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Australia – Guidance On The Meaning Of “Reasonable Endeavours”.

21 July, 2014

 

Legal News & Analysis – Asia Pacific – Australia – Dispute Resolution

 

Electricity Generation Corp v Woodside Energy Ltd

 
The High Court’s decision in Electricity Generation Corp v Woodside Energy Ltd1is important for the construction industry because it provides guidance on the meaning of “reasonable endeavours”, which is a common concept in construction contracts. The decision also considered principles of contractual interpretation.

 
Background

 
The decision concerned a gas supply agreement between Verve Energy (the Buyer) and a group of gas retailers (the Sellers). The Buyer was responsible for the generation and supply of electricity in the south west of Western Australia, including the Perth metropolitan area. The gas supplied under the agreement was for electricity generation in the south-west through the Dampier-to-Bunbury Gas Pipeline.2

 
The dispute between the parties was triggered by an explosion at the gas processing plant of a third party energy company, Apache Energy, on Varanus Island in the north west of Western Australia. At the time of the explosion, Apache and the Sellers were the two main suppliers of gas in the Western Australian domestic gas market.3

 
The shutdown of Apache’s plant reduced the supply of gas to the Western Australian market by 30 to 35%, which resulted in demand for gas exceeding supply.4
In addition to its agreement with the Sellers, the Buyer purchased gas from Apache and the explosion caused the Buyer to suffer a shortfall in supply. In order to meet the energy needs of the southwest of Western Australia, the Buyer had to secure supply from the other main supplier of gas in Western Australia, the Sellers.

 
The Buyer sought supply from the Sellers by relying on a clause in the parties’ agreement, which allowed the Buyer to nominate and purchase an amount of gas in excess of normal supply. The interpretation of the clause became the central issue in this case.

 
Relevant Clauses

 
Under clause 3.2 of the agreement, the Sellers were required to supply a maximum daily quantity (MDQ) of gas to the Buyer. Each day, the Buyer’s representative nominated the quantity of gas it required for the following seven days pursuant to clause 9 of the agreement. The quantity of gas to be supplied by the Seller was at the Buyer’s discretion and, depending on the Buyer’s requirements, could exceed MDQ. If the Buyer nominated an amount in excess of MDQ, the excess gas was termed the “supplemental maximum daily quantity” (SMDQ).

 
Clause 3.3 of the agreement set out the process for supplying SMDQ. Under clause 3.3(a), the Sellers were required to use “reasonable endeavours” to make available for delivery SMDQ. Clause 3.3(b) provided that, in determining whether they were “able” to supply SMDQ, the Sellers were entitled to “take into account all relevant commercial, economic and operational matters”. In making a determination, the Sellers were also entitled to consider production capacity at their facilities and their obligations to other customers.5

 
Dispute

 
The dispute was triggered when the Buyer requested that the Sellers supply SMDQ. In response, the Sellers declined to supply SMDQ for an indefiniteperiod under clause 3.3 of the agreement, and instead offered to enter into two short term gas supply agreements with the Buyer at a cost higher than the original agreement. The Buyer was not alone in its predicament. Many other customers in Western Australia attempted to contract with the Sellers at the same time, at prices exceeding those contained in the Buyer and Sellers’ agreement.6

 

The Buyer reluctantly accepted the Sellers’ offer to enter into short-term supply agreements and protested the Sellers’ conduct. The Buyer contended, among other things, that the Sellers were in breach of the agreement because the Sellers failed to use reasonable endeavours to supply SMDQ under clause 3.3 of the agreement. The Buyer commenced proceedings in the WA Supreme Court before Le Miere J and the matter was subsequently appealed to the WA Court of Appeal.

 
First Instance And Court Of Appeal Decisions

 
The WA Supreme Court, at first instance, and the WA Court of Appeal delivered opposing judgments on whether the Sellers breached their obligation to use reasonable endeavours to supply SMDQ pursuant to clause 3.3 of the agreement.

