Reaching “yes” on contract terms is often made easier by using commonly-employed subjective performance clauses, rather than developing and negotiating agreement on objective criteria for contract performance. Transactional lawyers and their clients take comfort from the familiar sound of these clauses, such as “reasonable” or “best efforts” provisions, “materiality” limitations and “consent” clauses. Comfort can become angst after the closing, when the practical meaning of those familiar-sounding clauses becomes hard to pin-down.
Subjective performance clauses are not merely seeds for later disputes — they can produce protracted litigation. Loosely-defined terms destroy prospects for a quick victory through a motion to dismiss or for summary judgment. For example, if the contract includes the word “material” without a specific definition, courts may interpret it in unexpected ways, applying vague and subjective standards of “materiality” that vary by jurisdiction: Does the term go to the root of the agreement between the parties? Does it affect a party’s decision to enter into the contract? Skilled litigators can shape nearly any set of facts to raise a summary judgment-defeating question of fact concerning an undefined materiality clause. The inherent subjectivity of performance clauses lacking objective benchmarks can lead to prolonged discovery and a trial (or an unfavorable settlement in lieu of trial), rather than a quick and predictable judgment.
Worse, courts frequently interpret these clauses in ways that surprise people who regularly negotiate deals, but do not litigate. For example:
- Transactional lawyers generally believe that the level of effort required by the term “best efforts” is greater than that required by a “reasonable efforts” clause. Some case law, however, defines “best efforts” as incorporating the concept of “reasonableness”—arguably merging the two standards of efforts. (For more, see Town of Roxbury v. Rodrigues, Cal. Pines Prop. Owners Ass’n v. Pedotti, and Crum & Crum Enters., Inc. v. NDC of Cal., L.P.)
- When similar, but slightly different “consent” or “efforts” clauses (e.g., “reasonable” versus “best”) are used in different parts of the same contract, or the word “material” is used in different contexts (e.g., “material” asset versus breach), uncertainties and protracted proceedings are all but guaranteed if litigation ensues. Courts will struggle to read different meanings into the slight differences between the similar clauses, or to find a single meaning to the common word that is used in different contexts, often by looking to evidence outside of the contract (translation — you are going to trial).
- The exercise of “sole discretion” to give or withhold consent may not always be upheld. A party cannot, for example, withhold consent for unlawful reasons (such as discriminatory reasons) or, some courts have held, where the withholding of consent would vitiate the contract’s essential purpose. Conversely, is it “reasonable” to withhold consent if doing so will impose much greater cost on the party seeking consent than it will benefit the one withholding consent?
Subjective performance clauses play vital roles in deal-making. The key is using these clauses in informed ways to make deals without also making litigation. Before employing these “gap-filling” devices, transactional lawyers should pause to balance the benefits and risks, and ask themselves at least two threshold questions: Is it feasible to develop and negotiate more objective standards or measures for performance in order to reduce risk of disputes, and increase the chances for a summary resolution if litigation nonetheless follows? If we have to use subjective performance clauses, have we used them consistently throughout the deal documents?