What is important in a confidentiality agreement or non-disclosure agreement (NDA)?

April 27, 2008

There are various factors to consider when reviewing or drafting a confidentiality or non-disclosure agreement (NDA). Obviously, your perspective on the agreement depends on whether you are primarily disclosing or receiving confidential information. The following points should be kept in mind:

  • Need for an agreement. Entering into an NDA increases the risk that the recipient may face charges of trade secret misappropriation if it develops similar information in the future or inadvertently discloses or uses the information. This is the primary reason that VCs will not enter into NDAs.
  • Mutual versus one-way. Some agreements only cover disclosure of confidential information by one party. Other agreements are mutual and cover disclosures by both parties. Generally speaking, mutual agreements are less likely to have provisions that are one-sided.
  • Non-disclosure and non-use. There are two important restrictions in an NDA. The non-disclosure provision prevents the recipient from disclosing the confidential information to third parties. The non-use provision prevents the recipient from using the information other than for a specified purpose. Occasionally, an NDA may not have a non-use provision. This would allow the receiving party to use the information for its own purposes as long as it did not disclose the information
  • Definition of confidential information. The discloser will want a broad definition of confidential information and may also want third party confidential information to be deemed confidential. The receiver will want to narrow the definition of confidential information in order to avoid being “tainted” by the information. The definition can be narrowed by (i) limiting it to information disclosed in writing (or oral disclosures reduced to writing within a certain time frame), (ii) specifically marking the information confidential, (iii) specifying the information that is deemed confidential or (iv) specifying the dates of disclosure. The discloser will want to avoid some of the limitations because of the possibility or inadvertent disclosure or over-marking information as confidential, which may impair the ability to enforce the agreement with respect to genuine trade secrets.
  • Exceptions to confidential information. The recipient will want broad exceptions to the definition of confidential information. Typical exceptions to the definition of confidential information include (i) information publicly known or in the public domain prior to the time of disclosure, (ii) information publicly known and made generally available after disclosure through no action or inaction of the recipient, (ii) information already in the possession of recipient, without confidentiality restrictions, (iv) information obtained by the receiver from a third party without a breach of confidentiality, and (v) information independently developed by the recipient. The discloser will try to limit the exceptions or add qualifiers such as the discloser must prove the exception with contemporaneous written records. Please note that the typical exception for information required to be disclosed by law should be an exception to the duty to not disclose, as opposed to an exception from the definition of confidential information (which would allow the recipient to disclose the information to anyone).
  • Residual information. The recipient will want to include a clause that allows the recipient to use the discloser’s information that is retained in its employees’ memory. The recipient will want to avoid being “tainted” by receiving the information. This is often strongly rejected by the discloser. In the event the residuals clause is included, the discloser may try to limit it to (i) use of general skills and knowledge, (ii) information retained in the unaided memory of employees after a certain amount of time after access to the confidential information, and (iii) explicitly noting that the discloser is not granting any license to the recipient.
  • Permitted disclosures. The discloser will want to limit disclosures to employees and contractors on a need to know basis with similar non-disclosure obligations. In addition, if disclosure is required by law, the discloser will want the recipient to notify the discloser in advance and provide the opportunity to obtain a protective order or otherwise maintain the confidentiality of the information.
  • Term. NDAs commonly have terms of three to five years. The period of time depends the strategic value of the information to the discloser and how quickly the information may become obsolete.

Comments

  • Pingback: Non-disclosure agreements and trade secrets at Indiana Trade Secrets Law

  • http://sfolaw.com San Francisco Lawyer

    Fantastic write-up and overview of the important points of an NDA agreement. I used to work for a hedge fund. We had everyone, down to the janitor, under NDA agreements. Many companies that should use NDAs don’t. You would think that more companies would use NDAs. But, for whatever reason they do not. Anyway, excellent writeup. Thanks for the information.

    Monty

  • Christian

    This is an amazing site Yokum and very helpful. Regarding NDAs, do you recommend having them fully executed for all possible investors that will review or have a copy of your business plan? I plan on having family/friends that are successful business people review it and wanted to know when is it “overkill.”

    I am also looking at some connections overseas and my concern is not with the individual, but having my document just “laying around.”

    My philosophy has always been “better safe then sorry,” but even you mentioned that VCs won’t typically sign NDAs. Even banks and attorneys because they are under a “governance” that they cannot disclose private information.

    Thanks,
    Christian

  • http://www.startupcompanylawyer.com Yokum

    @Christian – asking potential investors to sign an NDA is NOT commonly done. A newbie entrepreneur that asks looks very amateurish to a seasoned investors. Attorneys don’t sign NDA’s as they are already covered by an ethical duty of confidentiality.

  • Christian

    Thanks Yokum for the response. My attorney (who is new) told me the same thing. But I believe banks and CPAs are also bound by the ethical duty of confidentiality.

    So you are saying that signing one is commonly done, but if you ask to have one signed, you look like an amateur? I just wanted to clarify this or even better, when should NDAs be requested?

    I know you wrote this great article about the types of NDAs, so there is definitely an appropriate time for requesting one.

  • http://www.startupcompanylawyer.com Yokum

    @Christian – Sorry, typo. (Edited to fix comment response above.) Asking a potential investor to sign an NDA is NOT standard operating procedure.

  • Christian

    Thanks Yokum. So the best way would be to leave any sensitive IP information out of the document and probably just disclose it in person.

    So with the great explanation above, what is the purpose then of having one drafted and when is it best to use an NDA?

  • http://www.startupcompanylawyer.com Yokum

    @Christian – If you’re disclosing sensitive information to a party that could potentially use the information to their benefit (i.e. commercial relationship), then it would make sense to enter into an NDA. Of course, depending on the relative negotiating strength of the parties, the stronger company/receiver of confidential information may refuse to sign an NDA for an initial meeting (until they figure out that there is a benefit to them to the meeting).

  • Christian

    Thanks again Yokum. I understand and your explanation helps. It’s like the “Baby Syndrome” which one can compare their business idea. To you, your baby may look like the cutest baby in the world. But to others, it may not be the cutest baby.

    At the same time, better safe then sorry. I guess it comes down to feeling things out and if there is something that is too valuable to discuss, remove it from the business plan.

  • ala y

    what is the articlas or the words or terms that make the NDA limited on commerical and trade purposs
    without any politcal or unlegal information

  • http://www.startupcompanylawyer.com Yokum

    I don't understand the question.

  • Justina Kelly

    Yokum,

    I am a bit confused. Are you saying that you should NOT ask a potential Investor to sign a NDA because they are already bound to this anyway?

    J. Kelly

  • Justina Kelly

    Yokum,

    I am a bit confused. Are you saying that you should NOT ask a potential Investor to sign a NDA because they are already bound to this anyway?

    J. Kelly

  • Rmarti99

    Would a WA state Public Safety agency (Local Government) be obligated to disclose the NDA of a settlement, through a Public Records Request or a Freedom of Information Act(FOIA) request?

    Background: Agency terminated an union employee. Employee/Union “fought” up to an arbitration. A settlement was agreed to(not by arbitration). A NDA was part of the settlement. Would the NDA and the settlement terms have to be disclosed under FOIA? Would it be public record.

  • http://www.sojoodi.com Sojoodi

    Thank you very much for the post. I specifically needed information regarding non-disclosure versus non-use. But enjoyed reading the full article.

  • http://bayarealawyer.org Bay Area Lawyer

    Good stuff. You don't know how many clients we see using general NDA's they downloaded from some legal forms site and don't understand why they would never stand up. Each NDA agreement is going to be as unique as the two parties signing it.