What Is a Non-Disclosure Agreement? Non-Disclosure Terms Explained

Types of Non-Disclosure Agreements and Terms in Confidential Transactions

Confidentiality is necessary when it comes to profitable ideas, trade information, intellectual property, and important deals. Transactions like mergers and acquisitions (M&A) typically begin with some form of confidentiality agreement or non-disclosure agreement (NDA).

An NDA is a legally enforceable contract that offers protection for sensitive information that may come up during due diligence. The goal is to protect confidential information from a third party.

Often, the NDA protects any discussion of the negotiations and creates a confidential relationship between participating parties. This means neither party may discuss the deal with anyone else. In the context of an M&A transaction, the seller traditionally drafts and presents the NDA to the buyer. The NDA must be fully executed before any other proprietary information or sensitive information is shared.

Different types of NDAs provide different protections based on party involvement and the nature of the information used in the transaction. We will discuss these types of NDAs and other non-disclosure terms you may encounter in future agreements.

One-Sided NDAs

One-sided or unilateral NDAs are the most common type of non-disclosure agreements. While disclosing parties have more flexibility under a one-sided NDA, they should exercise extreme caution in drafting. Terms deemed too restrictive or demanding by the recipient may slow the transaction or, worse yet, jeopardize it entirely.

Mutual NDAs

Mutual NDAs, also known as bilateral NDAs, are less common. These non-disclosure agreements are used when both parties intend to share confidential information. These sometimes create legal obligations and rights for each party. Note that rights are not usually assigned in a non-mutual agreement.

A mutual NDA is more suited for joint ventures or investments, but you may encounter a mutual NDA in an M&A transaction. In situations where the buyer is required to share sensitive information, a mutual NDA relieves some risk for them and may be viewed as a necessary gesture of good faith.

Multilateral NDAs

Multilateral NDAs may be used in more complex transactions involving more than two participants to the agreement, in which at least one of those parties intends to share confidential information with the others. A multilateral non-disclosure agreement can protect multiple parties when necessary and eliminate the need for multiple bilateral agreements between the parties.

Essential Non-Disclosure Terms

While it is tempting to think you can use any NDA template available, you should not. Your NDA should be suited to fit your business and transaction needs. Therefore, close attention is required when selecting a template and drafting your NDA.

Though your NDA should fit your specific needs, there are some essential non-disclosure terms and concepts to keep in mind as you draft:

• Confidential Information: Define what information is confidential and can’t be shared. The party receiving the NDA (the buyer in the context of an M&A transaction) and upon whom an obligation is created will generally prefer this definition to be very specific. In contrast, the presenting party (the seller in the context of an M&A transaction) generally prefers a broad definition.
• Exceptions: Define what information is not considered confidential and can be disclosed without penalty. This generally includes knowledge available to the public or information already disclosed prior to the NDA.
• Compelled Disclosure: Define instances in which confidential information may have to be disclosed. For example, a government regulator or court may require the buyer to disclose materials while the NDA is still in effect. This clause aims to protect the closing and receiving parties on these rare occasions.
• Non-Disclosure of Discussions: Ensure the discussions contemplated under the NDA remain private. This prevents competitors, employees, or shareholders from reacting to rumors before a deal is agreed upon.
• Term: Define the NDA’s duration and termination date. The presenting party will generally prefer a lengthy term to protect trade secrets, while the receiving party will generally prefer a short term to avoid a lengthy commitment.
• Use of Materials: Define how confidential information may be used. A critical clause in every NDA will include language limiting the scope of its use, such as “used solely for evaluation of a potential transaction.”
• Disclosure of Materials: Identify who may receive the confidential information. This list generally includes executives, advisers, employees, attorneys, accountants, or other parties to whom the receiving party may disclose confidential information.
• Return of Materials: Include provisions for handling confidential information upon termination, or sooner, if desired, including instructions on how to return or destroy the confidential information.
• Breach: Define what action(s) or inaction(s) constitute a breach.
• Remedies: Address what happens should either party breach the agreement. Note some agreements will specify remedies based on the nature of the breach.

Presenting Your Non-Disclosure Agreement

In the context of an M&A transaction, sellers must reveal some information about their company to attract potential buyers. The NDA, therefore, needs to be executed after first contact but before opening up your books. As part of this process, a teaser sheet typically precedes the NDA. Once it is executed, a Confidential Information Memorandum (CIM) will follow the NDA. This sequence of events and the documents used are critical to understand, even if you do not use documents with these exact titles.

The Teaser Sheet

The teaser sheet, also known as an information sheet, is the first stage of the courting process between a buyer and seller. Formal teaser sheets are often produced through a specialized transaction advisor or investment advisor, but less formal marketing material can serve the same function. Teaser sheets should be carefully drafted to protect the seller’s identity and should only be sent to a curated group of buyers.

The Confidential Information Memorandum

The Confidential Information Memorandum (CIM) is a detailed breakdown of the business, its assets, liabilities, and other material information that a potential buyer may need to value the property. In other words, a seller is showing the books to the buyer. If the CIM process is executed through such an intermediary, there is no direct contact between the buyer and seller.

Do You Need an Attorney for Your NDA?

While an attorney is not required for every business transaction, it is highly advisable to engage an experienced attorney prior to drafting an NDA and certainly before signing one. There are many different types of NDAs, each with its complexities, agreement terms and conditions. However, regardless of type, every NDA is a legal document that carries risk for the unadvised. Even well-seasoned business owners could end up in court over a confidentiality breach.

Just as you should not blithely exchange sensitive or confidential information with counterparties, you should not risk creating an ineffective NDA or signing a document you do not fully understand. A lawyer will be able to draft or interpret the NDA terms and language more effectively.

We think you’ll also like:

1. A Visual Guide to the 5 Legal M&A Deal Structures
2. Purchase Agreements, Positive Covenants, and Restrictive Covenants in M&A Transactions
3. The Civil Courts: When Your ‘Confidential Business Information’ Isn’t So Secret
4. A Visual Guide to the 5 Legal M&A Deal Structures

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. M&A Boot Camp
2. Intellectual Property 101
3. Intellectual Property 201
4. The M&A Process: Understanding the Lifecycle of a Deal & Basic Deal Documents
5. Key Provisions in M&A Agreements.

This is an updated version of an article originally published on June 19, 2020.]

©2024. DailyDAC^TM, LLC d/b/a/ Financial Poise^TM. This article is subject to the disclaimers found here.