Non-Disclosure Agreement in M&A transactions

What is a Non-Disclosure Agreement?

While entering into any negotiations or even while executing a contract for commercial relationships, it is very common for the commercial entity disclosing some confidential information (including IPRs) to insist on the execution of a non-disclosure agreement (NDA).

This is primarily resorted to protecting confidential information qualifying as intellectual property.

Such information is very intrinsic to the successful functioning of any company and could include client lists, manufacturing processes, trade secrets, business structures, long term plans, technologies or sourcing codes, etc. NDAs are largely a compulsory part of contemplation of any important and close business relationship to protect disclosure of confidential information in future.

The provisions of NDA are applicable, irrespective of the contemplated transaction being concluded.

Even if an MOU or Term sheet falls through, in the absence of a definitive agreement between the parties, NDA obligations will survive.

This means that having an NDA is a fail-safe. Even if your deal falls through, even at the negotiation stage, if you were savvy enough to execute an NDA before official negotiations, your trade secrets and IPR are safe.

So, let this be the first item on your M&A checklist.

?Why is it important in an M&A transaction?

As you would have appreciated by now, an NDA is a safety net. Without it, even if you do execute the M&A deal successfully, you don’t want the other business to walk away with your sensitive information in the future.

What Terms and Clauses Should You Include in an NDA?

i.??????Parties.

This is the first clause that is included in any agreement.

Who is bound by the agreement?

Determining the parties can get tricky based on who all have access to the sensitive information being disclosed. Usually, the party disclosing the IPR or clients etc. (“the Sensitive Information”) is referred to as the “Disclosing Party” and the party receiving it as the “Recipient”.

Thus, we can identify the two types of NDAs involved in M&A: (i) Unilateral and (ii) Bilateral/Mutual NDAs.

In Unilateral NDAs, only one-party shares sensitive information whereas, in Mutual NDAs, both parties have sensitive information that they wish to share with each other for the purpose of the deal.

If there are any third parties involved, it is always better to include them as well.

Many disputes revolve around attaching a party in litigation who is not a party to the agreement that is being litigated. It could create problems while resolving the dispute.

ii.????Definitions.

It is important to define the parties, what disclosures are being made and key terms of the agreement that you will refer to repeatedly. Words have different meanings in different contexts. Legalese is its own language and thus, requires to be properly defined. Certain terms have industry-specific meaning and relevance. Make sure to define those as well.

iii.???Confidentiality.

This is the existential clause of the NDA. It revolves around confidentiality. As an NDA is a stand-alone confidentiality agreement, the confidentiality clause here would mainly deal with what items are confidential i.e., barred from disclosure.

iv.???Exclusions from Confidentiality

Certain disclosures/information are expressly excluded from being confidential in M&A deals. The Buyer (Recipient) generally requires the following information to be excluded:

1.????All information already in his possession (and not subject to some other confidentiality restriction);

2.????Information generally available to the public (other than through the buyer);

3.????Information that the recipient came by non-confidentially and ethically;

4.????Information obtained by the recipient from a third party without a breach of confidentiality; and

5.????Information that the recipient developed on its own.

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v.????Permitted Disclosures

Some disclosures may be needed for the M&A deal to be executed and implemented. These are primarily of two types:

a)????Disclosures to Third Parties

Vendors, distributors, and other stakeholders who need to be included in the deal may need to be given access to sensitive information on a strictly need-to-know basis. These are known as permitted disclosures.

b)????Disclosures Required by Law

Various approvals under FEMA, SEBI, RBI, Company laws etc. are required before the M&A deal can go ahead. Disclosures regarding sharing of resources, IPR, shareholding etc. will need to be made while seeking approval. Hence, such disclosures are permitted under this clause of the NDA.

vi.???Employee and Client Non-Solicitation

Solicitation in M&A can be of both employees as well as clients. It means to directly approach the clients of the other party and offer services to them and/or entice their employees away from them with better job offers if one can get access to them. Such employees can provide useful inputs to their new employer about the pricing, clients, resources, leads, business model, technical information, etc. of the old employer.

There is a greater opportunity for such solicitation during an M&A deal, as there are open channels of communication and document-sharing between the businesses. This is why it is important to have an employee and client non-solicitation clause in your NDA.

The loss due to such unethical practices is immeasurable for the affected entity.

By such a clause, you can bind the other party (employee, business associate, joint venture partner) not to solicit business from your clients or entice your employees to join them.

vii.?No Vesting of Rights

Your NDA must include a clause prohibiting the buyer from licensing any intellectual property contained in the confidential information. Additionally, no implied license to the technology or information should be granted to the buyer. Make sure to include such a clause as well.

viii.Return or Destroy the Information

The language should further state that all tangible contents of the information (e.g., models, data, and drawings) should be returned upon request and in no event later than the end of the agreement term, and that the buyer shall destroy all copies of information with him. In today’s digital age, this is harder to trace as there are multiple methods and sources to copy, store and transfer data. Destruction of sensitive information in such cases will be permanently wiping down all copies and not leaving any trace.

ix.???No Obligation to Consummate

Just because you have signed an NDA doesn’t mean that you agree to the M&A deal. The other party should not be able to tie you to the M&A against your wishes on these grounds. Although it is a basic business sense that such a thing shouldn’t happen, it is better to be safe than sorry. Hence, as a safety measure always included such a clause in your NDA.

