In almost all corporate transactions, the first piece of written documentation the parties exchange and execute (after a non-disclosure agreement) is a letter of intent or term sheet (“LOI”), which is intended to summarize the main deal points. And as many corporate transactions involve entities organized in Delaware, these documents often select Delaware as the governing law.

Typically, this same LOI documentation is clearly identified as “non-binding,” as it usually represents merely the initial, tentatively negotiated business points between the main players of each side of the deal. The task is then left to outside or in-house counsel to craft the definitive agreements to memorialize the business points reflected in the LOI. Unless a particular provision is clearly identified in the non-binding LOI as, in fact, “binding” (such as an exclusivity provision), most lawyers assume that there cannot be liability if the definitive agreement differs from the LOI or if no final agreement is ultimately reached based on that LOI. A decision earlier this year from the Delaware Supreme Court, however, calls that assumption into question, suggesting that, under Delaware law, both the “binding” and expressly “non-binding” provisions of an LOI may be enforceable as a binding contract if the trial judge were to determine what the parties “would have agreed to” had they negotiated in good faith. This case calls into question a provision that many practitioners may not focus on: what is (or should be) the governing law for the LOI, as that single provision may make all the difference between a non-binding LOI and an enforceable agreement.

In SIGA Technologies, Inc. v. PharmAthene, Inc., No. 314, 2012, 67 A.3d 330 (Del. May 24, 2013), the Delaware Supreme Court approved recovery of “benefit of the bargain” damages for breach of a duty to negotiate based on an expressly non-binding LOI. SIGA owned a potentially valuable antiviral drug for the treatment of smallpox. However, SIGA no longer had the resources to develop or exploit that drug. Sensing an opportunity for a merger, PharmAthene entered into negotiations to provide financing. SIGA was not interested in a merger and offered to enter into a license in exchange for funding. The parties negotiated a non-binding License Agreement Term Sheet (“LATS”). However, rather than agree to the LATS, PharmAthene insisted that the parties explore a merger first. Therefore, the parties executed to a merger agreement which specifically provided that, if the merger did not close by the stated deadline, the parties would “negotiate in good faith with the intention of executing a definitive Licensing Agreement in accordance with the terms set forth in the LATS.”

Predictably, perhaps, the merger failed to close by the deadline, which was not extended by SIGA. PharmAthene had its lawyers draft a definitive licensing agreement based upon the LATS. However, by this time, SIGA’s fortunes had improved significantly. SIGA had received NIH funding, and estimated that the value of its drug was worth more than three times what it had previously estimated. PharmAthene expressed a willingness to re-negotiate some of the economic terms of the LATS but insisted that the definitive agreement adhere to the structure and general terms contained in the LATS. SIGA suggested a higher up-front payment (from $6 million to $40 million) and a 50-50 profit split, and promised to draft a formal proposal. Instead, SIGA proposed a one-sided, 102-page draft LLC agreement that completely disregarded the LATS, as well as the terms it previously said would be acceptable. PharmAthene objected that the terms were “radically different” from the LATS. SIGA issued an ultimatum that, unless PharmAthene was willing to negotiate “without preconditions” regarding the LATS’ binding nature, the parties had “nothing more to talk about.” The lawsuit ensued.

The Delaware Supreme Court upheld the trial judge’s finding that SIGA breached the duty to negotiate in good faith by proposing terms that were not “substantially similar” to the economic terms in the LATS. The Court agreed that, even though the LATS was not signed and expressly stated on each page that it was “non-binding,” the incorporation of the LATS into the merger agreement, and the language requiring negotiation of an agreement “in accordance with” the LATS nevertheless meant that the parties were obligated to negotiate toward a license agreement with economic terms substantially similar to the terms of the LATS if the merger was not consummated. The Supreme Court upheld the trial court’s finding that SIGA acted in bad faith by proposing completely new terms and effectively disregarding the LATS.

To make matters worse, the Delaware Supreme Court held that PharmAthene could recover “benefit of the bargain damages,” i.e., the value of the licensing agreement that “would have been entered into” but for the bad faith. The Court held that “[w]here the parties have a . . . preliminary agreement to negotiate in good faith and the trial judge makes a factual finding, supported by the record, that the parties would have reached an agreement but for the defendant’s bad faith negotiations, the plaintiff is entitled to recover contract expectation damages.” To be sure, the trial court’s findings were based upon the particular and somewhat unusual facts in this case. Nevertheless, the Court’s determination that SIGA could not insist on terms or conditions that did not conform to the preliminary, expressly non-binding agreement, and that benefit of the bargain damages could be recovered, appears to differ from the laws in other states.

For example, in California (see Copeland v. Baskin Robbins U.S.A., 96 Cal. App. 4th 1251 (2002)) and New York (see Goodstein Construction Corp. v. City of New York, 80 N.Y.2d 366, 590 N.Y.S.2d 425 (1992)), “benefit of the bargain” or lost profit damages generally are not recoverable because, as the Copeland court explained, “there is no way of knowing what the ultimate terms of the agreement would have been or even if there would have been an ultimate agreement.”

As a result of Siga Technologies, individuals who draft LOIs should consider including the following provisions in order to protect their clients and companies:

• Choice of law other than Delaware to govern the LOI (e.g., California or New York). The definitive agreement can be governed by Delaware, but the LOI should not be, given the holding in Siga Technologies.

• Expressly state that the LOI is non-binding (except for confidentiality or exclusivity), disclaim any to be bound by any particular term or to be required to reach any agreement. While it may not be practicable or ideal to include such a provision, practitioners may also want to consider expressly disclaiming any duty to negotiate in good faith.

• Limit the remedies to preclude lost profits, recovery of costs for anything other than a breach of any binding terms that are specifically described.

Parties to a contract should not assume that an expressly non-binding agreement will be found to be unenforceable in every state. By expressly delineating what is enforceable, by limiting the remedies, and by choosing favorable law, parties can limit their exposure and avoid being surprised by an adverse court ruling.