A duty to act rationally? Court considers circumstances in which contractual consent can be refused

Where a contract prevents the taking of a step without the consent of the other party, there may be an implied term to act rationally when considering that request, in line with the Supreme Court’s decision in Braganza v BP Shipping Limited [2015] UKSC 17 (‘Braganza’).

The implied term prohibits a party from acting irrationally, or in a way which is unconnected with its business interests. It would still permit the party being asked to give consent to act in its commercial best interests, with no suggestion that it should act against its best interests or to balance its own interests with those of the requesting party. 

Key issues in dispute

Macdonald Hotels Limited and Macdonald Botley Park Limited (together, “Macdonald”) had brought proceedings against Bank of Scotland plc (“BoS”), in relation to BoS’ decision to force the sale of three hotels owned by Macdonald in order to repay sums owed to BoS under two facility agreements (the “Facility Agreements”).

The Facility Agreements contained clauses which precluded Macdonald from creating any security, selling or disposing of the hotels without BoS’ prior written approval (‘the Consent Clauses’).

Macdonald argued that:

• the Consent Clauses gave BoS a discretion to determine whether, when and on what terms it would permit Macdonald to repay the sums due under the Facility Agreements;
• BoS had a duty to exercise its discretion in a rational manner, in accordance with Braganza
• BoS had, in effect, forced the sale of the hotels by refusing to consent to an alternative proposal put forward; leaving Macdonald with no choice but to sell the hotels to repay sums due under the Facility Agreements
• BoS had acted in bad faith, contrary to the express terms and/or implied terms of the Facility Agreements and should have permitted Macdonald to repay BoS in other ways and/or over a longer period, to enable them to avoid or delay selling the hotels for a historically low value

BoS argued that there was no implied term in the Facility Agreements pursuant to Braganza as it had an absolute right whether or on what terms to consent to the release of its security. In any event, even if such a term was implied into the Facility Agreements, BoS had not breached that term. 

Decision

Was there an implied term pursuant to the Braganza duty?

The Judge found that the contractual terms requiring permission anticipated that Macdonald might request BoS’ consent for creating security, selling or disposing of the hotels. No reasonable person with the relevant background knowledge would have thought that BoS was entitled simply to refuse to consider the request or refuse it for reasons unconnected with its commercial best interests. As such BoS was under an obligation to exercise its discretion in a rational manner.

What was the scope of the Braganza duty?

The Judge applied the principle set out in the Court of appeal decision in Property Alliance Group v Royal Bank of Scotland [2018] EWCA Civ 355 finding that no reasonable person would have concluded that, by including an express right for Macdonald to dispose of the hotels with the prior written approval of BoS, BoS was agreeing to an obligation to act against its own best interests or even to attempt to balance its own interests against those of Macdonald. When considering any request from Macdonald, BoS was entitled to (a) freely act in what it perceived to be its own best interests; (b) not balance its interests against those of Macdonald; or (c) not do anything other than exercise its own judgment in arriving at a conclusion.

The Judge rejected BoS’ argument that the court should refuse to impose such a duty given the potential for “serious and far-reaching implications for all mortgagor-mortgagee relationships”, in circumstances where the issues related to a bespoke rather than standard form agreement and the option to obtain consent could be omitted from drafting leaving a mortgagor to seek a contractual waiver or variation instead.

Had there been a breach of the implied Braganza duty?

Whilst a Braganza term was implied into the Facility Agreements, there had been no breach of those terms by BoS. BoS had been acting rationally and in its own commercial interests when it rejected the alternative proposals for repayment of the sums due by Macdonald. This was not a case where Macdonald was simply seeking consent to sell the hotels of its own volition, and that request was refused by BoS. If that had been the case, the Judge’s analysis may have been different.

For this and other reasons, which are outside of the scope of this briefing, the claims against BoS failed.

Implications

Commercial organisations of all types, not just financial institutions, should be aware that where there is a contractual term which permits one party to obtain the consent of the other party to an action which is otherwise prohibited, the party whose consent is sought may be under an obligation not to unreasonably withhold that consent and act in a rational manner. This is the case even in the absence of the words ‘not to be unreasonably withheld’. However, that obligation will not extend to the party whose consent is sought being required to act against their legitimate commercial interests or balance those interests with the interests of the counterparty.

The Judgment carefully considered the authorities and distilled the key principles for when a term might be implied into a detailed commercial agreement. Generally speaking the courts will only imply a term if it is necessary in order to give the contract business efficacy or was so obvious that it goes without saying, and the proposed implied term appears fair or is one that the court considers the parties would have agreed if it had been suggested to them.

Whilst every case will turn on its own facts, a way for a party to avoid inadvertently becoming subject to a Braganza style implied term may be (as suggested by the Judge in this case) to avoid including any mechanism for the counterparty to seek consent for actions which are otherwise prohibited, relying instead on the usual process of contractual variation.