Bigger in Texas? High Court to Decide Scope of Protection for Third Party Trade Secrets in Civil Discovery

On August 22, 2014, the Texas Supreme Court ordered oral argument in In re: Magnum Hunter Resources Corp., a case concerning the discoverability of third-party trade secrets documents in civil cases. When should such documents be produced? And who gets to see them?

A simple summary of the facts of Magnum Hunter are as follows:

Party A hires Law Firm to help it negotiate a contract with Party B regarding an oil and natural gas venture. Party A and Party B ultimately reach an agreement on the venture and enter into a contract that says that Party B will provide to Party A all reports related to the venture upon request, provided that Party A agrees to treat such reports as confidential information.

Party A later sues Law Firm, alleging that Law Firm provided poor counsel to Party A regarding the venture. In connection with discovery into Party A’s claims, Law Firm subpoenas Party B and demands production of certain “reserve reports” (i.e., well production forecasts) relevant to valuation of Party A’s investment in the venture. Party B refuses to produce the reserve reports, alleging that the reports are trade secrets and that other public information provides the evidence Law Firm needs. Law Firm agrees that the reserve reports are Party B’s trade secrets but argues it nevertheless needs the reports because they are the best evidence on valuation, a critical issue in Party A’s lawsuit. Party A takes the position that it is indifferent as to whether the reports are produced or not. Question: Should the trial court compel production of the documents?

Under Texas law, a party seeking production of trade secrets must show that the requested evidence is reasonably necessary given the nature of the evidence in the context of the case. (See, e.g., In re Union Pac. R.R. Co., (Tex. 2009)). In Magnum Hunter, however, the trial court ordered production on an alternate theory. The court concluded that the reserve reports were in Party A’s “control” for purposes of discovery because the contract between Party A and Party B required Party B to furnish the reports upon request. The trial court further reasoned that because Party A asserted claims against Law Firm that put the reserve reports at issue, Party A could not withhold the documents from Law Firm under a line of cases, including, e.g., Ginsberg v. Fifth Court of Appeals (Tex. 1985), establishing that a plaintiff cannot use an evidentiary privilege to deny access to evidence favorable to the defendant (aka the “offensive use doctrine”). Texas Rule of Evidence 507 provides that: “a person has a privilege…to refuse to disclose and to prevent other persons from disclosing a trade secret owned by the person, if the allowance of the privilege will not tend to conceal fraud or otherwise work injustice.” The trial court therefore ordered Party B to produce the reserve reports.

Magnum Hunter raises a number of interesting issues, including whether Party A actually had “possession, custody, or control” of the reports, whether Party B waived its right to object to production of the reports, and whether the offensive use doctrine can apply in a third-party context. Perhaps most importantly, Magnum Hunter may provide significant guidance on what the “reasonably necessary” standard actually means. The parties and the court all agreed that other evidence could be used to prove the value of Party A’s investments; however, it is likely that the reserve reports constituted the best evidence. Undoubtedly, a costly battle of the experts is in the cards if the Texas Supreme Court reverses the trial court’s order to produce. To what extent should parties be forced to incur significant costs to obtain inferior evidence for the sake of a non-party’s purported trade secrets?

The issues presented by Magnum Hunter are available for public consumption on the Texas Supreme Court’s website for those who are interested. But beyond the issues presented in the parties’ briefs, the trial court’s reasoning—and the parties’ respective strategies—raise other interesting issue worthy of consideration.

The contract’s language suggests that, had Party A requested the reserve reports, Party B would have been obliged to turn them over to Party A. Party B might have refused (in breach of the contract), at which point Party A would have been able to argue persuasively that the reserve reports are not in its control (short of court action). Perhaps Party A made a sound strategic decision not to request the documents; the Texas Supreme Court’s grant of oral argument suggests that resolution of the issues presented may be decided on a thin margin. It is possible that the reports will not make their way into the case. But Party A could also, in such an event, have to end up explaining to the jury why it chose to pay an expert significant fees to create new reserve reports when Party A had a contractual right to request existing reports for free.

For its part, Law Firm may have chosen to bark up the wrong tree. Law Firm argues vehemently that the coveted reserve reports are in Party A’s possession, custody, and control. If this argument is correct, Law Firm could have filed a motion to compel Party A to produce the reports. This would have required Party A to show that it diligently attempted to procure the reports. Absent such a showing, Law Firm may have been entitled to an adverse inference or other evidentiary sanction against Party A under Tex. R. Civ. P. 215.2. A successful motion to compel may have even required Party A to subpoena Party B on its own behalf under threat of sanction.

Monday morning quarterbacking aside, there is one other important issue raised by Magnum Hunter that practitioners and businesses alike should take note of. The contract provision governing access to the reports says only that the parties agree to treat such reports as “confidential information.” The provision does not explain what this restriction means, does not require Party A to provide notice to Party B prior to disclosure of the reports to third parties, and does not require Party A to cooperate with Party B’s efforts to seek relief from a subpoena. Had the documents actually been in Party A’s possession, it is likely that Party A could have produced the documents (subject to a protective order) to Law Firm without breaching the confidentiality provision, depriving Party B of its day in court.

Regardless of how the Texas Supreme Court resolves the various legal issues presented in Magnum Hunter, the facts of the case demonstrate the importance of including provisions in non-disclosure agreements that provide protection against subpoenas and other governmental process.