Time to decide...how to exercise contractual discretion five years after the Braganza case

Contracts often allow parties to make decisions but recent cases show that there may be strings attached and that decisions can be challenged by the courts

13 February 2020

This article was originally published in the Commercial Litigation Journal January/February 2020. It looks at what we can learn from five years of case law since the landmark decision in Braganza v BP Shipping [2015] UKSC 17.

In Braganza, the Supreme Court held that, where one party to a contract had the right to exercise a discretion or to form an opinion which might be to the detriment of the other party, steps might have to be taken to ensure that such rights were not abused. Protection was provided by implying a term as to the manner in which such discretion should be exercised.

Braganza concerned a dispute over employment (death-in-service) rights, but in the five years since the Supreme Court’s decision, the principles of the case have been applied to a wider variety of contracts.

What was decided in Braganza?

Mr Braganza, an employee of BP Shipping, disappeared without trace in 2009 whilst working on one of BP’s oil tankers. Under the terms of his employment contract, BP did not have to pay death-in-service benefits to his widow if, in BP’s opinion, Mr Braganza’s death resulted from his wilful act, default or misconduct. BP’s conclusion that Mr Braganza had committed suicide meant that no benefits were payable. 

The Supreme Court held that the clause that required BP to form an opinion as to the circumstances of Mr Braganza’s death was subject to an implied term requiring BP to do so 'rationally'. This was not a radical decision; terms had been implied before Braganza which required a decision-maker to exercise discretion in a way that was not arbitrary, capricious or irrational (Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd [2013] EWCA Civ 200).

However, the Supreme Court specifically applied public law principles to a private law matter, holding that the two limbs of the Wednesbury unreasonableness test (Associated Provincial Picture Houses Ltd v Wednesbury Corporation [1948] 1 KB 223) should apply to a contractual discretion clause. This required the courts to consider whether:

  • the right matters had been taken into account in reaching the decision; or
  • the result was so outrageous that no reasonable decision-maker could have reached it.

The result was that BP’s conclusion that Mr Braganza had committed suicide was unreasonable and in breach of the implied term. Mrs Braganza’s claim for death-in-service benefits succeeded.

Braganza therefore, is a rare example of judicial intervention to limit private parties’ freedom to contract.

This article looks at how the courts have applied Braganza and offers practical tips for those who want to exercise contractual discretion.

When is a Braganza term implied?

Braganza has not opened the floodgates and those cases in which a Braganza term has been implied are few and far between.

Indeed, the courts appear more likely, at least in the cases to-date, to find that the relevant decision-maker was not exercising a discretion but rather a contractual power – to which Braganza is not relevant.

Contractual Power

A contractual discretion affords a party some freedom to decide what should be done or what opinion to reach. A party may, for example, be required to exercise its discretion over the interest rate for a loan or, as in the case of Braganza, form an opinion as to how an employee died. In contrast, a contractual power is binary; a party may exercise the power or not. Post-Braganza, the courts have been willing to find that many disputed clauses, including those that refer to a party’s ‘discretion’, are, in fact, powers that are not subject to the implied term.

For example, in Shurbanova v Forex Capital Markets Ltd [2017] EWHC 2133 (QB), the defendant (FX) revoked Shurbanova’s forex trades on the basis they had been 'abusive', in breach of its terms of business.

Shurbanova argued that FX’s decision was either:

  • an exercise of contractual discretion by which FX chose how to respond to abusive trading; or
  • a determination, in FX’s opinion, as to whether there had been abusive trading.

In either case, the decision should be subject to an implied Braganza term that it be exercised rationally.

HHJ Waksman QC was unpersuaded by Shurbanova’s arguments, holding FX’s stated contractual remedies could not be subject to a rationality provision and that, in any event, FX’s decision had been the exercise of a binary contractual power (there either had, or had not, been abusive trading), and not a discretion. 

In contrast, in BHL v Leumi ABL Limited ([2017] EWHC 1871 (QB)), the bank’s entitlement to charge the claimant an additional collection fee at up to 15% per cent of amounts collected was subject to the implied term. HHJ Waksman QC found that 'otherwise [the bank’s right] could be exercised oppressively or abusively' and 'must be exercised in a way which is not arbitrary, capricious or irrational in the public law sense'. The bank could not simply charge 15 per cent because it wanted to.

