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Confidentiality Agreements—It’s the Tone and the Details that Matter

Oct. 3, 2011, 4:00 AM

Frequently, the confidentiality agreement marks the first opportunity for negotiated interaction in an M&A process. A confidentiality agreement is entered into to allow a due diligence investigation to proceed under circumstances that the information disclosed during that process is used only for the purpose of evaluating a possible transaction. While these agreements fit into standard conventions, the approach to their negotiation can set the tone for the rest of the M&A transaction and the actual terms of the agreements can pose problems throughout the transaction or provide a means for secure protection of a party’s proprietary information. There is room for negotiation but the parties need to pick their points. The nuances add up and can make a difference.

Setting the Right Tone

At the outset of an M&A transaction, parties regularly size up each other and ask a series of related questions:

  • Is the other party really interested?


  • Do they have the execution capability to get the deal done?


  • Can we work with them or will their processes overwhelm our ability to complete a deal in a normal timeframe?

Theses issues are compounded for the potential target company which is going through a sale process, is evaluating the intent and capabilities of multiple interested parties, and seeks to achieve uniformity among their confidentiality agreements. Target companies are compelled to assure that they are adequately protected by confidentiality agreements in order to preserve important rights that might be compromised by the use of proprietary information disclosed during the due diligence process. Simultaneously, they are constrained to assure that the negotiation of a confidentiality agreement does not get mired in the weeds due to the need to keep the transaction on track at its earliest stage. Consequently, confidentiality agreements tend to be highly conventionalized and the negotiations over their provisions tend to be restricted to a narrow set of issues.

Format of Confidentiality Agreements

A confidentiality agreement is entered into with a potential bidder by the target company or the target’s financial advisor on its behalf. Confidentiality agreements typically cover the following points:

  • Transaction. The potential transaction is broadly defined in order to ensure that the confidentiality agreement applies to a broad set of potential circumstances.


  • Confidential Information. Information that is considered confidential is broadly defined to afford the target company protection of a broad array of information that is disclosed during the due diligence process. By convention, the definition of confidential information contains a number of exceptions for information in the public domain or prepared by or belonging to others.


  • Parties. The agreement usually obligates the potential bidder, its directors, officers and employees and a broadly defined set of representatives of the bidder. If securities are to be issued by the bidder in the transaction, rather than being a one-way undertaking of confidentiality by the bidder, the agreement may provide for reciprocal protections obligating the target company and its directors, officers, employees and representatives.


  • Confidentiality Restriction. The basic provision of the agreement requires that the potential bidder maintain the strict confidentiality of the disclosed information as well as the existence of discussions between the parties concerning a possible transaction. The agreement customarily contains a provision permitting disclosure of information if required by legal process or court order which is coupled with a provision requiring the party that is subject to the legal process or court order to seek to obtain a protective order. The agreement should contain a provision limiting the parties to whom disclosed information may be provided to only those who have a need to know the information in connection with an evaluation of the potential transaction. In some cases involving public company targets, the confidentiality restriction is coupled with a recitation that the bidder is aware of its responsibilities under the securities laws to abstain from trading on material nonpublic information. This recitation helps provide moral assurance to the target that the bidder will refrain from improper securities transactions. Moreover, a confidentiality agreement may contain an acknowledgment by the parties that they have a competitive business relationship. This acknowledgment may help a target in its efforts to enforce the confidentiality restriction. These days, targets more frequently use electronic data rooms to make evaluation materials available to bidders. The electronic data rooms can be set up to allow access to particular evaluation materials on a sequenced basis and to permit the target to monitor the areas of greatest interest to bidders in the due diligence process. The electronic data room also can reduce the overall cost of the due diligence process for both the target and potential bidders.


  • Standstill. The standstill provision generally prohibits the potential bidder from launching a hostile attempt to acquire control of the target company for a specified period of time. This provision is sought on the basis that the target company would not disclose confidential information without retaining control over the transaction process. Often, the standstill provision also prohibits the bidder from asking the target from granting a waiver of the standstill in order to reduce the pressure on the target company’s board of directors from considering waivers requests. By prohibiting the potential bidder from making a hostile offer, the target company has a greater opportunity to control the process.


  • Non-solicitation. The non-solicitation provision prohibits the bidder from hiring employees of the target company during a specified period. This provision is requested by the target company to preclude the bidder from using information obtained about the target company’s talent pool for recruitment purposes. In addition to prohibiting the solicitation of target employees, the confidentiality agreement also may restrict the access of a bidder to the target’s employees by requiring that all requests to communicate with target company employees be channeled through the financial advisors or a member of senior management of the target company.


  • Non-reliance. The confidentiality agreement will contain a disclaimer stating that the recipients of confidential information are not entitled to rely on the information and, instead, the only information that can be relied upon will be contained in the representations and warranties in the definitive transaction documents for the business combination. There is some case law, with mixed results, contesting the enforceability of this provision. See, e.g., AES Corp. v. Dow Chemical Co., 325 F.3d 174 (3d Cir. 2003), cert. denied, 124 S. Ct. 182 (2003); Harsco Corp. v. Segui, 91 F.3d 337 (2d Cir. 1996); Rogen v. Ilikon, 361 F.2d 260 (1st Cir. 1966).


