Learn about the best way for a business to protect its trade secrets.
A nondisclosure agreement – also called an NDA or confidentiality agreement – is a contract in which the parties promise to protect the confidentiality of secret information that is disclosed during employment or another type of business transaction. If you make a nondisclosure agreement with someone who uses your secret without authorization, you can request a court to stop the violator from making any further disclosures and you can sue for damages.
You can use a nondisclosure agreement to protect any type of trade secret – that is, any information that is not generally known and gives your business a competitive advantage in the marketplace. For example, using a nondisclosure agreement, you can prohibit someone from disclosing a secret invention design, an idea for a new website or confidential material contained in a copyrighted software program.
The use of nondisclosure agreements has become almost ubiquitous in the high-tech field, particularly for Internet and computer companies. For example, Sabeer Bhatia, founder of Hotmail, made sure that everyone who knew about his start-up company signed a nondisclosure agreement. Over a two-year period he collected over 400 NDAs from employees, friends and roommates. He believes that his secrecy efforts gave him a crucial six-month lead on the competition. He eventually sold Hotmail to Microsoft for a reported $400 million in stock.
However, the use of NDAs is not an end in itself. Their purpose is to create a confidential relationship between a person who has a trade secret and the person to whom the secret is disclosed. Only people who have such a confidential relationship are legally bound to keep the information a secret.
A confidential relationship can be created through an oral agreement or can be implied from the conduct of the parties, but few people rely on such informal arrangements because they are always more difficult to prove than a relationship based on a written agreement. In one case, for example, an inventor developed a ratchet by combining parts of two existing tools and brought it to the attention of an independent dealer for the Snap-On Tools company. Later, the inventor submitted a tool suggestion form to Snap-On’s corporate headquarters. The inventor never requested confidentiality and never indicated that he expected compensation for his idea. Snap-On manufactured and sold the ratchet without paying the inventor. The inventor sued, but the court ruled against him because he disclosed the information without stating that it was a business proposition for which he wanted payment.
NDAs are often categorized as either “mutual” or “one-way.” A mutual NDA is one in which both parties are exchanging confidential information – for example, you provide secret information for a company to evaluate and they provide you with secret information about their marketing strategy. A one-way agreement is used when only one party is making a disclosure – for example, when you explain your secret to a contractor or investor.
A company may want you to sign its nondisclosure agreement or modify your own. Generally, it does not matter who furnishes the nondisclosure agreement so long as it contains the basic elements to limit disclosure. There are five important elements in a nondisclosure agreement:
- definition of confidential information
- exclusions from confidential information
- obligations of receiving party
- time periods, and
- miscellaneous provisions.
Definition of Confidential Information
Every nondisclosure agreement provides a list of the types or categories of confidential information or trade secrets at issue in the agreement. The purpose is to establish the boundaries or subject matter of the disclosure, without actually disclosing the secrets. For example, an NDA may define confidential information by listing the various types of information considered confidential, such as: Confidential Information includes programming code, financial information, related software materials and innovative processes.When reviewing your agreement, make sure something on the list fits your type of disclosure.
Exclusions From Confidential Information
Every nondisclosure agreement excludes some information from protection. The party that receives the trade secret has no obligation to protect the excluded information. These exceptions are based on established principles of law – the most important one being that information is not protected if it was created or discovered by the receiving party prior to (or independent of) any involvement with you. For example, if another company develops an invention with similar trade secret information before being exposed to your secrets, then that company is still free to use its independently created invention.
Obligations of the Receiving Party
The receiving party generally must hold and maintain the information in confidence and limit its use. Under most state laws, the receiving party cannot breach the confidential relationship, induce others to breach it or induce others to acquire the secret by improper means. Most businesses will accept these contract obligations without discussion.
Some agreements require that the receiving party maintain the secret information for a limited period of years, including language such as “the receiving party shall not use or disclose the secret for a period of five years from the date of execution of the agreement.” You can often negotiate the time period. Disclosing parties want an open period with no limits; receiving parties usually want a short period. Five years is a common length in American nondisclosure agreements, although many companies insist on two or three years. In European nondisclosure agreements, it is not unusual for the period to be as long as ten years. Ultimately, the length you decide to use will depend on the relative bargaining power of the parties.
Miscellaneous terms (sometimes known as “boilerplate”) are included at the end of every agreement. They include such matters as which state’s law will apply in the event the agreement is breached, whether arbitration will be used in the event of a dispute or whether attorney fees will be awarded to the prevailing party in a dispute.