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Regulatory: The unintended consequences of due diligence nondisclosure agreements

Due diligence agreements can limit a potential buyer’s business long after the parties have parted ways

Transactional due diligence is almost always preceded by execution of a nondisclosure agreement (NDA) to protect trade secrets and confidential business information revealed to the potential buyer. Such agreements may be viewed as routine boilerplate—so uncontroversial that they are signed without even review from the legal team. However, due diligence agreements often restrict a potential buyer’s business long after the parties have gone their separate ways. While some restrictions are fair and reasonable, others can be burdensome and leave the potential buyer regretting its failure to think twice before signing the agreement.

Hiring restrictions

For example, a typical due diligence NDA may prohibit the prospective buyer from hiring any of the target company’s personnel for some period of time. Such restrictions are likely to chafe if the deal fails to happen. Because the target company often is a competitor in the same industry or operates in an area of desired expansion, its workforce is likely to be attractive when the potential buyer needs to scout out new talent. Additionally, turnover within the target company—a common occurrence in businesses experiencing the various stresses that prompt or result from the posting of a “for sale” sign – means that an increased number of the target company’s personnel may be seeking employment with the prospective buyer. That prospective buyer will not want to tie its hands and preclude itself from hiring qualified refugees from the target company. This is particularly true in industries with few employers or other limitations on the supply of appropriately trained talent.

Fortunately, placing the target company’s entire workforce off-limits is neither logical nor necessary. A non-hire provision generally is included in due diligence agreements to prevent a prospective buyer from exploiting its due diligence entrée to identify and recruit the target’s personnel. Such a prohibition, for a limited period of time, may be reasonable. But due diligence agreements are often drafted much more broadly, i.e., purporting to prohibit the prospective buyer from hiring any of the target’s personnel for a period of time, even those who have been laid off by the target company. A prospective buyer should consider seeking limitations, such as:

1. Limit the restriction to target company employees “to whom buyer is introduced as a result of the due diligence” and exempt the target company personnel about whom the prospected buyer had knowledge, or with whom it had contact, prior to engaging in due diligence

2. Further limit the restriction to those whose employment is not terminated by the target company

3. Shorten the ban on hiring and couple it with a slightly longer ban on solicitation, leaving the prospective buyer free, after a short period of time, to hire target company personnel from whom it receives an unsolicited application

Obligations regarding the sharing and return of confidential information

Confidentiality undertakings are another typical feature of due diligence NDAs. Such provisions often define the “confidential information” to be shared in problematic ways—or fail to define it at all. Does the agreement say that all information to be shared between the parties is confidential? Does it require that the producing party designate as “confidential” whatever information it desires to protect?

The desirability of a particular non-disclosure provision depends on which side of the transaction table your company finds itself. For example, provisions protecting only those materials that the target company designates as “confidential” (e.g., by stamping documents) generally favor the prospective buyer, since the burden of marking the documents, and the impact of failing to do so, rests with the target company.

Return-of-information clauses also require careful thought. If a target company includes such a provision in its due diligence agreements, it will want to monitor and demand compliance, in order to avoid the possibility that a court would deem its rights in that information abandoned. And what exactly does “return” of information mean when the information is stored and shared in electronic format? If “destruction” is offered as an alternative, is there a particular method of destruction specified? Although the use of secure cyberspace “data rooms” for the storage and review of due diligence materials is an effective means for addressing many of these issues, such contemporary practices are often used in tandem with outdated forms. Older-style due diligence agreements remain in use, even though their provisions are not consistent with current best practices—often creating more problems than they prevent.

For many companies, a 21st century “tune-up” of its due diligence forms may be in order, and any agreement pushed across the deal table should be carefully reviewed to ensure that its restrictions are reasonable.

Contributing Author

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Linda Stevens

Linda Stevens is a partner in the Chicago office of Schiff Hardin, LLP and co-chair of the firm’s Trade Secrets Client Services Team.

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Partner

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Matthew Prewitt

Matthew Prewitt is a partner in the Chicago office of Schiff Hardin, where he concentrates in complex litigation and also co-chairs the firm's Trade Secrets Client Services...

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