CHAPTER 6 CONFIDENTIALITY AGREEMENTS AND DUE DILIGENCE

• Jurisdiction: United States

Due Diligence in Mining and Oil & Gas Transactions
(Apr 2010)
CHAPTER 6
CONFIDENTIALITY AGREEMENTS AND DUE DILIGENCE
Margaret L. Meister
Daniel M. Alsup
Modrall, Sperling, Roehl, Harris & Sisk, P.A.
Albuquerque, New Mexico

MARGARET L. MEISTER is a Shareholder at Modrall, Sperling, Roehl, Harris & Sisk, P.A. in Albuquerque. She serves as the Chair of the Renewable Energy Service Group for the Industry Service Groups, practices primarily in the areas of real estate, commercial transactions and banking. Her real estate practice includes counseling businesses on siting and re-locating facilities, completing sales and tax free exchanges, representing developers and home owners associations in land use issues, and negotiating and drafting leases. Related to banking, Meg represents lenders and borrowers in a variety of lending transactions, including asset-based and real property secured transactions. Meg advises companies doing business on Indian lands and negotiates and structures business transactions involving Indian tribes and Indian lands. Meg's business practice includes entity selection and formation, governance issues, and buying and selling businesses.

TABLE OF CONTENTS

I. Introduction

II. Key Terms in Confidentiality Agreements

A. Definition of Confidential Information

B. Exclusions from Definition of Confidential Information

C. The Recipient's Use of Information

D. Restrictions on Disclosure; Persons and Parties Bound by the Confidentiality Agreement

E. Enforcement and Remedies

F. Disposition of Information

G. General Provisions

H. Logistical Provisions

III. Uniform Trade Secrets Act

IV. Ethical Considerations

A. Scope of Representation and Authority of Client

B. Client's Confidential Information

C. The Organization as Client

D. Supervisory Obligation of Lawyers

E. Multijurisdictional Transactions

F. The Future of Ethics

V. Conclusion

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I. Introduction

In the due diligence context, the free flow of information is necessary to enable parties to a transaction to meaningfully evaluate whether to proceed. Confidentiality agreements provide the legal and logistical framework for this information exchange. In most transactions, information flows mainly from one party, the provider, to another, the recipient.¹ Much of the information disclosed will inevitably be confidential and/or proprietary. Confidentiality agreements can do many things, but on a basic level, a confidentiality agreement serves the provider by protecting the confidentiality and trade secret status of its information. For the recipient, a confidentiality agreement is necessary because without it, the provider may not be willing to share confidential and proprietary information.

Such agreements serve two fundamental purposes. They limit the use of information deemed confidential by a counterparty in a transaction, where often the counterparty may be a direct competitor or someone who could benefit economically from unfettered use of confidential information. Secondly, they prohibit the disclosure of information deemed confidential to other parties, which disclosure could defeat legal protections of such information and cause economic harm to the provider.

The tension between the interests of the provider and the recipient influence the form the confidentiality agreement ultimately takes. Most of the duties in a confidentiality agreement burden the recipient of information. Therefore it may seem logical that a recipient would desire a shorter, less comprehensive agreement than the provider desires. However, a recipient, in fact, benefits from the clarity provided from a well-drafted, comprehensive confidentiality agreement.² The most notable terms that should be included in a confidentiality agreement are:

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• a definition of confidential information;

• exclusions from the definition of confidential information;

• permitted uses of the information by the recipient;

• a description of parties and persons bound, particularly third parties such as consultants and lawyers engaged by the recipient;

• enforcement and remedies provisions;

• disposition of information and tangible items upon a decision by either party not to proceed;

• general terms, such as choice-of-law and integration clauses;

• terms outlining the logistical framework for disclosure and use of information.

