comprehensive manner so as to make it possible to verify that it fulfils the criteria of secrecy and substantiality; the description of the know-how can either be set out in the franchise agreement or in a separate document or recorded in any other appropriate form."

The requirement of "identificability" has created great controversy. The actual texts of both Regulations state that know-how must be described, or recorded on a physical support. It is clear that the identificability by means of such a physical support can be required, not as a qualifying element of the subject-matter, but only ad probationem.

Doubtless, the communication of know-how can take place not only by way of the delivery of documents, but much more often through oral communication, or direct technical assistance or training.

Undertakings were opposed to inserting this requirement due to the difficulty of transferring the know-how into any "form" whatsoever. This objective difficulty (which concerns a limited number of cases, since in the great majority of them the description is included in the operating manual) (24) cannot lead, anyway, to forget that the lack of instruments of identificability makes impossible the control that the Commission has the duty to carry out.

The requirement of identificability is a precaution which the Commission pretends in order to apply block exemptions, considering that the exemption operates without any previous case by case analysis by the Commission itself.

Moreover, it must be said that such a requirement provides wider protection to the licensees, or to the franchisees, from whom it will be more and more difficult to obtain the payment of substantial royalties for non-existent or unimportant know-how.

Worth noting is that the “identification” of know-how is also required by U.S. Courts to enforce the contractual clauses which protect know-how: The enforcement of broadly written clauses may be refused when the information is not clearly confidential, or its secrecy has not been expressly recognised by the franchisee. (25)

The question then arises whether the requirement of identificability implies, as a consequence, that know-how licence agreements must be in written form. Although this happens in most cases, an accurate analysis of the rules leads to the conclusion that a valid franchising agreement, to which the block exemption is applicable, can be entered into without any written form, being sufficient that know-how is somehow documented. Indeed, the text of the regulation makes reference to a "separate document".

Obviously, the document in which know-how has to be described must not necessarily be a paper one. Both rules make clear reference to other forms of documents, including, any modern electronic technique of data storage and knowledge (e.g. films, tapes, diskettes).

6) The difference between "assignment" and "licence" of know-how.

Like any other good, know-how may constitute the subject matter of a contract.

First of all, know-how can be the subject matter of an "assignment". In such a contract the owner of the know-how communicates it, thereby transferring it to a third party, who can dispose of it as an owner without limitation, while the previous owner cannot exploit it any more. The prohibition, for the assignor, of any further exploitation, even in its own business is a consequence of the fact that, with the assignment, the assignee acquires all rights of exploitation of the know-how, without limitation. The legal effect of the assignment contract is usually strengthened by means of a non-competition clause, cast upon the assignor, that will last until the knowledge enters the public domain.

In contrast, with a "licence" of know-how, the owner of the know-how gives a third party the right to use it, under determined limitations of time, object and territory, while the proprietary rights remain vested in the licensor.

With regard to time, the duration of a licence of know-how cannot exceed the moment in which the entire know-how falls under public domain; if only some of the information which forms the know-how falls under public domain, the validity of the licence will be proportionally reduced.

As for the object, a licence may be limited to specified fields of activity or products only (the s.c. "field of use restrictions"), and in this case the licensor will maintain the right to exploit know-how, directly or through other licensees, in the remaining fields.

As for the territory, a licence can be granted without any exclusivity, with an exclusivity in favour of the licensee (i.e. who will not be exposed to competition from other licencees) or an absolute exclusivity, and in this case also the licensor is not permitted to compete with the licensee.


7) How to transfer know-how in franchising contracts

The franchisor must transfer his know-how to the franchisee. Of course, he will be interested in ensuring both that the know-how is correctly used by the franchisee, and that its secrecy is fully protected.

Moreover, the franchisor needs to reserve the right of further exploitation of the communicated know-how, both by using it in the business units which he manages directly and by communicating it to new franchisees.