Braganza and Abuse of Power

In those cases where a Braganza term has been implied, there is a clear justification that the term is necessary in order to prevent, or protect against, an abuse of power by the decision-maker. There are two occasions in particular when this might happen.

First, where the decision-maker has a conflict of interest when exercising their discretion or forming their opinion. Clearly, in Braganza, BP had an interest in the outcome of their factual inquiry into Mr Braganza’s death that would either result in BP paying, or not paying, death-in-service benefits.

Secondly, where there is an imbalance of power between the parties. In the employment context, an employee often has to contract on the employer’s terms and the employer has greater negotiating power and resources. 

There may not be an imbalance of power in other contexts, such as banking disputes. Take, for example, UBS AG v Rose Capital Ventures Ltd [2018] EWHC 3137 (Ch). UBS provided a loan to Rose that gave UBS an 'absolute discretion' to require repayment on three months’ notice. A factor in favour of finding that there was no implied term limiting how UBS could exercise its discretion was the relative balance of power between UBS and Rose.

Necessity

The Braganza term will also only be implied if it is necessary to make the contract work or if its inclusion would have been so obvious at the time of contracting that it goes without saying (UBSv Rose and Watson v Watchfinder, both applying Marks and Spencer plc v BNP Paribas Securities Services Trust Co (Jersey) Ltd [2015] UKSC 72). Chief Master Marsh saw no basis in UBS for implying a Braganza term because, in part, mortgage lending has built up its own protections in the form of the duty of good faith.

What are the practical issues when exercising contractual discretion?

Five years after Braganza, the courts continue to scrutinise contractual discretion clauses where an imbalance of power and a conflict of interest could lead to the decision maker abusing their powers. However, a proper application of Braganza will depend on the facts of each case, and this generates uncertainty for parties trying to apply the judgment in Braganza in practice. Looking at both the exercise and outcome of the discretion raises two practical problems: one for the claimant/decision-recipient and one for the defendant/decision-maker.

Claimant problem – Demonstrating irrationality

How can a claimant demonstrate that a decision-making process was irrational? Both parties will know the outcome. The claimant will rely on the contract and its context to explain, in their opinion, why the outcome was so unreasonable that it breached the Braganza requirement for a reasonable decision.

If the outcome is clearly unreasonable, the claimant may also be able to argue that the decision-making process was prima facie irrational – it would, arguably, be difficult for a defendant to maintain that an unreasonable outcome was the product of a rational decision making process. As a result, the claimant may be able to shift on to the decision-maker the burden of proving that the process adopted was rational.

But what can the claimant do if the outcome appears reasonable? Only the decision-maker will know what its decision-making process was, and it is likely that only they hold the evidence that will demonstrate the rationality, or otherwise, of that process.

Individuals, including those in the employment law context, may be able to access relevant information by making a data subject access or Freedom of Information Act request. The information provided in response may only paint a limited picture of the decision-making process, but this may nevertheless be sufficient to suggest the decision-making process was irrational, and, in turn, shift the burden on to the employer to justify its decision (UBS).

In other contexts, such as banking disputes between a bank and a corporate borrower, we do not yet know at what point the burden of proof may pass to the decision-maker. At the very least, claimants must adduce sufficient evidence that there has been a breach of the Braganza term (UBS). We anticipate that pre-action disclosure will become a key battleground in these disputes going forward, as claimants seek to gather enough evidence of irrationality to transfer the burden of proof.

Defendant problem – How to make a decision

This will depend, in part, on what standards the decision-maker is expected to meet under the implied term. In Braganza, the Supreme Court said that '[I]t may very well be that the same high standards of decision-making ought not to be expected of most contractual decision-makers as are expected of the modern state.' (our emphasis). There is a great deal to be uncertain about in this statement:

  • Are contractual/commercial decision-makers held to the (very) high standards applied to state actors or not?
  • If they are, do those standards apply to all contractual/commercial decision-makers or just some?
  • If a line is to be drawn, where is it drawn and what is the difference in standard on either side of the line?