In addition to the terms above, parties entering into confidentiality agreements for due diligence should keep several things in mind. First, both parties should be aware that information may be protected by common law or statutory regimes regardless of whether a confidentiality agreement is in place. For example, geological data can constitute a trade secret. The failure to safeguard the secrecy of the information by the provider can result in loss of trade secret status and resulting protections. The failure to safeguard the secrecy of the information by the recipient can result in liability. Second, lawyers must be aware of the ethical obligations involved in due diligence with particular emphasis on issues surrounding confidentiality agreements.

II. Key Terms in Confidentiality Agreements

A. Definition of Confidential Information

A key element in the confidentiality agreement is the definition of confidential information. One of the provider's primary goals in negotiating a confidentiality agreement is to maintain the economic or competitive value of its information by reducing the risk that the recipient will use the information to its own advantage, or to the disadvantage of the provider. Further, the provider should maintain its information's protected status as trade secrets, patents, or the like.³ Accordingly, the provider normally wants a broad, comprehensive definition of confidential information.

For example, confidential information could be defined to include "all information actually disclosed, whether before or after the execution of the agreement, whether tangible or intangible, and in whatever form or medium provided, as well as all information generated by the interested party or by its representatives that contains, reflects, or is derived from the provided

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information."⁴ The parties should use caution; however, as an overly broad confidentiality agreement could be at risk of not being enforced by a court.⁵ Further, just because the parties define something as a trade secret does not make it so.⁶ An agreement between private parties can work to safeguard confidential and proprietary information from disclosure by the parties to the agreement, but such an agreement cannot imbue information with the legal protection of trade secrets.

Many courts, as well as the Restatement of Unfair Competition, take the view that information cannot be protected from disclosure by agreement unless the information rises to the level of a trade secret.⁷ "A trade secret is any information that can be used in the operation of a business or other enterprise and that is sufficiently valuable and secret to afford an actual or potential economic advantage over others."⁸ Under the Restatement view, the "reasonableness of an agreement that merely prohibits the use or disclosure of particular information depends primarily upon whether the information protected by the agreement qualifies as a trade secret."⁹

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The parties to a confidentiality agreement should be aware of this potential limitation while negotiating the definition of confidential information.

Parties to a confidentiality agreement also should be aware that the agreement alone does not create a fiduciary relationship.¹⁰ Instead, to create a fiduciary relationship, there must be "a voluntary and conscious assumption or acceptance of the duties of a fiduciary."¹¹ A fiduciary has "a duty to act primarily for the benefit of another," and "is in a position to have and exercise, and does have and exercise influence over another."¹² Parties engaged in due diligence generally do not voluntarily and consciously assume the duties of a fiduciary. Providers and recipients alike should be aware of this limitation on the duties involved in execution of a confidentiality agreement. Conversely, parties to a confidentiality agreement should be aware that in certain instances the relationship developed during the course of a transaction can give rise to fiduciary duties, as where a possible joint venture is the purpose of the due diligence.¹³ For example, while "mineral leases generally do not create a fiduciary relationship between lessor and lessee" because "the relationship is purely contractual in nature," fiduciary relationships can arise where a joint venture is undertaken.¹⁴ Parties conducting due diligence must be aware of the limited nature of the duties confidentiality agreements are capable of creating, as well as the potential duties the law attaches to various relationships and transactions.

In light of these considerations, a provider should attempt to negotiate for a reasonably broad definition of "confidential information,"¹⁵ and to be thorough, should label specific information as proprietary and confidential.

B. Exclusions from Definition of Confidential Information

The party conducting due diligence bears the most potential liability with respect to the information disclosed.¹⁶ Accordingly, the recipient will want to limit the scope of information

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considered confidential under the agreement. This limitation can be accomplished through narrowing the definition of confidential information.

For instance, a recipient may not want to include all information provided by provider as confidential if provider and recipient have an existing relationship where non-confidential information is exchanged. In order to manage confidential information in such a context, a recipient may request that the provider mark documents intended to be confidential with a stamp. While such a procedure may not work in all...