It has long been considered at law that an agreement to negotiate is not a true agreement and cannot be enforced. That may be changing.
In Molson Canada 2005 v. Miller Brewing Company1, Molson was seeking injunctive relief to prevent Miller from terminating a licensing agreement Miller had with Molson. Since 2010, Molson had failed to meet the targets set by the licensing agreement, as the volume of some Miller brews sold each year in Canada had declined. Given the changing Canadian beer market, the parties attempted to renegotiate the terms.
The negotiations centered on a possible amendment to the Industry Standard Bottle Agreement (ISBA), which standardizes production of Canadian bottled beer and requires a dark brown glass bottle. Many Miller brews are packaged in clear bottles and because of the ISBA the clear bottles must be imported from abroad, which adds costs. The parties hoped that the ISBA would be amended to allow for local production of clear bottles, and a letter of intent was drafted in anticipation of this possibility.
Following the letter of intent, the parties signed an amendment to the licensing agreement providing that if the ISBA did not allow for local production of clear bottles, then the parties would negotiate in good faith, and specifically would negotiate about volume targets, marketing and equitable profit splitting.
A short while later it became clear that the ISBA would not likely be amended to allow local production of clear bottles, and Miller began exploring the option of selling its brand beers in Canada without Molson. Ultimately, Miller attempted to terminate the licensing agreement, which sparked the action and the request for injunctive relief.
In the written reasons for granting Molson’s request to prevent Miller from terminating the licensing agreement, the Ontario Superior Court of Justice stated that, while not binding, courts in the United States are prepared to find that an agreement to negotiate a contract in good faith may be enforced if all of the material terms of the contract have been agreed to in principle by the parties. The Ontario court referred the decision of the Supreme Court of Delaware in SIGA Technologies, Inc. v. PharmAthene, Inc., 2013 WL 2303303 (Del. Sup. Ct.). In that decision, the Delaware court agreed with the trial judge’s determination that a covenant to negotiate in good faith with the intention of executing a definitive license agreement in accordance with the terms set forth in a license agreement term sheet was enforceable even though the term sheet was unsigned and contained a footer on each page stating “Non Binding Terms”.
The Ontario court further stated that any covenant to negotiate in good faith, as with any other contractual obligation, must be interpreted in accordance with the intention of the parties in the context in which the agreement was negotiated and executed. The issue is not whether a court should imply an obligation to negotiate in good faith as a matter of commercial morality, but rather whether the parties themselves understood from the circumstances of the negotiation that any breach of the specific commitment to negotiate in good faith was to have some legal consequences. The Ontario court, in referencing the SIGA case, discussed below, determined that the Delaware court’s approach should be followed.
In SIGA, the Delaware Supreme Court ruled that SIGA acted in bad faith. SIGA owned an 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 term sheet which set out the terms of a license agreement. However, rather than agree to the term sheet, PharmAthene insisted that the parties explore a merger first. Therefore, the parties executed 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 term sheet.”
The merger failed to close by the deadline, which deadline was not extended by SIGA. PharmAthene had its lawyers draft a definitive licensing agreement based upon the term sheet. However, by this time, SIGA’s fortunes had improved significantly. SIGA had received funding, and estimated that the value of its drug was worth more than three times what it had previously estimated. PharmAthene was willing to re-negotiate some of the economic terms of the term sheet but insisted that the definitive agreement adhere to the structure and general terms contained in the term sheet. 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 agreement that completely disregarded the term sheet, as well as the terms it previously said would be acceptable. PharmAthene objected that the terms were “radically different” from the term sheet. SIGA issued an ultimatum that, unless PharmAthene was willing to negotiate “without preconditions” regarding the term sheet’s 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 term sheet. The Court agreed that, even though the term sheet was not signed and expressly stated on each page that it was “non-binding,” the incorporation of the term sheet into the merger agreement, and the language requiring negotiation of an agreement “in accordance with” the term sheet nevertheless meant that the parties were obligated to negotiate toward a license agreement with economic terms substantially similar to the terms of the term sheet 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 term sheet.
If you have questions about agreements to negotiate in good faith or other clauses in a typical letter of intent, contact any member of Clark Wilson’s Corporate Finance & Securities Group.
1This decision by the Ontario Superior Court of Justice was in connection with an action for injunctive relief. The main trial, which was scheduled for December 2013, was adjourned by the parties while they pursue an out of court settlement.