What are the most important terms in NDAs?

Takeaway: Some of the key terms of NDAs are the definition of confidential information, the purpose, the obligations of the receiving party, the term, the exceptions to the confidentiality requirement, the remedies in the event of an unauthorized disclosure, the jurisdiction for disputes, and the residuals clause.

As a startup founder, protecting your business idea, intellectual property (IP), and trade secrets is crucial. One of the tools used to achieve this is a Non-Disclosure Agreement (NDA). NDAs are legal contracts that establish a confidential relationship between your startup and a third party, compelling them to keep certain information confidential. Here are the most important terms you should understand when drafting or signing an NDA.

Definition of Confidential Information

The NDA should clearly define what constitutes “confidential information”. This might include trade secrets, software, customer lists, marketing plans, financial data, or other proprietary information. Be careful to balance the need for broad protection with the practicality of not overreaching, as too broad a definition can make the NDA difficult to enforce.

Purpose

The NDA should state why the receiving party is being given access to the confidential information. This is known as the “purpose” clause. It is important that the purpose is clearly defined and limited to what is necessary. The more specific you are about the purpose, the better protected you are. Conversely, the broader the definition of purpose, the more expansive the permitted use of the confidential information is.

Obligations of the Receiving Party

This section of the NDA outlines what the receiving party can and cannot do with the confidential information. Typically, the NDA will prohibit the receiving party from disclosing the information to others and limit the use of the information to the agreed purpose. NDAs may also provide that the receiving party is liable for unauthorized disclosures by any of its representatives (e.g. its employees and consultants).

Term

The term of the NDA determines how long the agreement will last. After the term ends, the receiving party is no longer obligated to keep the information confidential. For technology startups, terms are commonly 3-5 years on the basis that the industry evolves quickly and, in most cases, the technology will likely be less proprietary after that period. However, startups are sometimes able to require the receiving party to maintain the confidentiality of the information indefinitely - this is particularly true for technical trade secrets.

Exceptions

Most NDAs include exceptions to the confidentiality obligations. Common exceptions include information that was already known to the receiving party, information that becomes publicly known through no fault of the receiving party, and information that the receiving party legally (i.e. without a confidentiality obligation) received from a third party.

Remedies

This clause outlines the consequences if the NDA is breached. It often includes the right to seek injunctive relief (a court order to stop the use or disclosure of the information) and monetary damages. A more favorable term for startups is that instead of being permitted to seek injunctive relief, such injunctive relief is automatically applied upon a breach of the NDA. This essentially says that if the receiving party improperly discloses confidential information, it is under an immediate obligation to stop doing so. In practice, the receiving party should stop immediately anyway but this clause strengthens the startup’s case should a court review the facts.

Jurisdiction

The jurisdiction clause determines the state's laws that will be used to interpret the NDA and where any legal disputes will be resolved. Delaware, California, and New York are commonly preferred jurisdictions because there is general familiarity with their intellectual property laws. Other states and foreign countries may have intellectual property laws and if the NDA is governed by such a jurisdiction, it is prudent to have a lawyer familiar with those laws review the NDA.

Residuals

Residuals clauses are exceptions to confidentiality obligations in NDAs. They stipulate that the recipient party is free to use information retained in the unaided memories of its representatives who have had access to the startup’s confidential information. This clause presents a risk for the startup, as it creates a loophole where confidential information could potentially be used without restriction, so long as it's 'remembered' and not documented. For that reason, startups should always remove any residuals provisions from their NDAs.

Conclusion

NDAs can be an effective tool to protect a startup’s intellectual property. Some of the key terms of NDAs are the definition of confidential information, the purpose, the obligations of the receiving party, the term, the exceptions to the confidentiality requirement, the remedies in the event of an unauthorized disclosure, the jurisdiction for disputes, and the residuals clause.