7 November 2016 by and Corporate and Commercial Alert

Beware of excluding liability for consequential damages in confidentiality agreements

Confidentiality or non-disclosure agreements (NDAs) may limit or exclude the parties’ liability for damages in certain circumstances. Clauses such as “in no event shall either party be responsible to the other for indirect, special or consequential losses” are commonplace and are often accepted during contract negotiations, sometimes only subject to them being reciprocal. A clause such as the one above may appear to be standard and to the benefit of both contracting parties, but in the context of a NDA, this clause can have severe consequences for the business owner disclosing confidential information.

In Lavery and Co. Ltd v Jungheinrich, 1931 AD 156, the courts distinguished between:

  • “general damages” as damages that flow naturally and generally from a breach of contract and which the law presumes that the parties thought would result from such a breach of contract; and
  • “special damages” as damages that, although caused by the breach of contract, are ordinarily regarded in law as being too remote to be recoverable, unless the parties when entering into the contract, actually contemplated that such damages would likely be caused from a breach of the contract and agreed that the defaulting party will be liable in the event of such breach.

“Indirect damages” and “consequential damages” refer to indirect or consequential damages that flow from a breach of contract which damages will not constitute “general damages” or “special damages”.

When the person who received the confidential information shares or uses it in breach of a NDA, the business owner who disclosed the information may suffer indirect, special or consequential losses. For example, to attract a private equity investor or joint venture partner, the owner of a start-up may need to disclose her trade secrets, ideas, intellectual property and customer information to such investor. They then enter into a “standard NDA” to protect the business owner, stating that “the investor must keep the confidential information confidential”, but also stating that “neither party will be liable for special, indirect or consequential losses suffered by the other parties”. If the potential investor or joint venture partner breaches the NDA and divulges the start-up owner’s trade secrets, ideas, intellectual property or customer information to another of its investee companies or sells the confidential information to a third party in breach of the NDA, the investor or third party could potentially use the confidential information to make a huge profit. The courts may find that the only damage suffered by the start-up is a loss of profits that constitutes indirect, special or consequential losses. As the parties expressly excluded liability for such special, indirect or consequential losses in the NDA, the start-up will have lost its trade secrets, ideas, intellectual property and customer information (likely its biggest asset) and will have no remedy for loss of profits against the potential investor or partner. Claiming special damages will be easier if the NDA includes a clause stating that “the business owner will be able to claim special damages if the confidentiality provisions are breached”.

Damages for breach of contract aim to put a party in the position such party would have been had the contract been properly performed. The start-up in the example above might be able to prove the benefit to the receiving party or a third party, but it will be difficult for the start-up to prove the actual loss that it suffered.

Entering into a NDA does not afford a business owner who needs to share its confidential information with absolute protection, but by remembering the following points when negotiating a NDA, the business owner can reduce its risk:

  • check whether the agreement will apply one way (if only one person is disclosing information) or both ways (if both parties are disclosing information);
  • clearly define what constitutes “confidential information”;
  • agree that confidential information may only be used to evaluate the business or business opportunity;
  • define the durationof the agreement (expect that the business owner will want to make this as long as possible and an investor will want it as short as possible); and
  • don’t agree to limit or exclude liability for special, indirect or consequential damages where a party breaches its confidentiality obligations, or the NDA may not be worth the paper it is written on.
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