Commercial agreements routinely contain “reasonable endeavours” clauses (or words to similar effect). Cases on these clauses are relatively infrequent, particularly at appellate level.

In the Verve Energy v Woodside Energy Ltd and Ors [2014] HCA 7 case the interpretation of a reasonable endeavours clause came before the High Court of Australia. The case is interesting in a number of respects.

1. The Judge at first instance was overturned unanimously by the Court of Appeal, which was then reversed by a 4-1 majority of the High Court. There was a sharp divergence of opinion on the interpretation of the clause in issue.
2. The wording of a key part of a clause was very awkward. The interpretations put forward by both parties both had quite drastic results.
3. The judgment contains a useful discussion of reasonable endeavours clauses and principles surrounding them.

Facts

Woodside and a number of other energy suppliers supplied gas to Verve, an electricity generating company under a long term gas supply agreement (GSA).

The contract was what is known as a “take or pay” contract. Verve paid for a Maximum Daily Quantity (MDQ) at a fixed price whether or not the gas was used. However, clause 3.3 of the contract also provided for a Supplemental Maximum Daily Quantity (SMDQ).

Under clause 3.3(a) the sellers had to “use reasonable endeavours to make [SMDQ] available for delivery …” Clause 3.3(b) stated “In determining whether they are able to supply SMDQ on a day, the sellers may take into account all relevant commercial, economic and operational matters …” (emphasis added).

The key issue was the relationship between the sellers’ obligation in clause 3.3(a) to use “reasonable endeavours” to supply SMDQ and their decision under clause 3.3(b) as to whether they were “able” to supply SMDQ.

Other material clauses of the GSA were:

1. Verve had to pay the sellers for an annual minimum quantity of gas, whether or not Verve used it.
2. Verve was not obliged to nominate any SMDQ.
3. The sellers were not required to set aside any gas for SMDQ.
4. The GSA was not exclusive. The sellers could sell gas to other parties.

An explosion occurred on 3 June 2008 at a gas plant. This reduced supply in the Western Australian market by 30-35% until 30 September 2008. The sellers gave Verve notice that they would not supply SMDQ under the GSA to Verve during this period. Instead, Verve would have to pay for gas at the prevailing market price. This was much higher than the SMDQ price under the GSA.

Verve paid for the gas under protest and sued the sellers.

Lower court decisions

In the Western Australian Supreme Court Verve submitted that once it had made a nomination of SMDQ, the sellers were obliged to use reasonable endeavours to make that nominated amount of gas available.

Verve contended that clause 3.3(b) gave content to this by providing that “relevant commercial, economic and operational matters” could be taken into account by the sellers in determining whether they were “able” to supply SMDQ. However, this only related to whether they had the capacity to supply Verve, not whether they wished to (at [24]).

The sellers argued that you could not look at the obligation in clause 3.3(a) without considering clause 3.3(b) first. Clause 3.3(b) gave the sellers the right to determine their ability to sell SMDQ after they had taken into account all relevant commercial, economic and operational matters. If their determination was that supply of SMDQ was not in their commercial, economic or operational interest, then they did not have to supply SMDQ even if they had capacity.

Justice Le Miere found for the sellers. His Honour held that clause 3.3(b) “conditioned” the sellers’ obligation under clause 3.3(a) by prescribing the circumstances in which the sellers were not obliged to use reasonable endeavours to make SMDQ available for delivery (at [25]).

The Court of Appeal allowed the appeal favouring Verve’s interpretation.

High Court decision

The majority decision was delivered by Chief Justice French and Justices Crennan Hayne and Kiefel.

The Court said that contractual obligations framed in terms of “reasonable endeavours” or “best endeavours” were familiar. Argument proceeded on the basis that that substantially similar obligations were imposed by each expression (at [40]). The Court set out three general observations:

1. It is not an absolute or unconditional obligation (at [41]).
2. The nature and extent of such a condition is necessarily conditioned by what is reasonable in the circumstances which can include circumstances that may affect an obligee’s business. Justice Sellers in Terrell v Mabie Todd & Co Ltd (1952) 69 RPC 234 (at [236]) was cited where it was said that the obligation to use reasonable endeavours would not oblige the achievement of a contractual object “to the certain ruin of the company or to the utter disregard of the interests of the shareholders” (at [41] and [42]).
3. Some reasonable endeavours clauses have their own internal standard as to what is reasonable by some express reference to the business interests of an oblige (at [43]).