The communication of know-how usually takes place, in practice, by means of an operational manual, developed by the franchisor, to be used by the franchisee, both during his training sessions and during the subsequent running of his business. This manual contains, in written form, all information required for the franchisee’s activity. It has been pointed out (26) that the manual will enjoy copyright protection, which, of course, could not be granted to a spoken explanation, and thus represents an essential way of protecting the franchisor’s know-how.

Moreover, know-how can be communicated by franchisor training of the franchisee and of his staff, as well as by practical tryouts of the commercial techniques, updated by means of periodical courses and/or meetings. Needless to say, the franchisor is responsible for on going communication of know-how for the entire duration of the contract.

8) Clauses used to protect know-how:

8.1) for the life of the contract

The protection of know-how is, of course, of basic importance for the franchisor; therefore, adequate clauses must be included in the franchising agreement.

Reg. 4087/88 includes some provisos concerning the clauses which the franchisor can legitimately impose on the franchisee, in order to safeguard the know-how, without losing the benefit of the block exemption.

A list of these obligations is included in art. 3.2. First, the franchisee can be required “not to disclose to third parties the know-how provided by the franchisor” (lett. a). Moreover, the franchisee can be required “to communicate to the franchisor any experience gained in exploiting the franchise and to grant it, and other franchisees, a non-exclusive licence for the know-how resulting from that experience” (lett. b, s.c. “grant-back clause”), and “not to use know-how licensed by the franchisor for purposes other than the exploitation of the franchise” (lett. d, s.c. “field of use restriction”).

The clause sub lett. a) directly affects the protection of the secrecy of know-how towards third persons. The duty to maintain the secrecy of the know-how can, of course, be legitimately extended to all staff and employees of the franchisee. On this point, it must be noted that, in any case, the franchisor is not obliged to disclose all of his trade secrets to the franchisee and/or its employees. For example, at least at an early stage of the relationship, he might not disclose his long-term business plans. Moreover, the franchisor can require the franchisee not to disclose the communicated know-how within its organisation more broadly than specified by the franchisor. (27)

Finally, it may also be extended to all persons entering into a business relationship with the franchisee in the ordinary course of his business.

The clause sub lett. b) provides for a licence which the franchisee can be contractually obliged to grant the franchisor on developments and improvements of the know-how that may result from his own business experience. Worth noting is that for a grant-back clause to be valid, art. 3.2 of Reg. n° 556/89 requires the further condition that the licensee be allowed to use the improvements of the know-how which are “severable from the licensor’s know-how”, or to licence them to third parties “where such licensing would not disclose the licensor’s know-how that is still secret.”

It has been pointed out (28) that the reason for this difference is found in the less “technical” character of the know-how developed by the franchisee, and because, the franchisor and the franchisees are part of a single network, they ought to “benefit collectively from commercial techniques developed by its members.” The Commission adopted a similar point of view in its Service Master decision, of November, 14, 1988 . (29)

The clause sub d) protects the franchisor from his know-how being used by the franchisee to set up an activity in competition with the franchisor. (30)

In most cases, it may be quite difficult to prove whether or not a breach of these contractual duties can be considered as “fundamental”. In order to avoid this risk, I suggest the franchisor ask the franchisee to declare, in the contract, that he learned all information included in the know-how directly from the franchisor. In other words, the franchisee must recognise that no piece of information included in the know-how was previously developed by himself.

If the know-how is completely and correctly identified, any violation of a contractual clause concerning the know-how will amount to a fundamental breach.

Art. 3.1.d of Reg. 4087/88 states that the franchisee can legitimately be requiered “not to acquire financial interests in the capital of a competing undertaking”. This rule, which gave rise to great controversy during its preliminary drafting, is apparently justified by the fact that this “would give the franchisee the power to influence the economic conduct of such undertakings.” But, I think its real rationale is to be found in the fact that such a financial interest would create a serious risk of the know-how being communicated to competitors, given that a very easy defence for competitors would be to claim that they developed the know-how themselves, while the onus probandi of the wrongful communication would be extremely difficult.

