Those of us routinely asked to draft or review letters of intent (LOI), memorandum of understanding (MOU) and initial term sheets have a new challenge. The use of conventional text clearly stating “this is non-binding” to be sure a preliminary document memorializing negotiations does not give rise to the risk of unintended enforcement apparently is no longer sufficient. As a result of the Delaware Supreme Court’s decision in SIGA Technologies v. PharmAthene, Inc., No 314, 2012 2013 Del. LEXIS 265, 1-2 (Del. May 24, 2013), it is now suggested that counsel negotiating LOIs, MOUs and even term sheets designated as final include a specific negation of good faith. Text specifically stating the parties agree that neither party shall have a duty to negotiate in good faith is now considered appropriate. Getting both sides to agree to include such a forbidding sentence, however, is a significant challenge.
In SIGA Technologies, the court held that expectation or “benefit of the bargain” damages (and not just out of pocket, reliance damages) were appropriate where (1) the parties had a term sheet; (2) the parties expressly agreed to negotiate in good faith in a final transaction in accordance with those terms; and (3) but for the breaching party’s bad faith in trying to improve the terms, the parties would have consummated a definitive agreement with the terms set forth in the term sheet.
The SIGA Technologies decision might have been appropriate in light of the specific facts before the court but it leaves transactional lawyers at a loss. Business lawyers have been advising clients since the beginning of time that there is, and should be, a great difference between incomplete and preliminary letters, drafts and other communications clearly understood as non-binding (with the exception of specifically identified provisions, such as those relating to confidentiality and exclusivity) and final, mutually executed contracts with an integration clause. The former should have no legal effect other than as a basis to start the hard drafting process for definitive agreements. LOIs, MOUs and term sheets referring to the parties’ intent to finalize binding documents later are to be used as support for financing efforts and strategic planning and not evidence of a final oral or implied agreement between the parties. Exceptions to this rule were, until recently, very narrowly applied and usually only if the parties made an effort to carve out the intended exceptions with clear language (non-disclosure, exclusivity or no-shop provisions). Efforts by counsel for either party to impose a written duty of good faith and fair dealing on the other party are normally met with resistance with the better practice perceived to be silence on this point and text that allows either party to halt negotiations at any time for any reason as long as there is no breach of the binding confidentiality and/or exclusivity provisions. Termination fees are sometimes added to encourage good faith negotiations and cover out of pocket costs incurred as a cost of freedom to abandon those negotiations.
To avoid imposition of a SIGA Technologies penalty, many corporate advisors are now insisting the only safe course is to explicitly refute the presence of good faith. And yet, most clients do not want to suggest that they would ever negotiate in bad faith. Worse, most clients do not want to agree to allow the other party to the proposed transaction to abandon all pretenses of good faith and fair dealing. Who wants to go to the dance with a partner who asks for permission to humiliate you while there and tells you of his or her plan to possibly leave you without a ride home?
Bad faith in the midst of negotiations has historically been perceived as bad form but not an exception to the “non-binding” rule and certainly not the basis for expectation (lost profits) damages. To make this area even more challenging, a judicial determination of one company’s bad faith (e.g., trying to improve terms if the circumstances have become more favorable for the company) can easily be deemed by the shareholders/members of the same company to be the exercise of management’s fiduciary duty to maximize equity holders’ return. Failure to push for the best possible terms in the face of a non-binding term sheet could be found by another court to be a breach of that duty.
Whether bad faith should support an exception to the “non-binding” rule as a matter of law is an interesting question but the philosophy of law is rarely a topic businessmen and women wish to explore. Any number of things can make a deal that seemed attractive at a given point unacceptable some time later. Negotiations with respect to terms not included in the preliminary documents can be filled with real dispute; due diligence may reveal greater risks than anticipated; the industry-wide market may shift; or business may suddenly improve supporting more favorable terms for one party and less favorable terms for the other. Where the risk of the business enterprise does not begin to shift until after the execution of a definitive document, why should either party get the benefit of a preliminary bargain when the facts and circumstances supporting the transaction have changed?
While no one should be conducting negotiations in bad faith, the imposition of an implied duty of good faith and fair dealing in preliminary “non-binding” documents unless the parties specifically negate that obligation seems problematic. In contrast, once agreements are fully negotiated and signed, the covenant to act in good faith and engage in fair dealings is appropriate between business partners of all kinds. As found in other Delaware decisions, even where the contracting parties appear to have agreed to limit the scope of their common law and statutory fiduciary duties in a final document, good faith and fair dealing have an important role that should be implied and enforced by the courts. But, only after a final document is signed and sealed, however, should we be insisting a party trying to maximize their position “Did a bad, bad thing.”