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Corporate Alert: What Constitutes a Breach of an Agreement to Negotiate in Good Faith?; Transaction Fails Entire Fairness Doctrine; Delaware Court  Declares Directors Can Lose Independence if Intimidated to Act; Delaware Court Denies Appraisal Rights; SEC Approves Tougher Standards for Companies Going Public Through Reverse Mergers
November 2011
Authors: Edward B. Stevenson, Irwin A. Kishner

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What Constitutes a Breach of an Agreement to Negotiate in Good Faith?

The Delaware Court of Chancery has held that a party may be found to have breached an agreement to negotiate a term sheet in good faith, notwithstanding the non-binding nature of the term sheet and the fact that it was never executed.

In the case, Pharmathene, Inc. and Siga Technologies, Inc. negotiated, but failed to execute, a nonbinding term sheet outlining specific terms for a pharmaceutical licensing transaction between the parties. They subsequently negotiated and executed a merger agreement in lieu of the licensing transaction, but expressly agreed in the merger transaction documents to resume negotiating the licensing transaction in good faith pursuant to the term sheet (attached as an exhibit to the merger agreement) if the merger deal fell through.  Siga subsequently terminated the merger agreement and although the parties resumed negotiating the licensing transaction, Siga's overall financial picture and business outlook had dramatically improved and they proposed licensing terms materially different than those in the original term sheet. As an example, upfront payments were increased from $6 million to $100 million, milestone payments were raised from $10 million to $235 million and royalty rates were doubled. Pharmathene subsequently sued Siga, asserting, among other things, a breach of Siga's duty to negotiate in good faith.

The Court analyzed whether Siga acted in bad faith in proposing drastically modified terms for the licensing transaction. The Court noted prior findings of unambiguous acts of bad faith where a party attempts to condition a future agreement on a previously "contested and compromised point" that the other party relied upon in agreeing upon the compromise. The Court applied the current facts and found that Siga acted in bad faith in relation to its duty to negotiate in good faith. According to the Court, the two companies contested and compromised on the primary economic terms of the license, Pharmathene acted in reliance on that compromise and Siga subsequently disregarded those terms and attempted to negotiate an agreement with different economic terms.  The Court awarded Pharmathene certain expectation damages, as well as attorneys' fees and expenses.

Pharmathene, Inc. v. Siga Technologies, Inc., Civil Action No. 2627-VCP, Delaware Court of Chancery, September 22, 2011.

Transaction Fails Entire Fairness Doctrine - Delaware Court of Chancery Awards $1.263 Billion in Damages

The Delaware Court of Chancery has awarded Plaintiff-stockholders $1.3 billion in a derivative action challenging the fairness of an acquisition by Southern Peru Copper Corporation of a target company controlled by Southern Peru's controlling stockholder.  The award amount, one of the largest by the Court of Chancery to date, constitutes the difference between the price that would have been paid in an entirely fair acquisition and the price actually paid. 

Under Delaware's "entire fairness" doctrine, the burden of proving that a challenged transaction is entirely fair falls on the defendants in such action, who must show that either the transaction was approved by a Special Committee of independent directors or by an informed vote of the majority of the minority shareholders.  Here, the Court found that the process by which the transaction was approved was not fair and did not result in the payment of a fair sale price. Even though Southern Peru formed a Special Committee to evaluate the transaction, the Court criticized Southern Peru for limiting the authority of the Special Committee in its evaluation of the transaction, for failing to identify available alternatives to the transaction and for the Special Committee's failure to obtain an updated fairness opinion from its financial advisor, notwithstanding the rising price of Southern Peru's stock during the period between signing the merger agreement and the shareholder vote to approve the transaction.  The Court stated that "the Special Committee put itself in a world where there was only one strategic option to consider, the one proposed by the controller, and thus entered a dynamic where at best it had two options, either figure out a way to do the deal the controller wanted or say no." After carefully analyzing the Special Committee's actions and finding them deficient in many respects, the Court held that the transaction was not entirely fair and awarded damages to Plaintiff-stockholders in the case.

