Source: Richard Harroch from Forbes
In merger and acquisition (M&A) transactions, confidential and proprietary information (such as financial information and important contracts) often needs to be shared with the other party. But the path to doing so safely is making sure that the other party is bound to respect the confidential information provided and not use it to the disclosing party’s detriment.
One common way to protect the secrecy of confidential information given to another party is through the use of a Non-Disclosure Agreement, which is sometimes also referred to as a “Confidentiality Agreement” or “NDA.” In this article, the key terms of such agreements are discussed.
It should be noted at the outset that although NDA forms are abundant, and it seems like every buyer and seller has a “standard form,” NDAs, like all contracts, contain critical terms that should not be accepted as boilerplate.
The following discussion highlights a number of terms that require attention and should not simply be accepted by the parties without careful consideration. Indeed, since an NDA—unlike a letter of intent or a term sheet—universally is a binding contract, the parties need to be alert for nonstandard provisions and traps for the unwary.
Further, the parties need to make sure that the NDA they negotiate is suitable for an M&A transaction. “Standard” business NDAs usually omit significant terms that are common in M&A NDAs.
Mutual vs. Non-Mutual NDAs
Non-Disclosure Agreements come in two basic formats: a one-way agreement or a mutual agreement. The one-way agreement is used when only one side will be sharing confidential information with the other side. The mutual NDA form is for situations where each side may potentially share confidential information. Many times, a mutual NDA form that has been proffered by the other party is based on a business-oriented NDA that has not been tailored to the M&A context.
Although there is always some appeal to using a mutual form of NDA, M&A sellers shy away from the mutual form if they are not planning to receive confidential information from the other side. Also, a creditworthy buyer who will pay cash to acquire a seller typically will not share any of its confidential information with the seller. Sellers thus often let prospective buyers know that they don’t want to receive any of the buyer’s confidential information, and there isn’t a need for a mutual form if they are asked for one.
A one-way agreement is geared to protecting the seller (as the disclosing party). As the following discussion indicates, most of the important points in an NDA are intended to benefit the seller.
And, when an NDA is negotiated, the seller typically has considerable bargaining leverage, especially when it sends out numerous form NDAs as part of a sale process, and therefore most of the important issues will be decided in favor of the seller. That means that the buyers (as the recipients) must pick their battles and focus on what aspects of the NDA matter the most to them.
The Important Elements of NDAs
Non-Disclosure Agreements don’t have to be long and complicated. In fact, well-drafted ones usually don’t run more than a few pages long.
The important elements of Non-Disclosure Agreements include:
- Identification of the parties
- Definition of what is deemed to be confidential
- The scope of the confidentiality obligation by the receiving party
- The exclusions from confidential treatment
- The obligation to return or destroy confidential information when requested by the disclosing party
- The term of the agreement
The Parties to the Agreement
The parties to the agreement are usually established in a straightforward description set forth at the beginning of the contract. If it’s an agreement where only one side is providing confidential information, then the disclosing party can be referred to as the disclosing party, and the recipient of the information can simply be referred to as the recipient.
The one tricky part here is to think about whether any other people or companies should also be bound by the agreement. Does the recipient expect to show the confidential information to a related or affiliated company? To a partner? To a financing source? To an agent or advisor (such as counsel and accountants)? If so, the NDA should also cover those third parties or provide a mechanism for those third parties to later become bound by the NDA.
From the recipient’s perspective, especially as a potential buyer, the recipient needs to freely share the disclosing party’s information with its employees, outside advisors, and, sometimes, both its equity and debt financing sources. Accordingly, the recipient needs to make sure that the NDA clearly allows such sharing. And, if the NDA does not, it should at least have a provision that allows for the recipient to quickly obtain consent from the disclosing party to the sharing of confidential information with specified third parties (which consent should not be unreasonably withheld or delayed).
Regardless of whether these third parties become subject to the NDA, the disclosing party should insist that the NDA contain a clause holding the receiving party legally responsible for any disclosure of confidential information made by one of these third parties or even by one of its own employees in violation of the NDA.
What Is Deemed Confidential?
