Term sheets, letters of intent and other preliminary agreements are often useful in complex negotiations because they allow negotiating parties to focus first on the major deal issues before getting tripped up in the details. While such preliminary agreements or term sheets are often expressly deemed non-binding, contractual obligations to negotiate in good faith a final deal based on preliminary terms are typically binding. The Delaware Supreme Court’s decision in SIGA Technologies, Inc. v. PharmAthene, Inc. (Del. May 24, 2013) puts parties on notice that a Delaware-law governed agreement to negotiate a final agreement based on preliminary non-binding terms may have more teeth than the parties realize or intend. The court held that a breach of such an agreement to negotiate in good faith may, in certain circumstances, result in liability for expectation (i.e., “benefit-of-the-bargain”) damages for the breaching party, the same damages that would arise had the parties signed the final, definitive agreement.
In late 2005, SIGA Technologies, Inc., a company engaged in biodefense research and development, was developing an antiviral drug that had “enormous potential,” but was having trouble financing the remaining development costs. It sought to partner with PharmAthene, Inc., another company engaged in biodefense research and development, to help fund these costs. PharmAthene wanted a merger between the two companies, but SIGA preferred a license arrangement before discussing a merger because it needed an immediate cash infusion and prior merger talks between the companies had failed. In January 2006, the companies reached an agreement on a license term sheet. The license term sheet was unsigned and stated “Non Binding Terms” in the document footer, but included many of the material provisions of the license, including a worldwide exclusive license, upfront cash payments, funding guarantees, cash milestone payments, creation of a research and development committee and sublicensing rights.
After reaching agreement on the unsigned license term sheet, the parties began merger negotiations. Because of SIGA’s precarious financial position, it asked PharmAthene to provide bridge financing to continue development efforts while negotiating the merger. In March 2006, SIGA and PharmAthene signed a merger letter of intent that attached the license term sheet and also entered into the Bridge Loan Agreement that SIGA desired to cover costs during the merger negotiations. The Bridge Loan Agreement was governed by New York law and contained a mutual covenant of the parties to negotiate in good faith a license agreement “in accordance with the terms” of the license term sheet (which was attached to the agreement) in the event the merger was not consummated. The parties then focused on negotiating the terms of the merger and, in June 2006, entered into a definitive Merger Agreement, which was governed by Delaware law. The Merger Agreement provided a substantially identical covenant to the covenant contained in the Bridge Loan Agreement, requiring the parties to negotiate in good faith a license agreement based on the license term sheet (which was attached to the agreement) if the merger was not consummated. It also included a covenant that the parties use their “best efforts” to consummate the transactions contemplated by the Merger Agreement. Those provisions, among others, were specifically identified as surviving the Merger Agreement’s termination.
Subsequent to the execution of the Merger Agreement, SIGA’s financial position improved and it began experiencing seller’s remorse. It received grants from the National Institutes of Health (“NIH”) to fund the drug’s development and achieved several developmental milestones. By the time the Merger Agreement’s drop-dead date of September 30 arrived, the SEC had not approved SIGA’s proxy statement and PharmAthene asked for an extension of the drop-dead date. On October 4, SIGA’s board met and decided not to agree to an extension, but instead to terminate the Merger Agreement. Shortly thereafter, SIGA announced that it had received another NIH grant as well as other positive updates on development efforts. It then sold two million shares of stock at more than three times its 2005 share price.
After the Merger Agreement was terminated, PharmAthene quickly turned its attention to the license term sheet, and sent a draft license agreement, based on the license term sheet, to SIGA’s outside counsel. SIGA responded by asking for a new partnership structure and for substantial revisions to the underlying economic terms to reflect the advances in the drug’s development process. The revised economic terms included, among others, a materially different profit split between the companies, upfront payments of $100 million (instead of $6 million in the term sheet), milestone payments of $235 million (instead of $10 million in the term sheet), significantly increased royalty payments and greater SIGA control over development and distribution. SIGA further made clear its intention to renegotiate the terms contained in the term sheet, by issuing an ultimatum requiring PharmAthene to submit to negotiations “without preconditions” regarding the terms in the license term sheet by December 20. On December 20, PharmAthene filed suit in the Delaware Court of Chancery.
Delaware Court of Chancery’s Decision
After an 11-day trial, the Court of Chancery found under Delaware law that (1) SIGA was liable for breach of its obligation under both the Bridge Loan Agreement and the Merger Agreement to negotiate in good faith a definitive license agreement in accordance with the terms of the license term sheet, (2) SIGA was liable under the doctrine of promissory estoppel and (3) the appropriate remedy was an equitable payment stream approximating the terms of the license agreement that the parties would have reached had they negotiated in good faith. SIGA appealed the decision.
