Many of the comments in the back-and-forth commentary following G. Hudson's Seeking Alpha article "SIGA or PharmAthene: Who Really Won?" focused on the key issues that are discussed below. The purpose of this article is to add value to that discussion in three ways: to address all the important issues in one place and in context, to describe how some arguments have already been addressed by Vice Chancellor Parsons and Chief Justice Steele, and to increases the chances that quoted passages are interpreted as intended by their authors.
The Supreme Court of Delaware's rulings addressed three questions, which will be taken up in turn.
Which state's laws will be used to resolve the dispute?
SIGA (NASDAQ:SIGA) had argued that New York should prevail and PharmAthene (NYSEMKT:PIP) argued that Delaware should prevail. The Vice Chancellor found that Delaware law should prevail and the Delaware Supreme Court upheld his finding. As a result, the parties are bound by:
- RGC v. Greka (2001), in which after signing a term sheet, "neither party could in good faith insist on specific terms that directly contradicted a specific provision found" therein (p. 14); and
- The Delaware Supreme Court's own ruling in the current case (see below for details) regarding the kind of damages that may be collected when the contractual obligations to negotiate in good faith under a "Type II preliminary agreement" have been breached. Under Adjustrite Systems v. GAB Business Services (1988), the 2nd Federal Circuit Court differentiated between Type I and Type II preliminary agreements. In the former, the parties agree on all issues requiring negotiation but opt to construct a more formal document to memorialize their agreement. In a Type II agreement, the parties "agree on certain major terms, but leave other terms open for further negotiation" (p. 548).
Did SIGA breach its contractual obligation to negotiate in good faith?
The Delaware Supreme Court found that SIGA breached its contractual obligation to negotiate in good faith under a Type II preliminary agreement. This obligation was explicit in both a bridge loan agreement and a merger agreement. Both described what PharmAthene would obtain in return for providing SIGA with financial and technical assistance: if the two companies did not end up merging, they would negotiate with the intention of executing a definitive License Agreement for ST-246, SIGA's antiviral drug for treating smallpox, in accordance with the terms set forth in a license agreement term sheet (LATS). Among other things, the LATS described how future income streams from were to be shared under a license.
In the fall of 2006, according to Vice Chancellor Parsons, it "appeared that ST-246 would be a fantastic success and that SIGA could obtain all the capital it might need in the future from sources independent of PharmAthene" (p. 26). In the light of this reverse of fortune, SIGA sent PharmAthene a draft LLC agreement with rather different economic terms. Chief Justice Steele's opinion cites and endorses the Vice Chancellor's finding that:
... while the economic terms [SIGA] proposed in the Draft LLC Agreement may not have "directly contradict[ed]" the LATS . . . they differed dramatically from the LATS in favor of SIGA' to the extent that they virtually disregarded the economic terms of the LATS other than using them as a skeletal framework for the types of payments that would be made without giving any meaningful weight to the dollar amounts or percentages [SIGA] had negotiated earlier. [p. 27, quoting from p. 65 of the Vice Chancellor's opinion; the Vice Chancellor emphasized the word "types"]
Given that SIGA breached its contractual obligation, what are SIGA's financial obligations to PharmAthene?
This question can be divided into two sub-questions. The less important one is "Is SIGA required to pay some of PharmAthene's attorneys' fees, and if so how much?" The Delaware Supreme Court upheld the Vice Chancellor's affirmative answer to the first part, and the Delaware Supreme Court remanded the second part to the Vice Chancellor for further study. They endorsed his approach that SIGA should pay that portion of certain of PharmAthene's fees that related to the bases of liability and form of relief he found and ordered respectively. Yet since they are remanding task of determining the form of relief, they are also remanding the determination of the attorney's fees. In any case, because the potential amount that PharmAthene may collect for legal expenses, while not insubstantial, pales alongside the amount that might be awarded in response to the second sub-question, the remainder of this article focuses solely upon the latter-namely: "What should the remedy be for breaching the contractual obligation?"
Developing a basis for predicting how this question will be answered in the next round involves addressing the five related issues explored below.
1. May PharmAthene be awarded expectation damages or only reliance damages? Whether suffering economically as a result of a breach of contract or under the doctrine of promissory estoppel-which may apply when a party has reasonably relied on a promise that was broken-a party may recover reliance damages. Both kinds of damages restore injured parties to different hypothetical economic positions. Reliance damages restore them to their position prior to relying on the agreement or promise, whereas expectation damages restore them to the position that they would have enjoyed had the agreement or promise been fulfilled.
