The disclosure of confidential information during the negotiation and due diligence phases of an M&A transaction can expose the disclosing party to various risks. For example, competitors can initiate M&A discussions as a strategic tactic to gain access to sensitive proprietary information and to exploit that information at the expense of the disclosing party. In a hyper-competitive and technology-focused business environment, the protection of confidential information (and other intellectual property) should be a priority for all businesses – particularly during a merger or acquisition.
An example of the inherent risks in M&A disclosure is found in the ongoing US litigation between Stingray Digital Group (Stingray) and Music Choice. On June 6, 2016, Stingray, a publicly-traded Canadian media and entertainment company, was accused in the courts of the Eastern District of Texas of infringing on patents owned by Music Choice, a US provider of digital music. Stingray allegedly gained access to the patents during a failed attempt to acquire Music Choice in 2013. Since June 2016, Stingray has filed a countersuit alleging that Music Choice is engaged in a “smear campaign” designed to damage Stingray’s reputation through the dissemination of misinformation.
In the M&A context, a company should consider both legal and logistical methods to minimize disclosure risk. In particular, a company should not disclose any confidential information to a third party without first negotiating and executing an appropriate non-disclosure agreement (or, NDA).
A strong NDA (or confidentiality agreement) includes a comprehensive and relevant definition of confidential information, a clear definition of the permitted use of such information and covenants addressing the appropriate standard of care to protect the confidential information. An NDA should also prohibit any reverse engineering, decompiling or disassembling of the information.
The importance of the definition of “confidential information” is evidenced by the judgment in Visagie v TVX Gold Inc1. The facts relate to the aftermath of a failed joint venture attempt to purchase a mine, where one party (TVX) made an independent (and successful) bid for the intended target of the proposed joint venture a few months later. At trial, TVX argued that it was free to use the information provided by the disclosing party because the information was not “confidential” and therefore was not protected by the provisions of the NDA. The Ontario Court of Appeal, as part of its analysis on the breach of confidentiality, determined that the information provided by Visagie to TVX “had the necessary quality of confidentiality to be worthy of protection in law.” The Court found that “Mr. Visagie developed new information, new theories and new presentations on existing data so that he created new information which was confidential information to him until he disclosed it to others”. Further, the court determined that TVX first became interested in acquiring the mine because of the information provided to it by Visagie and that it used this information as a springboard in the ultimate acquisition. Consequently, the Court upheld the trial judge’s decision and recognized the existence of a constructive trust over the mine. In drafting NDAs, it is therefore important to define specific types – and forms (including verbal disclosure) - of information that are considered to be confidential.
Similarly, settling a precisely crafted definition of “permitted use” is also essential to an NDA. In Certicom Corp v Research in Motion Ltd2, an NDA was signed in contemplation of a friendly acquisition. However, when Research in Motion (RIM) initiated a hostile takeover after failed negotiations, Certicom asked the Ontario Superior Court to prevent RIM from continuing its bid. The signed NDA specifically limited the use by RIM of confidential information only for certain permitted “purposes,” which was defined to mean “some form of business combination between the Parties.” The Court found that RIM’s hostile takeover bid could not be interpreted to fall within the permitted “purposes” contemplated by the agreement, as a hostile takeover bid could not be understood as a business combination “between” the parties as the word “between” connotes each party’s consent and agreement. In reaching this conclusion, the Court placed considerable emphasis on the intention of the parties as determined through the wording of the NDA.
Significant consideration should also be given – particularly in a cross-border deal – to the governing law and forum clauses in an NDA, which should clearly indicate the jurisdiction that governs the agreement and the relevant forum for dispute resolution. Well-drafted governing law and forum clauses will reduce (if not eliminate) the ability of the receiving party to argue that conflict of law principles provide that another jurisdiction and/or forum (more beneficial to such party) should apply. Where the two parties are situated in different countries, litigation concerning applicable laws and forums can quickly become complex and expensive, so disclosing parties should take the time to confirm the desired jurisdiction and forum, as well as any exceptions to the governing forum (such as injunctive relief where the recipient is breaching the NDA in another jurisdiction).
