What you need to know about M&A confidentiality agreements

Most M&A transactions are material to the parties involved, and public disclosure that a deal is in the offing can have profound effects on a company’s operations, ranging from employee attrition to loss of confidence by commercial counterparties. Of course, for public companies, exploration of strategic alternatives may constitute material nonpublic information implicating Regulation FD (which restricts selective disclosure) as well as Exchange Act Rule 10b-5 and insider trading rules. Disclosure could impact public companies’ relative trading value, as well, which could interfere with closing a deal, and untimely disclosure may tip off potential interlopers who submit alternative bids and disrupt the transaction.

For these and other reasons, parties considering both private and public M&A typically begin discussions with negotiation of a confidentiality agreement, or non-disclosure agreement (NDA). These are usually relatively short (2-6 page) agreements that restrict one or both parties from disclosing the existence of discussions as well as the terms and conditions of any potential deal and information about one or both parties’ businesses.

Below, I’ll answer the following questions about NDAs used in M&A deals:

1. Does it matter if they’re mutual or one-way?
2. How should I define “Confidential Information” or “Evaluation Material”?
3. What should a recipient be required to do (or be prohibited from doing) with Confidential Information?
4. Are there typical exceptions to restrictions on disclosure?
5. What happens to Confidential Information after termination of discussions?
6. How do I enforce my rights under the agreement?
7. How long should restrictions last?
8. How do I stop the other side from stealing my employees and clients?
9. What is a standstill provision?

Please keep in mind that these answers are not intended to be comprehensive. I’ll just cover the highlights. Also, please let me know if there’s something you’d like me to cover beyond these topics.

Want to buy a confidentiality agreement?

Does it matter if M&A confidentiality agreements are mutual or one-way?

A gating issue to consider in preparing an M&A confidentiality agreement is whether the contract will grant only one party the right to protect information or whether that right will be reciprocal. In deals involving only one party disclosing confidential information to the other, such as, for example, where a small company is looking to sell assets to a large public company for cash, it may be appropriate to enter into an NDA that only protects the seller’s information (sometimes referred to as a “one-way” confidentiality agreement). In other transactions, where, for example, each party is making disclosures to the other about its respective business and assets, a mutual NDA may be necessary.

But you may be asking, why does it matter?  If I’m not disclosing sensitive information to the other party, I don’t care. Right?

In some respects, that is absolutely correct. If you aren’t disclosing anything sensitive, you don’t care about protecting your information. However, there may be more subtle implications of the choice between the two types of agreements. Mutual NDAs tend to be more balanced and reasonable than one-way agreements. If the drafting party knows that it will be bound by the same restrictions it is seeking to impose on the other, as it would be under a mutual agreement, it will generally be more moderate in its approach. This frequently makes the negotiation process much simpler and faster. On the other hand, it also means that the protections afforded to the disclosing party under a mutual NDA may be more limited than the alternative.

How should I define “Confidential Information” or “Evaluation Material”?

The restrictions on disclosure contained in a typical NDA apply only to a specifically identified category of information, most commonly defined within the agreement as “Confidential Information” (but also sometimes called “Evaluation Material” in the M&A context). The term may be defined broadly to cover a lot of information or narrowly to cover very little. Broader definitions favor the disclosing party, and narrower definitions favor the party receiving information.

If your goal is to broaden the definition of “Confidential Information,” include in the definition information that:

• relates not only to the discloser, but also to its affiliates,
• was not just delivered but also “made available” to the receiver (an important nuance when providing information through a virtual data room),
• was not just provided by the discloser but also by any of its affiliates and its and their respective owners, directors, officers, employees, representatives and other agents,
• is in electronic or physical form, including all copies, notes and other embodiments developed by the receiver and its representatives based in any way on the Confidential Information,
• may or may not have been marked “confidential” or otherwise communicated to be confidential or proprietary and
• was provided after or before the date of signing the NDA.

In addition, the fact that discussions between the parties are taking place should be deemed “Confidential Information.” This is particularly important in NDAs entered into in anticipation of an M&A deal. Also, exclusions should be drafted narrowly. These commonly include information that:

• is generally available to the public other than as a result of disclosure by the receiver,
• is available to the receiver from another source that isn’t prohibited from disclosing it or
• is independently developed by the receiver without violating the NDA.

Lastly, do not make the mistake of conflating the permissible disclosure provisions (discussed below) with exceptions to the definition of Confidential Information. From the discloser’s perspective, the fact that certain information may be disclosed under agreed-upon circumstances should not thereby cause the information to cease to qualify as Confidential Information. That would have the effect of permitting the receiver to misappropriate the information simply because, for example, it may have been compulsorily disclosed to a court.