Examples of such clauses are:

·??????“The execution of this Non-Disclosure Agreement between the parties does not consent to enter into any transactions between them or create any rights or liabilities inter se, unless specified otherwise in this Agreement.”

·??????“Until a written agreement between Seller and Buyer has been executed, neither party shall be under any obligation to consummate any transaction.”

·??????“Each party reserves the right, in its sole discretion, to reject any proposals made by the other party, and to terminate negotiations at any time and for any reason.”

?x.????Disclaimer Regarding Accuracy

A “no warranty” clause is a statement by the seller that they make no warranty that the information is accurate or complete. If the parties proceed to an M&A Agreement, it will contain representations and warranties related to the business.

Examples of such clauses are:

·??????“Seller makes no representation or warranty, express or implied, as to the accuracy or completeness of the information…”

·??????“Buyer agrees that Seller shall have no liability to Buyer resulting from the use of Confidential Information or any errors or omissions.”

?xi.???Binding Agreement

Any contract entered into by competent parties, for a legal object and consideration and with consent is binding upon them. Even so, it is good practice to include a clause in your NDA that is binding on both of the parties until its termination or as per the conditions within its clauses.

?xii.?Term and Termination

Unless you stipulate a specific duration of the NDA or tie it up with the completion of an event or timeline, the law assumes that it was meant to have perpetual applicability. Thus, the NDA can continue forever, which is not what you may have intended.

The NDA can be either time-bound or can come to an end when some specific event or action contemplated under it is completed. If the parties intend to have a specific duration for their relationship, it must be clearly stated. If only one party has the right to terminate the agreement, it may be incorporated in the terms and a termination clause may be added as well.

Here are some examples of such clauses that you can add to your NDA:

·??????The term of this Agreement shall commence as of the Effective Date and shall extend until the completion of the Project or 31st March 2020, whichever is earlier, subject to prior termination as stipulated under this Agreement.

·??????This Agreement shall come into force with effect from April 1, 2017, and shall continue to be effective for a term of 5 (five) years therefrom, unless terminated in accordance with the terms of this Agreement.

·??????This Agreement shall be effective from the date of Closing as contemplated in Article 4.3 hereof and shall continue to be in force till the Parties hold more than 10% shares each in the Joint Venture Company, subject to prior termination provisions stipulated under this Agreement.

·??????This Agreement shall be effective from April 15, 2017, and shall be valid for a period of 6 (six) months, that is, till October 2017 (“the Term”), unless terminated earlier as provided in this Agreement.

·??????This Agreement shall come into force from April 16, 2017 (“Effective Date”) and continue to be in force for an indefinite period, until terminated by the Parties by mutual consent or by either Party in accordance with Article 17 of this Agreement.

·??????The terms of this Agreement shall be effective from April 21, 2017, and shall continue in full force and effect till it is terminated by XYZ Continental Private Limited with 15 (fifteen) days prior written notice.

Typically, NDA clauses may last for a period of one to five years but most NDAs last for two to three years. The acquirer may ask for an auto-termination clause at the end of this period whereas the seller may ask for an auto-renewal clause. The middle ground here is a termination clause that stipulates that the NDA shall cease to operate after the agreed-upon number of years or when the M&A Agreement is entered into, whichever is earlier.

An example of a termination clause is:

“This Agreement shall expire upon the earlier of five years from the execution of this Agreement or upon the execution of a Purchase or Sale Agreement between the parties.”

?xiii. Territory

You may wish to limit the operation of the NDA to a certain geographical territory only. If so, it needs to be specifically included in the NDA.

For example, a manufacturer may give distributorship of its products to different entities/individuals for specific territories. An Indian manufacturing company may give distribution rights for domestic sale of its goods to a distributor and retain the right to export outside India.

Similarly, a foreign company may appoint an Indian company to be the distributor for its products in India. A global cold drinks company may have a different joint venture partner in each country for bottling its products. The appointee in this case can operate within the defined territory and not outside.

The legality or otherwise of such provisions should be checked keeping the governing law in mind and suitable provisions should be incorporated.

In the absence of any jurisdictional limits in the agreement, the agreement could be assumed to have a universal operation.

?xiv. Governing Law and Jurisdiction

Most sellers seek to be governed by the law of the state in which they are incorporated. Buyers seldom refuse this request unless the buyer has significant negotiation leverage over the seller.

If the parties are located in different countries (such as USA and India), they may choose a neutral country in which neither party has a hometown advantage, such as London, the United Kingdom or Paris, France.[1]

If the NDA is breached, the first battle between the parties will be to find an appropriate court or forum to resolve the dispute. If the parties, therefore, agree on governing law and jurisdiction, this battle can be avoided, saving legal costs and time.

This clause is particularly important in respect of NDAs between transnational parties. In such a scenario, the agreement may be executed and performed in different countries. Various legal systems may be relevant and have partial or complete jurisdiction to entertain a petition filed by a party. It is, therefore, advisable to have clarity and unanimity among the parties regarding the governing law and jurisdiction.

