It’s happened countless times and it’s probably happened to you. It’s late. There are only a few issues left. You are ready to trade away something—so long as you can keep the “best efforts” standard on a covenant. You win the argument, but what have you won?
If asked, we believe many deal professionals may cite the classic case on the issue, Bloor v. Falstaff Brewing Corp. and say that while the party with the “best efforts” burden need not spend itself into bankruptcy, it would have to spend money and expend some—probably significant—efforts. We believe many deal professionals would go on to say that the other standards, “reasonable best efforts” or “commercially reasonable efforts,” by definition, require less effort than “best.”
Unfortunately, a review of the case law, including recent New York and Delaware cases, suggests that judges do not enforce contracts in a manner consistent with this view. In this article we examine the recent case law and caution practitioners to be careful when negotiating “efforts” clauses. Specifically we suggest that practitioners shift their emphasis to specific, measurable criteria that a court can understand and enforce.
The leading case on the meaning of “best efforts” remains the Second Circuit’s 1979 case Bloor v. Falstaff Brewing Corp.1 In Falstaff, a family-owned brewery sold substantially all of its assets to Falstaff for a lump sum as well as for royalties related to the ensuing six years of sales of its brand, Ballatine. The purchase agreement required Falstaff to use its “best efforts” to promote and maintain a high volume of sales of Ballatine products. Three years later, Falstaff’s overall revenues had fallen substantially and the company had incurred losses of $22 million on Ballatine sales. At that time, control of Falstaff passed to Paul Kalmanovitz, who resolved to turn the company around by closing locations and otherwise cutting costs, including by slashing the advertising budget for Ballatine brands by nearly 90%. Falstaff swung to a profit under Kalmanovitz’s leadership, but sales of Ballatine products plummeted.
The Second Circuit held that Falstaff had breached its best efforts obligation because it “simply didn’t care” about sales of Ballatine products in its quest for overall profits. In other words, the decision suggests that one cannot satisfy a best efforts obligation by doing nothing at all. Though this uncontroversial holding was followed as recently as in 2008 in the Delaware Chancery Court case Hexion Specialty Chemicals, Inc. v. Huntsman Corp.,2 Professor Farnsworth points out in his treatise on contracts that Falstaff “did relatively little to add precision to the meaning of best efforts, since Kalmanovitz fell so far short of the mark.”3
Falstaff’s influence stems, instead, from its descriptions of the boundaries of best efforts. On the one hand, one cannot satisfy a best efforts standard by doing nothing at all. On the other hand, the court stated that best efforts does not require one to spend itself into bankruptcy, that best efforts does not require a party to incur financially disastrous consequences and that a party under a best efforts obligation is entitled to give reasonable consideration to its own interests. But, these guideposts do little to help the practitioner who is looking for the line demarcating where best efforts end and where the modified efforts standards begin.
Courts have offered additional formulations of the best efforts standard. In Kroboth v. Brent, a 1995 case, the New York Supreme Court Appellate Division stated that best efforts requires the obligor to use all reasonable methods to satisfy its obligation.4 In 2005, the District Court for the Southern District of New York in Scott- Macon Securities v. Zoltek Companies read business judgment into Falstaff’s standard of reasonableness, saying that a party under a best efforts obligation may exercise discretion, within its good faith business judgment.5 The Zoltek court also cited Professor Farnsworth’s formulation with approval: that a duty of best efforts requires a party to make such efforts as are reasonable in light of that party’s ability and the means at its disposal and of the other party’s justifiable expectations. In 2006, the court in Ashokan Water Services, Inc. v. New Start found precedent in New York for all of the following definitions of the best efforts obligation: due diligence, all reasonable methods, reasonable efforts, good faith business judgment, genuine effort, and active exploitation in good faith.6
Courts outside of Delaware and New York have also generated varied formulations of the best efforts obligation. A survey of case law by Kenneth Adams in 2004 uncovered a variety of best efforts standards being employed by courts.7 For example, the First Circuit has held that best efforts requires that a party act in good faith. The Third Circuit has held that the best efforts standard is one of diligence. The official comment to UCC §2-306 combines both of these standards with reasonableness, defining the implied obligation to use best efforts as an obligation to use reasonable diligence as well as good faith in performance of a contract.
Taken as a whole, these varied judicial definitions of “best efforts” have one thing in common: they impute a level of discretion to the obligor that we believe practitioners typically associate with “reasonable efforts.”
In 1979, the Falstaff court stated that the net result of its research on the law of best efforts was that such law was far from clear and that it was unfortunate that they had to apply it. Thirty years of jurisprudence has afforded little more clarity on what best efforts means, as the Delaware Court of Chancery stated in 2009, “it is doubtful that there even is a broadly and commonly accepted meaning to be ascribed to the phrase.” But we believe there is enough case law to make clear that whatever “best efforts” means, courts talk about “best efforts” in terms that most practitioners reserve for “reasonable efforts.”
Compared with Other Efforts Standards
Once we focus on the fact that courts view best efforts as an obligation defined by concepts such as reasonableness, good faith, diligence and business judgment, it should not come as a surprise that courts have not rendered a holding demarcating the difference between best efforts on the one hand and other types of “efforts” on the other hand.
