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Demystifying NDAs. What are the Risks, Really?

//Demystifying NDAs. What are the Risks, Really?

Demystifying NDAs. What are the Risks, Really?

What is a Non-Disclosure Agreement (NDA)?

An NDA, generally speaking, is an agreement between two parties regulating the exchange of confidential information for a specific purpose (often evaluating a future business deal).

Beyond evaluation purposes, NDAs can be used to safeguard highly sensitive information entrusted to employees, consultants, and other counterparts that will carry out services.

What is a Default under an NDA

A default under an NDA most commonly relates to the party receiving confidential information (“recipient”) using the information outside the scope permitted by the disclosing party (“discloser”) under the NDA for which the discloser sustains damages.

For example, earlier this year Facebook’s Oculus was ordered to pay $500 million to Zenimax in connection with a situation where a former employee of Zenimax (who was a recipient of information subject to a Zenimax NDA) began working for Oculus and allegedly misappropriated Zenimax information in carrying out services for Oculus. Such misuse of the information caused damage to Zenimax (the discloser).

The risks of a default under an NDA are typically considered low; however, the consequences can be severe. In light of this, risks should not be overstated but should be understood.

What are the main risks in NDAs?

This analysis is not a substitute for the legal review of your NDA. With this said, understanding these risks can be helpful.

  1. Recipient(s):

    Always contemplate whether the opposing party who will receive your information may be emerging as a competitor to your business. If so, you should reconsider disclosing any confidential information to such party. Additionally, it is best practice to obtain a copy of the official company documentation (e.g. certificate of incorporation) to directly verify that the party signing the agreement is permitted to bind the recipient company. Moreover, it is crucial to ensure the counterpart has sufficient assets to be able to pay a damage claim by your company for any misuse of your information. Finally, I strongly advise limiting dissemination of your confidential information as much as possible. The broader the distribution of confidential information, the greater the chance of misappropriation or misuse. Under the NDA, the recipient shall explicitly undertake to assume all liabilities in connection with any breach of the NDA by a party to whom the recipient discloses information. Your company can even require the list of companies to whom the recipient has disclosed your confidential information (and separate signed versions of the NDA by each such third party recipient).

  2. Implied Law:

    Generally, companies enter into NDAs regularly and often with counterparts beyond national borders. The risk in doing this is that if another country’s or state’s laws are implicated, there may be some provisions implied into the agreement. In light of this, it is best to be very specific about what the information can be used for and if for evaluation purposes that there is no commitment at this time to enter into any future commercial agreement- i.e. that any such future agreement must be regulated by a separate written and signed agreement. What is more, it is always wise for disclosers, under evaluation scenarios, to disclaim any liability if the information proves to be inaccurate or incomplete. Any such accuracy undertakings should be saved for commercial scenarios.

  3. Misappropriation:

    One of the most critical risks is the recipient will misuse or misappropriate your information as in the case of Zenimax’s confidential information being compromised above. The ways to mitigate the likelihood of this happening are to: always give as little information as necessary, to have a very narrowly defined purpose for the use of the information, identify with precision each critical piece of sensitive information provided, limit the length of time of the NDA- i.e. the shorter the better, and have a clear mechanism in place for what the recipient shall do with the information it has received upon termination of the agreement (e.g. return or destroy the information, execute a certificate that a purge has been completed, etc).

  4. Contamination:

    Where misappropriation is the chief risk a discloser faces under an NDA, contamination is the most serious risk a recipient must safeguarded against. Contamination refers to a scenario where a discloser gives information to a recipient and later claims the recipient’s intellectual property has become contaminated as a result of commingling such intellectual property with the discloser’s intellectual property. To avoid this, a recipient should always identify and agree to the information it shall receive before the information is accepted. Further, the NDA should include a list of situations where a recipient’s use or commercialization of the same or similar confidential information disclosed by the discloser is not actionable by the discloser as an infringement scenario because, e.g. the recipient already had such information, independently developed such information or otherwise lawfully obtained such information.

  5. Costs of Action:

    If your party is considerably smaller (in terms of financial capability) than the counterpart, your company should include a clause in the NDA enabling the prevailing party in a dispute to recover its legal fees and costs from the losing party. Without this, the costs of pursuing litigation may be prohibitive for the smaller company.

  6. Enforcement:

    This is one of the biggest and least understood risks in my experience. Many times a company will jump through hoops to make sure the NDA will be regulated by the laws of its home country and the venue of its home courts. This feels safe. Such sense of security can, however, be false and even dangerous. For instance, if you get a judgement against the counterparty in your country and the counterparty has no assets in such country nor in any other country in which the judgement from your country can be enforced, the judgment is valueless. Always ensure the governing law and dispute resolution sections of the NDA enable your company to enforce a judgement against the counterparty’s assets where the assets reside. Moreover, the term during which confidential information must be kept confidential should survive the termination of the NDA- the length of the survival period depends on the circumstances.

  7. No License or Assignment:

    An NDA typically only contemplates the entrusting of sensitive information to another party for a narrowly defined permissible use and does not implicate a licensing or assignment of ownership of the confidential information or related intellectual property. Be exceedingly vigilant in omitting any language from an NDA that can be construed as your company licensing or transferring rights to the information provided to the other party.

In closing, it is always best to use your own NDA draft which has been drafted by legal counsel. There are other issues that can arise under NDAs. Given the unique risks of every situation warranting an NDA, a legal review of the context/agreement should be conducted. We aim to simplify your company’s business / legal needs whether domestic or international. Feel free to Contact Us to learn more about how we can help you. Also, visit our testimonial portfolio to see what we have been doing: http://www.b2world.com/testimonial-portfolio/.

Thank you for your interest and best of luck with your business!

*This article is not legal advice and is provided for general information purposes only.