The Court said that the chief commercial purpose and objects of the GSA were twofold. First, Verve obtained a secure supply of gas which the sellers were obliged to make available at the specified MDQ. Secondly, the sellers had an assured price for MDQ which Verve was obliged to pay whether or not it took the gas.

The obligation to supply SMDQ was only a supplementary commercial purpose or object. Verve was not contractually bound to buy SMDQ nor were the sellers contractually bound to reserve capacity for it. This was contrasted with the unconditional obligation to supply MDQ. The Court said the language in clause 3.3(a) was a qualified obligation, and clause 3.3(b) provided an internal standard of reasonableness against which the obligation to use reasonable endeavours could be measured (at [46]).

What was a “reasonable” standard of endeavours was conditioned by the sellers’ responsibilities to Verve in respect of SMDQ and by the sellers’ entitlement to take into account “relevant commercial, economic and operational matters” in determining whether they were “able” to supply SMDQ. This was not confined to capacity or capacity constraints.

Therefore, the effect of clause 3.3(b) was that the sellers were not obliged to sacrifice their business interests when determining whether they were “able” to supply SMDQ. The interpretation put by Verve of “able” was too narrow and did not give effect to the full text of clause 3.3(b) (at [47]).

The Court said that this construction was consistent with the surrounding circumstances known to both parties at the time of entering into the GSA. These included that the sellers could supply gas to other customers that the gas price at any particular time might be lesser or greater than the price set for SMDQ in the GSA.

Justice Gageler dissented. He agreed with the Court of Appeal.

Comment

1. An interesting point is the statement of the Court that “reasonable endeavours” and “best endeavours” clauses impose “substantially similar obligations”. This is controversial. A detailed discussion is beyond the scope of the article. Shortly stated, the issue is that a simple reasonable endeavours clause will usually not require an obligee to act against its own commercial interests. Despite what the High Court said, this is not so clear with a “best endeavours” clause. None of the authorities cited at footnote 43 dealt with a simple “reasonable endeavours” clause and so may not support the broad statement made by the High Court. In any event, the comments are obiter.
2. The decision is not free from difficulty. This use of the word “able” in clause 3.3(b) was poor drafting (probably compromise wording). This showed in the outcomes of the interpretation put forward by each party. Both had fairly drastic results that arguably could not have been intended by the parties.
   a.  Under the interpretation accepted by the majority, even if the sellers had the ability to supply SMDQ, they did not have to. It is therefore difficult to conceive a situation where they would actually have to supply SMDQ if they did not want to: a point made with some force by Justice Gageler.
   b.  On the interpretation accepted by the Court of Appeal and Justice Gageler, though, as long as the sellers had capacity, then they had to supply SMDQ. This would leave clause 3.3(b) largely devoid of effect.
3. Neither interpretation is particularly attractive. The outcome of the approach of Justice Gageler would have been less attractive, though:
   a.  The Court was, with respect, correct to conclude that the GSA did not impose a strict obligation on the sellers to make SMDQ available. But that may have been the practical result of Justice Gageler’s interpretation.
   b.  Justice Gageler did not address the authorities cited by the majority on the issue of the obligee under a “reasonable endeavours” clause not having to perform the act if it was to its financial detriment.
   c.  Likewise, Justice Gageler did not adequately address the fact that the GSA was not exclusive and the obligation to supply SMDQ was not absolute.
4. The approach of the majority accorded with the commercial objects of the GSA – even if the interpretation of the word “able” was strained. Apart from the obligation to supply MDQ, everything else in the GSA was largely discretionary. Why then should Verve be able to nominate SMDQ and gain a big price advantage in a disrupted market?
5. The practical effect of Verve’s interpretation would have been to turn a take and pay contract for a fixed volume of gas into a fixed price contract for an uncertain volume of gas. The parties clearly did not intend this. The decision of the High Court is supported.

Michael Lenihan practices as a barrister specialising in civil and commercial work. Michael formerly worked at Henry Davis York in Sydney, Jones Fee in Auckland and Russell McVeagh in Wellington before going to the bar. Michael also teaches Guarantees at the Auckland University Faculty of Law. Michael’s website is www.lenihan.net.nz.