July 7, 2022

Earnouts: Del. Chancery Interprets Undefined “Commercial Best Efforts” Clause

In many cases in which the meaning of an “efforts clause” governing the buyer’s conduct with respect to the achievement of earnout payment milestones has been an issue, the Chancery Court has had contractual language defining the standard to work with. But agreements don’t always define what “best efforts”, “commercially reasonable efforts” or alternative terms mean. How should efforts clauses in those situations be assessed?

That’s one of the issues the Chancery Court recently addressed in Menn v. ConMed, (Del. Ch.; 6/22), which arose out of a dispute over a buyer’s compliance with the terms of an earnout. Among other things, the sellers alleged that the buyer failed to comply with a contractual obligation to use “commercial best efforts” to develop and commercialize a surgical tool.  The agreement didn’t define what “commercial best efforts” meant, so Chancellor McCormick looked to Delaware precedent. As this excerpt notes, in the absence of a definition, Delaware courts tend to view all formulations of efforts clauses as imposing similar obligations:

Deal practitioners who draft efforts clauses “have a general sense of [the] hierarchy” of such clauses. One commonly cited version of this hierarchy places “best efforts” as the highest standard with “reasonable best efforts,” “reasonable efforts,” “commercially reasonable efforts,” and “good faith efforts” following in descending order. “Commercially best efforts” provisions are not found on the standard hierarchy. Logically, such provisions would fall between “best efforts” and “commercially reasonable efforts.”

Although deal practitioners have some sense of the hierarchy among efforts clauses, courts applying the standards have struggled to discern daylight between them. This court, for example, has interpreted “best efforts” obligations as on par with “commercially reasonable efforts.” Because this court has consistently interpreted “best efforts” obligations as on par with “commercially reasonable efforts,” it follows that there is even less daylight between “best efforts” and “commercially best efforts” provisions. Indeed, the parties make no distinction in briefing. This decision, therefore, interprets “commercially best efforts” as imparting the same meaning as “best efforts.”

The Chancellor went on to note that Delaware has generally interpreted “best efforts” to require “a party to do essentially everything in its power to fulfill its obligations. . . ” In assessing breach claims based on an efforts clause, the Chancery Court has looked to whether the buyer had reasonable grounds to take the action it did and sought to address problems with its counterparty.’”

She observed that in cases arising out of merger agreements, the Court found efforts clauses were breached “where a party failed to work with its counterpart to jointly solve problems, failed to keep the deal on track, or submitted false data to and refused to cooperate with regulators.”  In other settings, the Court found that a buyer breached an efforts clause “when utilizing a sales force that was too small to achieve the revenue target, expending energy and resources on stimulating an alternative to the deal, or making no effort to sell or market the product.”

Chancellor McCormick found that none of those scenarios applied to this case, and that the buyer established that its efforts to develop and market the device complied with its contractual obligations, even though it ultimately decided to abandon those efforts.

John Jenkins