United States: Avoiding Pitfalls Of "Use" Clauses In NDAs

Last Updated: November 15 2019
Article by David B. Hennes and Mary Zou

Reprinted with permission from the October 28, 2019 edition of the “New York Law Journal”© 2017 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.

Non-disclosure agreements, or NDAs, are essential components of public and private merger and acquisition sale processes, as they facilitate the flow of commercial information from the target to the acquirer for due diligence purposes while protecting the target’s proprietary and competitively sensitive information. Particularly in circumstances where the potential acquirer and target operate in the same industry, the target may be concerned that the information provided to the acquirer for due diligence could be used for another, potentially improper, purpose. Thus, a key provision in almost every NDA is a “use” clause, which limits the ways in which the party receiving confidential information may use that information. 

Notwithstanding the fact that NDAs are commonplace in M&A transactions, breaches of NDAs are rarely litigated. Parties may be reluctant to make the dispute public and damages for breach of an NDA can be difficult to prove. Nonetheless, as the following cases demonstrate, “use” clauses can have collateral consequences if litigation does arise depending on other provisions in the NDA and how the transaction develops. Such consequences include exposing a party to potential liability for transaction fees or operating as a “standstill” that precludes the receiving party from pursuing an acquisition of the target.

Cases Addressing “Use” Clauses

In Goodrich Capital, LLC v. Vector Capital Corporation, a broadly drafted “use” clause triggered a separate “non-circumvention” fee payment clause, and exposed a party to potential damages of $3.5 million in advisory fees. 2012 WL 4123401 (S.D.N.Y. June 26, 2012). 

Goodrich arose from the desire of Treasurer, a cash management business, to acquire a smart safe company. Treasurer hired Goodrich as its financial advisor, and Vector, a private equity firm, agreed to finance the deal. The three parties entered into an NDA, which contained a “use” clause prohibiting Vector from using confidential information for any purpose other than the “contemplated business arrangement,” which the court interpreted to mean a transaction relating to cash handling services that involved all three parties. The NDA also contained a “non-circumvention” clause prohibiting Vector from avoiding the payment of Goodrich’s advisory fees at the closing of any such deal. 

Goodrich identified potential target companies for Treasurer and Vector to pursue, and Treasurer unsuccessfully attempted to acquire one such target. Goodrich then proposed that Treasurer and Vector attempt to acquire the smart safe business line of another potential target, Tidel. Vector, however, decided to acquire Tidel on its own, without involving Treasurer or Goodrich. 

Goodrich sued Vector for breach of the NDA, alleging that Vector used Goodrich’s confidential information (the list of potential targets) for a prohibited purpose (one other than exploring a transaction involving Goodrich and Treasurer). Goodrich argued that it was deprived of a $3.5 million advisory fee for its services. In denying Vector’s motion to dismiss, Judge Rakoff held that Goodrich plausibly alleged that Vector breached the NDA’s “use” clause. The court also found Goodrich plausibly alleged that Vector’s actions were an attempt to avoid having to pay Goodrich its fee, in violation of the “non-circumvention” clause, thereby exposing Vector to damages in the amount of the advisory fee. The parties settled the case shortly after the decision. 

In Martin Marietta Materials, Inc. v. Vulcan Materials Company, the Delaware Court of Chancery interpreted the parties’ “use” clause to have the same effect as a standstill. 56 A.3d 1072 (Del. Ch.), aff’d, 45 A.3d 148 (Del. 2012). In that case, Martin Marietta and Vulcan entered into an NDA to explore a potential merger. When merger discussions broke down, Martin Marietta launched both a hostile bid for Vulcan and a proxy contest to replace Vulcan’s directors. Vulcan filed suit, claiming that Martin Marietta breached the NDA by improperly using Vulcan’s confidential information in connection with its hostile bid. Then-Chancellor Strine agreed with Vulcan and enjoined Martin Marietta’s hostile bid, and the Delaware Supreme Court affirmed.

