I want to thank Jeff Eiseman for his article PharmAthene Vs. SIGA: Rebutting G. Hudson's 'Potential Award'. He has great credentials and is obviously a very smart man. I always try to keep an open mind to everyone's opinions so that I don't make an investment mistake that costs me money. In fact, in the past I have actually quickly changed from being long a stock that I was promoting to being short after I learned new information. However, in this case I still believe that SIGA (NASDAQ:SIGA) won't have to pay a significantly large damage award to PharmAthene (NPIP) but I have changed my opinion as to a potential option for an unjust enrichment damage award which could be larger than the reliance damage award available.
Here is Dr. Eiseman's thoughts as to the Delaware SC's May 24, 2013 Opinion-
"As I see it, the Supreme Court is only temporarily taking the remedy off the table. It didn't say "We have judged your remedy to be inappropriate and won't tolerate your sending it to us again." In effect it said, "Reconsider the remedy, keeping in mind that expectation damages may be appropriate in contract cases. After reconsidering what remedy is most appropriate, send us a clean justification. Don't mention 'promissory estoppel.' Ground your reconsidered remedy in contract law."
Now- here is an excerpt from the Delaware SC's May 24, 2013 opinion directing Judge Parsons to reconsider his damage award-
"we reverse the Vice Chancellor's damages award and remand the case for reconsideration of the damages award consistent with this opinion."
Just to make the above SC directive clearer, I looked up the meaning of "consistent with" (adhere to; conform to). Since the Delaware SC remanded the case to Judge Parsons with the specific guidance that the damage award be "consistent with" this opinion, I challenge anyone to find a legal case referenced within the SC's May 24, 2013 opinion that is about a damage award based upon an equitable damage payment stream.
The section of the May 24, 2013 SC opinion that is supposed to clearly define the SC's guidance to Judge Parsons as to the proper damage award is titled- "Proper Remedy" and is on page 30 through page 38. I have reviewed every legal case referenced in that section of the SC's opinion and noted that everyone of the cases referenced refer to a case that involved either an expectation damage award in a lump sum or a reliance damage award. Here is an excerpt of all of those pages followed by an excerpt of all of the reference notes-
"D. Proper Remedy
We now turn to the question of what is the proper contractual remedy for breach of an agreement to negotiate in good faith where the court finds as fact that the parties, had they negotiated in good faith, would have reached an agreement. Our decisions have not clearly answered this question. In Titan Investment Fund II, LP v. Freedom Mortgage Corp., we reversed the Superior Court judge's award of a one percent commitment fee for breach of an agreement to negotiate in good faith.75 We noted that it was "fatally inconsistent" for the trial judge to conclude"that the contract would not have closed[, ]even absent Freedom's breach," and at the same time award damages "that presupposed the opposite conclusion, namely, that the deal would have closed."76 We concluded that given the plaintiff's "inability to establish that the . . . [c]ontract would have closed but for [the defendant's] breach, [the plaintiff was] not entitled to damages measured on a 'benefit of the bargain' basis. Rather, [the plaintiff] was entitled only to its 'reliance' damages, measured by its actually incurred costs and expenses."77
In RGC International Investors, LDC v. Greka Energy Corp.,78 although that Vice Chancellor confusingly awarded damages for both breach of an obligation to negotiate and promissory estoppel,79 he concluded that he should "award damages and security in the amount equal to what [the plaintiff] should have received" under the term sheet.80 He reasoned that the award was not speculative because the term sheet embodied "how the parties themselves agreed to value [the defendant's] obligations to" the plaintiff.81
Even though our choice of law analysis mandates that we apply Delaware law, we find other courts' analyses instructive. Federal courts interpreting New York law recognize two types of binding preliminary agreements, "Type I" and "Type II."82 Parties create a Type II preliminary agreement when they "agree on certain major terms, but leave other terms open for further negotiation."83 "[T]he parties can bind themselves to a concededly incomplete agreement in the sense that they accept a mutual commitment to negotiate together in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement."84 A Type II agreement "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."85
