By: Kurt Spurgeon
This post is the second installment in our Mergers & Acquisitions series related to preparing your business for sale.
Within the context of a merger or acquisition, a confidentiality agreement, also known as a non-disclosure agreement (an “NDA”) is often one of the first agreements signed by the parties involved in a transaction. The primary purpose of an NDA is to facilitate further interaction between the parties by allowing them to exchange information while also providing some semblance of protection from unauthorized disclosures. It is advisable—particularly for a seller—to enter into an NDA as early as possible and prior to sharing any sensitive information with a potential buyer. In drafting an NDA, the parties may incorporate NDA language into a letter of intent; however, it is often advisable to enter into a separate NDA. By entering into a separate NDA, the parties may be able to more effectively negotiate the terms of a letter of intent if each party has access to additional information. Furthermore, the earlier the parties enter into an NDA, the sooner the due diligence process can begin and the sooner the parties will be able to determine whether the transaction is feasible. This allows the parties to save time and money negotiating terms to a purchase agreement for a transaction that may ultimately fall apart during the due diligence phase. When entering into an NDA pursuant to a contemplated transaction, it is advisable to specify in the document that the NDA in no way guarantees or requires that the parties consummate a transaction.
An NDA can be a mutual or a unilateral agreement. At a minimum, a seller will usually require the buyer to enter into a unilateral NDA, because the seller is the party typically providing the greatest amount of information; however, having both parties enter into a mutual NDA may help prevent delays if it becomes necessary to have the buyer provide sensitive information at some point. Moreover, a mutual agreement will give the parties an opportunity to place restrictions on information in addition to seller-disclosed information. Such information might include statements made during negotiations, the terms of the deal, the identities of the parties, or other matters prior to signing additional agreements.
The actual parties to an NDA are typically limited to the parties to the transaction; however, associated third-parties such as lawyers, accountants, and other advisors are also likely to have access to confidential information. As a result, it is advisable for an NDA to contain language making each party responsible for any unauthorized disclosures by associated third-parties and/or to require associated third-parties to sign acknowledgements of the NDA restrictions prior to accessing confidential information.
A key clause in any NDA is the definition of “confidential information.” In defining confidential information, the party disclosing the greatest amount of information—usually the seller—will prefer a broader definition and the recipient a narrower definition. After defining confidential information, an NDA should contain language specifying how each party will know whether particular information constitutes confidential information. The simplest method is to include essentially all disclosed information within the identified categories as confidential information; however, some NDA’s require the disclosing party to mark or identify particular information as confidential. Requiring a party to designate confidential information can be burdensome, but doing so may also limit the potential for confusion. The parties might also consider simply designating that any information shared to a particular folder in a data room constitutes confidential information.
The parties also generally include certain exceptions to the definition of confidential information. Some common exceptions are: (1) information that is otherwise available to the public, (2) information that became available to the recipient by means other than through the disclosing party, or (3) information that is independently developed by the recipient without the help of the disclosing party.
Most NDA’s also include a clause discussing how a recipient may utilize confidential information. For instance, the parties may agree that the information may only be used for the specific purpose of evaluating the transaction, or some other particular use. Moreover, the parties may specify a particular standard of care that the recipient is to adhere to in handling confidential information. This clause is likely to also contain certain exceptions to the use restrictions. For instance, the parties may include an exception whereby a recipient is authorized to share information with a potential lender or a governmental entity, if necessary under applicable law, or in order to facilitate the transaction.
In addition to limitations on the use of confidential information, an NDA typically includes other limitations on the information produced. As an example, the NDA may include language stating that any disclosing party is not granting any licenses or other property rights in relation to any disclosed information. It is also often advisable to include a representation stating that the disclosing party makes no representations or warranties as to the accuracy or completeness of any disclosed information. Another common clause that parties insert is a clause that limits any waiver of a disclosing party’s attorney-client privilege, attorney work product, or similar protections related to any disclosed information.
The length of an NDA term will vary. The parties may decide upon an indefinite term, or a term based on a specific length of time, date, or an event. The primary disclosing party generally prefers an indefinite or longer term, while a recipient will often prefer a shorter term. At the end of the term, the NDA should contain language addressing the return or destruction of confidential information received upon the termination of the NDA, or upon some other condition or event.
It should be noted, that even if an NDA requires the parties to return or destroy confidential information, it is often difficult for a party to verify whether this has actually has occurred. As a result, one should recognize that entering into an NDA alone does not ensure that a recipient party will not retain or use confidential information in an unauthorized manner. The primary way for a party to enforce an NDA is through an injunction and/or seeking damages; however, once a recipient has already released or improperly utilized disclosed information, an injunction may be worthless and successfully proving damages may be difficult and time-consuming. The party disclosing the most information may want to insert language that shifts the burden of proof regarding a breach of the agreement to the recipient in order to aid with enforcement. Furthermore, each party should carefully consider the choice of law provision in an NDA, because certain jurisdictions may be more favorable than others with regard to particular clauses.
Ultimately, while NDA’s have limitations, entering into such an agreement offers parties a path to facilitate the exchange of information to better assess the feasibility of a transaction while still offering some degree of protection. This entry has only provided a limited discussion of NDA’s, and it is advisable to seek counsel to discuss drafting an NDA if you are considering buying or selling a business.
Kurt practices in the Corporate & Transactional Law group at Lane & Waterman. His practice includes mergers & acquisitions, general business matters, securities exchange compliance, and commercial real estate.