The High Court (Chancery Appeals Division) has allowed a lender’s appeal of a District Judge’s decision to set aside statutory demands made against two guarantors, following a borrower’s default under a loan facility: Sibner Capital Ltd v Jarvis  EWHC 3273 (Ch).
This decision will be of interest to financial institutions seeking to exercise a contractual discretion or right following an event of default. The decision highlights that a financial institution’s exercise of its discretion/right will not necessarily be subject to an implied duty to act in good faith or to refrain from acting in a way which was arbitrary, capricious or irrational (as per Braganza v BP Shipping Ltd  UKSC 17), particularly where the documentation confers an absolute contractual right in favour of the financial institution. This is the latest in a recent line of decisions considering the exercise of contractual discretions in a financial services context (see our previous blog posts here).
In the present case, the court was satisfied that there was no realistic prospect of the guarantors establishing that the lender was under some sort of duty of good faith or other Braganza style duty in deciding whether or not to accept payment of less than the full amount of a tranche on the due date. The court underlined that the relevant clause in the facility agreement contained no qualification, and indeed went out of its way to say that the lender had an absolute right whether or not to accept less than it was entitled to.
We consider the decision in more detail below.
The claimant lender agreed to provide loans to the borrower company in relation to the development of a property. The loan facility was guaranteed by two individuals. A joint venture agreement (the JV Agreement) was also entered into on the same day by the lender, the borrower, the guarantors and the owner of the property which was to be developed.
The loan facility agreement provided that “The lender may in its absolute discretion accept a sum less than the Tranche A commitment plus interest on the Tranche A Repayment Date in satisfaction of the Borrower’s obligation to repay the Tranche A Facility on that Date…”.
The JV Agreement required the parties to act in good faith. However, the JV Agreement also provided that this requirement did not prejudice or restrict the lender’s rights under the finance documents including any rights which may arise following an event of default.
In 2020, the lender and the guarantors agreed that a certain sum would be accepted as part settlement of Tranche A on the following basis: (a) the agreed sum would be paid by 22 December 2020; (b) the lender would release its security over property when the repayment was made; and (c) the balance of the amount due would be paid by 31 January 2021. The agreement also included an undertaking by the guarantors that their guarantees would remain in force and that they would not object to any enforcement action in respect of the outstanding amount, including any statutory demand or bankruptcy petition. The part repayment was made on 22 December 2020, but the balance was not paid by 31 January 2021. Consequently, the lender served statutory demands on the guarantors.
The guarantors denied the claim and made an application to set aside the statutory demands.
District Judge’s decision
The District Judge found in favour of the guarantors and set aside the statutory demands.
The District Judge said the guarantors had a realistic prospect of demonstrating that there was an implied duty to act in good faith or to refrain from acting in a way which was arbitrary, capricious or irrational (as per Braganza). The District Judge also said that the lender had failed to exclude extraneous considerations in exercising its discretion under the facility agreement and had therefore called in the loan and called on the guarantees in reliance on its breach of duty.
The lender appealed, on the basis that its discretion under the facility agreement was absolute and was not restricted by the Braganza duty or any implied duty of good faith.
High Court (Chancery Appeals Division) decision
The court found in favour of the lender and upheld the statutory demands. The key issues which may be of interest to financial institutions are examined below.
The facility agreement
The court said that on the face of the facility agreement, the lender had an absolute discretion whether to agree to accept less than full repayment of Tranche A. The discretion was not expressly qualified in any way. Given that the lender would, in exercising the discretion, be accepting less than it would otherwise be entitled to, it might perhaps be surprising if it were under any obligation to consider anything other than its own interests.
Implied duty of good faith/Braganza duty
The court reviewed the authorities and highlighted the following key legal principles:
- A contractual discretion does not involve a simple decision whether or not to exercise an absolute right. Rather, a discretion involves making an assessment or choosing from a range of options, taking into account the interest of both parties (as per Mid-Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd (t/a Medirest)  EWCA Civ 200).
- When a contract gives one of the parties an absolute right, a court will not usually imply any restrictions on it, even restrictions preventing the right from being exercised in an arbitrary, capricious or irrational manner (as per Greenclose Limited v National Westminster Bank Plc  EWHC 1156 (Ch)).
- The court will refuse to imply a term that an unqualified right to terminate a contract should be exercised in good faith, even where there is an express clause requiring the parties to work together in a spirit of trust, fairness, and mutual co-operation (as per TSG Building Services v South Anglia Housing Ltd  EWHC 1151 (TCC)).
- The expression “absolute contractual right” is the result of a process of construction which takes account of the characteristics of the parties, the terms of the contract as whole and the contractual context. It is only possible to say whether a term conferring a contractual choice on one party represents an absolute contractual right after that process of construction has been undertaken (as per Equitas Insurance Ltd v Municipal Mutual Insurance Ltd  EWCA 718).
- Absolute rights conferred by professionally drawn or standard form contracts (including but not limited to absolute rights to terminate relationships and roles within relationships) are an everyday feature of the contracts that govern commercial relationships. Extending Braganza to such provisions would be an unwarranted interference in the freedom of parties to contract on the terms they choose (as per TAQA Bratani Ltd v Rockrose  EWHC 58 (Comm)).
- Even if a contracting party has a discretion to bring the contract to an end, and that such discretion should not be exercised capriciously or arbitrarily, it by no means follows that the same considerations apply to allowing the contract to continue, which does not require any positive act on the part of the non-defaulting party (as per Lomas v JFB Firth Rixson  EWCA 419).
The present case
The court concluded that there was no realistic prospect of the guarantors establishing that the lender was under some sort of duty of good faith or other Braganza style duty in exercising its discretion whether or not to accept payment of less than the full amount of Tranche A on the due date in accordance with the facility agreement.
In the court’s view, this was a commercial contract drawn up with legal assistance between experienced commercial parties. On the face of it, the relevant clause contained no qualification and indeed went out of its way to say that the lender had an absolute discretion whether or not to accept less than it was entitled to even though it was known that a new mortgage was being discussed and that a decision, in principle, had been made by the lender.
The court said that it was also relevant that the JV Agreement, whilst containing an obligation for the parties to act in good faith, specifically provided that this obligation should not affect the lender’s rights under the finance agreement. Another important consideration was that the documents were clear that Tranche A was to be repaid in full before any other steps were to take place.
In the court’s view, looking at the characteristics of the parties, the terms of the contract as a whole, and the contractual context, there was no doubt that this was not the sort of provision where it would be appropriate to imply an obligation of good faith. Accordingly, there were no substantial grounds for disputing the debt on this basis.
For all the reasons set out above, the court found in favour of the lender and upheld the statutory demands.
For further information, please contact:
Ceri Morgan, Herbert Smith Freehills