Legal Briefing

Endeavours covenants

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Corporate and commercial | 01 September 2012

Many contract negotiations reach a crisis point at which one party requires a commitment to do something the other will not give. Endeavours covenants are frequently adopted as a compromise, being seen as representing something less than an absolute commitment but also imposing an obligation to try to achieve the stated outcome, the level of effort required depending on whether the covenant is to undertake ‘best’ or only ‘reasonable’ endeavours.

Two recent decisions will require negotiators to approach endeavours clauses with increased caution: the clause may prove useless because it is void for uncertainty; or it may unexpectedly impose what amounts to an absolute obligation, in all likelihood frustrating one of the parties and giving the other an unexpected bonus.

In Jet2.com Ltd v Blackpool Airport Ltd [2012] the Court of Appeal analysed two separate endeavours covenants both dealing with the level of support which Blackpool Airport had to give to low-cost flights operating from the airport: (i) to ‘use their best endeavours to promote Jet2.com’s low-cost services from Blackpool Airport’; and (ii) to ‘use all reasonable endeavours to provide a cost base that will facilitate Jet2.com’s low-cost pricing’. It was conceded that ‘best’ and ‘all reasonable’ endeavours meant the same thing.

The dispute arose because, after a change in the ownership of Blackpool Airport, it decided it would no longer allow arrival and departure outside the airport’s published usual hours of operation. Out-of-hours operation was important to Jet2.com’s business. However, the charges levied by the airport for such operations did not cover its costs of remaining open to allow such operations. The airport argued that the endeavours covenants, if binding, did not require it to do anything that incurred a gross loss. Its main argument was that the endeavours covenants were void for uncertainty.

UNCERTAINTY

All three members of the Court of Appeal agreed that the starting point for interpreting an endeavours covenant is that the objective, to which the endeavours are to be directed, must be clear.

An obligation to use reasonable endeavours to reach further agreement will usually be void because of the multiplicity of possible contracts that could reasonably be agreed, if no objective criteria for assessing reasonableness can be discerned from the contract: see eg, P&O Property Holdings Ltd v Norwich Union Life Insurance Society [1994], where the void obligation was to use reasonable endeavours to let various properties. A number of different forms of lease and letting terms would have been reasonable depending on the subjective characteristics of the landlord (such as its cash flow position).

The disagreement emerged at the next stage: how does the court decide what the obligation to endeavour actually requires? If that cannot be determined, the obligation will be void for uncertainty.

Lewison LJ said: ‘the object of the endeavours and the range of possible endeavours must be considered together in order to decide whether there is a justiciable obligation’, although ‘if the endeavours are directed towards a result which can be identified with certainty, then whether the endeavours satisfy the obligation can also be decided if necessary with the aid of expert evidence’. He analysed this as a spectrum question. At one end, the parties have specified an objective criterion by reference to which the content of the obligation can be ascertained, either setting out a test expressly (as in EDI Central Ltd v National Car Parks Ltd [2012]) or because the object of the endeavours was such and specified with sufficient clarity as to enable the criteria to be derived from it. At the other end, the objective is either itself uncertain or, although itself certain, encapsulates a variety of possible outcomes, such as in the P&O Property case. He put the Jet2.com covenants in either or both of the latter categories.

Moore-Bick LJ, on this point in a minority, approached the question as simply involving the assessment of whether the objective of the endeavours was sufficiently clear. His solution to the difficulties of addressing the precise content of the obligation was to distinguish:

‘… between a clause whose content is so uncertain that it is incapable of creating a binding obligation and a clause which gives rise to a binding obligation, the precise limits of which are difficult to define in advance, but which can nonetheless be given practical content’.

His examples of binding clauses of this type were all ‘best’ endeavours covenants.

Longmore LJ identified a distinct stage requiring that the parties must provide ‘criteria on the basis of which it is possible to assess whether [the requisite] endeavours have been, or can be used’. He did not identify any such criteria in the Jet2.com contract but instead said:

‘… the status quo will always be an essential matter to be considered. Any question of best endeavours was most unlikely to arise before the agreement started to be performed. Once performance had begun, the party who proposed to change the status quo should have to justify that change of stance.’

Lewison LJ criticised this as ‘coming close to using the parties’ subsequent conduct in order to interpret the contract’, which is impermissible .

However, it might be better understood as following from Longmore LJ’s reference two paragraphs earlier in his judgment, to the dictum in Sheffield District Railway Co v Great Central Railway Co [1911], that ‘best endeavours’ ‘does not mean second best endeavours’. The airport’s conduct had shown a level of actual endeavour and so, apparently, a reduction from that level of endeavour cannot represent ‘best’ endeavours. The subsequent conduct is being used not to construe the contractual provision but as evidence demonstrating the ascertainment of the contractual qualification. It remains to be seen whether that is a distinction that will find judicial acceptance. Moreover, it cannot apply to a ‘reasonable’ endeavours covenant.