 
Justice Le Miere found that clause 3.3(b) “conditioned” the operation of clause 3.3(a), and allowed the Sellers to exercise their discretion to supply SMDQ.The obligation to use reasonable endeavours to supply SMDQ was subject to the Sellers’ ability to take into account all relevant commercial, economic and operational matters when determining if they were able to supply SMDQ. Justice Le Miere interpreted the Sellers’ ability to consider all relevant matters as a broad discretion to take into account any matter that affected the Sellers’ business including the profitability of supplying SMDQ. Therefore, the issue was not whether the Sellers had capacity to supply SMDQ but whether the Sellers were (after considering all relevant matters) willing to supply SMDQ. On this basis, Le Miere J held that the Sellers acted within their rights under clause 3.3(b) when they declined to supply SMDQ and were not in breach of their obligation to use reasonable endeavours under clause 3.3(a).

 
The Buyer appealed to the Court of Appeal and the appeal was unanimously upheld by McLure P, Murphy and Newnes JJA. Justice McLure (Newnes JA concurring) held that the Sellers’ obligation to usereasonable endeavours to supply SMDQ would only be limited or restricted if the Sellers did not have capacity to supply. The meaning of “able” in clause 3.3(b) of the agreement referred to the Sellers’ capability and capacity to supply, not the Sellers’ willingness. The expectation was that, if the Sellers were unable to supply SMDQ, the Buyer would look for another supplier. Justice McLure addressed the fact that the Sellers were not expressly obliged to reserve gas or production capacity for the Buyer by highlighting that the nomination process for SMDQ served that same purpose. Additionally, the parties agreed to a price for SMDQ and mechanisms for the future adjustment of that price. Similarly, Murphy JA considered that, once the Buyers made a nomination in accordance with clause 9, the obligation to use reasonable endeavours commenced. The Court of Appeal found that clause 3.3 did not entitle the Sellers to exercise its general discretion as to whether or not to supply SMDQ.

 
High Court Decision

 
The majority in the High Court (French CJ, Hayne, Crennan and Kiefel JJ) held that the Sellers’ obligation to use reasonable endeavours to supply SMDQ was a qualified obligation and the Sellers were entitled to take into account commercial matters, such as profitability, in determining whether they were able to supply SMDQ. The Sellers were not in breach of clause 3.3 of the agreement when they declined to provide SMDQ.

 
Meaning Of The Obligation To Use “Reasonable Endeavours”

 
The obligation to use reasonable endeavours was the starting point for the analysis in the joint judgment. The majority noted that reasonable endeavours clauses are not uncommon in mining and resources agreements and construction contracts, and that such clauses in commercial contracts are ordinarily included by parties at arm’s length who have their own business interests.8

 
Three general observations were made about the obligation to use reasonable endeavours to achieve a contractual object:

 

  • An obligation to use reasonable endeavours to achieve a contractual objective is not an absolute or unconditional obligation. 9
  • The nature and extent of an obligation to use reasonable endeavours is conditioned by what is reasonable in the circumstances. This can include the circumstances which may affect the business of the party tasked with the obligation.10
  • The obligation to use reasonable endeavours to achieve a contractual object may, in some contracts, be set by an internal standard of what is reasonable. For example, this may be achieved by express reference to the business interests of the party tasked with the obligation.11

 

No distinction was drawn between reasonable endeavours and best endeavours in the discussion of the clause. The High Court did not object to the parties making submissions and proceeding on the basis that reasonable endeavours and best endeavours are substantially similar obligations.12

 

Interpretation Of Clause 3.3 – Supply Of SMDQ

 
The joint judgment analysed the obligation in clause 3.3(a) in the context of the whole of clause 3 and the overall agreement. The agreement between the Buyer and the Seller was a commercial contract made at arm’s length with each party pursuing its independent business interests.13 The commercial objective of the agreement was to allow the Buyer to obtain a secure supply of gas up to the specified MDQ and the Seller benefited from an assured price for the gas. This objective was secured by clause 3.2, which made the supply of MDQ an unconditional obligation.

