Decision-making under commercial agreements: Far-reaching legal changes gather pace: part 2

By Andrew White


The law shaping decision-making under business contracts is evolving.  As we explained in Part 1 of this bulletin, where a contract confers a 'genuine discretion' on a party regarding a particular matter, there's an 'implied contractual term' that the discretion must be exercised in a way which is not 'arbitrary, capricious or irrational'. That implied term applies regardless of sector or industry, and may require a rethink in how businesses behave, and how they record their decisions.  

Distinguishing between a 'genuine discretion' and an 'absolute contractual right'

As with any implied term, it's important to identify where it does, and does not, come into operation. The crucial point is that it only applies to the exercise of a 'genuine discretion', but it does not apply to the exercise of an absolute contractual power or right. That's the topic of this second part of the bulletin.

Firstly, there is no definitive judicial statement on this distinction.  In essence, a 'genuine discretion' arises where one party has the right to decide a matter under a contract; it has more than one available option; it is provided with information concerning the affected party which is relevant to the decision; and the business interests of the party with the right to decide may differ from those of the affected party.   

By contrast, an 'absolute contractual right' arises where a business contract gives a party the power lawfully to take some action, irrespective of the circumstances of the other party, as long as the contractual requirements for taking the action are fulfilled.  'Freedom of contract' dictates that that right can be implemented as it is written, without any implied term being super-imposed onto the contract.             

Examples of 'absolute contractual rights' 

In many recent cases, courts have concluded that powers conferred under contracts amounted to absolute contractual rights, rather than being 'genuine discretions'. Each case hinged upon the drafting of the clause in question, taken in the context of the contract and all surrounding circumstances. The cases cannot therefore be used as precedents that the clause in question will always be subject to the same analysis.  What they provide are valuable practical illustrations. (In addition, the Court of Appeal judgment in the Compass case has proved to be a particularly powerful legal authority).  Here are four examples:   

- the contractual power of a customer to deduct certain fees paid to a service provider for inadequate provision of catering services to a hospital was held to be an absolute contractual right (Compass Group v Mid-Essex NHS Trust, Court of Appeal, 2013); note the contrast with the Portsmouth City Council v Ensign case, highlighted in Part 1 of this bulletin, which also concerned service level mechanisms;       

- the right of a housing association to terminate a long-term maintenance services agreement 'for convenience' was held to be an absolute contractual right, not a 'genuine discretion' (TSG v South Anglia Housing, High Court, 2013)

-  the power to amend the terms of a loan note unilaterally was held to be an absolute contractual right (Myers v Kestrel, High Court, 2015)

- the power of an online foreign exchange and commodities broker to revoke a trading agreement in the event of "abusive trading" by a customer was held to be an absolute contractual right (Shurbanova v Forex Capital Markets, High Court, 2017) 

In each of these cases, the implied term was held to be simply inapplicable.  

Use of the word 'may'

Several decisions have addressed use of the word "may" in a clause. It has been argued that if a clause states that a party "may" take certain action, that indicates a 'genuine discretion' by providing the party with a choice between options. After all, that party 'may' do certain things.... or it 'may not'. Surely, that's a discretion?  

This argument usually fails simply on linguistic grounds - it is reading too much into the word "may".  For example, a clause which states "If Customer does X, then Supplier may terminate" could simply be shorthand for "the Supplier shall be entitled to terminate". Rather than conferring a 'genuine discretion', 'may' is being used to describe an absolute contractual right. There is no necessary correlation between the word 'may' and a 'genuine discretion' - the correct legal position flows from analysing the clause fully, and in context. 

Take-away message 
When advising businesses, it is important to take a two-stage approach. First, consider whether the contractual provision creates an absolute contractual right, or confers a 'genuine discretion'.  If, but only if, the latter applies, assess the practical impact of the implied term.