Two recent rulings out of the Delaware Court of Chancery have highlighted the importance of clearly defining the terms of pre-closing obligations. In an M&A transaction, it takes significant time to get from a signed letter of intent to a closed deal. Pre-closing obligations, and the level of effort a party is required to exert to meet those obligations, are typically subject to heavy negotiation. While practitioners tend to negotiate according to a sliding scale of efforts standards—”commercially reasonable efforts,” for example, require something less than “best efforts”—neither Delaware nor New York courts have articulated tiered efforts standards in such a manner. Furthermore, and what the recent Delaware rulings again underscore, the various formulations do not have precisely defined meanings in common law.
The Delaware Court of Chancery recently shed a ray of light on the efforts clause mire. In a July 14 bench ruling on a motion to dismiss (WP CMI Representative v. Roche Diagnostics Operations), Vice Chancellor J. Travis Laster stated that “the inclusion of the word ‘reasonable'” in the commercially reasonable efforts standard makes it “an objective standard.” On this same point, Laster cited Vice Chancellor Sam Glasscock III’s June 24 opinion in Williams v. Energy Transfer Equity. By agreeing to use commercially reasonable efforts, Glasscock wrote, the plaintiff “necessarily submitted itself to an objective standard—that is, it bound itself to do those things objectively reasonable to produce the desired [tax opinion], in the context of the agreement reached by the parties.”
If the efforts clause situation still looks muddy, that is because it is. Laster offered up one additional sliver of light, illustrating the type of behavior that may run afoul of a commercially reasonable efforts standard. He stated that if the obligated party does something “that wasn’t originally contemplated and which has the effect of causing the milestone not to be hit,” it is “reasonably conceivable” that the change in behavior was contrary to such party’s obligation to use commercially reasonable efforts.
Interestingly, New York courts have employed the concept of objectivity in a different fashion. In Delaware, contractual best efforts clauses are enforceable as a rule; in New York, the law is unsettled as to how—or even if—an efforts clause is to be enforced in the absence of “objective criteria against which a party’s efforts can be measured” (Timberline Development v. Kronman [2000]). In support of this position, New York courts have suggested that when parties fail to contract for a clear set of guidelines against which to measure the contracted-for efforts, then courts can enforce an efforts clause only when external circumstances impart sufficient certainty to the meaning of the efforts clause, thereby serving as gap fillers. There is merit in this position, given that courts are wary of rewriting contracts or imposing meanings ex post facto on the terms of negotiated contracts.
More broadly, a survey of case law in Delaware and New York—two of the most popularly contracted-for jurisdictions in M&A transactions—demonstrates that little is clear when it comes to effort clause analysis. There are not generally bright-line or uniform requirements, and when parties do not define efforts terms, there is little certainty in how courts will interpret parties’ obligations.
Here is a quick and dirty summary of Delaware and New York case law.
Delaware
In Williams, Glasscock began his analysis by observing that the term “commercially reasonable efforts” was not defined in the parties’ merger agreement, and that it “is not addressed with particular coherence in our case law.” Earlier cases have noted that Delaware law does not define the “precise contours” of the best efforts standard. Hence, when analyzing a party’s obligations under an efforts clause, the court’s inquiry is necessarily fact-intensive.
Delaware courts have tended to use “reasonable best efforts” and “best efforts” interchangeably. This is at odds with the recent rulings in WP CMI and Williams, in which the court clearly equates “reasonable” with “objective.” Nonetheless, a brief survey of case law confirms that Delaware courts “do not define the precise contours” of a party’s duty under efforts clauses (Crum & Crum Enterprises v. NDC of California [2010]). The leading Delaware case, Hexion Specialty Chemicals v. Huntsman (2008), concerns a reasonable best efforts clause. The Hexion court found that the plaintiff failed to use reasonable best efforts to consummate the merger and failed to act in good faith. In reaching this holding, however, both the plaintiff and the court cited and applied best efforts case law. The plaintiff’s counterargument cited the seminal New York case Bloor v. Falstaff Brewing (1979) —a case concerning a best efforts clause—and the Hexion court then applied Bloor’s best efforts standard in analyzing the plaintiff’s performance under the reasonable best efforts clause. The court noted that while a party need not “spend itself into bankruptcy,” it is impermissible for a party to emphasize profits über alles without consideration of the other party’s interests. A party must make some genuine effort, and must take actions that are “both commercially reasonable and advisable to enhance the likelihood of consumat[ing]” the contracted-for objective.
