The Fifth Circuit Considers “Best Efforts”

In its recent opinion in Kevin M. Ehringer Enterprises, Inc. v. McData Services Corp. (go here for a PDF copy), the Fifth Circuit Court of Appeals reversed a jury award and granted a defendant’s motion for a judgment as a matter of law—the defendant’s “best efforts” promise wasn’t an enforceable promise and so couldn’t form the basis of a fraudulent-inducement claim. I’m happy that this case came along, as it has allowed me to explore an element of efforts provisions that for convenience I’ve dubbed “adverbial guidelines.”

Background

In 2003, McData and Ehringer entered into a contract providing for the sale of two product lines by McData to Ehringer, with Ehringer being obligated to pay McData a royalty on its sales of the products during a three-year period. For Ehringer, an important part of the deal apparently was that McData could provide access to customers. That’s why under the contract, McData was, among other things, obligated to use its “best efforts” to promote, market, and sell the products during  the three-year term.

In 2006, Ehringer sued McData, alleging that McData had breached the contract by, among other things, failing to comply with the “best efforts” obligation. It also alleged that McData had fraudulently induced it to enter into the contract because McData had never intended to comply with the best-efforts obligation and had never intended to be bound by a noncompetition provision in the contact.

The breach-of-contract claim was governed by Minnesota law; the fraudulent-inducement claim was governed by Texas law. The district court granted McData summary judgment on Ehringer’s breach-of-contract claim, on the grounds that a limitation-of-remedies provision in the contract prevented Ehringer from recovering the lost profits that Ehringer sought.

But the judge allowed the fraudulent-inducement claim to proceed to a jury trial. Before the case was submitted to the jury, McData filed a motion for judgment as a matter of law, one of its arguments being that the best-efforts provision was too indefinite to be enforceable. The judge denied the motion, and the jury subsequently awarded Ehringer $12.53 million in damages.

McData appealed, and the Fifth Circuit reversed, in part because Ehringer had failed to present sufficient evidence that McData had no intent to perform under the best-efforts provision.

The Fifth Circuit’s Analysis

The Fifth Circuit noted that to be actionable as fraudulent inducement, a breach must be coupled with a showing that the promisor had never intended to perform under the contract. McData argued that because “best efforts” has no precise meaning either in the contract or under the law, Ehringer could not prove that McData had had no intent to perform. In other words, there was nothing by which to measure the breach and lack of intent to perform.

In considering this argument, the Fifth Circuit started by looking to Texas caselaw on “best efforts,” concluding that it makes it clear that best-efforts obligations “may be enforceable under Texas law if they provide some kind of objective goal or guideline against which performance is to be measured.” The court then elected to apply that standard to analyze Ehringer’s fraudulent inducement claim, holding as follows:

[T]he “best efforts” provision in this case does not provide a goal or guideline by which McData can be expected to measure its progress. Therefore, the requirement that McData use its “best efforts to further the promotion, marketing, licensing, and sale of Products” is not enforceable under Texas law.

…

Because the “best efforts” clause is too indefinite and vague to provide a basis for enforcement, the claim for fraudulent inducement, as a matter of law, cannot rest on the alleged breach of this clause coupled with an alleged intent not to perform. Accordingly, this issue should not have been submitted to the jury.

My Analysis

I agree with the Fifth Circuit’s conclusion, but I have a quibble with how they got there.

Let’s look at what the court says about what it regards as the leading Texas case, CKB & Associates, Inc. v. Moore McCormack Petroleum, Inc., 809 S.W.2d 577 (Tex. App 1991), and a Fifth Circuit case, Herrmann Holdings Ltd. v. Lucent Techs. Inc., 302 F.3d 552 (5th Cir. 2002):

In CKB & Associates, the court noted that “[b]est efforts is a nebulous standard. Under some circumstances, a party could use best efforts to achieve a contractual goal and fall well short. Under different circumstances, an effort well short of one’s best may suffice to hit a target.” CKB & Assoc., 809 S.W.2d at 581. Therefore, the court determined that “to be enforceable, a best efforts contract must set some kind of goal or guideline against which best efforts may be measured.” Id.

If the contract sets out such goal or guideline, “[a] contracting party that performs within the guidelines fulfills the contract regardless of the quality of its efforts. When a party misses the guidelines, courts measure the quality of its efforts by circumstances of the case … and by comparing the party’s performance with that of an average, prudent, comparable [party].” Id. at 582 (citations omitted).

In interpreting CKB & Associates, we have held that the term “goal” or “guideline” need not be read narrowly. See Herrmann Holdings Ltd., 302 F.3d at 559. In Herrmann Holdings, the contractual language at issue stated that a party was to “use its reasonable best efforts to prepare, file and cause to become effective, as promptly as practicable … the Registration Statement ….” Id. at 556. We concluded that the phrase “as promptly as practicable” was an objective goal making the “best efforts” clause enforceable. Id. at 559–60. Therefore, we held that the plaintiff could pursue a claim for breach of this clause. Id. at 561.