8.2) after its termination (post-term bans)

Many of the above restrictions may survive the termination of the contract.

Mention must first be made of the obligation not to communicate the know-how to third parties. However, art. 5.d states that the franchisee cannot be prevented from using the know-how after the termination of the contract if it has become generally known or easily accessible. Furthermore, it must be said that this rule cannot apply when the know-how has been made generally known by the franchisee himself, in breach of his contractual duty. Additionally, it is not sufficient for the know-how to be considered as generally known, of course, if it has been communicated by the franchisor to other franchisees, or to the master-franchisee and their employees (in fact, such communication is not made to the public at large).

On the contrary, the franchisee cannot be prevented from using its self-developed know-how for its own purposes, even immediately after the termination of the franchising agreement.

The obligation not to use the know-how for purposes other than the exploitation of the franchise (art. 3.2.d) may be extended after the termination of the agreement.

Another common post-term ban is the non-competition clause that is regulated by art. 3.1.c, which states that the franchisee can be obliged “not to engage, directly or indirectly, in any similar business in a territory where it would compete with a member of the franchised network, including the franchisor; the franchisee may be held to this obligation after termination of the agreement, for a reasonable period which may not exceed one year, in the territory where it has exploited the franchise” (note that such a clause is not eligible for exemption in the exclusive distributorship agreements, under Reg. n. 1983/83).

Problems arise with reference to the precise identification of the territory, and particularly, it is doubtful whether or not the wording of art. 3.1.c includes the territory previously allocated to the former franchisee. It seems that this territory ought to be considered as included, because the franchisor’s interest in maintaining the commercial value of his franchise package in this territory and attracting new franchisees, must be protected.

Additional problems arise with reference to the relationship between art. 3.1.c and art. 3.1.d, given that the latter does not provide any guidelines as to the duration of the clause after termination of the franchising agreement.

My opinion is that the franchisee legitimately ought to be prevented from indirectly competing with the franchisor or other franchisees through a financial interest in a competing undertaking. Moreover, it seems that the clause sub art. 3.1.d should be considered as extensible after the expiration of the franchise agreement also because of its ratio of protecting the know-how.

It must be said, however, that the Commission, in its Computerland decision, (31) opposed any further extension of the duty of non competition after the termination of the contract beyond the territorial and time limits of art. 3.1.c.

9) Communication and protection of know-how in international franchising agreements

International franchising agreements are usually drafted following the s.c. “master franchising” scheme. The “sub franchisor” may have two different roles: He may enter into agreements with each sub-franchisee on his own, and in this case there would be no contractual relationship between the franchisor and the sub-franchisees; or he may act as a “middleman” between the franchisor and the franchisees, who would enter into the contract directly with the franchisor. In the latter case the sub franchisor’s job is only to search and eventually choose the perspective franchisees. Furthermore, the sub- franchisor may manage a franchised business himself, thereby becoming a franchisee. He may also supply goods or services to the sub franchisees.

Finally, the parties of an international franchising contract may choose the s.c. “area development agreement” scheme. In this case, the franchisee is allowed to manage several points of sale in a given territory, directly or through subsidiaries.

The communication of know-how may take place in different ways, and under different limits, in each of the above mentioned kinds of international franchising contracts. In the first case, the know-how must be fully communicated from the franchisor to the sub-franchisor (regardless of whether or not he manages a franchised business himself), who will then be contractually obliged to communicate it to his sub-franchisees; moreover, the need to communicate further know-how, developed by the franchisor during his previous experience in attracting and choosing franchisees in his own country, may arise.

The main problem, in this case, is preventing the know-how from being disclosed by the sub-franchisees, who are not in privity with the original franchisor, and therefore, not obliged to maintain confidentiality. Statutory rules protecting trade secrets in the sub-franchisees’ countries may not, of course, be sufficient to grant effective protection.

Contractual protection of know-how can anyway be ensured, in my opinion, in two ways: By means of appropriate clauses included in the contract between the franchisor and the sub-franchisor; and/or of similar clauses included in the contracts between the sub-franchisor and the sub-franchisees.

