Understanding NDA’s.

By Steve Gaynor and Neeraj Baghel

Yes, that’s right, do not sign that NDA (“Non-Disclosure Agreement” also referred to as the “Confidentiality Agreement”) until you have thoroughly reviewed and negotiated it. Too often parties contemplating a transactional or personal relationship perfunctorily sign an NDA thinking of it as a relatively harmless document that preserves everyone’s confidentiality. Instead, the NDA should be treated for what it is; that is, an agreement as significant as any other giving you legal rights, but also creating legal obligations that carry potential legal exposure.

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First, one should consider whether an NDA should be signed at all or not at the present time. Consider the example of a sell-side advisor in a large transaction who uses the NDA to shape the coalitions he desires among the potential buyers to form buying syndicates. Sell-side advisors will use buyer coalitions to reduce buyers’ risks, and to pool their resources in certain combinations that may enhance the transaction value.

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Once a buyer signs the NDA, the advisor’s permission is required to discuss the transaction with other potential buyers, leaving that buyer’s options wholly within the control of the seller’s advisor. In this example, the buyer may be better off delaying signing the NDA so it is free to form its own syndicate, even at the expense of temporarily not receiving the seller’s confidential information.

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Second, one should consider whether the NDA should be mutual or unilateral.  Mutual NDAs are routinely sent once again under the theory they are relatively innocuous documents, so let everyone sign and move on with it. But why be unnecessarily legally exposed to a party such as a financial buyer who will not be sharing confidential information? Sign a unilateral NDA instead.

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Another way to think about this issue is to consider the nature of the counter-party. A financial investor such as a venture capitalist or buyer such as a private equity fund will most likely not be disclosing their confidential information, so a unilateral NDA is suitable. In contrast, a sale of securities to a strategic buyer such as another company in the industry or sale of the company to a competitor may very well involve a two-way exchange of information, making the mutual NDA more appropriate.

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When it comes to negotiating the NDA itself, pay careful attention to the approach of the other party. Much can be learned from this initial exchange of documentation with respect to their flexibility, negotiating style and internal legal process, which of course will be part of the subsequent investing or transaction process.

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At the start of negotiations, one often hears “our NDA is standard,” or “making changes will cause substantial delay.”  While such pronouncements may be true, especially for larger companies that attempt to reduce their risks by standardizing the large number of NDAs they sign, nevertheless, treat them as a ruse to limit your negotiating aggressiveness, and brush them aside.

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Negotiation of the NDA typically is centered on a few significant clauses, though nothing should be ignored. Of course, “the devil is in the details” when it comes to legal documents, and the specific wording of each section must be reviewed. The following is an overview of certain key terms.

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The Definition of “Confidential Information”

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Of course the disclosing party wants a broad definition of what is confidential and does not want to be obligated to mark as confidential every document supplied, and the receiving party wants the opposite.  Usually the most productive way to proceed is to base the definition on the specific circumstances of the contemplated transaction. The defined scope usually includes the documents provided and oral conversations, and the materials derived from both such as notes, analysis and documents developed by the receiving party.

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Some information is explicitly excluded from the definition so as to cause it to fall outside the scope of the NDA. The typical exclusions are publicly available information, information known prior to receiving it from the disclosing party or received from a third party on a non-confidential basis, and information that must be disclosed to comply with law or regulation.

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The Use of the Confidential Information

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How the receiving party uses the confidential information should also be tailored to the specific circumstances of the situation. This is often referred to as the “Purpose” in many NDAs. For example, in an acquisition transaction, the use of confidential information should be limited to the evaluation of the subject of the transaction.

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Amend an existing NDA if necessary to cover a new situation. Often a seller and a buyer in an acquisition have an existing commercial relationship, and a NDA that covers their commercial relationship, but not a potential transaction.

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The disclosing party should ask to execute a new NDA or to amend the existing one to cover evaluation of a transaction, or else certain disclosures of a highly sensitive nature such as financial statements not normally disclosed in a commercial relationship but disclosed in due diligence related to a transaction may, a lawyer would argue, fall outside the scope of the existing “commercial” NDA.

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Term of Confidentiality

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Not surprisingly, the term agreed in a NDA can differ greatly depending on the circumstances. Of course disclosing parties prefer relatively long time periods, as much as three to five years, and can often get it when the transaction is strategic rather than financial, so both sides are making disclosures, and a mutual NDA is being signed.

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Relatively long terms are rare, however, in transactions involving investors or financial buyers such as private equity funds. If the deal does not occur, then they are left with legal exposure to a transaction that did not happen, which may subtly or manifestly inhibit their ability to look at other transactions in that industry. Do not expect them to agree to a term of more than two years, and sometimes less. Of course, many professional investors will not sign a NDA at all because of the potential legal exposure from reviewing several companies with similar technologies.

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A helpful benchmark to consider is the useful life of the information being disclosed. In our fast-pace technology based industry, few new technologies, processes or business models have a useful life of more than two years. A sober estimate of the life of the technology may yield a realistic number that can be defended and more easily agreed by the opposing party.

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Permitted Recipients of Confidential Information

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The NDA should define – and limit – the persons with whom the confidential information may be shared. Obviously, the more people with access to the confidential information, the greater the likelihood an unauthorized disclosure will occur.

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Employees are always included among those who may access confidential information, but sometimes they are restricted to a certain seniority level or a “need to know”. Difficulties sometimes arise with financial parties who must involve a seemingly large number of outside parties such as lawyers, consultants, accountants and financiers to evaluate, conduct due diligence, complete and finance a transaction. They are usually collectively referred to as “Representatives” in the NDA. This understandably creates apprehension in a seller of a private company.

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Other Terms

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Briefly, other important terms deserving special attention include:

• Governing law: Select a jurisdiction with favorable case law depending on whether you are the disclosing or the receiving party;
• No solicitation of employees: Each party agrees not to solicit the employees of the other, though an exception should be made for recruiters unaware of the NDA;
• No contacting employees not directly involved in the negotiations or due diligence related to the contemplated transaction: this should be a blanket prohibition without exception;
• Remedies in cases of breach: determine whether the disclosing party should be allowed to pursue injunctive relief in equity as an alternative to monetary damages, and under what terms such as not having to post a bond. An example is a breach that can cause immediate commercial or financial harm;
• Return or destruction of confidential information: this is standard, but an exception will often have to be made for regular archiving of materials received, which many companies and professional firms regularly do.

In conclusion, do not lightly treat the NDA, but consider it as you would other legal agreements that create legally binding rights and obligations. Do not sign that NDA it until you have consulted your legal advisor, or are confident in your ability and experience to address these important issues.

Disclaimer: This article is offered for informational purposes only, and the content should not be construed as legal or financial advice on any matter.