19
JUL
2013

Do You Need a NDA or NDA + Non-Competition Agreement?

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A common situation is to be asked by a client to prepare or review a “non-disclosure agreement” or NDA.  Such an agreement is often used by the parties to ensure that confidential or proprietary business information – a secret process, a novel business concept or other non-public valuable information – conveyed in exploratory business talks cannot be misused by the recipient should negotiations fail.  The typical format of these agreements excepts (and certainly they should except) information in the public domain, disclosures required by law, and information independently developed by the recipient, amongst other usual “take-outs”.    The core of the agreement is to obtain contractual protection against misuse of non-public valuable information.  In certain cases, a case can be made out at law or equity that the recipient is bound not to use the information for his own benefit even without having signed a written covenant to that effect.  However, in usual commercial discussions, it will often be difficult or impossible to show the necessary “fiduciary” quality to the relationship, i.e., a quality which implies an obligation of confidence and trust on the part of the recipient.  It is for this reason that it is always prudent to prepare and have signed a properly drawn NDA or confidentiality agreement to ensure as far as possible that the recipient is fixed with the necessary obligation to keep confidential information secret and to avoid conflict of interest in its regard.

These agreements raise numerous interesting issues, such as whether the obligations of confidence should or need to be reciprocal, how to define the confidential information, whether the obligation to maintain confidence should be time-limited or perpetual, and how to approach the issue of governing law where the parties are in different jurisdictions.

One question which has come up in recent years is whether one should seek to couple an obligation not to compete with an obligation not to disclose or use confidential information for one’s own benefit (i.e., outside the context of a business relationship between the parties to the NDA).   A client may consider that an obligation not to misuse confidential information is not enough, it may wish the recipient to agree not to engage in the kind of business which the disclosing party is interested to pursue with the recipient.  For example, say that a person possesses a novel, non-public concept to combine a children-oriented restaurant with an entertainment concept, different from all other existing such products in the market.  Approaching investors, it would be standard to request an NDA before disclosing the concept.  The owner of the information may have developed a novel theme or be in a position to license a distinctive name and design logo for his concept, one with national or North American recognition.  If the investment discussions do not succeed, the promoter will not want the recipient to take the idea and implement it on his own.  Thus, he might ask that in addition to an obligation to keep the information secret and not misuse it should a definitive agreement for investment not be entered into, the recipient agree not to be involved in a similar business for a certain period of time in the trading area contemplated by the promoter.

A quick Internet search discloses a number of legal precedents drafted in this way: the ones I have seen are governed by different state laws in the U.S.  Would such an agreement be enforceable in Ontario, i.e., the part that pertains to non-competition as such?  The reason I think it is fair to ask this question in the Ontario context is, first, the common law in principle holds non-competition agreements to be invalid and unenforceable as being in restraint of trade.  It is the policy of the common law to allow people the liberty of commerce, and considered of societal interest and benefit to do so.  There are to be sure well-established exceptions, such as where a person has sold a business: the buyer has an obvious interest not to see his vendor who has been paid a purchase price turn around and compete in the same area against the buyer.    Still, as an exception to the general rule, non-compete covenants in such context must meet a number of stringest tests to be valid, including that they be reasonable as to activities proscribed and temporal and geographic limits of the restraint.   Employment agreements were another area where it was recognized that a well-drawn non-compete obligation could be enforced against a former employee; however, some years ago, the Ontario Court of Appeal, in the well-known case of Lyons v. Multari, held that a non-competition obligation signed by a former employee will not be enforced where a more limited obligation, for example, not to solicit the trade connections of the former employer, would be sufficient to protect the interests of the latter.  There are certain other areas where a restrictive covenant has been held reasonable in law, notably in a commercial leasing context, e.g., the restriction to engage in a particular kind of business often requested of tenants in shopping mall leases.

How would a non-compete obligation be viewed in the context of the typical NDA, which falls into none of the standard exceptions?  I am not aware of an Ontario case on the point or authority elsewhere in Canada, nor are these notes an attempt to elucidate the black-letter law.  Rather, and as a practical working approach, my suggestion would be that the first question to be asked is, what is the minimum protection the owner of the concept needs and is it covered by the non-disclosure and use obligations?   Each situation will be different but I would caution against the assumption that a non-competition obligation, even one which is otherwise reasonable as to time, activities proscribed and geographic area, should be blithely inserted in NDAs in Ontario.    The existence online of templates which presuppose such structure may be based on different laws and even where the laws are similar, the situation underpinning or inspiring a given template may be quite different from the problem at hand.  In my view, creating a non-competition obligation as a correlative to non-disclosure, certainly one which is too broadly written but even a “reasonable” one, might result in the invalidity of the aggregate obligation (non-disclosure and non-use as well).  One needs to be careful that the baby isn’t thrown out with the bathwater…

In the example above of a themed childrens’ restaurant, I think arguably it would go too far to request a covenant that the proposed investor not engage in the area of themed restaurants if the negotiations do not succeed, even youth-oriented themed restaurants.  Perhaps if the prohibition extended to the particular theme in question the prohibition would be justifiable although just using the language of non-competition in this context may raise the risk of invalidity per se based on the common law doctrine that restraints of trade are, in principle, unlawful.    Where the “plain vanilla” obligation in all NDAs not to disclose or misuse confidential information should cover what the owner of the concept is really concerned with, and provided of course his concept was truly non-public (something not always easy to show), I see no benefit to adding a non-competition obligation to an NDA – only potential downsides.

I believe therefore in many cases, an NDA should be enough protection.  There may be cases where it needs to be supplemented by “something more”.  But care should be taken to ensure, especially in the post-Lyons v. Multari context (admittedly an employment case but one which shows the general trend of the higher courts these days), that a non-competition obligation can be justified by reference to its reasonableness, meaning that the additional protection it confers is truly necessary to protect the reasonable expectations of the owner of valuable non-public business information.  It will probably be the relatively rare case that requires this approach in Ontario.

The above notes are written once again from the practical angle, and to stimulate further thinking or research, as applicable, not as a strict legal explication.

About the Author
Gary Gillman holds undergraduate law degrees in Civil Law and Common Law from McGill University in Montreal, Quebec. He is a member of the Quebec Bar and has been a member of the Ontario Bar since 1983. He was trained and practiced for many years in nationally-known law firms in Montreal and Toronto, principally in numerous areas of corporate and commercial law. In 1995, he obtained a Master’s Degree (LL.M) with Distinction in European Management and Employment law from the University of Leicester in England. His training in the law of European economic and political integration allows him to help clients understand international business and legal trends, the North American Free Trade Agreement and economic globality. Gary regularly attends and speaks at professional conferences and keeps current on all the legal areas he covers. Gary has authored during his career numerous legal articles and papers for professional or trade journals. Gary co-authors the quarterly Gillman Financial Regulatory Report, a business law and financial law newsletter of our firm.