A 2013 bench ruling in Cooper Tire & Rubber v. Apollo (Mauritius) Holdings provided some insight into the types of actions that may satisfy a party’s obligations under a reasonable best efforts clause. Addressing the limited issue of whether the defendant was in material breach of the parties’ merger agreement with respect to its negotiations with a union, the court held that the plaintiff had “failed to demonstrate” that the defendant had not met the reasonable best efforts standard. In finding that the defendant had satisfied that requirement, the court noted that the defendant (1) took affirmative actions to negotiate with the union, and (2) did not intentionally frustrate the process or act in bad faith.
Perhaps unsurprisingly, Delaware courts have not identified a distinct “commercially reasonable efforts” standard and have tended to use terminology loosely and interchangeably. There is a dearth of case law in which courts have addressed the merits of a breach of commercially reasonable efforts clause claim. In a 2010 case, WaveDivision Holdings v. Millennium Digital Media Systems, the court appeared to apply the Hexion court’s reasonable best efforts criteria in analyzing the defendant’s breach of the commercially reasonable efforts clause in the parties’ purchase agreement. Interestingly, the WaveDivision court did not cite to Hexion or any other case in the course of its purely factintensive analysis. In holding that the defendant breached its obligations under the commercially reasonable efforts clause, the court employed the phrase “reasonable best efforts” twice and the phrase “commercially reasonable steps” once (thereby invoking Hexion), but never once couched its analysis or holding in terms of a distinct commercially reasonable efforts standard.
Quoting the seminal Bloor case, the U.S. Court of Appeals for the Second Circuit aptly noted, “New York law interpreting best efforts clauses is ‘far from clear.'” Courts have often used terminology interchangeably in analyzing “best efforts,” “reasonable efforts” and “reasonable best efforts” clauses, tending to reach decisions without delineating nuanced differences between standards. Delaware’s position that “reasonable” imparts inherent objectivity to efforts clause analysis is not echoed in New York case law, which has not tended to differentiate efforts clauses based on the word “reasonable.” For example, in interpreting a contract for cable programming, the New York Supreme Court held that “financial difficulty of performance” did not excuse the distributor’s performance under either a “best efforts” or a “reasonable best efforts” standard (Showtime Networks v. Comsat Video Enterprises).
What precisely is required under a best efforts, reasonable efforts or reasonable best efforts clause is unclear, although case law gives some guidelines. It is clear that a party has the right to give reasonable consideration to its own interests. As stated in the seminal Bloor case, however, a party cannot adhere to a “philosophy of emphasizing profit über alles without fair consideration of the effect on [the other party’s interests].” The Bloor court also stated that a party is not required to “spend itself into bankruptcy.” Nonetheless, more recent cases emphasized the lack of clear requirements. In a 2006 case, Ashokan Water Services v. New Star, the court stated: “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, and, particularly, the relationship between ‘best efforts’ and ‘good faith,’ ‘fair dealing,’ and ‘reasonable care.'”
The New York courts seem to differentiate “commercially reasonable efforts” clauses from other efforts clauses. Here again, however, there is no settled set of criteria. As with the other clauses, a party is not required “to act against its own business interests,” as stated by the court in MBIA Insurance v. Patriarch Partners VIII (2013). However, courts have not consistently applied this concept, resulting in surprising and contradictory outcomes. In some cases, such as MBIA Insurance, courts have found that financial harm excuses a party’s performance under a commercially reasonable efforts clause. In other cases, however, courts have found that financial harm does not excuse performance—and, in the extreme, that bankruptcy may be an acceptable result.
In Rex Medical v. Angiotech Pharmaceuticals (US) (2010), the defendant distributor argued that its continued performance under the parties’ agreement had become commercially unreasonable (due to financial losses incurred in performance of the agreement and an otherwise worsening financial condition, which could lead the defendant into bankruptcy). The Rex court outright rejected this argument, stating that the defendant’s financial argument was one that it “should save for a bankruptcy court.” Ultimately, the court granted the plaintiff temporary injunctive relief, requiring the company to continue performance until the issue could be permanently resolved by an arbitrator, as required under the broad arbitration clause in the parties’ agreement.
As case law continues to evolve, it is possible that Delaware and New York courts may opt to delineate a hierarchically defined set of criteria for efforts clauses. That is not the present reality, however. The moral of today’s efforts clause story: Practitioners would be wise to exert some effort drafting guidelines to measure contracted-for efforts clauses. If practitioners opt not to exert that effort, then time spent fighting over efforts terminology is likely time wasted.
Reprinted with permission from the October 27 edition of Corporate Counsel © 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-257-3382 or reprints@alm.com.