Added: Anisa Mcdavid - Date: 11.12.2021 10:26 - Views: 19176 - Clicks: 3772
Commercial contracts often afford one party a discretion as to whether or how it exercises its rights or fulfils its obligations. For example, a contractual option may give the option holder the right, but not the obligation, to exercise that option provided that any applicable conditions are met. In a variety of contexts, a party may require the consent of another to do certain things. Finally, under certain finance and derivatives contracts, one party is often tasked with valuing the underlying assets in certain circumstances e. In such instances, the following question arises: what are the limits, if any, on the exercise of such contractual right or discretion?
The simple if not the most practical answer is that it is fundamentally a matter of construing the contractual provision in question. That said, there has been substantial judicial scrutiny of this issue in recent years, resulting in the development of a set of principles, which will be of assistance to commercial parties. This article will survey this line of authorities, including the most recent developments in commercial and finance contexts, Need absolute discretion also seek to give some practical points to consider, both before and after any dispute arises as to the proper exercise of the right or discretion in question.
Leggatt LJ stated the following principle in relation to Need absolute discretion exercise of a contractual discretion:. In my judgment, the authorities show that not only must the discretion be exercised honestly and in good faith, but, having regard to the provisions of the contract by which it is conferred, it must not be exercised arbitrarily, capriciously or unreasonably.
It is important to note that the limitation applied even though there were no express limitations or qualifications on the exercise of such discretion. In a finance context, essentially the same limitation was held to apply in Socimer International Bank v Standard Bank London Ltd  EWCA Civa case in which one party to an agreement for the forward sale of a portfolio of securities was tasked with its valuation. Leaving aside for the moment the precise nature of the limitation and how it is applied by the Court which will be addressed in the next sectionwhen will any such a limitation be implied at all?
There will be no limitation implied in respect of an absolute contractual right, whereas there will be unless there are clear express terms to the contrary in respect of a contractual discretion. It is fundamentally a matter of construction of the particular contractual provision whether the party has an absolute contractual right or a mere contractual discretion. Therefore, the express terms will play a key role. If a contractual provision expressly limits or qualifies the way in which a party can exercise a right or perform its obligations e.
There are no hard and fast rules in this regard; the wording and the substance of the provision in question must be carefully examined to determine whether it confers an absolute contractual right or a mere contractual discretion. That said, and although not universal, it seems that where a party is entrusted with performing a quasi-adjudicative role in the context of conflicting interests of parties, the performance of that role will be subject to a limitation of the type described above.
Finally, being an implied term, the limitation may of course be excluded by contrary express terms. However, authorities suggest that although not utterly impossible, it would be extremely difficult to exclude. However, this language did not exclude the implication of the limitation.
How are we to interpret the implied limitation on the exercise of a contractual discretion? What are the standards it imposes? The authorities set out the following principles, which apply in the absence of express words to the contrary. The requirement of honesty and good faith seem clear enough; the party afforded the discretion the decision-maker must properly direct itself to the task in hand and should not exercise the discretion in question in furtherance of an ulterior motive.
However, this is not to say that the ambit of discretion will be wide in every case. In certain factual circumstances, it may well be that there are only very limited ways in which a party can exercise the discretion in question without falling foul of the rationality test. The more difficult and uncertain the exercise of the discretion in question, the wider the range of rational decisions will likely be.
For example, this will likely be the case in the valuation of illiquid securities in difficult market conditions with little or no reliable pricing information 3. This means that, where there is a range of decisions that a party could have taken within the bounds of rationality and the original decisions falls within that range, the decision remains that of the decision-maker and the Court does not Need absolute discretion it with a decision which it or anyone else, for that matter would prefer.
It seems that, at least in certain circumstances, the decision-maker may consult its own interests in exercising a discretion, as opposed to approaching the exercise with complete neutrality. However, it is suggested that caution must be exercised in this regard. In all of the cases above, the commercial rationale for giving the discretion as to valuation to one party was to protect itself from risk and the difficulty of the valuation in question were key factors in arriving at the conclusion that such a Need absolute discretion may take its own interests into.
