Using Nondisclosure Agreements to Protect Business Trade Secrets

Businesses often maintain valuable and confidential information. This information might include a sales plan, a list of customers, a manufacturing process, or a formula for a soft drink. These are referred to as "trade secrets." One of the dangers that businesses face is that employees may take trade secrets they learn on the job and leave for a competitor company.

Nondisclosure agreements ("NDAs") are one of the most effective ways to prevent this from happening. An NDA is a contract in which the employee promises to protect the confidentiality of secret information that is disclosed during employment or related types of business transactions. By using a nondisclosure agreement, an employer can ensure that its secrets stay secret by giving the company legal recourse against an employee who wrongfully discloses them.

Examples of NDA Usage

NDAs are used in essentially every industry. They are particularly common in the technology industry, particularly for Internet and computer companies.

Consider, for example, Sabeer Bhatia, founder of Hotmail, who collected over 400 NDAs from employees, friends, and roommates. He believes that his secrecy efforts gave him a crucial six-month lead on the competition. He eventually sold Hotmail to Microsoft for a reported $400 million in stock.

NDAs can also be used when presenting confidential information is a limited context, such as a meeting with a potential suitor of your company. You can force meeting participants to sign an NDA in connection with any documents or data disclosed during the meeting, so that you can feel confident that you can speak honestly.

If you have an NDA with someone who discloses your secret without authorization, you can ask a court to order the violator to stop making any further disclosures. You can also sue for consequential damages.

Creating a Confidential Relationship

The purpose of an NDA is to create a confidential relationship between the person who has a trade secret and the person to whom the secret is disclosed. People who have such a confidential relationship are legally bound to keep the information a secret.

An NDA is not the only way to create a confidential relationship, however. You can create a confidential relationship with an oral agreement or it can be implied from the conduct of the parties. However, such relationships are much more difficult to prove than a relationship based on a written agreement.

NDAs are often categorized as either "mutual" or "one-way." A mutual NDA is one in which both parties are exchanging confidential information—for example, you provide secret information for a company to evaluate and they provide you with secret information about their marketing strategy. A one-way agreement is used when only one party is making a disclosure—for example, when you explain your secret to a contractor or investor.

To protect the valuable trade secrets of your business, get Nolo's downloadable Nondisclosure Agreement.

Protect Trade Secrets

Use of a nondisclosure agreement is one of the most effective ways to protect trade secrets—that is, any information that is not generally known and gives your business a competitive advantage in the marketplace. For example, through a nondisclosure agreement, you can prohibit someone from disclosing a secret invention design, an idea for a new website, or confidential material contained in a copyrighted software program.

When attempting to sue for breach of an NDA, you will also want to show evidence that you otherwise work to protect your business's secret information. What security measures, beyond NDAs, do you employ? Software that provides digital security, for example, would be one way to establish that your business takes all necessary precautions.

To learn more about the essentials of trade secret law, including what you can protect, see Trade Secret Basics FAQ. Note that trade secret laws vary from state to state, although the overall concepts are very similar across the United States.

Elements of a Nondisclosure Agreement

There are five important elements in a nondisclosure agreement:

• definition of confidential information
• exclusions from confidential information
• obligations of receiving party
• time periods, and
• miscellaneous provisions.

Definition of Confidential Information

Every NDA provides a list of the types or categories of confidential information to be protected in the agreement. The purpose is to establish the boundaries, or subject matter, of the disclosure, without actually disclosing the secrets. For example, an NDA may state: "Confidential information includes programming code, financial information, related software materials, and innovative processes."

If you fail to list specific categories of information, a court may deem that the agreement is overly broad, and thus unenforceable.

Exclusions From Confidential Information

Similarly, most NDAs exclude some information from protection, meaning that the party that receives the excluded information has no obligation to protect it. These exceptions are based on established principles of law—the most important one being that information is not protected if it was created or discovered by the receiving party prior to (or independent of) any involvement with the disclosing party. For example, if another company develops an invention with similar trade secret information before being exposed to the disclosing party's secrets, then that company is still free to use its independently created invention.

Obligations of the Receiving Party

A nondisclosure agreement will typically state that the receiving party must hold and maintain the information in confidence and limit its use. Under most state laws, the receiving party cannot breach the confidential relationship, induce others to breach it, or induce others to acquire the secret by improper means.

Most businesses will accept these contract obligations without discussion.

Time Periods

Some agreements require that the receiving party maintain the secret information for a limited period of years. This is often done with language such as: "The receiving party shall not use or disclose the secret for a period of five years from the date of execution of the agreement."

Parties often negotiate over the time period. Five years is common in American nondisclosure agreements, although many companies insist on only two or three years. In European nondisclosure agreements, it is not unusual for the period to be as long as ten years. Ultimately, the length used will depend on the relative bargaining power of the parties. Note that, generally, an overly lengthy period may be found to be unreasonable in certain situations. The shorter the period of nondisclosure, the more likely a court will enforce it.

Miscellaneous Provisions

Miscellaneous terms (sometimes known as "boilerplate") are usually included at the end of NDAs. They include such matters as:

• which state's law will apply in the event the agreement is breached
• whether arbitration will be used in the event of a dispute, or
• whether attorneys' fees will be awarded to the prevailing party in a dispute.

Next Step

Get Nolo's online Confidentiality (Nondisclosure) Agreement. You can customize this agreement according to the detailed instructions that are included.