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Defining and Protecting Evaluation Material in M&A Confidentiality Agreements
Practical Law Legal Update 6-524-1567 (Approx. 6 pages)
Defining and Protecting Evaluation Material in M&A Confidentiality Agreements
by PLC Corporate & Securities
| Published on 14 Feb 2013 • Delaware, USA (National/Federal) |
A discussion of how the disclosing party and the recipient negotiate the definition and disclosure of "Evaluation Material" in confidentiality agreements for M&A transactions.
One of the first agreements that parties negotiating an M&A deal sign is a confidentiality agreement (sometimes referred to as a nondisclosure agreement or NDA). This agreement puts the parties on notice that certain information and material is confidential and also helps them avoid misunderstandings about what they may do during the initial stages of a deal.
A primary area of negotiation for the parties is to delineate what disclosures (often referred to as "Evaluation Material" in NDAs) should be treated confidentially. The following NDA excerpts discuss the definition and treatment of "Evaluation Material" and are taken from PLC's Standard Document, Confidentiality Agreement: Mergers and Acquisitions (section links direct to other sections of the Standard Document):
"1. For purposes of this Agreement, the following terms have the following meanings:
(a) "Evaluation Material" means all information, data, documents, agreements, files and other materials, whether disclosed orally or disclosed or stored in written, electronic or other form or media, which is obtained from or disclosed by the Disclosing Party or its Representatives before or after the date hereof regarding the Company, including, without limitation, all analyses, compilations, reports, forecasts, studies, samples and other documents prepared by or for the Recipient which contain or otherwise reflect or are generated from such information, data, documents, agreements, files or other materials. The term "Evaluation Material" as used herein does not include information that: (i) at the time of disclosure or thereafter is generally available to and known by the public (other than as a result of its disclosure directly or indirectly by the Recipient or its Representatives in violation of this Agreement); (ii) was available to the Recipient from a source other than the Disclosing Party or its Representatives, provided that such source, to Recipient's knowledge after reasonable inquiry, is not and was not bound by a confidentiality agreement regarding the Company; or (iii) has been independently acquired or developed by the Recipient without violating any of its obligations under this Agreement."
Evaluation Material: Definition
Disclosing Party
The definition of evaluation material should be broad enough to encompass every type of material that will be disclosed to the recipient and every way that the material could be disclosed (for example, oral disclosures). If the disclosing party is concerned about particular information, it may want to list out certain categories of materials preceded by the words "including, but not limited to." For example, if the company being acquired owns significant intellectual property, the disclosing party could include the following after the general description of evaluation material: "including, but not limited to, trade secrets, software programs, intellectual property, data files, source code, computer chips, system designs, product designs," and so on.
It is important to include materials that the recipient creates (or materials created for the recipient) using the evaluation material. For example, if the recipient creates a report using raw data supplied by the disclosing party, it should be treated as confidential evaluation material. The recipient will attempt to broaden the exceptions to the definition of evaluation material. The exceptions in the above definition are standard, but the disclosing party can tighten the language in its first draft. Often the disclosing party requires that any disclosures pursuant to clause (ii) are made on a "non confidential basis" and "not in violation of any legal, fiduciary or contractual duty" and does not include the exception clause (iii) in its first draft.
Recipient
The exceptions provided above are standard. When reviewing a confidentiality agreement, the recipient should ensure that evaluation material does not include material that is or becomes public through no fault of its own. Since the definition of evaluation material typically includes materials developed by the recipient using the confidential information, it is important to clarify that any material that was independently developed (without the use of the evaluation material) by the recipient is excluded. If the recipient and disclosing party have a pre-existing business relationship and the disclosing party has shared confidential information in the ordinary course of business, the recipient should try to carve out that information from the definition of Evaluation Material. Counsel to the disclosing party should confirm that a valid confidentiality agreement is in place (and will remain in effect) covering those previously disclosed and unrelated confidential materials.
Because the definition of Evaluation Material is broad, it picks up any information meeting the criteria set out in the definition, whether or not the information has been specifically identified as confidential by the disclosing party. Although usually not successful, the recipient can try to narrow the definition to include only those materials that are marked as "confidential" or otherwise identified by the disclosing party as confidential (for orally disclosed information). The recipient would argue that the disclosing party is in control of the material disseminated and better suited to determine what is or is not confidential and therefore subject to the terms of the confidentiality agreement. Most often the recipient loses this argument on the basis that it is too burdensome a task for the disclosing party to physically identify each and every document or other material that is confidential. But depending on the buyer's leverage and the amount of material to be reviewed during due diligence, it may prevail on this point.
"2. The Recipient shall keep the Evaluation Material strictly confidential and shall not use the Evaluation Material for any purpose other than to evaluate, negotiate and consummate the Transaction. The Recipient shall not disclose or permit its Representatives to disclose any Evaluation Material except: (a) if required by law, regulation or legal or regulatory process, but only in accordance with Section 5, [or] (b) to its Representatives, to the extent necessary to permit such Representatives to assist the Recipient in evaluating, negotiating and consummating the Transaction, [or (c) to Permitted Co-bidders,] [or (d) as permitted in Section 6(c)]; provided, that the Recipient shall require each such Representative to be bound by the terms of this Agreement to the same extent as if they were parties hereto and the Recipient shall be responsible for any breach of this Agreement by any of its Representatives."
