Introduction
The phrase “reasonable endeavours” is widely used in commercial contracts. A recent decision by the High Court of Australia demonstrates how the “reasonableness” of a reasonable endeavours obligation can be “conditioned” by the standard of reasonableness evidenced elsewhere in the contract, particularly in relation to the extent to which a party can have regard to its own commercial interests.
Who needs to know?
Read this article if you prepare or negotiate commercial contracts.
Background
The case of Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7 arose from the shortage of gas supplies in Western Australia following the explosion at the Varanus Island gas processing facility in 2008. The Varanus Island facility produced about 30% of Western Australia’s gas supply.
Woodside and Electricity Generation Corporation (trading as Verve Energy) were parties to a long term (20 year) Gas Sale Agreement. In very high level terms, Woodside was obliged to supply a Maximum Daily Quantity (MDQ) of gas to Verve. Woodside could also be required by Verve to “use reasonable endeavours to make available for delivery” an additional quantity of gas called the Supplemental Maximum Daily Quantity (SMDQ). The SMDQ was the amount of daily gas nominated by Verve in excess of the MDQ up to a maximum excess of 30TJ/day.
As it happened, Woodside’s ability to supply gas was unaffected by the Varanus Island explosion because it sourced its gas from different processing facilities.
On the day after the explosion, Woodside informed Verve that it would no longer supply SMDQ under the Gas Sale Agreement to Verve for an indefinite period. Instead, Woodside offered to supply an equivalent quantity of gas to Verve under a separate short term agreement. The price under the short term agreement was the then prevailing market price which, due to the shut down of Varanus Island, was many times higher than the price payable for SMDQ under the Gas Sale Agreement. Since there were no alternative gas supplies, Verve entered into the short term agreement under protest and without prejudice to its rights. Apart from the higher price, the short term agreement was also “fully interruptible” such that there was no certainty as to the quantity of gas that would actually be supplied by Woodside.
Verve alleged that Woodside had breached its reasonable endeavours obligation to make available the SMDQ under the Gas Sale Agreement. It was common ground that Woodside in fact had the gas and was able to supply the SMDQ. Rather than trying to supply the SMDQ under the Gas Sale Agreement, Verve argued that Woodside had deliberately exploited the scenario by forcing Verve to take the gas at the higher price under the separate short term agreement.
Key Provisions
The Gas Sale Agreement allowed Verve to request SMDQ. However, unlike MDQ (for which Verve was firmly bound to purchase on a take or pay basis), Verve was not obliged to purchase any SMDQ unless and until it actually requested the SMDQ. Importantly, Woodside was not prohibited from selling gas to third parties. Nor was Woodside expressly required to reserve any capacity at its plant so that it could supply SMDQ if and when requested by Verve.
As mentioned above, if Verve requested any SMDQ then Woodside had to “use reasonable endeavours to make available for delivery” that SMDQ.
The Gas Sale Agreement then went on to state that: “In determining whether [Woodside is] able to supply SMDQ on a Day, [Woodside] may take into account all relevant commercial, economic and operational matters”.
Without limiting this general statement about matters which Woodside could take into account, the contract then contained a non-exhaustive list of specific circumstances in which Woodside would not be required by the reasonable endeavours obligation to make available SMDQ. Briefly stated, these circumstances were: (1) insufficient capacity at Woodside’s facilities; (2) insufficient notice had been given by Verve to undertake necessary procedures at Woodside’s plant to make the SMDQ available; and (3) Woodside had “any obligation to make available for delivery quantities of Natural Gas to other customers, which obligations may conflict with the scheduling of [the SMDQ] to [Verve]”.
Verve argued that the general statement and list of circumstances were all aimed at determining whether Woodside was “able to supply” (i.e. whether Woodside had the capacity to supply), rather than whether or not Woodside actually wished to supply the SMDQ under the contract.
Woodside argued that it was not “able to supply” Verve because it had found other customers who were prepared to buy the gas at a higher price. Woodside’s interpretation essentially meant that it could decide whether or not it wished to supply the SMDQ to Verve. Woodside argued for a very qualified (i.e. watered down) reasonable endeavours obligation primarily because of the breadth of the general statement which gave Woodside the right to take into account all “relevant commercial, economic and operational matters”. It essentially argued that the skyrocketed market price for gas was a relevant matter it could take into account to justify its refusal to supply the SMDQ to Verve.
