In a recent post , I wrote about the circumstances in which courts enforce letters of intent as legally binding. Since then, a decision in Delaware has highlighted the circumstances in which courts will enforce oral agreements—and suggests the old adage “a verbal contract isn’t worth the paper it’s written on” doesn’t hold true anymore.
Last year, several funds controlled by Sarissa Capital commenced a proxy contest to elect three new directors to the seven-person board of directors of Innoviva, a drug licensing company. Three leading proxy advisory firms agreed with recommendations in favor of the Sarissa Capital’s nominees; two recommended that shareholders vote for all three of the Sarissa nominees; and one recommended that shareholders vote for two of the three Sarissa nominees. On the day before the vote, the election was too close to call, and Sarissa and Innoviva decided to engage in settlement discussions.
At noon on the date of the vote, Innoviva learned that one of its large shareholders would be voting for two of the Sarissa nominees, placing Innoviva at serious risk of losing the vote. Electoral victory hinged on one remaining large shareholder. How would it vote? The Innoviva board believed that the remaining shareholder would vote for the Sarissa nominees, thus, the board authorized its vice chairman to settle with Sarissa by essentially accepting its lastest proposal. At 2:30 that afternoon, the Innoviva vice chairman and a representative from Sarissa spoke by phone. The vice chairman made the settlement offer and the Sarissa representative accepted. The lawyers then exchanged draft settlement agreements over the next two hours.
However, at 4:43 p.m. Innoviva learned that the remaining large shareholder would vote in its favor, meaning that Sarissa would lose the vote. Due to this change in events, the Innoviva board determined not to proceed with the settlement, and at 7 p.m. Innoviva’s lawyers called Sarissa and told them that Innoviva would be proceeding with its annual meeting and not the settlement. The meeting was held, and all of the Innoviva nominees were elected.
Sarissa then sued Innoviva in Delaware Chancery Court to enforce the terms of the settlement. The Court held that there were two essential elements to enforcing the oral contract:
Using a “reasonable negotiator” standard, the Delaware Court concluded that Innoviva and Sarissa had reached agreement on all of the terms of the settlement that they deemed important and had agreed upon in the 2:30 p.m. phone call. The court also concluded that at that time, the parties did not intend to condition their agreement on the signing of a written document. As a result, the Court specifically enforced the terms of the 2:30 p.m. agreement, and required Innoviva to expand its board by two members and to seat two of the Sarissa nominees based on the original settlement agreement.
The ruling in the Innoviva case is important because it says a lot about who we are as a society and has tangible effects on the economic efficiency of business. Are we a society that believes in personal integrity and responsibility? Or are we a society where people do not have to live up to what they say and can renege on their promises? The Innoviva case is a victory for a more decent and civilized society in which people are bound by their agreements. If someone you are dealing with promises you something, they should have to live up to it, whether or not that promise is reduced to writing.
Moreover, oral contracts can lead to more economic efficiency. Think of all the time and effort that would be wasted if we couldn’t rely on people living up to their oral promises. If every single interaction had to be written down, the time and transactions cost of nearly every business interaction would increase exponentially—hardly an efficient outcome.
Although oral contracts are not as easily enforceable as written ones, they are still legally binding. Businesspeople should always live up to their oral contracts, both as a matter of personal integrity and to be legally compliant.
If you want to make an oral contract, make sure that you and your counterparty have a clear understanding of the specific terms of the contract and that there is no agreement that the binding agreement be written. That said, the safest course remains, time and transaction expense permitting, to apply material agreements to a signed document.
Author’s note: Willkie Farr & Gallagher LLP [in which Mr. Lefkort is a partner] represented affiliates of Sarissa Capital in the Innoviva litigation. The facts summarized in this posting are based solely on the decision of the Delaware Chancery Court. No information obtained from Sarissa Capital was used in connection with this posting.
