Honouring contract law

Professor Bob Baxt hopes a recent High Court ruling will temper attempts to further undermine the sanctity of the law of contract.

Much is happening on the competition law front. The federal government is looking at the operation of the unconscionable conduct provisions in legislation (in particular, in the Competition and Consumer Act 2010). It has also initiated a “root and branch” review of competition law policy (chaired by Professor Ian Harper) and franchise law reforms, and it plans to introduce an unfair contract regime.

Given this backdrop, it is pleasing to see that the High Court of Australia has confirmed that the intentions of parties in drafting contracts should generally be honoured. Even though a contract may contain language which allows the parties involved to try to ensure that the original contract terms are maintained, the ruling gives them flexibility in difficult commercial circumstances.

There are events that may lead the courts to a different conclusion – for example, if there is undue pressure (economic duress) present or possible unconscionable conduct, such as inequality of bargaining or the inclusion of clauses that are not necessary in the relevant contractual scenario. 

But many will be pleased with the High Court decision in Verve Energy v Woodside Energy Limited [2014] HCA 7 — a majority judgment by justices French, Hayne, Crennan and Kiefel (with Justice Gagelar in dissent).

In this decision, the High Court confirmed that a “tough” contract entered into by Woodside Energy with various purchasers of gas, which allowed Woodside “to use reasonable endeavours” to protect its commercial position in the event of a physical “disaster”, was one that should not be easily set aside.

In this case, Woodside had entered into contracts with a number of organisations, including the Electricity Generation Corporation which traded as Verve Energy. Under these contracts, Woodside agreed to supply gas under long-term gas supply agreements (known as GSAs). The relevant provision in the Verve GSA (a provision which also appeared in other contracts) required Woodside to “use reasonable endeavours” to make available to the purchaser a supplemental maximum daily quantity of gas (referred to as SMDQ) at a fixed price. The contract also provided that Woodside could “take into account all relevant commercial, economic and operational matters” in determining whether it was in a position to supply the relevant SMDQ to Verve on any given day.

A major explosion at a gas plant of a Woodside competitor led to a 30 to 35 per cent drop in the natural gas supplies available in the Western Australia. As a result, demand exceeded supply and the price of gas, in spot contracts particularly, increased dramatically.

Woodside informed Verve that, while it could not make available gas under the SMDQ, it would supply the same amount of gas to Verve under a new short-term agreement at the market price. This price was much higher than the fixed price that had been negotiated under the long-term contract.

Verve was, in effect, “caught between a rock and a hard place”. It could either take Woodside’s gas at the higher price or it could seek alternative supplies elsewhere.

Verve challenged Woodside’s interpretation of the contract, arguing that it was inappropriate for Woodside to increase the gas price in relation to the SMDQ provision.

As a result, Verve sued Woodside in the WA Supreme Court. The trial judge, Justice Lemiere, disagreed with Verve’s argument that Woodside had breached its agreement to “use reasonable endeavours” to make gas available under the SMDQ at the same price.

Verve argued that the fact that Woodside’s contract contained language that allowed it to take various matters into account in determining whether it was “able” to supply the relevant gas under the SMDQ, this was not sufficient to relieve Woodside of its obligation to supply the gas at the same fixed price regime provided for in the particular contract.

Verve also argued that by offering to supply gas at the higher price, Woodside was exerting undue pressure and that, as a result, Verve suffered economic duress.

Verve lost and appealed the decision.

The WA Court of Appeal reversed Justice Lemiere’s decision. Woodside then turned to the High Court of Australia for a further review.

In an important judgment, the High Court of Australia supported the arguments put forward by Woodside in the interpretation of the contract.

The majority of the High Court commenced its analysis (para 35) by noting that contracts of this kind were to be determined on the language of the contract and by “what a reasonable business person would have understood [the relevant terms] to mean”.

In the High Court’s view, this required it to apply an objective approach in evaluating the language and the circumstances surrounding the use of the language in the particular dispute.

The majority then considered the words “reasonable endeavours” and the effect of such an expression in evaluating contracts of this kind.

The language of the majority judges presents some interesting commentary on the reasonableness of behaviour on the part of vendors, and others who may be in a similar position in dealing with contractual relationships of this kind, particularly where extraneous events play havoc with normal expectations.

