When to Use an NDA
The underlying purpose of a non-disclosure agreement (NDA) is to alert all parties involved that release or dissemination of corporate information can and will most likely cause harm to various parties. It not only affects the owners/equity investors but it will most likely affect employees and vendors too.
Almost all NDA’s start out with an opening paragraph identifying the respective parties. The company is referred to as the ‘Owner’ of the information and the agreement is between the owner and the ‘Recipient’, the party receiving the secret/classified information. It typically is followed by two paragraphs. The first states the exchange of information is necessary due to several options including ownership, employment, a provider of goods/services (vendor relationship) or possibly to a customer. The second additional paragraph states the Owner requests confidentiality and the Recipient agrees to protect this information.
The following explain the four different types of recipients.
Often owners exchange personal information along with corporate information. This is necessary to maintain trust and cohesion among owners of an entity. The non-disclosure agreement often is expanded in scope to include personal information about the owners so the recipient (another owner) doesn’t disclose nor gain from having this information. As for the company aspect, often the information relates to trade secrets, processes, and other pertinent information which separates the entity from competition or allowing newcomers.
In exchange for employment, employees will sign NDA’s as their respective positions give them access to valuable information which could cause harm to the company if this information were public. Examples of information employees have access to and require NDA’s include:
- Access to processes and/or systems
- Financial information
- Customer names and/or terms
- How equipment is made or engineering of tooling especially custom tools
- Contract information (customarily known by lawyers and owners)
- Technical knowledge
In general, if an employee has access to any kind of information that were made public and could be detrimental to the company in any form, an NDA is necessary to protect the company.
In most cases, the vendor is the owner of information and has the company sign as a recipient in order to buy or possess such information. Every now and then, it is reversed. Sometimes vendors need to know what exactly is happening or what exactly is produced in order to properly perform their respective duties or sell the correct product/material. Here an NDA is appropriate. A good example is an outside engineering firm that provide valuable services to the company in order to manufacture a product or deliver a service. Other vendors that typically sign NDA’s with their customers include professional firms (lawyers, CPA’s, physicians etc.), long-term suppliers of raw materials, transportation companies (secrecy related to delivery and timing of delivery of goods) and even the janitorial service company.
Often the customer is buying the confidential information or renting it from the company. Here it is common for the customer to sign an NDA and a hold harmless agreement to reimburse the owner of the confidential information for its financial impact if the information were released. This is very common with data management companies selling this data to customers. Customers agree to only use the data for the contractual agreed upon use and any other use is a breach of a contractual relationship and will cost the customer additional money.
Clauses of a Non-Disclosure Agreement (NDA)
Every non-disclosure agreement has four main concepts to convey in the agreement. They include: who is involved, what exactly is confidential, terms of the agreement and a signatory page. The following subsections go into more detail about these concepts.
Owner and Recipient
As stated above, every NDA starts out identifying who owns the information and who is going to receive the information along with the corresponding purpose (ownership, employment, vendor or customer relationship). This section identifies the legal names, assumed names or DBA’s (doing business as) along with addresses. In many cases, the owner is the company, but the company will list all affiliates of the primary entity.
The recipient is often a legal entity in a non human form (corporation, partnership, etc.) and should include the actual names of people having access to the information and that the individuals involved will sign amendments agreeing to the NDA as if they were solely liable in case of default. With employment, the employee signs as an individual.
Description of Confidential Information
This section is the heart of the entire agreement. It is necessary to be descriptive and avoid generic wording. Generic wording will not hold up in a court of law if the owner seeks compensation or damages for release of such information. Therefore, the more descriptive the wording, the more likely the NDA is enforceable. As an example, a speciality sauces manufacturer will state in the NDA the specific recipes the recipient must not disclose. Generic recipes will not hold up in a court of law. To illustrate, if you manufacture chocolate chip cookies and the recipe is exactly the same as the Nestle’s Toll House recipe which is found on every bag of Nestle Chocolate Chips, the recipient will simply state that they gave away that recipe and not yours.
Common wording in this section includes: ‘… information of the Owner including business records and plans, trade secrets, technical data, product ideas, contracts, financial information, pricing structure, discounts, computer programs and listings, source code and/or object code, copyrights and intellectual property, inventions, patents, sales leads, strategic alliances/ventures, partners, customer/client, and vendor lists. The nature of he information and the manner of disclosure are such that a reasonable person would understand it to be confidential.’
The last sentence is bolded, this is the standard the courts use to determine compliance with the NDA.
In addition to the description of what is confidential information, the NDA will often describe what it does not include. It will state that public information, especially if it is released by the Owner is not confidential. Other, examples of what is open and not included within the power of the NDA is information independently developed by the Recipient; information disclosed as function of law; and information both parties agree is not confidential, usually in writing.
Terms and Duties of the Recipient
The agreement conveys this concept over several clauses in the agreement. It includes identifying the responsibility of the Recipient to protect the information and often suggests guidelines such as encrypting electronic files or using physical security to guard against intrusion and corresponding access to pertinent information.
Other terms include the period of time this agreement covers including the termination of the relationship and how long after the termination the Recipient must maintain the confidentiality of the information. Most courts accept five years after termination as acceptable and reasonable. In addition, the agreement outlines the right of the Owner to obtain an injunction against the Recipient for failure to comply which then places the Recipient in a possible criminal situation if the Recipient continues.
Often this section closes with how information is to be returned, indemnity in case of civil proceedings and of course any limitations the state may place on the agreement.
The final section is of course signatures from both parties. It is often a good idea for the Owner to get the Recipient’s signature with a notary as a witness thus precluding a defense of non signature in a court of law.
Nuances Related to the NDA
The overall value of the NDA relates more to the harm that release of the information may cause the Owner than the value gained by the Recipient in releasing this information. Therefore, NDA’s should be drafted by attorneys well versed with business issues and the Owner’s emphasis related to the information.
To Owners, you must remember that states will not grant you overall protection when using an NDA. If you or your company is doing something illegal, the NDA is powerless to protect you. In addition, courts will not grant you relief for something that is common knowledge or available to the public with a little bit of research. Your grandmother’s water recipe can’t possible provide you with a lot of financial value and the courts will not grant you relief if the Recipient uses it for their gain. Owner’s must be realistic about the value the confidential information really carries.
In more restrictive business relationships, the NDA does serve a purpose, but states have laws and regulations that govern the wording of the document related to certain relationships, most importantly and common is the employer/employee relationship and the use of the NDA with this relationship. Seek out legal advice when creating the employer/employee NDA.
Also, for those companies involved in interstate commerce or are on borders with other states; it is a good idea to have two NDA’s signed related to the respective states.
Finally, NDA’s are not going to stop your crazy employees or fellow owners from releasing information. Unless you can legally muzzle them, you can’t physically stop them. Therefore, the clauses that address remedies for the Owner are critical when drafting this document. You want to be able to get an injunction, then if the Recipient continues to release the information he/she can be found in contempt of court which then begins the path towards criminal activity in nature which is jailable. If you are going to give the document some power, this is the area that requires extensive wording. ACT ON KNOWLEDGE.
If you have any comments or questions, e-mail me at dave (insert the usual ‘at’ symbol) businessecon.org. I would love to hear from you. If interested in my services as an accountant/consultant; click on ‘My Services‘ in the footer of this article.