Question 4 of 7: Non-disclosure agreements, patents and trade secrets (15 marks)

Question 4 — Non-disclosure agreements, patents and trade secrets (15 marks)

Question text not reproduced: the examination questions are © Engineers and Geoscientists BC. Open the official past paper (linked at the top of this page) to read the question, then follow the worked solution below.

Given. An invention expected to yield an economic rent of CAD 200 000 per year, a discount rate of 10 % per year, patent pendency of 2.5 years within a 20-year term from filing, total patenting and maintenance cost of CAD 21 000 in present value, and an annual hazard of independent discovery or leakage of a trade secret of $\lambda = 0.12$ per year.

Find. The purpose of an NDA; the commercial case for patenting; the statutory and procedural requirements for obtaining a Canadian patent; the case for trade secrecy; and the present values that separate the two, including the leak hazard at which they are equivalent.

Approach. Answer A to D in the Canadian statutory frame (the Patent Act, administered by CIPO), then attach a discounted-cash-flow comparison, because the choice between patent and secret is finally an economic one made under a hazard rate.

A. Why non-disclosure agreements are used

An NDA is a contract that permits a controlled disclosure to occur at all. Its function is not primarily to enable a lawsuit after a breach — that remedy is slow, expensive and evidentially difficult — but to establish, before the information moves, four things that are otherwise undefined: what is confidential (the definition of Confidential Information, and what is carved out of it), what the recipient may do with it (the permitted purpose, which is the operative restriction and is routinely under-drafted), for how long the obligation runs, and what happens at the end (return or destruction, and the survival of the obligation).

Four practical reasons follow. First, it preserves patentability. Novelty is destroyed by public disclosure, and a disclosure made under an obligation of confidence is not public. An NDA is therefore what lets a company talk to a contract manufacturer, a tooling house or a potential investor without starting the clock on its own patent rights — a point of some importance because Canada and the United States allow a twelve-month grace period after the inventor's own disclosure, while most other jurisdictions, including the European Patent Office, allow none at all. A single unprotected conversation can extinguish worldwide rights while leaving Canadian rights intact, which is a trap for companies that assume the grace period is universal.

Second, it is the evidence that a trade secret is a trade secret. Protection for confidential information depends on the holder having taken reasonable steps to keep it secret; a signed NDA, together with access controls and marking, is the primary proof that those steps existed.

Third, it allocates ownership of what the collaboration produces, since a well-drafted agreement addresses background intellectual property, foreground intellectual property and improvements — without which a supplier may own the process improvement developed on the client's problem.

Fourth, it signals seriousness and defines the relationship, and it does so cheaply. Its limitations should be stated as clearly: an NDA does not stop disclosure, it only makes disclosure actionable; damages are hard to quantify and harder to prove; and an NDA is worthless against a party who independently develops the same idea, which is not a breach at all.

B. Why a company would choose to patent

A patent is a bargain with the state: the inventor publishes a complete, enabling description of the invention, and in exchange receives the right to exclude others from making, using, selling or importing it in that country for twenty years from the filing date. Companies take that bargain for reasons that go well beyond suing infringers.

The exclusive right itself allows the innovator to price above marginal cost long enough to recover the development investment, which is the classic justification. Beyond it, patents are assets that can be traded — licensed for royalties, cross-licensed to gain access to another firm's portfolio, used as security, or sold with a business unit — and for a start-up they are frequently the only asset an investor can value, so a filed portfolio materially affects the terms of a financing round. They provide freedom to operate and defensive leverage: holding patents in a contested area deters litigation because a counter-claim is available. They block substitution, since a well-drafted claim set covers the workarounds as well as the embodiment. They create a marketable signal of technical credibility, and where an idea will inevitably become public the moment the product ships — anything visible in the geometry, the interface or the user experience — a patent is the only protection available, because secrecy is not an option for something that can be bought and measured.

C. What is required in order to patent a product

The requirements divide into substantive conditions the invention must satisfy and procedural steps the applicant must take.

Substantive (Canadian Patent Act, R.S.C. 1985, c. P-4).

