Litigation and dispute resolution briefi ng from Macfarlanes published in the June 2013 issue of The In-House Lawyer:

Are you obliged to act reasonably? litigation and dispute resolution Macfarlanes LLP litigation and dispute resolution Macfarlanes LLP

Are you obliged to Commercial contracts often contain the decision maker was entitled to act in provisions that allow one party to take accordance with its own best interests. act reasonably? a certain step, or to make a particular 661 decision, which will have an impact on v another contracting party. Commenting In Barclays Bank plc v UniCredit Bank AG & on such a situation in National anor [2012] The claimant bank (Barclays) Macfarlanes LLP Tanker Co v Product Star Shipping Ltd (The entered into three synthetic securitisations ‘Product Star’) [1993], Leggatt LJ said that of loan portfolios with the defendant group ‘where A and contract with each other of (UniCredit). The securitisations BY Barry to confer a discretion on A, that does not were embodied in three deeds of guarantee. Donnelly render B subject to A’s uninhibited whim.’ The guarantees provided for Barclays to partner, Macfarlanes LLP In other words, the court will normally receive quarterly payments and a fixed fee. imply a term limiting the decision maker’s The guarantees also contained a clause discretion. which stated that, where a regulatory change occurred, UniCredit could terminate This article briefly considers the leading the guarantees early, provided that it had case of Socimer International Bank Ltd obtained the prior consent of Barclays. In BY JOnathan (in liquidation) v Standard Bank determining whether or not to grant such Pratt Ltd [2008], where the Court of Appeal consent, Barclays was required to act in a professional held that, where a contract confers an ‘commercially reasonable’ manner. support lawyer, Macfarlanes LLP absolute discretion on one party, that party must exercise its discretion honestly, in Changes were made to the regulatory good faith and not arbitrarily, capriciously, treatment of the guarantees, which perversely or irrationally. The article goes adversely affected UniCredit’s ability to on to consider three more recent cases obtain capital relief which the guarantees which consider the Socimer test, and were designed to achieve. UniCredit, whether instead the objective standard thereafter, sought the early termination of reasonableness should apply in the of the guarantees. Barclays responded by circumstances. stating that it would not consent unless it was paid the balance of five years’ fees, The Socimer Test which amounted to €82m. Unicredit refused In Socimer, the Court of Appeal had to to pay the fees and claimed that Barclays’ consider a provision in a forward sales demand for the fees was not a commercially agreement that gave the defendant bank reasonable ground for declining consent. an absolute discretion, following a default Barclays issued proceedings seeking by the claimant bank, whether to liquidate a declaration that it had acted in a or retain a portfolio of emerging market commercially reasonable manner in debt instruments to satisfy the total unpaid refusing to consent. amount due. The question before the Court of Appeal was whether the defendant’s A ‘commercially reasonable manner’ contractual obligation was to conduct an In considering what was meant by a honest but subjective valuation of the ‘commercially reasonable manner’, portfolio of assets, or whether, as a matter Popplewell J considered both the line of contractual implication the defendant of cases culminating in Socimer, and a was under a duty to take reasonable care to number of landlord and tenant cases where determine their true market value. a lease expressly required the landlord not to unreasonably withhold consent to The Court of Appeal held that there was no assignment or subletting by the tenant and obligation to take reasonable care to arrive where it was held that it was not necessary at the true market value of the assets. The for a landlord to prove that the conclusions decision maker’s discretion was limited, that led them to refuse consent were as a matter of necessary implication, only justified, provided they were conclusions by concepts of honesty, good faith, and which a reasonable person might reach in genuineness and the need for the absence similar circumstances. of arbitrariness, capriciousness, perversity and irrationally. Subject to those limitations Popplewell J held that the correct (which reflect the narrow, public law, approach to the application of the clause Wednesbury standard of reasonableness), was as follows:

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1 ) As the clause expressly restricted Barclay’s discretion to act in a commercially reasonable manner, it ‘In Barclays v Unicredit, it was held that an express term was not suffi cient for Barclays to show merely that the decision was made to act in a “commercially reasonable manner” imposes in good faith and was not arbitrary, greater limitations on the decision maker than the capricious or irrational (the Socimer test). Socimer implied term.’