  • Document Returns and Destruction. Traditionally, confidentiality agreements have provided that the recipient of confidential information will return or destroy all confidential information if the parties do not complete a transaction. Memos, notes and electronic copies of evaluation materials come within the scope of the return and destruction mandate. If the confidentiality agreement permits destruction, it is customary to require the recipient of the information to certify as to its compliance with the document destruction requirement.


  • Remedies. The confidentiality agreement should permit injunctive relief as a remedy for violation of the agreement. The remedy provision should recite that the bidder acknowledges that legal remedies may be inadequate to protect the target company in the event of a breach and that injunctive relief may be granted without the posting of a bond. In some cases, a bidder may elect to use confidential information or make a public offer for the target in violation of the confidentiality or standstill provision of a confidentiality agreement on the ground that the target will not be damaged by the bidder’s breach. In a couple of recent cases, Canadian courts have enjoined parties from proceeding with offers that involved breaches of confidentiality agreements. See, e.g., Gold Reserve Inc. v. Rusoro Mining Ltd., [2009] O.J. No. 533 (Can. Ont.); Certicom Corp. v. Research in Motion Ltd., [2009] 94 O.R. 3d 511(Can. Ont), [2009] O.J. No. 252 (Can. Ont).


  • Term. The confidentiality restrictions often are not limited in duration on the theory that information should be protected as long as it is confidential in nature. Some corporate policies require that confidentiality agreements be limited to a term, typically of three to five years. The standstill and non-solicitation provisions apply for a reasonable term in order to provide protections from the improper use of the confidential information. These terms typically range from one to two years.

Negotiation Nuances

There are a number of customary exceptions to confidentiality agreement provisions that are requested by bidders. Bidders tend to temper their comments because of concerns about setting the right tone for the transaction and, in an auction bid process, to avoid being behind other bidders in the due diligence and bidding process. Bidder comments typically cover the following matters:

  • Confidential Information. Occasionally, a potential bidder will seek to modify the exceptions to the definition of confidential information to reduce the burden on the bidder of determining whether information provided to it by a third party and which thereby could fall within an exception to the definition of confidential information was rightfully obtained by the third party. A middle ground is frequently achieved by providing that the information may be excepted if the potential bidder reasonably believes that the information was rightfully obtained by the third party.


  • Parties. A bidders frequently requests that it be able to share confidential information and the fact that the bidder is interested in the target with potential financing sources. This request could include equity financing sources in addition to debt financing sources. The inclusion of equity sources could lead to collaboration among potential bidders and thereby reduce interest in the target company which, in turn, could have a negative impact on the target company’s valuation, resulting in a lower deal price. A target company may want to hold off from approving a request to expand the list of permitted recipients of confidential information to avoid the possibility of a joint bid. Requests for exceptions can be handled on a case-by-case basis.


  • Standstill. The standstill provision frequently is the most heavily negotiated section of the confidentiality agreement. A bidder will seek to modify the standstill to ensure that it is not in a disadvantaged position relative to other interested parties in seeking to acquire the target. The target, on the other hand, will seek to control the potential change of control process as much as possible and seek as rigid a standstill as possible. Bidders frequently seek to modify the standstill to permit them to launch a hostile bid against the target in the event another party begins a hostile overture. In addition, bidders frequently seek to eliminate the provision of the standstill that precludes them from seeking to have the bidder waive the standstill. This change is requested out of uncertainty as to whether the target will deal openly with the bidder during the due diligence and transaction negotiation process. In most cases, targets are successful in rebuffing this request. Less frequently, bidders will seek most favored nation treatment under the standstill in order to assure themselves parity with other players in the process.


  • Non-solicitation. Due to the growth of recruiting through the Internet, bidders frequently ask that the general advertisement exception be expanded to include general recruitment by means of the Internet and to permit the recruitment of individuals who have left employment with the target. A target may refuse to permit the recruitment of former employees on the ground that the exception may facilitate the staging of a multi-step recruitment process by a bidder under which the recruited individual leaves the employ of the target and is then hired by the bidder.


  • Document Retention. Increasingly, as an exception to the document return and destruction provision, a bidder may ask to be able to retain one copy of the confidential evaluation materials upon termination of the transaction negotiations. This request is made for purposes of providing the bidder with a means of determining whether information it may use constitutes confidential information provided during the due diligence process and for regulatory compliance purposes. In response to this request, a target may require that the information be retained by outside or internal counsel to the bidder and used solely for compliance purposes.


  • Term. As a matter of corporate policy, some bidders will seek to impose a one to three year time term on the entire confidentiality agreement. This modification is sought frequently on the basis that the bidder is involved in numerous acquisition reviews in the ordinary course of business and compliance efforts are difficult in view of the volume of potential transactions it considers. A target may rebuff this request on the basis that its information should be accorded confidential treatment as long as it is not generally available to the public. As a practical matter, most of the information provided in the due diligence process has a limited shelf life and is no longer material, relevant or confidential after a reasonable period of time.

The negotiation of a confidentiality agreement should be reasonably straight forward. The rapid completion of these negotiations can help the transaction process advance in due course and assist the parties in getting their deal relationship off to a good start. The parties can leave the tough slogging and the real negotiation for a more meaningful stage of the deal process.