The nondisclosure or confidentiality agreement, commonly referred to as the “NDA,” is typically used in discussions for evaluating the potential for a new business relationship and as such, at this preliminary stage, neither party to the NDA wants to make any warranties regarding their products, services, or their business relationship when no value has yet been exchanged between the parties. From time to time, recipients of confidential information ask disclosers for a warranty regarding the accuracy of their confidential information, usually in one-way recipient favorable NDAs but also in some mutual NDAs. While such a warranty at first glance may seem innocuous, it can expose the discloser to significant liability.
RAA Management LLC v. Savage Sports Holdings (C.A. No. 577, 2011 (Del. May 18, 2012)). This case, decided by the Delaware Supreme Court in 2012, is informative on the potential liability that may arise from agreeing to accuracy warranties in NDAs. RAA Management LLC (“RAA”) was a potential bidder for the purchase of Savage Sports Holdings (“Savage”). After abandoning negotiations for the potential purchase, RAA sued Savage claiming $1.2 million in due diligence and negotiation costs, alleging that Savage had told RAA at the outset of their discussions that there were “no significant unrecorded liabilities or claims against Savage,” but then during RAA’s due diligence into Savage, Savage disclosed three such matters. The Delaware Supreme Court rejected RAA’s claim enforcing an express disclaimer in the NDA executed by RAA and Savage that provided that Savage was not making any representation or warranty, whether express or implied, as to the accuracy of the information furnished by Savage to RAA. Obviously, Savage’s liability would have been quite different (and potentially costing $1.2 million) if Savage had provided an accuracy warranty.
“But we need to be able to rely on the information provided.” This is the oft-repeated argument by recipients for insisting on an accuracy warranty in the NDA. However, aside from the point that the preliminary nature of discussions may not justify granting an accuracy warranty, the NDA is not the appropriate vehicle to grant such a warranty. The definitive agreement (or, if the opportunity is related to the supply or exchange of technology, an initial evaluation or trial agreement), aside from the NDA which should be separately executed, would be more appropriate.
Keep in mind that the main purpose of the NDA is to protect the discloser’s confidential information. Since direct damages associated with a confidentiality breach are small and the consequential damages (for example, lost profits) to the discloser’s business from such a breach may be significant, NDAs are structured to imposed unlimited liability on the breaching party. The reciprocal liability exposure for the discloser’s breach of its accuracy warranty may not, however, be justified. When giving an accuracy warranty in a definitive agreement, limitations on the type of information subject to such warranty, limitations on the recipient’s scope of use, applicability of exclusions, applicability of materiality thresholds to determine whether there has been a breach of such warranty, and exclusive remedies (for example, correcting the information) and limitations on liability if and when a breach occurs, are heavily negotiated. The parties’ mutual promises in the definitive agreement, the value exchanged between the parties, and the warranty terms that are standard based on the industry in which the discloser operates, are some of the factors that are considered during such warranty negotiations. An NDA should not specify such a warranty or any of these terms or limitations given its intended purpose. Also an ancillary consideration is that in many cases, given the business need to move quickly to initiate discussions on new opportunities, NDAs are often executed without an opportunity for legal review and a thorough understanding of the substantial risk associated with being the discloser of confidential information.
Concluding Tips. As a rule, therefore, if you are the discloser of confidential information, avoid providing an accuracy warranty (or, for that matter, any other warranty) in NDAs; there are more appropriate vehicles for such warranties that will come into play at a point in the transaction when value is exchanged between the parties justifying the risk undertaken by the disclosing party in providing such warranties. Also provide adequate time for legal review of warranties to limit the impact to your business from a breach of those warranties.