Written by Jacqueline G. Veit, Elizabeth C. Conway and Kelsey J. Davis
Corporate attorneys and clients will be relieved to learn of a federal jury verdict and judge’s decision that, together, limit the potential reach of the “duty to negotiate in good faith” that can arise during the early phase of a potential transaction from just a term sheet or letter of intent (LOI).
In sum, parties can now have more confidence that “nonbinding” actually means nonbinding, and even if such a “duty” exists in an LOI, that the damages will be limited, discouraging counterparties from weaponizing this claim to get a windfall.
On Aug. 15, a U.S. District Court for the Southern District of New York jury issued a defense verdict on a “duty to negotiate in good faith” claim arising from a non-binding LOI, finding no such duty existed in the LOI at all. This followed the court’s summary judgment decision, which reduced the $30 million claim to approximately $400,000, finding “expectation damages” were not recoverable.
Ten years after a controversial Delaware decision on this duty, SIGA Technologies v. PharmAthene, 67 A.3d 330 (Del. 2013) (SIGA), the limits of SIGA’s reach are finally coming into focus.
In Cambridge Capital v. Ruby Has, a private equity firm sued a target company for breach of an implied duty to negotiate in good faith allegedly arising from a non-binding LOI for the potential purchase of half the target company. Cambridge Capital LLC alleged breach in two ways: substantially raising the price for the proposed acquisition after six months of negotiations, and breach of the exclusivity provision. Relying on SIGA, the firm sought to recover tens of millions of dollars in “expectation damages,” which was the profit it expected to earn had the deal gone through.
On summary judgment, the court (Hon. Lewis J. Liman) knocked out Cambridge’s “expectation damages” under both New York and Delaware law. Cambridge Capital v. Ruby Has, F. Supp.3d, 2023 U.S. Dist. LEXIS 101866 (S.D.N.Y. June 2, 2023) (the decision). The court also dismissed the exclusivity claims. After a seven-day trial of the remaining issues, the jury rendered a defense verdict on the claim, finding that the non-binding LOI did not give rise to such a duty.
Risk of Expectation Damages Under ‘SIGA’—10 Years Later
In SIGA, the Delaware Supreme Court affirmed an award of more than $100 million in expectation damages for breach of a duty to negotiate in good faith arising from a term sheet. The term sheet between SIGA Technologies Inc. and PharmAthene Inc. was “nonbinding,” but it was incorporated into a binding Merger Agreement and Bridge Loan Agreement. The court adopted New York law as to what constitutes a binding preliminary agreement giving rise to this duty; however, it deviated significantly from New York law on potential damages, and thus the ramifications of a breach.
New York law categorically prohibits expectation damages in this context. The Delaware Supreme Court, however, has doubled down on its contrary damages position despite criticism, reaffirming the potential availability of expectation damages on this claim. See SIGA Technologies v. PharmAthene, 132 A.3d 1108 (Del. 2015), and Justice Karen Valihura’s dissent at 1139; Cox Comm. v. T. Mobile US, 273 A.3d 752, 760-61 (Del. 2022).
Although the SIGA decision itself was based on unusual facts and made clear that actual “bad faith” was required, the court also cited broad standards: that breach of this duty in any “[t]ype II preliminary agreement” could result in expectation damages, if “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.”
SIGA further held that such agreements “bar a party from renouncing the deal, abandoning negotiations or insisting on conditions that do not conform to the preliminary agreement.”
SIGA thus left open the possibility that a non-binding LOI could effectively be transformed into the final contract itself, subjecting the parties to lost profits damages if they did not negotiate in good faith, even though no final agreement was ever executed. SIGA sent shivers down the spines of company executives, who routinely use LOIs under Delaware law to provide the flexibility that SIGA seemed to eliminate.
Ten years later, however, not a single decision since SIGA has awarded expectation damages on this claim. Cambridge Capital, as well as another recent decision in Delaware federal court, are finally exposing SIGA’s limits.
Nonbinding Means Nonbinding
The jury verdict and the decision in Cambridge Capital make clear that the LOI’s language and the course of negotiations are key to the existence and scope of any duty. In Cambridge Capital, no duty existed. And even if it had existed, raising the price significantly as compared to the LOI did not necessarily suggest breach. See the decision at *100.
The court clarified the scope of the potential obligations under this duty, if it existed under this LOI. It said that that abandoning negotiations because of changed business conditions was not a breach where motivated by legitimate business concerns, and “acting in one’s financial self-interest … in response to market changes, does not constitute bad faith.” The court left for trial the question of whether the non-binding LOI at issue gave rise to a duty to negotiate in good faith. At trial, the jury found that it did not, ending the inquiry and resulting in a defense verdict.
