A brief summary of the principles, recent developments and practical tips relating to the exercise of contractual discretion and the "Braganza duty".
- For a number of years, English law has recognised a private law duty whereby a party exercising a contractual discretion must do so “reasonably” or “rationally”. This duty was discussed at length in the Supreme Court’s decision in Braganza v BP, such that the duty has informally become known as the Braganza duty, although it had been the subject of a number of earlier cases.
- As Lord Sumption said in one of those earlier cases, rationality has “in recent years played an increasingly significant role in the law relating to contractual discretion”. That trend is set to continue - there have been a number of cases in the last few months dealing with the Braganza duty in a range of circumstances.
- It is now clear that where a party has a contractual discretion, the Courts will imply a term into that contract requiring the relevant party to exercise its discretion in a way which is not irrational, capricious or arbitrary in a public law sense (ie similar to the Wednesbury unreasonableness threshold).
- Although there have been a number of recent cases addressing the Braganza duty, there remains some uncertainty about what amounts to a contractual discretion. The Court of Appeal has previously said that it is “when a contract allocates only to one party a power to make decisions under the contract which may have an effect on both parties”.
- It could be argued that a right to terminate for convenience is a “power to make a decision” which affects both parties. However, in our view, the Braganza duty is not intended to apply to such rights. We think the Court of Appeal’s formulation in another case is more accurate:
"An important feature of the above line of authorities is that in each case the discretion did not involve a simple decision whether or not to exercise an absolute contractual right. The discretion involved making an assessment or choosing from a range of options, taking into account the interests of both parties. In any contract under which one party is permitted to exercise such a discretion, there is an implied term [not to act in an arbitrary, irrational or capricious manner].”
- The Braganza duty has been implied in various scenarios: a right to unilaterally vary or fix contractual fees; a right to charge fees “up to” an agreed amount; an insurer’s ability to approve the insured’s settlement of a claim; a board of directors' right to veto an existing option agreement for the acquisition of shares; and an employer’s right to place an employee on gardening leave.
- Although the Braganza duty has been implied in various cases and has been found to have been breached, two recent cases (PAG v RBS and Faieta v ICAP) have confirmed that there is a “high hurdle” (as stated in the ICAP case) to establish a breach of this duty. It has been said previously that it must be established that the relevant party has exercised its discretion in a way which no reasonable person having that same discretion would have exercised it.
What this means
- It is clear from the number of recent cases that the Braganza duty is becoming more prominent in English law. Parties need to be alive to the restrictions that it places on any discretion afforded to them under a contract. Given that there is, in our view, some uncertainty about what amounts to a contractual discretion, parties should assume that any contractual right to make an assessment or decision from a range of options will be subject to this duty.
- Parties should be particularly wary of this duty when drafting contractual provisions which confer any sort of discretion and should consider whether this can be avoided or whether the limits of the duty can be expressly clarified in the contract. The English Courts have said that the Braganza duty will not be implied it there is “very clear” language to the contrary (which is consistent with the English law position that implied terms such as this can be excluded).
- Whilst there seems to be a trend towards an increased recognition of the Braganza duty, the English Courts have helpfully reminded us that the duty will not easily be breached. Parties should therefore take some comfort that, unless they make decisions under a contract in a particularly unreasonable manner, there should be no issues arising out of this recent trend.