In reaching its decision, the lower court analyzed the NDA’s “use” clause, which specified that Martin Marietta could use confidential information only for the purpose of evaluating a “Transaction,” defined as “a possible business combination transaction” between Martin Marietta and Vulcan. The court held that the definition of “Transaction” applied only to a negotiated transaction between the parties and did not include a hostile takeover. Although the NDA did not include an express “standstill” provision, the court remedied Martin Marietta’s breach of the NDA by enjoining Martin Marietta from “taking steps to acquire control of Vulcan shares or assets” for four months—the period left in the NDA at the time of the breach—and from running its slate of directors in the proxy contest. In effect, the “use” clause operated as a backdoor standstill provision, which the parties had not negotiated in the NDA. 

Depomed Inc., v. Horizon Pharma, PLC serves as an even broader example of a “use” clause acting as a backdoor standstill. 2015 WL 7433326 (Cal.Super. Nov. 19, 2015). In that case, Horizon was launched a hostile bid to acquire Depomed after Depomed purchased the rights to a drug from Janssen. Horizon had previously entered into an NDA with Janssen relating to that same drug. Depomed argued that it had inherited the rights of the NDA between Horizon and Janssen when it acquired the drug, and that Horizon was improperly using confidential information in violation of that NDA in its hostile bid. The court agreed with Depomed and preliminarily enjoined Horizon’s bid. 

The extraordinary relief granted in the Martin Marietta and Depomed cases serves as a reminder that NDAs drafted at the very beginning of a potential deal can have broad implications on the parties well after circumstances have changed. If the parties had addressed whether a “standstill” was an appropriate remedy for a breach of the “use” clause, litigation may have been avoided or the relief awarded may have been different. 

While these decisions serve as cautionary tales, case law also supports the notion that parties may pursue business opportunities directly related to their prior diligence of a company so long as the record is clear they did not improperly use confidential information. In Cardiovascular Support Perfusion Reliance Network, LLC v. SpecialtyCare, Incorporation, the court found that an NDA with a restrictive “use” clause did not prohibit SpecialtyCare from pursuing a separate contract that had previously been awarded to Cardiovascular Support. 629 F. App’x 673 (6th Cir. 2015). 

There, Cardiovascular Support planned to sell its perfusion business to SpecialtyCare. The parties signed an NDA agreeing that SpecialtyCare would use Cardiovascular Support’s confidential information solely in connection with that potential transaction. During the parties’ negotiations, Cardiovascular Support disclosed that its contract with Baylor University Medical Center was set to expire. When the contract expired, Baylor declined to renew it and instead contracted with SpecialtyCare. Cardiovascular Support sued SpecialtyCare for breach of the NDA, alleging that SpecialtyCare’s M&A team had passed confidential information about Cardiovascular Support’s relationship with Baylor to the SpecialtyCare sales team, and that the sales team used that information to secure the contract with Baylor. 

The district court granted summary judgment in SpecialtyCare’s favor, and the Sixth Circuit affirmed, rejecting Cardiovascular Support’s theory that SpecialtyCare had improperly used confidential information. The court found that Cardiovascular Support failed to present sufficient evidence that SpecialtyCare breached the “use” clause of the NDA, relying on the fact that SpecialtyCare’s sales team had testified that they did not receive any information regarding Cardiovascular Support from SpecialtyCare’s M&A team. While Cardiovascular Support pointed to emails from SpecialtyCare’s sales team to the M&A team about Cardiovascular Support’s known clients, the court found that such emails did not affirmatively show that information flowed in the other direction, from the M&A team to the sales team. 

Best Practices 

Case law provides a useful roadmap for drafting “use” clauses to avoid collateral consequences. Cases such as Goodrich and Martin Marietta illustrate that the unexpected and potentially consequential interaction between the “use” clause and other provisions in an NDA can create significant exposure, including for monetary damages or broad equitable relief. Lawyers negotiating NDAs should also consider precisely defining the consequences for violations of the “use” provision to avoid unintended consequences.

Case law also provides useful guidance for protecting against potential liability once an NDA containing a “use” clause is signed. Transaction participants should consider having protocols in place to identify potential conflicts with respect to an NDA counterparty. If potential conflicts are identified, a party may wish to take steps to segregate confidential information and restrict access to it. For instance, members of a deal team should be instructed not to share confidential information with colleagues outside the deal team, absent approval. In addition, if parties wish to engage in activities that may touch on the subject of the NDA, they should consider using a “clean team” of employees who did not previously have access to the counterparty’s confidential information. These steps may minimize the risk that a party would potentially be found liable for running afoul of a “use” clause.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions