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Be Aware of Residuals Clauses in Non-Disclosure Agreements

JULY 2008

Cohen, David, ASSOCIATE

The purpose of a Non-Disclosure Agreement ("NDA") is to define the type of information which should be considered confidential in the context of a particular relationship between parties, and to state what those parties may or may not do with such information. A recipient of confidential information under a standard NDA is generally precluded from using or disclosing the information to any third party without the discloser's consent.

The definition of the term "Confidential Information" is often a central point of contention when negotiating an NDA. As a general rule, the discloser of information aims to maximize his protection by broadening the definition of confidential information, while the receiver attempts to limit the scope of the NDA by "carving" certain types of information out of the definition.

Common examples of information that a receiving party may want to carve out of an NDA include: information that was already known to the receiving party prior to disclosure by the disclosing party, information which at the time of the disclosure is generally available to the public or information which was independently developed by the receiving party.

Residual clauses aim to exclude "residual information" from an agreement's definition of confidential information. The term "residual information" is understood as meaning - general or generic information which is retained unaided in the memory of a receiving party - where the word "residual", as used in this context, means "remaining as residue". In other words, residual information is the information residue, or imprint, left in the mind of a recipient after having been exposed to a discloser's information. In this respect, memory should be considered unaided if no steps have been taken to intentionally memorize information for the purpose of retaining and subsequently using or disclosing it. Depending on the qualifications and aptitude of the individual receiver, in many cases, residual information transcends mere memory to become an inherent part of the receiver's professional knowledge or skills.

The following is an example of a residuals clause:

"Receiving party may enhance its knowledge and experience retained in intangible form in the unaided memories of its directors, employees, contractors and advisors as a result of viewing Disclosing Party's Confidential Information. So long as Receiving party complies with its obligations with respect to the Confidential Information set forth above, Receiving Party may develop, disclose, market, transfer and/or use such knowledge, experience and intellectual property that may be generally similar to Discloser's Confidential Information, and Disclosing Party shall not have any rights in such knowledge, experience or intellectual property nor any rights to compensation related to the Receiving Party's use of such knowledge, experience or intellectual property".

Although the term "residual information" may suggest unimportance or triviality, in fact it can be extremely significant. It is important to note that information considered to be residual, is considered as such mainly because of the method by which it is maintained after it has been disclosed (i.e. unaided memory, experience etc.), rather than because of its subject matter. Consequently, although the content of residual information should always be generic, the nature of such content can in theory range from meaningless to highly confidential.

In view of the above, accepting residuals clauses in an NDA can be risky for a disclosing party and may drastically reduce the protective value of the NDA. A recipient who is being sued for unlawful disclosure or use of confidential information under an NDA which includes a residuals clause, would more certainly than not claim that any information so disclosed or used falls squarely within the definition of "residual information" and, because such matters are inherently vague, it may be difficult for the discloser to prove otherwise. It is not entirely unreasonable to argue, as some do, that residuals clauses are, essentially, a license to expropriate trade secrets.

That said, there is of course a legitimate argument in favor of including a residuals clause in an NDA. The underlying rational which justifies the exclusion of residual information from an NDA stems from the fact that residual information, once internalized by a recipient, may at times become, without wrongful intent, an inherent component of his or her professional knowledge and skills. Consequently, without a residuals clause, a recipient of residual information would risk having to abstain from making future use of certain "tainted" parts of his or her skills. As many technology based service providers may retain large quantities of residual information in the regular course of their business activities, non inclusion of a residuals clause would, ultimately, result in precluding them from working in their field.

It should be noted that under U.S. case law it seems that genuine residual information obtained by an employee during the course of his or her employment, is likely to be protected by the courts even if a residual clause was not included in the employee's NDA. Moreover, there have been instances where U.S. courts have refused to enforce residual clauses aiming to restrict an employee's use of residual information after the termination of his or her employment.

Nevertheless, it is advisable for the disclosing party to attempt negotiating the removal of a residuals clause. If the receiving party insists on keeping the residuals clause in the NDA, the disclosing party should consider disclosing as little as possible. Also, the definition of "Residual Information" should be as narrow as possible and should not allow for any exceptions to the receiving party's overall confidentiality obligations. A receiving party should be permitted to use residual information to gain generic or peripheral knowledge in its business activities, or to enhance its ideas, concepts, know-how and experience only – specific information should be excluded. Certain types of information, such as customer data, or

personally identifiable information, should be carved out of the definition of residual information. In no event should the receiving party be permitted to disclose, (as opposed to use), any of the confidential information it receives from the disclosing party. The residuals clause should be made mutual. A disclosing party should make clear that a memory is not considered "unaided" with respect to certain information if such information is remembered using mnemonic devices, notes, or other documents, or if it was intentionally memorized in any other way. Other solutions could include limiting information disclosure in the initial phases of negotiation to personnel who are incapable of utilizing such information for performing development (managers and not engineers), limit the disclosure of non-technological information, or, limiting the possible residual information to certain fields and not the core know-how of the disclosing party.

The author would like to thank Yaacov Houdijk, Adv., for his assistance in the research for this article.

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