The sub-franchisor may be held contractually liable for any breach of the obligation not to disclose the know-how by the sub-franchisees, their employees or co-operators. The disclosure of know-how may also be considered a breach of the subfranchisor’s obligation to carefully choose his sub-franchisees; however, the sub-franchisor may not be held responsible for such breach if, as is usually provided in international franchising agreements, the making of the contracts between the sub-franchisor and each of the sub-franchisees is subject to prior approval by the franchisor. In this case, a specific clause is needed to create such responsibility in the sub-franchisor.

Moreover, the sub-franchisor may be held liable, through an appropriate clause, for failure to set forth appropriate measures (e.g., to file suit in Court) against the breach of the obligation not to disclose the know-how included in the contract which it entered into with the sub-franchisees.

In the case when the sub-franchisor acts as a “middleman” between the franchisor and the sub-franchisees, no particular problems arise, because both the sub-franchisor and the sub-franchisees are contractually obliged to the franchisor not to disclose the know-how which the franchisor has communicated. It must be said, however, that in this case only a portion of the know-how may be communicated to the sub-franchisor; nevertheless, the sub-franchisor must acquire enough know-how to attract and to choose the necessary sub-franchisees, without whom he could not perform his contractual obligations.

It must be said that, if the sub-franchisor does not manage a franchised undertaking, the franchisor may not be obliged to communicate all of the information which the law of his country requires to be disclosed to the perspective franchisee, (32) because the contract which the sub-franchisor enters into with the franchisor cannot be strictly considered as a “franchising” agreement.

The information which the law requires to be communicated to the franchisee can be disclosed by the sub-franchisor as well as by the sub-franchisee, given that the eventual legally mandated “cooling-off” period between the disclosure of such information and the time the contract is entered into, is respected.

In the case of the “area development agreement”, problems may arise only when points of sale are managed by the area developer through subsidiaries (of course, if he manages directly his points of sale, he will be contractually responsible for any disclosure of the know-how). I think that the same contractual remedies proposed above may be used in this situation; moreover, in some countries (e.g., the common law countries), the area developer may be held directly liable for a breach of contract by his subsidiaries through “piercing the corporate veil”.

10) Legal remedies

10.1) Protection under criminal law

A comparative survey reveals two basic models:

a) The French model (which is also present in other legal systems, such as Italy, Spain and Switzerland, who have been influenced thereby) contains a specific provision in the Penal Code which calls for sanctions for any disclosure (or attempt of disclosure) of production secrets by employees or former employees (art. 418).

b) The German model, whose peculiarity lies in the fact that penal provisions are included in the special law concerning acts of unfair competition, with a detailed listing of different types of wrongful acts. Whereas § 17.1 UWG, of 1909, prohibits the disclosure of industrial or commercial secrets by the employees, § 17.2 punishes the unauthorised use or communication of an industrial or commercial secret (see also law of May 15, 1986, which extends the protection thereof). The German model has been followed, to some extent, by the “Unfair Competition Prevention Act” of Korea, passed December 31, 1991.

Other legal systems have penal provisions against the disclosure of secrets, scattered in various special laws (in the U.S.A., for example, the National Stolen Properties Act, 18 USC, § 2314, (33) and the “Computer Fraud and Abuse Act”, 18 U.S.C. § 1030).

A common feature of the two patterns is the rigid definition of the protected secret: The owner of an enterprise may not extend it to other information, whose nature goes beyond the legislative provisions, although he has the possibility of explicitly or implicitly renouncing legal protection.

The purpose of this type of provision is to encourage the research and development of new technologies. This purpose, of course, cannot be achieved by the owner of an enterprise without the “necessary” participation of internal and external collaborators, the addressees of the rule being, in the first place, such co-operators. (34)

It must be said, however, that recent developments show a tendency to apply the penal provisions to all persons who have obtained some information for specific purposes, but have then used or communicated it for other purposes (for Germany, § 17.2 UWG; for Italy, art. 623 of the Penal Code, for Brazil, art. 178, XII, of the Law n° 7903/45, for Switzerland, art. 162 of the Penal Code).

