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Luckey breach of NDA not so lucky for Facebook

No doubt you will have seen the headlines flooding social media sites in recent weeks to report that Facebook has been ordered to pay damages totalling $500 million to ZeniMax for various IP related infringements. A pretty hefty figure and a sum of money you might think you would never have to pay up. However, the scenario that tripped Facebook up is probably one that it would be dangerously easy to find yourself in, whatever side of the transaction spectrum you are on – and whether you are an investor or an entrepreneur looking to secure funding, there are lessons to be learned here.

Why was Facebook in trouble?

The damages awarded were actually against Oculus VR (a company bought by Facebook back in 2014 for roughly $2 billion) and its two co-founders, Palmer Luckey and Brendan Iribe. Oculus was a start-up tech company specialising in virtual reality – with Luckey billed as the genius rising star developer. Luckey commenced discussions with programmer John Carmack, widely considered to be an expert innovator in the field of virtual reality, about the development of Oculus technology. At the time, Carmack was an employee of id Software (a subsidiary of ZeniMax) but he subsequently jumped ship to become CTO of Oculus.

ZeniMax’s allegations form a pretty tangled web of IP related claims against all the parties involved, including Facebook. However, for the purposes of this blog I’m going to focus on the principal damages award (of $200 million against Oculus). Interestingly, this was not for theft of trade secrets, patent, trade mark or copyright infringement – but for breach of a plain old confidentiality agreement, which Luckey signed up to when he started chatting to Carmack about potential development ideas.

What is a confidentiality agreement?

A confidentiality agreement (also known as a “non-disclosure agreement” or “NDA”) is a frequently used and beguilingly simple document (or at least it should be). However, if used casually or carelessly it has the potential to strip away the value of a company – arguably something Luckey is guilty of here. The main reason, or risk, with an NDA is that, whilst it should be one of the most straightforward of agreements, its objective is often misunderstood.

The purpose of an NDA is purely to cover off and make clear the obligations of confidentiality on parties in respect of preliminary, commercial discussions. Essentially, it is good practice to use an NDA in all initial business discussions where confidential information may be disclosed (and certainly it proved that way for ZeniMax). In Scotland, obligations of confidentiality can sometimes be implied in the absence of a written agreement but it is far better to use an NDA wherever possible. This provides greater clarity both in terms of what information is considered confidential and also for what purposes the information is being disclosed.

In theory, that is it. In practice, parties usually have to contend with lawyerly bells and whistles and attempts by the other party to sneak in more onerous obligations – a common example is an indemnity provision, which is now pretty much a standard term in many NDA templates. More concerning is where an NDA includes contract terms which clearly have no place in a confidentiality agreement. From an IP perspective, this means any clause which seeks to grant any rights over your IP, or clarifies what is to happen to any IP created under the agreement – if you are signing up to an NDA with these types of clauses, you are not signing the right agreement. The purpose of an NDA is purely to cover initial discussions. If you are doing anything more than simply discussing a commercial arrangement, then you should be considering whether you need a full commercial agreement in place to cover that arrangement – this could be an evaluation licence, material transfer agreement or simply a contract for the supply of services. Whatever the situation, an NDA is not the answer once you’ve passed the point of preliminary discussion.

What do you need to consider?

If you are an entrepreneur / start-up company there are a few things to bear in mind. The value and benefit of signing up to an NDA if you are going to be disclosing confidential information is clear. An NDA will give you the comfort you need that your information will only be used for the purposes you have set out in that document, and a means of enforcing this. There was no indication that the Oculus /Zenimax agreement included any clauses not appropriate to include in an NDA – the damages awarded were simply because Oculus breached its obligations of confidentiality under it. However, this also works to highlight the care that should be taken when signing up to these agreements. Not only should you ensure that the document is what is says it is (i.e. a confidentiality agreement) and nothing more, but you also need to make sure that your employees are aware of the NDA and their obligations to keep information disclosed under it confidential.

From the perspective of an investor, NDAs might not be a key area of focus in every due diligence exercise, but looking at who the company has signed these agreements with, and for what purpose, could be a useful way of bringing to light matters that require further investigation. Knowing the right questions to ask means that you can flush out potential issues and deal with these – before investing your $2 billion.

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