Expert legal commentary: Reasonable Endeavours: Commercial Gains Trump Energy Supply Security in WA Domestic Gas Markets

By Ms Rowena Cantley-Smith

Ms Rowena Cantley-Smith

The contractual complexities of securing affordable energy supply in a partially privatised market have been revealed in a recent decision of the High Court of Australia, Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7. Against the backdrop of essential energy supply within the State of WA and no available alternative supply sources, the case considers the proper contractual construction and application of a supply clause (cl 3.3) in a long term gas sale agreement (GSA). This clause obliges Woodside Energy Ltd and Others (the Sellers) to use “reasonable endeavours” to supply quantities of supplemental gas to WA’s electricity generation and supply statutory corporation,  Electricity Generation Corporation (t/as Verve Energy) (Verve).

 

Background

Under the GSA, the Sellers have two key supply obligations regarding specified quantities of gas: (i) a maximum daily quantity of gas (MDQ) and (ii) a supplemental maximum daily quantity of gas (SMDQ), at a price fixed by cl 6.1(d). Constrained supplies of gas (30-35% reduction) resulted from an explosion at a supply gas plant in June 2008, causing demand to exceed supply and gas prices to rise considerably. In these circumstances, the Sellers initially advised Verve that it would not be supplied with SMDQ at the price fixed by the GSA, but rather, would need to pay the new prevailing market price for gas supplies during the month of June. As it became clear that the interruption to supply would continue for several months, the Sellers subsequently advised Verve that there would be no supply of the nominated SMDQ before the end of September 2008. Rather, if Verve wanted to receive any additional gas from the Sellers, it would have to engage in a supply tender process – compete with other customers – and pay the prevailing market price. Verve commenced proceedings in the WA Supreme Court in March 2009 arguing, relevantly, that the Sellers had breached their contractual supply obligation under cl 3.3 of the GSA by failing to use "reasonable endeavours" to supply nominated SMDQ between June and September 2008.

 

Proper Construction of Clause 3.3: Reasonable Endeavours to meet Supply

Under the GSA, the Seller’s primary obligation concerning the supply of the SMQD of gas to Verve mandates it to use reasonable endeavours when making additional supply available: cl 3.3(a). Clause 3.3(b) provides an important rider to this obligation, permitting the Sellers to take into account all relevant commercial, economic and operational matters when determining whether they are able to supply SMDQ of gas on any particular day. According to the majority judgement of the High Court (French CJ, Hayne, Crennan and Kiefel JJ), the core issue in dispute concerned the correct construction of the relationship between the Sellers' obligation (cl 3.3(a)) and entitlements (cl 3.3(b)).  In determining the joint operative effect of these clauses on the parties’ rights and liabilities, the High Court adopted an objective approach to contractual interpretation, stating that: ‘the meaning of the terms of a commercial contract is to be determined by what a reasonable business person would have understood those terms to mean’(¶35). The majority rejected Verve’s claim that the Sellers’ ability to supply should be narrowly construed, namely, that if the Sellers have available capacity then they are “able” to supply, and therefore, are obliged to deliver SMDQ at the agreed price in the GSA, regardless of any commercial changes in market circumstances, such as a significantly higher price (¶39&47).  In so doing, the Court expressly rejected the earlier decision of the Court of Appeal (WASC), which unanimously accepted Verve’s construction of cl 3.3(b), namely that the use of the word “able” in cl 3.3(b) refers to the sellers’ capacity, not their willingness, to supply SMDQ. 

Instead, the majority adopted the Seller’s construction of the contractual terms. In so doing, the Court held that the “reasonable endeavours” required under cl 3.3(a) is a ‘qualified obligation, and cl 3.3(b) provides an internal standard of reasonableness by which the obligation to use reasonable endeavours to supply SMDQ can be measured’ (¶46).  Such a construction entitles the Sellers ‘to determine their ability to supply SMDQ to Verve on any given day after taking into account all commercial, economic and operational matters relevant to them’ (¶24). As such, physical interruptions to gas supply and consequential changes in the prevailing market conditions – including price rises and higher profitability from sales to other customers – are held by the Court as constituting matters that fall within the ambit of the Sellers’ considerations under cl 3.3(b) when determining whether they are “able” to supply SMQD on any particular day. Accordingly, the majority concluded that the Sellers’ actions did not constitute a breach of its contractual supply obligations under the GSA.

Justice Gageler’s dissenting judgement expressly questioned the majority’s construction of cl 3.3(b), suggesting that it needs to be read, not only in conjunction with cl 3.3(a), but also with cl 6.1(d), the price fixing clause. When this is done, His Honour pointed out, it is difficult to accept the proposition that cl 3.3(b) should be read broadly; that to do so would ‘give the Sellers a discretion not to make gas available for delivery up to SMDQ merely because market circumstances present an opportunity for the Sellers to demand a substantially higher price for that gas than the price fixed by cl 6.1(d)’ (¶56). Such a construction, His Honour stated, has the effect of altering the operative effect of the price set out in the GSA, from a fixed price to a floor price. This, accordingly, raises the clear question of why, ‘as reasonable commercial parties’ they included cl 3.3 at all (¶61). It would also have the consequence of rendering the ‘obligation to use reasonable endeavours imposed on the Sellers by cl 3.3(a) of the GSA elusive, if not illusory … and would, in commercial terms, eliminate the distinction carefully drawn in cl 3.3 between delivery of nominated gas in excess of MDQ up to SMDQ’ (¶57). In accepting Verve’s construction of cl 3.3(b) as the correct one, His Honour also made the salient point that the objective approach applies to both clauses and, in particular, to the relevant terms, "able" and "reasonable endeavours". This highlights the underlying issue: that the Sellers were not objectively unable to supply the SQDM on any particular day, but rather, were subjectively unwilling to do so by reason of their desire to maximise profits (¶62-63).  

 

Consequences of this case

In practical terms, this case raises clear implications for the drafting and use of “reasonable endeavours” clauses in commercial settings. Given the High Court’s decision supports a broad construction of such clauses, it is clear that related clauses in a contract can be used to significantly qualify the nature and scope of “reasonable endeavors” clauses. In the context of gas supply contracts, the use of such clauses may prove to be problematic, especially given that this recent High Court decision has granted suppliers considerable freedom in calling on discretionary commercial considerations – such as higher profits – to trump the broader purpose underpinning the supply of gas into the domestic market. As such, when dealing with supply contracts, especially those concerning the provision of essential services such as electricity and gas, alternative clauses without a “reasonable endeavors” obligation may prove more suitable to securing affordable energy supply for those on the demand-side of the market.