According to some legal systems (Germany, § 20, UWG, Argentina, arts. 45-49 of the Penal Code), the culpability for the crime of disclosing secrets is extended to third parties, such as instigators or accomplices (i.e. primarily, those who want to acquire the knowledge from the persons to whom the prohibition of disclosing secrets is addressed).

However, in these cases it is required that the third party knows, or ought to have known, that the person whom he asks to disclose the secret was obliged not to transmit it to him. Within these limits, this is also true for the Italian law.

On the other hand, the models do not coincide with regard to the scope of penal protection: While Italian law protects industrial secrets per se (art. 623), and commercial secrets only if their use or disclosure may cause prejudice (art. 622) to their owner, according to German law both industrial and commercial secrets enjoy the same protection. (35)

10.2) Protection in tort (unfair competition)

The provisions against unfair competition, by granting the protection of trade secrets, aim at avoiding competition being exercised by the owners of undertakings through the exploitation of someone else’s secrets, (i.e., the results of another’s work, investments, experience, and so forth) that someone else has created or made.

This explains why it is generally agreed that the protection granted trade secrets by the provisions on unfair competition is broader in scope than that afforded by penal provisions. For example, this includes not only discoveries, scientific inventions and industrial applications, but also methods of production, lists of clients, sales practices, commercial know-how, unpatentable inventions and models.

With regard to the legislative models, domestic legal systems can be divided into four categories: (36)

i) Those which are patterned upon German law (such as Austria, Switzerland, Luxembourg, and the Scandinavian countries), where a special law on unfair competition has been enacted, according to which the disclosure of trade secrets is condemned by special provisions, in addition to being subject to the general rule of fairness in trade (gute Sitten). For example, § 1 of the German UWG applies to infringements of trade secrets committed against the bonos mores, such as the instigation of someone else’s employees in order to spy on the secrets of a competitor, or the introduction of persons in a competitor’s premises, for the purpose of spying on his activity. (37)

ii) The Italian model is characterised by a broad provision included in the Civil Code (art. 2598), which prohibits specific acts such as confusion, disparagement, passing off, and so on (among which the disclosure of secrets is not explicitly mentioned), followed by a general rule which prohibits any other act contrary to the principles of correct behaviour in the trade (secrets are protected by such closing rule).

iii) The French model, (38) which is followed by many countries (such as Belgium, Holland, etc.), uses the general rule on tort liability. See art. 1382, Code Napoléon; art. 1382 of the Belgian Civil Code (but now see art. 54 of the law of July, 14, 1971, art. 1401 of the Civil Code in Holland, art. 1902 of the Spanish Civil Code).

iiii) In the common law countries, to protect secrets Courts follow a broadened interpretation of the tort called “breach of confidence”, since the tort of “passing off”, a key instrument for the development of the rules concerning unfair competition, is not applicable to tradesecrets.

It must be said, however, that in spite of such differences, the ultimate results achieved by the various Courts in individual cases are very similar.

Under the profile of unfair competition rules, trade secrets run the risk of being stolen in two ways: By spying; or by the abusive use by somebody who had previously, legitimately acquired knowledge of them.

Spying is an active conduct, either by the competitor or through an intermediary, aimed at acquiring knowledge of someone else’s trade secrets. There is no interest of any sort that could justify so-called industrial or commercial spying, which is treated very severely.

It is generally considered contrary to the provisions on fairness of competition to either disclose or to use, for the purpose of competition, secrets whose knowledge has been obtained in a wrongful manner. (39) Sometimes there is also a third additional requirement, i.e. prejudice or the risk of prejudice, but it seems to me that the possibility of prejudice is in re ipsa, if there was a real secret that has been unlawfully extorted.

10.3) Protection in contract.

