A contractual obligation to use “reasonable endeavours” to supply gives the seller significant wriggle room, according to a recent decision in Australia’s highest court which we expect will be used as a precedent in this country.
Purchasers wanting an obligation to supply that is less than absolute but provides some certainty may be best advised to adopt alternative wording – “all reasonable endeavours” or “best endeavours”, or clearly-defined required steps – and avoid giving suppliers the benefit of subjective performance criteria.
The dispute concerned a long term gas supply agreement (GSA) between Electricity Generation Corporation, trading as Verve, and various gas suppliers in Western Australia.
The GSA required each supplier:
- to provide a proportionate share of a Maximum Daily Quantity (MDQ) of gas to Verve, and
- to use “reasonable endeavours” to supply a supplemental maximum daily quantity (SMDQ) but being able to take into account “all relevant commercial, economic and operational matters”.
The litigation arose when an explosion at a gas plant reduced supply of natural gas to Western Australia by around a third, so that the market could no longer be fully supplied.
Verve was informed that it would not receive the nominated SMDQ during that time and would have to enter a competitive tender process under two short term supply contracts to receive any additional gas above MDQ (invariably at a higher price than in the GSA).
Verve entered these contracts “without prejudice” to its rights under the GSA. At issue was whether the suppliers had breached the “reasonable endeavours” obligation in the GSA and, depending on the answer to that question, whether Verve was entitled to restitution for economic duress.
The majority of the High Court of Australia (4:1), reversing the Western Australian Court of Appeal, found that the contract should be given a “business-like interpretation”. Verve was not contractually bound to buy SMDQ from the Sellers and the Sellers were not contractually bound to reserve capacity in their plants in order to supply the SMDQ.
The majority concluded that the purpose of the wording, taken as a whole, was to provide for a balancing of interests of the parties in relation to SMDQ where those interests did not entirely coincide or conflict:
“What is a reasonable standard of endeavours … is conditioned both by the Sellers’ express responsibilities to Verve in respect of SMQD and by the Sellers’ express entitlement to take into account relevant commercial, economic and operational matters”.
Applied to the facts, the GSA did not oblige the suppliers to supply SMDQ to Verve when the gas plant explosion occasioned business conditions leading to conflict between the supplier’s business interests (in obtaining the higher price on offer) and Verve’s interest in obtaining nominated SMDQ at the GSA price.
Gageler J disagreed, saying that the majority’s construction of the contract rendered the obligation to use reasonable endeavours “elusive, if not illusory” and meant that the price fixed by the GSA for SMDQ was “meaningful only if and when the Sellers consider it to their commercial advantage to accept it.”
Chapman Tripp comments
The decision, although it may be able to be confined to the facts (in particular, by the express reference to the suppliers being able to take into account “commercial and economic” matters in determining whether to supply) is likely to become a leading case for suppliers wanting to weaken the obligation imposed by a “reasonable endeavours” clause.
To avoid the practical outcomes identified by Gageler J, purchasers wishing to give teeth to a less than absolute obligation to supply might consider alternative wording – such as “best endeavours” or “all reasonable endeavours” – and avoid the supplier having the benefit of subjective criteria to determine whether it performs or not.
These phrases have been held by the Courts, most recently by the Singapore Court of Appeal, to impose higher burdens on suppliers, including an obligation to act against their own commercial interests where the nature and terms of the contract indicate that this is an intended outcome.
Another approach would be to specify certain steps which have to be taken in order to satisfy the reasonable endeavours obligation, particularly if those steps may require one party to sacrifice its commercial interests.