1. Statutory subject matter. The invention must be an art, process, machine, manufacture or composition of matter, or an improvement thereof (s. 2). Excluded are scientific principles and abstract theorems (s. 27(8)), higher life forms, methods of medical treatment, and mere schemes or business methods that lack a physically embodied inventive contribution.
2. Novelty. The invention must not have been disclosed anywhere in the world before the claim date. Canada operates first-to-file (since 1 October 1989), with a twelve-month grace period for a disclosure made by the applicant or by someone who obtained the information from them. Third-party disclosure is fatal at once.
3. Non-obviousness (inventive step). The subject matter must not have been obvious on the claim date to a person skilled in the art, applying the four-step Sanofi framework.
4. Utility. The invention must be useful — it must work and do something — and the utility must have been demonstrated or soundly predicted at the filing date.
5. Sufficiency of disclosure. The specification must describe the invention fully enough that a skilled person can practise it (s. 27(3)), and must end with claims that define the monopoly distinctly and in explicit terms. This is the consideration the public receives, and an insufficient description invalidates the patent however good the invention.

Procedural. A prior-art and freedom-to-operate search; preparation of the specification, claims and drawings; filing with CIPO (or a provisional-equivalent priority filing, then a PCT application within twelve months to preserve the international options); publication at eighteen months from the priority date; a request for examination (which in Canada must be made within four years of filing for applications filed on or after 3 October 2022, previously five); prosecution — responding to the examiner's reports on novelty, obviousness and claim scope; payment of the final fee and grant; and thereafter annual maintenance fees for the life of the patent. Rights are national, so the same process must be run, and paid for, in every country where exclusion is wanted.

D. Why a company would choose a trade secret instead

Trade secrecy protects information that derives commercial value from not being generally known, provided reasonable steps are taken to keep it secret. It is not registered and has no term. A company chooses it when one or more of the following holds.

The subject matter cannot be patented — a customer list, a supplier's pricing, an internal manufacturing recipe, a process parameter window, an algorithm that fails the subject-matter test. The advantage would outlive a patent term, which is the Coca-Cola argument: a twenty-year monopoly is a bad trade for something that could remain secret for fifty. The invention is not detectable in the product, so infringement could never be proved — a process step that leaves no signature in the part is unenforceable as a patent but perfectly protectable as a secret. Publication would teach competitors more than the patent would block, since a patent specification is a complete instruction manual that expires, and in fast-moving fields the eighteen-month publication can hand a rival a two-year head start on a design-around. Cost and speed: secrecy is effective immediately and worldwide, with no filing fees, no prosecution and no maintenance, which matters most to a small company with a short product life.

The corresponding risks are severe and must be stated: a trade secret gives no protection against independent development or lawful reverse engineering, it is lost irretrievably on disclosure, it is vulnerable to employee mobility, and it may be defeated by a competitor who patents the same idea first — although Canadian s. 56 prior-user rights give a limited defence to someone who was already using the subject matter before the claim date.

The economics of the choice. Both routes can be valued as discounted rents. The patent yields the rent for the term less the pendency, $20 - 2.5 = 17.5$ enforceable years:

$$PV_{\text{pat}} = R\,\frac{1-(1+i)^{-N}}{i} = 200\,000 \times \frac{1-1.10^{-17.5}}{0.10} = 1\,622\,700\ \text{CAD}$$

and after the CAD 21 000 of filing, prosecution and maintenance costs, $\boxed{NPV_{\text{pat}} = 1\,601\,700\ \text{CAD}}$. The trade secret has no term but carries a constant hazard $\lambda$ of being discovered independently or leaking; a perpetuity whose survival decays exponentially is worth

$$PV_{\text{ts}} = \frac{R}{i+\lambda} = \frac{200\,000}{0.10+0.12} = \boxed{909\,100\ \text{CAD}}$$

with an expected secrecy life of $1/\lambda = 8.3$ years. On these assumptions the patent is worth roughly CAD 693 000 more, and the two are equal only when

$$\lambda^{*} = \frac{R}{NPV_{\text{pat}}} - i = \frac{200\,000}{1\,601\,700} - 0.10 = 0.0249\ \text{per year}$$

that is, only when the secret can be expected to survive $1/\lambda^{*} = 40$ years. That is the quantitative form of the Coca-Cola argument, and it explains why trade secrecy is the right answer for a genuinely undetectable recipe and the wrong answer for almost everything visible in a consumer product.