Beyond Confidentiality: The Legal and Economic Pitfalls of NDAs in India

– Dev Kumawat and Anisha

Introduction

A non-disclosure agreement (NDA) is a legally binding contract which establishes a special type of relationship between two parties in which one party holds sensitive information and the other party receives that sensitive information. These agreements are generally instituted to create a legal trust where there is no interpersonal trust, commonly between unrelated parties entering new business discussions.  These agreements have become an essential business tool for safeguarding confidential material in the modern economy. NDAs protect trade secrets, customer lists, intellectual property, business plans, etc., and constitute a solid wall on which commercial confidence is established. In industries such as pharma, fintech, and artificial intelligence, where innovation is both a commodity and currency, confidentiality goes beyond contractual requirements to assume the status of strategic necessity.

However, in this modern world, protection of these type of confidential information poses some intricate issues when analysed from the lens of competition law and economic theories. The vital function of these agreements is to protect the best interests of the company, but sometimes their abuse or overuse wreaks havoc on competitive forces, enhances market inefficiency, and crushes innovation. NDAs can restrict employees from switching jobs, suppress wages, and hinder innovation. FTC chair Lina Khan stated that banning NDAs could unlock around 8,500 new startups each year. These clauses often prevent individuals from launching new startups and ventures, limiting entrepreneurship and economic growth. These figures reveal that an early-stage paradox exists where legal frameworks that are set to facilitate innovation and collaboration are instead being leveraged to stifle it.

Legal Framework for NDAs

NDAs do not inherently exist in a legal vacuum. Their drafting to execution process intersects in various branches of Indian commercial laws, mainly in contract law and competition law.  The Indian Contract Act, 1872, generally recognizes the enforceability of such agreements when they satisfy the essentials of a valid contract under Sections 10 and 14, although Section 27 renders void any agreement that restrains trade, subject to very limited exceptions. Indian courts are strict when it comes to such restrictions. For example, in the case of Gujarat Bottling Co. Ltd. v. Coca Cola Co. (1995), the Hon’ble Supreme Court mentioned that negative covenants during employment or business may be valid and enforceable, but post-termination restrictions that are beyond protecting trade secrets are generally void.

NDAs with unreasonable and excessive restrictions like “no poach” and “no hire” clauses among competitors may fall against section 3(3) of the Competition Act, 2002, which deals with anti-competitive agreements between enterprises, especially when they start facilitating cartel-like behaviour and market allocation. It further mentions that any agreement that causes an appreciable adverse effect on competition is void.

In cases where a dominant player imposes unfair NDA terms on smaller parties, such as prohibiting dealing with third parties or stipulating under post-contractual restraints, it may trigger section 4(2)(a)(i) of the Competition Act, which bars imposing unfair conditions. Contracts falling under the private equity and venture capital umbrella often include a “standstill clause” which prohibits the target from negotiating any competing offers. If such a clause is combined with an NDA, it may constitute a “combination” under section 5 of the Competition Act, requiring CCI notification if it exceeds the thresholds prescribed.

The Companies Act, 2013, also limits the reach of NDAs. Section 134 mandates directors’ reports to contain all material information affecting stakeholders, and Section 188 controls related-party transactions that have to be disclosed and, in some instances, approved. NDAs hiding such transactions or withholding them could amount to a breach of fiduciary duty. In addition, Section 177(9) requires listed companies to establish vigil mechanisms, and any NDA that prohibits whistleblower reporting can be held void as against public policy.

From a corporate governance point of view, NDAs intersect with disclosure obligations under the SEBI (Prohibition of Insider Trading) Regulations, 2015. Regulation 3(4) requires the signing of NDAs while disseminating Unpublished Price Sensitive Information (UPSI) in the course of legitimate uses, such as due diligence or negotiations. Nevertheless, SEBI has made it clear that such kind of NDAs could not be used to circumvent compulsory disclosures under the SEBI (LODR) Regulations, 2015, specifically regulation 30, which addresses material event disclosures.

NDAs Across Market Structures: Economics, Competition, and Control

NDAs in Perfect Competition: Do They Belong?

A perfectly competitive market has many characteristics, such as several buyers and sellers, homogeneous products, no barriers to entry or exit from the market, and most importantly, complete information. In perfectly competitive markets, supply and demand determine the prices of the products, and no single entity can influence the conditions of the market. In such a market framework, an NDA holds little relevance or utility in the market since the nature of the competitive market is based on open access to information, i.e., a shared resource rather than being proprietary capital. So, when companies or firms try to introduce frameworks like NDA in a perfectly competitive market, it interferes with the natural flow of information, thus creating inefficiencies.

In the case where small-scale agricultural producers enter into agreements like NDAs to keep certain farming techniques or seed innovations a secret, they obstruct the flow of information, which is very important for a competitive equilibrium. This situation results in what economists usually call, the Pigouvian externalities, which means that the social cost of restricting information is more than the private gains from secrecy. Such a misallocation of resources reduces consumer surplus and also distorts pricing.

Even though in informal sector, the bilateral NDAs are not explicitly governed by competition law, it may still attract scrutiny under the “appreciable adverse effect on competition” (AAEC) test as per the Competition law framework, due to their cumulative effect and mainly when the wider dissemination of trade secrets is hindered by covert methods.

