Intellectual property and trade secrets are assets of extreme value in today’s economy and while certain types of such property may be protected by copyrights and patents, much of the world of trade secrets and confidential information is not protected outside of contractual protections that one may develop. Confidential information and trade secretes are protected by the proactive efforts of the holder of such property, both in terms of protecting it by keeping it fully confidential and inaccessible to the public and competitors, and by using written contracts to impose the duty of confidentiality upon parties.
Such contractual protections are often found in the employment or independent contractor relationship, as part of an employment or contracting agreement, as well as in third party contracts with vendors, customers or possible joint venturers or buyers during negotiations for the business relationship.
A critical aspect of any negotiation for either investment into a company or purchase/sale of a company is a close review of its operations and financial documentation by the Buyer. Normally this review is made before a final agreement is executed or, even if a final agreement is executed, the enforceability of the agreement is predicated on whether the Buyer is satisfied with the financial and operational documentation of the Seller. This normally includes customer lists, formulas, operational reports, etc. In short, the Seller opens its books and trade secrets to review by a Buyer before the deal is binding in most circumstances. Such disclosure to a party who may or may not actually buy the business requires protection of secrets should the deal not be consummated and Nondisclosure Agreements can provide such protection.
And if a contractor or employee is going to have access to confidential information and trade secrets, it is vital to ensure that such information is not transferred to third parties, especially competitors, and contracts are often used to increase the protection available to the employer holder of trade secrets.
This article shall discuss the Nondisclosure Agreement in that context.
The Contractual Obligations-Employees and Independent Contractors:
It is important to differentiate between the obligation to keep information confidential and a non-compete agreement which prohibits competition. The latter is usually unenforceable in California, though other states do allow such agreements. What we speak of here is a restriction on disclosure of confidential information, not restriction on competition.
Note that any employee, occupying a fiduciary duty to the employer, also has a duty of loyalty while employed. This necessarily means that while employed, the employee cannot act against the interest of the employer by secretly competing or disclosing confidential information without breaching his or her obligation to the employer.
Then why a contract for an employee? Because it simplifies enforcement and also may bind the employee to keep matters confidential even after employment ends.
A key question for most disputes as to protection of confidential information is (1) whether the information is truly the type that is confidential and (2) whether the company took appropriate steps to maintain its confidentiality. On the former, confidential information cannot simply be whatever the company claims is confidential. It must be truly private information. (Thus, on (1) if I state that the number of vendors of X in Europe is a confidential piece of information, but that information is readily found on the internet, it is not truly confidential. On (2) if I, myself, place confidential information on the internet or distribute publicly, I cannot later claim it was confidential since my own actions defeated its confidentiality.
These questions of fact can be difficult and expensive to prove, so a written agreement that provides precisely what is confidential and what is not solves that issue and, if combined with a good arbitration clause, can avoid expensive court fights.
A typical clause is as follows: (This is not for every state or all circumstances: this is merely an example.)
1.05 By this Agreement, Discloser and Recipient agree that all trade secrets and confidential information disclosed or made available to Recipient during this relationship will be kept strictly confidential and will further provide means to ensure full protection to Discloser should a question of unauthorized use and/or disclosure of such information arise. Recipient may utilize said information for the purposes of performing Recipient’s duties hereunder: Any other use of the information without prior written consent of Discloser is prohibited and unauthorized...
Article II. Confidential Information and Use…
2.01 For all purposes of this Agreement, the term "Confidential Information" or "Trade Secret" shall include any and all information and the fruits thereof which is not generally available to the general public and derives from Discloser or Discloser's agents. The Confidential Information may be oral, written and/or stored in any medium or manner whatsoever, including but not limited to magnetic disks, e-mails, recordings, etc. Such information may be technical or scientific, or relate to business matters such as business plans, existing or potential customers, finances, or personal matters, etc.
(a) Recipient may claim that the Confidential Information is not truly confidential in that it was previously known to Recipient or disclosed to Recipient by Third Parties not under contractual obligation to Discloser to keep said information confidential or already known by the general public, but Recipient shall have the burden of proving that such is the case. As to technical or scientific matters, such proof must be in writings created prior to the Recipient’s access to Confidential Information and dated accordingly.
(b) Should Recipient have access to alleged Confidential Information which Recipient contends is not Confidential Information, Recipient shall, within ten days of access, specify in writing to Discloser Recipient’s contentions regarding said Confidential Information or shall be forever barred from claiming said Confidential Information is not truly confidential information.
2.02 Recipient agrees that Confidential Information is of extreme value to Discloser and would cause irreparable harm to Discloser if disclosed to other persons, or if utilized by Recipient or Recipient’s agents for unauthorized purposes.
2.03 Recipient agrees to only utilize such information and/or the fruits thereof for the sole purpose of assisting in the performance of Recipient’s duties undertaken on behalf of Discloser. All information imparted shall be kept strictly confidential and may not be used or disclosed in any form or in any manner, whether directly or indirectly, to or by any person or persons without prior written consent of Discloser. Upon the termination of the business relationship with Discloser, Recipient shall not utilize the information for any purpose whatsoever, either directly or indirectly, nor reveal the information directly or indirectly, to any third person. Recipient shall destroy or return to Discloser all such Confidential Information previously delivered to Recipient, as directed by Discloser, as well as any copies, outlines, summaries, abstracts, or work product of any type and in any form deriving from such information.
The Contractual Obligation: Third Party Negotiations:
A far more dangerous situation occurs when a possible or existing competitor gains access to your trade secrets during negotiations for possible purchase or joint venture or when you are negotiating an ongoing business relationship with a vendor or customer who may very well share your information with a third party or use it themselves.
