Confidentiality Agreements: Mergers and Acquisitions
Confidentiality Agreements: Mergers and Acquisitions
One of the first agreements signed in most transactions is the confidentiality agreement (sometimes referred to as a nondisclosure agreement (NDA)). This agreement puts the parties on notice that certain matters are confidential and helps avoid misunderstandings about what the parties can do during the initial stages of a deal.
This Note discusses the principal provisions found in most confidentiality agreements and related considerations. While this Note primarily focuses on confidentiality agreements in the mergers and acquisitions (M&A) context, NDAs are used in a variety of other corporate transactions, including joint ventures and private placements.
This Checklist does not constitute legal advice, nor does it create an attorney-client relationship.
There are several matters parties should consider when determining whether to enter into an M&A confidentiality agreement. A few of these principal matters are discussed below.
Unilateral or Mutual Agreement?
Will both parties exchange information or will only one party disclose information to the other? Mutual NDAs are used more often for joint ventures and M&A transactions when buyers issue equity as consideration. Most M&A transactions for cash involve unilateral NDAs since it is usually only the seller that discloses confidential information. Even when the situation calls for a unilateral agreement, however, parties sometimes use a mutual agreement because:
Each party may provide information to the other at some point during the deal so a mutual agreement can save time later.
There are typically matters besides the actual business information that both parties want to keep confidential, such as the potential deal terms, the fact that negotiations are taking place, or the identity of the buyer and the seller.
Mutual NDAs are usually more balanced than unilateral forms. This typically results in a faster review and signing process.
When to Enter into the Agreement
The parties should sign an NDA as soon as possible. In particular, the seller should ensure the agreement is in place before disclosing any information to the buyer. If a party discloses information before signing the NDA, that party should specifically ensure that the NDA covers all prior disclosures.
Separate Agreement or Part of the Term Sheet?
Confidentiality agreements are usually separate agreements for the following reasons:
A party may need to conduct due diligence of certain non-public information before negotiating a term sheet.
Term sheets often take longer to negotiate, so signing a separate NDA starts the due diligence process sooner.
Confidentiality provisions are fairly lengthy so, to ensure that all applicable provisions are included, it may be more effective to include them in their own separate agreement.
If the parties decide not to use a term sheet and have no separate confidentiality agreement in place, confidential information may be disclosed without any written protections.
If the parties decide to include confidentiality provisions in the term sheet, they should ensure that all of the confidentiality provisions are binding because many term sheets are non-binding. If the parties negotiate a term sheet after the signing of an NDA, the term sheet should expressly state that nothing in that agreement supersedes the terms of the NDA.
Is Your Client More Likely to Receive or Disclose Information?
Like many agreements, confidentiality agreements can be drafted in a variety of ways. When preparing or reviewing the confidentiality agreement, consider whether your client will primarily disclose or receive information. When representing a buyer ensure that the exclusions to confidentiality are as broad as possible and that your client can share the confidential information with its affiliates, advisors, and representatives (for example, its equity investors and attorneys, financial advisors, and accountants), as well as, potential sources of financing. On the other hand, if you are representing the seller ensure that any confidentiality exceptions granted to the buyer are as narrow as possible and limit the persons with whom the buyer can share confidential information with.
Is the Disclosing Party a Public Company?
Consider the following matters if the disclosing party is a public company (or is a significant subsidiary of a public company):
Include a standstill agreement in the NDA restricting the buyer from making unsolicited bids on the public company.
Verify that the recipient and its representatives will comply with securities laws.
Ensure the terms of the NDA qualify for the confidentiality exception to Regulation FD under the Securities Exchange Act of 1934, as amended (Exchange Act). Regulation FD generally prohibits public companies from disclosing material, non-public information to certain people unless the information is publicly disclosed or the recipient expressly agrees to maintain the information in confidence.
Limitations of NDAs
While NDAs are meant to prevent unauthorized disclosures of information, they have inherent limitations and risks. These limitations include:
After information is wrongfully disclosed and becomes part of the public domain, it cannot later become undisclosed.