If, on the other hand, your goal is to narrow the definition of “Confidential Information” (i.e., if you are the receiving party) take the opposite position with respect to each of the foregoing points.

What should a recipient be required to do (or be prohibited from doing) with Confidential Information?

Most well-written confidentiality agreements entered into in anticipation of an M&A transaction include a covenant requiring the Confidential Information to be “used solely for the purpose of evaluation of a possible transaction” or words to that effect. This is one of the more important provisions of an NDA and isn’t normally subject to much negotiation or modification.

Conversely, there is usually quite a bit of back and forth about the standards that will govern the receiving party’s handling of Confidential Information in its possession. This can range from a low standard of protection that is favorable to the receiver (e.g., “the Receiving Party shall exercise reasonable efforts to preserve the confidentiality of the Confidential Information”) to a more stringent standard that would be preferred by the discloser, such as:

“The Receiving Party shall keep the Confidential Information strictly confidential and shall not sell, trade, publish or otherwise disclose all or any part of it to anyone in any manner whatsoever, including by means of photocopy or reproduction, without the Disclosing Party’s prior written consent, which may be withheld, conditioned or delayed in the Disclosing Party’s sole and absolute discretion, except as expressly provided in this Agreement. The Receiving Party shall use at least the same level of care to protect the confidentiality of the Confidential Information as it does to protect its own confidential or proprietary material, and in any event not less than reasonable care. At its sole expense, the Receiving Party shall take all measures (including pursuing court proceedings) necessary to restrain its Representatives from disclosure or use of any Confidential Information that is prohibited or not expressly authorized in this Agreement. To the extent not already marked, the Receiving Party and its Representatives shall mark each page, whether physical or electronic, of all Confidential Information received or prepared by the Receiving Party and its Representatives with the following legend: ‘Strictly Private and Confidential – Proprietary Information of [Discloser’s Legal Name] – Subject to Confidentiality Agreement.'”

It’s rare for parties to agree to language equivalent to either of these extremes. More often than not, they will find a middle ground that provides for a reasonable level of protection of Confidential Information with some amount of accountability by the receiver for the conduct of its representatives.

Are there typical exceptions to restrictions on disclosure?

Yes, despite the usual restrictions, most confidentiality agreements permit the receiving party to disclose Confidential Information if required to do so by law or equivalent binding authority (e.g., stock exchange listing requirement). This is an important exception to the agreement’s restrictive covenants. Without it, the agreement could violate applicable law, such as, for example, IRS regulations requiring disclosure of the tax treatment and tax structure of certain transactions.

The core concept of an exception for legally mandated disclosure is almost never subject to negotiation (though it is often, presumably unintentionally, omitted from many short-form NDAs). Yet there is usually back and forth as to the parameters of this exception and what steps must be taken by the receiving party before it is permitted to rely on it. For example, the exception may require:

• immediate, prompt or prior notice to the discloser of the legal requirement before disclosure is made (but subject to any legal restrictions on providing such notice),
• written vs. verbal notice,
• cooperation with, or assistance of, the discloser in resisting the mandatory disclosure,
• incurrence of related expenses by the receiving party,
• disclosure only to the extent necessary to comply with the mandate,
• efforts by the receiving party to ensure any Confidential Information disclosed is afforded confidential treatment and/or
• a written or informal legal opinion stating that the proposed disclosure is legally required.

Virtually all confidentiality agreements that expressly permit mandatory disclosure end up reflecting some combination of these requirements for reliance on the exception.

What happens to Confidential Information after termination of discussions?

M&A confidentiality agreements generally require receiving parties to return or destroy Confidential Information upon termination of discussions of a deal and/or upon request of the discloser. After all, information provided during the course of M&A due diligence may be extremely competitively sensitive, and its misuse or public disclosure may be quite detrimental to the subject company.

Frequently, a discloser will request that the receiving party certify its compliance with this covenant. It’s unclear that such a covenant actually provides any additional legal protection for the discloser given that the receiving party is in any event still obligated to destroy or return the materials. However, it may provide comfort to the discloser that the covenant was actually complied with and may additionally substantiate a claim of fraud (which could entitle the discloser to a higher damages award than a breach of contract claim would) if the certification turns out to be false.

Prudent receiving parties often negotiate for exceptions to return or destruction provisions like these, though, to ensure they account for the realities of contemporary communications and business practices. While it once may have been possible to return or destroy all physical and electronic copies of relevant information, use of third party email services, server backup routines, cloud computing and proliferation of mobile devices among other technological developments have made it increasingly impracticable, if not altogether impossible, to return or destroy all Confidential Information in the possession or control of a recipient. Similarly, many organizations are subject to regulations that require them to retain copies of certain materials in their possession for a period of time that may exceed the duration of discussions, and return or destruction provisions may need to be circumscribed to accommodate these requirements.

Despite these limitations, disclosing parties will often in turn demand a requirement that the confidentiality restrictions set forth in the NDA will continue to apply for a period of time to any Confidential Information that is not returned or destroyed by the receiver, notwithstanding the ordinary expiration or termination of such restrictions as they apply to other information.

How do I enforce my rights under the agreement?

If the receiving party breaches an NDA, the disclosing party looking to protect its information must pursue legal recourse in court (or in arbitration if required under the agreement). Monetary damages are often extremely difficult for a plaintiff to prove as a result of a breach of a confidentiality agreement. Consequently, a discloser’s best opportunity for recourse may be to seek injunctive or equitable relief (a court-ordered act or prohibition against an act) to stop any further disclosures. To that end, disclosing parties often request language that will make it easier to obtain such relief. Here’s an example that is favorable to the discloser:

“Each Party acknowledges and agrees that the other Party would be irreparably injured by a breach of this Agreement by the other Party and that money damages are an inadequate remedy for an actual or threatened breach of this Agreement because of the difficulty of ascertaining the amount of damage that will be suffered by either Party in the event that this Agreement is breached. Therefore, each Party agrees to the granting of specific performance of this Agreement and injunctive or other equitable relief in favor of the other Party as a remedy for any such breach, without proof of actual damages. Each Party further waives any requirement for the securing or posting of any bond in connection with any such remedy. Such remedy shall not be deemed to be the exclusive remedy for a Party’s breach of this Agreement, but shall be in addition to all other remedies available at law or equity to the other Party. Each Party also agrees to reimburse the other for all costs and expense, including attorneys’ fees, incurred by the other Party in enforcing the first Party’s obligations under this Section.”

While provisions like these designed to facilitate equitable relief are found in most M&A confidentiality agreements, they are rarely this pro-discloser. Instead, you will often encounter receiving party pushback on such terms as “would be irreparably injured” or “are an inadequate remedy,” instead preferring phrasing that may not be as helpful to the discloser-plaintiff along the lines of “may be irreparably injured” or “may be an inadequate remedy.” Similarly, the provision might state that the discloser-plaintiff may “seek” injunctive relief rather than being acknowledged as entitled to it. Depending on the law governing the contract, these changes may either moderate or completely undermine the purpose of the provision so disclosing parties should be careful in agreeing to them.

Of course, receiving parties also prefer not to include expense reimbursement language. Under most states’ laws, the parties to litigation will usually bear their own costs. Obviously, the allocation of costs may have a material effect on the discloser’s incentives to pursue relief under the contract.

How long should restrictions last?

The duration of confidentiality restrictions in M&A confidentiality agreements is a tricky subject. There are quirks of applicable rules that may have unintended consequences.  First, confidentiality restrictions are not necessarily coterminous with the duration of the NDA itself. You may want the restrictions on disclosure to expire on a specified date (e.g., two years after signing the agreement) while other provisions of the agreement continue for a period of time after expiration of the restrictions (e.g., those governing dispute resolution).

Second, depending on the law that governs the contract, remaining silent as to the duration of confidentiality restrictions may not, as you might expect, have the effect of making them perpetual. On the contrary, if you remain silent in some jurisdictions you run the risk of having a judge interpose his or her judgement as to what a reasonable duration should be. This may end up being a shorter (or longer) period of time than the parties would have negotiated on their own. Accordingly, before electing to say nothing about termination of the agreement or expiration of confidentiality restrictions, be sure to understand the consequences under the governing law.

Third, consider whether trade secrets may be disclosed under the NDA. This is often the case during M&A due diligence. Trade secrets are protected under common (i.e., judge-made) law until such time as they are no longer trade secrets. That means that restrictions on disclosure of trade secrets of indefinite or perpetual duration are more likely to be enforced so long as the owner continues to take reasonable efforts to maintain the information’s secrecy. If, in contrast, a company discloses information to a third party using an NDA with confidentiality obligations that expire, then the information will under most circumstances cease to be protectable as a trade secret after the restrictions lapse. Because receiving parties have no duty to maintain confidentiality after the specified time period, courts will not usually allow a company to claim that the information is a trade secret, even if the company is suing an unrelated party for misappropriation of the information.

Lastly, as mentioned above, receiving parties who negotiate exceptions to “return or destroy” provisions should be prepared to maintain confidentiality restrictions on retained Confidential Information for a longer period of time than the baseline survival period applicable to other information covered by the NDA.

Taking all of these considerations together, then, a well-written confidentiality agreement should contain a specified period of confidentiality (or its equivalent, a contract termination provision that identifies certain provisions that will survive termination of the agreement) that applies a longer, and perhaps indefinite, period of confidentiality to trade secrets and Confidential Information that is not returned or destroyed upon termination of discussions regarding the applicable deal.

