If you are in the early stages of negotiating the sale of your business, it is important to enter into a confidentiality agreement with your potential buyer, to ensure that any information you share pre-sale stays solely between you.
These legally binding contracts are also known as non-disclosure agreements or NDA’s, because they prevent the potential buyer from disclosing the seller’s confidential information to third parties who are not involved in the negotiations.
This article addresses key questions related to confidentiality agreements in a sale of business, specifically: the reasons they are necessary (for both the seller and the potential buyer); important details these agreements should include; parties and conduct which will/will not be subject to confidentiality; the consequences of breaching a confidentiality agreement.
Why do you need a confidentiality agreement?
As a potential buyer, you will need to inspect confidential information of the seller to receive a true picture of their business, to understand risks associated with the purchase and to make an informed decision about whether to proceed with the transaction.
This is done through the due diligence process, which allows the potential buyer by investigating relevant records and documents to examine the business’ legal, financial and trading status and obligations. Confidential documents that may be inspected through due diligence include financial statements, company records, cash flow records, business plans and strategy documents.
1. Keeping sensitive business information confidential
If a proposed sale falls through, a confidentiality agreement stops the potential buyer from sharing or using information they obtained through the due diligence process to the seller’s detriment. The potential buyer is prevented from sharing the confidential information with a competitor, going after the seller’s customers or employees or stealing the seller’s business strategies, ideas, trade secrets etc.
2. Preventing concern or rumours among those dealing with the business
Keeping news of a business sale confidential is also important to ensure that reactions from third parties and from the public to the potential change in ownership do not threaten the sale. Confidentiality agreements usually prevent one party from publicly announcing a sale until after it has been finalised.
This can help to avoid issues arising with both the parties’:
- customers, employees and suppliers (who may be concerned by sale prospects); or
- market competition (who might perceive that the business is unstable and attempt to target its customers or employees).
What should a confidentiality agreement contain?
A confidentiality agreement should outline the following:
- details of the business being sold (ie: its name, location, what the business does);
- the permitted purpose for which the potential buyer can use the confidential information (ie: to examine the business for the purposes of the negotiation);
- clearly defined, categories of information that are to be protected (eg: documents relating to the business’ financial status, strategies, contractual obligations, employee agreements, customer lists etc);
- that the potential buyer is restrained from disclosing the confidential information above;
- the length (in months or years) of the confidentiality agreement’s operation, or whether the agreement terminates on completion of a sale.
- the identity of those who are subject to the agreement (see below);
- circumstances where the potential buyer can disclose information to permitted parties and the manner in which this should be done;
- whether the potential buyer needs to destroy or return what they have received if the sale falls through and a time frame and process for doing so; and
- whether the fact the business is on the market is also confidential.
As every business sale is different, it is important that parties seek legal advice to draw up an agreement which matches the specific circumstances of their sale.
Who is bound by a confidentiality agreement?
The seller and potential buyer will sign the confidentiality agreement and be parties to this contract. However, as part of the pre-sale negotiations, the potential buyer will usually seek advice about the business’ sensitive information from their lawyers, accountants or financial advisers.
Advisers like these can be listed in the confidentiality agreement as permitted persons who are able to view confidential information and who are also subject to the obligation of confidentiality. The agreement should address how relevant information will be accessed when needed by permitted persons, who may also include directors, officers or employees of the potential buyer.
What will not be covered by a confidentiality agreement?
A confidentiality agreement will not protect the disclosure of:
- information that the potential buyer already knows about the business;
- information that is already available to the public or which becomes publicly known (through no fault of the potential buyer);
- information that the potential buyer has been given approval to disclose by the seller;
- information that the potential buyer was given from the seller through a third party who is not subject to the confidentiality agreement.
What happens if a confidentiality agreement is breached?
The agreement will also set out the consequences of one party breaching a confidentiality obligation by disclosing sensitive information about the business or about the occurrence of the sale, and the rights this gives to the other party.
Under the agreement, a party will usually have to pay monetary damages for any loss experienced as a result of their breach. However, where a party is threatening to share confidential information or continuing to do so, the other party will also want to stop this conduct from occurring.
The agreement is therefore likely to allow the party whose rights have been infringed to also seek:
- an injunction: this is a court order which restrains a party from carrying out an activity which breaches or is likely to breach an agreement; or
- specific performance: this is a court order which compels a party to carry out their obligations under a contract.
If you are negotiating the sale of a business, ensuring that confidential information cannot be disclosed has benefits for both:
- the seller: who can share the required information openly and freely without fear of it being misused by the potential buyer; and
- the potential buyer: who can make an informed decision about whether to purchase the business, with the confidence that they are receiving all relevant information.
If you need advice on drafting or entering into a confidentiality agreement, or on any aspect of the sale of a business, feel free to contact Lord Commercial Lawyers on 9600 0162 or email us at firstname.lastname@example.org.