Confidentiality Agreements: More Unintended Consequences

Confidentiality Agreements: More Unintended Consequences Photo: Brian A. Jackson/iStockphoto.com.

This is part of a series of articles on transactional contracts issues by Prof. Michael L. Bloom and students in the Transactional Lab at the University of Michigan Law School.

Confidentiality agreements are among the most common agreements in corporate practice, often viewed as routinized documents unworthy of close reading. When drafting and negotiating confidentiality agreements, however, both parties should be aware of potentially broad restrictions on their activities. For example, in an acquisition deal, a “use” restriction can be the source of a creative argument for a seller seeking to prevent an unsolicited offer or other activity that arguably requires use of the seller’s confidential information.

Use Restrictions, Generally

In a confidentiality agreement, a disclosing party will want to do more than contractually prohibit a receiving party from sharing the disclosing party’s confidential information with others. A nonuse provision—a common feature of most any confidentiality agreement—restricts how the receiving party may use the disclosing party’s confidential information.

A flat prohibition on the use of confidential information would likely be overly broad in many deal contexts. For example, an employer likely wants its employee to use confidential information disclosed by the employer when it helps the employee to do a good job. In an acquisition, a seller likely wishes a potential buyer to use the confidential information disclosed by the seller for the purpose of evaluating the potential transaction. Indeed, confidentiality agreements are often put in place because there is a desire on the part of both parties for at least one party to use the other’s confidential information.

The devil, then, is in the details around the scope of the nonuse restriction. A common solution is to restrict the receiving party to using the disclosing party’s confidential information solely for some purpose, commonly defined by the confidentiality agreement. As an example in the acquisition context:

“You shall use the Evaluation Material solely for the purpose of considering, evaluating and negotiating a Transaction and shall not use any of the Evaluation Material for any other purpose.”

Articulating Permitted Use: Defining Purpose or Transaction

Drawing the outer bound of a nonuse restriction in terms of an agreement or transaction’s purpose will often track the parties’ mutual interests in entering into the confidentiality agreement in the first place—to provide some comfort and space for exchanging information as is often necessary for cooperative activity (be that exploring a potential acquisition, entering into an ongoing services agreement, etc.).

However, the analysis of a use restriction’s scope does not end there. The above example provision kicks the issue of devilish details over to the definition of “Transaction,” as is common, especially in acquisition contexts.

For example, if Transaction is defined as a possible business combination transaction between the parties (as it was in the confidentiality agreement at issue in Martin Marietta, Inc. v. Vulcan Materials Co., 68 A.3d 1208, 1212 (Del. 2012)), a restriction that permits the use of confidential information solely for the purpose of evaluating a Transaction could be found to prohibit a party from using that information in seeking to acquire the other party’s stock directly from its shareholders (again, as was found in Martin Marietta).

Where a use restriction is tied to the definition of “Transaction” or “Purpose” (or any other concept), as with the example provision above, the receiving party will want to consider if the defined concept is broad enough to permit the range of activities for which the receiving party might wish to use the information. (For example, in Martin Marietta, a definition of Transaction that included not just transactions between the parties but also any transaction related to the parties might have given the acquirer the scope it needed to use the target’s confidential information in connection with tendering an offer to the target’s shareholders.) The pragmatic receiving party, in drafting a sufficiently broad scope of use, will also consider any other activities in which the disclosing party might argue that the receiving party “inevitably” had to have used the disclosing party’s information, even if the receiving party claims it did not actually do so.

Explicit Disclaimer

Parties seeking additional protection against potential restrictive readings of nonuse restrictions in confidentiality agreements might consider also including language explicitly clarifying the intended freedom to operate. For example:

“Notwithstanding anything to the contrary in this Agreement, either Party may pursue other discussions, negotiations or transactions (regardless of whether in connection with a transaction similar to the Transaction or a party similar to, or competitive with, either Party) and will not be deemed to have used the other Party’s Evaluation Material merely for having pursued such discussions, negotiations or transactions.”

This type of clarifying statement is not a substitute for careful articulation of the permitted scope of use in the first place, but could prove a helpful additional lever to pull if later faced with creative arguments that an agreement restricts a party in ways not intended at the time of execution.

Michael L. Bloom is a Clinical Assistant Professor at the University of Michigan Law School, where he teaches contracts, business, and transactional classes and where he is the founding director of the Transactional Lab. Katherine Meister is a recent graduate of the University of Michigan Law School, where she was a Contributing Editor on the Michigan Journal of International Law. Eric Fidel is a recent graduate of the University of Michigan Law School, where he was an editor on the Michigan Journal of International Law.

This article is for informational purposes and is not intended to constitute legal advice or to be relied upon. The views expressed in this article are those of the authors only and not those of any organizations, including those affiliated with any of the authors.

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