The Duty to Negotiate in Good Faith

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It is commonplace in employment law that, at the end of mediation, negotiations, or other informal attempts to resolve a dispute, that the Parties will arrive at a term sheet but not have a formal document.  Then, with some degree of frequency, the deal is not consummated or one party negotiates for terms which are substantially different.  The Delaware Supreme Court has handed down a very instructive opinion on this topic in SIGA Technologies, Inc. v. PharmAthene, Inc., No. 314  2013 Del. LEXIS 265 (Del May 24, 2013) (en banc) Affirming in part, Reversing in part, and Remanding 2011 Del. Ch. LEXIS 136 (Del. Ch. Sept. 22, 2011).  

In SIGA, Chief Justice Steele wrote for the court to address whether, and what, damages were available when parties execute a term sheet but fail to reach a final settlement agreement due to the bad faith of one of the parties.  The term sheet at issue in SIGA contains an explicit provision that the parties will “negotiate in good faith with the intention of executing a definitive License Agreement in accordance with the terms set forth in the License Agreement Term Sheet attached…”.  2013 Del. LEXIS 265 at *13.  

In affirming the Chancery Court’s opinion by Vice Chancellor Parsons, the Court found that an express contractual obligation to negotiate in good faith is binding on the contracting parties.  The Court also noted that the record contained sufficient evidence to support the Vice Chancellor’s determination that SIGA had failed to negotiate in good faith and, in fact, had negotiated in bad faith.  The Chancery Court based this determination, among other things, on its finding that SIGA’s negotiating position differed substantially from those memorialized in the License Agreement Term Sheet (the “LATS”).  Quoting CNL-AB LLC v. E. Prop. Fund I SPE (MS REF) LLC, the Court explained that, under Delaware law:

[B]ad faith is not simply bad judgment or negligence, but rather it implies the conscious doing of a wrong because of dishonest purpose or moral obliquity; it is different from the negative idea of negligence in that it contemplates a state of mind affirmatively operating with furtive design or ill will.

2011 Del. Ch. LEXIS 25 at *9 (Del. Ch. Jan. 28, 2011) (quoting Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199, 1208 n.16 (Del. 1993)).  Here, both the economic and non-economic terms proposed by SIGA subsequent to the execution of the LATS differed substantially from those contained in the LATS.  The Vice Chancellor went on to note that SIGA resorted to “a selective and biased memory of the parties’ negotiations”, that the individuals responsible for negotiating the LATS were not deeply involved in the subsequent negotiations, and identified evidence that “SIGA began experiencing ‘seller’s remorse’...”.  PharmAthene, Inc. v. SIGA Techs., Inc., 2011Del. Ch. LEXIS 136 at *24 (Del. Ch. Sept. 22, 2011).  As a result, SIGA’s subsequent proposals were “drastically different” and “significantly more favorable” to SIGA than those contained in the LATS.  Id.  

The Court also affirmed the Chancery Court’s determination that the parties intended to be bound by the LATS despite the fact that the LATS was not signed, and contained a footer on each page stating “Non Binding Terms.”  In so holding, the Court relied on the Vice Chancellor’s factual conclusion that the “incorporation of the LATS into the Bridge Loan and Merger Agreements reflects an intent on the part of both parties to negotiate toward a license agreement with economic terms substantially similar to the terms of the LATS…”  Even though the terms proposed by SIGA did not “directly contradict” those contained in the LATS, the fact that SIGA’s proposals “virtually disregarded the economic terms of the LATS” was sufficient to establish liability in this case.  The Court emphasized that liability of the type established here requires that the plaintiff show both “that a party’s proposed terms are substantially dissimilar and that the party proposed those terms in bad faith[.]”  