Protecting yourself via contract in this situation is often a delicate process since one does not want to offend the third party. However, use of such protective documents is becoming increasingly common and any potential buyer who will not sign such a document is certainly a dangerous negotiating partner. It is not uncommon for a buyer thinking about expanding into a market to explore buying existing competitors since a great deal of otherwise unavailable information may be found by sellers anxious (and foolish enough) to provide such information freely to obtain a possible sale of the business.
A wise old business man once told this writer that submitting a nondisclosure agreement to a possible buyer is always a very good test. First, it tells you quickly how sincere they are in buying rather than fishing for information. Second, it shows they are sophisticated enough to realize it is essential for any buyer. Third, it shows them that he is not a fool and knows how to run the business. “If they won’t sign, I won’t waste further time with them. They are either fools or think I am.” He died a millionaire so must have known what he was talking about.
The underlying problem is that the potential buyer, vendor or customer may not want to restrict their future activities by executing such an agreement and will claim that it is impossible to determine what was derived from confidential information. That “problem” is easily resolved by careful definition of confidential information and by restricted access to the information you are providing. Drafting of the correct agreement is vital.
Again, a typical set of provisions, that would not necessarily be appropriate for your locale or business but which give you a general idea follow:
NOW THEREFORE, in consideration of the mutual promises set forth below, and upon the following terms and conditions, ___________ and ____________ agree as follows:
1. Each party will use the Information heretofore or hereinafter obtained from the other party solely for the purpose of determining whether a potential sale or merger of the businesses or a business relationship between the parties could be mutually beneficial and for no other purpose whatsoever.
2. The undersigned represent and warrant that they have the authority to enter into this Agreement on behalf of the parties. Further, each party represents, warrants and covenants that it has the right to disseminate this information for any and all purposes of this Agreement and that it has not otherwise entered into any agreement with any third party which would encumber or otherwise interfere with the obligations of that party hereunder. For the term of this Agreement, and for thirty days thereafter, the parties agree not to enter into active discussions or negotiations with any third party concerning either the purchase or sale of X or its assets. The negotiations between them shall be exclusive to them.
3. In consideration for access to the Information, each party agrees that only those employees and agents of the party whose knowledge of said Information is necessary for the above-stated purpose shall have access to same. Each party agrees not to disclose the Information to any other third parties without first obtaining written permission from the party whose Information is proposed to be disclosed. Each party agrees not to duplicate or use the Information in any manner unless such duplication is necessary to further the purpose of this Agreement as stated in paragraph 1 above.
4. Each party warrants that all of its employees who shall have access to the Information are under an obligation: (i) to hold the Information in strict confidence in conformance with the terms and conditions of this Agreement, and (ii) to use the Information only for the purposes of this Agreement.
5. In the event the parties do not enter into a contractual or purchase relationship with each other, all Information shall promptly be returned or destroyed at the option of the provider of the information. However, each party shall have the right, at its sole option, to destroy any and all analyses, compilations, studies or such other documents that are created by it or its advisors in accordance with the proposed transaction. Upon request, either party shall certify in writing that it has fully complied with the requirements of this Section.
6. Further, neither Party shall utilize any information obtained from these disclosures for its own purposes nor shall they utilize any business contact or connection derived from the disclosure for their own purposes or to solicit any of the other’s employees. Such “contacts” shall remain the proprietary property of the disclosing party.
7. Notwithstanding anything herein to the contrary, neither party need maintain any Information of the other party as confidential (i) to the extent disclosure is required by any governmental body or any agency thereof or regulatory body or as otherwise required by law, provided, however, that neither party shall provide the Information without giving the other party sufficient time to object to the request; (ii) if such Information becomes a matter of public knowledge for any reason other than by the act, omission or default of the party obtaining the Information under this Agreement; (iii) if such Information shall have been acquired from the public domain or from a third party which has the right to disclose such Information; (iv) if such Information was demonstrably in the possession of the party to whom it is disclosed prior to the time of the disclosure of such Information; or (v) for more than three (3) years after the date hereof; otherwise the Agreement to hold the Information in confidence shall survive the termination of this Agreement. Specific Information disclosed by either party shall not be deemed available to the public or in the other party's possession merely because it is embraced by more general Information available to the public or by prior general Information in the other party's prior possession.
8. Each party shall notify the other promptly of the date of, and circumstances involved in, the loss of or unauthorized disclosure, if any, of any documents, drawings, descriptions in writings or samples relating to the Information and the party who disclosed such Information shall secure the return of the Information from the party to whom the Information was disclosed.
9. Both Parties agree that no exchange of information will be undertaken or understanding reached between them that is in violation of any applicable statute or case law regarding violation of any antitrust, or equivalent provision in any applicable jurisdiction. Any provision of this Agreement which is held by a court or arbitrator to be in violation of this prohibition is void and of no effect. The remaining provisions of this Agreement shall remain in full force and effect….
The usual provisions recommended in any contract should be incorporated into the Nondisclosure Agreement, such as mandatory arbitration and award of attorney’s fees to the prevailing party. Keep in mind that a well-formed contract can also act as a disincentive for an employee or competitor to try to steal trade secrets. It creates a relatively simple way to enforce rights and if arbitration is included, is relatively inexpensive and quick to enforce.
Above all, it is one more tool in the armory that every business must have to protect its own intellectual property and secrets. To not have an appropriate agreement is simply to fail to protect what may be your most valuable asset.