The majority (Longmore and Moore-Bick LJJ) decided that the best endeavours covenant was not void for uncertainty and, as a matter of construction, it obliged the airport to continue to allow out-of-hours operation.

Neither Longmore nor Moore-Bick LJJ found it necessary to decide whether the ‘all reasonable’ endeavours covenant was void because they held the best endeavours covenant had been breached.

This leaves the law in a most unsatisfactory state. The logic of their analyses is that a ‘best’ endeavours covenant requires to be done that which is capable of achieving the stated objective. Effectively, there is only one criterion of compliance: prospects of successful achievement of the objective.

A reasonable endeavours covenant cannot be approached in that way. In deciding whether a course of action is reasonable, the prospect that it will achieve its objective is usually only one factor. Many other factors may legitimately be taken into account and a range of possible actions or inactions could be considered ‘reasonable’ for these purposes. In Phillips v Enron [1996] Potter LJ identified this as the ‘difficulty… of drawing the line between what is to be regarded as reasonable or unreasonable in an area where the parties may legitimately have differing views or interests,’ and it led him (and, more recently, Teare J in Charles Shaker v Vistajet Group Holdings SA [2012]) to conclude that the obligation must therefore be unenforceable.

Longmore LJ did not address this question. He restricted himself to the particular meaning of a ‘best’ endeavours covenant, where only the ‘best’ will do.

Moore-Bick LJ gave two illustrations of binding obligations ‘difficult to define in advance but capable of being given practical content’. Both were ‘best endeavours’ cases. The only other case he described in which a covenant not containing an express standard of reasonableness but nonetheless considered enforceable was Yewbelle Ltd v London Green Developments Ltd [2007]. The fact that Moore-Bick LJ did not include this as an illustration is perhaps explained by the fact that, as the judge expressly observed, neither party argued that it was void for uncertainty. In any event the covenant was an ‘all reasonable’ endeavours covenant, a form which has been judicially equated with a ‘best’ endeavours covenant and was by concession treated in Jet2.com as being the same. His judgment gives no guidance how Potter LJ’s difficulty is to be overcome.

So, it would appear that, provided the stated objective of the endeavours is clear, a ‘best’ endeavours obligation should not be void for uncertainty. It may be more difficult to ascribe sufficient certainty to a ‘reasonable’ endeavours covenant, unless the parties have agreed a standard by reference to which reasonableness must be assessed, although the description of the objective, the other terms, or the contractual context, may be sufficient.

IF THE OBLIGATION IS ENFORCEABLE, WHAT DOES IT REQUIRE?

The principal debate has been the extent to which the party owing the obligation must sacrifice its own financial interests. Once again, it is necessary to consider ‘best’ and ‘reasonable’ endeavours covenants separately.

In Jet2.com Moore-Bick LJ said that ‘whether, and if so to what extent, a person who has undertaken to use its best endeavours can have regard to his own financial interests will depend very much on the nature and terms of the contract in question’ but he clearly took the view that the obligation may require incurring cost. Longmore LJ made the same point rather more clearly:

‘… the fact that he has agreed to use his best endeavours presupposes that he may well be put to some financial cost, so financial cost cannot be a trump card to enable him to extricate himself from what would otherwise be his obligation’.

Each decided that Blackpool Airport must bear the cost of performance. However, earlier cases have imposed some limits on best endeavours covenants.

Moore-Bick LJ referred to Terrell v Mabie Todd & Co Ltd [1952] and said that:

‘… the context in which the undertaking was given was sufficient in my view to make it clear that the company was not expected to do more than could reasonably be expected of a prudent board of directors acting in the interest of the shareholders’.

More assistance may be derived from IBM United Kingdom Ltd v Rockware Glass Ltd [1980]. This is a decision of the Court of Appeal and, unlike Terrell where the issue was obiter, in IBM the Court of Appeal formulated a declaration that ‘best’ endeavours required:

‘… all those steps in their power which are capable of producing the desired result… which a prudent, determined and reasonable [person], acting in his own interests and desiring to achieve that result, would take’.

A determined person will usually be willing to bear a cost, often a significant cost, to achieve a desired objective.

Of course, a prudent person would not act so as to prejudice the future existence of their business, but that would appear to be the principal limiting factor.

Terrell made clear that a party accepting a best endeavours covenant:

‘… must take his contracting party as he finds him. He cannot expect from a small company the same expenditure or production as from a large and powerful company. He cannot expect from an old-fashioned and financially embarrassed company that which he should receive from a better equipped and more flourishing concern’.

What is required is the subjective ‘best’ the contracting party can do, neither more nor less.

‘REASONABLE’ ENDEAVOURS MAY BE VERY DIFFERENT.