The first bit of quoted analysis from CKB & Associates doesn’t make sense: Best efforts isn’t “a nebulous standard.” Instead, it’s vague. Nothing wrong with that—vagueness is essential to contract drafting (see MSCD ¶ 6.15).

The Texas Court of Appeals suggested that “a party could use best efforts to achieve a contractual goal and fall well short,” but that would make sense only if the obligation were an unqualified one. Instead, it was considering a best-efforts obligation. If a party uses best efforts in performing a best-efforts obligation, it necessarily is complying with that obligation; as a matter of basic logic, it’s impossible that it should “fall well short.”

And complying with a given best-efforts obligation might require less than best efforts? No surprise there. The level of effort required would depend entirely on the nature of the task to be performed.

After starting off by driving into the ditch, the court in CKB & Associates then wrestled the car back onto the road by stating that “to be enforceable, a best efforts contract must set some kind of goal or guideline against which best efforts may be measured.” Let me try to flesh out this standard:

For a best-efforts obligation to make sense, it has to incorporate an adverb or adverbial phrase or some other structure that tells you how soon, how often, how long, how vigorously …. Without such a guideline, you’re left with a best-efforts obligation such as that featured in Ehringer Enterprises. McData was under an obligation to use best efforts to promote, market, and sell the products, but in the absence of an adjectival guideline, it’s not clear what sort of result Ehringer had in mind. You could even argue that McData could have complied with the obligation without consummating the sale of even a single product—if I have a lemonade stand, I’m selling lemonade, even if no one’s buying.

Herrmann Holdings stands for the same proposition. Imposing on a party a best-efforts obligation to file a registration statement doesn’t do much good unless you say how quickly they have to do so. Otherwise, they could take their sweet time.

So for contract drafters, the lesson of Ehringer Enterprises is that when imposing any efforts obligation, incorporate adverbial guidance. In other words, have the provision address whichever of the how questions applies. (Remember, as a matter of idiom and contract logic any distinction between best efforts and reasonable efforts or any other efforts standard is doomed to incoherence. To avoid confusion, strike best efforts from your deal vocabulary and use instead reasonable efforts. See MSCD chapter 7.)

What Others Are Saying

What lessons are others drawing from Ehringer Enterprises?

According to The Texas Lawyer, here’s what McData’s appellate lawyer, Roger Townsend of Alexander, Dubose & Townsend, had to say:

He also believes the 5th Circuit’s opinion will have broad implications: For example, don’t expect to rely on any “best efforts” clauses in contracts. “If something goes wrong, you probably are not going to be able to sue about it unless you spell it out beforehand,” says Townsend, a partner in Houston’s Alexander Dubose & Townsend.

I think that’s unclear and way too broad.

And here’s what one law firm said in this “legal alert”:

Ehringer may have achieved a different result if, rather than its best efforts, McData had promised to use reasonable efforts or commercially reasonable efforts. Texas courts do not appear to apply the “goal or guideline” requirement to reasonable efforts obligations, instead analyzing whether the promising party exercised the effort that would have been used by an ordinary, prudent comparable party under the circumstances. This disparate treatment suggests an “all or nothing” regime governing best efforts promises in contracts: when the parties fail to set a bar for what constitutes “best efforts,” courts applying Texas law will not reform the promise so that a “reasonable efforts” standard applies.

But the Fifth Circuit’s analysis provides no support for that advice. Nothing suggests that it would apply a different standard to a reasonable-efforts obligation. Instead, by quoting CKB & Associates to the effect that assessing compliance with a best-efforts provision requires that you compare the party’s performance “with that of an average, prudent, comparable [party],” the Fifth Circuit appears to endorse the notion that best-efforts provisions are subject to a reasonableness standard. That’s to be expected, given that the overwhelming majority of U.S. courts have, in effect, said that all efforts provisions are subject to a reasonableness standard.

So if anyone follows this law firm’s advice but neglects to include in their efforts provisions suitable adverbial guidelines, they could be in for an unpleasant surprise.

[Updated 4:00 p.m. EDT, August 11, 2011:

The Wrong Approach?

Reader Westmorlandia makes a good point when he notes, in a comment to this post, that whoever drafted the language at issue might have been better off omitting the efforts standard. Almost all the activities that fall within that provision were within the control of McData, so it would have made more sense to address them by means of a flat obligation.

The one exception is the obligation to sell the products. As I note above, an obligation to sell something could be read as not requiring that you actually consummate a sale. Using an efforts standard instead goes some way toward suggesting that more is required of McData, but the language used is inadequate. An alternative to beefing up the efforts language would have been to specify, in a flat obligation, exactly what resources McData had to devote to selling the products. Instead, or in addition, McData could have been given a financial incentive to sell the products.

As I note above, vagueness is essential to contract drafting. But if you can accomplish a given drafting goal without the uncertainty that comes with vagueness, so much the better.]