How NDAs Work and Why They're Important

What Is a Non-Disclosure Agreement (NDA)?

To maintain a competitive advantage, businesses must keep working projects, innovative ideas, or exciting new products secret lest they fall into the hands of a competitor. Similarly, startup companies with a new and profitable idea can only succeed if what they are working on remains under wraps. A non-disclosure agreement, or NDA, is a legal document that keeps the lid on such sensitive information. These agreements may be referred to alternatively as confidentiality agreements (CA), confidentiality statements, or confidentiality clauses, within a larger legal document.

How Non-Disclosure Agreements (NDAs) Work

An NDA is typically put to use any time that confidential information is disclosed to potential investors, creditors, employees, advisors, clients, or suppliers—or any other stakeholders that need access to the company's confidential information.

Having confidentiality in writing and signed by all parties can lend trust to these sorts of negotiations and deter theft of intellectual property. The exact nature of the confidential information will be spelled out in the non-disclosure agreement. Some NDAs will bind a person to secrecy for an indefinite period of time so that at no point in time can the signer divulge the confidential information contained in the agreement. Without such a signed agreement, any information disclosed in trust can be used for malicious purposes or be made public accidentally.

The penalties for breaking an NDA are enumerated in the agreement and may include damages in the form of lost profits and business opportunities.

Uses of NDAs

Business owners often need to discuss proprietary or sensitive information with outside individuals. Sharing information is crucial when seeking investment, finding potential partners in a business venture, obtaining new clients, or hiring key employees. In order to protect the person or people with whom this information is shared, non-disclosure agreements have long been a legal framework to maintain trust and prevent crucial information from leaking out where it could undermine the profitability inherent to that content. Information that may require NDAs includes secret recipes, proprietary formulas, and manufacturing processes. Protected information also typically includes client or sales contact lists, non-public accounting figures, or any specific item that sets one company apart from another.

For example, a start-up company seeking to raise money from venture capitalists or other investors may fear that their good idea will be stolen in lieu of receiving an investment. Having a signed NDA helps deter such idea theft. Without one, it can be difficult to prove that an idea has been stolen.

A company hiring outside consultants may also require those individuals, who will be handling sensitive data, to sign an NDA so that they do not disclose those details at any point. Full-time employees may also be required to sign an NDA when working on new projects that haven't yet been made public, as the effects of information leakage could damage the value of the project and the company as a whole.

What's Not Included in an NDA

Of course, not all of a business’s dealings are meant to be kept confidential. Public records such as information filed with the SEC or the address of the company headquarters are not covered by an NDA.

Courts have leeway to interpret the scope of an NDA, depending on the language of the agreement. For instance, if one party to the agreement can prove they had knowledge covered in the NDA prior to its signing, or if they can prove they acquired the knowledge outside the agreement, they may be able to avoid a negative judgment. 

Moreover, not all knowledge is protected in an NDA. If the information is revealed due to a court-ordered subpoena, the aggrieved party may not have legal recourse.

Types of NDAs

The particular content of each NDA is unique, as it will refer to specific information, proprietary data, or other sensitive details determined by the people involved and what is being discussed. Generally speaking, there are two primary types of non-disclosure agreements: unilateral and mutual.

A unilateral agreement is a contract that stipulates one party to the agreement, usually an employee, agrees not to reveal confidential information they learn on the job. The majority of non-disclosure agreements fall under this category. Though many agreements of this sort are intended to protect a business's trade secrets, they may also be created to protect the copyright for information created through an employee's research. Contract and corporate researchers in the private sector and professors at research universities are sometimes required to sign NDAs that give the rights to any research they conduct with the business or university that supports them.

On the other hand, a mutual non-disclosure agreement is typically executed between businesses engaged in a joint venture that involves sharing proprietary information. If a chip manufacturer knows about the top-secret tech going into a new phone, they may be required to keep the design a secret. In the same agreement, the phone manufacturer may be required to keep the new tech in the chip secret as well. NDAs are also an essential part of negotiations and deal-making for business transactions such as mergers and corporate takeovers.

The Bottom Line

Non-disclosure agreements are an important legal framework used to protect sensitive and confidential information from being made available by the recipient of that information. Companies and startups use these documents to ensure that their good ideas won't be stolen by people they are negotiating with. Anybody in breach of an NDA will be subject to lawsuits and penalties commensurate with the value of lost profits. NDAs may be unilateral whereby only the recipient of the information is required to keep silent, or mutual where both parties agree not to share each others' sensitive information.