The case of Electricity Generation Corporation T/As Verve Energy v Woodside Energy Ltd & Ors [2014] HCA 7 (5 March 2014) provides the latest guidance on drafting “reasonable endeavours” clauses.

Facts

Electricity Generation Corporation (Verve) and the North West Shelf Joint Venturers (Sellers) were parties to a long term contract for the supply of gas (GSA). The GSA contained clauses requiring Woodside to supply a maximum daily quantity of gas and obliging it to use “reasonable endeavours” to also supply a supplemental maximum daily quantity at a set price (SMDQ). The GSA also specified that the Sellers were entitled to “take into account all relevant commercial, economic and operational matters” in determining whether they were able to supply the SMDQ.

After an explosion at Apache’s gas plant on Varanus Island in 2008, there was a temporary shortfall in gas supply in the Western Australian market and as a result, the price of gas in the market at the time far exceeded the contract price payable by Verve in the GSA. The Sellers refused to supply the SMDQ to Verve at the contracted price, and instead offered to supply the gas to Verve at the prevailing market price. The Sellers accepted that they had capacity to supply the SMDQ during this time. Verve brought an action against the Sellers claiming this was a breach of the “reasonable endeavours” clause of the agreement.

High Court decision

On 5 March 2014 the High Court handed down a 4:1 majority decision in favour of the Sellers. This decision overturned the finding of the Western Australian Court of Appeal.

The High Court held that, given the wording of the relevant clause, the ability of the Sellers to supply the SMDQ at the contract price could be determined having regard to its own business interests. The High Court held that this was understood by both parties at the time of forming the GSA. This was evidenced by the fact that the examples of when the Sellers would not be in breach of the “reasonable endeavours” clause were not limited to lack of capacity, and both parties understood that there were factors that could affect the Sellers’ ability to supply SMDQ at the contracted price, including that the Sellers supplied gas to other customers and that gas prices were subject to significant fluctuation.

The High Court made three general observations about the nature of “reasonable endeavours” clauses:

  1. An obligation to use reasonable endeavours to achieve contractual objectives is neither absolute nor unconditional.
  2. The nature of the obligation to use reasonable endeavours is dependent on what is reasonable in the circumstances, and this can include consideration of the party’s own business interests.
  3. Where a contract sets out an express standard for determining what is reasonable, those matters will be given effect in interpreting the “reasonable endeavours” clause.

The High Court reaffirmed the well-established principles of contractual interpretation that the terms of a contract between businesses should be given a “commercial” meaning, having regard to what a reasonable business person would have objectively understood the terms to mean. It requires a consideration of the words of the contract, the surrounding circumstances and the commercial purpose of the contract to give the contract a businesslike interpretation.

Implications

Ultimately, what constitutes ‘reasonable endeavours’ will be judged by the courts based on general principles of contractual interpretation. When drafting such clauses, a contracting party should carefully consider whether the contract should contain its own “internal standards” governing the reasonable endeavours obligation. For example, it may not be in the best interests of the party relying on the benefit of the obligation to start negotiating a list of internal standards which ultimately may result in a narrower scope of the obligation than if the obligation had not been defined extensively in the contract.

Madeleine Bright