 
The majority characterised the supply of SMDQ under clause 3.3 as a “supplementary” commercial purpose of the agreement in contrast to clause 3.2. Two observations were made about the obligation to supply SMDQ, which led to the conclusion that the obligation was qualified. First, unlike the obligation under clause 3.2, the Buyer was not contractually bound to buy SMDQ from the Sellers. Second, the Sellers were not contractually bound to reserve capacity in their plant for SMDQ. The joint judgment compared the language in the obligation in clause 3.3 with theunconditional obligation to supply MDQ in clause 3.2 and concluded that clause 3.3 contained “the language of qualified obligation”.14 Clause 3.3(b) provided an internal standard of reasonableness by which the obligation to use reasonable endeavours to supply SMDQ could be measured.15

 

In determining whether they could supply SMDQ, the Sellers were entitled to take into account all relevant commercial, economic and operational matters pursuant to clause 3.3(b) of the agreement. The agreement between the parties was a commercial contract, which meant that the parties operated at arm’s length and each was entitled to pursue its own interest.16 The words “commercial, economic and operational matters”, were interpreted to mean any matter that affected the Sellers’ business interests.17 The joint judgment found that the Sellers were not obliged to sacrifice their business interests when determining whether or not to make SMDQ available for delivery.18 The use of the word, “able”, in clause 3.3(b) was held to refer to the Sellers’ ability to supply SMDQ, having regard to the Sellers’ capacity to supply as well as their business interests. Ultimately, the decision to supply SMDQ was at the Sellers’ discretion and the majority rejected the Buyer’s interpretation, which was that the word “able” referred only to the Sellers’ capacity to supply gas.

 
The majority, in their concluding remarks, explained that the construction of clause 3.3(b) did not oblige the Sellers to supply SMDQ in circumstances where there was a conflict with the Sellers’ own business interests. The Sellers were not expected to use reasonable endeavours for the common benefit of both parties.

 
Dissenting Judgment – Gageler J

 
Justice Gageler delivered a dissenting judgment, which focused on what reasonable commercial parties in the position of the Sellers and the Buyer would have intended clause 3.3 to mean.

 
Justice Gageler was not convinced by the Sellers’ construction of clause 3.3 because it made the obligation to use reasonable endeavours “elusive, if not illusory”. The Sellers’ construction eliminated the distinction drawn in the agreement between MDQ andSMDQ and, as the Buyer submitted, the effect of the construction was that clause 3.3 had no effect at all.19

 

Given that the parties had agreed to a price for SMDQ and the Sellers had an obligation to use reasonable endeavours, Gageler J was unable to conclude that the Sellers had a broad discretion not to make gas available merely because the market allowed the sale of gas at higher prices. Gageler J agreed with the Court of Appeal’s interpretation of clause 3.3, which provided that the Sellers’ right to take into account all relevant commercial, economic and operational matters was directed to the ability or capacity of the Sellers to supply SMDQ; not the willingness of the Sellers to supply.

 
The Sellers’ efforts to supply SMDQ should have been judged on whether they were objectively reasonable. On this interpretation, the Sellers would not be required to supply SMDQ if they did not have the capacity or ability to do so. Justice Gageler concluded that, as the Sellers were objectively capable of supplying SMDQ to the Buyer, the Sellers’ failure to do so for economic reasons amounted to a breach of clause 3.3 of the agreement.

