On 5 March 2014, the High Court handed down a decision in the dispute between Verve Energy and Woodside Energy and a number of gas suppliers which impacts on any organisation with existing supply contracts.
It is clear that that a seller/supplier (depending on the drafting of the agreement) can take advantage of a commercial opportunity, which is in its business interests even where there is a reasonable endeavours clause. It is important both to review your existing supply contracts to identify whether there are any reasonable endeavours clauses that are subject to the business interests of the supplier / seller and also to draft clauses as clearly as possible to avoid any unintended results.
Summary of facts
The dispute arose from an explosion at the Apache gas plant at Varanus Island, off Western Australia which resulted in a temporary reduction in supply of natural gas to the Western Australian market. This in turn led to demand quickly outstripping supply.
At the heart of the dispute was an argument about whether there had been a breach of the obligation to use reasonable endeavours to supply gas to Verve Energy under the long term gas supply agreement that existed between the parties. Under the contract, the Sellers were obliged to make available to Verve a maximum daily quantity of gas, and to use “reasonable endeavours” to make available a Supplemental Maximum Daily Quantity (SMDQ) of gas at a fixed price. In determining whether they were able to supply the SMDQ, the agreement relevantly provided the Sellers could “take into account all relevant commercial, economic and operational matters”.
After the explosion at Varanus Island, the Sellers advised Verve that they would not supply SMDQ under the agreement for an indefinite period. It was not in dispute that they had capacity to do so. They did, however, offer to supply an equivalent quantity of gas at the prevailing market price, which was a significantly higher price than provided for under the long term agreement. Under protest, Verve entered into short term gas supply agreements with the Sellers for the period of the shortage but commenced proceedings to, in effect, recover the difference between the amount paid and the amount that would have been paid if the gas was supplied under the long term agreement.
At first instance, Justice Le Miere held that there was no breach of the agreement, a decision which was reversed by the WA Court of Appeal.
Decision of the High Court
A majority of the High Court (French CJ, Hayne, Crennan and Kiefel JJ) overturned the Court of Appeal decision. They made 3 observations about reasonable endeavours clauses:
- The obligation is not an absolute or unconditional obligation.
- The nature and extent of the obligation is necessarily conditioned by what is reasonable in the circumstances, which can include circumstances that may affect a party’s business. They accepted that an obligation to use reasonable endeavours did not require the achievement of a contractual object “to the certain ruin of the Company or to the utter disregard of the interests of [its] shareholders.” The freedom for a company to act in its own business interests, in matters to which the agreement relates, is not necessarily sacrificed by an obligation to use reasonable endeavours to achieve a contractual object.
- Some contracts containing an obligation to use or make reasonable endeavours to achieve a contractual object contain their own internal standard of what is reasonable, by express reference to the business interests of the supplier.
The majority considered that, in this case, the reasonable endeavours clause required a balancing of interests, as the interests of the parties did not coincide in respect of supply of the SMDQ. A "reasonable" standard of endeavours was conditioned both by the Sellers' responsibilities to Verve in respect of SMDQ, and by the Sellers' express entitlement to take into account "relevant commercial, economic and operational matters" when determining whether they are "able" to supply SMDQ. The clause did not oblige the Sellers to forgo or sacrifice their business interests when using reasonable endeavours to supply SMDQ.
The High Court held the agreement did not oblige the Sellers to supply SMDQ to Verve when the Apache incident resulted in business conditions leading to conflict between the Sellers’ business interests and Verve’s interest in obtaining SMDQ at the price stipulated in the agreement.