- Best Efforts - A Recipe for Dispute
- September 22, 2011 | Author: Tauna Staniland
- Law Firm: Stewart McKelvey - St. John's Office
Contracting parties often need to deal with conditions and obligations that are not fully within their control. Consider the following examples:
- Example 1: A distributor ("DistributorCo") would like to enter into a distribution agreement to import a new product but needs to obtain a government permit to do so.
- Example 2: A manufacturer ("ManufactureCo"), who currently delivers 20,000 widgets per month to a customer, would like to enter into a new supply contract with that customer agreeing to deliver 30,000 widgets per month by January 2012, knowing that this 10,000 per month increase in widget making capacity will require the overhaul of its existing facility.
Generally, the promising party knows that it should not agree to contractual language that makes it their absolute duty to accomplish an objective that is not within their full control. However, parties faced with obligations outside their control sometimes decide to address the uncertainty by making the obligation subject to the promising party's "best efforts". In Example 1, DistributorCo might agree to add the following language to the distribution agreement:
"DistributorCo shall use its best efforts to obtain the import permit by October 1, 2011."
In many cases, parties use "best efforts" language without being aware of the law of best efforts. What they may think they are doing is adding some straight forward language to show their intention to work hard to complete the promise. In Example 2, the CEO of ManufactureCo thinks, "yes, we will work really hard to complete our facility renovation so that we are able to deliver the 30,000 widgets per month by January 2012" and so agrees to insert the following language in the contract:
"ManufactureCo shall use its best efforts to deliver 30,000 widgets per month commencing in January 2012."
To the layperson the above "best efforts" language may sound perfectly good and reasonable. However, contracting parties need to step back and consider what they are really promising. To do this they must consider (i) what does "best efforts" really mean, (ii) what are they promising to use "best efforts" to do, and (iii) if the promise cannot be fulfilled what will the other side say that they should have done?
What Does Best Efforts Mean?
A common view among Canadian corporate lawyers is that best efforts is the most onerous of the "efforts" standards, requiring the promisor to do everything in its power to accomplish the objective (even if it bankrupts itself in the process). Other standards - such as "reasonable efforts" or "commercially reasonable efforts" - are seen to be less onerous.
Atmospheric Diving Systems Inc. v. International Hard Suits Inc1., a 1994 decision of the British Columbia Supreme Court, remains one of the most cited Canadian cases regarding the "best efforts" standard and it states that:
- "best efforts" imposes a higher obligation than "reasonable efforts"
- "best efforts" means taking, in good faith, all reasonable steps to achieve the objective, leaving no stone unturned;
- "best efforts" includes doing everything known to be usual, necessary and proper for ensuring the success of the endeavour;
- "best efforts" are not boundless; the contract provisions, parties and purposes must be considered in setting the relevant boundaries;
- a party using best efforts must act honestly and fairly;
- evidence that a party could have achieved the contractual condition may be evidence that the party did not use its best efforts. However, evidence that a party could not have achieved the contractual condition - i.e., that there was inevitable failure - is not relevant to the issue of liability but is relevant to causation of damages.
There are many who argue that the various efforts standards (including, "best efforts", "all reasonable efforts", "commercially reasonable efforts", "reasonable efforts", etc.) as they are actually applied in court decisions generally amount to the same thing - and that at the end of the day all of the efforts standards will be bound by reasonableness. This view was recently supported by a decision of the Ontario Superior Court of Justice in Southcott Estates Inc. v. Toronto Catholic District School Board2, in which the court stated about the best efforts standard:
"The cases have used a variety of words to describe this obligation; "to act in good faith and to take all reasonable steps"; "to use best efforts"; "to act diligently and honestly"; "to do all that is necessary to act reasonably and in good faith and not in a capricious or arbitrary manner"[, "]to proceed in good faith using due diligence" and "take all reasonable steps". Whatever words are used, in the final analysis the court must determine, based on the particular facts, whether the party on whom the obligation rested and who seeks to rely on the non-fulfillment of the condition has satisfied the court that it took all reasonable steps to fulfill the condition."
So, despite the warnings, even under "best efforts" provisions you will likely not be required to bankrupt your company to fulfill the promise. People have attempted to reconcile "reasonable efforts" and "best efforts" by stating that best efforts is taking all reasonable steps (i.e., no "unreasonable" stone unturned) whereas reasonable efforts involves taking only some reasonable steps. However, there is lingering and perhaps legitimate fear that a contracting party which has promised to use "best efforts" to fulfill an obligation will be at greater risk when a court is determining (with the benefit of hindsight) what those "best efforts" should have entailed. Corporate lawyers acting for the promisor will be more comfortable with "reasonable efforts" because contracting parties should be able to justify their actions as long as they have taken a "reasonable" course of action to fulfill the promise - not all reasonable steps, whatever the additional steps required by the all might entail.
What Am I Promising to Use Best Efforts to Do?
In Example 2, ManufacturCo wishes to enter into a new supply contract with a customer which will require it to increase its capacity by 10,000 widgets per month, an increase which will require the overhaul of its facility. The CEO of ManufactureCo had agreed to use "best efforts to deliver 30,000 widgets per month commencing in January 1, 2012" without much thought as to how broad this promise might be.
Automaster Automotive Services Ltd. v. Kenco Enterprises Ltd.3 is a 2009 BC Supreme Court case which provides an excellent example of the repercussions of being "overbroad" in your best efforts promise.
Automaster operated a transmission repair shop in Nanaimo, British Columbia out of a property which it leased from Kenco. The parties entered into an agreement pursuant to which Automaster acquired an option to purchase the property from Kenco for a period of 18 months from the start of the lease. The option provided that Automoaster would use its "best efforts" to complete the purchase of the property within the first 12 months of the lease.
