A recent Delaware Supreme Court decision warns acquirers and targets they must be cautious when negotiating alternative transactions for the same target assets subject to substantial short term fluctuations in value.1 Parties often reach preliminary agreements to negotiate future contracts in good faith regarding target assets as a backstop in the event a transaction under a separate acquisition agreement is terminated. By ruling that lump sum contract expectation damages as opposed to mere reliance damages are available for breach of a preliminary agreement, the court put transaction parties on notice they will be held to an agreed term sheet’s economic and other definitive terms regardless of change in target asset value when obligated to negotiate future contracts in good faith.

In this case, two biodefense research and development companies, cash strapped SIGA Technologies (SIGA) and PharmAthene (Pharma), initially negotiated an unexecuted license agreement term sheet (LATS) under which Pharma would license SIGA’s smallpox treatment drug under development initially valued at $1 billion at the end of 2005. In early 2006, Pharma decided a merger was a better transaction and executed a merger agreement with SIGA with a September drop-dead date and an express provision to negotiate in good faith a license agreement in accordance with the LATS’ terms in the event the merger agreement was terminated, with the LATS attached as an exhibit. As the drop-dead date approached, SIGA achieved several drug development milestones and won substantial grant money, leading to seller’s remorse over what now appeared to be a drug worth $3 billion. Pharma requested a drop-dead date extension, but SIGA denied it and then terminated the merger agreement. In October, Pharma approached SIGA with a license agreement consistent with the LATS’ terms. Given SIGA’s progress since the original negotiations, it responded in November with a radically different proposal with significantly revised economic terms resembling a partnership rather than a licensing arrangement. When SIGA refused to negotiate a licensing agreement consistent with the LATS’ terms, Pharma sued for breach. The court held the merger agreement’s express good faith negotiation provision, together with the LATS, constituted an enforceable preliminary agreement and SIGA breached it in bad faith by attempting to substantially revise the prior agreed licensing terms under the LATS. As a result, the court held Pharma was entitled to contract expectation damages from SIGA for breach of the preliminary agreement and affirmed the Chancery Court’s $113 million damages award.

This decision is an object lesson for strategic and financial buyers and potential sellers in high technology industries defined by products subject to lengthy development time horizons, intermittent funding shortfalls and extensive governmental testing or regulation – all of which can lead to valuation volatility over time. In the face of initial deal uncertainty and financial distress, SIGA succumbed to pressure to negotiate deal alternatives simultaneously and to contractually link them and overlooked its agreement to fixed licensing terms. It then wanted to recut the deal in the face of substantially skewed economics due to rapid, positive company developments. This case demonstrates the premium to be placed on a party’s ability to anticipate a range of potential economic outcomes to effectively negotiate the desired degree of deal certainty and effective deal alternatives. When SIGA agreed to link the LATS to the merger agreement but failed to reserve a right to revisit the licensing economics, it thought it had at least one good deal in hand but ended up with two that were less than desirable, neither of which it wanted, with the court effectively saying it could not walk away from negotiating the one remaining to be had. Parties on either side of intended acquisitions in similar industries should carefully consider whether serial negotiations of alternative transactions might better suit them to avoid a scenario like that encountered by SIGA in this case.