A poorly designed confidentiality agreement can badly damage a company. Xu Yehong, a legal director at Nuctech, identifies seven key issues in-house counsel should focus on when reviewing such agreements
To protect confidential information on products and technologies, many companies incorporate confidentiality clauses into contracts with third parties, such as contract design or development agreements, contract manufacturing agreements, sales contracts, maintenance service contracts and equipment lease contracts. These confidentiality clauses play a crucial role during contract performance.
Sometimes parties need to exchange confidential information before deciding whether to proceed with the co-operation and execute a formal contract. Alternatively, both parties may value confidentiality so highly that they sign a separate confidentiality agreement in addition to the formal contract. This situation gives rise to a document such as a confidentiality agreement.
As the first line of defence in protecting a company’s competitiveness. A confidentiality agreement is not only a legal document but also a vital carrier of commercial strategy
Xu Yehong
LEGAL DIRECTOR
NUCTECH
In-house counsel must ensure the company’s interests are protected without unduly restricting normal business exchanges, and that breach provisions are enforceable to build a robust commercial security barrier for the company.
Unilateral v bilateral agreements
Confidentiality agreements are typically executed before the disclosing party provides confidential information to the recipient. When only one party discloses and the other only receives it, a unilateral confidentiality agreement suffices. In most cases, both parties disclose and receive confidential information as part of their co-operation. In such situations, a bilateral confidentiality agreement should be executed.
Scope of confidentiality
In a confidentiality agreement, the parties first need to specify which information constitutes confidential information. Some companies provide extensive product and technical information during co-operation and seek to define the scope of confidential information more broadly to protect their interests. In such a case, the author advises that confidential information includes, but is not limited to, trade secrets.
A trade secret is defined in the Anti-Unfair Competition Law as commercial information, such as technical or business information, that is not publicly known (secret), is commercially valuable (value), and has been subjected to appropriate confidentiality measures by the rights holder (confidential).
It mainly includes:
- Technical information. Non-patented technologies meeting the definition of trade secrets, such as production formulas, process flows, technical know-how and design drawings; and
- Business information. Information relating to business operations and management that meets the definition of trade secrets, such as development plans, production and sales strategies, customer lists, sourcing intelligence, bid proposals and floor prices.
Some companies, as the disclosing party, wish to broaden the definition of confidential information.
The following wording is recommended:
“For the purposes of this Confidentiality Agreement, the term ‘Confidential Information’ means any information or data provided by either party to the other in any form, relating to the objectives of the co-operation hereunder, including but not limited to any business, operational, product, customer, commercial or technical information and data in any format, along with any copies, summaries or excerpts thereof, including any information or data contained within modules, prototypes, samples, models or components that may be provided, regardless of whether such information is marked with such terms as ‘Confidential’, ‘Secret’ or other similar designation, and regardless of whether such information constitutes the final outcome of negotiations or discussions.”
Exclusions
The scope of confidential information is broadly defined. Some business personnel may ask: Does this mean all information disclosed by the parties during performance of the agreement constitutes confidential information? The answer is no.
The confidentiality agreement must explicitly provide that the recipient is exempt from confidentiality obligations if these circumstances apply:
- The recipient can show that the information was publicly available when disclosed by the disclosing party, or that it entered the public domain after disclosure without breach of the agreement by the recipient;
- The recipient can provide written evidence to the disclosing party showing it lawfully possessed the information prior to disclosure;
- Information where disclosure is consented to in writing by the disclosing party;
- Information independently developed by the recipient without reference to the disclosing party’s confidential information; and
- Any information required to be disclosed by law.
Obligated entities
Although confidentiality agreements are executed by the legal person entities of the parties, the actual performance rests with the specific handling officers. Accordingly, the entities bearing confidentiality obligations are not solely limited to the legal persons (i.e. the companies) that execute the agreement, but also include all natural persons representing the parties in the co-operation project, such as the sales personnel who execute the agreement and the R&D personnel who perform the agreement. A confidentiality agreement will typically provide as follows:
“The recipient of confidential information shall ensure that all personnel who have access to such information have executed separate confidentiality agreements with the recipient, warranting that they bear the same confidentiality obligations hereunder as the recipient. Such personnel may not use the confidential information for purposes outside the co-operation project nor use it to harm the interests of the disclosing party. In the event of a breach, the recipient shall bear liability for breach of contract.”
Obligations of information recipient
A confidentiality agreement should expressly specify the information recipient’s obligations to the disclosing party. The author recommends the following wording:
“The parties agree that the purpose of disclosing confidential information is to facilitate co-operation between the parties in the (name) business/project, accordingly, the use of confidential information provided hereunder shall be strictly limited to that purpose. Without the prior written consent of the disclosing party, the recipient may not use such confidential information for any other objective or purpose. Except for employees of the recipient who need to know or have access to the confidential information and who have executed confidentiality agreements with the recipient, the recipient may not, at any time or in any manner (directly or indirectly), disclose the confidential information to any other individual, legal person, social organisation or other entity without the prior express written consent of the disclosing party.”
It should be noted that the business or project specified in the above blank should be comprehensive, clear and unambiguous to avoid any misunderstanding.
Term of confidentiality
The term of confidentiality should be clearly specified depending on the nature and characteristics of the confidential information and the actual circumstances of the co-operation project. It is typically categorised as short term (one to three years), medium term (four to six years), or long term (seven to 10 years). The author recommends the following wording:
“If, after the execution hereof, the parties fail to execute a co-operation agreement, the term of confidentiality shall be effective for (agreed number) years from the date of execution hereof; if the parties execute a co-operation agreement, the term of confidentiality shall be effective for (agreed number) years after the expiration or termination of the co-operation agreement.”
This formulation offers flexibility by linking the term of validity of the confidentiality agreement to that of the co-operation agreement, obviating the need to renew the agreement if the co-operation agreement is not fully performed.
However, the above-mentioned wording uses “co-operation agreement” as an example; actual business scenarios may involve other contracts or agreements, such as commissioned design contracts or consulting service contracts.
For critical trade secrets, the parties may agree on perpetual validity of the confidentiality obligation, e.g.: “Once this Confidentiality Agreement is executed by the parties, the recipient’s confidentiality obligations shall remain in effect indefinitely.”
Damages
If the information recipient breaches its confidentiality obligations, it is liable to the disclosing party for damages. The agreement must explicitly provide for this. The following wording is recommended:
“If the information recipient, or a current or former employee or representative thereof, uses or discloses any confidential information without authorisation, the recipient shall fully compensate the disclosing party for all losses, damages and expenses incurred as a result thereof, such losses, damages and expenses including but not limited to loss of profits, loss of rights, reduction in market share, litigation expenses, arbitration fees and reasonable investigation expenses, appraisal fees, attorney’s fees, etc.”