Damages for breach of contract (or an accounting of profits where the buyer has made use of the information) may be the only legal remedy available once the information is disclosed. Damages may not be adequate, however, especially when the confidential information has potential future value as opposed to present value.
Proving a breach of a confidentiality agreement can be very difficult.
Even where a recipient is basically honest, it may inevitably take the disclosed confidential information into account in its own commercial plans regardless of the terms of the NDA.
Despite these limitations, the commercial benefits of disclosing the information under a confidentiality agreement (for example, encouraging the buyer to enter into an acquisition agreement) normally outweigh the risks of disclosing the information in the first place.
To protect its confidential information, the disclosing party should manage the disclosure process carefully and have a contingency plan for dealing with leaks.
Why Have a Written NDA?
Parties enter into a written NDA for several reasons:
Protection of trade secrets under state law can be lost (deemed waived) if they are disclosed without a written agreement.
Written contracts are typically easier to enforce.
Written NDAs are often required under prior agreements with third parties (such as agreements with suppliers and licensors).
NDAs avoid confusion over what the parties consider to be confidential.
The parties have more flexibility in defining what is confidential.
The parties can specify their expectations of each other.
NDAs are necessary for public companies to comply with securities regulations, including Regulation FD, prior to the disclosure of material nonpublic information.
NDAs often cover issues unrelated to confidentiality, such as non-solicitation, exclusivity, and standstill agreements.
NDAs are standard and an expected part of most negotiated deals.
Content of Confidentiality Agreements
Most NDAs contain the basic terms and provisions discussed below. Always consider the particular facts and circumstances of the relevant transaction, however, when drafting or reviewing a confidentiality agreement.
Parties to the Agreement
While the principal parties to the transaction (the buyer and seller) will be bound by the confidentiality agreement, representatives of the parties usually also have access to the confidential information. For example, buyers almost always involve their attorneys, financial advisors, and accountants in the due diligence process.
Most confidentiality agreements address disclosures to third parties. The disclosing party typically asks that the recipient be responsible for unauthorized disclosures by its representatives. This is done in several ways. For example, the disclosing party can include a general provision holding the recipient responsible for its representatives or it can require that the representatives sign an acknowledgement binding them to the confidentiality agreement. In addition, if the recipient is a holding company or part of a larger corporate structure, this provision often makes it clear that the recipient is responsible for the acts of its subsidiaries and affiliates.
Many recipients resist requiring their representatives to sign confidentiality documents and instead prefer to be directly responsible for their actions. Requiring attorneys, financial advisors, accountants, and other professionals to enter into separate written agreements can be time consuming and delay the due diligence process. An increasing number of financial buyers, however, prefer to have their financing sources enter into NDAs directly with the seller so that the buyer is not responsible for any breach by those financing sources. Even when not required by agreement, buyers and sellers may have their representatives enter into separate NDAs with them that mirror the terms of the confidentiality agreement that the party signs. These agreements are commonly referred to as “back-to-back” agreements.
Definition of Confidential Information
Defining what is confidential is central to any confidentiality agreement. The types of matters that are typically categorized as confidential include:
The seller’s business information (including trade secrets). Disclosing parties need to ensure that confidential information is defined broadly enough to cover all information they may disclose as well as any information they may have previously disclosed.
Derivatives of the seller’s business information. For example, a recipient may use confidential data to create its own financial projections for the target company.
The fact that the parties are discussing a transaction and the status of those negotiations. It can be very damaging to a seller if its employees or customers learn about a deal before a formal announcement is made.
The actual terms of any potential transaction.
The agreement should also clarify when confidential information is being disclosed. For example, the agreement can require labeling information as confidential at the time of disclosure or it can provide that confidential information includes all disclosed information, whether written, oral, electronic, or otherwise.
Parties often elect the latter option, as the labeling requirement can lead to confusion, delays, or restrictions in disclosing information. For example, if delivering information electronically, will each screen display of the information have to be labeled as confidential? Also, disclosing parties run the risk of forgetting to label important information as confidential and losing the protections of the NDA.