Some might consider the judges’ language as being rather harsh because it enables more powerful players in the market to extract higher prices than those agreed on in the contract, on the basis of extraneous events.

The majority argued that to deal with the contractual question, the court had to assess how the relevant clauses would be determined by the language and the surrounding circumstances known to the parties and the commercial purpose or objects to be secured by the contract (para 35).

Next, they considered the expressions “reasonable endeavours” or requirements that stipulate that “obligations are not absolute or unconditional” and noted that these were to be assessed by what “is reasonable in these circumstances”, which included circumstances that may affect an obligee’s business (para 41).

In essence, the majority’s view was that companies, such as those in Woodside’s position, were not necessarily required to use reasonable endeavours in circumstances under a contract which would lead to the “certain ruin of the company or the utter disregard of the interest of its shareholders” (para 42).

In the court’s view, the explosion had placed Woodside in the position where it would be against its interest to continue supplying the gas to Verve at the price originally agreed to and set out in the contract.

The majority added that the ability of Woodside to supply the gas at the agreed price was “qualified, in part, by reference to the restraints imposed by commercial and economic considerations” (para 47).

The majority concluded that it was not necessary for Woodside to continue to supply the gas at the price specified in the agreement even though it had a capacity to do so, because it was entitled to take into account its own peculiar economic and other commercial interests and to ensure that the company did not suffer significant loss.  Justice Gagelar, as noted earlier, dissented. A brief quotation from his judgment quite clearly expresses the position that many would feel is the better position to be taken in scenarios such as this.

He noted: “I am unable to see how reasonable commercial parties in the position of [Woodside] and [Verve] having agreed on ... the fixed price for such gas ... and having agreed ... that [Woodside] must use reasonable endeavours to make gas nominated by [Verve] available for delivery up to the [relevant amount] can be taken to have meant ... to give [Woodside] a discretion not to make gas available for delivery up to the [relevant amount] merely because market circumstances present an opportunity for [Woodside] to demand a substantially higher price for that gas than the price fixed” (para 59).

He ruled that Woodside’s desire to maximise its profits in the circumstances did not enable it to treat the language in the contract as giving it the kind of flexibility that it felt was appropriate.

It is interesting to note that the High Court’s interpretation is regarded as different to the approach that has been taken in other jurisdictions in interpreting the “best endeavours” or “reasonable endeavours” clauses.

These terms have sometimes been interpreted in a more generous manner to parties such as Verve (see, for example, Jet Two.com Limited v Blackpool Airport Limited [2012] to ALLER 153). The UK court took a softer line than that taken by the High Court.

I agree with the approach taken by the High Court of Australia because I believe that contract law should, by and large, be left untouched by some of the more extraordinary reforms that are being considered at this time.

The unconscionable conduct provisions inserted into the then Trade Practices Act in the 1990s (now the Competition and Consumer Act), to permit small businesses to challenge what they regard as “unreasonable”, or in the language of the statute “unconscionable” contracts with businesses both big and small, have so far proven to be a failure in our courts.

Very few cases have been run by the Australian Competition and Consumer Commission. There have also been very few private cases and most are lost. Competition is by its very nature very difficult and ruthless and inefficient businesses fail. There are many small businesses, however, that can, and do succeed even if they have to negotiate tough contracts.

As noted earlier, we are about to have introduced into Australian law a broad-based unfair contract regime. How broad it will be is as yet uncertain. Minister for Small Business, Bruce Billson, has signalled that the government is determined to create an environment in which small businesses will get what he sees as a “fairer go” in dealing with bigger businesses, or even equally small businesses, where unfair terms are imposed. What is the meaning of unfair? That issue will be of major interest to all lawyers, professional advisers and their clients.

Company directors need to watch out for these changes. They are coming in a number of different ways as noted above.

I hope the wisdom of the majority of the High Court in this case will temper attempts to further undermine the sanctity of the law of contract. This law has operated fairly and efficiently for many hundreds of years. Changing it as dramatically as has been suggested in recent innovations, has only led to significant uncertainty in how the law of contract will be treated in the future.