Revisiting the Standard NDA After ZeniMax v. Oculus

On February 1, 2017, a Dallas federal jury in the Northern District of Texas handed down a $500M verdict in the high-profile case ZeniMax Media Inc. v. Oculus VR, Inc. (Civil Case No. 3:14-cv-01849-P (Kinkeade, J.).  The jury found that defendants Oculus and Palmer Luckey, Oculus’s founder, breached a non-disclosure agreement (NDA) entered into with ZeniMax in 2012. A pioneer in virtual reality (VR) technology, Oculus was acquired by Facebook in 2014 for $2 billion. That same year, ZeniMax filed the suit against Oculus and Luckey, and later joined Facebook as a co-defendant. The suit alleged, among other things, breach of the NDA, misappropriation of trade secrets, and copyright infringement. Of the $500 million in damages awarded by the jury against Oculus in favor of ZeniMax, $200 million pertained to breach of the NDA.

Most technology enterprises are well-acquainted with NDAs. On the positive side, they recognize the importance of entering into NDAs with outside parties before disclosing confidential information, whether in the context of discussions related to potential commercial transactions, funding, or joint R&D projects, or for other purposes, such as to support product-related investigations or certification activities. On the negative side, enterprises commonly associate the negotiation of NDAs with cumbersome paperwork, obstacles, and delay.

As discussed below, ZeniMax offers useful insights for enterprises seeking to maximize the benefits of NDAs while minimizing the time and effort needed to negotiate them.

The Problem with Some NDAs

NDAs are not immune from the realities of negotiation. Indeed, the process of reaching a meeting of the minds is often complicated, unpredictable, and time-intensive, even when a transaction appears straightforward at the outset. Nevertheless, enterprises may fall into the trap of adopting corporate NDA templates with provisions that most counterparties perceive as unnecessary or unreasonable. Moreover, during negotiations, they may operate with the conviction that such provisions are needed to protect the enterprise, digging in their heels over counterparties’ objections. Taken together, these approaches may substantially increase the time and effort required to negotiate NDAs across the enterprise. In the minds of stakeholders, the negotiation process may seem to overshadow the very transactions that NDAs are intended to facilitate.

The ZeniMax NDA

The NDA executed by Palmer Luckey and ZeniMax is not publicly of record in ZeniMax, but pertinent excerpts are reproduced in the Complaint. The term “Proprietary Information” was defined in the NDA to mean, in part:

[A]ll information and know-how, regardless of whether or not in writing, of a private, secret or confidential nature that relates to the business, technical or financial affairs of the Disclosing Party [i.e., ZeniMax], its parent, subsidiaries, affiliates, licensors, customers, potential customers, suppliers or potential suppliers provided or disclosed to the Receiving Party [i.e., Luckey] or which becomes known to the Receiving Party, whether or not marked or otherwise designated as “confidential”, “proprietary” or with any other legend indicating its proprietary nature.

Illustrative examples of such information were provided within the definition. The NDA also imposed confidentiality duties on the Receiving Party:

a. Maintenance of Confidentiality. With respect to the Disclosing Party’s Proprietary Information, the Receiving Party undertakes and agrees that Receiving Party shall secure and keep such Proprietary Information strictly confidential and:

[…]

(ii) Restrict disclosure to those of its directors, officers, employees or attorneys who clearly have a need-to-know such Proprietary Information, and then only to the extent of such need-to-know, and only in furtherance of the Proper Purpose;

(iii) Use such Proprietary Information only for the Proper Purpose and not disclose such Proprietary Information other than as set forth above unless the Disclosing Party shall have expressly authorized such disclosure in advance in writing; and

(iv) Not use any Proprietary Information to compete or obtain any competitive or other advantage with respect to the Disclosing Party.

The NDA further stated that the Proprietary Information was to remain the property of the Disclosing Party:

b. Ownership. All Proprietary Information, including but not limited to that which is contained in files, letters, memoranda, reports, records, data, sketches, drawings, notebooks, program listings, or other written, photographic, or other tangible, intangible, or other materials, or which shall come into the Receiving Party’s custody or possession, is and at all times shall be the exclusive property of the Disclosing Party, and shall be used by the Receiving Party only for the Proper Purpose.

