Endeavouring to Solve a Contracting Puzzle: Verve Energy

By Wayne Jocic and Matthew Bell

Verve Energy Case Page

Every transactional lawyer, and his or her clients, can imagine the situation. Contract negotiations have stalled because one party is unable to commit unconditionally to an obligation: aspects of its performance, it says, are beyond its control. That party might be a builder who is reluctant to provide a warranty that a third party assessor will accredit a building’s environmental sustainability to a particular standard, or an information technology contractor which needs to provide documents to independent consultants but cannot guarantee that they will keep them confidential.

The contract needs to be finalised and signed. Where do the parties turn?

Inevitably, the drafter or negotiator will call for help from an ‘endeavours’ clause. Whether the adjective in which it is clothed is ‘best’, ‘reasonable’ or otherwise, the concept often ends up being the foundation on which the conditioned obligation rests. Prudent drafters typically seek to add precision, perhaps by specifying criteria by which the endeavours are to be tested, or by setting out specific action that the counterparty must take.

In Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7 (Verve Energy), the High Court was called upon to decide whether a clause requiring gas sellers to use ‘reasonable endeavours’ to supply a ‘supplemental’ amount of gas was breached by the sellers. They had declined to make that gas available, largely because they could charge more than the contracted amount for it.

A majority of the Court, consisting of French CJ, Hayne, Crennan and Kiefel JJ, found that there was no breach of the obligation (overturning the Western Australian Court of Appeal’s decision). Dissenting, Gageler J upheld the Court of Appeal’s interpretation. Both judgments provide useful guidance on the nature of endeavours obligations, as well as an interesting counterpoint to the detailed consideration of the topic recently provided by the Singapore Court of Appeal in KS Energy Services Ltd v BR Energy (M) Sdn Bhd [2014] SGCA 16 (KS Energy Services).

What happened?
The ‘Sellers’ (Woodside Energy in conjunction with other suppliers) entered into long-term contractual arrangements to supply gas to Verve Energy, a Western Australian electricity generator. The Sellers were obliged to make available a base quantity of gas known as the MDQ (for ‘maximum daily quantity’). They were also to use reasonable endeavours (on the terms set out below) to provide a supplementary quantity of gas known as SMDQ (for ‘supplemental maximum daily quantity’).

Disaster struck on 3 June 2008. An explosion at a gas plant at Varanus Island operated by a separate party (Apache Energy Ltd) temporarily reduced the supply of gas available across Western Australia by 30–35 per cent. However, the Sellers’ ability to supply gas was unaffected. Thus, the incident presented commercial opportunities for the Sellers.

The day after the explosion, the Sellers informed Verve Energy that, for the foreseeable future, they would not supply any SMDQ gas to Verve Energy. On 6 June 2008, the Sellers separately agreed to supply gas to Apache Energy. The prices for this gas far exceeded the prices under the agreement between the Sellers and Verve Energy.

Under protest, Verve Energy entered into two contracts with the Suppliers under which the Suppliers agreed to provide supplementary gas until 30 September 2008. This gas was provided at the then-prevailing (high) market rates, rather than the (lower) fixed rates that would have applied to SMDQ gas under the original agreement.

Ultimately, the dispute was over the excess amounts which Verve Energy had had to pay in order to maintain its access to the supplementary gas. We are not told how much money this involved, but it may be assumed that it was very substantial. (Le Miere J, at trial, noted that the prices were commercially sensitive and confidential, and that the trial was as to liability issues only, not the quantum of damages.) By the time it reached the High Court, there were two issues under appeal:

  • Whether the Sellers had breached the reasonable endeavours obligation; and
  • Whether Verve Energy needed to have rescinded the supplementary gas contracts (induced, as Verve Energy alleged them to be, by the Sellers’ economic duress) in order for restitution to be available.

Given that the majority found that there was no breach, they did not need to consider the second question. Gageler J, however, did consider it. Elise Bant discusses the restitution question here.

