20 Mar 2014

Set some sensible parameters to your "reasonable endeavours"

by Vanessa McBride

"Reasonable endeavours" clauses do not require a party to act in conflict of its own business interests, and will be interpreted in the light of any express constraints.

“Reasonable endeavours” and “best endeavours” clauses have long been used in commercial contracts, including construction contracts, to qualify strict obligations, generally where performance of the obligation may conflict with the obligor’s commercial and business interests depending on changing circumstances.

Since the 1980s, Australian law has treated “reasonable endeavours” in the same way as “best endeavours”. The 1984 case, Hospital Products Ltd v United States Surgical Corporation, remains a principal authority for the interpretation of such clauses; it says that "an obligation to use "best endeavours" does not require the person who undertakes the obligation to go beyond the bounds of reason; he is required to do all he reasonably can in the circumstances to achieve the contractual object but no more".

We've previously recommended that, where possible, parties should seek to agree any specific steps that must, or must not, be taken towards complying with a general "best” or “reasonable endeavours” obligation, thereby providing some clear parameters to the requirements which are otherwise undefined. On 5 March, the High Court handed down a decision that demonstrates just how important these parameters can be (Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7).

Woodside Energy Ltd v Electricity Generation Corporation

The issue determined by the High Court appeal was the construction and application of a long-term gas supply agreement (the GSA) between Electricity Generation Corporation trading as Verve Energy, and various gas suppliers in Western Australia including Woodside Energy Ltd (the Sellers).

Verve is the major generator and supplier of electricity to a large area in the southwest of Western Australia, and purchases natural gas under the GSA for use in its power stations. Separate contracts between Verve and each of the Sellers are contained in the GSA, which obliges each Seller:

  • to make available for delivery to Verve a proportionate share of a maximum daily quantity of gas (MDQ); and
  • to use "reasonable endeavours" to make available to Verve a supplemental maximum daily quantity of gas (SMDQ) (under clause 3.3 of the GSA).

On 3 June 2008 an explosion at Apache Energy's Varanus Island facility effectively reduced the supply of gas into the WA market by approximately 30-35%. The following day, the Sellers informed Verve that they would not be able to supply SMDQ for that month, but would supply the equivalent quantity of gas at a greater price, given the unique trading conditions caused by the explosion. Under protest, Verve entered into a series of short-term contracts with the Sellers for additional gas at the higher price between June and September 2008.

At first instance, the Sellers successfully defended Verve's claim that they had breached the "reasonable endeavours" obligation to make SMDQ gas available in clause 3.3 of the GSA. On appeal in the WA Supreme Court, Verve successfully argued that the reasonable endeavours requirement applied only to whether the Sellers were able to supply SMDQ, not whether they were willing to supply it.

The High Court's interpretation of this "reasonable endeavours" clause

In the High Court, the Sellers' appeal turned on the proper construction of cl 3.3 of the GSA, which stated:

            3.3 Supplemental Maximum Daily Quantity

(a)        If in accordance with Clause 9 ('Nominations') the Buyer's nomination for a Day exceeds the MDQ, the Sellers must use reasonable endeavours to make available for delivery up to an additional 30TJ/Day of Gas in excess of MDQ ('Supplemental Maximum Daily Quantity' or 'SMDQ').

(b)        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 and, [the clause then lists some specific circumstances in which the Sellers will not be considered able to supply SMDQ].

A majority of the High Court reversed the Court of Appeal decision and held that the gas supply agreement did not oblige the Sellers to supply the additional gas to Verve in conflict of their own commercial interests. They were entitled to take into account all relevant commercial, economic and operational matters in deciding whether to supply the additional gas.

The crucial issue for the High Court was the relationship between the Sellers' obligation in clause 3.3(a) to "use reasonable endeavours" to make the SMDQ available for delivery to Verve, and the Sellers' entitlement under clause 3.3(b) in determining whether they "are able to supply SMDQ" on any particular day, to "take into account all relevant commercial, economic and operational matters".

The Court considered the fact that the primary obligation in the contracts related to the strict obligations for supply and payment of the MDQ; supply of SMDQ was only a supplemental purpose of the contracts. It also noted that Verve was not obliged to nominate any SMDQ for supply from the Sellers, and the Sellers were not obliged to reserve daily capacity in their plants to supply SMDQ to Verve, nor to refrain from agreeing to sell gas to third parties. Verve was also free to purchase gas from other sellers.

In construing clause 3.3, the High Court found that it provided for a balancing of interests if the business interests of the parties in respect of the supply of SMDQ did not entirely coincide, or if they were in conflict. Indeed, this is often the purpose of a "reasonable endeavours" clause. The non-exhaustive list of scenarios in clause 3.3(b) was not confined to "capacity" and the overall effect of clause 3.3(b) was that the Sellers were not obliged to forgo or sacrifice their business interests when using reasonable endeavours to make SMDQ available for delivery.

Key lessons from the Verve Energy case about “reasonable endeavours” clauses

This decision revolves around the additional wording in clause 3.3(b) to qualify the general "reasonable endeavours" obligation in clause 3.3(a), and clearly demonstrates the benefits to a party in setting out some parameters or constraints to such an obligation in the express terms of the contract.

In addressing the "reasonable endeavours" clause, the High Court reaffirmed previous case law that "reasonable" and "best" endeavours create substantially similar obligations, and made the following three general observations about obligations to use "reasonable endeavours":

1.         they are not an absolute or unconditional obligations;

2.         their nature and extent depends on what is reasonable in the circumstances, including circumstances that affect the party's business; and

3.         some contracts include the standard for what is reasonable, by an express reference relevant to the party's business interests.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.