In Goodstein Construction Corp. v. City of New York, the New York Court of Appeals established that New York law limits a plaintiff to reliance damages for breach of an agreement to negotiate, without distinguishing between Type I and Type II agreements.86 In Fairbrook Leasing, Inc. v. Mesaba Aviation, Inc., the United States Court of Appeals for the Eighth Circuit, applying New York law, considered the remedies available for breach of a Type II binding preliminary agreement.87 The court recognized that "New York's intermediate appellate courts have . . . read Goodstein . . . as categorically precluding expecta[tion] damages for breach of a [Type II] binding preliminary agreement to negotiate a final agreement in good faith."88 The court nevertheless commented that it was "not as confident . . . that Goodstein . . . should be read as categorically precluding benefit of the bargain damages for all breaches of binding preliminary agreements to negotiate a final agreement in good faith."89 The court, citing conflicting majority and concurring opinions in Venture Associates Corp. v. Zenith Data Systems Corp.,90 noted that it was "a difficult, largely unsettled question of remedies."91 The Eighth Circuit then proceeded to analyze the question of whether Goodstein would bar expectation damages for breach of a Type II agreement.
The Eighth Circuit noted that the Goodstein court rejected expectation damages because there would be no way to measure them without knowing whether the parties would have reached an agreement.92 The Eighth Circuit questioned whether Goodstein would still apply if a judge could discern "what agreement would have been reached."93 Ultimately, the Eighth Circuit declined to award expectation damages because the "[t]erm [s]heet was silent on significant issues" and "the missing terms [could not] be judicially determined by objective criteria in the [t]erm [s]heet itself or in commercial practice, usage, or custom."94
Similarly, in Venture Associates, the Seventh Circuit Court of Appeals addressed "a binding agreement to negotiate in good faith toward the formation of a contract of sale" under Illinois law.95 The majority noted that "if the plaintiff can prove that . . . [but] for the defendant's bad faith[,] the parties would have made a final contract, then the loss of the benefit of the contract is a consequence of the defendant's bad faith," and the defendant is liable for that loss if it is foreseeable.96 In a concurring opinion, Judge Cudahy noted his disagreement, as a public policy matter, with the majority on that point.97
Our decision in Titan Investments leaves open the question of whether expectation damages are available where the trial judge makes a factual finding that the parties would have reached agreement but for the defendant's breach. In fashioning his remedy, the Vice Chancellor noted the lack of consensus.98 We now hold 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.99
In this case, the Vice Chancellor made two key factual findings, supported by the record: (1) "the parties memorialized the basic terms of a transaction in . . . the LATS, and expressly agreed in the Bridge Loan and Merger Agreements that they would negotiate in good faith a final transaction in accordance with those terms"100 and (2) "but for SIGA's bad faith negotiations, the parties would have consummated a license agreement."101 The Vice Chancellor's factual conclusions support a finding that SIGA and PharmAthene entered into a Type II preliminary agreement and that neither party could in good faith propose terms inconsistent with that agreement. Because we had not previously addressed whether Delaware recognizes Type II preliminary agreements and permits a plaintiff to recover expectation damages, and because it is unclear to what extent the Vice Chancellor based his damages award upon a promissory estoppel holding rather than upon a contractual theory of liability predicated on a Type II preliminary agreement,102 we reverse the Vice Chancellor's damages award and remand the case for reconsideration of the damages award consistent with this opinion.
Now here are the foot notes that are the references for the above numbers including the most important foot note #99 which indicates the requirements for an expectation damage award as well as the cases for Judge Parsons to refer to-
"74 Cf. Chrysler, 822 A.2d at 1033-34 (noting in response to an argument that "existing written contracts between the parties governed the relationship, and therefore promissory estoppel is inapplicable" that "the promises made . . . were in addition to the existing relationship").
