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Confidentiality Agreements – A Few Drafting Considerations

Written by Steve Nofar

Confidentiality Agreements are used in trade and business to protect ideas and trade secrets. Clients often assume that Confidentiality Agreements are simple boilerplate documents which can be recycled from your last client by simply changing names and dates from its last use. However, you as the attorney (or future attorney) know that a Confidentiality Agreement needs to be tailor-made and custom fitted for each client in order to protect your client’s property rights. Below are a few items to consider when drafting a Confidentiality Agreement for your client. Please Note: Readers of this article are cautioned not to rely on this article as legal advice as it is no substitution for legal representation with a licensed attorney in your state. Also see Legalnut’s Terms of Use Page.

1. Facts for this example. For purposes of illustration, let’s say that Buyer wants to purchase Seller’s business.    Buyer approaches Seller asking if Seller will consider an offer from Buyer. Buyer and Seller enter into general discussions about Seller’s business and transaction terms. Seller states to Buyer that its business is for sale for “the right price.” Buyer wants to do its due diligence and review Seller’s financial statements and some of Seller’s confidential information to determine what type of return on investment Buyer can expect if it were to purchase Seller’s business. Buyer also wants to make sure that he can afford Seller's business while offering Seller a respectable purchase price. Seller does not want to reveal too much of its confidential information to Buyer in case Buyer decides to not make an offer and/or Buyer decides to set-up shop across the street from Seller to compete directly against Seller.   Seller retains you as his legal counsel to draft a Confidentiality Agreement that is “Pro-Seller” (i.e. in Seller’s best interests).
2. When to Disclose Information. Seller should not disclose any confidential information to Buyer until Seller is comfortable that Buyer is a qualified purchaser and Seller’s attorney drafts a Confidentiality Agreement which is acceptable to Seller and later signed by Buyer.   Once signed, Buyer should be entitled to a “due diligence period” (i.e. time limit) to review Seller’s confidential information.
3. What is Confidential Information? What is confidential information depends on what the Seller deems to be its trade secrets. Seller should consult with his attorney and tell him what are its trade secrets which need to be protected and what are the biggest threat to its businesses. Every business is different, so Seller’s attorney should custom tailor a definition of what is Seller’s confidential information and what information will not be disclosed to Buyer. Seller must be careful not to disclose too much information to Buyer. Therefore, as Seller’s attorney you will likely restrict Seller’s disclosures to the minimum amount of necessary to close the deal, without being fraudulent or misleading. This way Seller maintains control over its trade secrets at all times. Once Buyer and Seller sign contracts to consummate and close the deal, both parties will be more committed to the process of protecting information.
4. What Information is Not-Confidential? Usually information that is available to the public is not confidential information.
5. To Whom to Disclose Confidential Information. Is Buyer a competitor who would greatly benefit from stealing Seller’s trade secrets? Is Buyer actually a broker/dealer on behalf of another? Is Buyer a CEO or other employee of the actual buyer? If so, caution must be taken to make sure that you are not giving away the family farm to someone who is not the actual buyer or to a competitor that many not follow through with the transaction in order to damage Seller’s business.
6. Risks of Exchanging Information. There is always a risk that confidential information will be leaked to unauthorized persons and used against the disclosing party (i.e. the Seller in this example). Therefore, Seller’s attorney should devise a way to best protect his client’s trade secrets and secure recourse against an infringer.
7. Use of Confidential Information. Buyer’s use and review of Seller’s confidential information should be restricted to evaluating the possible transaction without using the information to the detriment of Seller. Its usually permissible for Buyer to review Seller’s confidential information with Buyer’s trusted advisors; e.g. attorneys, Certified Public Accountants, and Licensed Appraisers. In addition, it should be spelled out in the Confidentiality Agreement that the Agreement shall not be construed as granting any rights to Buyer, by license or otherwise, to any of Seller’s confidential information.
8. Ownership of Confidential Information. Ownership of the confidential information should always reside with the Seller.
9. Return of Confidential Information to Disclosing Party. It’s a good idea to require Buyer to return or destroy confidential information at Seller’s request at the end of Buyer’s due diligence period.
10. Non-Compete & Non-solicitation. Depending on Seller’s business, specific business industry environment, and other relevant factors, if Buyer and Seller do not close on the proposed transaction, Seller may need to restrict Buyer’s ability to enter into Seller’s local market or to solicit Seller’s employees or client base. Seller’s attorney should consult with Seller as to Seller’s specific business market, common industry business practices, and foreseeable risks to Seller.
11. Legal Remedies. A well written confidentiality agreement will give a contractual legal remedy for unauthorized disclosure or misuse of confidential information. In addition, Seller may also have remedies under federal and state trade secret and copyright laws. These remedies are in addition to the contractual remedies in a Confidentiality Agreement.    Seller’s attorney should also consider reserving the right to sue for attorney fees if Buyer breaches the Confidentiality Agreement. Also, as Seller’s attorney you may want to require Buyer to expressly waive his defense that a remedy in damages alone will be adequate.
12. Governing Law. Seller and Buyer may be located in different cities, counties, or even different states. Therefore, as Seller’s attorney it’s important that you require that Seller’s city, county, and state be used as the venue for litigation if a lawsuit shall arise between the parties.
13. Restrictions on the Buyer. Seller’s attorney should restrict Buyer's due diligence period and access to Seller’s information as appropriate to the instant situation.
14. Severability of Defects. It’s become very common to include a clause which states that if any provision in the agreement is held to be invalid, unenforceable, or ineffective, that such provision shall not impair the validity or enforceability of the remaining provisions.
15. Entire Agreement. Seller should include a provision in the Confidentiality Agreement which states that the Confidentiality Agreement is the complete agreement between the parties and supersedes all prior or contemporaneous proposals, agreements, representations and understandings, whether written or oral, with respect to the subject matter. The purpose of such a clause is to limit prior written or oral agreements from affecting the validity of the Confidentiality Agreement.

Conclusion. Confidentiality Agreements are usually custom tailored and powerful legal instruments used to protect the trade secrets and property rights of your clients. A well discussed, negotiated, and written Confidentiality Agreement can protect both parties from lawsuits.

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