The trial judge in the Supreme Court of Western Australia found in favour of Woodside. On appeal, the Court of Appeal unanimously overturned that decision and found in favour of Verve. It found that Woodside’s interpretation was inconsistent with the “natural and ordinary meaning” of an obligation to use reasonable endeavours.
What did the High Court decide?
The High Court agreed with Woodside.
In reaching its decision, the High Court briefly recapped on the case law surrounding the meaning of reasonable endeavours. It observed that such obligations are not absolute or unconditional. The nature and extent of the obligation is “necessarily conditioned by what is reasonable in the circumstances”. In assessing what is reasonable in the circumstances, the impact on the obligor’s business will be taken into account. The High Court also expressly recognised that contracts can contain their own internal standard of what is reasonable.
In this case, the High Court particularly focussed on the way in which the factors listed in the contract “conditioned” the extent of the reasonable endeavours obligation. The High Court summed it up by stating that Woodside was not obliged to forgo or sacrifice its business interests when using reasonable endeavours to make available the SMDQ.
Overall, the way in which the contract expressly permitted Woodside to take into account all relevant commercial and economic matters meant that it was reasonable in the circumstances for Woodside to chase super profits on the gas rather than sell it to Verve under the contract. This is a very weak standard of endeavours by any measure, especially since Woodside had the gas and was physically able to supply it to Verve. Despite the reasonable endeavours commitment from Woodside, Verve was essentially treated no differently than any other gas customer that was facing gas shortages. It’s hard to see if the reasonable endeavours obligation (as “conditioned”) actually added anything at all in this instance. Absent the express wording about all commercial and economic factors, the outcome may have been very different.
It is interesting to note the dissenting judgment of Justice Gageler. He found in favour of Verve. He looked at the contract more broadly and particularly focussed on the way in which the Gas Sale Agreement contained a fixed price for SMDQ (albeit the price was subject to adjustment and review over the term of the contract). Noting these agreed pricing provisions, Justice Gageler found it difficult to accept that Woodside could simply choose not to supply the SMDQ merely because the market price was substantially higher than the price prescribed by the contract. Justice Gageler stated:
“[Woodside’s] construction is one which renders the obligation to use reasonable endeavours … elusive, if not illusory, and which renders the price fixed by [the Gas Sale Agreement] a price which is meaningful only if and when [Woodside] considers it to its commercial advantage to accept it”.
Justice Gageler agreed with Verve that the factors listed in the contract were directed to whether Woodside had the objective ability or capacity to supply the gas, rather than factors which gave Woodside a discretion to refuse supply if it was simply unwilling to do so. Justice Gageler summarised it as follows:
“The wholly understandable desire of [Woodside] to maximise its profits throughout the period of the GSA might well be described as a “commercial” or “economic” matter. But its desire to maximise its profits by withholding gas from delivery to [Verve] under the GSA so as to be able to sell that gas at a higher price would not be “relevant” to “whether it is able to supply SMDQ on a [d]ay” within the meaning of clause 3.3.(b). [Woodside’s] desire would not be “relevant” because it would not bear objectively on its ability or capacity to make gas nominated by [Verve] available for delivery up to SMDQ. That [Woodside] might be unable to put gas to a more profitable use as a consequence of making that gas available for delivery to [Verve] under the GSA would not mean that [Woodside] would thereby be less able or have less capacity to make that gas available for delivery to [Verve] under the GSA. [Woodside] would remain “able”, just reluctant or unwilling.”
Whilst Justice Gageler dissented, his reasoning is quite persuasive and should therefore be borne in mind when reviewing or drafting reasonable endeavours obligations.
Points to Take Away
• Parties can tailor the extent of a reasonable endeavours obligation by expressly including in the contract the circumstances to be taken into account (or not taken into account). This is not new, but this case serves as a timely reminder of how malleable the reasonable endeavours obligation can be.
• By expressly permitting a party to take into account “all relevant commercial, economic and operational matters”, a reasonable endeavours obligation is likely to be very weak or almost discretionary.
• Instead of relying on a reasonable endeavours obligation, consideration should be given to using alternatives. Obviously, an absolute obligation is the cleanest, but it’s not always practical or possible to negotiate. Alternatives include requirements to supply on a priority or preferential basis ahead of all other customers or on a proportionate basis. Rights of first refusal or options can sometimes also be used.
• Even if the Gas Sale Agreement required Woodside to use “best endeavours” rather than “reasonable endeavours”, the High Court would have reached the same conclusion. In fact, the High Court expressly noted that each expression involves “substantially similar obligations”.