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A Nondisclosure Agreement

When to use, and what to include in, a nondisclosure agreement.

Generally speaking, nondisclosure agreements are contracts in which a party (normally an employee) promises to protect the confidentiality of a secret that is disclosed to him or her during the course of their employment, or during another business transaction.

If you have a nondisclosure agreement with someone who then later uses your secret information without your authorization, you can make a request to a court to stop the person from violating the nondisclosure agreement. In addition, you can often sue the offender for any damages you suffered as a result of the breach of confidentiality.

The use of nondisclosure agreements within employment contracts grew dramatically at the same time the high-technology field was growing. As one example, the founder of Hotmail, one of the first browser-based e-mail clients, made sure that everyone who knew about his start-up company signed a nondisclosure agreement. He credits his carefulness with his six-month lead on all of his competition.

Trade Secret Protection

Perhaps one of the biggest uses for nondisclosure agreements is in the protection of trade secrets. Unlike patents, which must be part of the public domain, trade secrets are, by definition, secret. In addition, trade secrets are only afforded protection if the owner takes measures to keep the secret and the secret gives the owner an advantage in the marketplace.

Because of the tenuous nature of trade secrets, nondisclosure agreements are often used to protect them from becoming part of the public domain. As an example, Company X may use a nondisclosure agreement contained within an employment contract for Employee Y to prevent Employee Y from disclosing Company X's trade secrets about the perfect popcorn butter formula.

Creating Confidential Relationships

Perhaps the real purpose of nondisclosure agreements is to create confidential relationships between the party that holds the trade secret and the party to whom the trade secret is disclosed. Parties that contract into such relationships have a legal duty to keep the confidential information in confidence.

In addition to written nondisclosure agreements, confidential relationships can also be created by an oral agreement, or can be inferred by examining the conduct of the parties. However, it is not advisable to rely solely on such means to create a confidential relationship because they are notoriously difficult to prove.

As one example, an inventor once developed a ratchet and brought it to the attention of a Snap-On Tools company independent dealer. The inventor later submitted a tool suggestion form to Snap-On Tools. However, in submitting the tool for consideration to Snap-On, the inventor never asked for a confidential relationship in writing, nor did he ask to receive compensation for his idea. Snap-On Tools developed the ratchet and sold it for profit. The inventor sued the company, but he was unsuccessful in his lawsuit because he told Snap-On about his invention without stating that it was for a business purpose or that he wanted payment in exchange. The lesson is pretty clear -- get a written agreement.

There are generally two classifications that a nondisclosure agreement can fall into -- either "mutual" or "one-way." A mutual nondisclosure agreement is one where two parties to the agreement both disclose confidential information to each other. For example, a mutual NDA could be found when an inventor discloses his invention to a company in exchange for the company disclosing their secret client lists to the inventor.

What are more common in employment settings are one-way NDAs. These are found when an employer requires a nondisclosure agreement from the employee in exchange for providing employment.

What Goes Into a Nondisclosure Agreement

When you go to work for a company that requires you to sign an NDA, or you are a company looking to hire employees under a nondisclosure agreement, you will generally see at least five basic elements in the nondisclosure agreement. These are:

  • The definition of "confidential information" that the NDA deals with;
  • Any exclusions from the confidential information;
  • The obligations and duties of the party receiving the confidential information;
  • The time periods for which the NDA will be valid and enforceable; and
  • Any miscellaneous provisions.

What is "Confidential Information?"

If you are already looking at a nondisclosure agreement, the agreement should pretty clearly spell out what is considered confidential information. The purpose of defining this term within the NDA is to establish the boundaries of the agreement (the subject matter) and disclosure, but without actually disclosing the confidential information (keep in mind that the agreement itself is not always confidential). For example, an NDA may define "confidential information" to be all client lists and past purchasing records, but it does not have to provide the actual names of the clients or their past purchases. When you have finished drafting your NDA, be sure to look back over it and ensure that all of your trade secrets are covered by your definition of "confidential information."

Exclusions from Confidential Information

Almost every nondisclosure agreement will also contain exclusions from the definition of confidential information. This means that the party receiving the excluded information has no duty to protect the confidentiality of the excluded information. Most exclusions are created by law. Perhaps the most important exclusion is that information cannot be protected by an NDA if the information was created or discovered by the receiving party prior to, or independent of, any involvement with the disclosing party. As an example, if you bring on an employee that has invented something that utilizes your trade secrets before the employee was hired and entrusted with your trade secrets, then the employee is still free to use his invention in the public arena as his independent invention.

Obligations and Duties of the Receiving Party

Generally speaking, a nondisclosure agreement should also state the obligations and duties of the party receiving the confidential information. These duties include holding and maintaining the confidentiality of the information, and can also limit the receiving party's power to use the information.

Under most state laws, the party that receives the confidential information cannot breach the confidentiality, induce another to breach the confidentiality, or induce another to acquire the confidential information by improper means. Because many of these duties are mandated by state laws, many companies will accept them without discussion.

Time Periods

Many NDAs set a time period during which the receiving party must maintain the secrecy of the information. This time period can be set by dictating a number of years ("the receiving party shall not disclose the confidential information for a period of five years from the date of this agreement,"), or it can be set by a future event ("the receiving part shall not disclose the confidential information until the holding party sells Product X on the open market.")

For NDAs that set a number of years that the NDA shall be enforceable, five years is a common length in the United States. However, keep in mind that the receiving party may want to negotiate for a shorter period of time.

Miscellaneous Provisions

There are almost always miscellaneous provisions (sometimes called "boilerplate" language) included at the end of nondisclosure agreements. These provisions often use language taken directly from state laws regarding NDAs and include the possible consequences and penalties that could result if the NDA is breached. In addition, arbitration and venue selection clauses are also included in the miscellaneous provisions.

Read NDAs Carefully

Before you sign any NDA, you should read it very carefully. If you are about to hand over your trade secrets and the other side has prepared a "Nondisclosure" agreement for you to sign, read it over. Oftentimes, companies like to slip in clauses that will let them disclose your confidential information in a matter of months. Other times, the definition of "confidential information" will not cover your trade secrets, making the NDA worthless to you. Be wary of language such as:

  • The above agreement does not create a confidential relationship;
  • No confidential relationship is implied or established by the exchange of confidential information;
  • The exchange of any information under this agreement is not made in confidence; or
  • Neither this agreement nor the exchange of information creates any obligations of secrecy or confidentiality.

Other Issues Regarding NDAs

In recent years, more and more legal issues regarding NDAs have popped up. For example, venture capitalists (VCs) rarely sign NDAs. When you bring in a VC to look at your product and your methods, you may beg and pled with them to sign an NDA, but they probably won't. This is because at any given time, the VC that looks at your company may be looking at three or four other companies that have similar businesses, and the VCs don't want angry start-ups coming after them claiming they broke the NDA when they chose to fund another company.

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