NDA Use Restrictions — Use With Caution

David Fox is a partner at Kirkland & Ellis LLP, focusing on complex mergers and acquisitions as a member of the firm’s Corporate Practice Group. This post is based on a Kirkland & Ellis M&A Update by Mr. Fox and Daniel E. Wolf.

Much attention deservedly has been focused on the recent Delaware Chancery and Supreme Court decisions in the high-profile Vulcan/Martin Marietta case where the courts found that a “use restriction” in a confidentiality agreement (i.e., a provision that limits the recipient’s “use” of the disclosing party’s confidential information to a specified purpose) could in certain circumstances preclude the recipient from later commencing a hostile offer for a target company even absent an explicit standstill. A recent decision by Judge Rakoff in the Southern District of New York refusing the defendant’s motion to dismiss shows that “use restrictions” may also limit the ability of a recipient party to pursue an alternative opportunity after receiving confidential information under a non-disclosure agreement (NDA).

In the New York case (which at these preliminary stages accepts as true the factual allegations of the plaintiffs), a private equity investor signed an NDA with a broker/advisory firm that was seeking financing for a corporate client to implement a business idea in the cash management industry. The NDA stated that the PE firm would only use the confidential information shared by the broker to explore a potential business transaction involving the broker and the broker’s client. After actively considering a number of transaction opportunities with the broker and its client, the broker asserted that the investor later pursued and completed an acquisition of one of the potential targets allegedly identified by the broker without including the broker and its client.

The broker alleged that the PE firm had breached the NDA by wrongfully using the confidential market insights about the cash management industry shared by the broker with the investor in order to pursue its own acquisition and thereby avoid a fee obligation to the broker. The PE firm argued that the NDA only covered a transaction that actually in fact involved the broker, and that the broker’s proposed broad reading of the use restriction represented an “unreasonably indefinite obligation” on it not to enter the cash management industry.

The court rejected the PE firm’s position and found that the NDA in fact imposed a very clear “definite obligation” — not to use the broker’s confidential information other than for the specific purpose stated in the NDA (i.e., pursuing a transaction involving the broker and client).

The court’s reasoning was notably similar to the Delaware decisions in Vulcan. Just as the Delaware courts accepted that the NDA covering information shared in the consideration of a friendly deal did not by itself preclude a later hostile offer, the New York court did not find that the PE firm was necessarily prohibited from pursuing an alternative transaction in the cash management industry. However, in both cases, the courts found that in pursuing these permitted opportunities the recipient of confidential information under the NDA is not allowed to violate its explicit agreement with the disclosing party not to use confidential information shared by the other party for purposes other than those specified in the NDA.

While Judge Rakoff’s decision was at a preliminary stage of litigation, was fact-specific and involved a damages claim for a fee (rather than injunctive relief), it still offers some cautionary lessons to parties entering into NDAs with use restrictions. In the M&A context, acquirers are usually asked to agree that they will only use the potential target’s confidential information to explore a negotiated acquisition of the target. If the deal fails after the due diligence stage, the putative acquirer is exposed to the risk of claims that it “stole” and misused the target’s confidential materials if it later pursues a similar opportunity through internal resources or via another acquisition.

This recent court decision in New York, coming on the heels of the Vulcan decisions in Delaware, emphasizes the potential unforeseen consequences to buyers of broad “use restrictions” in NDAs. Parties asked to agree to use restrictions should consider drafting changes to mitigate some of these unanticipated outcomes (e.g., seeking express acknowledgment that the buyer may pursue similar deals or opportunities) while also taking steps (e.g., internal firewalls) to buttress an argument that confidential information was not later misused in violation of the NDA.

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  1. David Staub
    Posted Tuesday, August 14, 2012 at 10:03 am | Permalink

    Clients often feel that nondisclosure agreements are simply “boilerplate” and don’t require legal review. This case illustrates one of the potential risks that clients have in not truly understanding the content of the NDA and its longer range implications.

  2. Nicholas Kitonyi
    Posted Tuesday, August 21, 2012 at 5:27 am | Permalink

    While firms entering into Nondisclosure contracts pursue their optimistic ideas, it calls for caution with the content of the agreement. Some forget that the agreement is more of an injunction that not only outlines what the client must not do, but also the explicit details of what it can do with the secret information provided.

  3. Mr Sohail Khan
    Posted Monday, August 12, 2013 at 3:19 am | Permalink

    The premise upon an NDA should be between two party’s to whom enter discussions and conduct business.
    Where a Corporation is asked to sign with another say a Tech Firm to be bound by a NDA of another is also questionable.
    Thus for example a Government NDA should be between the two parties to the agreement. It is questionable to for a public sector entity to approach a corporation to sign an NDA through in effect a third Party.
    Predominantly because it would limit the corporation to conduct business within its own industry sector without the consent of the other.
    Thus what happens is a contemporary limitation on competition within the industry sector.
    The validity of an NDA would become questionable if it was on the behalf of another entity. Thus before a Non Disclosure is signed contracting signatories to the agreement must satisfy their own due diligence.
    Where there is an NDA issued through a third party in Industry that is for example a public sector entity NDA with a Private Corporation it becomes without reservation how that Corporate entity would be allowed to write an NDA for and behalf of the Public Sector entity.
    Thus in contemporary Corporate law a Chief Executive signing an NDA with a private Corporation on behalf of a public service entity can in contemporary law equally be questionable.
    Upon the question of limitation of business it can be argued in the courts of the State of California and of the courts of the United States of America for the Ninth Judicial District and appellate courts in California for example that the NDA is a Government NDA and that it is asking or making a third party Corporation to becoming a signatory and in so doing have also become signatory to the Government Entity.
    This placing considered restriction in business as well as limiting the ability to compete in the Industry without the expressed consent of not just the other Corporate Entity to the Agreement but also the Government Entity who are the true authors of the NDA.
    Thus in contemporary Non Disclosure Law there should be a separate agreement with the Government Entity in regards to an NDA and a separate one between the two contracting parties to a technology NDA.
    It is inconceivable to have three parties to an agreement like an NDA hypothetically A Government Entity,Tech Corporation and another Tech Corporation without the expressed knowledge and legal consent of each other.
    Thus in the printed Agreement there are two signatories and not three, I state so in reference to the above example.
    To get a Corporation say in the Tech Industry to sign an NDA through the premise of being bound by the conditionality and terms of a Government Entity then is a questionable practice to which again can be placed in a court of law.
    Thus is it then such that a Corporation is asked to sign an NDA with the premise to taking the intellectual property with limiting the other ability to compete with a free market. That is why I refer to the monopoly and competition law ruling.
    In contemporary law it then can be stated that the Government should have their own NDA and the Corporate Entities in the Tech Sector to equally have their own NDA.
    Thus a corporation presenting an NDA on behalf of the Government Entity then either has to have legal permission preferably through a Chief Justice In Intellectual Property and Technology Law to issue a Non Disclosure Document of behalf of the Government -in which there should be written proof or the NDA is deemed as invalid.
    Technically speaking the agreement should be between the Government Entity and the Technology Firm and the Two Technology firms we can say Tech firm A and Tech Firm B should have a separate legal NDA.
    It can also be argued in the above example respective courts that the Government entity conspired to entice the technology corporation to sign an NDA in a process of through another technology entity with a view to limiting the business of the corporation that is being asked to signed the agreement.

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