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The Unsettled Law of Best Efforts in California
Posted By Dominick Severance, Apr 21, 2013
Introduction and General Roadmap Best efforts obligations in contracts can be expressed in a variety of ways, from reasonable efforts to good faith efforts to even diligent efforts. Even though best efforts can be expressed in so many different ways, the default is that all the efforts standards mean the same thing unless the contract states otherwise.[1] Thus, courts will apply the same standard, where one exists, to a reasonable efforts term as a best efforts term. For the purposes of this paper, therefore, the term “best efforts” will be the favored term and will be understood to encompass any other “efforts” standard unless explicitly noted otherwise. California is very fortunate to be home to the headquarters for both the technology and media industries. Both of these industries rely heavily on licensing of their respective works in return for royalties. In fact, “the obligation to exploit is at the heart of, and is the very essence of, the ‘business’ of show business…. it is the exploitation of intellectual property that drives the entertainment industry.”[2] To protect the rights and interests of the licensor, many licenses contain clauses stating that the licensee must use best efforts in exploiting the licensed work. Despite this prevalence of best efforts clauses in California, however, the California Supreme Court has refrained from setting a positive best efforts standard. Thus, even though California law allows courts to imply best efforts in to contacts, no set standard exists in determining either when a court must imply best efforts or what standard a court is to use in examining whether a party has satisfied their best efforts obligation. This paper will have four parts. First, the paper will list the authorities and factors California courts have considered when determining whether to imply a best efforts obligation in to a contract. Second, the paper will list general guidelines California courts have used in determining whether a party has satisfied a best efforts obligation. Third, this paper will outline what remedies a party can receive should a court determine there is a breach of a best efforts obligation. And, finally, this paper will recommend proactive measures a licensor and licensee should consider before entering a contract where a best efforts obligation will or may apply. Preliminary Matter - State versus Federal Jurisdiction for Best Efforts Obligations THE US SUPREME COURT HAS HELD THAT BEST EFFORTS IS A CONTRACTUAL PROVISION TO BE INTERPRETED IN LINE WITH STATE CONTRACT LAW EVEN WHEN THE CONTRACT CONCERNS INTELLECTUAL PROPERTY In the case Aronson v. Quick Point Pencil Co., 440 U.S. 257, 262 (1979), the US Supreme Court held, “Commercial agreements traditionally are the domain of state law. State law is not displaced merely because the contract relates to intellectual property which may or may not be patentable; the states are free to regulate the use of such intellectual property in any manner not inconsistent with federal law.”[3] Thus, merely because a license concerns intellectual property does not mean federal law applies to whether a best efforts obligation will be implied or what standard to use to determine whether a best efforts obligation was satisfied. Both federal and state courts must use the appropriate state law when determining whether to imply best efforts and whether the best efforts obligation was satisfied.[4] Part 1 – Authorities and Factors for Implying Best Efforts Part 1A – Statutory Authorities Section 1549 of the California Civil Code states, “A contract is an agreement to do or not to do a certain thing.”[5] Situations arise, however, where the contract does not explicitly state what a party should “do” or “not do.” California has seven laws that allow and, sometimes, require courts to imply terms in to a contract: section 2306 of the California Commercial Code; sections 1643, 1647, 1652, 1655, and 1656 of the California Civil Code; and section 1860 of the California Code of Civil Procedure. These laws give California courts the flexibility to “fill in the blanks” and gaps of a contract to save it from being unenforceable. The basis for this implication is that the court is only effectuating the parties’ obvious intention to have an enforceable contract. The courts reason that the parties surely wouldn’t intentionally enter an unenforceable contract and, thus, must have impliedly considered and agreed to the obligation being implied prior to signing the agreement. SECTION 2306 OF THE CALIFORNIA COMMERCIAL CODE REQUIRES COURTS TO IMPLY BEST EFFORTS IN EXCLUSIVE OUTPUT/REQUIREMENT CONTRACTS FOR GOODS UNLESS THE CONTRACT STATES OTHERWISE Section 2306 of the California Commercial Code is the only statute that explicitly requires courts to imply a per se best effort obligation. Section 2306 subsection (2) states, “A lawful agreement by either the seller or the buyer for exclusive dealing in the kind of goods concerned imposes unless otherwise agreed an obligation by the seller to use best efforts to supply the goods and by the buyer to use best efforts to promote their sale.”[6] Comment 1 of section 2306 states that the principle underlying the law is that, “In every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract, which means that in every contract, there exists an implied covenant of good faith and fair dealing.”[7] Although section 2306 concerns goods, Comment 1 proceeds to state this principle is the same as the principle behind sections 1647, 1655, and 1656 of the California Civil Code and section 1860 of the California Code of Civil Procedure, which apply more generally to all contracts. SECTIONS 1643, 1647, 1652, 1655, AND 1656 OF THE CALIFORNIA CIVIL CODE AND CALIFORNIA CODE OF CIVIL PROCEDURE SECTION 1860 OF THE CALIFORNIA CODE OF CIVIL PROCEDURE PERMIT CALIFORNIA COURTS TO IMPLY TERMS LIKE BEST EFFORTS INTO CONTRACTS AS NECESSARY Section 1647 of the California Civil Code and section 1860 of the California Code of Civil Procedure are closely related. Section 1647 states, “A contract may be explained by reference to the circumstances under which it was made, and the matter to which it relates.”