75 Titan Inv. Fund II, LP v. Freedom Mortg. Corp., 58 A.3d 984, 2012 WL 6049157, at *3 (Del. Dec. 5, 2012) (ORDER).
78 2001 WL 984689 (Del. Ch. Aug. 22, 2001), overruled on other grounds by Scion Breckenridge Managing Member, LLC v. ASB Allegiance Real Estate Fund, - A.3d -, 2013 WL 1914714 (Del. 2013).
79 See supra notes 72-74 and accompanying text (explaining that promissory estoppel cannot arise based on a promise contained in a fully enforceable contract).
80 RGC Int'l., 2001 WL 984689, at *16.
82 Fairbrook Leasing, Inc. v. Mesaba Aviation, Inc., 519 F.3d 421, 426-27 (8th Cir. 2008)(citations omitted). A Type I agreement "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. Such an agreement is fully binding . . . ." Adjustrite Sys., Inc. v. GAB Bus. Servs., Inc., 145 F.3d 543, 548 (2d Cir. 1998) (citations omitted).
83 Adjustrite, 145 F.3d at 548.
84 Teachers Ins. & Annuity Ass'n of Am. v. Tribune Co., 670 F. Supp. 491, 498 (S.D.N.Y. 1987) (citations omitted).
85 Id. A Type II agreement "does not guarantee" the parties will reach agreement on a final contract because of "good faith differences in the negotiation of the open issues" may preclude final agreement. Id. A Type II agreement "does, however, bar a party from renouncing the deal, abandoning the negotiations, or insisting on conditions that do not conform to the preliminary agreement." Id.
86 Goodstein Constr. Corp. v. City of New York, 604 N.E.2d 1356, 1360 (N.Y. 1992).
87 Fairbrook, 519 F.3d at 428-30.
88 Id. at 428 n.7 (citations omitted).
89 Id. at 429.
90 96 F.3d 275 (7th Cir. 1996) (applying Illinois law).
91 Fairbrook, 519 F.3d at 429 (citing Venture Assocs., 96 F.3d at 278, 281).
92 Id. (quoting Goodstein Constr. Corp. v. City of New York, 604 N.E.2d 1356, 1361(N.Y.1992)).
94 Id. at 430.
95 Venture Assocs., 96 F.3d at 277.
96 Id. at 278 (citations omitted). Judge Posner, writing for the majority, addressed "the practicality of the remedy" and noted that "[t]he difficulty, which may well be insuperable, is that since by hypothesis the parties had not agreed on any of the terms of their contract, it may be impossible to determine what those terms would have been and hence what profit the victim of bad faith would have had." Id. at 278-79 (citations omitted).
97 Id. at 281 (Cudahy, J., concurring) ("As a matter of policy, I think it is undesirable to force agreement on parties under threat of a bad faith finding and subsequent imposition of consequential damages" and would instead limit a plaintiff to reliance damages for "breach of an agreement to negotiate in good faith.").
98 PharmAthene IV, 2011 WL 6392906, at *3 (Del. Ch. Dec. 16, 2011) (citing PharmAthene III, 2011 WL 4390726, at *31-34 (Del. Ch. Sept. 22, 2011)) ("In [PharmAthene III], the Court acknowledged that there apparently is not yet a consensus in Delaware or in other jurisdictions as to whether a breach of an express contractual obligation to negotiate in good faith is susceptible to a remedy at law of expectation damages, or limited to only reliance damages.").
99 An expectation damages award presupposes that the plaintiff can prove damages with reasonable certainty. Callahan v. Rafail, 2001 WL 283012, at *1 (Del. Super. Mar. 16, 2001) (citation omitted) ("It is well settled law that 'a recovery for lost profits will be allowed only if their loss is capable of being proved, with a reasonable degree of certainty. No recovery can be had for loss of profits which are determined to be uncertain, contingent, conjectural, or speculative.'").
