The High Court has reviewed, in the context of a share option agreement, the limits of an unqualified discretion to give consent. Limited (Watchfinder) entered a sales and marketing services agreement with another company, Adoreum Partners (Adoreum), a business development consultancy. At the same time Watchfinder also entered a share option agreement with three directors of Adoreum under which it granted an option over its own shares to those directors.

The share option agreement provided:

"3.1 The Option may only be exercised with the consent of a majority of the board of directors of the Company.

3.2 If the consent specified in Clause 3.1 has not been obtained by the Investors before the Options Expiry Date the Option shall lapse and neither party to this agreement shall have any claim against the other under this agreement except in relation to any breach occurring before that date."

The option holders sought to exercise the option and had complied with the formal steps required for the exercise of the option. However, Watchfinder refused to issue the shares, stating that the required board consent had not been obtained. The option holders brought proceedings for specific performance of the share option agreement.

The court held that clause 3 of the share option agreement did not give the board an unconditional right to veto the exercise of the option. If it did, the option would be meaningless. The option agreement was part of an overall contractual package for Adoreum and the option holders. It would be a commercial absurdity to conclude that, objectively, one part of that package was in fact worthless.

However, the clause could not be disregarded entirely, as it clearly purported to act as some sort of restriction to the right. The court noted that it is now well established that a discretion is to be exercised in a way which is not arbitrary, capricious or irrational. This means there has to be a proper process for the decision in question, including taking into account the material points and not taking into account irrelevant considerations. It also entails not reaching an outcome outside what any reasonable decision-maker could decide, regardless of the process adopted.

The court noted that to assess whether a discretion has been properly exercised it is necessary to know what the target of that discretion is, in the sense of what the decision-maker is meant to be considering when deciding whether or not to exercise it. In this case the agreement itself did not offer guidance, but the court found, on the evidence, that the target was whether Adoreum or the option holders had made a real or significant contribution to the progress or growth of Watchfinder.

The court went on to find that, on the facts, the discretion had not been properly exercised. There was no real discussion by the board, the board did not focus on the correct matters, it had proceeded on a mistaken view and been arbitrary.

Accordingly, as the directors of Watchfinder had failed to exercise their discretion properly, the option holders succeeded in their claim for specific performance.

A share option agreement usually sets out clear conditions that have to be satisfied for the option to be exercisable, and this case demonstrates the desirability from an option holder's point of view of clear conditions. More generally, however, the case is a good illustration of the fact that, even if a contract apparently gives a party an absolute discretion, that discretion must still be exercised in a way that is not arbitrary, capricious or irrational.