The High Court of Australia has delivered a judgment construing a reasonable endeavours supply obligation in a gas sale agreement in a way which will bring some comfort to producers, and valuable clarity in drafting such clauses.
The decision reverses the conclusion and reasoning of the Court of Appeal of the Supreme Court of WA, which we commented on in March 2013.1
Verve Energy (Verve) was the purchaser under a long-term gas supply agreement (GSA) with participants in the North West Shelf Joint Venture (the Sellers). Under the GSA:
- the Sellers were obliged to provide a mandatory minimum daily quantity of gas,
- if Verve indicated that it required gas beyond a maximum daily quantity specified in the GSA - Supplemental Maximum Daily Quantity (SMDQ) - the Sellers were required to use reasonable endeavours to make it available on a firm basis, and
- the Sellers’ obligation was qualified, including that “In determining whether they are able to supply [additional gas] on a Day, the Sellers may take into account all relevant commercial, economic and operational matters …”.
The supply of gas to the domestic WA gas market was impacted by an explosion at processing facilities on Varanus Island, which provided the only source of gas to the WA market other than that available from the Sellers. This meant that the Sellers were faced with more demand than they were able to meet, and purchasers offering prices above those stipulated in the GSA.
The Sellers informed Verve that the disruptions to supply meant that the Sellers would not supply Verve the additional gas it had requested under the GSA. The Sellers instead offered to supply an equivalent volume of gas under a new agreement under which Verve was required to pay a higher price for an interruptible supply. Verve entered the new agreement under protest.
The central dispute in the case was whether this breached the Sellers’ obligation to use reasonable endeavours to supply additional gas requested under the GSA. Verve alleged that the Sellers were obliged to provide additional gas if such gas existed, the Sellers argued, in essence, that the constrained supply situation and market demand at higher prices were commercial factors which they were properly entitled to take into account in deciding whether or not to supply additional gas.
History of the litigation
The Sellers were successful at first instance. The trial judge considered that:
- the GSA did not prevent the Sellers from entering into third-party contracts that would limit the Sellers’ ability to meet Verve’s requests for additional gas, and
- the words 'able to supply' had to be read in light of the Sellers’ entitlement to take into account 'all relevant commercial, economic and operational matters', which would include the relative profitability of the price offered by other customers.
The Court of Appeal overturned the first instance decision. It held that, although the Sellers were entitled to take into account commercial, economic and operational matters in reference to their ability to supply gas, this did not give them an ‘option’ not to sell additional gas to Verve under the GSA because they could sell that gas to others at a higher price on an interruptible basis.
The key elements of the Court of Appeal’s reasoning were:
- the fact that the requirement to use reasonable endeavours was expressed in the language of obligation, (able’ to supply, rather than ‘willing’ to supply), and
- the importance of that obligation within the scheme of the GSA, particularly the reliance that Verve placed on a firm supply of additional gas where it could be made available and the fact that the GSA expressly provided for the liability of the Sellers where they failed to use reasonable endeavours.
The High Court Judgment
Outcome – Sellers’ appeal successful
The majority of the High Court found that the Sellers’ obligation to use 'reasonable endeavours' to make SMDQ available to Verve was qualified by the Sellers’ entitlement under cl 3.3(b) to 'take into account all relevant commercial, economic and operational matters'.
The full High Court judgment is available here.
Other features of the GSA
Verve argued that the entitlement in cl 3.3(b) allowed the Sellers to take into account 'relevant commercial, economic and operational matters' in determining whether they had the capacity to supply SMDQ, not whether they wished to.2
The High Court looked to other provisions in the GSA to aid its construction of cl 3.3, including that:
- Verve was not obliged to nominate any SMDQ for supply from the Sellers and the Sellers were not obliged to reserve daily capacity to supply SMDQ to Verve,
- the Sellers were not obliged to refrain from selling to third parties, and
- Verve’s take or pay obligation only applied to the minimum daily quantity.
The High Court reaffirmed the position that the rights and liabilities of parties to a contract are to be determined objectively, by what a reasonable businessperson would have understood those terms to mean.3 The High Court emphasised the importance of understanding the transaction, the background, the context and the market, acknowledging that the GSA replaced a prior contract between the Sellers and Verve and that it 'reflects and facilitates a long term' commercial relationship between the parties.4 Interestingly, the Court did not consider it necessary to find ambiguity in the language before adopting this contextual approach.
Construction of 'reasonable endeavours'
The High Court held that:
- the obligation to use 'reasonable endeavours' was not absolute or unconditional
- the nature and extent of the obligation was necessarily conditioned by what was reasonable in the circumstances and
- some contracts containing a reasonable endeavours obligation also contain their own internal standard of what is reasonable, expressly referring to the business interests of the obligee.5
The Court concluded that the correct interpretation to be given to the reasonable endeavours clause was,
…that the Sellers are not obliged to forgo or sacrifice their business interest when using reasonable endeavours to make SMDQ available for delivery.6
The Sellers were not required to supply SMDQ to Verve,
when the Apache incident occasioned business conditions leading to conflict between the Sellers’ business interests and Verve’s interest in obtaining nominated SMDQ at the [applicable GSA] price.7
- Contracts are to be given a business interpretation, and are informed by the context in which the contract was entered into. Long term gas supply agreements and the factors that led to the parties entering into the GSA are inevitably relevant to its construction.
- The phrase ‘reasonable endeavours’ can be conditioned and contracts can contain their own internal standard of what is reasonable. Clarity can be provided when the drafter takes this course. In this case, ‘reasonable endeavours’ was expressly qualified by reference to commercial and operational considerations.
- At the heart of the dispute was the disconnect between the obligation to ‘use reasonable endeavours to supply’ and the reference to ‘ability to supply’. Drafters should be careful to adopt the appropriate mechanism to frame any obligation or option to supply gas beyond a maximum daily quantity, such as a ‘fully interruptible’ or an ‘as available’ supply of gas clause. They may avoid the need to rely on a reasonable endeavours obligation, the meaning of which is necessarily fluid.