2 ) The question was not whether the decision was justifi ed, but whether a reasonable commercial person in Barclays’ was the operator of the port of Yilport in the claimant must be reasonable. The position might have reached such a Turkey. The fi rst and second defendants claimant, on the other hand, relied on decision (as per the landlord cases). were the owners and managers of a vessel. Socimer and argued that: The vessel collided with another ship while 3 ) In determining what was commercially en route to Turkey. The vessel’s port side 1 ) The limitations on the claimant’s reasonable, Barclays was entitled to was pierced by the bow of the other ship freedom of decision were that the take into account its own commercial both above and below the waterline and claimant must have exercised its power interests. It was not obliged to carry two out of eight holds were fl ooded such or discretion honestly or in good faith out a balancing exercise between its that fi ve tiers of containers were fully and must not have done so arbitrarily or interests and Unicredit’s interests. submerged and a sixth tier was partially capriciously. submerged. 4 ) Barclays’ commercial interest was in 2 ) Unreasonableness in this context earning profi ts from its fee income The claimant gave the defendants permission was analogous to Wednesbury under the guarantees. Barclays would to berth the vessel at Yilport to discharge unreasonableness. be entitled to refuse consent in order the cargo on terms which were set out to protect its fee income unless the in a letter of understanding (LOU). The 3 ) Pursuant to the Wednesbury test, the nature or amount of the fee income LOU provided, among other things, for the decision remained that of the decision was so disproportionate to Unicredit’s defendants to pay: maker, in contrast to the situation obligation to pay that no commercially where the arbiter on entirely objective reasonable person in Barclays’ position ‘… all inward and outward charges criteria was the Court itself. could have reached such a decision. including but not limited to tuggage, pilotage, port duties, berth dues, Having noted that the scope of any implied On the facts, Popplewell J had little stevedoring, cranage and all other term will depend on the ‘circumstances hesitation in concluding that Barclays had charges levied in accordance with the of the particular contract’, the judge acted in a commercially reasonable manner terms and conditions of Yilport’. accepted the defendants’ submissions in refusing to consent unless and until it that, in this case, the relevant test was recovered fi ve years’ fees. When Barclays Those terms and conditions, in eff ect, one of reasonableness, in the broader entered into the deal it had a reasonable entitled the claimant to determine the objective sense, rather than the narrower and legitimate expectation that it would be rates, tariff and pricing that the defendants Wednesbury standard of reasonableness entitled to its fee income for a minimum of would be charged. (which, in Socimer , was equated with fi ve years, come what may. UniCredit had ‘rationality’). expressly agreed to pay Barclays a minimum After the cargo was unloaded the claimant of fi ve years’ fees if there was an optional presented the defendants with a bill for the In reaching this conclusion, the judge was termination by it as a result of a rating work that it had undertaken in relation to infl uenced by the fact that the claimant event, which might have had the same the vessel. The defendants refused to pay was claiming, subject only to very limited eff ect as a regulatory change. Barclays’ the bill in full, although they did make a part restrictions, to have the right to set the expectation of a minimum of fi ve years’ fees payment on account. The claimant issued price that it was paid for services rendered was protected under the terms of other proceedings for the balance. and that it was unable to cite a case in early termination provisions which expressly which the court had been prepared to dealt with the point. Further, UniCredit had ACTING UNREASONABLY? hold that a contract conferred on a party failed to show why Barclays’ insistence on It was common ground that the claimant’s such a wide discretion in relation to the fi ve years’ fees was unreasonable. right to fi x the charges payable by the primary contractual obligation (Socimer , defendant was not an unfettered one. for example, concerned the right of a YILPORT KONTEYNER TERMINALI VE However, there was a dispute about the party to determine the value of assets LIMAN ISLETMELERI AS v BUXCLIFF KG scope of the limitations on that right. The where the contract with the other party The claimant in Yilport Konteyner Terminali defendants argued that there was an was terminated as a result of that other Ve Liman Isletmeleri AS v Buxcliff KG [2012] implied term that the charges made by party entering into liquidation). Against www.inhouselawyer.co.uk June 2013 The In-House Lawyer 21 litigation and dispute resolution Macfarlanes LLP