100 PharmAthene III, 2011 WL 4390726, at *35. The Vice Chancellor ultimately found that the Bridge Loan and Merger Agreements "required the parties to negotiate in good faith a license agreement with economic terms substantially similar to those contained in the LATS." Id. At *23. He also found "that the parties also recognized that the negotiations probably would introduce new terms and lead to some adjustment of terms expressly embodied in the LATS, while other terms in the LATS were almost certain to remain." Id. at *35.
101 PharmAthene IV, 2011 WL 6392906, at *4; see also PharmAthene III, 2011 WL 4390726, at *40, *42.
Equitable Payment Stream Award Discussion
It should be obvious to everyone that the SC Judges reviewing this case would have read all of Judge Parsons' opinions including discussions by him about equitable payment streams. Also, since Judge Parsons sent the SC an opinion with a damage award that involved an equitable payment stream, you would think the SC Justices would have provided other case references and guidance if they considered an equitable payment stream a proper remedy for this case.
When I actually researched the use of equitable payment streams for this case, I found that Judge Parsons doesn't have a lot of confidence in his ruling either. Here is an excerpt from page 85 of Judge Parsons' September 22, 2011 Opinion. This is Judge Parsons' first sentence of the section titled- "EQUITABLE PAYMENT STREAM" -
"Admittedly, there is little precedent to aid this Court in fashioning an appropriate remedy for the breach SIGA committed."
The fact that Judge Parsons is willing to hang his hat on some remotely supported basis such as promissory estoppel or as he discusses on page 87 of that same opinion, establishing a quasi-contractual obligation to support the possibility of using some type of equitable payment stream to award damages, should scare both SIGA and PharmAthene investors since the SC will be making the final decision as to the appropriateness of his ruling. All he will be doing is running up legal and expert fees for both companies.
A quasi-contractual obligation is a fictional contract created by courts for equitable, not contractual, purposes. A quasi-contract is not an actual contract, but is a legal substitute formed to impose equity between two parties.
The original equitable payment stream damage award which was proposed by Judge Parsons and overturned by the SC seemed to be a fairly simple calculation. After the first $40 million of profit from the ST-246 drug, the two companies were to split the profits 50% to each company. Even with the simplicity of this award, SIGA and PharmAthene have battled and are still battling over how to calculate this award as well as when it should be paid.
Since cases like this can be fought over for years, most courts try to avoid getting involved with these type of situations. Both parties were already fighting over this simple award so on May 31, 2012 Judge Parsons issued a 17 page letter trying to more clearly define how this award would be calculated and paid. Obviously we all know that letter has not worked.
Everything becomes even more difficult now since the equitable payment stream formula has to based on an incomplete LATS which was devised almost nine years ago. On top of that, Judge Parsons has to come up with a formula that reverses the payment structure and that takes into effect that SIGA now has to pay for manufacturing, marketing and administrative costs that would have been transferred to PharmAthene had the LATS been completed. There are many other variables not addressed by the LATS that have changed over the past nine years that will also have to be taken into effect when deriving this formula. As a CPA, I am glad I am not the person having to come up with this formula and can't imagine the number of future battles that will occur between PharmAthene and SIGA if it comes to fruition.
Just to give you a partial example of the complexities that Judge Parsons will have to address, here is an excerpt about the LATS from page 102 of his September 22, 2011 Opinion-
"LATS at 2 (providing for incremental royalties of 8%, 10%, and 12% on yearly net sales of Patented Products of less than or equal to $250 million, greater than $250 million, and greater than $1 billion, respectively, as well as "50% of any amounts by which net margin exceeds 20% on sales to the US Federal Government"); Proposed License Agreement §§ 4.4(b) & 5.1 (providing for royalties as specified by the LATS); Draft LLC Agreement §§ 6.1, 6.5(c) & Schedule 1 (providing for royalties of 18%, 22%, 25%, and 28% on net sales of less than or equal to $300 million, greater than $300 million, greater than $600 million, and greater than $1 billion, respectively, as well as equal distributions to each member thereafter)."