The key clause
Clause 3.3 of the gas supply agreement between Verve Energy (referred to as the ‘Buyer’) and the Sellers provided as follows (italicisation reflects the emphasis in the majority judgment):

3.3 Supplemental Maximum Daily Quantity

(a)        If in accordance with Clause 9 (‘Nominations’) the Buyer’s nomination for a Day exceeds the MDQ, the Sellers must use reasonable endeavours to make available for delivery up to an additional 30TJ/Day of Gas in excess of MDQ (‘Supplemental Maximum Daily Quantity’ or ‘SMDQ’).

(b)        In determining whether they are able to supply SMDQ on a Day, the Sellers may take into account all relevant commercial, economic and operational matters and, without limiting those matters, it is acknowledged and agreed by the Buyer that nothing in paragraph (a) requires the Sellers to make available for delivery any quantity by which a nomination for a Day exceeds MDQ where any of the following circumstances exist in relation to that quantity:

(i)             the Sellers form the reasonable view that there is insufficient capacity available throughout the Sellers’ Facilities (having regard to all existing and likely commitments of each Seller and each Seller’s obligations regarding maintenance, replacement, safety and integrity of the Sellers’ Facilities) to make that quantity available for delivery;

(ii)            the Sellers form the reasonable view that there has been insufficient notice of the requirement for that quantity to undertake all necessary procedures to ensure that capacity is available throughout the Sellers’ Facilities to make that quantity available for delivery; or

(iii)           where the Sellers have any obligation to make available for delivery quantities of Natural Gas to other customers, which obligations may conflict with the scheduling of delivery of that quantity to the Buyer.

(c)        The Sellers have no obligation to supply and deliver Gas on a Day in excess of their obligations set out in Clauses 3.2 and 3.3 in respect of MDQ and SMDQ respectively.

The clause seems to make a genuine attempt to provide the parties with greater certainty as to what will constitute relevant reasonable endeavours. Yet — as will be seen — if the three words ‘they are able’ had been omitted from cl 3.3(b), the litigation may well not have been so prolonged.

The High Court’s judgments
French CJ, Hayne, Crennan and Kiefel JJ (in a joint judgment) and Gageler J (in dissent) approached the case as a matter of contractual interpretation.

In approaching this question of interpretation, the majority made three general observations that serve to consolidate the pre-existing law on endeavours obligations (at [41]–[43] (citations omitted)):

First, an obligation expressed thus is not an absolute or unconditional obligation. …

Second, the nature and extent of an obligation imposed in such terms is necessarily conditioned by what is reasonable in the circumstances, which can include circumstances that may affect an obligee’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 obligee.

Given the detailed drafting in cl 3.3, these statements about the general law are arguably of limited relevance to the decision. They do, however, helpfully put in a nutshell the Court’s general approach to endeavours clauses (which may then be contrasted with the Singapore Court of Appeal’s encapsulation in KS Energy Services — more on that below). There is also tacit acknowledgement — by reference to the parties’ argument having proceeded on this as a shared basis — that there is no substantive difference in the abstract between ‘reasonable’ and ‘best’ endeavours obligations (see [40]).

The majority expressed their task as being to give cl 3.3 ‘a businesslike interpretation in accordance with the authorities’ (at [44]). In determining this interpretation, the commercial purposes of the agreement and the drafting of cl 3.3 as a whole were seen as critical. On this basis, the majority concluded that the clause did not require the Sellers to supply SMDQ gas in conflict with their business interests.

On the other hand, Gageler J focused upon the phrase ‘whether they are able to supply SMDQ’ in cl 3.3(b) and therefore whether, viewed objectively, the Sellers were capable of such supply at the relevant time (at [62]). He found that the reasonable endeavours imposed on the Sellers would be rendered ‘elusive, if not illusory’ if the Sellers were required to make SMDQ gas available at the contractually-determined price ‘only if and when the Sellers consider it to their commercial advantage’ (at [60]). Gageler J therefore would not have disturbed the Court of Appeal’s finding on the interpretation point.

Unanswered questions
For our late-night lawyer facing the need to draft an ‘endeavours’ clause, Verve Energy is like a cup of milky tea: welcome yet uncoveted. The majority decision no doubt will be cited in reasonable endeavours clause cases, but it merely consolidates aspects of the law that were already tolerably certain. Indeed, the Court was able to evade several interesting questions.

The first was whether ‘best endeavours’ and ‘reasonable endeavours’ impose substantially similar obligations. Disputes over this choice of words are commonplace in contractual negotiations. They are also of some significance, since Australian authority suggests the obligations will be similar, whereas the approach in the UK has sometimes been to treat ‘best endeavours’ as imposing a higher standard. As was noted above, the majority skirted this issue by noting that argument had proceeded on the basis that the obligations were substantially similar. Unhelpfully, the corresponding footnote refers to mixed authority.

Nothing in the judgment disturbs the prevailing current view that there is little distinction in the abstract (that is, where the contract does not provide further guidance as to the specific intent) between endeavours which are ‘best’ and ‘reasonable’ (see, eg, Elisabeth Moran and Cameron Ross, ‘Best Endeavours and Reasonable Endeavours: Is There Any Material Difference?’ (2014) 30 Building and Construction Law Journal 4). That said, a clear sentence — even if in obiter — would have added to certainty in this area.

The second question underlies many cases concerned with contractual interpretation: must express terms be ambiguous before evidence of the surrounding circumstances may be led? The question is of pressing importance given Gummow, Heydon and Bell JJ’s refusal of special leave to appeal in Western Export Services Inc v Jireh International Pty Ltd [2011] HCA 45 (Western Export).

The majority (at [35] of Verve Energy) describe the task of interpreting commercial contracts as requiring ‘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’. The corresponding footnote does not, however, refer to Western Export, nor is there any deliberation as to whether to consider the surrounding circumstances in respect of this gas supply agreement.

What can properly be read into this? First instance courts, litigators and the commercial community urgently await authoritative clarification from the High Court.

Is the Singaporean approach preferable?
Quite apart from these unanswered questions, it seems a missed opportunity that the Court did not have the opportunity to engage with the KS Energy Services decision, handed down in the Singapore Court of Appeal the week before Verve. Whilst that case considered an ‘all reasonable endeavours’ clause, V K Rajah JA (delivering the judgment of the Court) observed (at [64]) that the Australian position does not ‘appear to draw any real distinction between a ‘best endeavours’ obligation and an ‘all reasonable endeavours’ obligation’. (It has been proposed above that Australian law recognises little meaningful difference in the direct impact of the adjectives ‘best’ and ‘reasonable’ in this context.)

The Singaporean Court’s approach to the interpretation of such clauses reflects, it may be argued, the usual commercial imperative for their insertion. At [42], the Court explains that

[a] party under an absolute obligation undertakes to achieve a result, whereas a party under a non-absolute obligation merely undertakes to try to achieve a result in accordance with a particular standard of conduct (eg, reasonable endeavours). Non-absolute obligations may be desirable where the obligation requires the party concerned to procure the doing of something by a third party over whom he [sic] may not be able to exercise absolute control.

The Court goes on to note (at [94]) that, where an obligee is willing to accept a non-absolute obligation, the obligee ‘would require some assurance that its interests are protected, since the obligor may find it in its interests to prioritise other goals.’ The Court therefore cloaks ‘all reasonable endeavours’ clauses in the language it has previously applied to ‘best endeavours’ clauses (in Travista Development Pte Ltd v Tan Kim Swee Augustine [2008] 2 SLR 474), namely, ‘the standard of a prudent and determined man [sic], acting in the obligee’s interests and anxious to procure the contractually-stipulated outcome within the time allowed’. It then becomes, the Court indicates, a matter for the obligor to condition this standard by reference to the specific steps which it needs to take to discharge the endeavours obligation.

Generally, the Singaporean conception of endeavours clauses privileges the interests of the obligee and places the onus upon the obligor to show that it has done what is required in the circumstances to discharge its (albeit conditioned) obligation – so much may be gleaned from the six guidelines endorsed by the Court at [93]. In other words, endeavours clauses are viewed as placing a meaningful requirement on the obligor but relieve the obligor from completing performance of that obligation where it has done what it may reasonably be expected to do in the circumstances.