Even if a duty had existed, the court showed SIGA’s limitations. At issue was Cambridge’s claim that Ruby Has LLC allegedly demanded a price “more than two and a half times the price agreed to in the LOI.” The court, however, found issues of fact on liability. If the parties acted “in their economic self-interest due to changed conditions,” as Cambridge itself did, there might be no breach. There were also issues of fact as to whether Ruby Has had previously terminated negotiations, and why.
Importantly, the court also questioned whether such a duty could even exist after the exclusivity period expired, as Ruby Has was then entitled to seek a higher price from other investors.
No Expectation Damages—‘Cambridge’ and ‘White Winston’
The Cambridge court held that New York law applied, but nonetheless examined Delaware law and dismissed the claim for expectation damages under both.
It noted that “[c]ourts in Delaware have interpreted SIGA narrowly,” and found the case distinguishable. While the damages in SIGA were reasonably foreseeable given the circumstances, that was not the case in Cambridge because, among other reasons, there was only a non-binding LOI and many key terms remained unresolved.
The court found no evidence that the parties would have reached an agreement but for the defendant’s alleged bad faith negotiations.
Recently, a U.S. District Court for the District of Delaware distinguished SIGA and similarly rejected expectation damages. White Winston Select Asset Funds v. Good Times Restaurants, No. 1:19-CV-2092-SB, 2022 U.S. Dist. LEXIS 93670 (D. Del. May 25, 2022). There, the non-binding LOI memorialized “tentative assent” to potential terms, but like the Cambridge LOI, there was no obligation to complete the deal or be bound by those terms.
The court refused to permit “expectation damages” because the situation was distinct from SIGA, calling it a “type III agreement.”
Practical Implications
The use of non-binding LOIs is extremely common in mergers and acquisitions. It allows the parties to explore a potential acquisition without committing to the ultimate transaction until they vet one another and fully negotiate the terms. The system works best when each side has the freedom to study the other, and negotiate deal terms in a way that allows them to take into account changing circumstances facing their businesses over the course of negotiations.
SIGA undermined this practice. It put parties acting under Delaware law at risk of extraordinary damages, even where no final deal was reached, if they were found to have negotiated in bad faith.
In Cambridge Capital and White Winston, judges and a jury have refused to find liability or award expectation damages on this claim where solely a non-binding LOI was at issue. These holdings show the narrow reach of SIGA, and align with common business practice. This precedent should help to constrain SIGA to its unique facts.
Parties can also do their part to avoid liability. Choice of law clauses can have real impact: New York law precludes any expectation damages, as opposed to Delaware law, which allows them in some circumstances. In addition, although the duty can in some instances be implied, parties should avoid including an express requirement to negotiate in good faith—a term that may, on its face, seem innocuous.
Parties should be careful to specify what terms are, and are not, binding, and to use proper language to limit liability under preliminary agreements.
Jacqueline G. Veit, a partner at Golenbock Eiseman Assor Bell & Peskoe, has litigated and provided counseling in a wide range of commercial lawsuits, arbitrations and appeals, with a particular focus on M&A disputes, internal and fiduciary duty matters, fraud and commercial contract cases. Partner Elizabeth C. Conway has represented individuals and businesses, foreign and domestic, in all phases of dispute resolution, from investigation through trial and appeal. Associate Kelsey J. Davis, admitted to the bar both in New York and in her native Australia, also represents clients in a wide array of commercial disputes.
###
Reprinted with permission from the New York Law Journal. For a PDF of the article, click here.
Golenbock Eiseman Assor Bell & Peskoe LLP
Golenbock Eiseman Assor Bell & Peskoe LLP, a full-service Manhattan-based business law firm, serves clients’ complex litigation, corporate, reorganization, intellectual property, real estate, tax, and trust & estate needs. The firm takes pride in its sophistication, experience, and ability to take on major engagements for its domestic and international clients while also maintaining a hands-on, personalized approach to all matters.
Golenbock represents entrepreneurial, portfolio, and institutional clients, ranging from start-ups to Fortune 500 companies, with a specific focus on the mid-market segment. Corporate clients include middle-market private corporations, public companies, private equity firms, venture capital firms, individual investors, and entrepreneurs on a global scale.
The firm’s litigation group represents clients in all aspects of litigation in state and federal courts. Corporate clients include middle-market private corporations, public companies, private equity firms, venture capital firms, individual investors, and entrepreneurs on a global scale.
Golenbock is a member of the Alliott Global Alliance, which was named Band 1 of global law firm alliances by Chambers Guides, the prestigious international legal survey. Alliott numbers 215 firms in 94 countries on six continents, and helps member firms partner with others in countries around the globe.