Surprising Contract Risks in Portfolio Company Contracts – Part 5

GTX Legal
Aug 25
4 min read

When purchasing a company (the “Target”), most institutional buyers (e.g., PE firms, hedge funds, and family offices) understand that the Target’s customer and vendor agreements can present significant issues depending on how the Target manages those agreements daily. Although the Buyer’s counsel will have an opportunity to diligence the Target’s contracts, budget constraints, document availability, and other factors can limit a thorough review. As a result, Buyers often close deals with the understanding that their new portfolio companies may have some contractual “warts” to address post-closing.

In the first four posts of this series, we explored three common contractual "warts" — the Most-Favored Nation (MFN) clause, limitations of liability, payment terms, and termination provisions. Now, let's shift our focus to another critical aspect of contracts: confidentiality. In this post, we'll dive into the challenges associated with confidentiality provisions and offer practical strategies for mitigating potential issues.

Understanding Confidentiality Provisions

Confidentiality provisions outline how the parties can use and disclose each other’s confidential information in connection with the goods/services being provided. The key elements a company should keep an eye out for when negotiating confidentiality provisions include:

The Definition of Confidential Information: This defined term outlines what information constitutes “confidential information” for purposes of the agreement and is protected, so it is very important to scope it appropriately. Unless circumstances dictate otherwise, it is generally a best practice to limit the definition to information shared by or on behalf of the disclosing party on or after the date of the agreement (rather than before) in connection with the provision of goods/services (rather than any information shared under any circumstance). Having a properly scoped definition helps the parties have clarity around what is and isn’t confidential information and subject to restrictions.
Disclosure to Representatives: There is almost aways a provision that allows the receiving party to disclose confidential information to a limited group of people (e.g. directors, officers, employees, lawyers, and accountants). There are three best practices to keep in mind with regards to this provision:
- First, the list should be limited to only those persons who have a need to know the confidential information to assist the receiving party in connection with its performance under the agreement.
- Second, the list of representatives should be limited and tailored depending on the situation. It should not include broad categories like “representatives” or “agents,” as those give the receiving party too much leeway as to who they can disclose confidential information to.
- Finally, the receiving party should be liable for its representatives’ breach of the confidentiality and use terms of the agreement.
Duration: There should be a provision stating how long a party is bound to the confidentiality terms, and the parties should ensure that term is appropriate based on the circumstances and what is being shared. It is best practice to include a set duration so these restrictions don’t survive indefinitely, but how long exactly is dependent upon the nature of the relationship, what is being shared and by who, and how the restrictions may impact a party’s business.
Return or Destruction: After the agreement expires or is terminated, it is best practice to require the parties to return or destroy the other party’s confidential information. This provision helps mitigate the risk of unauthorized use or disclosure of the confidential information by ensuring it is no longer accessible to the other party. A party may negotiate to include certain retention rights, but those should be limited as much as possible.

Failing to properly scope and negotiate an agreement’s confidentiality terms can have severe consequences, particularly if sensitive, strategic information is shared and not properly handled by the other party.

Treatment Plan

If a Buyer discovers that their new portfolio company has not adequately negotiated confidentiality terms in its various agreements, there are several steps to consider taking to address the issue:

Address the Source: Confidentiality provisions are often nuanced and require careful tailoring to fit the specific circumstances of each situation. Many companies lack internal resources to scrutinize confidentiality terms. This often results in accepting disadvantages confidentiality provisions that do not adequately protect the parties involved. A practical solution is to collaborate with cost-effective external legal counsel with experience in customer and vendor agreement negotiations to ensure confidentiality terms (amongst other things) are vetted and adjusted going forward.
Localize the Impact: Confidentiality provisions can have far-reaching implications if they are too vague or overly broad. Companies should prioritize reviewing existing agreements with their key partners and vendors who have access to the company’s sensitive information and consider renegotiating those agreements where the protections are inadequate (whether upon renewal or otherwise).

Institutional buyers are focused on creating value by enhancing the operations of portfolio companies. A crucial aspect of operational improvement they should consider is legal operations. By proactively addressing contractual issues, like problematic confidentiality, limitation of liability, termination, and MFN terms, institutional buyers can improve the contractual health of an organization and improve its overall value upon exit.

If you have any questions or want to discuss ways to improve your portfolio company’s customer and vendor agreements or legal operations overall, please feel free to contact us at: info@gtxlegal.com – we’d love to help!