BHL v Leumi [2017] EWHC 1871 (QB) is an interesting decision in which the court applied a higher standard to Leumi’s decision-making. Leumi was a sophisticated organisation with experience of performing collections. It was familiar with the process for estimating collection fees and, therefore, the court held that it was appropriate to hold Leumi to a high standard when considering its decision. 

The nature of the decision to be reached will also be relevant. In Braganza, the fact that suicide was an 'improbability' meant 'cogent evidence [was] required to form the positive opinion that it has taken place'.

How should a decision-maker evidence their decision?

Evidence was an issue in Watson v Watchfinder [2017] EWHC 1275 (Comm). The claimants sought specific performance of a share option agreement between themselves and Watchfinder in which the claimants would receive options in Watchfinder if they introduced new shareholders to the company. Watchfinder relied on a clause which they said gave them a right to veto the option being exercised, but the claimants contended that the clause amounted to a discretionary power which should be subject to an implied Braganza term. HHJ Waksman QC held that the clause was subject to an implied term; the issue then became whether it had been breached.

Watchfinder provided inconsistent evidence about who was involved in making their decision, when it happened, and what (if any) discussion led to the decision. This was, in part, because the directors worked on the mistaken belief that they had an unconditional right to veto any payment to the claimants. As a result, the claimants were able to establish breach. In the extreme, if there is no evidence, it might appear that the decision was made “by throwing darts at a dart board” (Hills v Niksun Inc [2016] EWCA Civ 115).

The nature of the evidence needed to demonstrate that a decision-making process was rational will depend on the facts of each case, but evidence of how, when and by whom the decision was made will be a starting point for any decision-maker seeking to resist a claim. The decision-maker will also need to follow any contractually agreed procedures (Daniels v Lloyds [2018] EWHC 660 (Comm)). Balance needs to be struck between the provision of sufficient evidence to show that the discretion was exercised properly but not so much that, if disclosed, it could be used against the decision-maker.

Can the implied term be excluded?

A final, short, point on exclusion. A Braganza term acts as a brake on a potential abuse of power and as such, it is extremely difficult, although not impossible, to exclude its application to a contract (Mid Essex). Rather than exclusion, it may be preferable to draft a contract to avoid the need for a Braganza term at all.

As we have highlighted above, a clause which grants a contractual power rather than a discretion is not subject to a Braganza implied term. Similarly, providing a contractual mechanism for determining what action a party should take, as in Mid Essex, provides operational certainty and removes the need for a Braganza implied term. 

However, drafting a contractual power or mechanism may not be suitable in all circumstances; the decision-maker may need flexibility over the decision that they need to reach. For example, a bank may require flexibility to set interest rates in case unforeseen economic problems arise.

In UBS, a case in which where there was no implied term, the court appeared to attach a great deal of relevance to the contractual words 'absolute discretion'. However, the court also had regard to the underlying banking relationship, which placed UBS under a duty of good faith and which itself operated as a restraint on UBS’s powers. In those circumstances, it was not necessary for the court to find that a Braganza term should be implied.

In its most basic form, the position of the law, at present, is that:

  • if the court determines that the circumstances require an implied Braganza term, it is highly unlikely that any attempt to exclude the term will succeed; but
  • if the circumstances suggest either that the decision-maker’s authority is borne from a contractual power rather than a discretion, or that the decision-maker is otherwise obliged to treat the other party fairly, exclusion of a Braganza term is unlikely to be necessary.

Conclusion

There will always be a need for certain contracts to grant one party the authority to reach a decision or form an opinion on a matter which impacts on the other party. We anticipate that, over the coming years, we will see a growth in Braganza-type disputes and the development of a body of legal guidance on the key principles. For now:

  • contractual parties should scrutinise clauses which deal with decision-making authority and ensure clarity of intention, scope and operational mechanics; and
  • decision-makers should ensure that they understand why and how contractual decisions are to be made, be certain that they are made by appropriate personnel, and follow (any) necessary procedures on the basis of accurate information or evidence.

This article was written by David Hall, Tom Whittaker and Harry Jewson. For more information please get in touch with the key contact or your usual Burges Salmon contact.

Key contact

David Hall

David Hall Partner

  • Head of Dispute Resolution
  • Banking Disputes
  • Business Crime and Regulatory Investigations

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