Does a reasonable endeavours clause restrict a supplier's ability to exploit other commercial opportunities?

The Supreme Court of Western Australia's Court of Appeal recently had cause to consider the effect of a reasonable endeavour obligation in the context of a unique commercial opportunity (Electricity Generation Corporation t/as Verve Energy v Woodside Energy Ltd [2013] WASCA 36).

At issue was whether a seller was bound to supply under a reasonable endeavours obligation, to which a pre-agreed pricing mechanism applied, or whether the seller could take advantage of higher prices caused by a material decrease in supply within the relevant market.

The gas sale agreement and reasonable endeavours clause

Verve Energy, the major generator and supplier of electricity to Perth and the south western areas of Western Australia (Buyer), was party to a gas sale agreement (GSA) with certain participants in the North-West Shelf Joint Venture (Sellers). The Sellers and Apache Energy were the two principal suppliers of gas into the Western Australian market at the relevant time.

The terms of the GSA included a firm commitment from the Sellers to supply the Buyer up to a prescribed maximum daily quantity of gas each day, and an obligation on the Sellers to use their reasonable endeavours to make available for delivery up to an additional prescribed quantity of Gas (Supplemental Maximum Daily Quantity or SMDQ) at a prescribed price (SMDQ Price). The obligation to use reasonable endeavours to supply SMDQ Gas was triggered by the Buyer nominating for a quantity of SMDQ Gas.

On 4 June 2008, the day after the explosion at Apache Energy's Varanus Island facility that effectively reduced the supply of gas into the WA market by approximately 30%, the Sellers' agent informed the Buyer that the Sellers would not be able to supply SMDQ Gas for that month, but could supply the equivalent quantity of gas at a price in excess of the SMDQ Price, given the unique trading conditions caused by the explosion. Consequently, the Buyer (under protest) entered into a series of short-term contracts with the Sellers covering the period 4 June to 29 September 2008 for additional gas at prices above the SMDQ price.

In proceedings before the Supreme Court of Western Australia and the Court of Appeal, the Buyer alleged, amongst other things (including the tort of economic duress), that the Sellers were in breach of their reasonable endeavours obligation under the GSA.

The issue: the reasonable endeavours clause

In the relevant respect, the case turned on a clause intended to qualify the reasonable endeavours obligation under the GSA, which provided: "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".

According to the Sellers, this clause gave the Sellers the entitlement to determine, as a threshold issue on those criteria, whether they were able to supply SMDQ on a Day. On that argument, if after having regard to the relevant commercial, economic and operational matters, the Sellers determined that they were able to supply SMDQ on a Day, the Sellers would then have been required to use their reasonable endeavours to make available the nominated SMDQ.

The Buyer rejected the Sellers' construction on the basis that the clause did not confer an option to supply the SMDQ. Instead, the reasonable endeavour obligation was concerned with whether the Sellers were able to supply SMDQ by having regard to the relevant commercial, economic and operational matters. According to the Buyer, the question was whether the Sellers were able to supply SMDQ, not whether they were willing to supply SMDQ.

A question of timing

A key distinction between Justice Le Miere's judgment in the Supreme Court of Western Australia (in favour of the Sellers) and the Court of Appeal's decision in favour of the Buyer concerned the Sellers' ability to take advantage of the increase in the price of gas following the Varanus Island explosion.

Justice Le Miere held that as the Sellers had no express obligation under the GSA to reserve a quantity of Gas to be used as SMDQ, they were at liberty to enter into gas supply agreements with third parties even if such commitments precluded the Sellers from being able to meet SMDQ nominations on a Day. Consequently, Justice Le Miere held that the Sellers could have regard to the profitability of supplying gas to third parties at a price in excess of the SMDQ Price in determining whether they were able to supply SMDQ on a Day.

Although the Court of Appeal agreed with Justice Le Miere that the Sellers' "potential to exploit other commercial opportunities […] serves to illustrate the scope and intended operation of the reasonable endeavours obligation", it held that the Sellers' ability to exploit other commercial opportunities could not leave the obligation without any operation if, at the time the reasonable endeavours obligation must be met, the Sellers had not exploited those opportunities and remained capable of supplying SMDQ.

Recommendations

Whereas each "reasonable endeavours" obligation must be interpreted objectively and within the context of the contract as a whole, it is clear from the judgments of both courts that, in the absence of a clear obligation to supply SMDQ, the Sellers could have taken advantage of the higher gas prices following the Varanus Island explosion without being in breach of their reasonable endeavours obligation, if they had secured agreements with third parties before the Buyer nominated for SMDQ Gas.

Reasonable endeavour clauses should not preclude sellers from taking advantage of commercial opportunities, provided both the timing and drafting are right.