12 ways non-disclosures are misused
The other party tells you that they want to sign a non-disclosure agreement (NDA) with you.
If you agree, you’ll be required to keep confidentiality of information that they designate as confidential and not use any of it in your own business without their permission. They suggest that the NDA be a mutual or two-way NDA.
This means that they too, will agree to keep any confidential information that you share with them secret and not to use it without your permission either.
This sounds fair to you, although something in your gut tells you to be careful. What risks are there for you in signing an NDA? Here are 12 possible ways it can be misused:
1. Not truly “Mutual”
Bigger companies often insist that you use their NDA. They justify this by saying that their agreements are better because they were drafted by a team of attorneys.
The problem is that the NDA is normally drafted in their favor.
Even though the agreement is described as “mutual,” it may not really be weighted fairly for both parties.
2. Bad terms
This problem ties into point #1 above.
Sometimes, bigger companies use a standard NDA that has indeed been drafted by a team of attorneys.
But because they have used it so often, they get lazy about checking the agreement’s terms to see if the terms are relevant or appropriate to your situation.
There have been real cases where terms have been left in a “standard” NDAs that were completely inappropriate such as the transfer of intellectual property rights without an understanding between the parties.
3. Overly extensive definition of Confidential Information
The definition of confidential information in an NDA is important.
A definition that’s overly extensive or vague may result in you being bound and limited to secrecy on the other party’s behalf for information that’s not really confidential.
This is even worse if there’s a non-use clause that prevents you from using the confidential information as well without the other party’s permission.
4. Disclosing information unnecessarily
This point ties in with point #3 above.
There have been cases where a bigger company has proposed an NDA with a clause that states that the Disclosing Party would own any ideas, inventions or information relating to confidential information disclosed.
If you’re a smaller startup, you’re likely to have a lot less confidential information to disclose.
The bigger company could intentionally disclose confidential information that’s related to your intended product/service and then claim ownership over that information.
If the other party wanted to act unethically, it could inundate you with so much confidential information related to what you are doing that you could be hamstrung from making any progress with your own projects.
5. Difficult marking procedures
Be very careful about any clauses in the NDA that require a certain procedure to be followed before information can be considered confidential.
For example, if the other party requires that confidential information be labeled within 24 hours in green ink, with 11.5 font size and Arial Narrow font, this should raise a red flag for you.
If you see such difficult and onerous requirements, you should probably question their true motives in wanting to draw up that kind of agreement with you.
To illustrate this point, let’s consider the case of Convolve, Inc. And Massachusetts Institute of Technology v. Compaq Computer Corporation and Seagate Technology, LLC.
In this case, there was a clause in the NDA signed by the parties that required verbal confidential information to be marked as such within a certain period. Alternatively, the information needed to be confirmed in a written memorandum.
For some reason, the plaintiff failed to follow the procedure and ended up losing his confidentiality claim to that information.
We all know that when things start to get busy, slip ups and omissions can happen. If the other party proposes a burdensome marking procedure for confidential information that would otherwise render your information as not confidential any longer, you need to proceed with caution.
In many cases, it’s too risky to agree to a marking procedure that might result in you losing ownership to your confidential information.
However, marking procedures do play an important role in helping parties to identify what information is confidential.
If you want to use marking, choose a simple procedure and give yourself an easy way to comply with the requirement. Perhaps the marking can be done anytime throughout the period of time when the NDA is still active.
Or perhaps you can state that marking is only required for documents that have not already been mentioned in the definition of confidential information in the NDA.
6. Assignment of IP rights
As mentioned before, standard terms can be left in NDAs from previous agreements that are completely inappropriate for your situation.
For example, the agreements used to hire independent contractors often have a “work for hire” clause that transfers created intellectual property rights to the other party.
You definitely don’t want such a clause like that in your NDA.
7. Third-parties and affiliates
Be careful of a clause that allows the confidential information to be shared with third parties and affiliates without your permission.
Unless the clause expressly states that the Receiving Party of the confidential information will ensure that the third party and affiliates be bound by similar obligations of confidentiality in your agreement, you stand the risk of the information being exposed or misused by these extra parties.
Here’s an example of some clauses from Bell Fund’s Confidentiality and Non-Disclosure Agreement that covers the exposure and use of confidential information with third parties:
8. The “Unlimited Testing” clause
Although rare, there may be clauses that provide a license to the Receiving Party to use confidential information for unlimited testing purposes.
The risk of such a clause is that the receiving party could hire an external party to reverse engineer your technology or process in order to uncover your entire procedure.
If you allow an unlimited testing clause and don’t include a clause that binds external parties to confidentiality and non-use of your confidential information, then essentially you’re giving an external party the opportunity to reproduce a competing product/service.
9. Unsuitable duration
The “term” or “duration” clauses of an NDA can be quite tricky.
