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01 Dec 2015
Confidentiality, Nondisclosure and Secrecy Agreements
By: Rebecca K. Myers, Vandenberg & Feliu, LLP
CONFIDENTIALITY AGREEMENTS, ALSO REFERRED TO AS nondisclosure agreements (NDAs), or secrecy agreements, are legal agreements between parties specifying information that one or both of the parties consider confidential and prohibiting the other party from disclosing it. The party disclosing the information is commonly referred to as the “Disclosing Party” and the party receiving it is referred to as the “Receiving Party.”
Confidentiality agreements can exist in a variety of contexts, one of the most common being between an employer and its employee. They can also exist in a multitude of other arrangements, as well. For instance, they are commonly entered into with independent contractors, suppliers, and between parties considering a financial or business arrangement, such as with a potential investor or parties to a joint venture.
In the employment context, confidentiality agreements are beneficial to an employer because they allow the free-flow of confidential information within an organization in order to maximize business efforts but at the same time prohibit employees from using or disclosing confidential information, such as client lists, strategic plans, know-how, technologies, marketing strategies, and proprietary relationships outside the scope of their job responsibilities. They work similarly in other contexts as well - allowing information to pass to authorized parties without fear that it will enter the public domain.
Confidentiality agreements will bind the Receiving Party during the term of the agreement itself, and typically for a period thereafter, and prohibit the Receiving Party from using or disclosing confidential information outside of the scope of the relationship. For example, in the employment context, the Receiving Party is the employee and he or she will be bound to a confidentiality obligation during the term of his or her employment and for a period after the employment ends.
When drafted and used properly, confidentiality agreements are an effective way to protect confidential information. Parties entering into confidentiality agreements should consider including several important clauses outlining their respective obligations (see below).
Mutual or Unilateral Obligations
Depending on the circumstances, a confidentiality agreement may contain mutual or unilateral obligations. Unilateral obligations are appropriate when only one party is disclosing information, such as when a Disclosing Party is sharing confidential information about the development of a new product and the Receiving Party, a potential investor, will only be providing publicly available information, such as interest rates and their experience in the industry. In this case, only one party (the inventor) is disclosing confidential information and only one party (the potential financier) is restricted by the agreement not to disclose confidential information to third parties.
Mutual obligations are appropriate when both parties are disclosing confidential information, such as when a company hires a vendor to develop proprietary software for the business and the parties must share confidential information about their respective software. In this situation, both parties are disclosing confidential information and both parties are restricted from disclosing what they have learned.
Definition of “Confidential Information”
There are three basic approaches to defining the confidential information covered by the agreement: (1) providing a general description; (2) providing a specific description; and (3) expressly marking the confidential information. There are advantages and disadvantages to each approach.
- General description. Providing a general description of the confidential information to be disclosed (such as “marketing information, sales strategies, procurement requirements, manufacturing, customer lists, and investors”) can be a good strategy to protect information that may expand with the business arrangement. A general description is broad enough that it will cover later-created confidential information as well as items that were not anticipated at the time the agreement was entered into. The drawback is that a definition with such breadth creates some legal and practical risks. Because it is not specific, it is difficult for a Receiving Party to fully understand its obligations and to apply the confidentiality agreement in day-to-day situations.
- Specific description. This is almost the other end of the spectrum. Here, the agreement will specifically identify the confidential information to be exchanged. This type of description is helpful in targeted, shorter-term relationships that are entered into for a particular reason, such as between a company and a software consultant or a company and a consultant on compensation issues. A specific description would not be the best choice in a longer- term relationship where the type of information intended to be protected will expand or change, such as in an employer/ employee relationship.
- Marking. With this approach, the specific items that are designated as containing confidential information are stamped “Confidential.” The benefit of this approach is that nothing falls through the cracks in terms of the supplied definition. And the Receiving Party will have a tough time arguing that it was not on notice that the information was designated confidential by the Disclosing Party. The drawback to this approach is the administrative burden and practical ability of actually marking the items confidential, especially where items are intangible or bulky in nature.
An “Exclusions Clause” should also be considered. This carves out information that loses its confidential status through acts outside of the Receiving Party’s control. An Exclusions Clause is an important protection for the Receiving Party, as it excludes specific information from the definition of “Confidential Information.” The Exclusions Clause can contain anything the parties agree to, but most commonly it will exclude items that (1) are already known by the Receiving Party, (2) have become part of the public domain, (3) were received from a third party, and/or (4) were independently developed.
IP Ownership
Each party will represent that it retains the exclusive ownership and intellectual property rights in its respective confidential information, and that no license or any other interest in a party’s confidential information is granted or implied by the agreement.
The Disclosing Party may obtain a further layer of protection against third party IP rights, particularly in situations involving research and inventions. Including language that the information disclosed is provided without any express or implied representation or warranty, including without limitation that (i) it does not infringe any third party’s intellectual property rights, (ii) it is accurate or complete, or (iii) it will be suitable for the Receiving Party’s purposes, may help to limit the Disclosing Party’s potential liability.