In the normal course of business, trade secrets must inevitably be communicated to some persons.

Despite this fact, the holder of a secret can, in various ways, prevent the recipient from using or disclosing it, by means of appropriate contractual clauses: The clauses of this kind that can be legitimately included in franchising agreements have been discussed above.

Generally speaking, it must be remembered that duties of non-competition, which include the commitment not to use or reveal secrets, as well as specific duties of non-disclosure, (40) can legitimately be imposed on employees or former employees in all industrialised constituencies.

Contractual restrictions dealing with the use of confidential information with persons other than employees or former employees generally do not require specific compensation, but they must usually undergo certain limits in time, geographical area and field of activity, if they form the only subject matter of the agreement (non ancillary restraints). (41) In contrast, if they constitute ancillary restraints, no time limits are required, and the duration of the agreement may extend for the entire duration of the main contract. (42)

Contractual clauses for the protection of trade secrets may be included, of course, in both licence and sublicence agreements. However, all legal systems take care to avoid making the licencee or sublicencee undergo obligations that could not be imposed on third parties. In the industrialised countries, this control is exerted by antitrust provisions and in the developing countries by the rules governing the transfer of technology.(43)

It is impossible to list here the provisions about licences contained in the various antitrust laws (some references have been made above to EC Regulations).(44) Worth noting, however, is the emergence of the so-called “inherent restrictions” doctrine (or the restrictions covered by the patent), whose formulation found its clearest example in § 20 of the German GWB (a reference to this legislative provision has expressly been included in § 21 GWB, for licence agreements relating to industrial secrets): Such doctrine is also generally applied, by analogy, to know-how.

In the USA, the Courts and the antitrust enforcement agencies apply the so-called “rule of reason approach”.(45) According to the Department of Justice and Federal Trade Commission guidelines, adopted on April, 6, 1995, the clauses concerning the protection of know-how are subject to the standard antitrust analysis, which requires a comprehensive inquiry into market conditions. The American authorities share the opinion that intellectual property rights do not necessarily confer market power, and also that technology licences are generally pro-competitive, since they normally facilitate the combination of the licensor’s intellectual property rights with the complementary factors of production, including distribution facilities, owned by the licencee.

Although know-how licencing is different from franchising, it can however be inferred that clauses also protecting valuable know-how in franchising ought to be considered pro-competitive, and therefore admitted.

The approach within the EC is somewhat different, as we have explained above, since the Commission has preferred to enumerate, in general terms, the clauses which will be exempted and those which will not, instead of conducting a case-by-case analysis involving market condition research.


Turin, July 26,1995

Prof. Avv. Aldo Frignani

Published in Journal of International Franchising and Distribution Law, 1996,59-67

f/univers/relazion/iba.doc


(*) © Copyright Aldo Frignani, Turin, Italy [<<]

(1) See KITCH, The Law and Economics of Rights in Valuable Information, 9 J. Legal Studies, 1980, 689; BECKER, Human Capital: A Theoretical and Empirical Analysis, in Nat’l Bur. Econ. Res., 2nd ed., 1975, 29. [<<]

(2) See MILGRIM, Trade Secrets, New York, 1987 [<<]

(3) On this subject, see ASBILL, CUNDIFF, Protection of Know-how and Trade Secrets in the United States, paper presented at the IBA-SBL 12th Biennial Conference, Committee X, International Franchising, held in Paris on September, 21, 1995. [<<]

(4) See KRASSER, Grundlagen des zivilrechtlichen Schutzes von Geschäfts-und Betriebsgeheimmissen sowie von Know-how, in GRUR, 1977, 177; GAUR, Die Durchsetzung des Schutzes eines betriebsgeheimen Know-how, in WRP, 1988, 215; BEIER, The Protection of Trade Secrets in Germany with reference to other European Countries (report presented in Tokyo on June, 5, 1990, at the Intellectual Property Institute Conference). [<<]