In re S. Peru Copper Corp. S'holder Derivative Litig., C.A. No. 961-CS (Del. Ch. Oct. 14, 2011)

Delaware Court of Chancery Declares Directors Can Lose Independence if Intimidated to Act

The Delaware Court of Chancery has refused to dismiss a breach of fiduciary duty claim brought against the directors of infoGROUP, Inc. by former shareholder, the New Jersey Carpenters Pension Fund.  NJC Pension Fund alleged that the disinterested and independent board of directors came under the control of the beneficial owner of approximately 37% of infoGROUP's outstanding common stock, Vinod Gupta.  In addition to being the largest shareholder of infoGROUP, Mr. Gupta was also infoGROUP's founder, and served as its CEO and Chairman of the Board.  NJC Pension Fund alleged that Mr. Gupta possessed power over infoGROUP's board of directors, which was derived from a pattern of threats and other irrational actions aimed at the directors by Mr. Gupta.  In light of this pattern of intimidation, NJC Pension Fund alleged that Mr. Gupta forced the seemingly disinterested board to approve the sale of infoGROUP at an inopportune time, at an unfair price, and while utilizing a flawed and inadequate sales process.  As such, NJC Pension Fund alleged that the directors lost their independence and breached their duty of loyalty in connection with their approval of the sale of infoGROUP.

The Court held that NJC Pension Fund's claim survived the defendant directors' motion to dismiss because NJC Pension Fund sufficiently alleged that the sale was not approved by a disinterested and independent majority of the directors. The Court found that Mr. Gupta's desperate need for liquidity and his personal financial stake in the transaction rendered him an interested director. Moreover, the Court found that even though the other directors were not financially dependent on, nor did they have close familial relationships with Mr. Gupta, one may reasonably infer that NJC Pension Fund's allegations of intimidation could render the directors non-independent for purposes of voting on the sale.

New Jersey Carpenters Pension Fund v. infoGROUP, Inc., C.A. No. 5334-VCN (Del. Ch. Sept. 30, 2011, revised Oct. 6, 2011)

Delaware Court of Chancery Denies Appraisal Rights Where Optional Merger Consideration Offered to Minority Stockholders

In an opinion clarifying minority stockholder appraisal rights, the Delaware Court of Chancery has held that a stockholder of a public company is not entitled to appraisal rights under Delaware General Corporation Law §262 when the stockholder is given a choice among types of merger consideration, and the merger agreement expressly states that failure to make a timely election will result in receipt of cash only. 

Wesco Financial Corporation, a publicly traded corporation, entered into a merger agreement with its parent company, Berkshire Hathaway Inc. and Montana Acquisitions LLC, a Berkshire subsidiary.  Pursuant to the merger agreement, each of Wesco's minority stockholders, at the stockholder's election, was offered as consideration for its Wesco shares, either (i) cash, (ii) publicly traded shares of Berkshire Class B common stock or (iii) a mix of cash and the Berkshire stock. Failure, however, of the stockholder to elect one of the options, would result in that stockholder receiving cash for its Wesco shares. 

Under Delaware law, appraisal rights are generally limited to situations where stockholders are required to accept cash for their shares (other than cash in lieu of fractional shares).  Here, Plaintiff-stockholder, Krieger, asserted that appraisal rights were owed to stockholders that failed to make an election, since they were essentially required to accept cash.  The Court of Chancery disagreed with Krieger, finding that because Wesco was a publicly traded company its stock fell within the "market-out" exception to the appraisal rights statute.  The Court found further that the exceptions to the "market-out" exception (found under §262(b)(2), which restore appraisal rights in certain situations where stockholders are required to accept a certain type of merger consideration) were not applicable in this case, and that stockholders had a clear choice as to what type of merger consideration to accept.

Krieger v. Wesco Financial Corp., 2011 WL 4916910 (Del.Ch.)

SEC Approves Tougher Standards for Companies Going Public Through Reverse Mergers

The United States Securities and Exchange Commission has approved new listing rules for the NASDAQ Stock Market, the New York Stock Exchange and the NYSE Amex Stock Exchange relating to companies seeking to go public after completing a reverse merger.  When the SEC determined that many such companies - and in particular overseas companies - were not accurately reporting financial results, it decided that heightened requirements on reverse merger companies prior to their listing on an Exchange would provide greater protections for investors.

Under the new rules, prior to applying to list with any of the Exchanges, the shares of such reverse merger companies must trade in the United States over-the-counter market, on another national securities exchange or on a regulated foreign exchange for at least one year after filing all required information with the SEC, including but not limited to, information regarding the reverse merger transaction and audited financial statements.  Additionally, the new rules require that a company going public through a reverse merger maintain a minimum share price for a sustained period and for at least thirty of the sixty trading days immediately prior to submitting a listing application and the Exchange's decision to list such company.  The SEC anticipates that the required seasoning period and increased disclosure requirements associated with the new rules will provide greater protection for investors and help prevent fraudulent accounting disclosures.

SEC Release No. 34-65710 (November 8, 2011).

For more information on the other issues in this alert, or corporate matters generally, please contact:

NY          Irwin Kishner at 212.592.1435 or
NJ           Edward Stevenson at 973.274.2025 or


Copyright © 2011 Herrick, Feinstein LLP. Corporate Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.