Disclosing parties must also be careful not to disclose information that is restricted by other confidentiality agreements. For example, a buyer may want to review a seller’s joint venture agreement with a third party, but that agreement may contain its own confidentiality provision. In that case, the seller must either restrict access to that document or obtain permission from its joint venture partner to disclose a copy of the joint venture documents.
Exceptions to Confidentiality
Almost all NDAs provide certain exceptions to the confidentiality obligations. Many of these exceptions are fairly customary and include information that:
Is or becomes public without a breach of the agreement by the recipient.
Was already in the recipient’s possession.
Was or becomes available to the recipient through a third party not bound by a confidentiality agreement or other fiduciary obligation.
Is independently developed by the recipient without using the confidential information.
Although these exceptions are generally standard, there are different ways to draft them depending on which party you represent.
Permitted Use and Restrictions on Disclosure
This section of the confidentiality agreement sets out the recipient’s duty to maintain the confidentiality of the information, clarifies how the information can be used and who may see it.
The disclosing party should clarify that the information can only be used for a specific purpose, such as the evaluation of the current transaction. If the information pertains to a public company, the Delaware Supreme Court’s decision in Martin Marietta Materials, Inc. v. Vulcan Materials Co. highlights the fact that a failure to clearly define how a recipient may use the target’s confidential information received during the course of a deal could effectively create a backdoor standstill, prohibiting the recipient from pursuing a hostile deal while the confidentiality agreement is in effect (68 A.3d 1208, 1218 (Del. 2012), as corrected (July 12, 2012)); see also Legal Updates, Martin Marietta: Delaware Court of Chancery Holds Use of Confidential Information in Hostile Bid Breaches Confidentiality Agreements and Delaware Supreme Court Affirms Court of Chancery Ruling in Martin Marietta). The Marietta/Vulcan case emphasizes the importance of careful drafting. In particular, if a recipient is able to negotiate a confidentiality agreement without a standstill provision, it needs to be careful that the other provisions in the confidentiality agreement (such as the use and disclosure provisions) do not otherwise restrict its ability to make an unsolicited bid.
This provision also clarifies who is permitted to access and use the information. Typically, the parties to the agreement and certain of their representatives and advisors are permitted access to the information. The disclosing party sometimes tries to limit access to those with a need to know the confidential information.
In addition, this section typically includes the recipient’s affirmative duty to keep the information confidential. This duty is often tied to a certain standard of care. For example, the agreement might require the recipient to maintain the confidentiality of the information using at least a reasonable degree of care.
There are a few ways to try to protect against unauthorized disclosure. For example, the confidentiality agreement may provide that document requests can only be made through a designated person and information can only be reviewed at a particular location (such as a data room).
If the parties are direct competitors consider the following:
There may be certain information that is so sensitive (for example, customer or supplier lists) that the parties may consider signing a separate NDA with much more specific provisions and controls regarding the disclosure of that information (for example, the NDA may provide that the sensitive information be shared with only a clean team).
A close competitor may not want to review certain documents to avoid a later claim that it misused the information.
Sharing certain information with a competitor may violate antitrust laws.
Recipients often need one or more exceptions to the general restrictions on use and disclosure, including:
Disclosing the existence and terms of the deal to a bank or other lending source to secure financing.
Disclosures required by law, regulation, or legal or regulatory process. NDAs usually allow the recipient to disclose confidential information if required to do so by court order or other legal requirement or process. Sometimes the recipient is required to deliver a written opinion of counsel verifying the legal necessity of the disclosure. Prior to the disclosure, the recipient usually must also notify the disclosing party and cooperate with the disclosing party in an attempt to obtain a protective order.
NDAs can run indefinitely or terminate upon a certain date or event. Disclosing parties typically prefer an indefinite period while recipients generally favor a set term. Any term often depends on the type of information involved and how fast such information changes. For example, some information becomes obsolete fairly quickly (such as certain technological matters) while other information may need to remain confidential long into the future (such as certain trade secrets or customer lists). A majority of the confidentiality agreements that do specify a termination date include a term of between one to two years (with two years being the most common term).
Some NDAs contain provisions unrelated to confidentiality obligations that always have set expiration dates, such as standstill agreements and non-solicitation clauses. The term of the confidentiality agreement should be longer than the expiration date for any of these provisions.
