“Reasonableness” Now Reasonably Defined.

November 2009

Summary:  Every corporate lawyer has drafted “best efforts” and similar contract provisions but often without much thought to the meaning and most certainly without a lot of guidance from US case law.  Now the UK High Court has provided some guidance, with some particularity.  Equally interesting, the opinion clearly indicates that at least that court will go beyond the four corners of the document and look at the conduct of the distributor relative to overall conditions of and business efforts in the relevant industry.  This makes sense, insofar as “reasonable” requires some examination of the real world.  In the end, this opinion helps in the US.  Somewhat.  And why?  Because important phrases with little meaning to the drafting lawyers now have to obtain more substance within the agreement itself.  This also gets to our drafting philosophy—that a contract is also a roadmap for the non-lawyers to use in guiding the relationship.  It is also critical reading for anyone with agreements governing UK (and EU) distributors.

The Details.

What corporate lawyer hasn’t drafted a “best efforts,” “reasonable efforts” or “commercially reasonable efforts” contract provision?  And what such lawyer hasn’t scratched his or her head about the legal meaning of these phrases?  Oddly enough, there is not much guidance from US case law.  So now, we have the UK High Court offering a pretty detailed analysis of the UK law equivalent—“reasonable endeavours.”

The case is CEP Holdings Ltd & CEP Claddings Ltd v Steni AS.  Basically, Steni manufactured cladding (building siding) distributed in the UK by CEP and they terminated the distribution agreement on the grounds that CEP had breached the “reasonable endeavours” provisions of that agreement.  The distributors sued them for the termination.  (UK and EU distribution agreements are notoriously difficult to terminate but we will not discuss that part of the larger context here.)

Clean Up Your Act. Well, the court disagreed that the supplier had been in the wrong after the court looked at the business conduct of CEP.  Interestingly, the court took note of the sales performance during an up market:  The relevant market went up roughly 18% while CEP sales declined roughly 62%.  The court noted that much of the decline was attributable to a “lack of an adequately structured, and directed, sales and marketing organization[.]”  To the facts of the case, the court pointed out that everything rested on one man and internal processes were pretty informal.  In our view, it looks like the court did not like the sloppiness of the distributor as well as the lack of communications (rolling sales reports are mentioned).

The opinion included some guidance in the abstract.  In a nutshell:  Plan; promote, monitor, communicate (with your supplier); and improve your sales team if things go bad.  Probably paramount among these matters is regular and meaningful communications with the supplier (e.g., rolling sales reports).

So What?

Let’s look at the consequences—i.e., what should be drafted.  Perhaps the agreement should specify just what those “commercially reasonable efforts” are and are not.  In other words, one could include language that says something to the effect that “such efforts do not include the preparation of reports beyond those specified in this Agreement or promotional efforts beyond those normally conducted by Distributor.”  Put in the positive, one could include an attachment that enumerates the specific marketing efforts to be undertaken.

Communications is often handled in US agreements by a reporting provision that spells out in some detail the sorts of reports needed by the supplier on a regular basis.  This begs the question, then, whether that provision needs to be expressly tied to the “commercially reasonable” standard, as suggested in the language above.

A “contrarian” approach for domestic agreements might be to leave everything out and rely upon a comparison by the courts to the outside world, thereby leaving the definition of “reasonableness” to the court.  This may make some sense.  The absence of case law may support this proposition.  Moreover, the courts are notoriously reluctant to look at specific business practices and an industry as a whole (excluding for the moment egregious corporate behavior in other areas).

We, however, would be disinclined to take the contrarian approach.  Better to specify (in an attachment) the marketing efforts to be undertaken.  However, in California, there may be a risk of an “accidental franchise” if the supplier imposes too many conditions, including, for example, both a marketing plan and employee training.  (We’re just as surprised as you are about that one, by the way.)  That is one of the reasons that we like such efforts to be tied to the normal marketing efforts of the Distributor.

It’s a Small World. And besides, many distribution agreements now cross borders and jurisdictions.  Many companies have distributors in the UK or elsewhere in the EU.  They will be affected by this decision.  And they should be.  True, this opinion does not carry much (if any, by some views) weight in this country for domestic agreements.  That fact does not mean that its utility as a guide for drafting should be ignored.  And there are many agreements already in existence guiding UK and EU relationships with the vague language now subject to scrutiny under this case.

Contract as Roadmap. You have heard us before say that a contract should be a roadmap for non-lawyers responsible for maintaining the relationship.  An attachment that elaborates—or gives the right and responsibility to the parties to elaborate—marketing (including co-marketing) efforts goes a fair amount of the way towards achieving just that goal.

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