In SIGA Technologies, Inc., v. PharmAthene, Inc.,1 the Supreme Court of the State of Delaware reaffirmed that an express agreement to negotiate in good faith in accordance with a term sheet is an enforceable obligation. The Supreme Court also ruled that a trial judge may award expectation damages to the non-breaching party where the trial judge makes a factual finding, supported by the record, that the parties to a preliminary agreement would have reached a final agreement but for the breaching party’s bad faith negotiation.
In 2004, SIGA Technologies, Inc. (SIGA), acquired an antiviral drug for the treatment of smallpox (ST-246) that it believed had enormous potential, but which remained at an early stage. By late 2005, SIGA was experiencing difficulty developing ST-246 and needed additional capital to complete the development process. As a result of these difficulties, SIGA entered into discussions with PharmAthene, Inc. (Pharm) regarding a possible collaboration.
Pharm expressed interest in a merger between the two companies, but SIGA focused at least initially on a license agreement that would satisfy its short-term funding needs and allow SIGA and Pharm to share in the potential profits of the development and commercialization of ST-246. The parties reached tentative agreement based on a two-page license agreement term sheet (LATS), although the LATS was not signed and a footer on both pages stated “Non Binding Terms.”
In January 2006, SIGA and Pharm subsequently began merger discussions, and SIGA asked Pharm to provide bridge financing so SIGA could continue developing ST-246 while merger negotiations proceeded. Pharm agreed to consider providing financing on the condition that Pharm would obtain a license for ST-246 if merger negotiations fell through.
On March 10, 2006, SIGA and Pharm executed a merger letter of intent, attaching a merger term sheet and the LATS. On March 20, 2006, SIGA and Pharm executed a Bridge Loan Agreement pursuant to which Pharm loaned SIGA US$3 million for expenses related to the proposed merger, developing ST-246 and overhead. The Bridge Loan Agreement was governed by New York law and expressly obligated the parties to negotiate in good faith a definitive license agreement in accordance with the terms of the LATS if the merger term sheet was terminated or a definitive merger agreement was either not executed or terminated after execution.
On June 8, 2006, SIGA and Pharm executed a Merger Agreement that contained a provision, similar to the corresponding provision in the Bridge Loan Agreement, obligating the parties to negotiate in good faith a definitive license agreement in accordance with the terms of the LATS if the Merger Agreement was terminated for any reason. The Merger Agreement was governed by Delaware law, which the Delaware Court of Chancery (and the Supreme Court) applied to the claims at issue because the Merger Agreement occurred later in time than the Bridge Loan Agreement and encompassed the activity that lay at the heart of the case. The Supreme Court also noted that the Merger Agreement’s termination triggered the obligation to negotiate the license agreement in good faith.
In the months after signing the Merger Agreement, SIGA received more than US$20 million in funding from the National Institutes of Health, and “several comments by SIGA representatives indicate that SIGA began experiencing seller’s remorse.”2 SIGA subsequently terminated the Merger Agreement once its September 30th drop-dead date had passed. Pharm then sought to finalize a license agreement consistent with the LATS, but SIGA ultimately proposed and insisted upon a SIGA-Pharm partnership with significantly different and contradictory economic terms than those set forth in the LATS.3 SIGA also disputed that the LATS was binding and argued that its purpose was simply to provide a “jumping off point” for negotiations. After SIGA conditioned any further discussions on Pharm expressly agreeing to negotiate without any preconditions regarding the binding nature of the LATS, Pharm filed suit in the Delaware Court of Chancery.
After extensive discovery, an 11-day trial and extensive post-trial briefing, the Court of Chancery held that, among other things: (i) SIGA was liable for breach of its obligation (under both the Bridge Loan and Merger Agreements) to negotiate in good faith a definitive license agreement in accordance with the terms of the LATS and (ii) the proper remedy was an equitable payment stream approximating the amount payable under the terms of the license agreement to which the Court of Chancery found the parties would ultimately have agreed were it not for SIGA’s breach.4 SIGA appealed the Court of Chancery’s decision.
