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Non-Disclosure Agreements May Not Protect Intellectual Property

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Recently I discussed the impact of the "work for hire" doctrine on intellectual property ownership. Another risky situation involves disclosures made to potential investors or partners in the course of negotiating a "deal." After the negotiations fail, the individuals receiving the disclosure develop something substantially similar to what the creator disclosed. Conventional wisdom favors non-disclosure and confidentiality agreements prior to disclosure. A recent federal District Court decision demonstrates the potential ineffectiveness of these agreements (nClosures Inc. v. Block and Co., Inc.).

The parties to the negotiation in question signed a "Confidentiality and Non-Disclosure Covenant." Subsequently there were disclosures of significant confidential information. The recipient used the information to create a similar product while asserting that the parties had a partnership. Even more information was disclosed. A few months later the recipient terminated the relationship while continuing to sell their manufactured items that were represented to be from the original creator. This misrepresentation resulted in an out-of-court unfair competition settlement.

The creator sued to prohibit any use of its intellectual property but lost by summary judgment without a trial. Its arguments were ineffective. Why did this happen?

The Court rejected the creator's arguments.

1. The creator asserted that false assurances of a partnership were fraudulent while the defendant considered this to be merely a statement of opinion. Without more than the assertion that a partnership existed, the fraud argument would likely fail. Here, the disclosures were made seven months before any statements about a partnership were made. Consequently, the creator could not have disclosed information in reliance on partnership status.

2. The creator asserted trade secret misappropriation. The confidentiality and non-disclosure agreement stated that it was entered into "relative to a potential business relationship..." Subsequent negotiations failed to produce an agreement. Additional disclosures made after these negotiations ended were likely not covered by the limited description contained in the agreement. Furthermore, according to the Court, even before the negotiation in question the creator had failed to take reasonable steps to keep the information secret. The creator did not have a written confidentiality and non-disclosure agreement with its own designer or the manufacturer of its product. The creator asserted that it had relied upon "industry practice that its confidential information would be maintained in confidence" by its manufacturer. The Court found insufficient evidence of "reasonable efforts to maintain the secrecy of its design files."

3. The creator alleged breach of fiduciary duty. While a fiduciary duty may exist between partners, the parties did not jointly share profits and losses, a central requirement to have a partnership. Additionally, draft documents produced in the incomplete negotiation stated that nothing in the conduct of either party "shall be deemed to constitute an agent, partner, joint venturer or employee of the other." Under these circumstances no fiduciary duty existed.

4. The creator asserted breach of contract. The court stated that the confidentiality and non-disclosure agreement would only protect information that was actually confidential. Having already determined that the creator failed to take reasonable steps to maintain confidentiality, the Court ruled against the creator on the breach of contract claim.

This case contains several lessons. First, there must be confidential information or trade secrets in order to have a meaningful confidentiality and non-disclosure agreement. This requires the creator, at every step from design to manufacture, to obtain a series of confidentiality and non-disclosure agreements and constantly take visible steps to protect these trade secrets. Second, a confidentiality and non-disclosure agreement that only references a "potential business relationship" may only apply to that specific course of negotiation and not to subsequent activities. Third, conversations about a partnership do not create a partnership. Fourth, without some special relationship such as a partnership, parties have no fiduciary duties to one another. Negotiators in general have no special duties of "fairness" or "good faith." Finally, the active advice of an experienced attorney before disclosing intellectual property is essential and well worth the cost.