Just to give Dr. Eiseman peace of mind, I do understand that Apples and oranges are both subject to Newton's gravitational laws. However, I also can recognize the differences between apples and oranges. The cases cited to support an equitable payment stream (Cura Financial Services and ID Biomedical) by PharmAthene and Dr. Eiseman are completely different legal situations than the current case being discussed.
I am glad that Dr. Eiseman agrees with me that this case does not involve fraud but his statement that SIGA's action comes very close to the criteria for tortious interference is totally inaccurate. Tortious interference involves a third non-contractual based party interfering with a plaintiff's business. (NOTE: Employees of a business within a contractual based relationship are not considered a third party.)
Dr. Eiseman's attempt to justify referencing these two cases, one involving fraud and the other involving a situation where there was no contract between the plaintiff and the tortious interference defendant, should demonstrate to you that PharmAthene as well as Dr. Eiseman really do not have any cases that provide a reasonable precedent to reference for Judge Parsons' equitable payment stream award.
It should be obvious to everyone that when there is fraud involved or when there is no contract for guidance, the Chancery Court has more flexibility in designing a solution for someone who has been wronged. So that you can understand how different these two cases are, below is some additional information on each case as well as links to these cases (NOTE: Dr. Eiseman's statement that these were both contract cases is inaccurate as the tortious interference defendant in the Cura Financial Services case had no contractual relationship with the Plaintiff.)
ID Biomedical- In this case the defendant, after signing a binding letter agreement that conferred title to the plaintiff for improvements in a product, fraudulently hid those improvements and then applied for their own patents based on the improvement.
Cura Financial Services- This case has very little similarities to the present case being discussed and involves a 3rd party non-contractual defendant who was used to steal commissions from the plaintiff. The original contractual defendant tried to transfer business to a new corporation (non-contractual defendant) that they became part of, sold their corporation's assets to that new corporation, and then using that new corporation began running credit card processing through a bank that was confidentially introduced to the original contractual defendant by the plaintiff who was entitled to finders fees and commissions.
Specific Performance Discussion
At this point in the game, specific performance is highly unlikely as it relates only to the two signed contracts between these two companies, the merger agreement and the bridge loan agreement, which required SIGA to negotiate the LATS using good faith. Here is an excerpt from pages 24 through 25 of Judge Parsons' November 23, 2010 Memorandum Opinion (NOTE: Subsequently to this opinion, the LATS has been ruled to not be a contract on its own.)-
"As SIGA notes, "[u]nder Delaware law, a party seeking the equitable remedy of specific performance must prove the existence and terms of an enforceable contract by clear and convincing evidence."54 Where essential terms are lacking, "a court is not permitted to insert its own judgment and terms" as "it is a fundamental principle of equity that the remedy of specific performance will only be granted as to an agreement which is clear and definite and as to which there is no need to ask the court to supply essential terms."55 As with the issue of whether the LATS constituted a binding and enforceable contract, discussed supra Part II.B.1.b, the question of whether the remedy of specific performance is available to PharmAthene also turns on whether the LATS contained all essential elements. Moreover, to obtain specific performance, PharmAthene must prove the existence of an agreement on all essential terms by the higher standard of clear and convincing evidence. Nevertheless, I am not convinced that PharmAthene will be unable, as a matter of law, to prove that it reached agreement with SIGA on all essential terms of a licensing agreement that is sufficiently definite to be specifically enforced."
Judge Parsons discussed the great difficulty of involving the Court being in the oversight of negotiations between PharmAthene and SIGA on pages 89 and 90 of his September 22, 2011 Opinion per the below excerpt (NOTE: Anyone thinking it will be any easier now is delusional.)
