The Achilles Heel of NonDisclosure Agreements

The Achilles Heel of NonDisclosure Agreements

Having represented many clients with selling their businesses, raising capital, or entering into joint ventures, the issue of Non-Disclosure Agreements (“NDA”) always arises. The primary focus of clients is on ensuring that the NDA is as secure as possible and often such that no reasonable party would agree to it. Thus, I find my job is to help them understand what is commercially reasonable, and more importantly, to work with them to understand who is the other party executing the NDA.

Most sales of small companies these days in the US are to Private Equity Groups, and so many people become complacent about understanding who the other party is. If the other party is not someone that is known, far more work needs to be done to understand:

  • Who is the other party is;

  • Where are they located;

  • What you each have; and

  • How much you share.

Failure to do this potentially exposes you to the “Achilles Heel” of the NDA.

First of all, if there is a breach of the NDA, most NDAs allow for injunctive relief, which is obtainable in the US, so damage within the US may be limited. However, if you want more than injunctive relief in the US, the areas of concerns are:

 

Who?

Who is the company? A Fortune 500 Company, some sizeable foreign company that you have never heard of, but there is information on or some company that for which there is no information? Many people don’t look at who is executing the agreement if they believe the person they are dealing with is with XYZ Corporation that they know.

However, if the entity executing the NDA is a single purpose subsidiary of XYZ, does it have any capital? Is XYZ a party to the transaction? Finally, there are cases in some developing markets, especially China, where government entities own many companies, i.e., the People’s Liberation Army owns many Chinese businesses, and thus for all practical purposes, these are immune from any claims.

Recently I came across a situation where ABC, a US company, found that their confidential information was being used against them by Z, a subsidiary of Company Y in China. ABC had executed an NDA with X, a Singaporean special purpose subsidiary of Y with no assets. Also, there was a Letter of Intent with T, a US subsidiary of Y, which also had no assets. As a result, there were no identifiable assets to go against, and to win in China would be hard.

 

Where?

If the NDA is with a non-US company, you may have issues in bringing a claim. While the NDA may provide that the venue and choice of law are your home state, the other party has to be served and appeared in federal or that state’s court. If the other party is not in the US, it may be challenging to serve even them because they may not exist, or the address/agent provided doesn’t exist. If you can’t serve them, a proceeding may be complicated.

Assuming you serve them, and they fail to appear, you should win in court. However, even if you do, you may not be able to enforce any claims because their courts will not recognize the US court’s decision. In some countries I have dealt with, judges have not recognized contractual agreements because “times have changed.” Not all countries have a judicial system like ours with precedent and some predictability.

Even if governmental agencies don’t own these companies, in some countries, if well-connected business people and politicians do, that may have the same result. Bringing any claims against a company owned by such a businessman or politician may result in you, your company, or employees being harassed or imprisoned on some charge in these countries, i.e., China and Russia.

 

How Much Has Each Party?

1. What Assets do They Have?

If it is a single purpose entity with no assets, even if you bring the claim and win, there are no assets to pay monetary damages. Injunctive relief is all you have. That may not fix any damage done to your brand or pay for all the litigation. Even if they have assets, if there are superior claims on those assets, i.e., bank liens, that can rank above your claim, you could win but still receive no monetary damages.

Finally, if they are a large company with deep pockets, they may fight you in court with a full army of in-house and third-party lawyers. Besides, even if they lose, they may be willing to fight through many appeals. The purpose is to wear down a smaller company just by having more resources.

2.  What Assets do You Have?

While many client’s businesses are profitable and have value, the company may not have the financial wherewithal to fund litigation, especially international litigation. To fight a company in the US that is determined to protect its image on an NDA could cost $0.5MM and more. Many small companies don’t have that amount of excess cash to put towards litigation. Besides, not only is there the cost of the lawsuit but the disruption to the business. Discovery, depositions, etc. can absorb large amounts of time and resources from a small company causing it to lose its way or position and thus value.

3.  What Loss have You Experienced?

Raising this issue causes an angry response from many clients? The value of the business, which they may think, is very high, has now suffered a loss in value. As with all litigation, you must demonstrate the damage. If there is a $XMM offer from a buyer who immediately reduces the offer to $YMM quickly on finding out about the breach, then the loss is $(X – Y)MM. However, in all other situations proving the quantum of the damage is much more complicated. Experts are required to determine your loss, which also increases the costs of litigation. The other side will also have their experts to prove no loss in value and show where your experts are wrong. Finally, the winner and amount of the win are never guaranteed when walking into a court, no matter what you think.

