In the latest round of a high-stakes pharmaceutical case, the Delaware Court of Chancery felt compelled to re-evaluate its earlier position on the plaintiff’s lost profits testimony. Under the court’s new ruling, the plaintiff stands to win—big.

‘Seller’s remorse’: The parties are biotech firms whose eight-year-long fight centers on a promising drug to treat smallpox, ST-246, which they expected to sell to the U.S. government. The defendant had acquired the drug but in 2005 ran out of money. It also lacked the institutional experience to take a drug to market. Consequently, it pursued collaboration with the plaintiff. While the plaintiff wanted a merger, the defendant insisted on outlining a license agreement, which included a term sheet that set forth key terms. By late 2005, the defendant valued ST-246 conservatively at approximately $1 billion. During merger negotiations, the defendant achieved important milestones in the development of the drug and received millions of dollars in funding from the U.S. government. ST-246 suddenly looked more like a multi-billion-dollar drug. The defendant experienced “seller’s remorse” and reneged on the merger. Ultimately, it also walked away from discussions with the plaintiff over a license agreement.

In December 2006, the plaintiff sued in the Delaware Court of Chancery, arguing that the term sheet was a binding agreement, which the defendant had breached. The Chancery disagreed but found the defendant had violated its contractual obligation to negotiate in good faith a license agreement, the terms of which were substantially similar to those in the term sheet. As a remedy, the Chancery awarded the plaintiff an “equitable payment stream or equitable lien” based on the defendant’s future profits from the successful commercialization of the drug. Then the Chancery found that lump-sum expectation damages were too speculative. The Delaware Supreme Court subsequently affirmed the Chancery’s bad-faith finding but remanded for a damages award based on contract liability only. The Chancery read the higher court’s opinion as an invitation to reconsider its prior rejection of a lump-sum award. Any meaningful review required a re-examination of the original expert testimony on expectation damages, it said. And a re-evaluation of the testimony required the court to take into account the $460 million government contract the defendant was able to procure following the wrongdoing. According to the Chancery, this fact greatly reduced the court’s earlier concern that the drug might never generate a profit.

Reversal of fortune: On remand, the Chancery found that the plaintiff proved that at the time of the breach it had a “reasonable expectancy” that it would make a profit from the sale of the drug. Then it already was likely the government would want to buy the drug for the strategic national stockpile. The court generally approved of the damages calculation the plaintiff’s expert originally had presented but ordered adjustments to key components, most importantly the number of sales. The expert’s computation assumed roughly 14.9 million sales to the U.S. government, including the defense department, and 14.7 million sales to “the rest of the world” at $100 per treatment. The price was reasonable, the court found, but the number of sales to foreign governments was not. Therefore, it struck damages based on those sales. By the expert’s original calculation, lost profits amounted to over $1 billion. Even though the Chancery’s modifications cut into this amount, the ruling augurs a big award. Given the parties’ fierce fighting, another challenge also is likely.

Takeaway: It ain’t over ’til it’s over. Even the Delaware Chancery is not above reversing itself and saying so in great detail. Interestingly, the court finds it is appropriate to use post-breach information—sparingly—to determine the expectation of the parties at the time of wrongdoing. Also noteworthy is the court’s dismissive attitude toward the defendant’s rebuttal expert. His credibility was undermined, it said, because “he merely attempted to discredit [the opposing expert’s] analysis without providing an alternative calculation of his own.”

Find an expanded discussion of PharmAthene, Inc. v. SIGA Technologies, Inc., 2014 Del. Ch. LEXIS 142 (Aug. 8, 2014) in the November issue of Business Valuation Update; the court's opinion will appear soon at BVLaw.