Lawyers at Fulmer Ware LLP have litigated all types of breach of contract cases over the years. One area of a contract that is ripe for dispute involves “efforts” clauses. These clauses can be found in license agreements and almost any kind of commercial contracts. This blog post offers practical advice on how in-house counsel and business people can draft these clauses to mitigate the risk of disputes later on.
WHAT IS AN EFFORTS CLAUSE?
Efforts clauses require a party to a contract to commit to use a certain level of effort to achieve a stated goal. Such clauses include “best efforts”, “reasonable efforts” and “commercially reasonable efforts”. Some attorneys view these clauses to require different levels of effort, e.g., “best efforts” being the most exacting standard, followed by “reasonable efforts” and then “commercially reasonable efforts” being the least demanding of all. Case law and the UCC, however, do not support such a hierarchy. In fact, there are no universally accepted standards or definitions for these terms.
THE LAW CAN DIFFER DRASTICALLY BY STATE
Courts in New York have treated “best efforts” and “reasonable efforts” interchangeably. These courts have found that such efforts (1) impose an obligation to act with good faith in light of one's own capabilities; (2) give promising parties the right to give reasonable consideration to their own interests; and (3) permit promising parties to rely on their good faith business judgment. (See Soroof Trading Dev. Co. v. GE Fuel Cell Sys. LLC, 842 F. Supp. 2d 502, 511 (S.D.N.Y. 2012); Bd. of Managers of Chocolate Factory Condo v. Chocolate Partners, LLC, 992 N.Y.S. 2d 157 (N.Y. Sup. Ct. 2014)). Other New York courts have found a hierarchy with best efforts being the most exacting standard. See In re Chateaugay Corp., 198 B.R. 848, 854 (S.D.N.Y. 1996).
California courts on the other hand have found that a promise to use best efforts creates a more exacting standard than a promise to use good faith. California Pines Prop. Owners Ass'n v. Pedotti, (2012) 206 Cal. App. 4th 384, 394-95. The California Pines court found that best efforts requires diligence within the bounds of reasonableness, which leaves the hierarchy between best efforts and reasonable efforts unclear. According to the court, “we do not agree that a promise to use best efforts creates an obligation equivalent to a fiduciary duty. Instead, we agree with the courts from other jurisdictions that when a contract does not define the phrase ‘best efforts,’ the promisor must use the diligence of a reasonable person under comparable circumstances. Diligence is certainly required, but the obligation is framed within the bounds of reasonableness.” Likewise, in Delaware, a US District Court has similarly found that a best efforts clause requires the promising party to undertake its contractual obligations diligently and with reasonable effort. Crum & Crum Enter., Inc., v. NDC California, L.P., No. 09-145, 2010 WL 4668456 (D. Del. Nov. 3, 2010). Whatever standard a court may use, it is a fact-intensive inquiry.
PRACTICAL ADVICE AND TIPS
So how can in-house counsel protect their client when utilizing such clauses? Here are a few ideas to consider.
Define the Term in the Contract
One way to avoid a fight over efforts clauses is to specifically define and set forth what level of effort is required in the contract. A court interpreting such a provision will look first to the contract and how the parties chose to define the efforts clause. Work hard to eliminate any ambiguity in the definition, which would allow a court to look outside the four corners of the agreement. Be careful not to guarantee an outcome in the definition; yet, don’t make the definition so specific that you unnecessarily limit your client.
Consider Including Carve-Outs
Another strategy is to consider including carve-outs where the efforts term is undefined or broad. Such carve-outs describe the kind of efforts that the promising party is not obligated to take. Carve-outs can provide that the promising party is not required to (1) spend a specified dollar amount where the dollar amount is not already included in the contract; (2) engage in conduct that would have a materially adverse effect on the promising party; (3) take any action that would cause the promising party to incur costs or suffer any other detriment that is out of reasonable proportion to its benefits under the agreement; (4) take any action that would subject it to liabilities; (5) disregard its own business strategy and economic interests; (6) take illegal actions or (7) take any action that would harm its existence or solvency.
Use Effort Terms Consistently
The parties should take great pains to use the terms consistently throughout a contract. If the contract includes definitions of efforts terms, the parties should use the terms only according to their defined meanings. Failure to use terms consistently will create confusion and suggest that the parties themselves do not value the differences between the terms, which only invites the court to substitute its own interpretation for that of the parties
Use Objective Criteria
Parties to a contract should consider using objective criteria to provide standards against which efforts can be measured. One such criteria is to provide a timeframe such as “promptly”, or in the “most expeditious matter practicable” or within a specific number of days or weeks or a specified term. The parties can also include a triggering event at which point best efforts are triggered, or when a certain quantity or production level is met.
Consider Making the Conduct an Obligation Instead of Subject to an Efforts Provision
If you get to the point in your contract negotiation where you have defined what the effort would be with specificity, set the carve-outs and used objective criteria to define the standard, consider forgoing the efforts clause and instead making the conduct an express obligation under the agreement.
Fulmer Ware LLP is a San Francisco based law firm. Our lawyers have experience litigating and advising on all type of contract matters, including matters involving interpretation of “efforts clauses”.
On May 11, 2016 President Obama signed into law the Defend Trade Secrets Act (“DTSA”), which went into effect immediately. The Act creates a federal cause of action for trade secret misappropriation, which is meant to supplement and not preempt state trade secret law.
The DTSA provides litigants with a number of remedies including ex-parte seizure orders , damages for actual loss and unjust enrichment, or instead of damages, a reasonable royalty for unauthorized use or disclosure. Exemplary damages for willful or malicious misappropriation can also be awarded as well attorneys’ fees and injunctive relief.
Whistleblower Protections Require Immediate Action
Importantly, the Act contains new whistleblower provisions that require companies to take immediate action to be able to take advantage of the Act. Employees, independent contractors and consultants who disclose trade secrets are protected from prosecution if the disclosure was made to report or investigate an alleged violation of law. If the employee’s disclosure of highly sensitive company information is made in confidence to "a Federal, State, or local government official…or to an attorney…solely for the purpose of reporting or investigating a suspected violation of the law" or as part of a legal proceeding, then that disclosure cannot form the basis for a misappropriation claim against the employee. This safe harbor extends immunity to both state and federal trade secret claims.
What You Must Do.
Employers must include notice of this immunity in any agreements entered into or amended on or after May 12, 2016 with employees, contractors or consultants that govern the use of confidential or trade secret information. Failure to include the notice would preclude the employer from being awarded attorneys’ fees or exemplary damages in any lawsuit against the employee. The notice requirement applies to all employee proprietary information and invention agreements, nondisclosure and contractor and consulting agreements with individuals. At Fulmer Ware LLP we advise our clients on how to comply with the notice requirement and other steps to protect their valuable trade secrets.
Pam Fulmer is a member of the Standing Committee on Trade Secrets of the Intellectual Property Owner’s Association. The Committee supported the passage of the Defend Trade Secrets Act.