 
Contractual Interpretation

 
In the decision, the majority restated principles that apply to the construction of a commercial contract. The principles emphasise an objective approach to interpreting contracts, which draws on what reasonable businessperson would understand the terms of a commercial contract to mean. The principles that can be extracted from the judgment are that: 20

 

  • an objective approach should be adopted in determining the rights and liabilities of parties to a contract;
  • the terms of the commercial contract are to be determined by what a reasonable businessperson would have understood those terms to mean;
  • the court will consider the language used by the parties, the surrounding circumstances known to them and the commercial purpose or object of the contract;
  • the commercial purpose or object is informed by an understanding of the genesis of the transaction, the background, the context of the transaction and the market in which the parties are operating; and
  • commercial contracts should be given a businesslike interpretation on the assumption that the parties intended to produce a commercial result.

 
The joint judgment and Gageler J’s dissenting judgment did not expressly find that clause 3.3 was ambiguous. One effect of this was that the High Court did not revisit its decision in the special leave application, Western Export Services Inc v Jireh International Pty Ltd.21

In Jireh, the Court emphasised the binding nature of Mason J’s “true rule” in Codelfa v State Rail Authority of NSW.22 Put simply, the true rule is that evidence of surrounding circumstances will be admissible to assist in the interpretation of a contract if the language is ambiguous or susceptible of more than one meaning.23

 
Generally, appellate courts in Australia have followed the High Court’s message in Jireh that they are bound to follow Codelfa until the court revisits the issue. Given that there was no express statement by the High Court on the status of Codelfa, this approach is likely to continue.

 
Relevance For Construction Contracts

 
The decision has practical implications for the construction industry in relation to contractual interpretation and drafting.

 
The terms “reasonable endeavours” and “best endeavours” are likely to be interpreted in a similar manner.

 
If a contract does not prescribe what reasonable endeavours means, the concept of what is reasonable will be informed by the circumstances.

 
Parties can obtain some certainty by drafting an internal standard that describes what is required for reasonable endeavours. However, parties should also be clear about the contractual object to which reasonable endeavours must be applied.

 
An obligation to use reasonable endeavours is not an absolute or unconditional obligation.

 

End Notes:

 

Electricity Generation Corporation v Woodside Energy Ltd (2014) 306ALR 25.

The Dampier to Bunbury Gas Pipeline is an underground pipeline that extends for 1489 kilometres from Dampier to Bunbury in Western Australia.

Electricity Generation Corporation t/as Verve Energy v Woodside Energy Ltd [2013] WASCA 36 (20 February 2013) [3] (McLure P).

Above, n 1, at [5].

Clause 3.3(b)(i) to (iii) of the agreement between the parties.

Above, n 1, at [6].

7 Electricity Generation Corporation t/as Verve Energy v Woodside Energy Ltd [2011] WASC 268 at [70].

Above, n 1, at [40].

Above, n 1, at [41].

10 Above, n 1, at [41].

11 Above, n 1, at [43]

 
12 Above, n 1, at [40]. An interesting comparison is the Singaporean Court of Appeal’s decision in KS Energy Services Ltd v BR Energy (M) Sdn Bhd [2014] SGCA 16. The court held that there was no material difference between “all reasonable endeavours” and “best endeavours” (at [62]). The court distinguished “reasonable endeavours” (such as the obligation imposed on the Sellers) as a less onerous standard than “all reasonable endeavours” and “best endeavours” (at [63]). The reason for the distinction was that “reasonable endeavours” might require the obligor to take only one reasonable course of action, and not all of them (at [63]).

 
13 Above, n 1, at [44].

14 Above, n 1, at [46].
15 Above, n 1, at [46].
16 Above, n 1, at [44].
17 Above, n 1, at [47].
18 Above, n 1, at [47].

19 Above, n 1, at [61].
20 Above, n 1, at [35].

21 Western Export Services Inc v Jireh International Pty Ltd (2011) 282 ALR 604; 86 ALJR 1; [2011] HCA 45.
22 Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337; 41 ALR 367; 56 ALJR 459.

23 Western Export Services Inc v Jireh International Pty Ltd [2011] HCA 45, [3]–[4] per Gummow, Heydon and Bell JJ; and Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337, 352 per Mason J (Stephen and Wilson JJ).

 

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