How to Use and Review Non-Disclosure Agreements (NDAs)

We are frequently asked by clients to review Non-Disclosure Agreements (“NDAs”) in various contexts. It goes without saying that you should be careful of what kind of NDA you sign and not be afraid to negotiate any terms you do not like. 

Nondisclosure or confidentiality agreements come in a wide variety of forms and styles, and they should always have provisions covering non-use by the receiving party–not just a restriction on disclosing such information to third parties. Many NDAs you encounter will be fine to sign as is, but you will also often receive one that contains objectionable terms. This simple guide will better acquaint you with the basics and help you spot common red flags.

What information should NDAs cover?

If you are the disclosing party, you want to make sure the definition of “Confidential Information” is as broad as possible. Typically, every NDA will cover confidential, proprietary, technical, financial, or other non-public information, including intellectual property rights, trade secrets, software source and object code, etc. A “trade secret” is any information that is valuable and whose owner has taken reasonable steps to remain secret, such as encryption mechanisms, password protection measures, physical protections, requiring employees and others to execute NDAs, etc. Examples of trade secrets are the KFC recipe, the Coke recipe, Google’s search algorithms, software source code, manufacturing processes, and customer lists. Trade secrets may or may not be patentable. 

There are typically always customary exclusions from what would be considered confidential, including information that is (a) already in the public domain at the time of or after disclosure, (b) rightfully in the recipient’s possession free of any obligation of confidence or not otherwise obtained unlawfully, (c) independently developed by the recipient without use of the discloser’s confidential information, and (d) required to be disclosed in connection with a court proceeding.

In which scenarios should you sign a NDA?

NDAs should be signed by two parties in advance of entering into discussions or evaluating a certain business relationship or transaction.  Here are some common scenarios: 

• Commercial agreements and IP/technology development deals 
• Mergers and acquisition transactions
• Financing transactions in which investors are conducting due diligence
• Joint ventures 
• Requests for proposals
• As a catch all, any scenario in which you are receiving or sharing sensitive or confidential information with another person or entity.

Another point to note is that there are one-way NDAs and mutual NDAs. With a one-way NDA, only one party will be disclosing confidential information, and therefore only the recipient will be obligated to protect it. In a mutual NDA, both sides will exchange information and be under such obligations. 

As a practical tip, if you are the only side making disclosures, make sure to use a one-way NDA so you don’t also sign yourself up for unnecessary confidentiality and non-use obligations.

When should you enter into an NDA?

The answer is simple: as early as possible, and ideally prior to any discussions, meetings, or negotiations have occurred.  If the parties have disclosed confidential information prior to the execution of the NDA, make sure that the NDA explicitly covers such prior disclosure.

What are some red flags and nuances to watch out for?

1. The duration of your confidentiality obligations. If you are the recipient, you want these to be shorter (1-2 years) and vice versa if you are the discloser. 2-5 years is typical.
2. Make sure if you are disclosing any trade secrets that the NDA obligates the recipient to keep it confidential and not use the trade secrets indefinitely, which generally means until such trade secret enters the public domain.
3. We recommend that you avoid disclosing your highly confidential “secret sauce” trade secrets if you can avoid it, even if the NDA adequately obligates the recipient to protect them. 
4. The purpose and use of the confidential information. The NDA should explicitly say that the recipient may only use your confidential information for a predefined purpose, such as its obligations under an agreement or in connection with the evaluation and negotiations of a proposed business relationship or transaction.
5. To whom the confidential information may be disclosed. Typically, the recipient will be allowed to disclose the confidential information to its officers, directors, and key employees. But you should consider whether it is appropriate for the recipient to share the confidential information with its independent contractors, consultants, advisors, and other professionals like accountants and lawyers, who are essentially third parties outside the scope of the recipient company. If this is appropriate, then you should make sure the NDA provides that the recipient may only disclose to such parties if they have executed an agreement providing for confidentiality and non-use on terms no less restrictive than the NDA you and the recipient entered into, and that the recipient will be liable for any breach by its independent contractors. 
6. Many times lower level employees of a recipient should not have access to your confidential information, so we recommend adding that the recipient may disclose such information only to employees only on a “need-to-know basis.”
7. Any unwarranted provisions. Make sure there are not any Non-Solicitation or Non-Competition obligations. Sometimes the other side will attempt to sneak in these clauses, which are not typically appropriate.
8. A “residuals” clause. Sometimes the recipient will attempt to include a “residuals” carveout to the non-disclosure and non-use obligations by allowing its employees to use the discloser’s confidential information they remember from their “unaided memory.” A residuals clause is most often employed by large, sophisticated corporations especially when they think they have leverage over a smaller company. This clause should be deleted every time you see it.    
9. The relationship or engagement between the parties being included as confidential information. Oftentimes the NDA will state that the presence of the NDA and such  negotiations or engagement or relationship is confidential. This isn’t necessarily a dealbreaker, but you should consider whether it is appropriate for the situation. For example, you may be excited to announce to your investors or prospective investors that you have entered into negotiations with a big customer like Amazon or Microsoft, but be aware of whether this would be a breach of confidentiality and consider striking such provision in the NDA upfront.   
10. A license for the recipient to use the confidential information.  Double check to make sure you are not granting a license to any of your confidential information. If you and the other side intend to eventually enter into a licensing arrangement for some IP, this provision should be negotiated separately and housed in a License Agreement. 
11. Obligations to destroy confidential information. You should make sure the other party has an obligation to destroy any confidential information it has received during the engagement after it is over. But there should be a carveout to this exception that states you do not have to go back into your automatic email archiving system and delete any information there. This makes it far less burdensome on you.
12. Injunctive relief. The NDA must provide that, in the event of a breach (or alleged breach) by the recipient, the discloser is entitled to seek an injunction from a court to prevent any further unauthorized disclosure or use by the recipient and any third parties. 
13. A Liquidated damages clause should be deleted if present. Double check and see if the other party has tried to sneak in such a  provision, meaning the NDA states that you have to pay a certain monetary amount for each breach. Depending on the amount, this could add up quickly. 
14. An Attorneys’ fees clause. Make sure the NDA provides that the prevailing party in any legal action to enforce the NDA is entitled to be reimbursed its attorneys’ fees and related costs. 

There are of course more issues that may come up, but this will be a great start for you as you begin your own NDA review. 

By: James Graves and Daniel Neuman

If you have any questions regarding the above, please contact James Graves or Daniel Neuman.

For more posts like this, please visit The Startup Law Blog.

Disclaimer: this post is for informational and educational purposes only. It is not intended to provide any legal advice.

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