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  • Writer's pictureAlex Keeley

What’s in Your NDA? – The Dangers of the “Residuals Clause”

Updated: Dec 21, 2021

We are all familiar with the Non-Disclosure Agreement (commonly referred to as an “NDA”); if you are doing any business, you are probably signing these agreements all the time (if you’re not, you might want to ask yourself why not). They are so commonplace these days in the business world, that many small business owners don’t even read them. Generally, the purpose of the NDA is to protect your, their, or both parties’ “Confidential Information.” As a small business, you may be interacting with larger businesses that have the potential to become rivals. Thus your goal of your NDA is to protect your ideas from being stolen. However, a growing trend in NDAs, especially NDAs which larger companies will require smaller companies to sign, is to include what is called a “residuals clause.” This is where you can run into trouble.

Let’s start with the basics of an NDA. NDAs will define what the parties mean by “Confidential Information,” and then move into how it can, or more importantly, cannot be used. When defining Confidential Information, the disclosing party generally desires this definition to be as broad as possible, so that their information is protected to the fullest extent possible. The flip side of that coin is that the receiving party (generally the large company) will look for loopholes, or carve-outs in the definition of Confidential Information. The most common examples of such carve outs are: “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.” These make sense, “If I could know it without talking to you, or I already knew it, it’s not confidential.”

The residuals clause takes this concept and adds a twist. In a residuals clause, any information that is “intangible,” or “unaided,” is excepted out of being Confidential Information. This is where it can get sticky if you are a small business. This could mean that interacting with the large company, sharing your great ideas, concepts, secrets could result in their smart people “remembering” your ideas and developing them independently. Then you will be left trying to sue them (already a daunting task given the cash flow discrepancy between you and them) and having to argue that their use was not “residual.” That is going to take some sort of smoking gun memo; i.e. some piece of evidence that their memory was aided by a tangible record or document. So the risk of the residuals clause is that the larger company can take your ideas and not pay you for them. Said simply: they have a free reign to rip you off.

What are the advantages of the residuals clause? As a large company, you can protect yourself if your engineers come up with something they happened to see while interacting with a smaller company. If you are a service provider, it might make sense to be able to develop your services through the interactions with the other company. But generally, if you are a smaller company interacting with a larger company, you will want their NDA to be scrutinized for any back-door carve outs like a residuals clause.

Here are some common examples of residuals clauses:

1. “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.”

– This means the receiving party can use your ideas so long as they don’t write them down!!! All they have to do is remember your ideas, and they are not confidential.

2. “Notwithstanding anything to the contrary herein, the receiving party may use Residuals for any purpose, including without limitation, use in development, manufacture, promotion, sale and maintenance of its products and services. “Residuals” means any information retained in the unaided memories of the receiving party’s employees who have had access to the disclosing party’s confidential information pursuant to the terms of the Agreement.”

– Again, this means all the other party needs to do is remember your proprietary formula for branding and franchising your stores, and they can use it for ANY USE (read compete with you!!).

3. “Notwithstanding the confidentiality obligations contained in Section [ ] hereof, the receiving party may, during and after the term hereof, use in its business any Residual Information. “Residual Information” means the ideas, know-how and techniques that would be retained in the unaided memory of an ordinary person skilled in the art, not intent on appropriating the proprietary information of the disclosing party, as a result of such person’s access to, use, review, evaluation, or testing of the Confidential Information of the disclosing party for the purposes described herein. An employee’s memory is unaided if the employee has not intentionally memorized the confidential information for the purpose of retaining and subsequently using or disclosing it. Nothing in this paragraph, however, shall be deemed to grant to the receiving party a license under the disclosing party’s intellectual property rights.”

– This is a little less broad (“ordinary person”) rather than any smart person, but it still means that if they remember your idea, its their idea. This Blog, and the information contained herein, are intended for informational use only. Nothing in this Blog should be construed as legal advice.

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