Vice Chancellor Parsons noted:
In this case, reliance damages in the narrow way SIGA defines them would be on the order of a few hundred thousand dollars-basically de minimis - in the context of the billion dollar business opportunity at issue. (p.91)
He found that it was appropriate to award expectation damages either as a result of a breach of contract or under the doctrine of promissory estoppel. The Delaware Supreme Court made four key rulings related to this finding:
- SIGA and PharmAthene had indeed entered into a Type II preliminary agreement;
- the doctrine of promissory estoppel does not apply to this case "because a promise expressed in a fully enforceable contract cannot give rise to a promissory estoppel claim" (p. 2);
- when a party breaches a Type II agreement's obligation to negotiate in good faith, it is permissible for an injured party to be awarded expectation damages; and
- "because it is unclear to what extent the Vice Chancellor based his damages upon a promissory estoppel holding rather than upon a contractual theory of liability predicated on a Type II preliminary agreement, we reverse the Vice Chancellor's damage award and remand the case for reconsideration of the damages award consistent with this opinion" (p. 38).
This last ruling requires some elaboration. At 8:31 on May 29,2013 in response to G. Hudson's article, VLD said:
It is incredible to me that anyone who has Parsons opinion and the Supreme's opinion can't see the handwriting on the wall. The Supremes basically said to Parsons: Feel free to make the same damage award, but base it on breach of contract, not equitable estoppel. It really is that simple.
While I believe that the Vice Chancellor may indeed be able to propose the same damage award, it is not quite as simple as basing it on breach of contract rather than promissory estoppel. The issues include not only what are the proper criteria for breach of contract expectation damages, but also what is a legally acceptable basis for the somewhat unusual stream of payment form of the award. After all, the Chief Justice said on page 38 in Footnote 102:
We note that when explaining his damage award, the Vice Chancellor found the reasoning in RGC International supportive of an equitable payment stream, but he relied on the portion of RGC International which awarded fees both because the defendant breached its `obligation to negotiate in good faith and [because the plaintiff] reasonably relied on the promises made by [the defendant] and thereby took action to its detriment. [Citing RGC International Investors v. Greka Energy Corp), bracketed passages inserted by, and the word "and" emphasized by, the Chief Justice]
In other words, if the Vice Chancellor wishes to reissue his original award, he also must refrain from basing it upon Greka. His main focus should be upon explaining why an equitable income stream is an appropriate remedy under "a contractual theory of liability predicated on a Type II preliminary agreement."
2. What are the proper criteria? The particular criteria that a remedy must meet are applied within a context. In talking about of principles and the extent of his discretion in applying them, Vice Chancellor Parsons draws attention to "the maxim of equity that `[e]quity will not suffer a wrong without a remedy.' To that end, the Court of Chancery will award `such relief as justice and good conscience may require' and `has broad discretion to form an appropriate remedy for a particular wrong.'" (p. 86, citing Wolfe & Pittenger (2010), Lichens v. Standard Commercial Tobacco (1944), and Whittington v. Dragon Gp. (2011), respectively)
In his ruling, Vice Chancellor Parsons mentions the specific criteria that he must address:
"The `standard remedy' in Delaware, as elsewhere, `for breach of contract is based upon the reasonable expectations of the parties ex ante. This principle of expectation damages is measured by the amount of money that would put the promisee in the same position as if the promisor had performed the contract.' As I stated in SIGA II, `a plaintiff can only recover those damages which can be proven with reasonable certainty. Moreover, no recovery can be had for loss of profits which are determined to be uncertain, contingent, conjectural or speculative.'" (pp. 79-80, citing Duncan v. Theratx (2001) and his earlier opinion (2010), respectively)
3. How has the Vice Chancellor already addressed these criteria? First, I shall discuss what Vice Chancellor said about "reasonable certainty," and then the phrase "no recovery can be had for loss of profits which are determined to be uncertain, contingent, conjectural or speculative." The context for both sets of remarks are his attempt to see if a remedy in the form of an equitable income stream might meet both the overall goal of approximating "the reasonable expectations of the parties ex ante" and the particular criteria being discussed.
