Non-Disclosure Agreements in Merger and Acquisition Negotiations

When two parties engage in acquisition negotiations, it quickly becomes necessary for confidential and proprietary information to be shared. Typically the potential buyer wants to analyze all available information to ensure its perception of the target company is accurate. However, a seller who agrees to disclose any information without first executing a non-disclosure agreement (“NDA”), risks becoming a victim of predators who seek to take advantage of inattentive business owners by stealing their ideas or making the information available to competitors. Further, even if a buyer has no bad intentions and acts ethically in every respect, and even if the information is never disclosed to third parties, disclosure of certain information without an NDA may expose the business to the risks of destruction of its trade secret or patent rights or of being held in violation of privacy laws, such as the Health Insurance Portability and Accountability Act of 1996 (HIPAA). See Health Insurance Portability and Accountability Act, Pub. L. No. 104-191, 110 Stat. 1936 (1996).

While confidentiality is certainly the primary concern of the seller, this does not mean that it is irrelevant to the buyer. A buyer who is requested to disclose certain information about itself, including information about its ultimate beneficiaries or financial condition and ability to fund the transaction, should insist on mutual confidentiality.

In these situations, we recommend that the parties execute a non-disclosure agreement as early in the negotiation process as possible. Unlike with letters of intent[hyperlink], it is irrelevant how likely the deal is going to happen and whether or not there is an agreement as to what the structure or the economic terms of the transaction would be. It is a good practice to execute an NDA at the outset. In fact, if you are a seller, you should avoid disclosing the fact that your business is for sale without first obtaining from any potential buyer a written commitment for confidentiality. The only exceptions to this rule are for professional advisors, such as attorneys, accountants, financial advisors, and other persons who are already bound by a duty of confidentiality.

A typical nondisclosure agreement identifies the parties involved, defines confidential information, obligations in maintaining confidentiality, information excluded from those obligations, an obligation to return or destroy confidential information when requested, and the term of the agreement among other provisions. These typical elements require a substantial degree of fine tuning in order to create an effective agreement applicable to the particular transaction. For example, a non-disclosure agreement which may be used for your employees or suppliers will likely not work well for an M&A transaction. For this reason, before using a pre-existing form of NDA, make sure to have an attorney review it to assure adequate protection. When it comes to disclosing critical business information to an entity which is under no obligation to follow through with the deal, too much is at stake to trust an unreviewed form agreement.

One of the critical issues to be addressed in an NDA is the scope of confidentiality obligations. Generally, the party receiving confidential information should be prohibited from sharing information with any third parties. Although the receiving party would have to share information with its employees and advisors, the disclosing party would normally request that such sharing is limited to those employees and advisors who actually need to know such information. Of course, this provision may be difficult to comply with from the receiving party’s perspective, so the provision limiting the ability to disclose information internally is often subject to negotiations.

Further, defining confidential information often sees conflict between buyers and sellers. Sellers want a very broad definition of confidential information to protect all information that is disclosed no matter whether such information is actually secret. Buyers generally prefer narrower definitions of confidential information that exclude information that is generally known or made available to the public through no fault of buyer or that is developed by parties other than seller without the use of seller’s confidential information. Inclusion of such exceptions will assure buyer that it will not be sued for using or disclosing information that is not actually to seller.

In addition to the provisions discussed above, there are many optional clauses which are frequently included in an agreement at the urging of one or both parties. For example, a seller may seek to prevent the buyer from hiring any of seller’s employees or otherwise interfering with seller’s business for a set period of time in case the deal falls through. Both parties may be interested in inserting a disclaimer which makes it clear that the NDA is meant only to further negotiations and places no obligation on either party to agree to a deal.

Information security should be a top priority for any business. Before agreeing to share any business information with anyone, disclosing parties must ensure that the receiving party is bound by an agreement which adequately protects the disclosing party’s confidential information and limits the recipient’s ability to use such information beyond the M&A negotiations.

Should you wish to discuss any legal issues related to the sale or purchase of a business, please contact attorney Steven Migala at (847) 705-7555 or smigala@lavellelaw.com, or attorney Roman Perchyts at (224) 836-6192 or rperchyts@lavellelaw.com.

This article is provided for informational purposes only and does not constitute legal advice. You should not rely on the information contained in this article without first consulting a licensed attorney.