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Discretionary right in contract

Most people would assume that, if a contract gives one party a right to do something “in its absolute discretion”, that is the end of the matter.

It’s not that simple. Whilst carefully avoiding doing anything that could be seen as re-writing commercial contracts or putting themselves in the position of the party with the benefit of the discretion, the English courts have, in recent years, shown a great deal of willingness to decide that terms are implied into contracts about how discretions have to be exercised.  

As well as the more widely-known and nebulous duty of good faith, which may prevent exercise of a discretion and taking of a decision in bad faith and for an improper purpose, there is also the lesser-known “Braganza” duty, named from a 2015 Supreme Court case, Braganza v BP Shipping. Here, a widow was entitled to receive a death-in-service payment for her husband unless “in the opinion of the company or its insurers, the death … resulted from … the officer’s wilful act, default or misconduct…”, meaning that the employer, BP Shipping, had a fact-finding role, which could end up with the employee’s estate being deprived of a contractual benefit. Mr Braganza had been lost overboard from a ship, MV British Unity, in unexplained circumstances. A general manager decided, having received a report from its investigation team, that Mr Braganza had committed suicide, which meant that his widow was not entitled to receive the death-in-service benefit because of his “wilful act”.

What was wrong here, in the view of the Supreme Court, was that the decision-making process followed was not correctly carried out and did not take into account matters that should have been taken into account. There was no particularly cogent evidence that Mr Braganza had committed suicide and so an implied duty of rationality had not been observed, a duty not to act arbitrarily or capriciously in carrying out a decision-making process under a contractual right. Mrs Braganza won her appeal, and US$230,265 and interest.

An earlier case had put it like this; “a decision-maker’s discretion will be limited, as a matter of necessary implication, by concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality. The concern is that the discretion should not be abused.” Although the “Braganza” duty is of general application (but see below), it is more likely to be implied in cases where there is an inequality of bargaining power between the parties to the contract, such as an employment contract.

A couple of caveats.

The English courts have, in recent years, shown a great deal of willingness to decide that terms are implied into contracts about how discretions have to be exercised.  

First, the “Braganza” duty is not a duty of reasonableness. In other words, it is not a duty to act in a way that is objectively reasonable. A contract may require that, but that is not a “Braganza” duty.

Second, lenders are generally not subject to a “Braganza” duty when deciding whether to exercise an “absolute discretion” to call in a loan, for example under security documents. This is because the duty generally only applies in contractual decisions that affect the rights of both contract parties, meaning the decision-maker is likely to have a conflict of interest. Where a loan is repayable on demand, the power to demand repayment is exercised solely for the lender’s benefit; in fact, the law relating to lenders’ entitlements to call for repayment is very clearly in their favour. A recent case, UBS v Rose Capital Ventures Limited, has emphasized this.

By way of conclusion, for a party (other than a lender perhaps) holding a discretion under a contract where there is any element of decision-making involved in the exercise of that discretion, it is important that all relevant matters are properly considered, that there’s sufficient (and auditable) evidence to support the decision and the views of those taking it at the relevant time, and that, ultimately, the final decision is credible and doesn’t defy common sense.

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This information is for guidance purposes only and should not be regarded as a substitute for taking legal advice. Please refer to the full General Notices on our website.

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