On the contrary, in Zoltek, the court cited Timberline Development LLC v. Kronman for the proposition that New York courts use the term reasonable efforts interchangeably with best efforts. In Timberline, the New York Supreme Court Appellate Division stated, “the requirement to employ reasonable efforts or ‘best efforts,’ as it is generally expressed, in the performance of contractual obligations is deemed to be implicit in every agreement.”8
Delaware courts similarly conflate the purportedly distinct standards. For example, though the relevant agreement in Hexion imposed a reasonable best efforts obligation, the Chancery Court applied the Falstaff approach for determining whether there was a breach of best efforts. Moreover, the court used the two phrases interchangeably throughout its opinion.
Though no court has held that there is a difference between best efforts and any other efforts standard, some courts have stated as much without citing authority for the proposition. In one case, the 1995 LTV Aerospace and Defense Co. v. Thomson, a New York bankruptcy court said that the standard imposed by reasonable best efforts is indisputably less stringent than that imposed by best efforts clauses.9 In another, the 2009 case Alliance Data Systems v. Blackstone Capital Partners, the Delaware Court of Chancery cited Lou R. Kling and Eileen T. Nugent’s book Negotiated Acquisitions of Companies, Subsidiaries and Divisions and included the following in its explanatory parenthetical: “it is not clear how far a party must go to satisfy best efforts, which is a more rigorous standard than reasonable best efforts.”10 Then, without irony, in the same footnote the court cited “best efforts” case law to support its holding that “reasonable efforts” is a lesser standard than an unconditional commitment.
Negotiated Best Efforts Criteria
While the case law provides little guidance as to how a judge may determine the way best efforts may be differentiated from other efforts, the courts do consistently look to the parties and their contracts for guidance on interpreting the clauses. In fact, some courts will not enforce best efforts provisions in the absence of objective articulated criteria to use in evaluating such provisions. The Ashokan court described the need for guidance from the parties this way: “part of the difficulty in adequately articulating the best efforts obligation is that the obligation operates in different transactional settings, and can serve different purposes in those settings.”
In Ashokan, the relevant agreement stated that Ashokan, a water company, must use “best efforts to bring about savings in [New Start’s] past, current and future utility bills” in the form of obtaining credits to New Start’s accounts. In exchange, New Start would pay Ashokan one third of all credits New Start received on its water/sewer utility accounts. When the Department of Environmental Protection granted credits amounting to $48,226.17 to six of New Start’s accounts that had been consolidated by Ashokan, New Start paid only a portion of the one-third Ashokan believed was due it according to the contract’s terms. New Start claimed that Ashokan’s action of consolidating the accounts had led to an increase in billing.
The court held Ashokan made a prima facie showing that it used best efforts to generate the credits. The court stated that best efforts can only be defined contextually, and that the most significant context for the best efforts obligation was the contract itself. The contract expressly allowed Ashokan to consolidate New Start’s accounts, and Ashokan showed that the credits came from Ashokan’s efforts. On this basis, the court held that a prima facie showing was made.
Though the Ashokan court did not ultimately decide whether the best efforts obligation was satisfied, the court was able to evaluate the obligation because it found sufficient criteria in the agreement. But the court also noted that “it is still unclear when and how an express best efforts provision is to be enforced in the absence of articulated objective criteria in the agreement.” As the court pointed out, many courts in New York have declined to enforce best efforts clauses if the agreement does not also contain clear guidelines for such measurement. On the other hand, other courts in New York have applied best efforts provisions in the absence of objective criteria. Still others have implied best efforts provisions where none were written into the agreement.
So what did our deal professional get for his or her client by trading something away to keep the best efforts provision? By itself, probably not very much. In 2009, the Delaware Chancery Court provided one answer: “perhaps a best efforts standard approaches an unconditional obligation, or perhaps it diverges by some material distance from an unconditional obligation.”11 And, regardless of what the clause may mean, in the absence of articulated objective criteria, our deal professional cannot be sure that the clause will be enforced at all.
Nonetheless, as practitioners, we think it’s fair to say that the best efforts standard—or some variation thereof—is an important drafting tool. It can help break log-jams or avoid a detailed negotiation. In most cases, it will never be litigated and therefore never tested. But when using this tool, it is critical to recognize what was noted in Falstaff and rehashed in the 2008 New York case Mofet Etzion Ltd. v. General Dynamics Land Systems: the law on best efforts is far from clear.12 Courts may yet hold a distinction between reasonable efforts and best efforts in line with Alliance and LTV. More likely, the common law interpretation of these various standards will remain murky.
Where does this leave the practitioner? Back where we began—caveat emptor. If you intend to enforce the benefit of your bargain when negotiating one of these standards, be precise about what you mean. If you require a party to obtain a license or consent, specify a dollar amount the party must pay to get it. If you’re expecting performance according to a standard of care, specify the amount of time or money that standard contemplates and what milestones will be used to measure it. By making the effort to define efforts standards objectively, you greatly increase the chance that you’ll get what you bargained for.
(Special thanks to Sohana Barot for her contributions to this article).