Letters of intent, or term sheets (“LOIs”), are commonly used in M&A and other corporate transactions. However, when discussions between parties breakdown the question often arises, are any of the terms in the LOI enforceable?  A recent Delaware case, SIGA Technologies v. PharmAthene, which has twice been appealed to the Delaware Supreme Court, serves as an important reminder for parties to be intentional when they “agree to agree.” 

What is an LOI?

An LOI typically summarizes the principal deal terms and oftentimes creates the framework from which parties work to reach a definitive agreement.  Parties may decide to execute an LOI for several reasons, including:

• an LOI may help each party better understand the other’s position on deal terms and structure,
• in some cases, an LOI may be submitted to regulatory agencies to initiate the approval process, and
• an LOI simply may be customary in the industry or the type of transaction.

LOIs may include provisions regarding the structure of the transaction, the purchase price (including any earn-out component), a timeline for the transaction, key closing conditions, due diligence and access provisions, exclusivity, allocation of transaction expenses and confidentiality, among others.

One of the key considerations in drafting and negotiating an LOI is to clearly identify which provisions are binding and which are non-binding.  Oftentimes, an LOI will include express provisions that identify the binding and non-binding provisions as such.  Other times, the binding nature of the terms of an LOI may be less clear.

SIGA Technologies v. PharmAthene

In SIGA Technologies, two biotech companies negotiated the terms of a license agreement term sheet (the “LATS”).  After negotiating the LATS, the parties decided instead to enter into a merger and, therefore, negotiated and executed a merger agreement.  The LATS was never signed and it included a footer that read “non-binding terms”. The merger agreement, on the other hand, was signed and included a provision that provided that if the merger agreement was terminated that the parties would negotiate a license agreement in good faith and “in accordance with the terms set forth” in the LATS. 

After SIGA’s prospects as an independent company dramatically improved, it decided to terminate the merger agreement and stay independent. When PharmAthene stated that it was ready to move forward with the license agreement, SIGA prepared a draft license agreement that contained radically different terms than the LATS and insisted that the parties negotiate a license agreement “without preconditions.” PharmAthene promptly filed suit claiming that SIGA breached the terms of the merger agreement, among other claims.

The Delaware Supreme court sided with PharmAthene, concluding that an express contractual obligation to negotiate in good faith is binding and that SIGA had contracted to negotiate the license agreement in good faith and on terms substantially similar to the LATS despite the fact that the LATS, by itself, was not a binding contract.  

On the second appeal to the Delaware Supreme Court, the Court affirmed the award of expectation (or “benefit of the bargain”) damages to PharmAthene as opposed to reliance damages (i.e. expenses incurred during negotiations) because the Court found that there was enough evidence to support the lower court’s finding of fact that the parties would have reached an agreement but for SIGA’s bad faith negotiations.

What Does SIGA Technologies Mean?

SIGA Technologies conclusively determined that Delaware will enforce a breach of an express contractual duty to negotiate in good faith under appropriate circumstances.  As you might expect, the determination of whether the party breached its duty to negotiate in good faith is a fact specific analysis and, under Delaware law, bad faith requires a showing of “dishonest purpose or moral obliquity.”  Accordingly, the mere failure to reach a definitive agreement does not necessarily constitute a breach to negotiate in good faith.

SIGA Technologies also makes it clear that expectation damages can be awarded based on a preliminary agreement despite the fact that some of the terms of the preliminary agreement are open for future negotiation so long as:

• the parties are obligated to negotiate in good faith, and
• there is sufficient evidence showing that an agreement would have been reached but for the defendant’s bad faith negotiations.

This is a significant development because previously there had been no consensus on whether a plaintiff could recover expectation damages in such a case. And while SIGA Technologies certainly does not mean that all LOI’s are binding, it does serve as a good reminder for parties to be careful when “agreeing to agree.”

Practice Pointers

• Clearly identify binding and non-binding provisions. In determining whether the terms of an LOI are binding a court will first look to the express terms of the LOI.  If certain provisions of an LOI are intended to be binding and certain provisions are intended to be non-binding, that should be clearly identified in the LOI.  It is also a good idea for the LOI to expressly state that neither party has any liability with respect to the non-binding provisions.
• Be intentional about “agreeing to agree.” Parties should be keenly aware of any provision imposing a certain standard of conduct in how the parties will conduct negotiations regardless of whether that provision is in an NDA, an LOI or any other transaction document. 
• Draft LOIs thoughtfully. If provisions are meant to be non-binding consider using conditional language like “would” versus “will”.  When naming defined terms, consider using “Potential Transaction” instead of “Transaction” or “Prospective Buyer” instead of “Buyer” to make it clear that the transaction at issue is still subject to negotiations and a definitive agreement.  It may also be helpful to include language in the header or title of the LOI indicating that it is “subject to a definitive agreement,” “non-binding” or “subject to approval.”
• Ensure other transaction documents do not unintentionally incorporate the LOI. Ensure that a non-binding LOI is not somehow incorporated into another transaction document in a way that could make it binding.  For example, the integration clause of the definitive agreement should not inadvertently incorporate the LOI.
• If a subsequent definitive agreement is contemplated, make sure that is clearly stated in the LOI.  If the parties intend to formalize the complete terms of the transaction in a subsequent agreement, that fact should be clearly stated in the LOI.
• Remember From 8-K Item 1.01 and assess whether an LOI may trigger a filing. Under Item 1.01 of Form 8-K, a reporting company must file a Form 8-K if it enters into a material definitive agreement.  If certain terms of a material LOI are binding, it could constitute a material definitive agreement that would require an Item 1.01 Form 8-K. Consider whether those binding terms are material to the company.

Conclusion

Because LOIs are typically informal documents and are sometimes drafted by business persons with little input from lawyers, they sometimes do not receive the scrutiny they deserve.  SIGA Technologies is a reminder of the potential consequences of such an oversight.