Virginia’s Uniform Trade Secrets Act Given New Teeth under Bankruptcy Code Sec. 523(a)(4)

A recent decision from the United States Bankruptcy Court for the Eastern District of Virginia provides new teeth for businesses that bring claims under the Virginia Uniform Trade Secrets Act.  In this decision, the Bankruptcy Court held that a state court finding of willful and malicious misappropriation of trade secrets incorporates all of the elements necessary to support a determination that the debt is nondischargeable in a subsequently-filed bankruptcy case.  Often, businesses that have been harmed by having their valuable intellectual property stolen were frustrated in enforcing judgments after the perpetrators declared bankruptcy and sought to have the judgments discharged.  But in this decision, the Bankruptcy Court stopped the judgment debtor’s effort cold, holding that the judgment was nondischargeable.

In La Bella Dona Skin Care, Inc. v. Harton (In re Harton)*, Adv. P. No. 13-03028-KRH (E.D. Va. Bankr. Oct. 1, 2013), the plaintiff, a med-spa salon, previously obtained a state court judgment against the defendant, a Virginia resident, for willful and malicious misappropriation of trade secrets under relevant provisions of the Virginia Trade Secrets Act.  The actions of the defendant giving rise to the judgment were egregious.  While still employed with the plaintiff, defendant started her own competing salon.  Days after her new business was organized, she entered her employer’s offices after hours, accessed its computer, and printed out a customer contact list and three months’ worth of scheduled appointments.  Using the customer list, the defendant mailed over 2,000 postcards to the plaintiff’s existing customers, leading the customers to believe that the plaintiff’s business moved to a new location.  She then contacted customers with scheduled appointments to get them to change in favor of the defendant’s new and competing salon.  The dollar value of the scheduled appointments exceeded $100,000.

The state court found that the defendant “did not rightly access the client list,” and that her use of a master password to obtain after-hours access to plaintiff’s computer was unauthorized.  The state court also found that the misappropriation occurred while defendant was still an employee and that the misappropriated list was used to contact and mislead a large number of plaintiff’s clients.  From these facts, the state court concluded that the misappropriation was both willful and malicious.

Defendant subsequently commenced a Chapter 13 case in the Bankruptcy Court.  The plaintiff in turn filed a complaint against the defendant in the bankruptcy court seeking a determination that the judgment awarded by the state court was nondischargeable under 11 U.S.C. §523(a)(4), which excepts from discharge any debt resulting from embezzlement or larceny.  Plaintiff then filed a motion for judgment on the pleadings pursuant to Federal Rule 12(c), contending that the pleadings alone clearly demonstrated that there existed no material issue of fact that needed to be tried, that defendant was collaterally estopped from re-litigating the issues previously adjudicated in the state court, and that the state court judgment incorporated all of the elements necessary for a determination of nondischargeability.

The defendant argued that “willful and malicious” torts are not excepted from discharge in Chapter 13 cases.  In fact, Chapter 13 expressly excludes the provisions of section 523(a)(6) of the Bankruptcy Code, which excepts from discharge debts for “willful and malicious injury.”  But the bankruptcy court found that the state court determination of “willful and malicious misappropriation” fell within the scope of section 523(a)(4), regardless of the applicability of section 523(a)(6).  The bankruptcy court noted that: “Bankruptcy courts are not bound by the state law definition of larceny but may follow federal common law.  Under federal common law, larceny is the felonious taking of another’s personal property with the intent to convert it or deprive the owner of the same.”  While the defendant’s intentional tort shared all of the elements of the kind excepted from discharge under section 523(a)(6), the court found that it contained one additional element that placed it squarely within the provisions of section 523(a)(4): defendant’s realization of the value of the property that she took for her own benefit.  A “knowing theft” therefore satisfied the requirements of larceny within the meaning of section 523(a)(4).

Since the state court’s determination of willful and malicious misappropriation of the plaintiff’s client list was sufficient to establish the elements essential to defendant’s liability for larceny under section 523(a)(4), the defendant was precluded from re-litigating the issues in the Bankruptcy Court.  The state court judgment was therefore held to be nondischargeable.  This decision provides new teeth to claims under the Virginia Uniform Trade Secrets Act and puts defendants on notice that they may not seek the refuge of bankruptcy if they are found liable under the Act.

*Redmon, Peyton & Braswell, LLP represented La Bella Dona Skin Care in the state court action for actions against the debtor and other individuals for misappropriation of trade secrets.

La Bella Dona Skin Care, Inc-v-Erika Brooke Harton-Opinion (PDF)

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