[8]Section 1860 basically permits the judge to use evidence that would be relevant to explaining a contract under section 1647.[9] InMeyers v. Nolan, 18 Cal. App. 2d 319 (1936), the California 2nd Circuit Court of Appeal used sections 1647 and 1860 as the basis for holding that an express but unqualified best efforts clause did not make a manager’s contract with an actor void for uncertainty. The court found that both parties knew the manager represented other actors prior to contracting.[10] The court reasoned, therefore, that the parties must have impliedly agreed that the manager would satisfy his best efforts obligation by making a good faith effort to balance his other responsibilities while effectively representing the plaintiff.[11] Sections 1655 and 1656 of the California Civil Code are also closely related. Section 1655 states, “Stipulations which are necessary to make a contract reasonable, or conformable to usage, are implied in respect to matters concerning which the contract manifests no contrary intention.”[12] Section 1656 states, “All things that in law or usage are considered as incidental to a contract, or as necessary to carry it into effect, are implied therefrom, unless some of them are expressly mentioned therein, when all other things of the same class are deemed to be excluded.”[13] In Brawley v. Crosby Research Foundation, 73 Cal. App. 2d 103 (1946), two parties entered into an exclusive patent license. Per the contract, the licensee was to pay a royalty to the licensor in return for the right to develop, manufacture, exploit, and sell the patented invention.[14] Shortly after signing the agreement, the licensor filed suit claiming that the contract allowed the licensee to sit on its rights regarding the invention and thereby deny royalties to the licensor, which was obviously not what the licensor intended in entering the contract.[15] Thus, the licensor argued, there was no meeting of the minds as to an essential element of the contract thereby making the contract void and unenforceable.[16] The California Second Circuit Court of Appeal referenced sections 1655 and 1656 in holding that since the contract made no statement as to what was expected of the licensee, the implied obligations of good faith and best efforts necessarily applied to the contract to make it reasonable and able to be carried into effect.[17] The court explicitly held that the licensee was “obligated in good faith and by its reasonable and best efforts to develop, exploit, produce and make sales of the [invention]” under the contract.[18]Thus, the court held, the licensor’s fears were unfounded because the contract could not have relieved the licensee of these implied duties outside of an express provision in the contract.[19] The final two statutes that form the basis of California courts implying terms in to a contract are sections 1652 and 1643 of the California Civil Code. Section 1652 states, “Repugnancy in a contract must be reconciled, if possible, by such an interpretation as will give some effect to the repugnant clauses, subordinate to the general intent and purpose of the whole contract.”[20] Section 1643 states, “A contract must receive such an interpretation as will make it lawful, operative, definite, reasonable, and capable of being carried into effect, if it can be done without violating the intention of the parties.”[21] Taken together, sections 1643, 1652, 1655, and 1656 seems to command courts to imply terms where such action is necessary or reasonable without violating the intent of the parties in order to save a contract from failing either section 1652 or section 1643. In the case, Third Story Music, Inc. v. Waits, 41 Cal. App. 4th 798, 809 (1995), the second district court of appeal explained the law’s focus on necessity. For the court, “The law refuses to read into contracts anything by way of implication except upon grounds of obvious necessity”[22] because courts shouldn’t be in the position to “make better agreements for parties … or rewrite contracts because they operate harshly or inequitably.”[23] The court explained, “Parties have the right to make such agreements.”[24] Thus, the law’s focus on necessity serves as a practical barrier to prevent parties from running to the courts when a contract becomes unfavorable to them. Part 1B – Judicial Authorities WOOD V. LUCY, LADY DUFF-GORDON IS THE SEMINAL CASE ON WHEN TO IMPLY BEST EFFORTS AND LISTED THE FOLLOWING THREE FACTORS FOR COURTS TO CONSIDER PRIOR TO IMPLYING THE OBLIGATION: 1) THE EXCLUSIVITY OF THE CONTRACT; 2) WHETHER THE LICENSOR HAS EXTRA-CONTRACTUAL SOURCES OF REVENUE FOR THE LICENSED ITEM; AND, 3) WHETHER THE CONTRACT HAS GUARANTEED PAYOUTS FOR THE LICENSOR. The seminal case on when to imply best efforts is Wood v. Lucy, Lady Duff-Gordon, 222 N.Y. 88 (1917), decided by the Court of Appeals of New York in 1917. In that case, the defendant, Lucy, Lady Duff-Gordon (Lucy) was a well-known artist in the fashion world who “employed the plaintiff to help turn [her] vogue into money.”[25] The plaintiff, Otis Wood (Wood), received the exclusive right to use the defendant’s endorsements on other people’s designs, to license the defendant’s works and to license others to market them.[26] In return for his effort, Lucy was to receive ½ of all profits and revenues derived from his efforts.[27] Wood brought forward his complaint upon learning that Lucy was endorsing items without his knowledge and without sharing profits with him.[28] In response to his complaint, Lucy made a similar argument as the licensor in Brawley. Lucy argued that the contract was void because there was no meeting of the minds as to how the licensee would use the license and thus there was no mutual obligation to support enforcement of the contract.[29] In response to Lucy’s claim, the court iterated three factors as the basis for it finding an implied obligation to use best efforts: exclusivity; reliance solely upon the licensor for revenue; and no guaranteed payments for the licensor. Regarding the first factor – exclusivity - the court stated, “[His] acceptance of the exclusive agency was an assumption of duties…. We are not to suppose that one party was to be placed at the mercy of the other.”[30] For the second and third factors, the court focused on the fact that Lucy’s sole compensation for her endorsements was in the form of future royalties. Thus, “Unless he gave his efforts, she could never get anything. Without an implied promise, the transaction cannot have such business ‘efficacy, as both parties must have intended that at all events it should have.”[31] Thus, the court concluded, for the contract be enforceable in its current state, Wood must have impliedly “promise[d] to use reasonable efforts to bring profits and revenues into existence.”[32] In its ruling, the court held that when Wood entered into a contract with Lucy he had accepted this implied obligation to use his best efforts in the performance of his duties.[33] In making this ruling, however, the Wood court was actually quite revolutionary. Prior to this ruling, courts followed the exact terms of the contract. But, in Wood, the court stated, “The law has outgrown its primitive stage of formalism when the precise word was the sovereign talisman, and every slip was fatal. It takes a broader view today. A promise may be lacking, and yet the whole writing may be ‘instinct with an obligation,’ imperfectly expressed.”[34] Wood’s revolutionary ruling paved the way for courts like those in California to read implications in to contracts. Today, “The tendency of the law [today] is to avoid the finding that no contract arose due to an illusory promise when it appears that the parties intended a contract…. An implied obligation to use good faith is enough to avoid the finding of an illusory promise.”[35] Thus, Wood was the foundation for courts saving seemingly unenforceable contracts on the basis of upholding the original intentions of the parties. CALIFORNIA COURTS HAVE ESTABLISHED A SEEMINGLY STATUTORY BASED FIVE-FACTOR TEST TO DETERMINE WHEN TO IMPLY TERMS IN CONTRACTS IN CALIFORNIA In the case Lippman v. Sears Roebuck & Co., 44 Cal. 2d 136 (1955), the California Supreme Court outlined a five factor test for determining when to imply covenants into a contract. The court said that, to be imposed: (1) the implication must arise from the language used or it must be indispensable to effectuate the intention of the parties; (2) it must appear from the language used that it was so clearly within the contemplation of the parties that they deemed it unnecessary to express it; (3) implied covenants can only be justified on the grounds of legal necessity; (4) a promise can be implied only where it can be rightfully assumed that it would have been made if attention had been called to it; (5) there can be no implied covenant where the subject is completely covered by the contract.[36] This five-factor test is interesting in that the court does not make a direct reference to the statutes that support these factors. Upon further analysis, however, each of the factors has a direct tie to at least one of the statutes noted in the prior sections. The first, second, and fourth factors seem most closely related to sections 1647 and 1860’s allowance for considering the circumstances surrounding the formation of the contract and the matter of the contract itself. The third factor seems to be related to sections 1652, 1643, 1655 and 1656’s explicit mentioning of necessity as the basis for implication. The final factor, five, seems to relate to sections 1655, 1656, 1643 and 1652’s focus on not having terms implied that might run counter to contractual provisions or the intention of the parties. PART 1C - RECONCILING LIPPMAN, WOOD, AND THE CALIFORNIA STATUTES It can be difficult to determine what is required to find an implied best efforts obligation in California. For starters, the only statute that speaks of best efforts explicitly is section 2306 of the California Commercial Code. Moreover, the Lippman test is a general test used in deciding whether to imply an obligation. Finally, while Wood speaks directly to best efforts, it’s not binding law in California - although the California Supreme Court has referenced Wood in two of its holdings, neither case dealt with the implication of best efforts.[37] The truth is, the California Supreme Court has not set a positive standard for when California courts must imply best efforts into a contract. To simplify the issue, it is necessary to consider whether any of the three methods – seven statutes, Lippman, and Wood – satisfy each other such that a court could use one test as a means of satisfying all three. As demonstrated in the prior section, the Lippmantest actually satisfies the seven California statutes. Thus, if a court uses the Lippman test, the seven California statutes should be satisfied as well. The question remains, however, if the Wood factors would satisfy both the Lippman test and the seven California statutes. Wood satisfies the seven California statutes. As noted in a prior section, the underlying principle for the statutes is necessity. Wood’sfactors relate directly to that underlying principle. An exclusive license with no guaranteed payouts and licensor dependency would need an implied obligation to make it enforceable and not illusory. Thus, in a situation where a court uses Woods as the basis for implying a best efforts obligation, the seven California statutes would be satisfied as well. If a court were to imply best efforts based on Wood’s three factors, then Lippman would also be satisfied as well. Wood’s focus of exclusivity would satisfy Lippman’s first, second, and fourth factors’ focus on effectuating the intent of the parties. As the Wood court established, the law is willing to look at the circumstances and nature of the contract in determining whether to imply a best efforts obligation. Wood’s second and third factors, sole revenue and no guaranteed payout, would satisfy Lippmann’s third and fifth factors’ focus on necessity and not varying express contractual terms. There are two reasons why those factors are satisfied. First, if the contract already provides a payout then there is a mutuality of obligations to support enforcement and thus implying best efforts wouldn’t be necessary. Second, the contract would have already accounted for the potential that a licensee may not exploit a license since the licensee has guaranteed compensation. Thus, since Wood’s three factors satisfy both the Lippman test and the seven California statutes, a court applying California law could use Wood’s three factors as the basis for implying best efforts. In a rather recent case, Third Story Music, Inc. v. Waits, 41 Cal. App. 4th 798, 805 (1995), the California Second District Court of Appeal used both Woods and Lippman as the primary basis in deciding whether to imply a best efforts obligation.[38] In that case,musical artist Tom Waits agreed to an exclusive license to render his services as a recording artist and songwriter to Third Story Music.[39] Third Story Music transferred its rights in Waits’ music to Warner Communications in exchange for a percentage of the amount earned by Warner from the exploitation of the music in addition to advance royalties.[40] The contract between Third Story Music and Warner also gave Warner the right to refrain from using Waits’ work at Warner’s election.[41] The controversy before the court came twenty years later when Third Story Music sought to create a compilation album of Waits’ work that was subject to the original Waits and Third Story Music contract.[42] Since Warner now owned the rights to those works, Third Story Music approached Warner about the deal.[43] Warner replied to Third Story Music that while it, Warner, did not object, it would not proceed unless Waits approved of the idea.[44] Waits turned down the deal and Third Story Music brought suit based on breach of the implied covenant of good faith and fair dealing because Warner had added the impediment of getting Waits’ permission.[45] In determining how to resolve the issue, the court mentioned the five factor Lippman test, but did not go into detail analyzing each factor.[46] Interestingly, almost immediately after mentioning Lippman, the court stated that Wood was in the same vein as Lippman.The court then quoted Wood, stating that “covenants to use ‘good faith’ or ‘best efforts’ to generate profits for the licensor are routinely implied where the licensor grants exclusive promotional or licensing rights in exchange for a percentage of profits or royalties, but the licensee does not expressly promise to do anything.”[47] Ultimately, the court held that since Warner had paid Third Story music advance royalties, no obligation could be implied against Warner.[48] Warner, therefore, had not breached the contract by adding the requirement of Waits’ permission prior to authorizing Third Story Music to proceed with the compilation.[49] Part 2 – What is the Best Efforts Standard in California? BLOOR V. FALSTAFF, A NON-BINDING BUT FOUNDATIONAL CASE ON BEST EFFORTS, ESTABLISHED AN OBJECTIVE STANDARD FOR BEST EFFORTS BASED ON WHAT AN AVERAGE, PRUDENT, AND COMPARABLE PERSON OR BUSINESS IN THE POSITION OF THE LICENSEE WOULD HAVE DONE In the case Bloor v. Falstaff Brewing Corp., 601 F.2d 609, 613–614 (2d Cir. 1979), the defendant, Falstaff Brewing Corporation, had bought everything but the actual brewery of the fifth largest brewing company in the United States, Ballantine Brewery.[50] The agreement called for an immediate payment of $4 million to Ballantine and royalty payments for each barrel of Ballantine beer sold by Falstaff for next six years.[51] The agreement included a best efforts clause wherein Falstaff was required to “use its best efforts to promote and maintain a high volume of sales” of Ballantine beer.[52] Over time, however, the market declined and so did the sales of both Falstaff and Ballantine beer accordingly.[53] Control over Ballantine passed to Paul Kalmanovitz, who succeeded in turning the company around but only after closing locations and cutting costs, including slashing Ballantine advertising by nearly 90%.[54] Shortly thereafter, sales of Ballantine fell even more sharply.[55] Ballantine quickly brought suit claiming, among other things, that Falstaff had breached the best efforts clause of the contract by not using its best efforts to promote sales of Ballantine beer.[56] The District Court, in determining what standard to use for best efforts, reviewed the standard proposed by both parties. On one side, the court found that the “Defendant [argued] that the interpretation of [best efforts] requires the application of a subjective standard: Falstaff contracted to use ‘its’ best efforts, and any determination of those efforts must include considerations of Falstaff’s own allegedly precarious financial position … and its right to look to its own interest.”[57] On the plaintiff’s side, the court found that the “Plaintiff, cites substantial precedent holding that financial difficulty and economic hardship do not excuse performance of a contract, and argues for the application of an objective standard, that of the ‘average, prudent comparable’ brewer.”[58] Ultimately, the District Court rejected the defendant’s deferential, subjective standard and adopted the plaintiff’s objective standard instead.[59] In adopting the plaintiff’s standard, the court held that, “Best efforts is a term which necessarily takes its meaning from the circumstances.”[60] The court then iterated that the single most important circumstance to review was what an average, prudent, and comparable brewer would have done in the defendant’s position.[61] The court then proceeded to make a few qualifications and clarifications to the standard. First, the court stated that a licensee does have the right to act in the furtherance of its own interests, even if those actions “may incidentally lessen [a licensor’s] royalties.” That right does not extend, however, to actions that are manifestly harmful to the licensor and which the licensee should have known were going to be manifestly harmful.[62] Second, the court noted that even though the licensee may face bankruptcy or insolvency during a contractual period, “performance of the contract [will] not [be] excused” due to financial difficulty in fulfilling contract obligations.[63] The District Court ultimately found for the plaintiff, reasoning that once the peril of insolvency had been averted, an average, prudent, and comparable brewer would have taken steps to increase sales of Ballantine beer.[64] The court held that Falstaff had breached its best efforts obligation by focusing on its own profits and failing in taking the same steps an average, prudent, and comparable brewer in Falstaff’s position would have done.[65] After the court’s ruling, Falstaff appealed to the US Court of Appeals for the Second Circuit.[66] On appeal, however, the Second Circuit agreed with the District Court’s adoption and application of the plaintiff’s “average, prudent, and comparable” best efforts standard.[67] The Second Circuit further clarified the standard by holding that best efforts does not require a licensee to “bankrupt itself … or even to sell [licensed] products at a substantial loss.”[68] Where a licensee has both a licensed and in-house product, however, the court held that best efforts is not satisfied by the mere demonstration that the licensee has treated both products the same or that both products have suffered equally.[69] Thus, a licensee might have to put itself on the verge of bankruptcy to satisfy its contractual obligations even though such an obligation does not exist for its own products.[70] Regarding this last point of approaching bankruptcy, the Second Circuit explained the difference by noting that the licensee has different obligations to different people for the licensed product and the in-house product.[71] For instance, the in-house product demands satisfaction of the very deferential business judgment rule since the obligation is based on the relationship of the managers to the shareholders of the company. The licensed product, on the other hand, demands satisfaction of the much higher best efforts standard since the obligation is based on the contractual provision of royalty payments to the dependent licensor.[72] Interestingly, in a footnote at the bottom of the appellate ruling, the Second Circuit noted, “other cases suggest that under New York law a ‘best efforts’ clause imposes an obligation to act with good faith in light of one’s own capabilities.”[73] However, the court noted that other cases have held for “the average prudent comparable” standard.[74] Thus, just as in California, the court found the standard very difficult to define either based on precedent or statute. In the end, the Second Circuit admitted, “The net of all this is that the New York law is far from clear and it is unfortunate that a federal court must have to apply it.”[75] ALTHOUGH THE CALIFORNIA SUPREME COURT HAS NOT EXPRESSLY STATED WHAT STANDARD TO USE IN DETERMINING A BEST EFFORTS OBLIGATION, THERE IS A QUESTION AS TO WHETHER THE CALIFORNIA SUPREME COURT CONSIDERS GOOD FAITH AND BEST EFFORTS AS INDISTINGUISHABLE AND THUS THE SAME STANDARD Although other states have developed positive definitions for “best efforts,” the California Supreme Court has refrained from doing so. This lack of a set standard led the California Third District Court of Appeal to conclude that although “California courts have enforced best efforts contracts, [they] have not defined the term ‘best efforts.’”[76] Thus, the standard in California will vary from district to district. There is a possibility, however, that the Supreme Court has not defined best efforts because it believes that the implied obligation of good faith and the obligation of best efforts are essentially the same thing. In that case, the court would consider it unnecessary to distinguish best efforts from good faith. Holdings from the California Second District Court of Appeal and the underlying principle of section 2306 seem to support the Supreme Court’s seeming inference that best efforts and good faith are, in fact, indistinguishable standards. In the case, Carma Developers (Cal.), Inc. v. Marathon Development California, Inc. 2 Cal. 4th 342 (1992), a plaintiff-tenant and defendant-landlord entered a commercial lease that contained a recapture clause on the part of the landlord. Several years into the contract, the landlord exercised the recapture privilege so as to lease the property to another tenant willing to pay higher rent.[77] The plaintiff filed a complaint seeking contract damages claiming the defendant breached the covenant of good faith and fair dealing in the exercise of the recapture provision.[78] In ruling on the case, the court held that, “the covenant of good faith and fair dealing was developed in the contract arena and is aimed at making effective the agreement’s promises.”[79] Thus, for that reason the court felt comfortable holding that, “in situations where one party is invested with a discretionary power affecting the rights of another…. such [discretionary] power must be exercised in good faith.”[80] This case is distinguishable from Wood since the tenant was not reliant on the landlord’s work for financial gain. The Supreme Court’s holding, however, is broad enough to cover instances where Wood might be satisfied. The contract in Wood, after all, did not mandate that Wood had to work and, therefore, he had discretion on whether to exploit the right or not. Thus, it seems that if the Supreme Court were to have ruled in the Wood case instead of the New York Court of Appeals, the court would have implied the same obligation but called it good faith instead of best efforts. In the Supreme Court case, California Lettuce Growers v. Union Sugar Co., 45 Cal. 2d 474, 484 (1955), the plaintiff was a beet farmer who entered into an agreement with the defendant, a sugar processor, for the defendant to buy its beets. The contract did not contain a provision for determining the price the defendant would pay for the beets.[81] After receiving payment for a shipment, the plaintiff filed suit against the defendant claiming that the contract lacked mutuality since it gave the defendant the sole discretion to determine and fix the price of the beets.[82] Ultimately, the Supreme Court found that the parties’ actions over the course of the contract clearly established a reasonable method for determining the price the defendant would pay for each shipment received.[83] In support of its ruling, the Supreme Court held that, “The duty to exercise good faith … imposes a duty on [the defendant] to sell at the prices best obtainable in the sugar market.”[84] Thus, the Supreme Court seems to infer that good faith imposes best efforts. Unfortunately, the Supreme Court did not have to determine whether the defendant acted in good faith since the court decided the case on the much narrower ground that the parties had established price and process parameters through their prior dealings. Unfortunately, regardless of whether best efforts and good faith are indistinguishable, the Supreme Court has refrained from defining the good faith standard.[85] In Carma, the court even reviewed several possible definitions, but ultimately refrained from choosing one.[86] Instead of defining the standard, the court decided to list some general principles that have emerged from case precedent over the years.[87] First, the Supreme Court found that for there to be a breach, it is not “necessary that the party’s conduct be dishonest. Dishonesty presupposes subjective immorality; the covenant of good faith can be breached for objectively unreasonable conduct, regardless of the actor’s motive.”[88] Second, implied good faith and fair dealing cannot vary express terms of the contract even when such “acts and conduct would otherwise have been forbidden by an implied covenant of good faith.”[89] In sum, while the Supreme Court has explicitly held that good faith is implied in every contract, it has refrained from defining that standard and from explaining how that standard might differ from best efforts. Moreover, the Supreme Court’s explanation of why good faith is implied in contracts, namely to effectuate the parties’ intention especially where one party has discretionary power that affects another party, is broad enough to cover a best efforts implication. Thus, the Supreme Court could theoretically find Wood’sthree factors satisfied based on good faith alone. In that case, good faith and best efforts would be indistinguishable. Until the Supreme Court defines best efforts or good faith, best efforts law in California will continue to be fractured from jurisdiction to jurisdiction as lower courts adopt differing definitions of for these implied obligations. The California Third District Court of Appeal, for instance, adopted Bloor’s definition of best efforts. Since Bloor recognized best efforts as a higher standard than good faith, the Third District could be at odds with the California Supreme Court’s arguable position that the two obligations are, in fact, indistinguishable. THE CALIFORNIA SECOND DISTRICT COURT OF APPEAL AND SECTION 2306 OF THE CALIFORNIA COMMERCIAL SEEM TO BE IN AGREEMENT WITH THE CALIFORNIA SUPREME COURT THAT BEST EFFORTS AND GOOD FAITH BEING THE SAME STANDARD Both the California Second District Court of Appeal and section 2306 of the California Commercial Code seem to agree with the California Supreme Court that best efforts and good faith are, in fact, the same standard and indistinguishable. Section 2306, for instance, fails to make a distinction between a good faith and best efforts standard. The first comment of section 2306 states that the underlying principle for the statute is the same as the underlying principle for sections 1647, 1655, 1656 of the California Civil Code and section 1860 of the California Code of Civil Procedure. The comment then defines that principle as follows: “In every contract there is an implied covenant that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract, which means that in every contract, there exists an implied covenant of good faith and fair dealing.”[90] Section 2306 clearly states, however, that “a lawful agreement by either the seller or the buyer … imposes … an obligation … to use best efforts….”[91] Thus, similar to the Supreme Court’s holding in Callifornia Lettuce Growers, section 2306 seems to indicate that the fulfillment of a good faith obligation means the fulfillment of best efforts. And, if that is the case, then good faith and best efforts would be the same standard. In the California Second District Court of Appeal case, Brawley v. Crosby Research Found., 73 Cal. App. 2d 103, 112 (1946), the plaintiff and defendant had entered into an exclusive patent license based on the payment of royalties, an upfront payment of $1 to the licensor, and the option to terminate at the discretion of the licensee.[92] After signing the contract, the plaintiff filed suit complaining that the contract was void for having no meeting of minds regarding the material term of how the licensee would exploit the invention.[93] The court replied that: In this, as in every contract, there is the implied covenant of good faith and fair dealing; that neither party will do anything that would result in injuring or destroying the right of the other to enjoy the fruits of the agreement…. The law will therefore imply that under its agreement appellant was obligated in good faith and by its reasonable and best efforts to develop, exploit, produce and make sales of the rotary pump in question.[94] Here, the court explicitly mentioned both good faith and best efforts as part of the licensee’s obligation. Yet, for the remainder of the ruling, the court only speaks of a good faith obligation.[95] Ultimately, the court found that the $1 up front payment served as sufficient consideration to find the entire contract enforceable.[96]The court held that, “it was not necessary that the provision giving to one party an option to terminate on substantial notice shall be supported by a consideration different from considerations supporting the entire agreement. One valid consideration supports each and all of the obligations of the contract.”[97] The court, therefore, could not imply a standard into the contract even if it had wanted to since such an implication was unnecessary.[98] Thus, the court’s whole discussion of the standard is not illustrative of what standard the court would have used if the case was not determined on such narrow grounds. THE THIRD CIRCUIT IS AN EXAMPLE OF A CALIFORNIA CIRCUIT THAT HAS ADOPTED A DEFINITE BEST EFFORTS STANDARD Since the California Supreme Court has not set a unified standard for all of California to follow, individual appellate districts have had to adopt their own best efforts standards accordingly. The California Third District Court of Appeal adopted the standard set forward inBloor v. Falstaff. The Third District held that the holding of Bloor was as follows: “When a contract does not define the phrase ‘best efforts,’ the promisor must use the diligence of a reasonable person under comparable circumstances…. [Best efforts] ‘requires a party to make such efforts as are reasonable in … light of that party’s ability and the means at its disposal and of the other party’s justifiable expectations….’”[99] The court then clarified that, “While diligence is certainly required, the obligation is framed within the bounds of reasonableness.”[100] The Third District then went on to clarify where it saw the limits of the best efforts standard. For starters, a best efforts clause must be reconciled with and cannot vary express terms of the contract.[101] Moreover, the court held that, “Best efforts does not mean every conceivable effort.”[102] Citing Bloor once again, the court also noted that, “Best efforts does not require the promisor to ignore its own interests, spend itself into bankruptcy, or incur substantial losses to perform its contractual obligations.”[103] Citing Farnsworth, the Third District held that, “While we agree … that a promise to use ‘best’ efforts is different than a promise to act in ‘good faith’, we do not agree that a promise to use best efforts creates an obligation equivalent to a fiduciary duty.”[104] In explaining its position, the court noted that: Farnsworth distinguishes the standard of best efforts from that of good faith: “Good faith is a standard that has honesty and fairness at its core and that is imposed on every party to a contract. Best efforts is a standard that has diligence as its essence and is imposed on those contracting parties that have undertaken such performance. The two standards are distinct and … best efforts is the more exacting….”[105] Thus, for Third District, the best efforts standard would lie somewhere between good faith and fiduciary duty on the spectrum of responsibility to the other contracting party. Part 3 – Remedies for Breach of Best Efforts THE CALIFORNIA SUPREME COURT HAS HELD THAT REMEDIES FOR BREACH OF AN IMPLIED TERM GENERALLY INCLUDE STANDARD CONTRACT DAMAGES AND, IN RARE CIRCUMSTANCES, TORT DAMAGES BUT DOES NOT INCLUDE SPECIFIC PERFORMANCE There has been an ongoing issue regarding what damages an implied term such as good faith and fair dealing should receive in California courts. For contract damages the California Supreme Court has explicitly held in multiple cases that standard contract principles will apply for breached implied obligations. In the case Foley v. Interactive Data Corp., 47 Cal. 3d 654, 683-84 (1988), for instance, the court clearly acknowledged that breach of an implied duty entitles the plaintiff to contract damages, such as lost profits, in line with standard contract principles. Tort damages, on the other hand, are much more contentious. In the case, Freeman & Mills, Inc. v. Belcher Oil Co., 11 Cal. 4th 85, 102 (1995), the California Supreme Court expressly overruled its prior ruling in Seaman’s Direct Buying Service, Inc. v. StandardOilCo., 36 Cal. 3d 752 (1995).[106] In Seaman’s, the court had “recognized a tort cause of action based on the defendant’s bad faith denial of the existence of a contract between the parties.”[107] The Supreme Court stated that it was overruling Seaman’s “in favor of a general rule precluding tort recovery for noninsurance contract breach, at least in the absence of violation of ‘an independent duty arising from principles of tort law’… other than the bad faith denial of the existence of, or liability under, the breached contract.”[108] Thus, under current California precedent, a plaintiff is entitled to standard contract damages but tort damages require a very specific set of circumstances to be awarded. Regarding specific performance, in the California Supreme Court case Poultry Producers of S. California v. Barlow, 189 Cal. 278, 290 (1922), the defendant entered into a contract with the plaintiff to sell to the plaintiff exclusively all the eggs the defendant produced over the contract period.[109] The plaintiff was to then use its best efforts to sell the eggs and give the defendant a royalty for each egg sold.[110] During the contractual period, the plaintiff learned that the defendant had been marketing and selling its eggs to other buyers.[111] The plaintiff filed suit requesting “a decree of specific performance enforcing plaintiff’s obligation to resell the [defendant’s] eggs at the best prices obtainable.”[112] The Supreme Court held that the best efforts provision of the contract meant it would be impossible for the court to grant specific performance.[113] The Supreme Court named two reasons for not granting specific performance. First, the court found that considerable judicial resources would have to be spent gaining the requisite “special knowledge, skill, and judgment” in the egg market to be able to determine whether the parties had upheld their best efforts obligations.[114] Second, the court found that it would also have to spend considerable judicial resources constantly reviewing the actions of the parties for the remainder of the contract.[115]Thus, the Supreme Court held that “a court of equity should always decline to enforce specific performance where, as here, [such a mandate] would impose upon the court” a seemingly impossible duty to maintain.[116] Part 4 – Proactive Suggestions for Parties Considering a Contract that May Include a Best Efforts Clause The first section of this paper demonstrated that California has no set standard in place for determining whether to imply best efforts. The second section of this paper demonstrated that the law is incredibly unsettled as to what standard to apply for a best efforts obligation. With those two sections in mind, parties entering into a contract where a court might be justified in implying best efforts would do well to preempt such a situation by taking certain proactive measures. PART 4A - IF THE PARTIES AGREE TO AN EXPRESS BEST EFFORTS PROVISION, THE PARTIES SHOULD DEFINE THE PARAMETERS AND OBLIGATIONS OF THE PROVISION IN GREAT DETAIL If the contract expressly includes a best efforts obligation, the parties should list out the methods and procedures in the contract to satisfy or breach that obligation. The contract should outline specific measurable performance metrics, statements as to expectations, and express consequences for non-performance, including liquidated damages and termination rights. Since courts cannot imply terms that vary express provisions, the court would be forced to uphold the parties’ methodology. The benefits of the parties creating the standard are extensive. The licensee can reduce the chance the court may force near fiduciary duties on to it similar to the way the court did in Bloor. From the licensor’s perspective, it can demand certain parameters be met in the licensee’s ongoing exploitation that would allow the licensor to back out if the licensee fails to live up to expectations. Expressly outlining the best efforts obligation also provides the court interpreting the contract with an easy to apply standard. This not only limits expensive litigation costs but also prevents the court from potentially creating an unfair standard based on the conflicting and inconclusive precedent in this unsettled area of the law. PART 4B - TO PREVENT A COURT FROM IMPLYING BEST EFFORTS, CONTRACTING PARTIES SHOULD CONSIDER DISCLAIMING BEST EFFORTS WHILE INCLUDING A NOMINAL GUARANTEED PAYMENT If the parties decide to not have a best efforts obligation in their contract, the parties’ can disclaim the best efforts requirement. To ensure the contract has sufficient consideration, the licensee should give the licensor some form of consideration sufficient to support the contract as a whole. In the Brawley case, the court found $1 as sufficient consideration for the whole contract.[117] By providing at least a nominal form of consideration, the parties would ensure that a court wouldn’t be able to imply best efforts on the basis of lack of mutuality. Taken as a whole, if the parties follow the proactive suggestions in this section, they can best insure that their expectations are fully protected and satisfied with the least risk of expensive litigation. Conclusion As this paper has hopefully demonstrated, the law of best efforts in California is both unsettled and complex. The California Supreme Court has not created a standard for either determining when to imply best efforts or how to determine a best efforts obligation is satisfied. The court may have refrained from setting a positive standard because it viewed good faith, which is implied in every contract, and best efforts as indistinguishable. Because the Supreme Court has not explicitly ruled that good faith and best efforts are the same, however, each California appellate district must move forward by deciding that issue for itself. As a best practice, persons entering a contract should be aware of the unsettled nature of best efforts law in California and take proactive steps to either disclaim or expressly include best efforts in their contracts where appropriate. If best efforts is to be disclaimed, the contract may have to include some form of consideration for both parties to prevent the contract from being illusory. If best efforts is expressly included in the contract, the parties should expressly define the term in as much detail as possible. Courts cannot imply terms that go against express provisions of a contract and will uphold the parties’ standards unless the contract is otherwise unenforceable. Best efforts law is definitely an area in California where an ounce of prevention is worth a pound of cure - parties who are aware of the law’s unsettled nature and take appropriate measures will reap the rewards of reduced litigation costs down the road. [1] Kenneth A. Adams, “Understanding ‘Best Efforts’ and Its Variants (Including Drafting Recommendations),” 50 Prac. Law. 11, 14 (2004). [2] Daniel J. Coplan, When Is “Best Efforts” Really “Best Efforts”: An Analysis of the Obligation to Exploit in Entertainment Licensing Agreements and an Overview of How the Term “Best Efforts” Has Been Construed in Litigation, 31 Sw. U. L. Rev. 725 (2002). [3] Aronson v. Quick Point Pencil Co., 440 U.S. 257, 262 (1979). [4] Bloor v. Falstaff Brewing Corp., 601 F.2d 609, 613 (2d Cir. 1979). [5] Cal. Civ. Code § 1549 (West). [6] Cal. Com. Code § 2306 (West). [7] Cal. Com. Code § 2306 (West) Comment 1, citing Universal Sales Corp. v. Calif. Press Mfg. Co., 20 Cal.2d 751 (1942). [8] Cal. Civ. Code § 1647 (West). [9] Cal. Civ. Proc. Code § 1860 (West). [10] Meyers v. Nolan, 18 Cal. App. 2d 319, 323 (1936). [12] Cal. Civ. Code § 1655 (West). [13] Cal. Civ. Code § 1656 (West). [14] Brawley v. Crosby Research Found., 73 Cal. App. 2d 103, 107 (1946). [20] Cal. Civ. Code § 1652 (West). [21] Cal. Civ. Code § 1643 (West). [22] Third Story Music, Inc. v. Waits, 41 Cal. App. 4th 798, 809 (1995). [25] Wood v. Lucy, Lady Duff-Gordon, 222 N.Y. 88, 90 (1917). [35] 2 Corbin, Contracts, § 5.28 at pp. 149–150. [36] Lippman v. Sears Roebuck & Co., 44 Cal. 2d 136, 142 (1955). [37] Quader-Kino A.G. v. Nebenzal, 35 Cal. 2d 287, 299 (1950); Davis v. Jacoby, 1 Cal. 2d 370, 379 (1934). [38] The court used Wood and Lippman in determining whether to imply good faith. Part three of this paper will raise the question of whether the court saw good faith and best efforts as the same obligation. Thus, Third Story Music could stand for the principle thatWood has been adopted, at least for the second circuit, in determining whether to imply best efforts. [39] Third Story Music, Inc. v. Waits, 41 Cal. App. 4th at 801. [50] Bloor v. Falstaff Brewing Corp., 601 F.2d at 610. [57] Bloor v. Falstaff Brewing Corp., 454 F. Supp. 258, 266 (S.D.N.Y. 1978). [66] Bloor v. Falstaff Brewing Corp., 601 F.2d at 611. [73] Id. at 613 citing Van Valkenburgh v. Hayden Publishing Co., 30 N.Y.2d 34 (1972). [74] Bloor v. Falstaff Brewing Corp., 601 F.2d at 613 citing Arnold Productions, Inc. v. Favorite Films Corp., 176 F. Supp. 862, 866 (S.D.N.Y.1959). [75] Bloor v. Falstaff Brewing Corp., 601 F.2d at 613. [76] California Pines Prop. Owners Assn. v. Pedotti, 206 Cal. App. 4th 384, 392-93 (2012) citing Gilmore v. Hoffman, 123 Cal. App. 2d 313, 319–320 (1954) and Midland Pacific Building Corp. v. King, 157 Cal. App. 4th 264, 274 (2007). [77] Carma Developers (Cal.), Inc. v. Marathon Dev. California, Inc., 2 Cal. 4th 342, 350 (1992). [81] California Lettuce Growers v. Union Sugar Co., 45 Cal. 2d 474, 478-79 (1955). [85] Carma Developers (Cal.), Inc. v. Marathon Dev. California, Inc., 2 Cal. 4th at 372. [90] Cal. Com. Code § 2306 (West) Comment 1, citing Universal Sales Corp. v. Calif. Press Mfg. Co., 20 Cal.2d 751 (1942). [91] Cal. Com. Code § 2306 (West). [92] Brawley v. Crosby Research Found., 73 Cal. App. 2d at 107. [99] California Pines Prop. Owners Assn. v. Pedotti, 206 Cal. App. 4th at 392-93. [103] Bloor v. Falstaff Brewing Corp., 601 F.2d at 613–614. [104] California Pines Prop. Owners Assn. v. Pedotti, 206 Cal. App. 4th at 395 citing 2 Farnsworth on Contracts, § 7.17c p. 405. [106] Freeman & Mills, Inc. v. Belcher Oil Co., 11 Cal. 4th 85, 102 (1995). [109] Poultry Producers of S. California v. Barlow, 189 Cal. 278, 283 (1922). [117] Brawley v. Crosby Research Found., 73 Cal. App. 2d at 112.