NDAs: the Good, the Bad, and the Ugly

Recently, a client came to me seeking to start a new small business.  She was transitioning from a job she had held in an industry she knew well, and her new business would fill a need in that industry that would continue to become more imperative over the next few years.  By nature, this client admittedly was not much of a risk-taker and planned to work in the business with no specific exit strategy.

Among the other things, her big concern was how to protect her new business concept from potential competitors in the industry during start-up, as she began marketing the idea or trying to raise money.  She sheepishly admitted having told a few, trusted colleagues about her idea in order to begin tentative market research about its viability.  But now she was concerned one of them or someone they told might take her idea and get it to market before her.  Specifically, she was considering using an non-disclosure agreement or NDA with people to whom she was pitching her new service.

An NDA is usually provided when parties have a business need to share confidential or non-obvious information that, if learned by others, could be damaging to the disclosing party(ies).  NDAs must be signed in advance of the disclosure of the otherwise secret information.

For example, an NDA may be sought by a product inventor who needs to disclose a secret formula to a contract manufacturer.  The NDA would then give the inventor the contractually-granted right to sue that manufacturer if it or someone else who learned the formula from the manufacturer begins marketing a competing product using the inventor’s proprietary formula.  The manufacturer may sign a reasonable NDA in order to learn the formula so it can prepare a bid for the job and, if successful, to undertake production.

The question of whether and when to use an NDA, however, falls in that weird space between law and business consulting in which I occasionally find my clients stymied for sound advice.  And truthfully, in this space, good business practice and sound legal strategy may sometimes be at odds with each other.

That being said, here’s a rule of thumb I developed to help clients decide when contracts like NDA, non-competition, etc., are best used:  When you are disclosing you general business concept, do not use an NDA.

Why? Because there are a million and one great ideas out there, and believe me, the idea is only the beginning. To raise money, attract strategic partners, find a market, and sell to something takes way, way more than just an great idea. It takes stellar execution of that idea.

When you are disclosing confidential trade information such as a patentable idea, client identities or client lists, vendor information, upcoming strategic alliance information, or proprietary methodologies, however, an NDA likely would be appropriate.  I say, “likely,” because the question can be pretty fact specific and there may be exceptions in the instance you are addressing. Probably time to ask your attorney to take a look at the situation with you.

* N.B., you need never use an NDA with advisors you hire which have a legal or ethical obligation to keep your information confidential, such as attorneys or CPAs.  There are statutory remedies you can use should they disclose your information.  Be sure to ask.

As a practical matter, then, if the person you are speaking to is that dangerous type with ability to execute yours or anyone else’s unique concept, more than likely s/he is probably busy successfully working on a few of his/her own.  They will have little inclination to sign an NDA, when they have nothing to gain from the relationship, but you may wish to speak to them for advice or even to explore possible partnership or investment.  Any other type of person probably isn’t interested in starting a new business and/or doesn’t have the ability to do so.

The last thing I explain to my business clients about NDAs is that they are only as helpful as you are well-funded enough to sue the information recipient in the event of a breach.  Your NDA should have some language agreeing in advance that the court may issue an injunction barring the recipient’s further disclosure.  And as with any contract dispute, however, the recipient’s lack of money with which to pay damages may diminish the effectiveness of the NDA in protecting your information.  So try to deal with solvent people.

For information on when a patentable idea must be protected (and not disclosed) prior to filing, please consult with an intellectual property attorney or patent attorney.  This site may also be helpful: USPTO.gov, General Information About Patents.


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