Although in many cases the very purpose of affording a discretion to one party might well be to protect that party from risk, it may not always be so. The authorities have generally focussed on the end result of the exercise of a contractual discretion. In that case, the Supreme Court did scrutinise not only the outcome but also the decision-making process. Many will regard Lehman v ExxonMobil as a welcome decision for sophisticated commercial parties who, in most cases, may wish to avoid the uncertainties and expense of a full judicial review of the decision-making process pursuant to a contractual discretion.
However, this is not Need absolute discretion encourage parties to pay no regard to the process adopted in exercising the discretion. In practice, a rational decision-making process carried out honestly and in good-faith is likely to lead to a robust and defensible outcome. Finally, of course parties are entirely free to expressly provide for the review of both the process and the outcome.
What does the Court do if: a the Court has decided that the original exercise of a contractual discretion was contractually non-compliant; or b the discretion had to be exercised but, for whatever reason, the discretion was not exercised at the relevant time and cannot now be exercised? Consistent with the principle set that the decision remains that of the decision-maker, the authorities are clear that the Court will ask a question of what contractually compliant decision the decision-maker would have made 4.
First, this means that the Court will not simply provide its own preferred contractually compliant decision. To do so would largely deprive the decision-maker of the benefit of the discretion conferred upon it.
That said, it may well be that, on the evidence, the most favourable contractually compliant decision which the decision-maker could have made was what it in fact would have made. This is entirely credible in cases such as SocimerWestLB v Nomura and Lehman v ExxonMobil where the decision-maker would have been entitled legitimately to consult its own interests. Given the hypothetical nature of the exercise, this will most likely be in the form of a witness statement from the individual who was or would have been entrusted with making the relevant decision 6.
In conclusion, the exercise of contractual discretion has received substantial judicial scrutiny in recent years, with many cases reaching the appellate level. See, for example, Cantor Fitzgerland v Horkulak where the Court rejected the submission that an employer should be assumed that it would simply have paid the minimum permissible level of discretionary bonus instead of working through how it would, in fact, have determined the level see paragraph .
Introduction Commercial contracts often afford one party a discretion as to whether or how it exercises its rights or fulfils its obligations. Own interests It seems that, at least in certain circumstances, the decision-maker may consult its own interests in exercising a discretion, as opposed to approaching the exercise with complete neutrality.
Process v outcome The authorities have generally focussed on the end result of the exercise of a contractual discretion. The key practical points for commercial parties are as follows: Express terms. Much of the analysis above applies in the absence of further or contrary express terms in relation to the right or discretion in question. Clear express terms to the contrary may displace the above analysis so careful attention should be given in drafting and interpreting provisions conferring contractual rights or discretion.
The decision maker. One should determine at the outset whether the contractual provision confers: a an absolute contractual right; b an absolute contractual obligation; or c a contractual discretion. Under aits Need absolute discretion will be unfettered. Under bthere will be no right or discretion and the obligations must be performed strictly in accordance with the contract.
Under cthere may be a range of options, the width of which will depend on the particular circumstances. In an extreme case, there might only be one or a very narrow range of rational decision swhich will make the discretion largely illusory. Challenging the exercise of the right or discretion. Under athe exercise cannot be challenged.
Under bthe decision-maker will be in breach if it does not perform its obligations strictly in accordance with the contract. The more difficult the decision, the more likely it is that the decision-maker will be afforded a wide discretion. In such cases, it may be difficult to displace the original decision. Adduce the right evidence. Where there has been no or no contractually compliant exercise of discretion, the need to produce factual evidence as to what the decision-maker would have done has been mentioned above. In some cases, expert evidence may also be required to assist the Court in deciding what the range of contractually compliant outcomes is i.
However, when adducing such evidence, it is important to ensure that the Need absolute discretion evidence addresses the right question: that is, what range of outcomes could the decision-maker have determined, acting honestly, in good faith and rationally. What the experts themselves would have done, or would prefer, is legally irrelevant and will be of little assistance to the Court 7. Recent publications. Publication Banking and finance perspective. Global July 13, Banking and finance. Publication Getting back on track: Mental health and a return to the workplace As things continue to move in the right direction vaccinations, declining infection s employers and teleworking employees are contemplating a return to the physical workplace soon.
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