Where the confidential information pertains to formulae, code, processes or methodologies, it is prudent to include a provision prohibiting the reverse engineering, decompiling or disassembling of the disclosed information. Further, one or both parties may choose to prohibit the other from soliciting its existing employees, customers and suppliers through restrictive covenants in the NDA.
Finally, an NDA should provide for specific performance and injunctive relief in the event of a breach by the recipient, including the actual or threatened disclosure of the confidential information.
Common Law Remedy
In many circumstances, a written NDA will not exist between the parties. For example, most venture capital funds refuse to sign NDAs.3 This is a risky situation for the disclosing party, but where an NDA is not in place, the Supreme Court of Canada has clarified that a common law remedy of “breach of confidence” can be established under certain criteria. However, the threshold is high and this is not a suggested strategy. The leading case (International Corona Resources Ltd. v LAC Minerals Ltd)4 provides that in the absence of a signed NDA, LAC’s misuse of confidential information obtained from Corona constituted a breach of confidence. However, in order to establish breach of confidence, Corona had to prove that:
a) the information conveyed was confidential5;
This three part analysis requires proof of subjective knowledge and requires an assessment of whether the third party knew or ought to have known that the information is confidential. In order to circumvent this complex and subjective analysis, it is much more efficient to establish through an NDA that specific obligations of confidentiality apply.
The disclosure of highly sensitive information such as trade secrets6 must be accompanied by contractual protection; otherwise the value of the information disclosed may be significantly compromised. Unlike patents, which are protected by statute upon disclosure to the relevant regulatory body, trade secrets do not enjoy legislative protection. Instead, in order for a trade secret to hold common law rights of exclusivity, it must maintain its status by being kept confidential (for example, being safeguarded by employees). Disclosure without the proper contractual framework may result in the information losing its “trade secret” status and thereby expose the information to reverse engineering and replication with no legal remedy.
The Oculus Decision
The recent (and highly publicized) February 1, 2017, decision (Texas Northern District Court) in ZeniMax Media, Inc. v. Oculus VR, LLC7 highlights the difficulty of establishing the misappropriation of trade secrets versus a breach of an NDA. In a claim filed after Facebook offered US$2.3 billion to acquire Oculus, ZeniMax alleged (in a US$6 billion claim) that Oculus and the other defendants8 misappropriated trade secrets, breached an NDA between ZeniMax and Oculus and infringed copyright and trademarks. The jury ultimately found Oculus guilty of copyright and trademark infringement, as well as breach of the NDA. For its infringement and breach, Oculus was found liable for US$250 million and other defendants were found liable for another US$250 million for false designation.
Although ZeniMax’s primary claim was for misappropriation of trade secrets (including the following technologies: (1) distortion correction technology; (2) chromatic aberration correction method; (3) gravity orientation and sensor drift correction technology; (4) head and neck modeling technology; (5) HMD view bypass technology; (6) predictive tracking technology; and (7) time warping methodology), the jury did not find in favour of ZeniMax on this point. Instead, after hearing the evidence, the jury determined that while Oculus had infringed both ZeniMax’s copyright in code and trademarks, ZeniMax failed to establish by a preponderance of evidence that:
(1) any trade secrets existed;
Without the benefit of legislative protection, NDAs and other steps designed to preserve confidentiality are paramount to the effective protection of sensitive information constituting a trade secret. This case is ongoing as ZeniMax filed a motion dated February 23, 2017 seeking a permanent injunction to stop Oculus from using and distributing products that infringe ZeniMax’s copyrights.
Practical Tips – What and When to Disclose
Whether or not a written NDA exists, a number of practical steps are recommended for disclosing parties in the M&A context. It should be noted that courts will assess the precautions that a disclosing party took to ensure the secrecy of confidential information. Accordingly, consider the following suggestions: