July 10, 2013

By Oliver Herzfeld

Contractual counterparties often negotiate and agree upon the key terms of a commercial transaction in a term sheet, leave other terms for further negotiation in due course, and agree to negotiate such other terms in good faith with the intention of entering into a definitive agreement based upon the initially agreed key terms. The question is, are such agreements to negotiate in good faith enforceable? And if so, what is the proper measure of damages if such an agreement is breached? Is the aggrieved party entitled to expectation damages (which would put such party in the position it would have been in had the agreement been fulfilled), or is its remedy limited solely to reliance damages such as attorney’s fees and other out-of-pocket expenses (which would only put such party in the position it would have been in had the agreement never happened)? The Delaware Supreme Court’s recent decision in SIGA Technologies v. PharmAthene provides some important guidance regarding the answers to these questions.

Background

SIGA and PharmAthene fully negotiated a two page license agreement term sheet. The term sheet included a footer that stated “Non Binding Terms.” The parties then proceeded to enter into a merger agreement instead of the license agreement. The merger agreement provided that, upon termination of the merger for any reason, the parties would negotiate in good faith a definitive license agreement in accordance with the term sheet. When SIGA’s business and financial position improved significantly, it experienced seller’s remorse and found an opportunity to terminate the merger agreement. PharmAthene then sought to enter into a definitive license agreement based on the term sheet. However, SIGA insisted on materially different terms relying on the “Non Binding Terms” footer. For example, SIGA sought to increase the (i) advance payment from $6 million to $100 million, (ii) guaranteed milestone payments from $10 million to $235 million, and (iii) escalating royalty rates from 8%, 10% and 12% (depending on sales) to 18%, 22%, 25% and 28%. When PharmAthene commenced litigation against SIGA claiming it breached its obligation to negotiate in good faith, a lower Delaware court ruled in favor of PharmAthene and SIGA appealed to the Delaware Supreme Court.

The Decision

On appeal, the Court ruled that an agreement to negotiate in good faith in accordance with a term sheet can be a legally-enforceable obligation, and the breaching party will be subject to expectation damages (not just reliance damages) if the evidence indicates that an agreement would have been reached in the absence of the breaching party’s bad faith. Expectation damages provide the non-breaching party with the full “benefit of its bargain.” In other words, the breaching party is liable to pay the non-breaching party everything it would have received had the agreement been entered into and fully-performed as promised. Nonetheless, to be eligible to receive expectation damages, the non-breaching must prove its damages with concrete evidence establishing to a reasonable certainty the nature and extent of the probable loss it has sustained or will in the future sustain. This is so because the law does not permit a recovery of damages that are merely speculative as demonstrated by conjecture, indeterminate estimates or mere assumptions.

In this case, the Court held that (i) SIGA breached its agreement to negotiate in good faith by demanding materially different terms that “virtually disregarded” the term sheet, and (ii) but for SIGA’s breach, the parties would have entered into a license agreement in accordance with the term sheet’s terms. The Court remanded the case back to the lower court to reconsider PharmAthene’s damages award in light of the Court’s decision, including whether PharmAthene’s expectation damages can be determined with reasonable certainty, and are not speculative.

The Lesson For Contracting Parties

This case is a wake-up call to contracting parties to avoid casually drafting or agreeing to deal memos, letters of intent, memorandum of understanding and other preliminary term sheet documents – even if they include language stating they are not legally binding. To avoid potential disputes and awards of damages, contracting parties are encouraged to engage competent legal counsel to provide advice and guidance as to whether their term sheet documents create an agreement to negotiate in good faith or other legal obligations, what provisions and disclaimers should be included to properly clarify and memorialize the parties’ intent, and what conduct will be expected of the contracting parties as they move forward with their proposed transactions.