The standard for ‘reasonable’ endeavours is objective. The performance required is that of a reasonable person applying the relevant standard. If the contracting party in question is, as a result of their subjective attributes, unable to perform, they may be in breach and in this sense the ‘reasonable’ endeavours covenant may impose a stricter obligation than ‘best’ endeavours.

This has been illustrated recently by Ampurius Nu Homes Holdings Ltd v Telford Homes (Creekside) Ltd [2012]. A construction company (T) agreed with a property developer (A) to construct a series of residential blocks on A’s land and to use ‘reasonable endeavours to procure completion… by the Target Date’. The ‘credit crunch’ intervened and T was unable to obtain sufficient funding to maintain progress and suspended work. T claimed that suspension was not a breach of contract if it arose as a result of lack of finance provided that it had used reasonable endeavours to obtain adequate funding and had been unable to do so. Roth J held that the obligation was not limited in this way and so, if the only reason work was suspended was lack of funding, that was no defence and T was in breach of its obligation to make reasonable endeavours.

He decided that ‘reasonable endeavours’ was ‘designed to cover matters that directly relate to the physical conduct of the works… such… as inclement weather or shortage of materials for which the defendant was not responsible’ and that the obligation was otherwise ‘absolute’. The subjective difficulty that the defendant experienced in raising finance was irrelevant. The standard of the obligation was objective.

The judge did not explain his reasoning for reaching that conclusion and his analysis of authority was limited to a brief dismissal of the decision in Yewbelle as not providing ‘any assistance in the very different circumstances of the provision at issue in this case’. In Yewbelle, one of the issues which arose was whether it was necessary for a party to purchase an additional parcel of land in order to comply with its obligations. The Court of Appeal decided that this was not required by an ‘all reasonable endeavours’ obligation. It is possible that Roth J had in mind that, whereas the need for expenditure in Yewbelle had not been anticipated at the time of contracting, in Ampurius it must surely have been contemplated that a party required to undertake work would be required to fund that work. However, this was not explained.

At least in some quarters it had been understood that a ‘reasonable’ endeavours obligation did not require a financial sacrifice: an understanding derived from eg, Rhodia International Holdings Ltd v Huntsman International LLC [2007] and the decision of the Court of Appeal in Phillips Petroleum Co UK Ltd v Enron Europe Ltd [1997]. However, it would now appear that a party undertaking a reasonable endeavours obligation cannot safely assume that it will not require a financial burden to be shouldered. Indeed, the effect of Roth J’s judgment was that a ‘reasonable endeavours’ covenant imposed an absolute obligation to arrange applicable funding to withstand the financial burdens of the contract.

This suggests an important difference between ‘best’ and ‘all reasonable’ endeavours: the latter requires the exhaustion of all qualifying alternatives available to the notional reasonable person, whereas the former simply requires the contracting party to do their subjective best.

ENDEAVOURING TO ACHIEVE THE UNACHIEVABLE

It is reasonably clear that an endeavours covenant will not impose an obligation to try to achieve an impossible outcome. Indeed, in Jet2.com Moore-Bick and Longmore LJJ agreed that ‘best’ endeavours to support a business did not require support where the business would inevitably be unprofitable, notwithstanding that the clause nowhere required that the business be ‘profitable’.

When assessing what endeavours are ‘reasonable’ it appears to be established that the prospects of success are a relevant factor. In Yewbelle various adjectives were used to describe the level of likelihood of success that would require action to be taken, such as a chance that was ‘real’, ‘worthwhile’ or ‘significant’, suggesting a much lower threshold for excusing performance than applicable to ‘best’ endeavours.

CONCLUSIONS

When contemplating an endeavours covenant as a way through a troublesome negotiation, caution will be needed in light of the recent authorities. It is too simplistic to approach these provisions as providing a spectrum of increasing obligation from ‘reasonable’ through to ‘best’ endeavours. As illustrated by Ampurius, a party undertaking a ‘reasonable’ endeavours covenant may be assuming an obligation which in important respects is both absolute and beyond its control. But care will also be needed to assess whether an enforceable obligation has been created.

A covenant to endeavour to reach a future agreement will be treated in the same way as an agreement to agree: while an agreement can be structured in such a way as to render such an agreement enforceable (for example if an arbitrator is empowered by reference to objective criteria to impose such an agreement in default of agreement) a bare covenant is likely to be unenforceable.

A clause requiring the exercise of ‘best’ endeavours to achieve other objectives is more likely to be enforceable provided that the objective is set out clearly. However, a ‘reasonable’ endeavours covenant may prove difficult to enforce unless the contract sets out criteria by reference to which ‘reasonableness’ can be assessed.

Where an existing contract includes an endeavours covenant the parties may wish to reassess what, if any, obligation it imposes.