By contrast, the majority of the High Court — whilst proceeding upon a similar distinction between absolute and conditioned obligations (see [46]) — are, via a ‘businesslike interpretation’ of the contractual matrix provided (primarily) by cl 3.3, willing to read into the word ‘able’ both the Sellers’ capacity and business interests (see [47]). In turn, the Sellers were, in effect, held entitled to subordinate their (conditioned) obligation to supply supplementary gas to their own commercial interests. The upshot, therefore, was that there was no breach of the reasonable endeavours obligation even though the Sellers apparently made no substantial attempt to discharge the obligation during the day between the explosion at Varanus Island and the Sellers’ notification to Verve Energy that no SMDQ would be forthcoming for the foreseeable future.

The Singaporean approach may have been attractive to Gageler J in framing his judgment in Verve Energy. It certainly addresses his apparent underlying concern that accepting (as the majority did) the Sellers’ construction means that ‘there is no apparent reason to have included cl 3.3 at all’ (at [61]). In other words, if the endeavours obligation does nothing to stop the obligor from doing exactly what the Sellers did — in V K Rajah JA’s words, ‘prioritis[ing] other goals’ — it is difficult to see what meaningful comfort an endeavours obligation could give to an obligee.

The Singaporean Court offers an insight into why it takes the approach it does when it notes (at [3]) that express endeavours clauses are included to address the ‘lacuna’ that ‘[p]arties to a contract governed by Singapore law … do not ordinarily have either the burden or the benefit of a general obligation to conduct themselves in accordance with an ascertainable standard of commercial behaviour’. In other words, the Court considered that the lack of recognition of an implied duty of cooperation or good faith in contractual performance justified a stance which offers protection to obligees via an endeavours clause, even where those parties are — as in KS Energy Services — sophisticated commercial entities contracting at arm’s length.

This raises one intriguing additional aspect which, it may be hoped, the High Court will deal with when it finally addresses the question of a universal implied duty of good faith under Australian law: the interaction (if any) between such an implied duty and express endeavours provisions.

Pending such consideration, Verve Energy — whilst a useful restatement — changes very little for the lawyer contemplating her midnight drafting task whilst sipping upon her milky tea. Her own endeavour remains to obtain from the parties agreement as to the aspects of the relevant obligation which are in fact conditional, and then to reflect that agreement in drafting expressed in clear and practical terms.

Ultimately, therefore, the case serves as a reminder that endeavours-based clauses may — if appropriately framed — be viable where a party’s performance relies on factors which are in fact beyond its control. However, here, the objectively-determined intent was (at least in the view of the majority of the High Court) that the Sellers could have regard to their own commercial interests, to the exclusion of those of Verve Energy, in deciding whether to perform. Negotiators and drafters should typically resist the temptation to condition the obligation by reference to the obligor’s ‘interests’.

Verve Energy and KS Energy Services are, in this context, but the latest in a procession of judgments that demonstrate an important point. If the deal is in fact that a party should have discretion as to whether they will perform, rather than that they should be excused for imperfect performance (the latter being the proper domain of endeavours clauses), that is what the drafting should reflect. It then becomes a matter for the obligee to ensure that the basis on which the discretion is enlivened is acceptable. With respect, Gageler J is correct to note that the value of the endeavours clause to Verve Energy is essentially annulled by the majority’s approach to its interpretation. Perhaps the main practical lesson from the case is that an endeavours obligation, however framed, was never going to be adequate to protect Verve Energy’s own commercial interests in respect of the supplementary gas supply.

AGLC3 Citation: Wayne Jocic and Matthew Bell, ‘Endeavouring to Solve a Contracting Puzzle: Verve Energy’ on Opinions on High (14 March 2014) <http://blogs.unimelb.edu.au/opinionsonhigh/2014/03/14/jocic-bell-verve>.

Wayne Jocic and Matthew Bell are Senior Lecturers at Melbourne Law School.

M Bell 160 x 120Matthew Bell joined the Law School in 2005 after several years’ experience as a construction lawyer with Clayton Utz and Clifford Chance. He now leads the specialisation in Construction Law in the Law School. He is Professional Support Lawyer to the Construction and Major Projects Group at Clayton Utz on a part-time basis and the author of many publications in the field, including the texts Construction Law in Australia and Understanding Australian Construction Contracts (with Ian Bailey).