A previous post described some general issues regarding Non-Disclosure Agreements (See “Hey Can you Keep a Secret”). This post highlights a few additional key issues to watch out for when reviewing Non-Disclosure Agreements (“NDAs”).
Some NDAs include a clause known as a “residuals” clause. A residuals clause may take a variety of forms, but here is an example of one:
“Notwithstanding any other provision of this Agreement, the Recipient shall be free to use, for any purpose, information retained in unaided memory by persons who have had access to the Confidential Information, including ideas, concepts, or know-how (“Residuals”).”
A residuals clause represents a significant risk to the disclosing party under an NDA, because with a residuals clause, the recipient of confidential information will have the right to use Residuals for any purpose–even to compete with the disclosing party– if an individual can “remember” the information. The only protections for the disclosing party is if either: 1) the confidential information is also protected under copyright or patent law, which often is not the case; or 2) the parties have negotiated some sort of non-compete agreement that, as a practical matter, would prohibit the use of the Residuals.
If a startup company is presented with an NDA that includes a residuals clause, the first option is to push back and request that the clause be deleted. When the other company is very large and has the leverage in the transaction, this request is often denied. In such cases, we advise startup companies to be extremely careful as to the confidential information which is disclosed, and to avoid disclosing information that is not related to technology that is otherwise protected by patents or copyrights and certainly confidential information that is not directly relevant to the specific purpose under the NDA (an investment decision, a specific transaction or potential agreement, etc.). Ultimately, a startup may not have the financial wherewithal to pursue violations of an NDA, so often your highest and best protection is to significantly limit the amount of information you choose to disclose.
Disclaimer of Consequential Damages
When a party breaches a contract, including an NDA, there may be both “direct damages” and “consequential damages”. Direct damages are damages that are a direct result of the breach, and consequential damages are damages that not a direct result, but nonetheless flow from the breach.
In an NDA, there is a risk that lost profits which are the result of a breach of nondisclosure obligations may be considered “consequential damages”. Since lost profits may be the only damages which result from the breach, disclaimers of consequential damages, although common in other contracts, should not be included in NDAs, and should not apply to confidentiality provisions in other contracts.
An NDA should only address confidential information that is owned by a party and disclosed to another party in the context of a proposed or current business relationship. Some companies try to include language in an NDA which is signed at the beginning of a relationship (when neither party knows how the relationship will proceed) to “back door” ownership of new technology.
If the parties have discussed and agreed on ownership of new technology which may be created as a result of the collaboration, an NDA is not the correct agreement to document such ownership rights. In reality, these issues are usually not resolved at the start of a relationship, which is why a mutual NDA, without any ownership provisions, is often the appropriate contract for the beginning of the relationship.
NDAs are often standard, but be careful that the other party does not include provisions which are not standard, and which could result in inadvertent loss of ownership of technology, or the right to pursue remedies for breach of nondisclosure obligations.