Next, the Court moved to the question of the appropriate measure of damages.  First, the Court, noted that “[o]ur decisions have not clearly answered [the] question” of the appropriate remedy for a breach of the duty to negotiate in good faith where the court finds that, had the parties negotiated in good faith, they would have reached an agreement.  In so doing, the Court reaffirmed the notion that parties to a term sheet can be bound to negotiate in good faith.  See, e.g., Great-W. Investors LP v. Thomas H. Lee Partners, L.P., 2011 Del. Ch. LEXIS 6 at *9 (Del. Ch. Jan. 14, 2011) (“[A]n agreement to negotiate in good faith may be binding under Delaware law, however, and specific performance could, in theory, be an appropriate remedy for breach of such a provision.”); RGC Int’l Investors, LDC v. Greka Energy Corp., 2001 Del. Ch. LEXIS 107 (Del. Ch. Aug. 22, 2001) overruled on other grounds Scion Breckenridge Managing Member, LLC v. ASB Allegiance Real Estate Fund, 2013 Del. LEXIS 235 (Del. 2013) (dealing with obligation to negotiate a definitive agreement based on a term sheet).  

As an initial matter, it is worth noting that the Court had earlier determined that although Delaware, not New York, law governed this matter, that, in its opinion, the choice of law would not have altered the outcome in this case.  Relying on New York law, which it called “instructive”, the Court noted that New York recognizes two types of “binding preliminary agreements”.  A “Type I” agreement is an agreement which is “a fully binding preliminary agreement, which is created when the parties agree on all the points that require negotiation (including whether to be bound) but agree to memorialize their agreement in a more formal document.”  Fairbrook Leasing, Inc. v. Mesaba Aviation, Inc., 519 F.3d 421, 426-27 (8th Cir. 2008); Adjustrite Sys., Inc. v. GAB Bus. Servs., Inc., 145 F.3d 543, 548 (2d Cir. 1998).  A “Type II” agreement is an agreement which “does not commit the parties to their ultimate contractual objective but rather to the obligation to negotiate the open issues in good faith in an attempt to reach the alternate objective within the agreed framework.”  Teachers Ins. & Annuity Ass’n of Am. v. Tribune Co., 670 F. Supp. 491, 498 (S.D.N.Y. 1987).  A Type II agreement does bar a party from renouncing a deal, abandoning the negotiations, or insisting on conditions which do not conform to the preliminary agreement, but does require good faith negotiation. 

Moving to the appropriate measure of damages, the Court affirmed the Vice Chancellor’s determination that PharmAthene was entitled to expectation damages, not mere reliance damages.  Noting that the recently decided Titan Investments Fund II, LP v. Freedom Mrtg. Corp., left this question open.  In Titan, the court found only that the parties had failed to negotiate in good faith.  2012 Del. Super. LEXIS 168 (Del. Super. Mar. 27, 2012).  In fact, the lower court in Titan specifically found that “the contract would not have closed[,] even absent [breach of the duty to negotiate in good faith].”  Accordingly, the Court awarded only reliance, not expectation, damages. 

Here, by contrast, the Court found that “where the parties have a Type II 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.”  SIGA, 2013 Del. LEXIS 265 at *51-*52.  The key findings supporting the Court’s holding were: 1) that the parties memorialized the basic terms of the transaction and expressly agreed that they would negotiate the final transaction in good faith based on those terms; and 2) that but for SIGA’s bad faith negotiations, the parties would have reached a final agreement.  Id. at *53.  In such circumstances, the Court found that the plaintiff is entitled to recover its “expectation” as damages, based on the anticipated “benefit-of-the-bargain”.  

Although SIGA is not an employment case, the holding would nonetheless apply to a situation where settlement of an employment dispute fails even though the parties had earlier, typically at the conclusion of a mediation, executed a term sheet which memorialized the material terms of apparent agreement.  Mediators may well consider requiring that an explicit obligation to negotiate the formal settlement papers be included in the term sheet.  While SIGA’s formal holding is an application of Delaware law, there seems to be no good reason why its various holdings would not be applicable in any jurisdiction.  Thus, practitioners ought to consider whether they consider themselves to be in a Type I circumstance or a Type II, that is, whether the agreement memorializes all material terms and evidences the parties’ intent to be bound (Type I) and, if not, whether the agreement evidences the parties’ intent to negotiate in good faith toward a deal using the term sheet as a framework (Type II). 

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