This section of the NDA deals with defining what “confidential information” means. Is it any information? Is it information that is only marked in writing as “confidential”? Can oral information conveyed be deemed confidential?
On the one hand, the disclosing party wants this definition of confidential information to be as broad as possible to make sure the other side doesn’t find a loophole and start using its valuable secrets.
On the other hand, the recipient of the information has a legitimate desire to make sure that the information that it is supposed to keep secret is clearly identifiable so that it knows what it can and cannot use.
Oral information in particular can be tricky to deal with. Some recipients of information insist that only information conveyed in writing need be kept confidential. Of course, the party giving oral information usually says that such a definition is too narrow. The usual compromise is that oral information can be deemed confidential information, but the disclosing party has to confirm to the other side in writing shortly after it has been disclosed so that the receiving party is now on notice as to what oral statements are deemed confidential.
Sometimes a recipient of confidential information will seek to add a “residuals” clause to an NDA so that certain information that the recipient’s team learns from the disclosing party and that is retained in the “unaided” memories of the team members is not treated as confidential. Usually, the recipient is concerned about general concepts learned during diligence or information that a team member remembers without reference to documents. A disclosing party will strongly argue against such a clause, or at least seek to make it very narrow. From the disclosing party’s perspective, a broad residuals clause could allow a receiving party to freely develop intellectual property or other ideas based on what its team learns from the disclosing party.
The parties to the NDA also need to address the issues of M&A discussions the seller is undertaking. Even in a one-way NDA, the parties should address this topic. From the buyer’s perspective, it will not want the seller to disclose to third parties its interest in the seller. In contrast, if the seller is in the process of soliciting indications of interest from multiple parties, it will want the flexibility to make some disclosures to those third parties (exclusive of the name of the buyer).
Scope of the Confidentiality and Non-Use Obligations
The core of the Non-Disclosure Agreement is a two-part obligation on the recipient of the information: to keep the confidential information confidential, and not use the confidential information itself for any purpose other than to evaluate and negotiate the M&A transaction.
The first obligation is that the recipient of the confidential information has to keep the information secret. This usually means that the recipient has to take reasonable steps to not let others have access to it. For example, reasonable steps could include that only a few people within the recipient’s company have access to the information, and they are all informed of the nature of the confidentiality restrictions. Sometimes the NDA will, in fact, specify a standard to which the recipient must adhere when handling the disclosing party’s confidential information.
The second part is also crucial—that recipients can’t use the information themselves for any purpose other than to evaluate and negotiate a transaction.
The disclosing party will want the right to sue for damages or to stop the recipients if they breach either their confidentiality obligations or their non-use agreement.
Exclusions from the Confidentiality and Non-Use Obligations
Every NDA has certain exclusions from the obligations of the recipient. These exclusions are intended to address situations where it would be unfair or too burdensome for the recipient to keep the information confidential, or where confidentiality is simply inappropriate.
The common exclusions include information that is:
- Already known to the recipient and not subject to any confidentiality obligation
- Already publicly known (as long as the recipient did not release it to the public)
- Independently developed by the recipient without reference to or use of the confidential information of the disclosing party
- Disclosed to the recipient by some other party who had no duty of confidentiality to the disclosing party
These exclusions are good examples of “boilerplate” that a recipient party might accept without much consideration. Yet, for example, how does the recipient know that information it received from a third party was not provided in violation of a third party’s duty of confidentiality? How does the recipient know if information it already possesses is not subject to a confidentiality obligation? As with other portions of the NDA, the recipient and its counsel need to closely examine the exceptions to the definition of “confidential information” in the NDA in order to make sure that the recipient can accept them.
The NDA should also address the situation in which the recipient of the information is forced to disclose the information through a legal process. If forced by a court order, the recipient should be allowed to do that without breaching the NDA, as long as the recipient has warned the disclosing party in advance of the legal proceeding so that it can seek a protective order if possible.
Sellers—as disclosing parties—also need to be aware that a public company buyer may have an obligation to disclose some of the seller’s confidential information, either due to securities law or stock exchange requirements. Nevertheless, a disclosing party should carefully consider the wording of any NDA exception here to make sure that the recipient only discloses what it absolutely must disclose without running afoul of the law or its listing requirements.