Treatment of Evaluation Material
Disclosing Party
If the recipient is permitted to disclose the evaluation material to its representatives, the representatives should also be obligated to keep the material confidential. If the definition of representatives is broad and includes third parties not under the recipient's immediate control (such as co-bidders or lenders), the disclosing party can require the recipient to obtain its consent before sharing the information with those parties. Often the recipient objects to any obligation to obtain consent.
Also, this provision allows for the recipient to share evaluation materials with permitted co-bidders (assuming that clubbing is allowed). Counsel to the disclosing party should note that the recipient is not itself liable for any breaches of the agreement by permitted co-bidders (unless they are affiliates of the recipient), although the recipient is responsible for breaches by its representatives. As drafted, co-bidders are directly responsible for their own breaches because they will have either executed their own confidentiality agreement with the seller or be bound under the subject confidentiality agreement as an affiliate (and therefore a "representative") of the recipient (see Section 1(b)).
The bracketed clause (d) above should only be included if Section 6(c) is a part of the agreement. Section 6(c) restricts the recipient from sharing the evaluation materials with any actual or prospective financing sources (equity or debt) unless it is a bona fide lender disclosed in an exhibit to the agreement. The seller will need to take a position on whether it wants the recipient to be responsible for any breaches of confidentiality by its lender(s) or whether it should require the lender to enter into a separate confidentiality agreement with the seller. A common way to handle this scenario is to include the prospective lenders in the definition of "Representative." By doing this, the recipient is directly responsible for the lender's breach (if any).
Recipient
The recipient should try to eliminate any requirement making it responsible for the breaches of its third-party representatives, but this is usually an important point for the seller. Counsel to the recipient should also try to replace any obligations to "cause" or "prevent" its representatives from taking or refraining from certain actions with an obligation to "direct" or "inform" them because the recipient usually does not have complete control over its representatives. The recipient can propose the following language to replace the proviso in Section 2:
"provided, however, that the Recipient agrees that it or one of its Representatives shall inform such Representative of the provisions of this Agreement and instruct it to comply with the provisions hereof applicable to its Representatives."
To protect itself, the recipient sometimes requires its representatives to sign a confidentiality agreement in favor of the recipient, which mirrors the provisions in the confidentiality agreement it signs itself. These are commonly referred to as "back-to-back" agreements. This is a more common structure in a financed deal where lenders are included in the definition of "representatives."
The recipient should also object to any obligation to obtain the disclosing party's consent before sharing evaluation materials with its representatives because it often complicates and delays the due diligence process.
Use of Evaluation Material: Lessons from Martin Marietta Materials, Inc. v. Vulcan Materials Co.
The Delaware Court of Chancery's decision in Martin Marietta Materials, Inc. v. Vulcan Materials Co. highlights the fact that a failure to clearly define how a recipient may use the target's confidential information received during the course of a deal could effectively create a backdoor standstill, prohibiting the recipient from pursuing a hostile deal while the confidentiality agreement is in effect ( (Del. Ch. May 4, 2012), affirmed by Martin Marietta Materials, Inc. v. Vulcan Materials Co., (Del. July 10, 2012)). The Court found that the recipient, Martin Marietta, breached two confidentiality agreements it entered into with Vulcan, the target, when it initiated a hostile bid for Vulcan using confidential information acquired during its merger negotiations. To remedy the breach the Court enjoined Martin Marietta from taking any actions to advance its takeover strategy for a period of four months.
As drafted above, this Standard Document provides that the recipient can only use the evaluation material to "evaluate, negotiate and consummate the Transaction." This language conveys that:
- The parties are contemplating a consensual business combination because of the inclusion of the word "negotiate."
- The recipient is not authorized to use the evaluation materials for any purpose other than a negotiated transaction.
Parties, particularly the disclosing party, should review the definition of "Transaction" to confirm that it remains consistent with the agreement's use clause. If the disclosing party wants more assurances that the recipient is prohibited from using the disclosed confidential information in a hostile scenario, it can narrow the definition of "Transaction" to refer only to a negotiated deal (see Drafting Note, Martin Marietta v. Vulcan: Definition of "Transaction").
The recipient, on the other hand, must ensure that the language is consistent with its understanding and the intent of the parties. If the recipient successfully managed to keep a standstill provision out of the agreement (see Section 9) and it wants to preserve its flexibility to pursue a hostile transaction if negotiations fail, the use provision must be broad enough (including the definition of "Transaction") to pick up a possible nonconsensual deal.
For more information on the Martin Marietta decision, see Legal Update, Martin Marietta: Delaware Court of Chancery Holds Use of Confidential Information in Hostile Bid Breaches Confidentiality Agreements and Legal Update, Delaware Supreme Court Affirms Court of Chancery Ruling in Martin Marietta.
For a checklist of issues that parties negotiate and the objectives that each side may seek in a typical confidentiality agreement for an M&A transaction, see Confidentiality Agreements for M&A Transactions: A Checklist for Buyers and Sellers.