 

How Much Information Do You Share

While you are going to discuss your business, the products, customers, and opportunities, I think it is advisable to be economical with some of that information. Give the other party enough for them to make a decision and be interested. However, many owners are so proud and excited about their business, with good reason; they cannot help themselves from disclosing how they do everything. While some of this information may be a trade secret, it may not have been protected as such or may be more difficult to claim such in litigation. If the other party knows how you do everything, they may decide they can duplicate your business using your processes but not using your technology or approaching your customers. They do this; it may be much hard to identify and protect.

Thus, be careful with your NDAs by knowing:

  • Who you are dealing with;

  • Where are they located;

  • What they have;

  • Know what you can do if they breach; and

  • Let your advisor help you control the information flow.

 

© 2015 Marc Borrelli All Rights Reserved

Recent Posts

Do You Truly Know Your Core Customer?

Do You Truly Know Your Core Customer?

Knowing the profit of your core customers is key to building a growth model. Many companies have identified core customers that are generating a sub-optimal profit and so they cannot realize the profits they seek. Identifying the correct core customer allows you to generate profits and often operate in “Blue Ocean.”

The Greatest Own Goal or the Greatest Collapse

The Greatest Own Goal or the Greatest Collapse

The European Super League collapsed within days of launch due to hubris and the founder forgetting the key parts of their business model, value creation, sales, and value delivery. The collapse might bring a high price.

Does Your Financial Model Drive Growth?

Does Your Financial Model Drive Growth?

Working with many companies looking to grow, I am always surprised how many have not built a financial model that drives growth. I have mentioned before a financial model that drives growth? Here I am basing on Jim Collin's Profit/X, which he laid out in Good to...

COVID = Caught Inside

COVID = Caught Inside

As we emerge from COVID, the current employment environment makes me think of a surfing concept: “Being Caught Inside When a Big Set Comes Through.” Basically, the phrase refers to when you paddle like crazy to escape the crash of one wave, only to find that the next wave in the set is even bigger—and you’re exhausted. 2020 was the first wave, leaving us tired and low. But looking forward, there are major challenges looming on the horizon as business picks up in 2021. You are already asking a lot of your employees, who are working flat out and dealing with stress until you are able to hire more. But everyone is looking for employees right now, and hiring and retention for your organization is growing more difficult.

Why is there not MORE common sense

Why is there not MORE common sense

“Why don’t they use common sense?!” You may have said this phrase yourself, or heard it with your managers, when discussing an employee’s actions. However, the frustrated appeal to “common sense” doesn’t actually make any meaningful change in your organization. We all make decisions based on the information we have and the guides we have to use. So if the wrong decisions are being made in your organization, it’s time to examine the tools you give decision-makers.

Do You Understand Your Costs to Ensure Profitability?

Do You Understand Your Costs to Ensure Profitability?

You can only determine profitability when you know your costs. I’ve discussed before that you should price according to value, not hours. However, you still need to know your costs to understand the minimum pricing and how it is performing. Do you consider each jobs’ profitability when you price new jobs? Do you know what you should be charging to ensure you hit your profit targets? These discussions about a company’s profitability, and what measure drives profit, are critical for your organization.

Sunk Costs Are Just That, Sunk!

Sunk Costs Are Just That, Sunk!

If you were starting your business today, what would you do differently? This thought-provoking question is a valuable exercise, especially when it brings up the idea of “sunk costs” and how they limit us. A sunk cost is a payment or investment that has already been made. Since it is unrecoverable no matter what, a sunk cost shouldn’t be factored into any future decisions. However, we’re all familiar with the sunk cost fallacy: behavior driven by a past expenditure that isn’t recoupable, regardless of future actions.

Do You REALLY Know Your Business Model?

Do You REALLY Know Your Business Model?

Bringing clarity to your organization is a common theme on The Disruption! blog. Defining your business model is a worthwhile exercise for any leadership team. But how do you even begin to bring clarity into your operations? If you’re looking for a place to start, Josh Kaufman’s “Five Parts of Every Business” offers an excellent framework. Kaufman defines five parts of every business model that all flow into the next, breaking it down into Value Creation, Marketing, Sales, Value Delivery, and Finance.