Obligation to Return or Destroy Confidential Information
Every NDA includes a provision requiring the recipient of confidential information either to return the information or destroy it. Usually, this obligation kicks in if either party terminates acquisition discussions or the buyer informs the seller that it does not wish to move forward.
Recipients will negotiate for an unqualified right to destroy information, rather than return information that has been downloaded, printed, or received in paper form. Also, recipients who are potential buyers will not wish to turn over analyses that they have prepared which contain the seller’s confidential information or documents which might contain someone’s margin notes.
Recipients also will insist that they not be required to delete electronic files from servers and back-up systems. A disclosing party oftentimes will agree to this exception so long as the recipient agrees that only its information technology personnel will have access to such files.
Lastly, it has become common for NDAs to include a clause allowing a recipient to retain a copy of confidential information for regulatory purposes or in the hands of its outside counsel. The disclosing party will, of course, want to make it clear in the NDA that the NDA’s confidentiality and non-use provisions remain in place with respect to such retained information.
Term of the Agreement
How long should the NDA last? Some attorneys may argue that the NDA should last forever. Why should someone have the right to use the disclosing company’s confidential information at any time, especially proprietary information?
But, the recipient of the confidential information will insist on a definite term as to when the NDA ends. After all, most information after a certain number of years becomes useless anyway, and the cost of policing confidentiality obligations—especially if the recipient signs numerous NDAs on a regular basis—can become very expensive if it’s a “forever” obligation. Indeed, current market practice is for an NDA to specify a term and not stay in effect indefinitely.
So if the disclosing party agrees to a term, what is reasonable? Well, it really depends on the industry that the disclosing party is in and the type of information conveyed. In some businesses, a few years may be acceptable because the technology may change so fast as to render the information pretty much worthless.
Most agreements, if they have a term, have a time limit of two to five years. But the NDA also needs to say that, even if the term is ended, the disclosing party is not giving up any other rights that it may have under copyright, patent, or other intellectual property laws.
More Provisions That May Make Sense for the NDA
An NDA often includes several other provisions, such as:
- Employee nonsolicitation. If the recipient has significant access to the disclosing party’s employees, the disclosing party may want to insert a clause that prevents the recipient from soliciting or, to the extent lawful, hiring these employees for an agreed period of time (12 to 24 months is common). The recipient may sometimes agree to that restriction, with some carve-outs. For example, the recipient may want the limitation to apply only to those employees that they have come into contact with during their review of information or interviews. Also, the recipient will want to be able to contact and hire employees who respond to general solicitations for employment made by the recipient.
- Jurisdiction in case of a dispute. Both parties have a keen interest in the governing law for the NDA and the forum for resolution of any dispute. Many NDAs will specify the courts in which the parties must litigate a dispute.
- Injunction. The disclosing party frequently insists that the NDA include a clause that mandates injunctive relief from a court to stop the recipient from breaching the agreement. The recipient, in turn, will resist this clause and seek language leaving it to the court to decide whether the facts of a dispute warrant injunctive relief.
- No rights in the receiving party. For the disclosing party, it’s sometimes helpful to have a clause that says just because confidential information will be shared with the receiving party, the receiving party doesn’t get any rights to the disclosing party’s ideas. Essentially, it should be clear that the recipient has no right to use or license any technology or similar information the disclosing party shares with the recipient.
- No obligation to make a deal. The NDA can make it clear that neither party has a contractual obligation to complete a deal, except as provided in a future definitive acquisition agreement, if any.
- Disclaimer. Further, the disclosing party should consider including in the NDA a clause stating that it is making no representations or warranties to the recipient as to the accuracy or completeness of the information it provides, except as set forth in a future acquisition agreement. Further, the disclosing party might insist on a clause expressly disclaiming any liability to the recipient with respect to any of the disclosed information.
- Access to employees. The disclosing party may wish to include in the NDA a clause preventing the recipient from contacting employees, except through specified contacts. Controlling the recipient’s access to information which might afford the recipient an advantage in M&A negotiations usually is an important priority for a seller. And, the NDA can be a useful binding contract in furtherance of this objective.