So You Have A Great Idea – Now How Do You Avoid Giving Away The Secret Sauce? Key Items To Be On The Lookout For In Non-Disclosure Agreements
April 6, 2022
Now that you have that great idea for your business, you need to be proactive in protecting it. While maintaining the confidentiality of your proprietary data, processes and materials is critical to protecting your business and its prospects, there are many situations in which you will have to disclose that information to others, such as potential investors in connection with an M&A. The bullet points below discuss a handful of key considerations for using an NDA to protect your great idea.
What is an NDA?
- A non-disclosure agreement (commonly referred to as an “NDA” or a “confidentiality agreement”) is an agreement between two or more parties governing the treatment of certain confidential information that will be exchanged between the parties.
- Carefully review the scope of the definition of “Confidential Information” that you plan to use in your NDA and cover all items that you believe need to be kept confidential, including any intellectual property. Consider mentioning any specific items that are especially important to you, rather than hoping they fall within broader categories in a laundry list of confidential items. The definition of “Confidential Information” should also cover any summaries, analyses, reports, etc., prepared by or on behalf of the receiving party or its representatives containing Confidential Information.
- Make it explicitly clear that Confidential Information not only includes written documents (regardless of whether they are marked as “confidential”), but also includes information that is exchanged orally.
- Discuss with your counsel what qualifies as a “trade secret” and what actions you may need to take to try to ensure that treatment as a trade secret is respected. Any trade secrets you may have should be described and defined as such. Importantly, if a court agrees that such information qualifies as a trade secret, that information – in addition to any contractual protections you build in under the NDA – may be entitled to protection under trade secret laws at the state and/or federal level. One of the most well-known trade secret laws, the Defend Trade Secrets Act of 2016 (“DTSA”), provides a right of action in federal court to seek relief from trade secret misappropriation.
Stated Use of Confidential Information
- After defining Confidential Information, it is important to determine the purpose for sharing the Confidential Information and the stated use for the disclosed Confidential Information (e.g., this information is only to be used by the receiving party for the purpose of evaluating a potential M&A with the disclosing party).
- As the disclosing party, drafting the purpose and stated use as narrowly tailored as possible will give you a better chance of avoiding unintended uses by the receiving party (and a better chance of successfully litigating if the receiving party steps outside of the narrowly tailored bounds of the purpose and use clause). However, understand that receiving parties will want to limit the amount of restrictions that are placed on them.
- Once the Confidential Information is defined and the purpose and stated use of the Confidential Information is determined, you should consider requirements for the safekeeping of the received Confidential Information.
- Typical safekeeping requirements include requiring the receiving party to keep the Confidential Information in “strict confidence” (or, if the receiving party deems that to be too onerous, safeguarding it with at least the same degree of care as the receiving party protects its own Confidential Information) and only allowing the receiving party to disclose Confidential Information to its counsel, accountants, and other professional representatives on a need-to-know basis. As an additional layer of protection, NDAs may require that those representatives also sign an NDA agreeing to keep that information confidential.
- Additionally, consider requiring the receiving party to alert you within a specified number of days of any breach or unauthorized use or disclosure of Confidential Information.
- Again, understand that receiving parties will want to limit the amount of restrictions that are placed on them. There are a variety of ways to balance your (the disclosing party’s) desire to safeguard your information and the receiving party’s hesitancy to be subject to onerous restrictions. Your counsel can help you achieve this balance, while also helping you get over the finish line and get your NDA executed.
Residual Information and Unaided Memory Clauses
- A receiving party may seek to include a residual information clause. Residual information clauses come in a variety of forms, but generally provide that the receiving party will not be restricted from using any general knowledge it obtains through its review of the Confidential Information (which may be difficult to separate from its general knowledge of the industry that pre-dates the execution of the NDA) if the receiving party did not purposefully memorize such information (it simply knows or can remember this information without looking back to the tangible Confidential Information, i.e., it uses its unaided memory to recount such information).
- You should strongly resist the inclusion of this type of provision – as the old saying goes, here the exception can swallow the rule. If this comes to litigation, it will likely be a costly and lengthy battle in court to determine whether, (i) the information the receiving party had pre-dated the execution of the NDA, (ii) if it did not, whether the information it used was general knowledge or not, and (iii) assuming it was, whether the receiving party intentionally memorized it or was able to use it through its unaided memory.
- That being said, refusing to include this provision may be a deal breaker for certain potential acquirers. If that is the case, then you should work closely with your counsel on ways in which you can limit the residual information clause to a narrow provision that is acceptable to both parties (e.g., limit the scope of what constitutes residual information, exclude certain highly sensitive types of confidential information (such financial plans and projections and trade secrets) from the scope of residual information, limit the list of individuals who may have access to the information and prohibit them from working on any competitive projects during the term of the NDA, etc.). Additionally, if a residual information clause is included, you should also consider whether you want to refrain from sharing, for as long as you reasonably can in the course of the negotiations, particularly sensitive information that is core to your business, particularly if the receiving party is a competitor. While you should alert the receiving party if you are proceeding in that manner, this may be a means of protecting certain information until you feel confident that the deal will move forward.
Other Restrictive Provisions
- Consider whether you would like to add any other obligations to the NDA, such as a non-solicitation, non-hire, or non-competition provision. For example, if you are exploring an M&A deal with a potential acquirer, they may have obtained access to information about your clients and employees during the course of their due diligence on your company. If the deal goes sideways, you would not want to subsequently discover that the potential acquirer chose not to buy your company, but did choose to raid your workforce and solicit your clients. Thus, depending upon who the other party is and what leverage you have, you may want to include some further restrictions.
- The terms of any restrictive covenants should be reasonable, including with respect to the length of time and geographic scope. If a court determines that some of these restrictive terms are unreasonable, it could potentially jeopardize the enforceability of some or all of the NDA. While some courts will strike unreasonable restrictive terms from the NDA, other courts will throw out the whole NDA because of unreasonable restrictive covenants. As such, it is important to work with your counsel on crafting reasonable restrictions in the agreement.
What Happens When It’s Over?
- Consider whether you want to require the receiving party to destroy all information it received and provide you with a certification that they did or, alternatively, whether you want to require that they return all information to you. As the disclosing party, you should push for any notes that the receiving party may have created, or any notes that were created on the receiving party’s behalf that contain any Confidential Information to be included in the destruction or return.
Costs and Remedies
- If you have leverage, consider requesting a prevailing party provision and an injunctive relief provision, especially if this is a unilateral (i.e., one-way) NDA.
- A prevailing party provision typically requires the losing party in a lawsuit, claim or litigation to pay for the prevailing party’s legal expenses incurred during the lawsuit, claim or litigation.
- An injunctive relief provision allows a party to request that a court require the other party to refrain from doing a certain act (e.g., disclosing or improperly using Confidential Information) or to require it to perform an act it is obligated to perform (e.g., destroying or returning Confidential Information).
This client alert provides a brief overview of certain considerations for drafting and negotiating an NDA. It is not intended to be a comprehensive list or summary of the above noted issues or other issues that should be considered when negotiating an NDA. For additional details or relevant forms to help address the needs of a specific business transaction, please contact Lindsay Kaplan at email@example.com or Kirk Haynes at firstname.lastname@example.org.