How do I stop the other side from stealing my employees and clients?

Parties to potential M&A deals are frequently afforded a great deal of access to the other party’s personnel, vendors, suppliers and other commercial counterparties during the negotiation and due diligence process. Meanwhile, the companies are often direct competitors or participating in the same industry with overlapping business needs. They may therefore attempt to poach one another’s employees and commercial partners if the deal doesn’t close, or even if it does close, if the transaction involves a sale of a division or the parties otherwise remain independent post-closing.

To mitigate this risk, M&A sellers, and sometimes buyers, insert provisions into NDAs that prohibit the other party from soliciting their employees and commercial counterparties.  Here’s a typical example:

“The Receiving Party will not, and will cause its affiliates not to, for a period of __ years from the date hereof directly or indirectly (a) employ any individual who is as of the date hereof or at any time during such period an employee of the Disclosing Party or its subsidiaries; provided that the Receiving Party will not be prohibited from employing any such individual (i) whose employment with the Disclosing Party or its subsidiaries has been terminated by the Disclosing Party or its subsidiary, as applicable; or (ii) who responds to a general solicitation of employment through media advertisements not targeted specifically at any employees of the Disclosing Party or any of its subsidiaries; or (b) cause, induce or attempt to cause or induce any customer, strategic partner, supplier, distributor, landlord of, or others doing business with, the Disclosing Party or any of its affiliates to cease or reduce the extent of its business relationship with the Disclosing Party or its applicable affiliate or to deal with any of the Disclosing Party’s or its affiliates’ competitors.”

While such provisions may seem appropriate and perfectly reasonable from one perspective, there are also equally valid bases for resisting them, particularly where the transacting parties have large operations that may compete in a number of industries and geographic areas. It may be difficult, and sometimes practically impossible, to monitor every new employment decision or commercial relationship to ensure compliance with provisions like this, and companies rightly do not want to run the risk of unknowingly incurring liability for breach. This problem is compounded for large companies that may be asked to sign multiple non-solicitation provisions like these.

What is a standstill provision?

In M&A deals involving target companies with publicly-traded shares, targets will usually refuse to offer due diligence to any potential buyer that may attempt a hostile acquisition (an acquisition without the consent of the target’s board of directors) or engage in other coercive activities. Otherwise, targets may not only be increasing the likelihood of a hostile bid or destabilization campaign but also its chances for success. Consequently, public company targets typically insert standstill provisions into M&A confidentiality agreements. These clauses restrict the potential buyer from acquiring additional target company shares, participating in a proxy contest, launching a tender offer or taking any coercive actions.

Here’s an example standstill provision:

“For a period of ___ [years] [months] from the date of this Agreement, neither you nor any of your Representatives or affiliates will in any manner, directly or indirectly, without the prior written consent of the Company or its board of directors:

(a) acquire, offer to acquire, or agree to acquire, directly or indirectly, by purchase or otherwise, any [voting] securities or direct or indirect rights or options to acquire any voting securities of the Company or any of its subsidiaries, or of any successor to or Person in control of the Company, or any assets of the Company or of its divisions or of any such successor or controlling Person;

(b) make, or in any way participate, directly or indirectly, in any, “solicitation” of “proxies” (as such terms are used in the rules of the United States Securities and Exchange Commission), or advise or seek to influence any Person with respect to the voting of any voting securities of the Company or any of its subsidiaries;

(c) make any public announcement with respect to, or submit a proposal for, or offer of (with or without conditions) any tender or exchange offer, merger, recapitalization, reorganization, business combination or other extraordinary transaction involving the Company or any of its subsidiaries or any of their securities or assets;

(d) form, join or in any way participate in a “group” as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended, in connection with any of the foregoing;

(e) otherwise act, alone or in concert with others (including, without limitation, by providing financing to another party), to seek or offer to control or influence the management, board of directors, policies or affairs of the Company;

(f) advise, assist or encourage any other Persons in connection with any of the foregoing; or

(g) request the Company or any of its Representatives, directly or indirectly, to amend or waive any provision of this paragraph.

You will promptly advise the Company of any inquiry or proposal made to you with respect to any of the foregoing.”

Some bidders will argue that the target does not require a standstill provision because the confidentiality obligations contained in the confidentiality agreement provide it with sufficient protection. Target companies are likely to reject this argument because, if there is no standstill provision and the bidder makes a hostile bid, then the target may have difficulty proving that the bidder has used the target’s information in violation of the confidentiality agreement. It would be easier for the target to prove that the bidder has violated a standstill provision.

Target companies should be mindful that the standstill provision should not be used to favor one bidder over another improperly when Revlon duties requiring maximization of shareholder value have been triggered.

*               *               *