Despite ‘egregious’ theft of trade secrets, damages hard to prove

Pure Power Boot Camp v. Warrior Fitness Boot Camp, 2011 WL 4035751 (S.D. N.Y.) (Sept. 12, 2011)

While working as a Wall Street trader, the plaintiff got inspired to start her own physical fitness studio, based on a military boot camp. She visited Fort Knox to research the design, and after investing substantial time and all her savings, she opened the first “Pure Power Boot Camp” in New York City in 2003.

Unique concept. The studio used military camouflage colors and obstacles fitted to the smaller, indoor facility, with flooring made of crushed rubber tires, separated by sand bags, and a running track overhead. Unlike other personal gymnasiums, the “Boot Camp” did not charge a membership fee but enlisted clients as “recruits” who signed up for returning “tours of duty,” outfitting each in camouflage pants and a “Pure Power” t-shirt. The owner hired former marines as “drill instructors,” including two who became her most trusted and sough-after employees.

The studio was an immediate success, and the owner planned to franchise the operations. She had each instructor sign an Employment Agreement, which required them to “devote their skills and best efforts” to the company and contained non-disclosure, non-compete, and non-solicitation provisions. She also registered the “Pure Power” trade dress, receiving a service mark consisting of drawings for an “exercise facility styled to look like a military boot camp training course.”

The owner also opened a second studio just outside Manhattan. She offered one of her top two instructors the option to become a partner in this second studio—but he declined, saying he didn’t have the money. In reality, he was planning his own military-themed gym with the other instructor. Backed by investments from their girlfriends, the two instructors leased a space just fifteen blocks away from the Pure Power studio. They also stole documents from the owner’s office and personal computer, including Pure Power’s business plan, its start-up and operations manuals, and its client list. They also destroyed a folder full of employment agreements—including their own.

The instructors used the stolen materials to launch their “Warrior Fitness Boot Camp.” The sent emails to Pure Power clients, providing detailed description of Warrior Fitness and its classes that closely mirrored Pure Power’s promotional materials. They also disparaged the owner of Pure Power to potential clients. In the spring of 2008, one of the instructors engaged in a “heated exchange” with the owner, prompting her to fire him; within two weeks, the second instructor quit, leaving the studio understaffed.

Three weeks later, the owner discovered the theft of her confidential materials and the plans to open Warrior Fitness by reading her former employees’ personal emails, stored on the company’s computer. In May 2008, she sued both instructors in state court, seeking a temporary restraining order against opening their competing business. The court denied the request, finding that the non-competition agreement was unenforceable, but nevertheless ordered the defendants to return the stolen materials and alter the Warrior Fitness décor to remedy some of the trade dress issues.

Plaintiffs also lose their expert. The defendants then removed the action to federal court and sought to preclude the plaintiff from using their personal emails. The court agreed that the plaintiff’s access of the employees’ personal email accounts, without their permission, violated the federal Stored Communications Act (18 U.S.C. § 2701 et. seq.), and ordered $4,000 in damages. In a pre-trial Daubert proceeding, the court also precluded the plaintiff’s damages expert from testifying as to lost profits, finding that he used a “fundamentally flawed methodology” by calculating lost profits over a ten-year period without adequate support. (Note: research indicates the court made this ruling from the bench rather than in a published opinion.)

The parties subsequently agreed to a bench trial, at which the court considered the plaintiff’s claims that the defendants breached their employment contracts and their common law duties of loyalty, infringed the plaintiff’s trade dress and committed torts of interfering with her prospective economic advantages and contracts.

After a review of the facts and evidence, the court found that the defendants clearly breached the non-disclosure provisions in their employment agreements. As compensatory damages, the plaintiff submitted two alternative measures of lost profits for the claimed damages period (May 2008 to December 2010). First, she attributed all of Warrior Fitness’s revenues to Pure Power and then applied the latter’s 58% profit margin to yielded nearly $1.4 million in lost profits. Second, she took the 147 clients that the defendants had allegedly stolen and, asserting average annual revenues for each of $2,655.00, arrived at nearly $355,000 in damages.

To recover lost profits for breach of contract under New York law, however, the plaintiff needed to show not only that the employment agreement contemplated such a remedy, but that the defendant’s breach caused the loss, which was “capable of proof with reasonable certainty,” the court explained. Based on the evidence presented, the plaintiff failed all three requirements. First, the employment agreements made no reference to lost profits and there was no proof that the parties contemplated such when they entered the contracts.

Second, “regardless of the alternative measures of lost profits offered by the plaintiff,” she failed to establish that her losses were caused by the breach of the non-disclosure agreement, the court held. In other words, there was no proof that “but for” the employees’ stealing her records and client lists, they would not have opened Warrior Fitness. Nor did the plaintiff show that use of the client list was the specific reason why 147 former clients signed up for Warrior Fitness.

Finally, the plaintiff’s proof of lost profits failed for lack of reasonable certainty. Attributing all of the defendants’ profits to Pure Power was “overreaching, inherently speculative, and cannot be tied to the breach,” the court ruled. More importantly, although the relevant information was available to the plaintiff, she chose to ignore the actual financial data in the case, preferring to rely instead on the “mass asset” theory that her expert had promulgated.

“Here, the plaintiff’s lost profits calculation with respect to the 147 allegedly solicited Pure Power clients is based, not on Pure Power’s financial statements or on the actual revenue generated by those clients, but instead on [her expert’s] excluded…report,” the court stated. Although she claimed that her expert’s limited trial testimony established the existence of those 147 clients, the court disagreed, and, “in any event,” found that it had excluded the expert’s report as “inappropriate” to the case. The plaintiff tried to argue that financial evidence in the case established her 58% profit margins, but the court found this number came directly from the “arbitrary” assumptions in her expert’s excluded report, and denied lost profits for breach of contract.

Misapplication of the law for breach of loyalty. The facts of the case clearly established the defendants breached their common law duty of loyalty to the plaintiff, for which she claimed a disgorgement of their profits during the damages period, or close to $2.4 million. Although New York law permitted the plaintiff to recover “an accounting of the disloyal employee’s gain” through a profit disgorgement, the court said, it also required that she show the breach took place during the time of employment and was a “substantial factor” that contributed to the defendants’ gain.

In this case, the defendants opened up their competing gym after the plaintiff terminated them, the court emphasized. Further, the plaintiff “mistakenly conflates [the] defendants’ breaches of loyalty with the profit they earned by opening a competing business.” As with the breach of contract, the documents stolen by the defendants were not a “substantial factor” enabling them to open Warrior Fitness, the court said. Instead, “it was the knowledge [they] gained as trainers at Pure Power that was key.” Accordingly, it denied the plaintiff’s requests for damages for breaches of loyalty.

At the same time, the court found the defendants liable under the New York “faithless servant” doctrine. This entitled the plaintiff to recover the compensation that she paid the defendants while they still worked for her and acted adversely to her business interests, which began in August 2007 with their theft of documents, the court found, and continued until approximately April 2008, when they were terminated. Accordingly, it ordered the defendants to forfeit a total of roughly $96,000.00 in salary between them. In addition, it ordered the defendants to pay an additional $150,000 in punitive damages for their “egregious” betrayals of the plaintiff’s trust. (Final note: research also reveals that the case is currently under appeal.)