A letter of intent, also known as a term sheet or a proposal, is typically a brief document that parties sign prior to drafting a detailed contract. In theory, a letter of intent functions as a tool for parties to make sure they are on the same page as to the significant points of a deal before they undertake the time and expense to prepare a detailed contract to express their complete agreement. Oftentimes, letters of intent state they are “non-binding,” which can sometimes lead to confusion as to what a party is obligated to do (or not do) when they sign a letter of intent. Above all, parties should be sure to negotiate in good faith after signing a letter of intent or they may be exposed to significant damage awards.
Recently, the Delaware Supreme Court issued another ruling in an extended litigation battle involving the failure of parties to finalize a contract after signing a letter of intent. (See SIGA Techs., Inc. v. Pharmathene, Inc. (Del. 2015) 132 A.3d 1108.) Earlier in the litigation, the Delaware Supreme Court held that one party’s failure to negotiate in good faith, after executing a letter of intent that included a footer on each page stating “Non Binding Terms,” entitled the non-breaching party to not merely reliance damages but, in fact, expectation damages. In other words, a non-breaching party can recover the profits it expected to realize from an anticipated contractual relationship even though the final contract was never executed.
In SIGA, the court held that the breaching party did not negotiate in good faith because it attempted to change fundamental points of the deal in order to take advantage of changing external conditions and extract more favorable terms than were initially agreed upon in the letter of intent. Although the SIGA ruling relied upon an especially unique set of facts, the upshot is that a party who fails to negotiate in good faith after executing a letter of intent can be exposed to significant damages under Delaware law.
California has not gone so far as to award expectation damages for breach of a letter of intent – at least, not yet – but reliance damages are available in California for breach of a letter of intent. In Copeland v. Baskin Robbins U.S.A. (2002) 96 Cal. App. 4th 1251, the court dealt with a similar dispute in which a negotiation fell apart after the parties signed a letter of intent but before a final contract was executed. The letter of intent in Copeland recited the main points of the deal but included the proviso that it was subject to a “separate . . . agreement and negotiated pricing.”
The court held that the party who did not breach the letter of intent could only be entitled to reliance damages such as “out-of-pocket costs in conducting the negotiations.” But, the court continued, the non-breaching party “cannot recover for lost expectations (profits)” because of the difficulty in establishing the amount of lost profits flowing from a contract that was never finalized.
The Delaware approach is different from the California approach in that Delaware courts can potentially award greater damages for failure to negotiate in good faith after executing a letter of intent. California business owners, however, should note two points. First, Delaware courts have a reputation for well-developed contract and corporate law, and therefore the recent SIGA decision could potentially influence future California decisions. Second, when signing a letter of intent with a Delaware corporation, be on the lookout for whether the letter of intent specifies that Delaware law applies because, if so, even a California entity could be subject to the Delaware rule allowing for recovery of expectation damages for failure to negotiate in good faith. The best practice, therefore, is to be sure a letter of intent accurately characterizes what you intend to negotiate in good faith regardless of whether the letter of intent states it is “non-binding.”