Damages that can be proved with reasonable certainty. Note that the "reasonable certainty" is used differently from the way "uncertain, contingent, conjectural or speculative" (which will be discussed subsequently). The first refers not to the certainty of profits, but rather to the certainty that the nature of the damages can be specified. The Vice Chancellor commented: "Rather than mathematical precision, `the law requires only that there be a sufficient evidentiary basis for making a fair and reasonable estimate of damages.'" (p, 80, citing Delaware v. Nuance Communications, 2010)
Here is how the Vice Chancellor described his efforts to develop a sufficient evidentiary basis:
In providing a reasonably compensatory remedy, I find guidance in the primary purpose of a constructive trust: to redress a wrong rather than `to effectuate the presumed intent of the parties.' In other words, I need not award a payment stream on proceeds from ST-246 that mirrors the terms of the LATS. My focus, therefore, is on what cashflows, with reasonable certainty, PharmAthene would have received had good faith negotiations yielded a definitive license agreement and on how best to compensate PharmAthene for the loss of those cashflows.
At all stages of negotiation between PharmAthene and SIGA, a license agreement for ST-246 comprised, at a minimum, (1) some combination of upfront, deferred, and milestone payments from PharmAthene to SIGA and (2) some combination of revenue sharing in the form of royalty payments on net sales and 50/50 profit splits on all or part of certain net margins. [pp. 100-102, citing Hogg v. Walker, 1993]
In other words, by "reasonable certainty," Parsons means that if a license agreement had been consummated in accordance with the LATS, he is reasonably certain that it would have contained substantially similar terms to what he has proposed. Eventually, Parsons described and justified an equitable income stream that he designed to be a simpler approximation of what PharmAthene would have received under the agreement.
No recovery can be held for loss of profits which are determined to be uncertain, contingent, conjectural or speculative. In his Seeking Alpha article, G. Hudson quotes the following passage from pages 84-85 of the Vice Chancellor's ruling:
Applying these precedents to the facts before me, I conclude that I cannot award PharmAthene the present value of its estimated lost profits on a license agreement that (1) would have contained the risk of receiving no profits and (2) was never consummated, because such an award would be speculative.
When the Vice Chancellor made this comment, he was responding to PharmAthene's claim for a single up-front lump sum payment based on the present value of its estimated lost profits. On page 95 of his ruling, in a passage that G. Hudson also quoted, he lists scenarios under which PharmAthene might receive no profit, and explicitly says that a single up-front lump sum payment would be "speculative and too uncertain, contingent, and conjectural." However, the Vice Chancellor rejects the notion that no appropriate framework for expectation damages can be devised for this case: "Nevertheless, damages are not `speculative' merely because they are difficult to calculate. Rather than mathematical precision, `the law requires only that there be a sufficient evidentiary basis for making a fair and reasonable estimate of damages.'" (p, 80, citing Delaware v. Nuance Communications, 2010)
Here is the Vice Chancellor's explanation regarding why his equitable income stream proposal escapes the criticism that it is compensating for profits that are determined to be uncertain, contingent, conjectural, or speculative:
Applying the equitable principles and remedies discussed supra to the facts of this case, I conclude that an appropriate remedy would be to afford PharmAthene a stream of future payments if and when commercial sales of ST-246 commence, after accounting for certain marginal expenses. Such a remedy would operate somewhat similarly to an award of a constructive trust or of an equitable lien on a partial interest in the proceeds derived from the patents and related intellectual property for ST-246. A remedy of this sort would comport with the Court's authority to provide relief `as justice and good conscience may require' and the requirement to avoid speculative damages.
Viewing PharmAthene's request for an equitable payment stream as akin to a request for imposition of an equitable lien addresses most of SIGA's remaining objections to that request. . . . [B]ecause the remedy would be prospective in this case-i.e., a share in the future proceeds from ST-246, if any-PharmAthene would not be relieved of the risk that ST-246 generates no profits. Furthermore, the prescribed share can be tailored to account for payments PharmAthene would have had to make under a negotiated agreement consistent with the LATS. In this way, a payment stream similar to an equitable lien would not relieve PharmAthene disproportionately of risks or costs it otherwise would have had to bear under a formal licensing agreement. [pp.99-100, underlining added for emphasis, citing Lichens v. Standard Commercial Tobacco (1944).]