One week before the expiry of the 18 month option period, Automaster gave notice that it was exercising its option to purchase the property. Kenco indicated that it was not prepared to proceed with the transaction. Automaster then commenced an action for specific performance of the option agreement - to force Kenco to sell Automaster the property.
At trial, witnesses for Kenco indicated that during the first 12 months of the lease the period during which "best efforts" were to be used, Kenco received no indication that the option would be exercised. Automaster stated that the option was not exercised earlier because it was in the process of selling another property in Vancouver the proceeds of which would have been applied to the purchase of the Kenco property. The Vancouver sale did not close as planned and Automaster did not exercise its option to purchase the new property until that sale was completed.
The court was satisfied that during the first 12 months of the lease, Automaster was making all reasonable efforts to sell its property in Vancouver. However, Automaster's obligations under the option agreement required it to use "best efforts" to acquire the Kenco property, not to sell the Vancouver property. The Court found that, given that the sale proceeds from the Vancouver property were not forthcoming, Automaster's best efforts promise required it to explore other sources of financing to complete the purchase. The court found that Automaster had lost its rights under the option as a result of its failure to use "best efforts" to complete the sale.
In Example 2, it is clear that ManufactureCo's promise to use best efforts to deliver 30,000 widgets per month commencing in January 1, 2012 is overbroad. This promise would likely require it to go above and beyond completing the facility renovation. For example, if it is unable to complete the renovation and produce the extra widgets in its facility, the customer may argue that "best efforts" would require ManufactureCo to buy the widgets from another manufacturer and sell them to the Customer at the contract price or, perhaps, the best efforts promise would require cancelling other customer contracts so that ManufactureCo could free up an additional 10,000 units for delivery to the customer.
If the promise does not end up being fulfilled what will the other side say that I should have done?
Even if the promisor has picked the proper subject for its "best efforts" promise, best efforts promises are by their nature vague and imprecise. The result of this imprecision is that determining whether a party has made sufficient efforts will depend on the circumstances and will likely be decided by a court with the full benefit of hindsight. A promisor may find that a court interprets its best efforts promise to require it to have taken steps that were unpalatable to it but that are seen by a court to be one of a number of "reasonable steps" that should have been taken. Indeed a court may hold that a party subject to a best efforts clause is obligated to take steps and make efforts that in the view of the promisor are out of proportion to the benefits to it under the contract or not normal steps it would choose to take in the business.
So, in Example 2, assume that the CEO of ManufactureCo had been more focused in its best efforts promise and had agreed to use "best efforts to complete the necessary facility upgrades by December 31, 2011" so that it would be in a position to deliver 30,000 widgets per month to the customer by January 2012. Even in this case ManufacturCo may end up being surprised at what a court viewed "best efforts" to be. The CEO of ManurfactureCo should consider if, for example, best efforts may require it to finance the facility upgrade on terms that are not desirable to the CEO, to incur substantial cost overruns to get the facility upgrade completed on time, or to hire someone other than ManufactureCo's preferred contractor to complete the work, if the preferred contractor has a scheduling conflict.
What to do when faced with a contractual obligation outside your control
By thoughtlessly inserting best efforts provisions into contracts - perhaps just to signal a desire to work especially hard to meet a condition of the contract - the promising party opens itself up to a substantial risk of opportunism and litigation should they be unable to fulfill best efforts obligation. Instead when faced with a contractual promise that is not within the promisor's control, the promisor should consider what promises it is actually willing to make and craft its promise to reflect those efforts and, where appropriate, put limits on the scope of its promise. In particular, we would encourage commercial parties to:
- Use the "reasonable efforts" rather than the "best efforts" standard so you are not open to a reassessment of whether all reasonable steps were taken and should be able to argue from a position of strength if you are unable to fulfill the promise but took a reasonable course of action in diligently pursuing the promise.
- Understand the scope of the promise and ensure the promise is appropriately focused on the proper subject matter of the promise.
- Where appropriate, define "reasonable efforts" or "best efforts" to set out or provide greater guidance on the parties' actual expectations for fulfilling the obligation This could include incorporating specific promised actions, references to industry practice or to the promisor's normal or past practice. If you are the recipient of the promise - remember that if an action is not seen by the court to be "reasonable" it will not be required under either the "reasonable efforts" or "best efforts" standard. Therefore, the recipient of the promise should consider specifically listing any actions that it wants taken that may potentially be over and above what is "reasonable".
- Where appropriate, provide carve-outs from the "reasonable efforts" or "best efforts" standards specifying what the promisor is not required to do to achieve the promise. Carve-outs can be tailored to the circumstances of the promise and may include, for example (a) stating that the promisor will not incur any liabilities, (b) setting limits on the expenditures that the promisor must incur in attempting to fulfill the promise, (c) stating that the promisor will not take any actions that would cause it to incur costs or suffer any losses that are out of reasonable proportion to the benefits provided by the contract, (d) stating that the promisor will not take any action that in the opinion of the promisor would jeopardize a material customer or supplier relationship, (e) stating that the promisor will not change its business strategy or dispose of significant assets, (f) stating that the promisor will not initiate any litigation, or (g) stating that the promisor will not lobby or provide inducements to foreign officials.
Indeed, what your "best efforts" or "reasonable efforts" promise looks like should depend on the particulars of the promise. For example, it may be perfectly reasonable, in Example 1, for DistributorCo to promise to "use reasonable efforts to obtain the import permit by October 1, 2011" without further definition or carve-out. On the other hand, in Example 2, the fulfillment of ManufacturerCo's promise to complete a facility upgrade is much more complex and it would be appropriate to insert a definition of reasonable efforts, including limits on the actions that ManufacturerCo is required to take to achieve the promise.
1  B.C.J. No. 493
2 2010 CarswellOnt 2602
3 2009 BCSC 1594