Thus, with the stroke of a pen, Luckey became bound to an NDA whose breach led to a massive damages award.

Necessary Ingredients of an Effective NDA

The outcome in ZeniMax is an important reminder that NDAs remain a fundamental and powerful tool to protect an enterprise’s proprietary information and provide a legal remedy in the event of a breach. Yet, a review of the above ZeniMax NDA excerpts leads to an obvious conclusion: This was just a standard NDA. That is, the ZeniMax NDA employed standard NDA language that many an attorney has read hundreds of times and expects to see in any reasonable NDA, whether drafted by one’s organization or proposed by a counterparty. Except for the $200 million in damages awarded for its breach, nothing about the NDA’s language looks particularly clever, unconventional, or exceptional. In short, the ZeniMax NDA included necessary ingredients that were deemed enforceable and secured ZeniMax a substantial remedy.

Like the ZeniMax non-disclosure agreement, to be effective, a non-disclosure agreement should include the following six key components:

1. Purpose. An NDA should clearly articulate its purpose—that is, why information is being exchanged—and reference that purpose in connection with confidentiality and use obligations set forth elsewhere in the NDA. Whenever possible, the purpose should be defined with specificity so that the NDA clearly expresses the parties’ mutual intention regarding how disclosed information can be used.

2. Definition of proprietary or confidential information. An NDA also should clearly define what types of information will be considered confidential. Often, broad, inclusive definitions may be appropriate, with no distinction made between written and oral disclosures. Other times, narrower definitions may be employed, such as definitions limited to specific documents or datasets to be disclosed. Exceptions to what constitutes confidential information, such as information disclosed to the public through no fault of the receiving party, should be enumerated.

3. Confidentiality and use obligations and their duration. An NDA should clearly and unambiguously describe the duties or obligations being imposed on the party receiving information, and for how long such obligations persist. This includes positive duties—what can a party do with the information—and negative duties—what must a party refrain from doing with the information. 

4. Permitted recipients. An NDA should expressly list parties with whom the receiving party can share the disclosed information, as well as conditions for sharing, such as entering into NDAs with downstream recipients, notifying the disclosing party in advance of disclosure, and the like.

5. Intellectual property (IP). An NDA generally should only address IP with a statement that the parties retain their respective background IP, and that no IP licenses are being granted by the NDA.

6. General legal language. As with any contract, an NDA needs appropriate general language, such as governing law and integration clauses. However, an NDA may be enforceable in many jurisdictions without resorting to the full battery of clauses typically seen in complex contracts. NDA negotiations may be significantly streamlined across an enterprise if compact, concise templates are employed.

Tactics to Avoid When Drafting and Negotiating NDAs

Some enterprises or their legal advisors view NDAs not just as tools to bind third parties to secrecy, but also as vehicles for pursuing additional rights, such as IP rights. To attempt to secure such rights, they may embed relatively aggressive provisions in standard NDA templates or in drafts received from counterparties. When assessing the sufficiency of an NDA form for use across the business, they also may neglect to think through certain practical or legal considerations, thereby adopting a deficient template for widespread use. These approaches inevitably prolong the negotiation of NDAs because astute counterparties will object to substantively unreasonable positions and highlight other deficiencies. In the final analysis, the iterative exchange of NDA revisions and conducting of negotiation sessions circuitously may lead to a final NDA version that, like the ZeniMax NDA, includes the necessary ingredients discussed above. However, delays attributable to the negotiation process often block parties from timely exchanging information and realizing the benefits of collaboration.

In general, the following eight tactics are counterproductive to the expeditious negotiation of NDAs, especially when leveraged as an enterprise’s default positions.

