The Supreme Court of Delaware recently held that covenants to negotiate in good faith are enforceable and can be used to compel negotiating parties to adhere to otherwise non-binding term sheets.  

Accordingly, parties wishing to negotiate non-binding term sheets, letters of intent and similar preliminary agreements should ensure that such agreements cannot be enforced by (i) including a disclaimer that the preliminary agreement is non-binding and can be terminated or re-negotiated at any time, and (ii) avoiding provisions in subsequent binding agreements that reference or otherwise incorporate such non-binding agreements.

On May 24, 2013, the Supreme Court of Delaware held in SIGA Technologies, Inc. v. PharmAthene, Inc. that a merger agreement’s covenant to negotiate the terms of a definitive license agreement rendered an otherwise non-binding term sheet enforceable.  The provision in question required that the counterparties negotiate in good faith a license agreement in accordance with the term sheet if the parties terminated the merger.  When the merger collapsed and one party insisted on license terms that were radically different from those of the term sheet, the court held that the party had breached the covenant to negotiate in good faith by demanding terms that were not “substantially similar” to those in the term sheet.

While the full scope of the decision is not yet clear, the SIGA Technologies case underscores that term sheets can impose binding obligations on the parties.  Rendering a term sheet binding may be beneficial in certain circumstances, such as in an auction process where the seller desires a commitment from a prospective buyer.  However, term sheets are too often viewed as mere jumping off points, despite the SIGA Technologies finding that term sheets may be enforced.  Consequently, parties to term sheets risk inadvertently binding themselves to terms that may ultimately prove detrimental.  

The SIGA Technologies decision establishes that term sheets can be enforced in certain circumstances and that contracting parties should proceed cautiously when drafting preliminary agreements.  Accordingly, contracting parties generally should take steps to ensure that term sheets cannot be construed as binding.  

A disclaimer that a term sheet is not binding and may be terminated or renegotiated at any time is an essential starting point, but the SIGA Technologies decision makes it clear that even this may be insufficient.  Instead, negotiating parties must also take care to ensure that term sheets are not integrated into binding agreements through provisions that reference the term sheets, such as the covenant to negotiate in good faith contained in the merger agreement at issue in SIGA Technologies.