Why Non-Disclosure Agreements (NDAs) should be taken seriously?


In this article, we examine the importance of Non-Disclosure Agreements (NDAs) through ZeniMax v. Oculus.

Palmer Luckey, once considered a poster boy in the virtual reality (VR) industry, created the prototype Rift VR Headset. At that time, another well-known VR developer was “id Software”, which was cofounded by John Carmack. The company was later acquired by ZeniMax Media in 2009 and became its subsidiary.

In 2012, ZeniMax Media had signed a nondisclosure agreement (“NDA”) with Luckey through its subsidiary, “id Software”. In the arrangement, ZeniMax Media would disclose certain proprietary information as the Disclosing Party, and Luckey would receive this information as the Receiving Party.

In 2012, Luckey founded the Oculus VR and eventually hired Carmack as Oculus’ chief technical officer after his departure from id Software. The new Oculus Rift VR Headset attracted enough attention, resulting in Facebook’s acquisition of Oculus in March 2014 for approximately US$2 billion.

In May 2014, ZeniMax Media sued Luckey and Oculus for contract violation of the 2012 NDA (ZeniMax v. Oculus, Case 3:14-cv-01849-K (N.D. Tex.)). ZeniMax Media eventually added Facebook as an additional defendants. Apart from contract violations, ZeniMax Media also sued for trade secrets misappropriation, copyright infringement, etc. which are not covered in this article.

In 2017, the lawsuit went to a jury trial in the US District Court Northern District of Texas. In the final judgment (Case 3:14-cv-01849-K, Document 1121), the jury found that the defendants had breached the contract resulting in US$200 million damages plus prejudgment interest dating back to May 2014. Although the parties eventually settled the case in 2018 without disclosing settlement terms, the damages previously awarded in the judgment in 2018 symbolizes the importance of NDAs and their enforcement.

Here we highlight certain key areas of the Non-Disclosure Agreement:

(1) “Ownership. All Proprietary Information, including but not limited to that which is contained in files, letters, memoranda, reports, records, data, sketches, drawings, notebooks, program listings, or other written, photographic, or other tangible or intangible, or other materials, or which shall come into the Receiving Party’s custody or possession, is and at all times shall be the exclusive property of the Disclosing Party, and shall be used by the Receiving Party only for the Proper Purpose.”

This is NOT a mutual NDA in which both parties are disclosing and receiving parties. Since this a unilateral NDA with one disclosing party and one receiving party, it was easier for ZeniMax Media to prove its case in court given that all the data belonged to ZeniMax Media’s trade secrets, and not to Luckey.

From a contractual perspective, the one disclosing party NDA gave the impression that ZeniMax Media was more knowledgeable and owned more advanced technology, while Luckey owned nothing and provided nothing in return, despite Luckey’s reputation.

(2) ““Proprietary Information” means all information and know-how, regardless of whether or not in writing, or a private, secret or confidential nature that relates to the business, technical or financial affairs of the Disclosing Party, its parent, subsidiaries, affiliates, licensors, customers, potential customers, suppliers or substantial suppliers provided or disclosed to the Receiving Party or which becomes known to the Receiving Party, whether or not marked or otherwise designated as “confidential”, “proprietary” or with other legend indicating its proprietary nature. Proprietary Information includes, by way of illustration and not limitation, all forms and types of financial, business, scientific, technical, or engineering information, including patterns, plans, compilations, inventions and developments, products, formulas, designs, prototypes, methods, techniques, processes, procedures, computer programs and software (whether as source code or object code), documentation, technologies, plans, research, marketing, and reports, other technical information relating to the Disclosing Party’s business, and any information not generally known to the public or within the industry or trade in which the Disclosing Party competes, whether tangible or intangible, and whether or not stored, compiled, or memorialized physically, electronically, graphically, photographically, or in writing.”

Although the definition of proprietary information is clear, it has broadened the scope of the definition such that the receiving party has the burden of proof. For example, last part of the sentence stating that “any information not generally known to the public or within the industry or trade in which the Disclosing Party competes” covers everything conveyed to Luckey. In sum, this clause further strengthens ZeniMax Media’s claim that everything conveyed to Luckey is protected - almost with no exceptions.

(3) “Maintenance of Confidentiality. With respect to the Disclosing Party’s Proprietary Information, the Receiving Party undertakes and agrees that the Receiving Party shall secure and keep such Proprietary Information strictly confidential and: … (ii) Restrict disclosure to those of its directors, officers, employees or attorneys who clearly have a need-to-know such Proprietary Information, and then only to the extent of such need-to-know, and only in furtherance of the Proper Purpose; (iii) Use such Proprietary Information only for the Proper Purpose and not disclose such Proprietary Information other than as set forth above unless the Disclosing Party shall have expressly authorized such disclosure in advance in writing; and (iv) Not use any Proprietary Information to compete or obtain any competitive or other advantage with respect to the Disclosing Party.”

The key resides in the use limitation set forth in (iii) above. According to ZeniMax Media, Luckey breached “the Non-Disclosure Agreement by wrongfully using and misappropriating ZeniMax Media’s Contract-Protected Information beyond the scope of “Proper Purpose” authorized in the Non-Disclosure Agreement, including using ZeniMax’s Contract-Protected Information for testing, developing, demonstrating, promoting the Rift Headset, and selling Oculus to Facebook.”

In other words, ZeniMax Media claimed that Luckey could use such information as defined by the Proper Purpose, and not for any other purpose unless authorized in writing by ZeniMax Media. ZeniMax Media’s accusation of Luckey’s violations of the NDA’s use limitations appeared to be a successful strategy for convincing the jury. This was easier to prove for ZeniMax Media instead of arguing technical aspects, which would have confused the jury.

Lessons Learned:

  1. Although NDA's are custom, one should pay close attention to the following sections of an NDA: (i) Purpose (ii) Use limitation (iii) The definition and exception of “confidential information” or “proprietary information” (iv) Duration of non-disclosure.
  2. Some simplified examples from the list above: general vs special purposes, survival of non-disclosure after termination of contract.

  3. NDAs should NOT be treated as standard forms and should be valued as technology-related documents that constitute a critical portion of a company’s trade secret protection management system and relevant performance Standard Operating Procedure (SOP) – because the legal impact could be serious as shown in the US$200 million damage awarded to ZeniMax Media.
  4. Without good cause, we advise against acting as a sole Receiving Party. A sole Receiving Party gives the impression of being the sole beneficiary of the underlying arrangement without contributing valuable information in return – as a freeloader who takes advantage of the more knowledgeable disclosing party.
  5. Contract review is about the details; you should hire an attorney who has the ability to anticipate problems associated with contracts. They should have a firm grasp of the language and logic to properly structure the contract. Your attorney’s ability to read and write proficiently plays an important role when it comes to NDAs.
  6. It is worthwhile to review your NDAs with attorneys specialized in contracts if you have any concerns.
  7. Do not assume that all law firms are equally capable of preparing and reviewing contracts. You should find a law firm who has extensive experience such as a boutique law firm specialized in this area.

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