"That gulf and the long and contentious history of this dispute indicate that the parties would approach any mandated negotiations from extremely different perspectives. In such circumstances, it would be difficult to distinguish a violation of a specific performance order (i.e., a bad faith negotiation), on the one hand, from faithful, but hard-fought negotiations, on the other. In other words, enforcement of the order would force me to assume an ongoing and onerous supervisory role, which black-letter principles caution courts to avoid.206 Based on these considerations and the fact that the propriety of ordering specific performance is firmly committed to the sound discretion of the Court,207 I deny PharmAthene's request for an order compelling SIGA to engage in faithful negotiations of a license agreement for ST-246 in accordance with the LATS."
Unjust Enrichment Discussion
In Dr. Eiseman's rebuttal article, he makes the following statement about an unjust enrichment award-
"The Supreme Court used different words but ended up in the same place. It said that because it found that SIGA was liable based on its contractual breach, it didn't consider or issue findings related to PharmAthene's unjust enrichment claim. The bottom line is that neither court has ruled out unjust enrichment claims, and both courts anticipate that a just remedy can be imposed without revisiting the unjust enrichment claim."
After additional research, I made a mistake in my article, and Dr. Eiseman's above statement is correct. However, anyone expecting a large unjust enrichment award will be disappointed since the breaching of a contract agreement cannot be considered as part of this award. In other words, PharmAthene cannot look to either the Merger Agreement or the Bridge Loan Agreement for an unjust enrichment award as per this excerpt from page 70 of Judge Parsons' September 22, 2011 Opinion-
"To the extent PharmAthene's claim for unjust enrichment relies on its provision of capital in the form of the Bridge Loan, the Bridge Loan Agreement alone provides the measure of PharmAthene's rights. Once the merger had been terminated, the Bridge Loan Agreement required SIGA to "negotiate in good faith with the intention of executing a definitive License Agreement in accordance with the terms set forth in the [LATS]."152 As discussed supra, SIGA breached that duty and thereby breached that contract. Therefore, PharmAthene must look to the Bridge Loan Agreement to enforce its rights in that regard, and it cannot pursue an independent claim for unjust enrichment based on SIGA's use of the capital it provided under that Agreement."
If Judge Parsons decides to award an unjust enrichment award, I am not sure that it will be significantly more than the reliance damage award that I think should be awarded. PharmAthene will have to prove the value of the operational support its team provided SIGA over a few months while working with SIGA's team to launch the ST-246 drug. This certainly will not be an award of a size similar to the one Judge Parsons is trying to calculate by deriving the terms from the LATS. Here is my supporting excerpt from page 70 to 71 of Judge Parsons' September 22, 2011 Opinion-
"PharmAthene, however, has not predicated its claim for unjust enrichment solely on the monetary capital it provided. It also relies on its provision of operational support to SIGA. Because PharmAthene has demonstrated that SIGA was enriched, to some degree, by that support, the first element of unjust enrichment is satisfied. Second, PharmAthene was impoverished by its extension of the operational support it provided. Although PharmAthene has not presented evidence to demonstrate a dollar value of that assistance, I am convinced that its employees expended considerable time that they would have spent on other PharmAthene matters were it not for their expectation that PharmAthene would control ST-246. Third, SIGA's enrichment-i.e., its receipt of free development assistance-directly resulted from PharmAthene's provision of it."
I actually appreciate anyone, especially Dr. Eiseman, who will provide me documented information which refutes any of the statements or information provided in this article. The last thing I want to do is to hold on to an investment based on false assumptions.
I am long both SIGA and PharmAthene as I believe both stocks are undervalued. I believe anyone who invests in both of these companies will come out significantly ahead when (or should I say if) Judge Parsons delivers his opinion as long as it is not one that keeps these two companies embroiled in this lawsuit. However, since I believe that SIGA will come out on top, I would recommend using most of your money to invest in SIGA stock.
Disclosure: The author is long SIGA, PIP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.