Beware: Residuals Clauses in your NDA

Non-disclosure agreements (NDAs) are a tool that CEOs, inventors, entrepreneurs and business owners normally use when they need to share trade secrets, proprietary or other types of confidential information with third parties but want the third party to keep their information confidential and not use it without permission.

The party that’s making disclosures shall be referred to as the Disclosing Party (“Disclosing Party”), presumably yourself, and the party that’s receiving the confidential information shall be referred to as the Receiving Party (“Receiving Party”).

The terms of the NDA are normally crafted for the benefit of the Disclosing Party to protect her/his confidential information, unless it’s a mutual agreement wherein the benefits of the agreement apply equally to both parties.

What are residuals clauses

Although the terms of the NDA are normally crafted in favour of the Disclosing Party, there’s one clause that could potentially result in the cancellation of the benefits of the agreement.

This clause is generally known as the “residuals” clause or “residual information” clause. Basically, this residuals clause allows the Receiving Party to share and use general information and concepts that are retained as a result of the working relationship, including confidential information.

Here’s an example of a residuals clause that’s very relaxed and broad in its scope, mainly because it’s used in a mutual agreement that benefits both parties:

The range of what is considered “residual” can vary widely in definition. This can include:

• Confidential information that’s retained only by unaided memory (that is, no notes, documents or anything was recorded but only what was retained in the mind).
• Confidential information that’s retained involuntarily (ie. not intentionally memorized) without any intention to steal.
• Confidential information that’s still retained by unaided memory after a certain time has passed after the completion of the contract.
• General information that’s retained that does not include any information that’s expressly marked as confidential.
• General confidential information that’s retained by unaided memory that does not include certain specific types of confidential information or specific ideas (eg. customer data or designs).
• General confidential information that’s retained which can only be applied to specific uses (eg. no competition uses).

Normally, a residuals clause is added to the NDA due to a push back by the Receiving Party. Of course, some Disclosing Parties may just automatically have a residuals clause in their agreements to avoid negotiations over this.

A Receiving Party may want to have a residuals clause in the NDA to avoid any lawsuits that could stem from them learning or developing new information as a result of their work with a Disclosing Party.

On a practical level, it can be very difficult to separate, segment and differentiate previous known information from new information that they develop during the working relationship.

A Receiving Party also may already be in the midst of a similar project to yours and they want to make sure that you’re not going to sue them if they were to independently come up with products and services that seem similar to yours.

A startup or big company may want to have a residuals clause because they’re worried that their employees may become compromised from your confidential information which affects their ability to do their own work.

Independent contractors who work with a lot of different clients and often from the same industry may find it difficult to remember where a general piece of information came from and even harder to keep track of all the different restrictions on confidential information. This is especially so if the independent contractor’s job is to develop stuff for their clients.

For example, you may hire a tech developer to write code for you. She/he may learn a new strategy of writing code during the course of the project that she/he wants to continue to use for future work with other clients. Though she/he may not use your specific codes, she/he has retained some general information about methods of writing better code.

There’s also another sinister side to NDA that Receiving Parties may be worried about. There have been cases where some Disclosing Parties misuse the NDA to share all types of confidential information with the Receiving Party, whether relevant or irrelevant to the work at hand, with the sinister intention of limiting the Receiving Party’s ability to ever compete with them in the future.

Potential problems of residuals clauses

Residuals clauses are generally for the benefit of the Receiving Party and not for your benefit as the Disclosing Party. The main problem with residuals clauses is that there’s potential for abuse.

For example, if you have a residuals clause in your agreement that allows the Receiving Party to retain confidential information with unaided memory, what if the Receiving Party has a photographic memory? Or worse, what if the Receiving Party is unethical and goes home and writes down what she/he remembers in their own personal notes? How will you ever find out and how can you prove it?

Not only that but if you haven’t limited the permitted sharing and uses of the retained confidential information, then the Receiving Party can also share the information with third parties, including your competitors.

Don’t sign an NDA with a residuals clause

There are a few situations where it’s especially dangerous for you to allow residuals clauses in your NDA:

• Trade secrets

  Where you have trade secrets that you intend to share with another party, you should never allow a residuals clause.

