High Court provides guidance on “reasonable endeavours” contractual obligations

By 05/03/2014Contract
reasonable endeavours

In Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7 the majority of the High Court (French CJ, Hayne, Crennan and Kieffel JJ) has provided important general observations on the proper construction of obligations to use reasonable endeavours to achieve a contractual object (at [41] to [43]).

General observations

  • First, such an obligation is not an absolute or unconditional obligation;
  • Second, the nature and extent of such an obligation is necessarily conditioned by what is reasonable in the circumstances, which can include circumstances that may affect an obligor’s business;
  • Third, 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 some express reference relevant to the business interests of an obligor.

The majority noted that:

“Contractual obligations framed in terms of “reasonable endeavours” or “best endeavours (or efforts)” are familiar.  Argument proceeded on the basis that substantially similar obligations are imposed by either expression.  Such obligations are not uncommon in distribution agreements, intellectual property licences, mining and resources agreements and planning and construction contracts.  Such clauses are ordinarily inserted into commercial contracts between parties at arm’s length who have their own independent business interests.” (at [40])

Facts

The appeal concerned the supply of gas to the Western Australian market, which was disrupted by an explosion at Apache Energy Limited’s gas plant on Varanus Island in 1998. Electricity Generation Corporation (trading as Verve Energy) is the major generator and supplier of electricity to a large part of southwest Western Australia, including Perth. Verve purchases natural gas under a gas supply agreement (GSA) from a number of sellers, including Apache, for use in its power stations. The GSA required the sellers to use their “reasonable endeavours” to make available to Verve a supplementary daily quantity of gas, in addition to a maximum daily quantity of gas.

The explosion on Varanus Island caused the cessation of gas production at Apache’s plant, which resulted in a 30-35% reduction in the supply of natural gas to the Western Australian market. Verve sought supplementary gas from the sellers, who declined to supply it under the GSA, but supplied it under a number of separate short term gas supply agreements, at prevailing market prices (that exceeded the price of supplementary gas in the GSA).

Findings

The High Court found, by majority, that on the proper construction of the GSA, the sellers were not obliged by the reasonable endeavours obligation to supply supplementary gas to Verve under the GSA. This finding was based in part on the “reasonable endeavours” obligation being conditioned by the sellers’ express entitlement to take into account “all relevant commercial, economic and operational matters” when determining whether they were “able” to supply supplementary gas. The Court observed that this was an internal standard of reasonableness by which the obligation to use reasonable endeavours was measured (at [46]).

It was also relevant, inter alia, that under the GSA Verve was not obliged to nominate any supplementary gas quantity, and the sellers were not obliged to reserve daily capacity in their plants to supply supplementary gas to Verve, or to refrain from agreeing to sell gas to third parties (at [21]). The effect of these clauses was that the sellers “were not obliged to forgo or sacrifice their business interests when using reasonable endeavours” to make gas available for delivery (at [47]), notwithstanding conflict between the sellers’ business interests and Verve’s interest in obtaining supplementary gas at prices set under the GSA (at [49]). In other words the sellers were at liberty to offer to supply supplementary gas to Verve outside the terms of the GSA. 

This conclusion was also found to be consistent with the surrounding circumstances known to both parties at the time of entering the GSA (at [48]). In doing so the majority reaffirmed the objective approach to be taken in determining the rights and liabilities of parties to a contract (at [35]):

“The meaning of the terms of a commercial contract is to be determined by what a reasonable businessperson would have understood those terms to mean.  That approach is not unfamiliar.  As reaffirmed, it will require consideration of the language used by the parties, the surrounding circumstances known to them and the commercial purpose or objects to be secured by the contract.  Appreciation of the commercial purpose or objects is facilitated by an understanding “of the genesis of the transaction, the background, the context [and] the market in which the parties are operating”.  As Arden LJ observed in Re Golden Key Ltd, unless a contrary intention is indicated, a court is entitled to approach the task of giving a commercial contract a businesslike interpretation on the assumption “that the parties … intended to produce a commercial result”.  A commercial contract is to be construed so as to avoid it “making commercial nonsense or working commercial inconvenience”.”

Comment

This decision has potentially significant ramifications for existing contracts that contain “reasonable endeavours” obligations. Such contracts should be reviewed, as a matter of risk management, to determine the extent to which an obligee may be entitled to avoid a “reasonable endeavours” obligation. Re-negotiation may be necessary to more clearly express the parties’ intentions. Similarly new contracts should be drafted paying careful attention to the language used to express a “reasonable endeavours” obligation and any terms used to condition or qualify that obligation.