By Jigar Desai
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During the COVID-19 pandemic, many owners have been forced to sell their business. Business owners should understand the importance of drafting a proper sale agreement and a non-disclosure agreement. The terms of these contracts can make the purchase process smoother for the business owner. During the sale of a business, the price of business is affected by information, such as client information, potential earnings and manufacturing processes. This is information that a business owner would not freely provide to their competitor or the public. A non-disclosure agreement is a powerful tool that can accurately detail the full price of business without potentially harming the business, in case the deal does not pan out.
What is an NDA?
A non-disclosure agreement (NDA) is a common contract used by businesses. This contract offers the most protection against the risk of someone leaking important business secrets. A non-disclosure agreement creates a legal obligation of privacy and compels those who sign the contract to keep any specified information secured. Information commonly protected by a non-disclosure agreement are client information, sales information, manufacturing processes and various intellectual property. If a non-disclosure agreement is violated, the other party has the right to take legal recourse against the violating party. This legal recourse is usually in the form of a lawsuit for the damage caused by the leaked information and various costs associated with it.
Essentially, a non-disclosure agreement is a basic contract between two parties to keep a secret. Although a non-disclosure agreement can be easily formed, they must define a few key terms to be effective. The first term is to create the obligation of secrecy with the penalty of legal recourse. This term should also highlight the purpose of the restriction on the disclosure. This term will generally lay out the process for how to reconcile a violation of the agreement, such as whether the parties will have to go to court or seek mediation. This term will also lay out the money damages associated with a breach and other legal payments needed to fix the issue. The second term must define what is protected and what can be disclosed. This term should be well thought-out and drafted to avoid future issues, as a business owner does not want to spend time parsing through the contract. Both parties should understand the scope and definitions of the items being kept secret. The information that can be covered by the terms of the agreement can be almost anything. For example, a non-disclosure agreement between two parties doing a joint venture can lay out that the intellectual property on a specific project and any of its derivatives must be protected.
Another key term highlights which individuals from the contracted party will be designated to receive the confidential information. When dealing with a company with a sizeable number of employees, not everyone within the company should be receiving the information. This prevents leaks occurring from those who are not working on the shared project. Typically, the individuals who are privileged with the information will include managers, directors, lawyers, bankers, and employee working on the project. The final term should define the duration of the agreement, how long the parties are obligated to secrecy. NDAs usually last around four to five years, but can last indefinitely if the information is very important and can have permanent long-term damaging effects. An example of this would be social security information or other information regarding employees. Keep in mind that information on an NDA does not have to have a uniform termination period. The effects of the NDA can have varying lengths depending on the sensitivity of each specific item. Investopedia has provided a summary of a non-disclosure agreement and their general importance.
An NDA is a business’s first line of defense during business negotiations. If the other party is refusing to sign the agreement, then the business has the right to proceed with caution. An NDA is the only way to compel the other party to secrecy. This requires a signature from the other business and also usually the individual recipients. Marking important pages as “confidential” is not effective and does not compel a party to secrecy. Keep in mind that the other party should be willing to accept the NDA as it opens up a channel towards vital information they need to make an informed decision.
A Business Sale NDA’s Benefits
For the sale of a business, a non-disclosure agreement is a contract formed between a business seller and a potential buyer of the business. This is essentially the same as the aforementioned basic non-disclosure agreement above. However, this non-disclosure agreement is used when a party is interested in purchasing the business, but have no obligation to do so. It is essential because there is a possibility that even if the sale does no move forward, the non-disclosure agreement would prevent the buyer from disclosing trade secrets to other third-parties during their negotiations.
During the sale of a business, the business owner must provide the potential buyer with pertinent information about the business in order for them to fully understand the business. The last thing the business seller would want is for the deal to fall through and the potential buyer to have information that they can leverage against the seller. As a business owner looking to sell their business, an important provision they must add to their NDA is a non-solicit provision. A non-solicit provision is a clause in an NDA that prevents the potential buyer from obtaining a list of clients or employees during negotiations and using that information for their own company. For example, a non-solicit clause prevents a competing business that obtains the company’s client list during negotiations from contacting the clients under their own operations. Historically, businesses have poached customers through the guise of negotiating, leaving the selling company with less value than before. This clause tends to last around two years, as anything much longer can be seen as anti-competitive under anti-trust law or certain state law. This is a good way to gauge a company’s actual interest in the sale, as this clause would protect the business’ information from being stolen by a competitor. This is especially important in a business that is selling to a limited group of clients. Modern courts and arbitrators who analyze the NDA during a dispute tend to greatly disfavor anti-competitiveness and non-solicit clauses, so they must be written very specifically and worded carefully. For more information on non-solicit clauses, G&G Law, LLC has provided more information.
Another key clause in a business sale NDA is the clause that describes the return or destruction of confidential information. This clause is important when the deal does fall through. This clause lays the process for how the confidential information will be returned or destroyed. This ensures that the other party will not hold on to the confidential information past the negotiating process. There are a few exceptions used in common NDAs where they allow the recipient of the information to retain one copy of the information. This is usually done to abide by internal retention policies or industry regulation; however, the recipient cannot use the information in another manner.
Exceptions
There are a few exceptions of what can be covered in the agreement. The terms can only cover information that is not publicly known, such as trade secrets. Information that is commonly known to the public or to the industry cannot be held a secret by the NDA. This would be information that is common among the business owner’s peers, even if the information is known among a group of less than ten people. For example, a business owner cannot compel an NDA on someone for information on a manufacturing process that is being used or known by at least two other businesses in the industry.
Another exception to the liability imposed by an NDA is if the obligated party acquired or can acquire the information legally through another source. If the obligated party can find the information elsewhere, they cannot be held liable because the information is assumed not to be a secret. This is usually done by third parties who are not bound by an NDA or information that can be discovered by other ways, such as research. This also places a burden on the business seller to keep their information as confidential as possible. A business seller cannot expect another party to keep their information a secret when the seller themselves is leaking information, using insufficient protective measures.
Lastly, a potential buyer has no obligation to keep information that they learned prior to signing the NDA a secret. A business owner must keep in mind that the protection from an NDA only begins once the parties have signed the contract and protects information from that point on. This seems obvious but oftentimes, business owners will provide some information to a potential buyer to bring them to the negotiating table. However, this information provided to the potential buyer cannot be protected. Venable has provided more information on these exceptions and other things a business owner should look out for when drafting an NDA. Similarly, the effects of the NDA can be broken by lawful requirements for disclosure, such as subpoenas or other legal proceedings.
Closing Thoughts
A non-disclosure agreement is a great way for a business owner to protect themselves during the long process of selling their business. Even during the pandemic, there are tools available for buyers and sellers to review the contract and sign them virtually without any physical meeting. An NDA is the first step in the process of selling a business, and allows for open negotiations. Requiring an NDA is also a good gauge for how the whole sale process will go. An NDA is usually sent from one party to another and is usually sent back within 14 days. If a party signs and sends the NDA promptly, this can be an indication of their willingness to do business, if they continually make modifications then this could be telling of their negotiating process.
Eforms provides a template for business owners to construct their own NDA. This is a great resource for a business owner who is selling their small business and is looking to save money on third-party costs. However, we do caution that business owners seek guidance from a lawyer. As mentioned above, there are many complications that follow an NDA, as an owner will be sharing business details with another party. Consulting a lawyer to create a well-drafted NDA can protect a business owner in the present and future, even if a business deal does not work out.
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