SIGA’s contractual obligation and Pharm’s remedy
In reaching its conclusion, the Delaware Supreme Court reviewed a number of Delaware and non-Delaware decisions and ultimately reaffirmed that “an express contractual obligation to negotiate in good faith is binding on the contracting parties.”5 Turning to the express contractual language in the Bridge Loan and Merger Agreements, the Supreme Court held that the record supported the Court of Chancery’s conclusion that the incorporation of the LATS into the Bridge Loan and Merger Agreements reflected “an intent on the part of both parties to negotiate toward a license agreement with economic terms substantially similar to the terms of the LATS if the merger was not consummated.”
The Supreme Court considered and dismissed SIGA’s assertion that requiring parties to propose terms “substantially similar” to those in a term sheet introduces uncertainty and litigation risk into negotiations, noting that to find liability in these circumstances a trial judge must find that a party’s proposed terms are “substantially dissimilar and that the party proposed those terms in bad faith.”6 It then reviewed and upheld the Court of Chancery’s finding that SIGA acted in bad faith when it disregarded the terms of the previously identified and agreed-upon terms in the LATS and attempted to negotiate a license agreement containing economic and other terms significantly different and more favorable to SIGA than those in the LATS, thereby breaching its contractual obligations under the Bridge Loan Agreement and Merger Agreement.
With respect to the proper contractual remedy for breach of an agreement to negotiate in good faith where the trial court finds that the parties, had they negotiated in good faith, would have reached an agreement, the Supreme Court acknowledged that its prior decisions had left that question open. It reviewed cases from Delaware, New York and several federal circuits, analogizing the agreement between SIGA and Pharm to a so-called “Type II” binding preliminary agreement—one in which parties agree on “certain major terms, but leave other terms open for further negotiation.”7
The Supreme Court upheld the Court of Chancery’s findings, supported by the record, that SIGA and Pharm would have consummated the transaction on the terms of the LATS but for SIGA’s bad faith negotiations. It ultimately held that, where parties have a Type II preliminary agreement to negotiate in good faith and the trial judge makes a factual finding, supported by the record, that the parties would have reached an agreement but for the breaching party’s bad faith negotiations, the plaintiff is entitled to recover contract expectation damages. Having clarified the question of applicable damages, the Supreme Court reversed the Court of Chancery’s damages award, which was based on a different theory of damages, and remanded the case for reconsideration of the damages award consistent with its opinion.
The SIGA Technologies decision is informed by facts specific to the underlying dispute; nevertheless, it highlights certain important considerations for parties negotiating a term sheet, letter of intent, bid letter or other preliminary statement of terms, including, among others, the following:
- Delaware courts take obligations to negotiate in good faith seriously. The consequences of what is often referred to as “boilerplate language” in term sheets or other preliminary statements of terms should be considered carefully by parties entering preliminary negotiations.
- Even if a term sheet does not contain an express agreement to negotiate in good faith (and, as in SIGA Technologies, contains a disclaimer indicating it is non-binding), but other agreements between the parties contain such an express agreement with respect to such term sheet, Delaware courts will treat as binding such express agreement to negotiate in good faith with respect to such term sheet.
- If parties drafting term sheets or other preliminary statements of terms intend such documents to be truly preliminary in nature and do not intend for them to be treated as Type II preliminary agreements, they should include therein appropriate express provisions to such effect. In addition, they should ensure that they do not override any such provisions through other agreements.
- Delaware courts will consider a party’s stance and conduct during negotiations, as well as the relation its negotiating terms bear to the terms previously agreed to in a Type II preliminary agreement, in assessing whether such party negotiated in good faith.
- The Court of Chancery may award expectation damages where parties have entered into a Type II preliminary agreement (which can include a term sheet, depending on its terms) to negotiate in good faith and the Court makes a factual finding, supported by the record, that the parties would have reached a final agreement but for the breaching party’s bad faith negotiations.