  Trade secrets bear special protection status under statute and common law because it derives inherent independent economic value from not being known to the public.

  As the owner of a trade secret, you have a legal obligation to take reasonable efforts to ensure that its secrecy is maintained, otherwise, the information loses its trade secret status.

  If a Receiving Party believes that they have the right to share your trade secret with the public, or worse, reveal it to your competitors, your trade secret status will potentially be destroyed.

• Where your business’ survival is dependent on the confidential information

  If you have particularly sensitive technology or confidential information upon which the survival of your entire business is based, then you need to be particularly protective of your confidential information.

  Make sure that you don’t allow yourself to be pushed around, especially if the Receiving Party is a potential competitor or works for other competitors in your industry as well.

• Patents and copyrights

  You should never include any rights under patents or copyrights under the residuals clause.

  Make sure that you explicitly exclude the grant of any patent or copyright licenses in the agreement.

The compromise around residuals clauses

If you’re unable to get around with not having a residuals clause in your NDA, then there are several compromises that you can make to ensure that the Receiving Party feels comfortable that they won’t be unduly restricted in their future work but you still receive sufficient protection for your confidential information.

1. Use a narrow definition and scope

   As much as possible, try to narrow down the scope and definition of the residuals clause.

   For example, you could state the residuals clause should only apply to general confidential information that’s retained unaided in the Receiving Party’s memory after a time lapse of 6 months and that any such retention of information can only be for the Receiving Party’s own general use and not to create any product or service that is in direct competition to you.

   You can state that under no circumstances can specific confidential information be included in this category.

   In other words, the Receiving Party is not allowed to make notes or record anything down in relation to your confidential information.

   Although this clause could be more restrictive, this clause from the European IPR Helpdesk’s Mutual NDA does at least provide that the Receiving Party cannot act in breach of the agreement:

   

2. Have separate categories of confidential information

   If you have particularly sensitive confidential information, you could provide a separate category for those and state that the residuals clause will not apply to that type of confidential information.

   In other words, complete confidentiality must be preserved for such special information.

   For example, you could state that the residuals clause shall not apply to customer data, financial records, your business plans, your supplier list and a specific source code or design.

3. Restrictions on key personnel

   If you’re working with a particularly large company that employs a lot of employees or contractors and a few have been picked to work with you, you could request that those key personnel that will have access to your confidential information are prohibited from working on work similar to yours for a defined period of time.

   This compromise may be hard to achieve especially if the company’s work is only focused in a few limited areas and/or they don’t have a lot of rotating staff to spare.

4. Independent contractor restriction

   You may negotiate with an independent contractor to see if she/he will agree to avoid work similar to yours for a specific period of time.

   Depending on the length of the prohibition, she/he may agree to it or may rather prefer to remove the residuals clause entirely.

5. Prohibit sharing of information with third parties

   There’s no reason why the Receiving Party needs to share your information with a third party so you could state that any general information retained cannot be shared with a third party.

6. Mutual obligations under the same NDA

   If the Receiving Party is going to be sharing confidential information with you as well under a mutual NDA (where both of you have obligations of confidentiality towards the other), a residuals clause may be appropriate as both of you will similarly benefit from such a clause.

1. Expressly state that no rights are to be granted

   It’s very important that you state in your residuals clause that no license or rights under copyrights or patents are to be granted.

   Here’s an example of a clause from Microsoft’s Confidentiality Agreement for Licensing Discussions:

   

2. Limit your disclosures

   The best thing to do is to limit the amount of sharing of confidential information to only what is truly necessary to be shared.

In summary, since a residuals clause is mainly for the benefit of the Receiving Party, you should try to avoid it entirely in your NDA if you’re the Disclosing Party.

If you cannot, then you should seek a suitable compromise that does not jeopardize your confidential information.

The exception to this is if you’re creating a mutual NDA. If so, a residuals clause may be helpful for both parties to avoid any conflicts over similar or competing projects.

Credits. Icon “Share Document” created by Nikita Kozin from the Noun Project.