Return of Confidential Information
Disclosing parties should ensure they have rights to the return of their confidential information. NDAs typically provide for the return of confidential information in the following circumstances:
On the termination of negotiations between the parties.
At the end of the term of the agreement.
At any time upon the disclosing party’s request.
Recipients often want the option to destroy the confidential information instead of returning it to the disclosing party. While conducting due diligence a buyer may insert its own confidential information onto seller’s confidential documents or reproduce the seller’s confidential information in the buyer’s confidential documents (for example, including the seller’s projections in its financial models). In that instance, the buyer usually wants to destroy the information because returning it means disclosing its own confidential information. Sellers usually allow this destruction option but often require the buyer to certify in writing that the information was, in fact, destroyed. Clearly, there is no way for a seller to be certain that a buyer has destroyed the information, so sellers need to be aware of the inherent risk in this option.
In addition, recipients often try to include language that allows them to keep copies of the confidential information for document retention policy, evidentiary purposes, or if required to do so under law or professional standards. Disclosing parties generally agree to these exceptions but sometimes require that third parties (such as the recipients’ outside attorneys) keep the copies to protect against abuses.
Due to the potential consequences of unauthorized disclosures, NDAs often provide injunctive relief as a remedy in addition to monetary damages. Injunctive relief is particularly attractive to a disclosing party because that party usually wants to stop the recipient from disclosing information and not just sue for damages.
In addition, disclosing parties sometimes try to include an indemnity provision holding the recipient responsible for all costs relating to the enforcement of the agreement. Recipients typically resist this language. A typical compromise is to have the losing side in a dispute pay the fees and expenses (including legal fees) of the prevailing party.
Like most agreements, NDAs contain boilerplate (often referred to as “miscellaneous”) provisions. Although these provisions are considered standard, they can have a significant impact on the agreement and its enforcement. For example, the choice of law provision can greatly impact the enforcement of the agreement as states have different laws regarding confidential information and trade secrets. Common miscellaneous provisions include:
Entire agreement clauses (also known as the merger or integration clause).
Assignment clauses restricting the parties’ ability to assign their rights under the agreement.
Choice of law, jurisdiction, and venue clauses.
Amendments and waiver clauses.
Confidentiality agreements often also include provisions that do not necessarily relate to confidentiality. Some of these provisions are described below.
No Representations or Warranties
The disclosing party may clarify that unless and until it enters into a definitive agreement with the recipient regarding the transaction it makes no representations or warranties with respect to any of the disclosed information. If the recipient claims that the information is incomplete or inaccurate in any way, the disclosing party relies on this clause to deny liability.
A non-solicitation clause restricts the buyer from hiring the seller’s employees for a certain period of time (although terms vary, with most falling within the range of one to three years, a one-year term is the most common). Naturally, sellers do not want buyers to be able to hire away its employees, especially when they are evaluating a potential deal and speaking to the seller’s employees. Buyers try to include several exceptions to these provisions (such as excluding general solicitations not directed at seller’s employees) and limit the scope of the restriction to seller’s key employees (such as directors and executive officers) or employees who the buyer first met in connection with the transaction. Non-solicitation provisions can also restrict the buyer from soliciting the seller’s customers and suppliers.
When the disclosing party is a public company (or is a significant subsidiary of a public company), the NDA typically includes a standstill agreement. A standstill agreement can help the target company to control the deal process. More importantly, the standstill can prevent the prospective buyer from making a hostile takeover attempt after the parties fail to complete a friendly deal when the buyer has had access to the public company’s confidential information. The standstill period typically varies from six months to three years depending on the negotiating strength of the parties and the past history of the buyer in pursuing hostile acquisitions (with a one-year term being the most common).
During the standstill period, the buyer may not, for example, solicit proxies or otherwise try to indirectly obtain control of the seller. In addition, standstill agreements often limit the buyer’s ability to buy and sell the public company’s stock. Affiliates of the buyer or its financial sources sometimes request an exception to the standstill provision for trading activity that is not influenced by the confidential information (for example, a hedge fund’s regular trading activities).
