Self-Dealing Lawyer Held Jointly and Severally Liable in Trade Secret Misappropriation

By on March 17, 2022
Posted In Trade Secrets

The US Court of Appeals for the Fifth Circuit affirmed a judgment holding a lawyer jointly and severally liable for trade secret misappropriation and fraudulent transfer and enjoining any further use of the trade secrets until a money judgment against the lawyer-purchased client business was satisfied. Thomas v. Hughes, Case No. 20-50671 (5th Cir. Mar. 3, 2022) (Wilson, J.)

James Pearcy founded Performance Products, Inc., (PPI) to develop and sell probiotics for livestock. In 2006, Pearcy sold PPI to his lawyer, Lou Ann Hughes. Hughes paid cash for PPI’s stock and agreed that PPI would pay Pearcy a 14% licensing royalty for use of his proprietary formulations, up to $1.35 million over five years, at the end of which PPI would have the option to purchase Pearcy’s formulations for $100,000. When PPI did not fully pay the royalties, Pearcy brought a Texas state court action against Hughes and PPI for breach of contract, misappropriation of trade secrets and breach of fiduciary duty. The jury found for Pearcy, and the Texas court entered judgment against PPI in the amount of $1 million. Hughes and PPI appealed the Texas judgment and posted a supersedeas bond, but the appeal was unsuccessful. Pearcy received the supersedeas bond, but PPI never paid the balance of the judgment. Pearcy sought post-judgment discovery and set a hearing on a motion to compel. The day before the hearing, PPI filed for bankruptcy.

Earlier, in 2006, Hughes had formed a second entity called Performance Products International, LLC. At the time of the Texas judgment, the LLC had no assets. During pendency of the Texas appeal, Hughes changed the second entity’s name to Performance Probiotics, LLC, and obtained a license to sell and distribute commercial livestock feed. In January 2012, Hughes ceased selling products through PPI and began selling them through the LLC. Hughes also formed a third entity called Advance Probiotics International, LLC (API).

Shortly after PPI declared bankruptcy, Pearcy’s widow (also Pearcy) and PPI’s bankruptcy trustee (Thomas) sued Hughes, Performance Probiotics and API in federal court for misappropriation of trade secrets and fraudulent transfer of PPI’s assets in violation of the Texas Uniform Fraudulent Transfer Act (TUFTA). The plaintiffs sought to pierce the corporate veil of both Performance Probiotics and API, alleging that Hughes had used them to commit fraud. Thomas further alleged that Hughes had breached her fiduciary duty to PPI. At trial, the jury found for Pearcy and Thomas, awarding about $1.4 million plus interest in actual damages, which was derived from the amount then due under the Texas judgment. The jury further awarded $1.2 million in exemplary damages., The district court entered final judgment, further ordering Hughes to disgorge $860,000 in compensation from Performance Probiotics. The district court enjoined Hughes and Performance Probiotics from using Pearcy’s trade secrets until the judgment was fully satisfied and held Hughes and Performance Probiotics jointly and severally liable for “all relief granted” and “all amounts due” under the Texas judgment. The district court retained jurisdiction over API in case Hughes transferred any assets to that entity. Hughes filed a motion under Rule 50(b), which the district court denied. The district court further awarded Pearcy and Thomas $380,000 in attorneys’ fees and almost $30,000 in expenses. Hughes appealed.

Hughes challenged the sufficiency of the evidence to support the verdict of trade secrets misappropriation (specifically that Pearcy had any trade secrets and that Hughes or Performance Probiotics improperly used any such trade secrets) and challenged the damages award. The Fifth Circuit held that Hughes had waived the first two issues by not raising them in her Rule 50(a) motion. As to the damages award, Hughes argued that the Texas award was an inappropriate measure of compensatory damages because it included attorneys’ fees and prejudgment interest. The Court rejected Hughes’s argument because those amounts represented additional losses incurred because of PPI’s breach and misappropriation. Hughes further argued that the award of exemplary damages was inappropriate because the evidence was insufficient to prove that she acted with malice or gross negligence. Hughes did not, however, challenge the sufficiency of the evidence of fraud, and the Court found that notwithstanding waiver, there was sufficient evidence that Hughes committed fraud. Because fraud is an independent basis for awarding exemplary damages, the Court affirmed the award.

Hughes also challenged the propriety of the injunctive relief. She argued that an injunction was inappropriate because an amount of money had already been found that would compensate Pearcy for any misappropriation of trade secrets. The Fifth Circuit rejected this argument because Hughes had no right to use the trade secrets until the money judgment was paid, and Hughes’s failure to pay the Texas judgment showed that the entry of judgment alone would not provide an adequate remedy, making an injunction pending payment of the judgment appropriate.

Hughes also challenged the sufficiency of the evidence to support the verdict of breach of fiduciary duty. The Fifth Circuit found that there was evidence that Hughes had an attorney-client relationship with PPI in 2012, and therefore, she owed PPI a fiduciary duty. The Court found that Hughes had engaged in a self-dealing transaction that created a presumption of unfairness that had not been rebutted and thus supported a finding of breach of fiduciary duty. The Court held that disgorgement of attorneys’ fees paid to Hughes by Performance Probiotics was appropriate because the money that Performance Probiotics used to pay Hughes was derived from the self-dealing transaction—the money belonged to PPI all along.

Hughes challenged the sufficiency of the evidence to support piercing of the corporate veil. The Fifth Circuit affirmed, noting the finding of actual fraud under TUFTA and that the fraud redounded to Hughes’s personal benefit in her continued ability to operate PPI’s business using Performance Probiotics without satisfying the judgment against PPI.

Hughes also challenged the award of attorneys’ fees and costs to Pearcy and Thomas, arguing that the award was based on a provision of TUFTA but that only some of the fees were related to the TUFTA claim. The Fifth Circuit noted that the facts supporting the TUFTA claim were sufficiently in common with the facts supporting Pearcy and Thomas’s other claims and found that the fees associated with the various claims could not be separated.

Paul Devinsky
Paul Devinsky advises clients on patent, trademark and trademark litigation and counseling, as well as copyright counseling. He is also active in intellectual property (IP) licensing, transactions and due diligence, as well as post-issuance US Patent and Trademark Office (USPTO) proceedings such as reissues and inter partes review, covered business method patent review and post grant review, and appellate (Federal Circuit) advocacy. Read Paul Devinsky's full bio.