The Achilles Heel of NonDisclosure Agreements

Having represented many clients with selling their businesses, raising capital or entering into joint ventures, the issue of Non-Disclosure Agreements ("NDA") always arises. The primary focus of clients is on ensuring that the NDA is as strong as possible and often such that no reasonable party would agree to it. Thus, I find my job is to help them understand what is commercially reasonable, and more importantly to work with them to understand who is the other party executing the NDA.

Most sales of small companies these days in the US are to Private Equity Groups, and so many people become complacent about understanding who the other party is. If the other party is not someone that is known, far more work needs to be done to understand:

  • Who is the other party is;
  • Where are they located;
  • What you each have; and
  • How much you share.

Failure to do this potentially exposes you to the "Achilles Heel" of the NDA. 

First of all, if there is a breach of the NDA, most NDAs allow for injunctive relieve which can be obtained in the US so damage within the US may be limited. However, if you want more than injunctive relief in the US, the areas of concerns are:

Who? 

Who is the company? A Fortune 500 Company, some foreign large company that you have never heard of but there is information on, or some company that for which there is no information? Many people don't look at who is executing the agreement if they believe the person they are dealing with is with XYZ Corporation that they know.

However, if the entity executing the NDA is a single purpose subsidiary of XYZ, does it have any capital? Is XYZ a party to the transaction? Finally, there are cases in some developing markets, especially China, where government entities own many companies, i.e. the People's Liberation Army owns many Chinese business, and thus for all practical purposes these are immune from any claims.

Recently I came across a situation where ABC, a US company, found that their confidential information was being used against them by Z, a subsidiary of Company Y in China. ABC had executed an NDA with X, a Singaporean special purpose subsidiary of Y with no assets. In addition, there was an Letter of Intent with T, a US subsidiary of Y also with no assets. As a result, there were no identifiable assets to go against, and to win in China would be hard.

Where?

If the NDA is with a non-US company, you may have issues in bringing a claim. While the NDA may provide that the venue and choice of law are your home state, the other party has to be served and appeared in federal or that state's court. If the other party is not in the US, it may be difficult to serve even them because they may not exist, or the address/agent provided doesn't exist. If you can't serve them, proceeding may be very difficult.

Assuming you serve them, and they fail to appear, you should win in court. However, even if you do, you may not be able to enforce any claims because their courts will not recognize the US court's decision. In some countries I have dealt with, judges have not recognized contractual agreements because "times have changed." Not all countries have a judicial system like ours with precedent and some predictability.

Even if governmental agencies don't own these companies, in some countries if well-connected businessmen and politicians do, that may have the same result. Bringing any claims against a company owned by such a businessman or politician may result in you, your company or employees being harassed or imprisoned on some charge in these countries, i.e. China and Russia.

How Much Has Each Party?

1. What Assets do They Have?

If it is a single purpose entity with no assets, even if you bring the claim and win, there are no assets pay monetary damages. Injunctive relief is all you have. That may not fix any damage done to your brand or pay for all the litigation. Even if they have assets, if there superior claims on those assets, i.e. bank liens, that can rank above your claim, you could win but still receive no monetary damages.

Finally, if they are a large company with very deep pockets, they may just fight you in court with a full army of in-house and third party lawyers. In addition, even if they lose they may be willing to fight though many appeals. The purpose is to wear down a smaller company just by having more resources.

2.  What Assets do You Have?

While many client's businesses are profitable and have value, the businesses may not have the financial wherewithal to fund litigation, especially international litigation. To fight a company in the US that is determined to protect its image on an NDA could cost $0.5MM and more. Many small companies don't have that amount of excess cash to put towards litigation. In addition, not only is there the cost of the litigation, but the disruption to the business. Discovery, depositions, etc. can absorb large amounts time and resources from a small company causing it to lose its way or position, and thus value.

3.  What Loss have You Experienced?

Raising this issue causes an indignant response from many clients? Obviously the value of the business, which they may think, is very high has now suffered a loss in value. As with all litigation, this has to be proved. If there is an $XMM offer from a buyer who immediately reduces the offer to $YMM immediately on finding out about the breach, then the loss is $(X – Y)MM. However, in all other situations proving the quantum of the loss is much more complicated. Experts are required to determine your loss, which also increases the costs of litigation. The other side will also have their experts to prove no loss in value and show where your experts are wrong. Finally, the winner and amount of the win is never guaranteed when walking into a court, no matter what you think.

How Much Information Do You Share 

While you are going to discuss your business, the products, customers, and opportunities, I think it is advisable to be economic with some of that information. Give the other party enough for them to make a decision and be interested. However, many owners are so proud and excited about their business, with good reason; they cannot help themselves from disclosing how they do everything. While some of this information may be a trade secret, it may not have been protected as such or may be more difficult to claim such in litigation. If the other party knows how you do everything, they may decide they can duplicate your business using your processes but not using your technology or approaching your customers. If this is done, it may be much hard to identify and protect.

Thus, be careful with your NDAs by knowing:

  • Who you are dealing with;
  • Where are they located;
  • What they have;
  • Know what you can do if they breach; and
  • Let your advisor help you control the information flow.