Contract Best Practice Nutshell – Exercising of Contractual Discretion Following Braganza
The UK Supreme Court in the case of Braganza v BP Shipping Ltd  UKSC 17 (Braganza) revisited the principles of law...
...when considering disputes relating to a party's exercise of contractual discretion.
A contractual discretion arises where one party under a contract is afforded the right to determine a substantive matter which may have an effect on the interests of both parties, and so involve elements of potential conflict of interest. Prior to Braganza, the courts, in assessing whether a contractual discretion has been exercised rationally, would consider the outcome of the contractual discretion and also take into account whether the decision was so unreasonable that no reasonable person acting reasonably could have made it.
Post Braganza, if the so-named Braganza duty applies, the courts would not only review the reasonableness of the outcome of the contractual discretion but would also review the decision making process to ensure that the contractual discretion afforded to one party is not exercised "dishonestly, for an improper purpose, capriciously or arbitrarily." A decision maker, in exercising its contractual discretion, must also take into account any material relevant factors and disregard the irrelevant factors.
Absolute contractual right and contractual discretion distinguished
In considering whether the Braganza principles would apply, the courts distinguish between the exercise of an absolute contractual right and the exercise of a contractual discretion. The Braganza principles would only apply if the dispute arises from a party's exercise of its contractual discretion.
If the contract implies limitation in the way in which a party may exercise its rights, for example the requirement of honesty and good faith, or the exercise of the right involves choosing from a range of options and requires the party making the decision to take into account the interests of the other party, then the right is likely to be discretionary rather than absolute. Where no limitation is implied, a party is entitled to rely upon its freely negotiated contractual rights and the Braganza principles would likely not be relevant.
It is important to highlight that the Braganza duty is likely to be most relevant in circumstances where the commercial bargaining position of the parties is not equal, and indeed the Braganza duty arose in an employment context.
It is common in circumstances of more equal bargaining position, such as institutional financial agreements, to afford one party the right to exercise its discretion more freely in a particular scenario. In the case of Crowther & Crowther v Arbuthnot Latham & Co Limited  EWHC 504 (Comm), the court considered a "consent not to be unreasonably withheld" clause in a banking context. In this case, the court did not apply the Braganza principles. The court indicated that it was not necessary to prove that the grounds for refusing the consent were justified. Instead, the conclusion must be one that may be reached by a reasonable man in the circumstances.
Since the Braganza judgment, there have been numerous instances of a party unsuccessfully litigating on the Braganza principles, and it would appear that English courts will not give the Braganza principles the breadth of application that may have been anticipated following the judgment.
What is clear in the cases that follow Braganza is that the courts are keen to restrict a party's ability to enhance its contractual position when looking to exercise its contractual discretion. It is the protection of one's contractual position that is most appropriate when looking to exercise contractual discretion.
However, this does not mean that the court will not, in future, set aside cases involving disputes relating to a party's exercise of contractual discretion on grounds of the principles under Braganza. As the circumstances under which the Braganza principles would apply are very fact specific, prudent care must be exercised when drafting and exercising contractual discretions in contracts and the specific circumstances of the contract must be taken into consideration when drafting and exercising contractual discretions. Among other things:
- Draft contractual discretion provisions as expressly as possible to try to protect the level of discretion you wish to afford yourself;
- Do not assume when considering the exercise of contractual discretion, and exercising it, that such exercise is subject purely to the terms of the contract and will not be subject to challenge;
- When exercising contractual discretion, especially on particularly substantive or sensitive matters, consider taking external counsel advice on any relevant considerations to seek to reduce the potential for challenge. Ultimately, the application of the principles of fairness, honesty and good faith in considering and exercising your contractual discretion are likely to help support your decision on any future challenge; and
- Carefully evaluate the discretion to be exercised and document the process followed to reach the decision, to seek to protect against any future challenge.