Contractual discretion and interpretation

Answer

Certain clauses in a contract allow for an element of discretion on the part of one or more of the parties. In some cases, the court will imply that the party exercising that discretion must ensure that it doesn’t do so “arbitrarily, capriciously or irrationally”. This is known as a ‘Braganza duty’, after the Supreme Court case of Braganza v BP Shipping Limited [2015]. The recent High Court case Sibner Capital Ltd v Jarvis [2022] EWHC 3273 (Ch) considered whether a lender’s right to exercise its discretion in deciding what sum to accept was subject to an implied duty to act in good faith and/or subject to a Braganza duty. 

Background

A lender agreed to provide loans to the borrower company to develop a property. The loan facility was guaranteed by two individuals. A joint venture (JV) agreement was also entered into that same day by the lender, the borrower, the guarantors and the owner of the property to be developed.

The loan facility agreement stated: “The lender may in its absolute discretion accept a sum less than the Tranche A commitment plus interest on the Tranche A Repayment Date in satisfaction of the Borrower’s obligation to repay the Tranche A Facility on that Date…”.

The JV agreement required the parties to act in good faith. However, it also stated that this requirement didn’t restrict the lender’s rights under the finance documents, including those arising following an event of default.

The lender agreed to accept a certain sum from the guarantors, but on the basis that the agreed sum would be paid by 22 December 2020 and the balance would be paid by 31 January 2021. The guarantor failed to pay the balance on time and the lender therefore served statutory demands on the guarantors. The guarantors made an application to court to set aside the statutory demands, on the basis that the debt was disputed.  

District judge’s decision

The district judge found in favour of the guarantors and set aside the statutory demands, stating that:

• the guarantors had a realistic prospect of demonstrating that there was an implied duty to act in good faith or to refrain from acting in a way which was arbitrary, capricious or irrational; and
• the lender had breached that duty.

The lender appealed on the basis that it had absolute discretion under the loan facility agreement.

High Court (Chancery Appeals Division) decision

The High Court found in favour of the lender, upholding the statutory demands. It noted that, under the terms of the loan facility agreement, the lender had an absolute discretion whether to agree to accept less than full repayment and the discretion wasn’t expressly qualified in any way.

The court noted that, when a contract gives one of the parties an absolute right, a court will not usually imply any restrictions on it. Absolute rights conferred by professionally drawn or standard form contracts are an everyday feature of the contracts that govern commercial relationships. Extending Braganza to such provisions would be an unwarranted interference in the freedom of parties to contract on the terms they choose (TAQA Bratani Ltd v Rockrose [2020] EWHC 58 (Comm)).

The court concluded that there was no realistic prospect of the guarantors establishing that the lender was under a duty of good faith or other Braganza style duty in exercising its discretion whether to accept payment of less than the full amount of Tranche A on the due date in accordance with the loan facility agreement.

This was a commercial contract, prepared with legal assistance between experienced commercial parties. The relevant clause contained no qualification and stated that the lender had an absolute discretion whether to accept less than it was entitled to.

It was also relevant that the JV agreement, while containing an obligation for the parties to act in good faith, specifically provided that this obligation shouldn’t affect the lender’s rights under the loan facility agreement. In addition, the documents were clear that Tranche A was to be repaid in full before any other steps were to take place.

Taking into account the characteristics of the parties, the commercial context and the terms of the contract as a whole it was clear that this wasn’t the sort of provision where it would be appropriate to imply an obligation of good faith.

Accordingly, there were no substantial grounds for disputing the debt on this basis.

Impact of the decision

Financial institutions acting as lenders with an unqualified contractual discretion can exercise that discretion absolutely. 

This also applies to other parties with an unqualified contractual discretion where the contract has been negotiated.

The court’s aim when reviewing contracts is to strive to uphold the clear wording of the clause wherever possible (Arnold v Britton [2015]). A party seeking to exercise a contractual discretion is only likely to owe a Braganza duty where there’s some conflict between its contractual obligations and the decision-making process. 

Top tips for aspiring lawyers

The past decade has seen a number of key decisions emerging from the court on the interpretation of contracts. The current trend is for the court to take a literalist, and less interventionist, approach to interpretation. 

Lawyers drafting contracts, or advising on contractual disputes, must be aware of the following cases relating to contractual interpretation and implied terms:

• Investors Compensation Scheme Limited v West Bromwich Building Society (No. 1) [1997] UKHL 28.
• Equitable Life Assurance Society v Hyman [2000] UKHL 39.
• Attorney General of Belize v Belize Telecom Ltd [2009] UKPC 10.
• Mid Essex Hospital Services NHS Trust v Compass Group UK & Ireland Ltd (t/a Medirest) [2013] EWCA Civ 200.
• Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Ltd [2015] UKSC 72.
• Wood v Capita Insurance [2017] UKSC 24.
• Federal Republic of Nigeria v JP Morgan Chase Bank NA [2019] EWHC 347 (Comm).
• Barton v Morris [2023] UKSC 3.

Susannah Jury is a trainee solicitor at Bevan Brittan LLP