[co-author: Tarek El Erian, LL.M., Law Clerk]
The recent Delaware case, Williams Cos v. Energy Transfer Equity LP (No. CV 12168-VCG, (Del. Ch. June 24, 2016)), sought to provide some additional guidance on this question, but at bottom the standard adopted by the court is consistent with other decisions in the area.
In contrast to flat covenants, efforts clauses are frequently used in agreements when one or all parties have an action to perform or a result to achieve that is outside of the pledging party’s immediate control. Although often heavily negotiated by parties, the difference between the most commonly used effort clauses, “best efforts,” “reasonable efforts” and “commercially reasonable efforts” is not entirely clear. Courts first look for a definition of the efforts clause when assessing if a party has exerted the requisite efforts. While [if not defined] many courts hold “best efforts” and “reasonable efforts” to the same standard and regard them as interchangeable terms, such as held in Liu v. Beth Israel Med. Center (No. 02 CIV. 2034 (DLC), (S.D.N.Y. June 26, 2003)), there are multiple standards the courts have applied over the years in New York and Delaware.
There is no doubt that there is scarcity in clear, straightforward guidance on the differences, if any, between the efforts clauses in court decisions. However, it is often perceived within the legal profession that the efforts clauses are on a sliding scale in terms of what the seeking party has to do to achieve the result, the level of impact it will have on the seeking party in terms of adverse effect, monetary costs to the action and finally the efforts it will exert and lengths it will have to go to, to achieve the result. “Best efforts” is considered to be the highest of standards, then “reasonable efforts” and then finally the least onerous standard, “commercially reasonable efforts.”
In Bloor v. Falstaff Brewing Corp. (601 F.2d 609 (2d Cir. 1979)), the New York Court of Appeals, Second Circuit, held that the “best efforts clause” allows the undertaking party to consider its own reasonable financial interests, and as such, does not need to bankrupt itself in pursuit of satisfying the “best efforts” clause. Furthermore, the U.S. Court of Appeals, First Circuit, in Triple-A Baseball Club Association v. Northeastern Baseball, Inc. (832 F.2d 214, 216–17 (1st Cir. 1987)) stated that there is no precedent holding that “best efforts” means every conceivable effort. However, in Showtime Networks Inc. v. Comsat Video Enterprises, Inc. (N.Y. Sup. Ct. June 29, 1998), the court held that the undertaking party is not excused from taking the action merely because the required action is unprofitable.
In determining whether or not “best efforts” have been exerted or the party is in breach of contract, many New York courts have analyzed if the acting party’s course of action in pursuit of the result has been in good faith. Such was the case in Soroof Trading Dev. Co. v. GE Fuel Cell Sys., LLC (842 F. Supp. 2d 502 (S.D.N.Y. 2012)), where the court interpreted “best efforts” to “impose an obligation to act with good faith in light of one’s own capabilities.” Furthermore, in Scott-Macon Sec., Inc. v. Zoltek Companies (No. 04CIV.2124MBM, (S.D.N.Y. May 12, 2005)), the court held that the parties’ own interests in achieving its “ultimate goal” should not be harmed in order to satisfy the efforts clause, so long as it acts in good faith. In Travellers Int'l, A.G. v. Trans World Airlines, Inc.( 41 F.3d 1570, 1571 (2d Cir. 1994)), the court held that a party may exercise discretion, within its good faith business judgment, in devising a strategy to comply with its contractual obligations while striving towards its “ultimate goal.”
In Williams Cos v. Energy Transfer Equity LP, the Delaware Chancery court determined that “commercially reasonable efforts” required the party to have undertaken those actions objectively reasonable to produce the desired result, in the context of the agreement between the parties. The Chancery court noted that the party to whom the efforts were owed was unable to provide examples of actions the other party could have pursued in order to achieve the required result.
New York courts are often reluctant to enforce efforts clauses, except if there is objective criteria against which the party’s efforts can be measured, or well-developed industry standards exist, which give a reasonable degree of certainty to the meaning.
In some circumstances one of the parties seeks to bind the other to do anything and everything possible to reach the desired result. In such circumstances, as is the case in many of the agreements that require antitrust approvals, Hell or High Water provisions are used. Unlike the “best efforts” clause, Hell or High Water provisions clearly specify that the party obligated to seek antitrust approval will be forced to go as far as to divest part of the business or even hold businesses separately. Litigating with the government over the given antitrust approval is also sometimes an obligation, were the approval to be denied.
In conclusion, it is clear that factors such as “good faith,” the circumstances surrounding the contract and the cost to the undertaking party relative to the benefit of and the impact on the enforcing party are consistently taken into account regardless of the actual level of efforts specified. Williams Cos v. Energy Transfer Equity LP is just another example of that line of cases. Rather than arguing over the specific level of efforts in general, it may be a better for the parties to define the efforts clause and the standard to which the party’s performance would be measured, with respect to each specific result, similar to the Hell or High water provisions.
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It is worth noting that the position under U.S. law, as described above, is quite different from that under English law (where “best efforts” implies a significantly higher standard of effort, including the obligation to incur significant costs if necessary, than “reasonable efforts”). We may make this the subject-matter of a future bulletin in Private Equity News.
