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Caveat Emptor: Non-compliance with a Non-Binding Term Sheet Results in $195 Million Judgment

Robert M. Siegel

On December 23, 2015, the Delaware Supreme Court affirmed the Delaware Chancery Court’s award of $195 million to PharmAthene, Inc. (“PharmAthene”) as compensation for lost profits (a/k/a expectation damages) on account of the failure by its counter-party to a term sheet to negotiate a license agreement in good faith.  The judgment was affirmed notwithstanding the fact that the obligation to negotiate in good faith was set forth in a non-binding term sheet.

Term sheets and letters of intent (“LOIs”) are an integral part of our legal practice and an expected component of any sophisticated financing or other corporate transaction. This court decision underscores the importance of clarity in these preliminary documents, even on something as boilerplate as agreeing to negotiate binding deal documentation in good faith.  Moreover, it increases the risk of using non-binding preliminary agreements governed by Delaware law to set forth the terms of prospective transactions.

The PharmAthene dispute dates back to a merger agreement between SIGA Technologies, Inc. (“SIGA”) and PharmAthene that was negotiated in 2005.  No longer able to fund its R&D needs in connection with a developmental anti-smallpox drug, SIGA had at that time entered into a merger agreement with PharmAthene. However, because SIGA had previously walked away from merger discussions with PharmAthene, PharmAthene also required SIGA to execute a license agreement term sheet (“LATS”) in connection with the merger agreement. The LATS provided that if SIGA were to once again walk away, SIGA and PharmAthene would negotiate a license agreement for PharmAthene’s use of the drug in good faith in accordance with the terms of the LATS. The LATS was labeled as “non-binding” and executed by the parties, who then continued their merger negotiations.

Thereafter, following favorable research results, SIGA received a number of grants and a sizable order for the drug, which obviated its need to merge with PharmAthene.  According to the Delaware Chancery Court, at that point in time SIGA’s value had increased to at least $3 to $5 billion (previously SIGA had been valued at approximately $1.2 billion) and evidence introduced at trial indicated that SIGA regretted entering into the merger agreement with PharmAthene at the much lower valuation. Not surprisingly, SIGA terminated the merger agreement and refused to enter into negotiations of a license agreement with PharmAthene at all, let alone on the terms agreed-to in the LATS.  PharmAthene then sued SIGA, arguing that the LATS was designed to protect PharmAthene from the very behavior in which SIGA was now engaging.

Following years of litigation, the Chancery Court found that SIGA had acted in bad faith and breached its contractual obligation to negotiate the license agreement with PharmAthene.  After much back and forth between the Chancery Court and the Delaware Supreme Court regarding PharmAthene’s entitlement to expectation damages rather than damages based on promissory estoppel, the Chancery Court ultimately awarded PharmAthene $195 million in expectation damages.  The Delaware Supreme Court affirmed the ruling in December 2015.

We believe there are a lot of lessons to be learned from the SIGA/PharmAthene situation; one of the most crucial being that business people should take agreements to negotiate in good faith seriously, even when they are set forth in non-binding preliminary agreements. That is not to say that if you fail to reach agreement on documentation you will be found to be in breach of the term sheet or LOI. Rather, the commitment is one of engaging in good faith negotiations to reach agreement on open issues. In other words, this case decided that you cannot completely renounce the obligation to negotiate in the first instance. Moreover, PharmAthene/SIGA suggests that you cannot merely commence and then abandon negotiations without good faith efforts to reach agreement, unless there is a legally justifiable basis for doing so, or to insist on conditions or terms that are materially inconsistent with the term sheet with the intent to cause the other party to break off negotiations.

We suggest that when negotiating a deal, business people also consider the following:

  • Carefully consider the benefits of entering into preliminary documentation rather than moving straight to definitive documentation, particularly if the deal is not particularly large or sophisticated.
  • Confirm that your term sheet or LOI is explicit about which obligations set forth therein are binding and which are not.
  • Remember that a change in circumstances (such as what happened to SIGA) does not necessarily mean that you can renegotiate the terms of a business deal.
  • Speak to your counsel before executing a term sheet.  Concepts such as enforceability and good faith are old friends of any good transactional attorney.

The Supreme Court’s opinion is SIGA Technologies, Inc. v. PharmAthene, Inc., Case Number C.A. No. 2627-VCP, Delaware Supreme Court (December 28, 2015).

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