Trading in Securities
If the disclosing party is a public company (or is a significant subsidiary of a public company), the confidentiality agreement typically also contains an acknowledgement by the buyer that the buyer and its representatives may not buy or sell the public company’s securities if they have material, non-public information. This provision reminds the parties of their obligations under securities laws, including the potential insider trading liabilities that may arise under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.
Anti-Clubbing and Lock-Ups
Although more common in private equity deals, the seller may include an anti-clubbing provision to prohibit the practice of consortium bidding or club deals. Consortium bidding, often referred to as “clubbing,” is the acquisition strategy of forming a group of bidders to collectively participate in an acquisition. Clubbing gives some private equity sponsors the benefit of participating in a deal that might have otherwise been prohibitively expensive to undertake alone. However, club deals can adversely impact the seller by lessening competition for bids and reducing the price that might otherwise be paid for the target company.
The seller may also request that the buyer make a representation that it is not a party to any exclusivity (or lock-up) arrangement with a potential source of financing. By having some assurance that a bank or other possible financing source is not exclusively tied to the buyer, the pool of financing sources that could be available to other potential buyer candidates (either in an auction scenario or in a deal with a different buyer) will not be so limited. A seller considering competing offers does not want other bidders constrained because a desirable bank is locked up from providing financing to another possible buyer.
The parties often provide that neither party can make public announcements about the deal unless agreed to in advance by both sides. In addition, this section usually requires that both sides agree not only to the announcement itself but also to the wording of the announcement. This means that the press release or other statement must be reviewed by each party and their counsel.
Sometimes referred to as a no-shop clause, this provision requires the seller to deal exclusively with the buyer for a certain period of time. Buyers spend a lot of time, money, and resources evaluating a transaction and want to ensure that the seller is not shopping the deal to other parties.
Depending on the circumstances, sellers may agree to an exclusivity period but try to limit its duration as much as possible or may otherwise try to negotiate for other deal terms in exchange for agreeing to exclusivity. Sellers in a particularly competitive industry typically have more leverage in this regard. Before agreeing to an exclusivity agreement, sellers need to also consider the fiduciary duty implications of doing so.
Exclusivity agreements, while sometimes part of the NDA, are usually separate agreements or included in the term sheet.
No License Granted
The disclosing party often makes it clear that it is not granting the recipient any licenses in the disclosed information. In that regard, the confidentiality agreement often limits the recipient’s review of the information to only that which necessary for the limited purpose of evaluating the deal.
Obligation to Inform of Unauthorized Disclosure
Disclosing parties often try to require the recipient to inform them if there are any unauthorized disclosures under the NDA. Disclosing parties want to know about any unauthorized disclosures as soon as possible to avoid or minimize potential damage.
No Further Obligations
The parties sometimes provide that entering into the NDA and exchanging information does not require them to enter into any further negotiations, agreements, or transactions. Simply entering into an NDA does not typically require the parties to enter into any other agreements or negotiations, but including this section helps ensure that there are no future misunderstandings. Sometimes this provision is combined with the no representations or warranties provision.
Residual rights clauses allow the recipient’s employees to use any confidential information retained in their memories. Buyers often have technical employees review certain information (for example, scientific processes) and want to avoid a later claim that the buyer developed a technology or product based in part or in whole on the disclosed information.
Sellers often strongly object to residual rights clauses and have concerns over abuse. To limit potential abuse, some residual rights provisions state that employees cannot intentionally remember information to sidestep confidentiality obligations. This approach has obvious practical problems if a seller tries to prove that someone intentionally committed information to memory.
THIS PUBLICATION DOES NOT CONSTITUTE LEGAL ADVICE, BUT IS A GENERAL OUTLINE FOR DISCUSSION PURPOSES. THIS PUBLICATION WILL NOT BE REVISED PAST ITS PUBLICATION DATE THEREFORE ANY READER SHOULD CHECK THE STATUS OF THE LAW, AND CONTACT AN ATTORNEY WITH ANY QUESTIONS PRIOR TO ANY ACTION. THIS PUBLICATION ONLY OUTLINED COLORADO LAW.