United States: Are You Afraid Of Commitments? (If So, Be Careful Using "Non-Binding" Term Sheets.)

Background:

 Non-binding Letters of Intent, Term Sheets, Indications of Interest or similarly titled documents are often used by business parties to outline business and financial arrangements that will be documented in a formal written agreement. These "preliminary agreements" are typically marked with a legend that includes a phrase such as, "NON-BINDING and PRELIMINARY" or "FOR DISCUSSION PURPOSES ONLY."   In addition to the legend, the parties often include a disclaimer stating that they do not intend the document to create a binding or other enforceable obligation on either party (other than a duty to maintain confidentiality).

 A recent case in Delaware, however, held that a "Letter of Intent and Term Sheet" marked with the words, "NON BINDING TERMS" on each page could nevertheless be enforceable if combined with an express obligation to negotiate in good faith.

Delaware Case – SIGA Techs., Inc. v. PharmAthene, Inc., C.A. No. 2627 (Del. May 24, 2013):

 In 2006, SIGA Technologies, Inc. ("SIGA") was developing a new drug for the treatment of smallpox. SIGA needed additional financing and the original plan was to structure a deal for a capital infusion from PharmAthene, Inc. ("PharmAthene") via a technology license agreement. The parties developed a "License Agreement Term Sheet" ("LATS") which included the material terms (financial and otherwise) each party expected in the final license agreement. The LATS included a legend on each page that it was "NON-BINDING and PRELIMINARY."

 Subsequently, the parties changed course and decided that PharmAthene would acquire SIGA in a merger. The parties then executed a Bridge Loan Agreement to provide SIGA with liquidity for the merger expenses, continued development of the smallpox drug and SIGA's overhead expenses. The Bridge Loan Agreement contained a provision that if the merger terminated, the parties remain obligated to negotiate in good faith a license agreement "in accordance with the terms" set forth on the LATS. When the merger negotiations broke down, SIGA's financial outlook had changed in the intervening period and SIGA no longer desired the technology license agreement on the original LATS terms. Instead, SIGA sought significantly higher payments and control.

 The Delaware Supreme Court ruled that the obligation to negotiate the technology license in good faith as required by the supplemental Bridge Loan Agreement was enforceable. The Court also affirmed the Court of Chancery's holding that SIGA had acted in bad faith by seeking revised financial and other terms under the LATS, despite the LATS being marked as "NON-BINDING and PRELIMINARY."  Finally, the Court found that the parties would have reached agreement on the LATS, but for SIGA's bad faith in seeking better financial and other terms.

Lessons Learned:

 Caution needs to be exercised when drafting and executing preliminary agreements such as Letters of Intent, Memoranda of Understanding, Term Sheets or other similar documents. Do not rely solely on a legend or other disclaimer in the preliminary agreement. In the SIGA case, there was a subsequent agreement that trumped the LATS designation as "NONBINDING and PRELIMINARY." However, if the term sheet itself had contained the obligation to negotiate in good faith, the analysis would be the same. Under the Delaware analysis, combining a preliminary agreement with an obligation to negotiate in good faith can significantly alter the parties' rights and obligations. (Because principles of contract law are applied pursuant to each jurisdiction's laws and court interpretations, the analysis must be made under the laws of the applicable jurisdiction.)

Best Practices for Drafting Preliminary Agreements:

In order to avoid issues in any jurisdiction, however, an express disclaimer of any obligation to negotiate in good faith in a term sheet, letter of intent, etc. is suggested. This also applies to subsequent agreements which might incorporate the preliminary agreement. Additionally, the drafter should consider including a provision that any party is free to terminate negotiations at any time for any reason and not be bound by the terms of the preliminary agreement.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.