Your Word is Your $113 Million Bond – Some Important Guidance on Negotiating Letters of Intent
- by Maurice M. Lefkort
A letter of intent is often used by parties to a transaction to set out the basic provisions of the transaction before substantial time, effort, and expense is spent negotiating complex legal agreements. Generally, the terms of a letter of intent are intended to be non-binding and to only set out a framework for future negotiation. Sometimes, however, parties may want a legally binding letter of intent. The fourth decision by a Delaware court in the long-running battle between SIGA Technologies and PharmAthene upholding the award of $113 million in damages against SIGA provides important guidance and a cautionary tale regarding legally binding letters of intent.
Letters of intent, term sheets, and similar agreements are often referred to as Preliminary Agreements. In disputes, courts tend to categorize Preliminary Agreements in one of three ways (hey don’t blame me, these are the labels that courts use):
- Type I Preliminary Agreements: These are Preliminary Agreements in which the parties have specified all of the major terms, and while final, definitive agreements are contemplated, there is sufficient definitiveness and intention to be bound that the court will enforce the Preliminary Agreement as a binding contract.
- Type II Preliminary Agreements: These are Preliminary Agreements in which the parties have specified the major terms and have agreed to negotiate “in good faith” to reach a final agreement.
- Non-Binding Agreements: These are Preliminary Agreements in which the parties have no legally enforceable obligation relating to the deal terms; although there may be ancillary legally enforceable obligations such as confidentiality or exclusivity.
Which Type of Preliminary Agreement Should I Use?
There is no universal right or wrong answer as to what type of Preliminary Agreement a party should use in any particular circumstance. That will be governed by the facts and circumstances of the deal. The only wrong answer is to be ambiguous as to what type of Preliminary Agreement you want your letter of intent to be.
What is the New Guidance from Delaware?
The resolution of this long-running fight in the pharma industry has created two important developments in Delaware that deal professionals should be aware of in negotiating Preliminary Agreements:
- Delaware courts will award “lost profits” to a party with a Type II Preliminary Agreement if its counterparty negotiates in bad faith, and the bad faith results in the failure to reach a final, binding agreement.
- The Delaware result is different from the result in other major jurisdictions, including California and New York.
What are the Best Practices for Deal Professionals?
- Specify Type. Best practice is to ensure that your Preliminary Agreement specifies whether or not it is legally binding. The only wrong answer is to not be specific.
- Don’t Renegotiate. In the deal world, one of the biggest “cultural sins” that a party can commit is to “renegotiate” a settled point. That can lead to stigma and ignominy. However, if you are a party to a Type II Agreement, it can also lead to material monetary damages. It is certainly acceptable to negotiate over terms that have not yet been agreed to by the parties, but if a party has agreed to terms, best practice is to live up to them. Failing to do so, may be costly, as SIGA found out. More on that below.
- Governing Law Matters. In the area of Type II Preliminary Agreements, Delaware has staked out a position different from other jurisdictions that can have material consequences on the outcome of a case. Although choice of law is often seen as an arcane issue for the lawyers, best practice would be to consult with counsel as to which governing law should be chosen.
The SIGA Cases as Described by the Delaware Courts
In 2006, SIGA Technologies was developing a small pox drug, but was running out of money. It obtained a bridge loan from PharmAthene and signed a merger agreement under which PharmAthene would acquire SIGA. As SIGA needed a path to survival, they insisted as part of the merger agreement that in the event the merger was not consummated, the parties would negotiate, in good faith, a license agreement for the small pox drug. The terms of the license were set forth in a term sheet included as an exhibit to the merger agreement; that term sheet is referred to as the LATS. The provision of the merger agreement requiring the negotiation of a license on the terms of the LATS is a Type II Preliminary Agreement for a license agreement.
As the period between signing and closing progressed, it became increasingly likely that SIGA’s drug would gain regulatory approval and that SIGA would be able to obtain funding for development. The PharmAthene merger, which was a life saver when it was signed, was now a financial albatross to SIGA. So, when the outside date under the merger agreement arrived without the deal having closed, SIGA terminated the merger agreement.
The problem, for SIGA, was the Type II Preliminary Agreement for a license. The small pox drug was now a lot more valuable, and SIGA would lose much of that value if a license on the terms contained in the LATS was entered into. When PharmAthene tried to negotiate the license agreement, SIGA indicated that it was only willing to proceed on different economic terms and PharmAthene sued.
The Issue is Damages
In the early rounds of the SIGA case, the Delaware courts determined that SIGA’s refusal to negotiate a license agreement on the terms set forth in the LATS was a breach of its contractual obligation to negotiate in good faith. That is not surprising.
As the SIGA case wound its way back and forth through the Delaware courts, the issue became one of damages. How much could PharmAthene collect as a result of SIGA’s breach. That is where the new news is.
The measure of damages is a sometimes arcane subject that is often begun on the first day of law school. The issue is indelibly ingrained in every law student’s memory by the movie The Paper Chase in which noted actor John Houseman, playing Professor Kingsfield, tortures a law student with Hawkins v. McGee the infamous “matted and hairy hand case.” No YouTube link was found, but if you have Amazon Prime, you can watch it here. The most fulsome form of contract damages, as explained by Professor Kingsfield, are Expectation Damages, which is providing the injured party with the benefits of the contract as if it had been fully performed.
PharmAthene faced two challenges in getting Expectation Damages. First, there was no license agreement for PharmAthene to enforce. The whole point of the case, was that the parties did not reach a binding contract, so what contract was the court supposed to calculate damages under? The Delaware Courts addressed this problem by conducting a detailed analysis of what the terms of a license agreement would have been, starting with the LATS, and building on that with the limited negotiations between the parties.
Second, as a doctrinal matter, as Professor Kingsfield would tell us, lost profit generally has to be proved with some degree of particularity, and PharmAthene wasn’t able to do that. The Delaware Courts solve this problem by adopting the “Wrongdoer Rule.” Under the Wrongdoer Rule, the wronged party only needed to prove the fact of damages, and then because the Court doesn’t want to let the wrongdoer profit from the ambiguity that it created, it will award damages even if it is “an estimate, uncertain or inexact.”
Applying the Wrongdoer Rule, the Delaware Courts found that the discounted prevent value of the expected profits under a license agreement negotiated in good faith based on the LATS would have been $113 million, and it awarded those damages to PharmAthene.
In awarding Expectation Damages in the SIGA Case, the Delaware Courts charted a different course from other major commercial jurisdictions, notably New York and California, which typically do not award lost profits for breach of a Type II Preliminary Agreement.
Preliminary Agreements can be of great use in negotiating a transaction. The SIGA Case demonstrates that a legally binding Preliminary Agreement can protect the legitimate economic expectations of the parties. It also highlights the necessity for specifying what type of Preliminary Agreement is being entered into, and the governing law, as those choices can dramatically affect the outcome in the event of a dispute.
Editor’s note: This blog post is intended as general information on the law and legal developments, and is not legal advice as to any particular situation. Under New York ethical rules, please note that this post may constitute “ATTORNEY ADVERTISING.”