Consideration
Like any other contract, confidentiality agreements require consideration, which means that the Receiving Party must receive something in exchange for its promise not to disclose the information.
In the employment context, if the confidentiality agreement is signed at the inception of employment, employment alone is usually sufficient consideration. However, if it is signed after employment begins, many states require fresh consideration for the employee’s promise, such as the payment of a bonus, promotion, additional vacation days, or enhanced benefits.
Outside the employment context, consideration will depend on the relationship of the parties. In an independent contractor relationship, the designation of “contractor” and payment for services provided in connection with that relationship, should be sufficient. In the case of a business alliance, such as a joint venture or the exchange of confidential information in connection with the consideration of a new business arrangement, the ability to fully consider the potentially beneficial arrangement is usually enough.
Term of the Confidentiality Obligation
Confidentiality obligations are not typically intended to terminate when the relationship ends. Rather, most Disclosing Parties desire that the confidentiality obligations last at least as long as the information remains confidential. In reality, this could be as short as a few months or as long as indefinitely. The Receiving Party would prefer that the term is as short as necessary so that the obligations under the agreement are absolved as soon as possible. Because the parties may have very different ideas about how long the obligations will inure, it is always a good practice to expressly set forth the term of the prohibition in the confidentiality agreement.
Receiving Party’s Duty to Protect Confidential Information
A confidentiality agreement should contain a clause requiring the Receiving Party to use a certain level of care in handling the confidential information. While some agreements provide that the Receiving Party must take reasonable measures to keep the information confidential, others require specific steps to protect the information, such as to keep it locked in a secure place or, if it exists electronically, to secure it through one or two levels of password-protected security. There could also be restrictions as to who may access the information and for what reason. A Disclosing Party should consider how secret and valuable the information being disclosed is and require efforts from the Receiving Party that would - at a minimum - protect the information to the same degree that the Disclosing Party uses.
Permitted Disclosures
A well-thought-out confidentiality agreement should provide the ability for the parties to disclose the confidential information in specific instances, such as when required by court order or other court proceeding. Depending on the relationship, there may be other circumstances where disclosure is permitted. Where a party is permitted to disclose the confidential information, the agreement should require that the Receiving Party provide notice to the Disclosing Party.
The notice provision should specify that the Disclosing Party shall be given written notice a certain number of days prior to the disclosure so that the Disclosing Party has an opportunity to intervene to protect its rights, if possible or necessary.
Return of Documents
Confidentiality agreements should provide for the return or destruction of confidential information at the conclusion or termination of the relationship. Since so much information exists digitally, in many instances it is more practical for the parties to agree to destroy each other’s information and once concluded, send certifications that destruction is complete. With regard to electronic information, parties should consider to what extent destruction need occur. For example, must the Receiving Party destroy back-up tapes, slack space in its computer files? Or is it adequate that an average person would not be able to access the information without the use of computer imaging and advanced forensic tools?
Assignability
The decision to share confidential information with another party is a personal and subjective one. As such, confidentiality agreements typically contain clauses prohibiting either party from assigning the agreement to any other party, whether expressly or by operation of law. For instance, if a company retains a specialized software developer to write new source code to support existing applications, it may not want to give that developer the ability to assign the rights and obligations under the agreement. Sometimes, however, the agreement will permit the Disclosing Party to assign the agreement to a successor without the need (and administrative burden) for the Receiving Party to consent to such assignment.
Non-Solicitation
One, and sometimes even both, parties may be concerned about the other party soliciting its employees, customers, or suppliers. If this is the case, the parties should consider adding a non-solicitation term in the confidentiality agreement restricting the other party from engaging in such solicitation.
Third party contractors in particular often work in a specialized capacity for a company, and have regular contact with employees, customers, and/or vendors. Thus, it is important to hold third party contractors to a non-solicitation agreement prohibiting them from recruiting the company’s employees away and/or soliciting business from the company’s customers and vendors.
Governing Law
Confidentiality agreements usually contain a choice of law clause specifying that the law of the Disclosing Party’s state controls. Without good reasons or unusually strong negotiating leverage, the Receiving Party is not likely to get the Disclosing Party to agree to application of another state’s law. However, where both parties are disclosing confidential information, or the Disclosing Party has multiple locations, there may be some choice in the designation of the law. Therefore, parties should review the law of the potential states to fully understand any limitations or benefits each state may confer on the parties’ rights and responsibilities.
Choice of law clauses are usually enforceable if the law selected bears some reasonable relationship to the confidentiality agreement, and so long as the public policy of the selected jurisdiction is not contrary to the subject matter of the confidentiality agreement.
Boiler Plate Clauses
As with any contract, the parties may wish to include some boilerplate provisions that are fairly standard and typically included in any contract. Boiler plate provisions can have an impact on the parties’ rights under the agreement. Thus, although they are somewhat standard, the effects of their inclusion or exclusion should be carefully considered. Some of the more common provisions are:
Arbitration. Any disputes about the contract must be resolved through arbitration proceedings, not in a lawsuit.