Delaware Supreme Court Decision
The Delaware Supreme Court reaffirmed that an express contractual obligation to negotiate in good faith is binding on contracting parties under Delaware law. It noted that the express language in the Bridge Loan Agreement and the Merger Agreement obligated the parties to negotiate in good faith a license agreement “in accordance with the terms set forth” in the license term sheet. It then found that the trial record supported the Court of Chancery’s finding that, despite the fact that the license term sheet was unsigned and contained a footer stating “Non Binding Terms,” that the Bridge Loan Agreement and Merger Agreement language created a duty for the parties to negotiate “a license agreement with economic terms substantially similar” to the terms of the license term sheet and was not merely intended by the parties to be a “jumping off point” for future negotiations.
Turning to the question of good faith, the Delaware Supreme Court noted that under Delaware law, “bad faith is not simply bad judgment or negligence, but rather it implies the conscious doing of a wrong because of a dishonest purpose or moral obliquity. . . .” It found that the trial record supported the Court of Chancery’s finding that SIGA’s counterproposal to the license agreement not only had dramatically different economic terms from those in the license term sheet, but that SIGA made those counterproposals in bad faith. It therefore upheld the Court of Chancery’s conclusion that SIGA had breached its contractual obligations under both the Bridge Loan Agreement and the Merger Agreement to negotiate in good faith the license agreement in accordance with the terms of the license term sheet. The Delaware Supreme Court overturned the Court of Chancery’s finding that SIGA was liable on the basis of promissory estoppel because promissory estoppel does not apply where an enforceable contract governs the promise at issue.
The Court then turned to the question of proper remedy. It noted that there was previously some ambiguity under Delaware law as to what is the proper remedy for a breach of an agreement to negotiate in good faith. It noted that although Delaware law applied, New York law was instructive on the point. New York law distinguishes between “Type I” and “Type II” preliminary agreements. Type I preliminary agreements are fully binding agreements, where the parties agree on all points that require negotiation, but commit to memorialize their agreement in a more formal document. Type II preliminary agreements, however, only set forth major terms and leave other terms open for further negotiation. Such an agreement commits the parties to an obligation to negotiate the open issues in good faith to reach the ultimate contractual objective within the previously agreed framework.
The Delaware Supreme Court held that a party may recover expectation damages — which compensate the non-breaching party as if the breaching party performed the contract and include, in addition to direct damages, any incidental or consequential damages (as opposed to reliance damages, which only compensate the non-breaching party for its actually incurred costs and expenses) — under a Type II preliminary agreement where a court finds that the other party breached its obligation to negotiate in good faith and that the parties would have reached an agreement but for the breaching party’s bad faith. It then held that expectation damages were warranted based on the trial record which showed that (1) the parties memorialized the basic terms of the license in the license term sheet and expressly agreed in both the Bridge Loan Agreement and the Merger Agreement to negotiate in good faith a final license in accordance with those terms and (2) but for SIGA’s bad faith negotiations, the parties would have entered into a definitive license agreement. Because it had not previously decided the proper remedy for such situations, it reversed the Court of Chancery’s damages award and remanded for a reconsideration of the damages award in accordance with its opinion.
The SIGA opinion makes clear to negotiating parties that Delaware courts will enforce agreements to negotiate in good faith and will award expectation damages for a party’s failure to do so. In SIGA, this meant that the parties’ failure to negotiate a definitive license agreement based on the non-binding term sheet resulted in benefit-of-the-bargain damages as if they had actually executed the definitive agreement. Not all states follow Delaware’s approach on this point, however. New York, for instance, enforces agreements to negotiate in good faith, but limits parties’ recovery to reliance damages (i.e., costs of the negotiations). Other states will not enforce agreements to negotiate at all. Therefore, it is very important that parties understand and control which law will govern their preliminary agreements. Further, parties should be wary of committing themselves to a contractual obligation to negotiate in good faith a definitive agreement with respect to transactions contemplated by a preliminary agreement because a failure to reach an agreement may result in liability for breach as if the definitive agreement had been reached. When parties do commit themselves to negotiate in good faith a definitive agreement with respect to transactions contemplated by a preliminary agreement, they should consider, if desired, including provisions that qualify that obligation to ensure flexibility in negotiations, such as strengthening the disclaimer language to expressly state that the terms included in the preliminary agreement are non-binding and are open to further negotiation. They should also consider limiting the remedies available for breaches of the covenant to negotiate in good faith, such as providing exclusively for liquidated damages.