Non-Disclosure Agreement Pitfalls

One of the most frequently used agreements by entrepreneurs is the non-disclosure agreement (also known as an “NDA”). There are various schools of thought around NDAs, particularly how and when to utilize them.

If you are an entrepreneur, you may have heard somebody at some point say something to the effect of, “NDAs are useless,” or “NDAs can’t be enforced.” Both of those statements are simply wrong. It is true that NDAs can be difficult to enforce simply because they often require evidence that is hard to obtain. However, they can still be extremely important.

In addition to paying attention to NDA terms, it is also important to have advisers and counsel that understand NDA convention. It is true that venture capitalists generally frown upon NDAs and often refuse to sign them, at least in early discussions. The reason VCs do that is because, first, they have the market leverage not to sign them. Usually you need their money more than they need your deal, so they can drive protocol. Second, they see a lot of deals and do not want to give someone who shared some information even a whiff of a claim against them. Even if a potential investor will not sign an NDA, it is important that entrepreneurs understand what information NOT to provide when no NDA is in place. As I will discuss more in a more moment, providing trade secrets without an NDA can jeopardize the trade secret status of that information.  

While NDAs can be highly negotiated and more extensive among sophisticated players, they are still, by and large, one of the more standardized and simple agreements that entrepreneurs and businesses typically enter. NDAs can be one-way (meaning there is one provider of information and one recipient who has the non-disclosure obligation) or mutual (both parties can be either the disclosing party or the recipient). NDAs generally bind the recipient of “confidential” information, which is often defined rather broadly, to maintain its the confidentiality except in various enumerated exceptions. Those exceptions generally include the following: 1) the information became available through no fault of the recipient, 2) the information was already independently known to, or independently cultivated by, the recipient without use of confidential information, or 3) a time period has elapsed (known as a sunset clause).

Sunset clauses, in particular, are more important than people might realize at first glance and can now cause disclosing parties real issues by jeopardizing trade secret status of certain information. Trade secrets are broadly defined as information that possesses independent economic value and which is subject to reasonable efforts to preserve its secrecy. Trade secret protection can be an important form of intellectual property protection and it provides recourse, for example, in the case of theft or unauthorized disclosure. Additionally, trade secrets are subject to federal protection and generally state and/or common law protection as well. Certain companies like Coca-Cola, which has famously guarded its secret cola recipe, are built on trade secrets. Others rely more on other kinds of intellectual property protection, like patents, which are publicly filed with the U.S. Patent and Trademark Office and are, by definition, not trade secrets. 

Now, however, there is case law in some jurisdictions that sunset clauses permitting disclosure of confidential information after a sunset can negate trade secret protection, and many practitioners and entrepreneurs are unaware of these possible adverse effects. On the one hand, that is bad news for parties that want to share sensitive information to recipients with whom they may be interested in providing information. On the other hand, these developments provide an excellent basis on which to insist upon more favorable terms from the recipient of confidential information and to shift NDA terms in favor of the disclosing party.  

However, some U.S. jurisdictions also will not enforce NDA terms that are indefinite in duration as an unfair restraint of trade, leaving entrepreneurs in a pickle and reinforcing the need to have competent counsel in the right jurisdiction.

As always, entrepreneurs can easily get mired down in legal considerations from every single angle and lose site of what it takes to build a business, and entrepreneurs also must remain practical when it comes to allocating limited financial resources. However, even seemingly simple agreements can carry a whole host of other considerations. That’s why good, practical legal advisers should be part of any business’s plan to grow. 

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