Take the Time to Negotiate What Is Expected
When parties negotiate ongoing obligations in a contract, the parties typically make reference to a particular standard of effort. A number of different terms or phrases are used, such as “best efforts,” “reasonable efforts,” “commercially reasonable efforts,” “commercially reasonable best efforts,” and “diligent efforts.”
But what exactly do these phrases mean, and how are they different from each other?
In the push to get contracts negotiated and signed, the use of these terms, without properly defining them, is common. Also common in reviewing legacy contracts is that the same contract can use different terms in different places. For example, one portion of the contract uses “commercially reasonable efforts” and another uses “commercially reasonable best efforts.” Is this merely inconsistent drafting or was something different intended by the parties?
The practical challenges are completely understandable. More times than not, when an Israeli company is negotiating with a United States company (be it a credit lender, equity investor, strategic ally in a joint venture, sales & marketing contract, distribution arrangement, etc.) the U.S. company has the superior bargaining position by being the larger enterprise at the negotiating table. The goal is to get the deal signed and avoid topics that could prolong those negotiations. Accordingly, it is a completely legitimate tactic to intentionally use these phrases, and worry about what they may mean another day (and hopefully never). But if that is the tactical decision, it is best the decision be made with one’s eyes wide open.
A classic scenario of where this becomes relevant is where an Israeli company has developed a product (either tangible goods or the offering of services), has found it to be successful in the Israeli market, and now wishes to contract with a strategic party in the U.S. for marketing and sales of the product. The expectation is that the U.S. company will market and sell the product aggressively, and not treat the Israeli company’s product as a low priority (or worse). This is particularly critical if the U.S. company has exclusive rights to market or sell the product for some period of time. So the contract provides that the U.S. company will apply one of the above standards of effort to the endeavor.
But what does that really mean?
Using Delaware law as an example (and this is a State law, not Federal law, situation), “best efforts,” “reasonable best efforts,” and “commercially reasonable efforts” do not have material differences (although there is minority judicial thought to the contrary). So if a contracting party believes it is getting a higher or lower level of effort standard depending on which phrase is used, that is likely not the case. Generally speaking, any of these phrases would place an affirmative obligation on the party so bound to take all reasonable steps to solve problems and perform the stipulated task.
This, of course, begs the question: What are “reasonable steps”? And here is where the post-signing risk comes in, when these terms are used without further explanation or definition in the contract.
The Courts will determine the necessary level of effort, but cases show this occurs in the context of litigation all the way to trial and sometimes beyond to appeal. Courts engage in a strict contractual interpretation and fact-heavy analysis in determining this necessary level of effort. This means lengthy and extremely expensive litigation, at a cost smaller companies are often ill-equipped to afford. In other words, if the larger U.S. company believes the required level of effort in taking “reasonable steps” is less than the level of effort the Israeli company believes is required, then as a practical matter, the Israeli company may have neither the time nor the financial resources to prevail in litigating its position.
The best practice is to provide more certainty in the contract as to what the parties have agreed upon to satisfy the level of effort standard.
Once again, using the marketing of products scenario as an example, the parties should provide additional details on what constitutes satisfaction with the level of effort, such as requiring the U.S. company to use not less than the same efforts and to expend approximately the same resources as it does in the sales and marketing of its own products. The details could even be more involved, such as requiring certain minimal efforts in advertising, attendance at trade shows, customer calls, issuing reports so the other side may monitor performance and the like. Another example would be where the other party is required to pursue a governmental approval of some type. Here, additional detail might include the requirement to retain legal counsel and other necessary professional advisors experienced in obtaining the type of governmental approval desired, executing the engagement sufficiently in advance, fully and timely cooperating with the legal counsel and necessary professional advisors, paying any required filing fees, and pursuing necessary appeals of adverse rulings, if applicable.
In summary, the level of effort standard can be a very important, perhaps even critical part of whether your contract will achieve its objectives. If the tactical decision is made to leave it undefined and vague, be sure that decision is made with an understanding of the implications, and with your “eyes wide open.”