High Court’s commercial approach to reasonable endeavours obligation

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19 March 2014

The High Court recently held that a party’s contractual obligation to use ‘reasonable endeavours’ to deliver a product under a supply agreement did not require it to forgo its own business and commercial interests.

The High Court held, by a majority of 4:1, that the sellers of natural gas did not breach their contractual obligation to use reasonable endeavours to supply additional quantities of gas in circumstances where the buyer had to purchase the additional gas at a market price which was significantly higher than the price agreed under the supply agreement. While the decision does not depart from established principles of contractual interpretation, the decision serves as a reminder to negotiators of the importance of including express contractual qualifications on the scope of a party’s obligation to use reasonable endeavours so as to ensure that those qualifications may be taken into account in determining what is reasonable in the circumstances.

Background

Woodside Energy Ltd and other gas suppliers in Western Australia as part of a joint venture (together the Sellers), entered into a long term gas supply agreement (the GSA) with Electricity Generation Corporation t/as Verve Energy (Verve) for the supply of natural gas for use in Verve’s power stations.  Verve is a statutory corporation and one of the major generators and suppliers of electricity in Western Australia.

The GSA imposed on the Sellers an absolute obligation to make available to Verve the amount of gas nominated for each day up to a maximum daily quantity.  The GSA also required the Sellers to use reasonable endeavours to supply additional gas up to a maximum additional quantity if required by Verve.  In determining whether the Sellers were able to supply the additional gas, the GSA allowed the Sellers to take into account "all relevant commercial, economic and operational matters".

On 3 June 2008 an explosion occurred at a gas plant in Western Australia operated by a third party. The explosion caused a temporary reduction in the supply of natural gas to the market which resulted in demand in excess of the available supply. The Sellers informed Verve that they would not supply any additional gas to Verve on the terms of the GSA between June and September 2008 but offered to supply Verve with additional gas at a market price higher than that agreed in the GSA.  Under protest, Verve entered into a series of short term agreements with the Sellers for the supply of gas above the maximum daily quantity at the market price.

In March 2009 Verve commenced proceedings in the Supreme Court of Western Australia against the Sellers arguing that the Sellers had breached their obligation to use "reasonable endeavours" to supply additional gas in accordance with the GSA.

How should the obligation to use ‘reasonable endeavours’ be construed?

Verve submitted that whether or not the Sellers were able to supply additional gas should be confined to the question of whether or not the Sellers had the capacity to do so - that is, the Sellers were not permitted to consider their willingness to supply the additional gas.  Verve also submitted that the clause operated to impose on the Sellers an absolute obligation to supply the additional gas if it was within their capacity to do so.

The Sellers submitted that when determining whether or not they were able (in the necessary sense) to supply additional gas, they were entitled to take into account their own commercial, economic and operational interests.  The Sellers argued that this construction permitted them to take into account matters such as the gas explosion and the consequential business conditions in determining whether they were able to supply the additional gas.  Accordingly, the Sellers argued that they were entitled to decline to supply the additional gas pursuant to the GSA and that supplying gas on a fully interruptible basis at prevailing market prices did not constitute a breach of its obligation to use reasonable endeavours.  

Decision

The High Court agreed with the Sellers that the reasonable standard of endeavours the Sellers were required to exercise was informed by both the Sellers responsibilities to Verve to supply additional gas and the Sellers express right to take into account relevant commercial, economic and operational matters.  The Court found that the expression “commercial, economic and operational matters” referred to matters affecting the Seller’s business interests and that the Sellers were not obliged to sacrifice those interests when using reasonable endeavours to make available the additional supply of gas under the GSA.

In reaching its decision, the High Court approached the question of construction by giving the GSA a business like interpretation consistent with established principles.  In doing so the Court identified that the chief commercial objects of the GSA were that Verve obtained a secure supply of gas which the Sellers were required to deliver up to an agreed amount and the Sellers had an assured price for a minimum amount of gas.  The supply of additional gas was found to be a supplementary commercial purpose.

The High Court also considered as relevant the fact that the GSA contained provisions which indicated the Sellers supplied gas to other buyers as well as Verve and provisions which acknowledged that Verve was entitled to purchase gas from other suppliers. That is, Verve had no obligation to purchase additional amounts of gas from the Sellers and the Sellers were not obliged to reserve additional amounts of gas in order to supply those additional amounts to Verve.

The majority of the High Court made the following three observations about the obligation to use reasonable endeavours to achieve a contractual object:

  1. it is not an absolute or unconditional obligation;
  2. the nature and extent of the obligation imposed is conditioned by what is reasonable in the circumstances, which can include circumstances that affect the business of the obligated party; and
  3. contracts containing such an obligation may contain their own internal standard of reasonableness.

In this case the High Court held that the language of the relevant clause was “recognisably the language of qualified obligation” and provided for a balancing of interests if the business interests of the Sellers and Verve were to conflict.  Accordingly, the clause created an “internal standard” of reasonableness by which the obligation to use reasonable endeavours could be measured.  

Implications: Does this decision change the approach to a reasonable endeavours clause?

The express entitlement of the Sellers to take into account "relevant commercial, economic and operational matters" was crucial to the ability of the Sellers to make a commercial decision not to supply Verve with additional gas at the price stipulated under the GSA without breaching its obligation to use reasonable endeavours to supply the additional gas. 

While the decision does not depart from established principles of contractual interpretation, the High Court itself pointed out that contractual obligations framed in terms of ‘reasonable endeavours’ are not uncommon in distribution agreements, intellectual property licenses, mining and resourcing agreements and planning and construction contracts.  Accordingly, the decision serves to reinforce for negotiators the importance of including express contractual qualifications on the scope of a party’s obligation to use reasonable endeavours so as to ensure that those qualifications may be taken into account in determining what is reasonable in the circumstances.


The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.


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