As a general principle, the parties to an agreement are free to choose the governing law. However, this choice is not unfettered. The governing law should have a connection with the agreement.

Some valid considerations for choosing a specific governing law could be:

·??????The place where the agreement is executed;

·??????Place of performance;

·??????Place of domicile, residence or business of the parties;

·??????National character of companies/corporations involved in the transaction;

·??????Subject matter of agreement; and

·??????Other facts that help to localize the agreement.

Therefore, the governing law clause may provide you with important advantages while seeking relief for a breach. Be strategic about this choice.

Here is a common example:

“This Agreement shall be governed by the laws of India. Each party hereby irrevocably agrees to submit to the exclusive jurisdiction of the courts of Delhi, India for any action, suit, or proceeding arising out of or relating to this Agreement.”

Be sure to include the language by which your agreement and any legal proceedings arising out of it will be governed by.

xv.?Dispute Resolution

In the present dispute resolution scenario, there are various forms of dispute resolution that parties are seeking to mitigate losses, legal and time costs. For example, mediation, negotiation, and arbitration are increasingly used either as alternatives or mandatory pre-condition to litigation.

You may choose either of these options as well. However, be careful to adopt binding language such as “shall” while drafting these clauses as otherwise it will not be upheld in court. For example:

“Any dispute arising out of or in connection with this agreement, including any question regarding its existence, validity or termination, shall be referred to and finally resolved by arbitration under the Arbitration and Conciliation Act, 1996. The number of arbitrators shall be three. Each party shall appoint one arbitrator each and together, both arbitrators shall appoint a third, who shall be the Presiding Arbitrator. The seat of arbitration shall be New Delhi, India. The language of the arbitration shall be English. The governing law of the contract shall be the substantive law of India.”

?xvi. Injunction

As a disclosing party, you must insist that the NDA include a clause that mandates injunctive relief from a court to stop the recipient from breaching the agreement.

The recipient will likely resist this clause and seek language leaving it to the court to decide whether the facts of a dispute warrant injunctive relief.

?xvii.??????????????????Consequences of Breach and Damages

Most of the time, where the information disclosed is very sensitive and important, the disclosing party wants to impose a very heavy cost for any breach of the confidentiality provisions on the receiving party to make it a disincentive for the receiving party. Therefore, provisions relating to:

a)????Availability of cumulative remedies to the disclosing party; and

b)????Exemplary, punitive, and liquidated damages imposed on the breaching party should be incorporated in the agreement.

You should gauge the nature, importance and sensitivity of the confidential information being exchanged in the current context and include suitable clauses in this regard accordingly.

You can also seek damages for violation of the NDA. Such breaches result in huge losses to the company because the IPR, clients, etc. which are the sources of business income for the company are compromised. Thus, seeking damages is the preferred method to recoup these losses, at least to some extent.

Damages are of the following types:

??????i.?????????Compensatory damages

?????ii.?????????Restitution

???iii.?????????Liquidated damages

???iv.?????????Nominal damages

?????v.?????????Quantum Meruit

???vi.?????????Remedies in Equity

??vii.?????????Punitive Damages

Generally, damages may be classified into two categories, namely compensatory and punitive. When we refer to compensatory damages, we could also refer to it as ‘actual damages.’ These ‘actual damages’ may be subject to proof and would not include any punitive component.

Compensatory damages seek to merely compensate the affected party for actual loss or injury, rather than punishing the defaulting party.

Punitive damages on the other hand are used as a punishment for the defaulting party and the idea is to provide a deterrent. Sometimes, the amount of damages could be quantified in terms of multiple factors e.g., double rent after expiry/termination of the lease, thrice the consultancy fee for any material breach, etc.

Generally, damages are compensatory in nature unless the breach is established to be deliberate and willful. It may also differ from case to case, whether a monetary penalty is adequate to compensate the affected party and put it in a condition which it would have been, had the default not taken place or whether specific performance should be insisted.

?xviii.????????????????Indemnity and Costs

Indemnity means to put a person in the position that he was in before i.e., to make good his losses. Thus, you should insist on an indemnity clause in your NDA as a consequence of loss due to a breach by the other party.

You can also insist on recovering the legal costs involved in enforcing your rights under the NDA. Here is an example of such a clause:

“Seller agrees that it shall indemnify and shall not hold the Buyer liable for any loss arising out of a breach of this Agreement.”[2]

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[1] Non-Disclosure Agreement (NDA): A Complete Guide for M&A, Morgan & Westfield, Non-Disclosure Agreement (NDA) | A Complete Guide for M&A (morganandwestfield.com)

?[2] Non-Disclosure Agreement (NDA) | A Complete Guide for M&A (morganandwestfield.com)

This is ninth article in the series on #mergersandacquisitions by our student researchers Swasti Patoria, Annapurna Prabhu, Astha Agarwal, Aayomi Sharma, Amrutha Alapati and Aradhya Singh, students of Jindal Global Law School (JGLS) Symbiosis Law School, Pune and Symbiosis Law School, NOIDA

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