Points to Keep in Mind When Drafting an NDA (Non-Disclosure Agreement)

When starting a new business relationship with a business partner, you’ll exchange confidential information, right? However, if you haven’t signed a confidentiality agreement in advance regarding that confidential information, it could be used for purposes other than intended or disclosed or leaked to third parties. Furthermore, if confidential information is leaked, it could result in financial losses for the company. To prevent such situations, companies enter into an NDA (Non-Disclosure Agreement) before exchanging confidential information with new business partners. In this article, I’d like to outline some key points to keep in mind when entering into an NDA.

Definition of Confidential Information

How “Confidential Information” is defined is extremely important. If the scope of confidential information is broadened, it benefits the disclosing party; if it is narrowed, it benefits the receiving party. For example, if confidential information is defined as the disclosing party’s “business, technical, and all other information,” the scope of confidential information becomes very broad. This benefits the disclosing party because the recipient must treat a greater volume of information as confidential; conversely, the recipient is at a disadvantage because they are subject to confidentiality obligations covering a larger volume of information. However, since this puts the recipient at a disadvantage, they will submit a counterproposal to narrow the scope of confidential information. For example, they might propose that, among “business, technical, and all other information,” information disclosed in writing must be explicitly marked as “confidential,” while information disclosed orally must be explicitly marked as “confidential” within ● days (e.g., 14 days, 30 days). In my experience, the terms often settle on something like this in the end.

Prohibition on Use for Unintended Purposes; Prohibition on Disclosure or Leakage to Third Parties

To ensure an NDA is effective, provisions prohibiting use for purposes other than those specified are crucial. While confidential information is generally not intended for external disclosure, parties often enter into NDAs and provide such information to the other party for purposes such as exploring business partnerships or service usage. Since the confidential information is disclosed solely for these purposes, the recipient must not use it for any other purpose. The prohibition on use for purposes other than those specified is the provision that governs this. Furthermore, even if confidential information is used for the intended purpose, it would be problematic for the disclosing party if it were disclosed or leaked to a third party completely unrelated to the recipient. Therefore, provisions prohibiting disclosure or leakage to third parties are also very important. It is common practice to specify that this definition of “third party” excludes the disclosing party’s own officers, employees, and those subject to a legal duty of confidentiality—such as attorneys and tax accountants—who need to know the confidential information in order to carry out the intended purpose.

Confidentiality Period

No matter how well confidentiality obligations are stipulated in a contract, they will be effectively meaningless if the confidentiality period is too short. From the perspective of the disclosing party, it would be preferable to set the duration of the contract to three years—with automatic renewal every year thereafter—effectively making it perpetual. However, from the perspective of the receiving party, a perpetual confidentiality period places a significant burden on them; therefore, in the example above, the receiving party often proposes an amendment such as a three-year duration of this contract, with the confidentiality provisions remaining in effect for three years following the termination of the contract.

Return and Destruction of Confidential Information

It is common practice to stipulate that, upon request by the disclosing party, or upon the expiration of the duration of the contract, or upon termination or cancellation of the contract, the recipient must either return the confidential information to the disclosing party or destroy it. From the disclosing party’s perspective, there may be cases where they wish to receive a certificate of destruction if the recipient destroys the confidential information rather than returning it; therefore, provisions may be included stating that the disclosing party may request such a certificate. Furthermore, from the recipient’s perspective, there may be instances where a legal obligation to retain the confidential information arises due to laws, regulations, or other requirements; in such cases, the recipient may propose an amendment stating, “This provision shall not apply if a legal obligation to retain the information arises due to laws, regulations, or other requirements.”

Rights regarding Confidential Information

It is necessary to explicitly state that all rights regarding confidential information (including intellectual property rights) remain with the disclosing party even if the information is disclosed, and that no rights are granted to the receiving party. Confidential information is disclosed solely for the specified purpose (such as a business partnership or the provision of services) and does not confer any rights—including intellectual property rights—on the receiving party; this provision serves to clarify that fact.

Injunctions

In the event that the recipient of information breaches the contract—for example, by using the information for purposes other than those specified or by disclosing it to a third party—monetary damages may be insufficient to provide adequate compensation. Therefore, it is important for the disclosing party to stipulate in the contract that it may seek a temporary or permanent injunction or an order for specific performance against the recipient.

Damages

This provision ensures that the disclosing party can seek damages from the receiving party in the event of a breach of contract, such as the receiving party using the information for purposes other than those intended or disclosing the information to a third party. A common point of legal dispute here is the scope of “damages.” From the disclosing party’s perspective, a broader scope of damages results in a higher compensation amount; therefore, they would prefer to define the scope broadly to include “settlement costs, attorneys’ fees, litigation costs, and all other reasonable expenses arising from the breach of contract.” Conversely, since the recipient of the information is highly likely to face a claim for damages, they will want to narrow the scope of damages by stating, for example, that “the responsible party shall not be liable for incidental, consequential, indirect, or special damages, including but not limited to lost profits and punitive damages.”

Governing Law and Jurisdiction

If both parties entering into the contract are corporations (or individuals) located in California, the governing law may be California law, and the jurisdiction may be designated as state or federal courts in California; however, if the other party is a corporation (or individual) located in another state, disputes may arise regarding which state’s law and jurisdiction should apply. In such cases, depending on the balance of power with the other party, if your position is advantageous, you will likely be able to designate your own state; conversely, if the other party’s position is advantageous, you may have no choice but to designate their state. If the parties are on equal footing, selecting a neutral third state is also an option.

Attorney Profile

Attorney in Charge: Tomoharu Ogawa has experience as a former outside director of a publicly traded company and has been involved in four IPOs in Japan and the U.S. (the former TSE Second Section, the former TSE Mothers, TSE Growth, and NASDAQ). Drawing on approximately 18 years of experience in corporate legal affairs at publicly traded companies, he provides support tailored to the practical standards required of growing companies and those preparing for an IPO. Consultations are available in Japanese.

Contact

Tomoharu Ogawa, California Attorney at Law

Tom Ogawa Law Corporation

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