From the perspective of the Coase theorem, if the transaction costs are minimal, then the parties can freely negotiate around information-sharing but NDAs require significant transaction costs, contradicting the assumptions of the theorem. Here, the economic inefficiency aligns with the structural issues that are widely acknowledged by antitrust jurisprudence, where informal barriers are established by misusing confidentiality tools to establish informal entry barriers in otherwise open and competitive markets. Therefore, in competitive markets, openness is fundamental, and NDAs act as market distorters rather than efficiency enhancers.

NDAs in Monopolistic Competition: Protecting or Entrenching?

Unlike a competitive market, in a monopolistic competition, the products are differentiated but not substitutable. Although entry barriers are relatively low, the upgrowth in this market depends on brand recognition, innovation, and intellectual property. In this context, NDAs have a critical role as they protect proprietary information that differentiates one company from another. But if it is used widely, then it can be misused too, as it discourages fair imitation, which is an important feature of a dynamic and healthy market.

For instance, let’s take an example of India’s consumer electronics market, where mid-sized technology firms use NDAs to secure vendor lists and software designs. Although it is reasonable to protect legitimate trade secrets but such excessive or broad use of NDAs can create a bridge between two sides of information and a lack of information respectively, thus causing an imbalance. Moreover, it can also disrupt allocative efficiency, as the flow of resources like skilled employees or capital is restricted to reach their most valued use, thereby stifling innovation and new enterprise formation.

Here, economic concepts like the Learned Hand Rule become relevant to evaluate the use of an NDA. As per the rule, if at the cost of enforcing an NDA (B), the probable loss from disclosure (P x L) exceeds, then the NDA causes a net social loss. Therefore, the companies must use NDAs judiciously; otherwise, they risk creating Pareto inefficiency, where some parties can be made better off without making others worse off, but legal restrictions prevent it.

A notable illustration is found in pharmaceutical industries, where NDAs are used by mid-sized pharmaceutical firms to prevent generic manufacturers from learning R&D methodologies. This leads to inhibition in competition, delays in the dispersal of innovation, thus limiting consumer access to affordable drugs.

NDAs in Oligopolistic Markets: Strategy, Secrecy, and Power Plays

The characteristic feature of an oligopoly market is that there are few dominant players, high entry barriers, and interdependent decision-making. In such a framework, companies not only protect their information through an NDA but also use it as a strategic weapon for dominance in the market. For instance, in India’s digital payments ecosystem, only a few major players dominate the market, where they use NDA not only to protect code or algorithms but also to prevent former employees or partners from joining competitors.

This dynamic fits the Prisoner’s Dilemma in game theory. Ideally, if all companies refrain from using restrictive NDA, then the market would see mutual and greater innovation. But, even if one of such companies’ defects and imposes an NDA while others don’t, then it gains a short-term competitive edge. This results in anticipation of potential disadvantage by each firm and therefore, they opt to enforce an NDA, which consequently leads to a Nash Equilibrium that is suboptimal for everyone as innovation slows, costs rise, and consumers suffer.

It can be illustrated using a game theory matrix, which involves two firms- Firm A and Firm B. Each of them has two strategic options: (i) Permit employee mobility (i.e., no NDA), (ii) Enforce restrictive NDAs. The outcomes are based on the following variables:

• I = Innovation value from open mobility (e.g., 10)
• S = Short-term strategic gain from enforcing NDAs (e.g., +2)
• L = Loss from talent leakage when only one party gives openness (e.g., -5)
• R = Mutual rigidity outcome when both enforce NDAs (e.g., 6)

Nash Equilibrium: (6, 6) – Both enforce NDAs, fearing opportunism, but this outcome is Pareto-inferior to mutual cooperation (10,10).

To explain the payoff matrix, both firms benefit equally from innovation if both allow employee mobility, receiving a payoff of I=10. Whereas, if one firm imposes a restrictive NDA and gains a short-term advantage (S=+2), while the other remains open (losing L = -5), the firm that has enforced the NDA ultimately ends up with a higher payoff of 12, while the open one drops to 5. And if both of them choose to enforce an NDA, then each one receives a reduced payoff of R=-6, less than what they would receive through cooperation. This shows how the fear of defection brings up suboptimal outcomes.

For example, in the real world, let’s take an example of the telecom industry, where dominant companies use NDA to prevent employee mobility to rising competitors, limiting the diffusion of knowledge. Moreover, in pharmaceuticals, companies use NDAs to withhold intellectual property and to slow down the appearance of biosimilars, thereby strengthening oligopolistic control. Such a condition depicts how NDAs could be wielded not just for protective measures but rather for control, shaping competition and, therefore, begging for informed policy intervention.

Conclusion

The non-disclosure arrangements or confidential agreements serve a legitimate and an essential function for protecting proprietary information, but their unregulated use in different market structures has brought about serious legal and economic difficulties. When one considers that they tend to distort the transparency required by perfect competition in the marketplace, provide barriers to fair imitation in monopolistic settings, and sustain anti-competitive behaviour embraced by oligopolies in other situations, non-disclosure agreements can slip away from being a protective shield to being an instrument for suppression and control. Their intersection with Indian contract law, competition law, and corporate laws necessitates a more nuanced regulatory framework that may shift from a worthy cause of protection against strategic entrenchment. Given the rising demand for innovation and market dynamism, which greatly gives a boost to collaboration and mobility, India must shift its focus on NDAs in the hope that it will not contain but rather enhance competitive spirit.

The authors are students of Tamil Nadu National Law University, Tiruchirappalli.