Some companies want perpetual confidentiality while others may insist that confidentiality ends once the discussions are over.
On one hand, you want to make sure that the obligation of confidentiality covers your confidential information long enough so that you can retain any market advantage that you might have.
On the other hand, you don’t want to be bound by a term that covers the other party’s confidential information (especially if it is related to what you are doing or was something that you were planning to use yourself) for too long.
Ensure that the term is reasonable for both your purposes.
10. The “Residual” clause
A residuals clause allows the Receiving Party of confidential information to bypass the usual obligations of confidentiality and non-use for general information and concepts that are retained in one’s memory, including confidential information.
Normally, a party may want to have a residuals clause in the NDA to protect themselves from any lawsuits that could result from them being unable to unlearn confidential information that they remember.
Some companies may want to have a residuals clause because they are worried that their employees may become compromised from your confidential information. The other party also may already be in the midst of a similar project to yours and they want to make sure that you are not going to sue them if they were to independently come up with products and services that seem similar to yours.
It’s understandable that it can be very difficult to separate, segment and differentiate previous known information from new information that they develop as a result of confidential information.
However, as you can imagine, a residuals clause can be easily abused as well.
Imagine if the other party’s developers came to your meetings, memorized all your confidential information and recreated your procedure once they were back in their office?
There are in particular two situations where you should be extra careful about residuals clauses:
- If you intend to share trade secrets.
- If your startup’ survival depends on your confidential information being kept secret and not used.
If so, a residuals clause is just too big a risk to allow into a NDA agreement in such circumstances.
11. The “Non-competition” and “Non-solicitation” clauses
It’s not uncommon for non-competition and non-solicitation clauses to be included in NDAs.
Non-competition clauses prevent either party from competing with the other party. This is likely to be a bigger problem for you if you are a startup/new business compared to a bigger company.
For example, imagine the other party was Google. You may find that Google is so diversified and invested in your industry that almost everyone else is a competitor. This means that you won’t be able to work with any other tech company in the same industry because that party is a potential competitor for Google.
A non-solicitation clause prevents either party from attracting, poaching and hiring employees from the other party.
Again, a clause like this stands to benefit a bigger company which will have more employees than you do. How likely is it that a bigger company will be impacted by such a clause? How difficult will it be for you to ever hire anyone from big company, even if they left of their own accord and approached you themselves?
Tread very carefully with these clauses as bigger companies stand to benefit more from these clauses.
12. Governing law and/or Jurisdiction
“Governing law” refers to the law that will apply to the NDA while “jurisdiction” refers to the court that you want to decide your case in the event of a lawsuit.
Because laws can vary across states and countries, your choice of a governing law and jurisdiction may impact the end result of the agreement.
Be careful if the other party insists on a governing law and jurisdiction that’s heavily biased towards larger companies. Make sure you seek legal advice so that you are clear on what your choices are.
Here are some suggestions for how you can potentially reduce the risk of having an NDA be misused against you:
- Read the NDA carefully yourself. Make sure you understand the terms.
- Ensure that the definition of confidential information is as accurate as possible.
- Hire a third party to act as a neutral “gatekeeper” to screen confidential information before it is shared to ensure that neither party can abuse the NDA by recklessly sharing information that’s not relevant.
- Make sure that you’re comfortable with any marking procedures for confidential information.
- Ensure that you’re not transferring any IP rights to the other party.
- Always be on the lookout for tricky terms that don’t make sense to you.
- Request a list of any third parties and affiliates that will have access to your confidential information and don’t allow confidential information to be shared with external parties without your permission.
- Don’t just accept any residuals, non-competition and non-solicitation clauses. Consider the potential impact on your business carefully.
- Get advice from your attorney about the best governing law and jurisdiction to choose for your situation and if possible, try to find a fair compromise.
- Negotiate any terms that make you feel uncomfortable.
- If the terms are too biased towards the other party, draw up a new NDA instead. This will force the other party to come out with what’s truly important for them to achieve with the agreement.
When you have a potential business opportunity with a bigger company, it can seem like a dream come true. However, never ignore your gut. If something feels wrong, check things out and be prepared to walk away.
As the saying goes, “It’s better to be safe than sorry.”
Credits. The following icons are from The Noun Project: “agreement” by gira Park, “Information” by Gregor Črešnar, “Unlock” by No More Heroes, “labyrinth” by Sandor Szabo, “Infinity” by Lloyd Humphreys, “hourglass” by Creative Stall, “Thought” by Gregor Črešnar, “prohibited” by Star and Anchor Design, “Institution” by Diego Naive, “thumbs” up by Gregor Črešnar.
Nov 22, 2017 | Non-disclosure Agreements
This article is not a substitute for professional legal advice. This article does not create an attorney-client relationship, nor is it a solicitation to offer legal advice.