Where, however, the only choice conferred ‘The Court of Appeal accepted that where, as in on a contracting party is whether or not to exercise an absolute contractual right Socimer, a contract gave one party the right to make provided under the contract, no such term will be implied. an assessment or to choose from a range of options, a In Barclays v Unicredit, it was held that term would be implied that this discretion should not be an express term to act in a ‘commercially reasonable manner’ imposes greater exercised in an arbitrary, capricious or irrational manner.’ limitations on the decision maker than the Socimer implied term. The test was whether a reasonable commercial person that background, the judge took the view number of service failures and making in the decision maker’s position might have that a reasonable user of the claimant’s payment deductions representing more than reached the same decision as the one taken. services would, upon reading the terms half the payment due for a six-month period). and conditions, understand them to be The scope of any implied term will depend on recording the claimant’s right to charge The Court of Appeal accepted that where, the ‘circumstances of the particular contract’. a higher price for its work than would as in Socimer, a contract gave one party Where the relevant discretion is to determine arise under its standard rates in the given the right to make an assessment or to the price payable under a contract, especially circumstances, rather than conferring a choose from a range of options, a term without a choice of options, it is more likely discretion which was as broad as the one would be implied that this discretion that the discretion will be limited by an claimed by the claimant. should not be exercised in an arbitrary, objective standard of reasonableness, rather capricious or irrational manner. (Jackson than the narrower Socimer test of rationality. This victory was, however, a pyrrhic one for LJ also commented that it would be very the defendants. The judge went on to hold difficult to exclude such an implied term Where a contract contains its own ‘control that reasonableness would depend on the although he accepted that it would not be mechanism’, it will not be necessary to facts and circumstances of each particular ‘utterly impossible’ to do so.) In this case, imply a term that a discretion must be in case and, in this case, most of the sums however, the contract contained precise exercised in good faith in a manner which is claimed by the claimant were reasonable. rules as to how service failure points and not arbitrary, capricious or irrational. deductions should be calculated and Mid Essex Hospital Services the discretion involved a simple decision By Barry Donnelly, partner, NHS Trust v whether or not to exercise an absolute and Jonathan Pratt, In Mid Essex Hospital Services NHS Trust v contractual right in accordance with those professional support lawyer, Compass Group UK and Ireland Ltd (trading rules. The contract already contained a Macfarlanes LLP. as Medirest) [2013], Mid Essex Hospital ‘control mechanism’ which limited the E-mail: [email protected]; Services NHS Trust (the Trust) engaged a Trust’s rights under clause 5.8 such that [email protected]. contractor (Medirest) to provide catering it was not necessary to imply a term that and cleaning services at two hospitals in the Trust would not act in an arbitrary, Abu Dhabi National Tanker Co v Product Essex. Clause 5.8 of the contract between capricious or irrational manner. Star Shipping Ltd (The ‘Product Star’) the parties provided that, in the event that [1993] 1 Lloyd’s LR 397 the services provided by Medirest fell below Key Points Associated Provincial Picture Houses Ltd. the required standard, the Trust ‘shall be Where a contract confers on one party v Wednesbury Corporation [1948] 1 KB 223 entitled to levy payment deductions’ from an absolute discretion to take a decision, Barclays Bank plc v UniCredit Bank AG & the monthly contract price and ‘may award choosing from a range of options which will anor [2012] EWHC 2655 (Comm) service failure points’. Both the deductions have an impact on the interests of another and the service failure points were to be contracting party, the court will, as a bare Mid Essex Hospital Services NHS Trust v calculated by agreed mechanisms, which minimum, imply a term that the discretion Compass Group UK and Ireland Ltd (trading were set out in the contract. must be exercised in good faith in a manner as Medirest) [2013] EWCA Civ 200 which is not arbitrary, capricious or irrational. Socimer International Bank Ltd (in Medirest argued that this provision was Subject to those limitations, the decision liquidation) v Standard Bank London Ltd subject to an implied term that in exercising maker will be entitled to act in accordance [2008] EWCA Civ 116 its rights under clause 5.8, the Trust with its own best interests. Yilport Konteyner Terminali Ve Liman would not act in an arbitrary, capricious or Isletmeleri AS v Buxcliff KG [2012] EWHC irrational manner (and that it had breached It is very difficult, albeit not ‘utterly 3289 (Comm) this implied term by awarding an excessive impossible’, to exclude such an implied term.

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