(5) In JCP, 1967, III, n° 716. For the case law, see LAMY, Droit économique, sub “Les contrats de transfert de techniques”, 1991, 7700. See also M. BOURGEOIS, La protection juridique de l’information confidentielle économique. Etude de droit québécois et francais, in Cahiers de propriétE9‚ intellectuelle, 1988-1989, 1. [<<]

(6) In AJ, 1989, n° 3459; about this case see MASSAGUER, El contrato de licencia de know-how, Barcelona, 1989, 37. [<<]

(7) See M.H. ALBERS - K.E. LANDOLT, Protection of Know-how and Trade Secrets in Switzerland, paper presented at the International Bar Association Section on Business Law 12th Biennial Conference, Committee X, held in Paris on September, 21, 1995. [<<]

(8) For a list (updated to 1989) see FRIGNANI, Il contratto internazionale, Padova, 1990, 52; for the texts of these statutes see BORTOLOTTI - COSTA, I contratti internazionali di trasferimento della tecnologia, Milan, 1986. [<<]

(9) This is the case, for example, of the Argentine Decree n° 580/81, of 25/3/1981, and of the Portuguese Decree 197-D/86 of 18/7/1986. [<<]

(10) See LEE, Protection of Trade Secrets and Know-how in Korea, paper presented at the IBA-SBL 12th Biennial Conference, Committee X, International Franchising, held in Paris on September, 21, 1995 [<<]

(11) Court of Cassation, 27/2/1985, n° 1699, in Giur. It., 1986, I, 1, 889; similar definitions were given by the Court in the cases Kock Engineering v. Min. Finanze, 17/6/1981, n° 3931, in Dir. Prat. Trib., 1982, II,17; PZI v. Cividini, 20/1/1992, n°659, in Giur. It., 1992, I, 1, 1021. [<<]

(12) See, for example, MAGNIN, Know-how et propriété industrielle, Paris, 1974. [<<]

(13) This wiew is shared by DESSEMONTET, The Legal protection of Know-how in the United States of America, Geneva, New Jersey, 1976, 46: “Know-how is nothing more than trade secrets”. [<<]

(14) See REICHMANN, Computer Programs as Applied Scientific Know-How: Implications of Copyright Protection for Commrcialized University Research, in 42 Vanderbilt Law Rev. (1989), 639. The protection of computer software is one of the most discussed issues, at least in the U.S.: in recent years, patents for computer software are being issued, but problems remain, concerning, for example, the protection of source-codes. [<<]

(15) So the Italian Court of Cassation in the above mentioned case PZI v. Cividini. [<<]

(16) The conclusion of OPPENHEIM, Unfair Trade Practices, St.. Paul, Minn., 1974, 237, is that “Practically any knowledge or information is capable of protection as a trade secret”. [<<]

(17) The same is true with the Korean Law of December 31, 1991, which has been strongly influenced by U.S. law. [<<]

(18) Case PZI v. Cividini, already mentioned. See also BORTOLOTTI, La tutela del know-how nell’ordinamento italiano, in Dir. Econ., 1970, 549. [<<]

(19) For further observations see FRIGNANI, Il franchising, Turin, 1990, 157. [<<]

(20) See BURNSIDE, EC Know-how Regulation Analyzed, in LES Nouvelles, June, 1989, 68; KORAH, Know-how Licensing Agreements and the EEC Competition Rules. Regulation 556/89, Oxford, 1989; ID., An Introductory Guide to EC Competition Law and Practice, 5th ed., London, 1994, 216; GUTTUSO - PAPPALARDO, La disciplina comunitaria delle licenze di know-how, Milano, 1991. [<<]

(21) See KORAH, Franchising and EC Competition Rules, London, 1989; MENDELSOHN, HARRIS, Franchising and the Block Exemption Regulation, London, 1991; WELTRICH, Die EG- Gruppenfreistallungverordnug für Franchisevereinbarungen, in RIW, 1989, 90, GAST, Les procedures européennes du droit de la concurrence et de la franchise, Paris, 1989; FRIGNANI, The Block Exemption Regulation for Franchise Agreements Adopted by the European Community Revisited, paper presented at the IBA-IFA Joint Committe, held in Washington on May, 4, 1994. [<<]

