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Contractual right or discretion? How to tell the difference and why it matters.

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Richard Hooley gave Allen & Overy a talk about "contractual discretions" versus contractual rights. It is a topic we have covered a number of times on this blog and, one which still the courts are grappling with. Richard covered a lot of ground; below I highlight a few practical points he drew out.

Contractual discretion has been described as one party making a decision under a contract which entails "an assessment or choosing from a range of options and taking into account the interests of both parties". It is usually contrasted with an "absolute contractual right".

Why does the distinction matter?

The nub of the issue is that if you have an absolute contractual right then, generally, your motivation and any processes leading to its exercise are irrelevant.  With a contractual discretion, however, the court will imply, as a matter of necessity, a standard to which you must adhere, even where the discretion is expressed to be absolute.  The person exercising a contractual discretion must do so honestly and in good faith, and having regard to the provisions of the contract by which it is conferred. The discretion must not be exercised arbitrarily, capriciously or unreasonably. Where the discretion involves determining whether something happened, the more unlikely that thing is to have happened, the more cogent must be the evidence required to persuade the decision-maker that it has indeed happened.

Elements of an absolute contractual right

How, then, do you identify whether a provision gives rise to an absolute contractual right (and does not entail the exercise of a contractual discretion)?

Richard referred to and summarised a paper by David Foxton QC which has some useful questions to ask yourself:

  1. Is there an existing control mechanism in the contract? If so, the court is more likely to regard a contractual right to be absolute. The thinking here is that if the parties have included a pressure valve there is no need for the court to impose any additional fetters. (See eg Mid Essex v Compass and PAG v RBS.)
  2. Is there really only a "binary choice" as to how to exercise the right in question? If so, it is more likely to be an absolute contractual right. This only goes so far, since in shipping, a charterparty may allow the charterer to nominate ports from within a range for loading or discharge and this is regarded as an absolute contractual right.
  3. A right is more likely to be regarded as absolute where it is apparent that that was part of the price of the deal. (See eg NatWest v Greenclose.)
What is the consequence of failing to comply with the implied limitations on discretion?

In the Supreme Court decision in Braganza, the irrational decision that the individual had committed suicide was held to be invalid and so the exemption in question, that death-in-service benefits were not payable if the death resulted from a wilful act, did not apply.

In BHL v Leumi  the court was prepared to consider the so-called counterfactual. So where Leumi had exercised a discretion and charged collection fees of 15% of receivables recovered, the judge determined what Leumi could have chosen if acting rationally. The answer, based on expert evidence, was 4%.