Costs and attorneys’ fees. The losing party in a legal proceeding must pay the prevailing party’s legal fees.
Counterparts. Each party may sign the agreement separately and all parties do not have to be together at one time to sign.
Entire Agreement. The written contract represents the final agreement of the parties and any prior agreement or discussions of the agreement are replaced by the written contract. It also usually provides that any modification to the contract, in order to be effective and enforceable, must be in writing and signed either by both parties or by the party to be charged with the obligation.
Force majeure (also referred to as “Acts of God”). The agreement will be suspended or terminated in the event of unforeseen disasters preventing performance (such as earthquakes, hurricanes, floods, fires, etc.). Headings. The headings used throughout the agreement have no special significance and should not be used to interpret the agreement.
Indemnity. A guarantee by one party to the other that certain costs will be covered if actions or challenges are brought by third parties. These provisions usually have a cap on liability and a procedure for notifying the indemnifying party when its indemnity is triggered.
Jury trial waivers. If there is a court proceeding, the parties may waive their right to a jury trial and agree that a judge will hear and determine the dispute.
Notice. The mechanism by which each party will notify the other, such as when the agreement is terminated or when there is an impending court-ordered disclosure.
Publication. Whether or not the parties can make public the fact that they have a business arrangement, for marketing or other purposes.
Severability. The parties may agree that any provisions determined to be wholly or partially invalid can be struck from the agreement and the remainder of it will remain enforceable.
Venue. The court or arbitration panel has authority to hear a dispute arising from the agreement.
Limitations of Confidentiality Agreements
A confidentiality agreement does not give perfect protection to the owner of a trade secret or other confidential information. It is important to understand the limitations involved in one.
The major limitations are:
The agreement can only be enforced against the parties who are bound by it. It is therefore important to ensure that the person or organization to whom the information is disclosed is bound by the agreement. For example, if a company shares confidential information with a supplier but, in order to fulfill the request for services, that supplier must share the company’s confidential information with a joint venturer, agent, or investor, the transmission of confidential information between the supplier and those additional parties is not protected. Accordingly, the Disclosing Party must take great care to ensure that any party receiving its confidential information is given a copy of the confidentiality agreement and signs and acknowledges that it has read and understands its obligations thereunder. This can be accomplished by understanding the manner in which a Receiving Party will handle its business obligations and including a provision in the confidentiality agreement obligating the Receiving Party to require any person who needs to know the Disclosing Party’s confidential information to sign the confidentiality agreement.
The agreement is only as effective as a court says it is. While certain strong language and obligations contained in a confidentiality agreement may be effective to chill bad behavior on the part of a Receiving Party, if and when a confidentiality agreement is challenged in court (which may be a lengthy and costly process), the party seeking to enforce the confidentiality agreement bears the burden of proof to establish breach and injury. In addition, it likely will not reflect well on a Disclosing Party where a court perceives that there was unequal bargaining power during negotiations and overreaching by the Disclosing Party.
The true “confidential status” of the information at issue. An agreement that prevents a Receiving Party from revealing confidential information is enforceable only if the information sought to be protected is actually confidential. If a Disclosing Party cannot demonstrate that the information it seeks to protect is confidential or that the information is unique or extraordinary, a court will not enforce the confidentiality agreement. Therefore, if an agreement is challenged and ultimately determined unenforceable, such a finding can have a snowball effect on other confidentiality agreements that the Disclosing Party signed with other parties (employment agreements, supply agreements, consultant agreements) and may open the door to more litigation challenging those agreements.
Remedies
A confidentiality agreement must be “reasonable” to be enforceable. To determine reasonableness, courts will look at factors such as:
- the interests of the Disclosing Party in keeping the information secret;
- the period of time the information must be kept secret;
- the burden on the Receiving Party; and
- the interests of the public.
Acknowledgement of irreparable harm. Damages for breach of confidentiality under a breach of contract theory are typically difficult to quantify and the loss cannot be measured fully in money damages. Thus, the harm is irreparable. For these reasons, having the Receiving Party acknowledge that a breach of the agreement would result in irreparable harm to the Disclosing Party is helpful, although not determinative.
Liquidated Damages Clause. Because the harm may be impossible to quantify, the parties can consider adding a liquidated damages provision, setting a formula or sum certain due to the injured party upon breach of the agreement. The amount specified should be large enough to act as a deterrent to the Receiving Party. If the parties opt for a liquidated damages clause, however, they should be aware that, upon breach, a court is unlikely to find irreparable harm justifying an injunction since the agreed-upon liquidated damages provision acts as a substitute for irreparable harm and provides an adequate remedy at law.
Rebecca K. Myers is Of Counsel at Vandenberg & Feliu, LLP and focuses her practice on intellectual property law.