1. Intellectual property ownership provisions. Some NDA templates include language that purports to give a party ownership of IP, such as IP resulting from discussions under the NDA or IP created based on a party’s use of disclosed information. While appropriate in some cases, this language may be highly objectionable to the proposed non-owning party for various reasons. For example, at the time an NDA is being negotiated, it is often unclear or speculative what, if any, valuable IP the parties plan to disclose, what new IP hypothetically might result from the parties’ exchange of information, and which party is likely to contribute most to the invention of such new IP. Also at the negotiation stage, the parties may not have discussed, let alone agreed upon, a framework to govern a prospective business relationship, including a scope of work and commercial terms. As such, it may be premature to formulate a meaningful IP ownership structure. Given the potential detriment to the non-owning party, such party may assert that IP ownership should be negotiated later and memorialized in more robust commercial or development contracts. In sum, the inclusion of IP ownership, or even IP licensing, clauses in a draft NDA may signal a need for the parties to negotiate more than simply an NDA.

2. Imposing a one-way NDA. At times, an enterprise seeks to impose a one-way or unilateral NDA form on a counterparty, knowing quite well or having reason to believe that the counterparty has confidential information of its own that it needs to disclose during the parties’ interactions. This approach results in needless effort and delay since either the NDA must be manually converted into a mutual or bilateral NDA, or the negotiation process must be restarted with a mutual NDA form.

3. Requirements to hand over derivative materials. Some NDA templates require that the receiving party, at termination or expiration of the NDA, hand over to the disclosing party any and all derivative materials created by the receiving party based on or related to the disclosed information. The receiving party may perceive this requirement as another inappropriate attempt to gain access to, or ownership of, IP.

4. Requirements to destroy all disclosed materials. An NDA template also may require that the receiving party destroy all disclosed materials. Because many enterprises utilize backup or archival regimes as part of their IT systems, it may be impracticable for the receiving party to fulfill such a requirement with respect to information disclosed in electronic form. Further, it may be reasonable for the receiving party to retain a copy of certain disclosed information for evidentiary purposes should a breach of the NDA ever be alleged.

5. No flexibility for affiliates to receive or disclose information. Large enterprises, including multinational corporations, frequently operate through affiliated companies that collaborate on transactions. An NDA form that does not contemplate participation of the parties’ affiliates as disclosers or recipients may need to be revised during the negotiation process. Additionally, if an affiliate framework is absent from an NDA at the time of its execution, amendments will be needed later if an affiliate must receive or disclose information consistent with the NDA’s purpose.

6. Too broad a list of permitted recipients. An NDA that allows the receiving party to share disclosed information with contractors or other agents retained by the receiving party may be of concern even if the purpose of the NDA is narrowly defined. For instance, a supplier/disclosing party may fear that a customer/receiving party may share the supplier’s proprietary information with a competing contractor that also supplies components to the customer, particularly where the supplier and contractor supply equivalent or interfacing components.

7. Confidentiality obligations of short duration. An enterprise may assert that only NDA confidentiality obligations lasting a relatively short period—for example, 3 years—are acceptable. However, if the counterparty intends to disclose trade secret or other highly-sensitive information, such a duration likely will be unacceptable. An NDA form that includes a multi-tier structure, such as a 3-year confidentiality period for information other than trade secrets, and a longer period for trade secrets, is often a better approach.

8. Requirements for paper originals. Requiring the execution, exchange, and retention of original hard copies of NDAs may consume valuable time and resources without material benefit. Unless prohibited by applicable law, a party should embrace the use of electronic technology to eliminate paper-intensive activities surrounding the execution of NDAs. This includes the use of electronic signatures and related software, as well as treating scanned executed NDAs as legally binding contracts.

Conclusion

Much to the chagrin of Oculus and Facebook, the ZeniMax NDA and subsequent jury award remind us that standard NDAs are highly effective. Thus, to maximize the benefits of NDAs and minimize business disruptions and delay stemming from the negotiation process, enterprises should craft and negotiate NDAs with an emphasis on what is reasonably necessary. Over-engineering corporate NDA templates and taking default positions that will be untenable to reasonable counterparties should be avoided. A prudent approach will lead more quickly to fully-executed—and enforceable—NDAs so that parties can actually sit down to do business.

NOTE: This article reflects my current personal views and should not be necessarily attributed to my current or former employers, or their respective clients or customers.