Confidential Disclosure Agreements
The three be's
In many transactions, the first legal agreement to be discussed is a
confidential disclosure agreement ("CDA"). The parties often need to
exchange information prior to proceeding with the time and expense of detailed
negotiations. A CDA facilitates this exchange by establishing the conditions
under which the parties will provide confidential information and by imposing
legal obligations upon its receipt. While intended as a preliminary step, a CDA
can nevertheless have long-lasting consequences. In reviewing and preparing a
CDA, three rules may keep these obligations in their proper perspective and
avoid unintended consequences in the event the transaction does not proceed.
Be clear. The CDA imposes affirmative obligations to hold items in
confidence. This requires active monitoring and safekeeping. It may also
restrict a company's development activities and those of its employees. All of
this has costs. Breach, even if inadvertent or by a former employee, can lead
to litigation, injunctions, damages and legal fees. Therefore, always question
whether a preliminary exchange of confidences is really required. If so, make
certain that the CDA covers only material that the parties reasonably need to
make their decisions, and define the protected material with precision.
Require information, in order to be protected, to be in writing and
conspicuously marked as confidential. If oral delivery is unavoidable, insist
that the discloser promptly confirm the material's confidential status in a
non-confidential written summary.
Unless the recipient insists on an adequate paper trail, it will be forced
to make a case-by-case determination about every bit of information each of its
personnel receives, subject to second-guessing by a court or arbitrator. A
clear paper trail will
also reduce the legal burden and expense should a disagreement arise, often
years after the initial disclosure, when memories , have become murky. Clear
documentation will also make identification of third-party confidential
information easier in the event of a sale of the business, and may keep a
disappointed customer, supplier, or former suitor from hindering a future sale
under the guise of a broad claim of confidentiality.
Be limited. First, limit the use of the confidential information. Remember
that a CDA is the first, not the last, step in the transaction. Therefore, the
agreement should precisely state the purpose of the disclosure. and limit the
recipient's use of the information solely to that purpose.
Second, limit the number of individuals who will have access to the
confidential information. If feasible, the CDA should identify the persons who
are authorized to receive the information, by name, by class or by position.
The information should go no
farther within the company and its advisors than is necessary for the
limited purpose of the disclosure. This is particularly important if the
recipient insists that it be free to pursue the independent development of
material similar to the confidential information. The nature of the information
being disclosed and its intended use (consider the difference between a merger,
on the one hand, and the pricing of a part, on the other) make it imprudent to
rely on generic boilerplate in defining the protected information.
Third, limit the duration of the CDA. As a general rule, the obligation of
confidence should last only as long as the time it would take to
reverse-engineer the information or for the information to reach the trade
through ordinary channels. The length of time will vary based on the nature and
sensitivity of the information, as well as on industry practice. Failing to
specify a cut-off date, however, will mean that the recipient must hold the
information in confidence forever, or at least until the recipient can
demonstrate that the information has reached the public domain. In addition to
imposing an unwarranted burden on the recipient, such an indefinite obligation
may be viewed negatively by future acquirers or public markets.
Finally, limit the representations contained in the CDA. Disclaim
warranties, including patent infringement. Leave warranties and reliance to the
definitive agreement, assuming the transaction proceeds.
Be Prepared. Every CDA does not lead to a completed transaction. The CDA
should anticipate this possibility, and should require return or destruction of
the confidential material (including all copies) on cessation of the
discussions. Exceptions to confidentiality should be specified. Generally,
these include information in the public domain, information that the recipient
knew already, information that the recipient receives independently from others
, and information that the recipient is legally
required to disclose, i.e. by subpoena or by regulation.
Examine each exception in light of the information to be disclosed and its
intended use. For example, defining "information in the public
domain" as "information generally known to the public" may be
far too restrictive. Certain information may be generally known to experts in
the field or industry and still be unknown to the person in the street. Careful
consideration should also be given to the merits of agreeing to the so-called
"independent developments" exception, which permits a recipient to
use information that it subsequently develops on its own, even if that
information turns out to be identical to material furnished by the discloser. A
person disclosing a truly unique and revolutionary idea should resist this
exception. If you can't avoid it altogether, limit this exception to
information developed only by persons about whom the recipient can
affirmatively demonstrate were not exposed to the original confidential
information. This shifts the burden to the recipient to show that its hands are
clean.
Preliminary discussions can alert the other party to a company's key
personnel. A non-solicitation clause is worth considering, particularly when
dealing with a competitor. The parties should also allow for the possibility of
a subsequent dispute about the CDA.. Which state's law governs the agreement,
consent to jurisdiction, and a provision for an award of attorneys' fees to the
prevailing party in the event of subsequent litigation are all subjects worthy
of discussion and inclusion in the CDA.
By focusing on the "be's," the parties to a CDA can ensure that
the realities of their business, and not the unintended consequences of
boilerplate drafting, govern their relationship, however long- or short-lived
the underlying transaction turns out to be.