Private Equity

The Confidentiality (or Non-Disclosure) Agreement (NDA) is the most maligned, and the most likely to be given short shrift, of the many contracts involved in the M&A process.  Because an NDA must be negotiated and signed simply to get access to information that can result in a quick decision not to waste any more effort pursuing a particular transaction, it is difficult for most private equity buyers and their portfolio companies to invest any significant time in understanding the potential pitfalls an NDA can present long after they have walked away from a potential transaction.  In most cases, the approach is to limit negotiation to only the most critical items (although there is not always full appreciation of or agreement on what those items are) and get the NDA signed as quickly as possible.  Once the NDA is signed and the information is obtained that generates real interest in pursuing a transaction, private equity buyers are much more willing to invest the time and effort to negotiate each and every additional contract that is a necessary part of the M&A process.  But like it or not, the agreements made in that little-thought-of NDA, quickly signed to get access to information that enabled you to determine you were not interested in pursuing a transaction at all, remain just as binding as the more thought-through agreements negotiated as part of an acquisition deal that actually happened. And the risk of claims arising when an NDA is executed with an “intermediary,” who is promising access to another party, are particularly acute when the deal does not go forward through that intermediary.

Among the most basic of the many agreements encompassed in a typical NDA is the agreement to keep the “confidential information” confidential, and to use that information only for the purpose of evaluating the potential transaction. But to properly evaluate that information, the named party to the NDA must be permitted to share that information with its financing sources, advisors and certain of its “affiliates,” whose input or approval will be required to actually pursue the proposed transaction.  Permitting the sharing of this information with these representatives or other recipients is typically one of those “critical items” that will actually be negotiated in the NDA.  But the distinction between allowing certain “affiliates” to have access to the confidential information to assist the named party in evaluating the proposed transaction and actually binding those “affiliates” to the NDA is even a more critical one, particularly in the private equity world.  Nothing is more basic to private equity deal making than shielding the private equity firm and its funds from liability for the obligations of the fund’s affiliated acquisition vehicles and portfolio companies; and this certainly includes liabilities for breach of an NDA.^[1]

Knight Capital Partners Corp. v. Henkel AG & Co., KGaA, No.18-2189, 2019 WL 3162486 (6th Cir. July 16, 2019) is a recent illustration of the importance of this distinction, as well as the nightmare that can arise from claims made under an NDA that was entered into with an intermediary when an actual transaction never occurs.  Henkel Corporation (Henkel US) was the U.S. subsidiary of Henkel AG & Company, KGaA (Henkel Parent Co.).  Knight Capital Partners Corporation (KCP) held a license from AI Sealing, LLC (AIS) related to AIS’s purported patent for a citrus-based compound developed for cleaning oil rigs and refineries.  KCP approached Henkel US concerning a potential marketing and distribution deal for products that were to be based upon this citrus-based technology.  But before commencing negotiations, Henkel US and KCP entered into an NDA.  During the negotiations with KCP, which involved representatives of Henkel US and Henkel Parent Co., a representative of Henkel Parent Co. allegedly requested “direct access” to AIS, which KCP refused.  Negotiations between the Henkel entities and KCP thereafter cooled, and AIS terminated its license with KCP, which was apparently conditioned upon the distribution deal being timely completed between KCP and Henkel US.  AIS then allegedly approached Henkel Parent Co. and Henkel Parent Co. informed KCP that its negotiations with KCP were on hold pending the possibility of a direct deal being negotiated between AIS and Henkel US.  Although no deal was ultimately done by Henkel US or Henkel Parent Co. with either KCP or AIS, KCP sued Henkel Parent Co. (not Henkel US) for breach of the NDA, claiming that Henkel Parent Co. “used confidential information it acquired through the NDA to develop the product on its own.” The trial court suggested that the evidence was that there had been no breach of the NDA by either Henkel US or Henkel Parent Co.  But the trial court granted summary judgment in favor of Henkel Parent Co, the sole defendant, based on the simple premise that Henkel Parent Co. was not a contracting party under the NDA, only Henkel US and KCP were. 

The Sixth Circuit affirmed the trial court’s judgement.  While Henkel Parent Co. was clearly an “affiliate” of a “Party” to the NDA (i.e., “any individual, corporation or other business entity, which directly or indirectly, controls a Party, is controlled by a Party, or is under common control with a Party”), and therefore entitled to receive the confidential information as a defined “Receiving Party” under the NDA, Henkel Parent Co. was not actually bound by and liable for breaches of the NDA as a contracting Party, only Henkel US was.  In other words, only Henkel US was responsible for alleged breaches of the NDA, whether they were the result its own actions or those of Henkel Parent Co., its parent.

And this formulation is the common approach in the private equity world, where the acquisition/pursuit vehicle or the portfolio company is the only named party to the NDA, but a defined group of representatives or permitted recipients, including certain affiliates, are identified as being persons with whom the named party is permitted to share confidential information, and the named contracting party agrees to be liable for violations of the NDA by those other permitted recipients.  But NDAs will on occasion purport to bind affiliates, and this is certainly a possibility depending on whether the entity, or persons signing on behalf of the entity, that is the named party to the NDA has actual or apparent authority to do so.^[2]

Although summary judgment was ultimately obtained, this dispute was litigated for over three years because a middleperson with whom a potential counterparty had entered into an NDA apparently felt cut out of a deal that in fact was never consummated.  That’s the potential nightmare that needs to be considered anytime these intermediary arrangements are contemplated.  Getting the language right in the NDA is paramount, of course, but avoiding these situations unless absolutely necessary is even better.