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Contractual discretion: practical pointers for decision-makers

Overview

The authors examine various scenarios in which the exercise of a contractual discretion typically arises in banking and finance and provide a list of practical considerations for decision-makers.

The exercise of a contractual discretion typically involves some form of evaluative judgement on the part of a decision-maker in arriving at a determination which it is empowered to do under a contract. A contractual discretion is often contrasted with an absolute contractual right, which exercise is typically unfettered. The classic example of an absolute contractual right is an unqualified right to terminate a contract without cause.[1] While a contractual discretion is usually subject to restrictions (see further below), if a provision is properly construed as an absolute contractual right, then the court will usually not imply any restrictions on its exercise, even those preventing the right from being exercised in an arbitrary, capricious or irrational manner.[2] The proper characterisation of any given contractual provision as either a contractual discretion or an absolute contractual right is fundamentally a matter of contractual interpretation.

The scenarios in which the exercise of a contractual discretion arises span the full spectrum of banking and finance activities and include:

  • Valuations under the ISDA Master Agreement, other derivatives master agreements and other financial contracts.[3]
  • A variation of the interest rate by a lender under a mortgage.[4]
  • The granting or withholding of consent by a lender under a facility agreement to the disposal of assets by the borrower.[5]
  • Close-out of a client’s account by a spread betting firm.[6]
  •  A bank charging a fee for taking over the collection of the client’s outstanding receivables under a receivables finance agreement.[7]
  1. WHAT ARE THE CONSTRAINTS ON THE EXERCISE OF A CONTRACTUAL DISCRETION?
  2. PRACTICAL POINTERS FOR DECISION-MAKERS
  3. CONCLUSION

Now Reading

WHAT ARE THE CONSTRAINTS ON THE EXERCISE OF A CONTRACTUAL DISCRETION?

The starting point is that the constraints imposed by the court on the exercise of a contractual discretion is founded on the theory of implied terms [8]. Therefore, the court's analysis will always be fact-specific and the degree of restraint applied to the relevant contractual discretion will depend heavily – often decisively – on the precise language of the relevant contractual provision, as well as its background and purpose. In other words, the terms of the contract and the relevant circumstances will determine not only whether a provision is a contractual discretion, properly construed, and therefore whether there is to be implied a duty which constrains the exercise of that discretion, but also the scope of that duty.

However, broadly speaking, as a minimal standard[9], there is an implied duty to exercise a contractual discretion honestly and in good faith, and not capriciously, arbitrarily or irrationally. While this standard has now become synonymous with the Supreme Court's 2015 decision in Braganza[10], aspects of the formulation can be traced back to two key Court of Appeal decisions in the banking and financial services sector in 2001 (Paragon Finance)[11] and 2008 (Socimer International)[12]. This "rationality" standard is a lower standard than "objective" reasonableness, and more akin to Wednesbury unreasonableness in the sphere of administrative law, meaning the result is so outrageous that no reasonable decision-maker could have reached it.[13]

Where the requirement for "reasonableness" is expressly stated in the provision conferring the discretion, historically the courts have tended to adopt the Wednesbury standard over "objective" reasonableness, particularly in the banking and finance context[14[. However, this is not a cast-iron rule, and it has been held in the context of the definition of "Close-Out Amount" under the 2002 ISDA Master Agreement that, in contrast to its use under "Loss" in the 1992 ISDA Master Agreement, the concept of "reasonableness" there is an "objective" one.[15]

It is also important to remember that certain other duties may be imported under general law – for example, the law of equity – by virtue of the nature of the relationship. The classic example is the equitable duties that arise in the context of the mortgagor/mortgagee relationship, which has been held to point against the implication of any other duty, such as Braganza-type duties, in relation to certain core contractual powers.[16]

PRACTICAL POINTERS FOR DECISION-MAKERS

Based on our experience of advising clients on these issues, both in real-time at the point of determination, and in subsequent challenges, we have compiled a list of practical pointers for decision-makers to help make their determinations as robust from challenge as possible.