4. What did the Delaware Supreme Court say about the Vice Chancellor's analysis? In his ruling, Chief Justice Steele did not comment on whether or not the Court agreed with the Vice Chancellor's conclusions:
- that if a license agreement had been consummated in accordance with the LATS, it is reasonably certain that it would have contained substantially similar terms as his proposed equitable income stream; and
- that his proposed equitable income stream would escape the criticism that PharmAthene would be compensated for profits that are determined to be uncertain, contingent, conjectural, or speculative.
As mentioned above, the Court made clear that he needs to demonstrate that whatever he proposes is an appropriate remedy under "a contractual theory of liability predicated on a Type II preliminary agreement." But it also said for the first time that when a party breaches a Type II agreement's obligation to negotiate in good faith, it is permissible for an injured party to be awarded expectation damages.
What should we make of the Supreme Court's statement that they could not determine the extent to which the Vice Chancellor based his equitable income stream idea upon the doctrine of promissory estoppel or a contractual theory of liability? This finding seems academic, given that conceptually, the amount of expectation damages does not depend upon whether a defendant broke a promise or failed to perform a contract. (Note, however, Vince P.'s May 29 6:46 pm comment about possible differences; he does not imply that the difference he cites will result in trimming the size of the award.) In both cases, proposals for expectation damages should be judged by the extent to which they restore the injured parties to the economic position they would have enjoyed if they had not been wronged. In fact, in the previously quoted passage (written by the Vice Chancellor but quoted from the 2001 Delaware case Duncan v. Theratx), the person failing to perform a contract is called a "promisor." Here it is again:
The 'standard remedy' in Delaware, as elsewhere, for breach of contract is based upon the reasonable expectations of the parties ex ante. This principle of expectation damages is measured by the amount of money that would put the promisee in the same position as if the promisor had performed the contract.
My point is that the basis that the Vice Chancellor needs to use-and did use-is not the nature of the wrong that enabled the Court to impose expectation damages, but rather the size of the lost business opportunity. Here is how the Vice Chancellor made this point:
Indeed, according to Professor Farnsworth, the general rule against recovery of uncertain damages has been relaxed to permit recovery of the lost business opportunity of an aleatory contract, i.e., a contract dependent on an uncertain contingency, so long as the value of the `lost chance' is fairly measurable. [p. 82, citing Farnsworth (2004).]
I have twice quoted Parsons citing a phrase from Lichens v. Standard Commercial Tobacco (1944). The full sentence form Lichens makes an even more compelling point. As you can see, not only do Chancery Courts have broad discretion in imposing damages, but when appropriate to meet their objectives, they may invent a new format:
A Court of Chancery will seldom disregard fundamental principles, but in view of its general function to give such relief as justice and good conscience may require and in view of changing conditions, equity's powers with reference to corporations are not necessarily limited by a lack of early precedents.
5. Could the remedy be larger? In his May 28 comments, VLD raises the possibility of the award being higher, presumably with a larger percentage of profits or for a longer period. But Parsons has already argued that the 50% split was his best estimate of how to approximate the benefits to PharmAthene that a license agreement negotiated in accordance with the LATS would have contained. Regarding the duration of the equitable income stream, the Vice Chancellor has provided his reasons for selecting a ten-year term on pages 106-107, and there is nothing in the Supreme Court decision to suggest that he revisit the duration of an equitable income stream.
Vice Chancellor Donald F. Parsons was careful in his initial opinion. Perhaps because Delaware law had not been clear regarding whether expectation damages could be imposed for a breach of the obligation to negotiate in good faith, he imposed damages that would have been permissible under a doctrine of promissory estoppel, but his remedy did not depend upon settled law related to promissory estoppel. The Delaware Supreme Court clarified that expectation damages could apply to a breached contract, and agreed that Parsons had developed an evidentiary record demonstrating that there had been such a breach in this case. He developed a remedy within his discretion that addressed the criteria for expectation damages, and addressed how they met SIGA's objections. Because SIGA and PharmAthene have both already weighed in on all of the issues discussed, he may not be obligated to provide them additional opportunities to weigh in.
Disclosure: I am long PIP. I was long PharmAthene before the Supreme Court of Delaware’s ruling and increased my holdings after reviewing the ruling and the Seeking Alpha commentary. I have no positions in SIGA, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.