Starting a Deal – Non-disclosure Agreement

Introduction

We live in an information age, where information is easily transmittable and informs market or business decisions.  A piece of information can cause big ripples to the valuation of a company. For businesses, protecting its commercially sensitive information is an important aspect in securing business interests, but it is also through disclosing information that they may attract investment, collaboration, merger, acquisition and other business opportunities.

A non-disclosure agreement (“NDA”) (also commonly referred to as a confidentiality agreement) helps kick-off the deal by allowing parties to exchange information for defined purposes.

The structure and negotiations of an NDA would need to take into account the landscape of the underlying transactions, for instances, whether there would be one-way or two-way information flow, whether the target is a public or a private entity.  In this update, we hope to highlight some of the important factors to consider when drafting or negotiating NDAs, and the limitations of NDAs and why protecting confidential information goes beyond entering into one.

Important factors to consider

• • Parties to the confidentiality obligations – the obvious answer would be that a NDA should be entered into between seller and the prospective buyer(s).

However, in a competitive process, it may be worth considering including the target company as a party to the agreement, so that in the event of breach by an unsuccessful buyer after the acquisition, the successful buyer may enforce the agreement through the target company.

The information disclosing party (generally the seller) may also wish to consider listing out the categories of entities who would necessarily be involved in the deal and would receive the subject information to assist the other party (general the prospective buyer) in evaluating the deal (e.g. valuers, lawyers, financial advisers), and correspondingly insert provisions imposing obligations on the prospective buyer to procure such categories of entities to comply with the same set of confidentiality obligations or even to provide similar undertakings.

• • What is considered confidential information – the seller (disclosing party) may wish to have the scope of protected information as broad as possible, but it is important to also ensure that the information is clearly defined to ensure that truly critical information is properly protected. For example, they may wish to include notes and interpretations prepared by the prospective buyer based on the confidential information provided by the seller into the defined scope; and to include information provided before entering into the NDA.  Other than commercially sensitive business information disclosed in relation to the target company or the seller itself, the seller may also wish to keep the fact of the potential sale and the negotiations itself, confidential.

Prospective buyers would want to exclude certain information, for instances, those already in the public domain at the time the NDA was entered into and information which subsequently enters the public domain otherwise than by a breach by the prospective buyer. The prospective buyer may also require that information that they already possessed before it was disclosed by the seller or those received from an independent third party and not subject to confidentiality obligations should not be subject to the NDA.

The seller cannot prevent disclosure pursuant to a court order or as part of a regulatory investigation, but may impose duties on the prospective buyer to give prior notice to the seller, and to co-operate to control disclosure.

• • Confidentiality obligations – the main undertakings to be provided by the prospective buyer would generally be non-disclosure restrictions, and restrictions on using the information except for the purpose of the subject transaction. In recent cases, we noted that seller would insist that the information should not be used for detrimental purposes or in a manner which would operate adversely to the seller or the target company.  The seller may also specify the need for the prospective buyer to adopt security measures in protecting the information by for example, requiring that electronic documents be password encrypted, and a record of when and by whom information was accessed be maintained.

• • Timing – the NDA should ideally be entered into at early stages of negotiations, before any confidential information is disclosed. In any event, the seller may wish to clarify that confidential information provided before the NDA was signed be subject to confidentiality.

• • Duration – the sellers will often try to omit a termination or expiration date. However, instead of the obligations running indefinitely, the period may range from 1 year to 3 years.

• • Others
    • Upon the seller’s request or in the event that the negotiations are terminated, the sellers may insist that all the information provided to the prospective buyer be returned or destroyed. The prospective buyers on the other hand may consider whether it is required to retain any copies for regulatory compliance purposes.

• • Sellers may insist that non-solicitation provision be included to prevent the prospective buyer from poaching their employees. The prospective buyer may however consider the coverage of the provision from both time and scope perspectives, and whether any exceptions would apply.

Limitations and precautions

There are limitations to the extent of protection that an NDA can provide. In most cases, remedies to any breach of an NDA can only be sought for after there has been a breach. By then, the seller can seek to apply for an injunction against the prospective buyer from continuing its actions, but there may already be damage arising from the breach; whereas monetary compensation for the breach may not be adequate to remedy the harm caused. Further, proving the breach and that the unauthorized disclosure is from a specific party may also be difficult.

Nevertheless, these are risks that businesses would have to take to push ahead with a deal.

It would be important that the appropriate confidentiality undertakings and obligations be included in the NDA to ensure that parties are on the same page in respect of how confidential information should be treated and could be accessed.  It is additionally important that the disclosing party take the appropriate precautions in itself in respect of how and when information is disclosed at each stage of the deal and the security measures they can adopt in ensuring that the information is properly accessed and used.

For more information, please contact the authors of this article:

Alfred Leung, partner (alfredleung@hkytl.com)

Tammy Ha, associate (tammyha@hkytl.com)