(22) The American “Restatement ((First) of Torts”, Sec. 757, comment b) (1939) adheres to the same theory, stating that “Some factors to be considred in determining whether given information is one’s trade secret are: 1) the extent to which information is known outside its business; 2) the extent to which it is known by employees and others involved in his business...”. [<<]

(23) This rule was stated by the Supreme Court in the case Aaronson v. Quick Point Pencil Co., 440 U.S. 257 (1979). [<<]

(24) See RITTER, RAWLINSON, BRAUN, EEC Competition Law. A Practitioner’s Guide, Deventer-Boston, 1991, 241. [<<]

(25) See, for example, Electrocraft v. Controlled Motion Inc., 332 N.W. 2d 890 (Minn., 1983) [<<]

(26) MENDELSOHN, The Guide to Franchising, 4th ed., Oxford, 1984, 57. [<<]

(27) See ASBILL, CUNDIFF, supra, note 3. [<<]

(28) MENDELSOHN, HARRIS, Franchising and the Block Exemption Regulation, London, 1991, 93. [<<]

(29) In O.J., L332, 3/12/1988, 38, at n. 14. [<<]

(30) See also the Service Master decision, at n. 8. [<<]

(31) Decision 13/7/1987, in O.J., L222/12; see also RITTER, RAWLINSON, BRAUN, EEC Competition Law. A Practitioner’s Guide, Deventer-Boston, 1991, 244. [<<]

(32) For an analysis of the main “disclosure laws” see PETERS, Franchising: “To legislate, or not to legislate, that is the question , in Dir. Comm. Int., 1994, 615, 617 ff. [<<]

(33) See also GLANCY, The US Crime of Trade Secret Theft, in EIPR, 1979, 179. [<<]

(34) A similar approach is adopted by the Korean “Unfair Competition Prevention Act”: see LEE, supra, note 9 [<<]

(35) KRASSER, Grundlagen des zivilrechtlichen Schutzes von Geschäfts-und Betriebsgeheimnissen sowie von Know-how, in GRUR, 1977, 177. [<<]

(36) See FRIGNANI, item Segreti d’impresa, in Novissimo Digesto Italiano, App., VII,1987,10. [<<]

(37) See also Arts. 5 and 6 of the Swiss Law of Dec., 19, 1986. [<<]

(38) See LE STANC, Trade Secret Law-The protection of know-how in France, in EIPR, 1981, 13. [<<]

(39) For Germany see § 17.2, UWG; for Great Britain the Saltman case, of 1963. [<<]

(40) The difference of the two kinds of agreement is generally agreed about in the USA: see BLAKE, Employee Agreements Not to Compete, in 73, Harv. L. Rev., 1960; HAWKLAND, in The Protection of know-how in 13 Countries, (paper presented at the 8° International Congress of Comparative Law, held in Pescara, in 1970), Deventer, 1972, 134; for Canada see British Columbia C. of Appeal, 17/7/1984, Moore v. Carter, 1 C.P.R. (3rd, 1985, 171). [<<]

(41) See, for example, art. 2596 of the Italian Civil Code. [<<]

(42) More diffusively, see FRIGNANI, Prohibition of Competition, in Pinner’s World Unfair Competition Law Encyclopedia, Deventer, 1979, 330. [<<]

(43) For more references see SORDELLI, Sul Know-how, in Studi in memoria di Biscardi, Milano, 1984. [<<]

(44) For more references see ECKSTROM (editor), Licensing in Foreign and Domestic Operations, New York, 1985. [<<]

(45) On this subject see SUBIOTTO, Technology Licensing: the EC and US Rules Compared, paper presented at the Solicitors’ European Group Annual Conference, held in Brussels on June, 16 and 17, 1995; ASBILL, CUNDIFF, supra, note 3. [<<]