  • Review the relevant contractual provisions and formulate a “playbook”: Where there is an involved and complex process in the exercise of a contractual discretion (for example, in “close out” scenarios), ensure that you are familiar with all of the relevant contractual provisions, the requirements of each, how they interact with each other, and a timeline of steps to be taken. Ideally, this would be reduced to writing (eg a “playbook”) which is accessible to the relevant members of the organisation.

  • Training: Periodic training for both the legal team, as well as business and other functions that might become involved in exercising a contractual discretion: (i) on the process to be followed in advance of, at the time of, and following the relevant determination; and (ii) on the key (legal) principles relating to that exercise (including risks of a challenge), and how best to mitigate those risks. The latter may include financial consequences of a determination being successfully challenged as well as potential regulatory and reputational risks of a public court finding that the contractual discretion was exercised improperly.

  • Consideration of own interests: The case law, particularly in a banking and finance context, shows that the decision-maker is usually entitled to consider its own interests, in particular, if the purpose of the relevant contractual discretion is to protect or insulate the decision-maker from risk,[17] or where the occasion for exercising the discretion has arisen because the counterparty is in breach of contract or there has been an event of default.[18] However, it may be prudent not to emphasise this point, both internally and externally in correspondence with the counterparty. If the decision-maker is seen to be placing too much weight on its own interest, it may be questioned whether it is addressing the correct question before it [19] and in any event, it may colour the court’s view on whether the eventual determination met the applicable standard. Indeed, where there is a range of possible determinations that would be compliant with the applicable standard, it is questionable whether a decision-maker can, unless it can be justified by reference to other considerations, simply select the result at one end of the range that suits its interest best.[20]

  • Clear documentation of processes: Clear, contemporaneous documentation of the processes followed, the factors and considerations taken into account, and the rationale for reaching the eventual determination will go a long way towards defending any future challenge. They may include: (i) any conversations with the counterparty (ie take contemporaneous notes), including any attempts to reach a consensual resolution with the counterparty, in particular, if the decision-maker, before exercising the discretion, considered any proposals advanced by the counterparty;[21] and (ii) if the discretion is exercised, the basis for doing so and the manner in which it was exercised.[22] For example, if the discretion involves setting a fee amount, document how the level of the fee has been arrived at, in particular, by reference to any factors which are said to be relevant to the determination of the fee level. In the case of valuation of securities, record all the pricing sources considered (actual trades concluded, quotes, internal pricing models etc), the number and identity of trading counterparties approached, and the justification for the final valuation arrived at.

CONCLUSION

The presence of contractual discretions is widespread in banking and finance. There has been a rapid rise in the number of reported cases concerning this topic, both in banking and finance contexts, and also more widely, in recent years. This has, in the authors’ view, given rise to additional complexity and more questions than answers. Nonetheless, there is still much that market participants can do in anticipation of, and in the course of, events giving rise to a contractual discretion being exercised that can put them in the best position to resist any future challenges.

This article was first published in the October issue of Butterworths Journal of International Banking and Financial Law. 

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  1. MacDonald Hotels Limited v Bank of Scotland Plc [2025] EWHC 32 (Comm) at [152].
  2. See, for example, Lombard North Central Plc v European Skyjets Limited (In Liquidation) [2022] EWHC 728 (QB) at [152] referring to TAQA Bratani Limited v Rockrose UKS8 LLC [2020] EWHC 58 (Comm) at [44]-[53] and Greenclose Limited v National Westminster Bank [2014] EWHC 1156 (Ch) at [145] and the cases cited therein, although see the obiter comments of Leggatt J in Tesco Stores Ltd v Union of Shop, Distributive and Allied Workers and others [2024] UKSC 28 at [114]-[120].
  3. See, for example: Socimer International Bank Limited (in liquidation) v Standard Bank London Ltd [2008] EWCA Civ 116; Fondazione Enasarco v Lehman Brothers Finance SA [2015] EWHC 1307 (Ch); Lehman Brothers International (Europe) (an unlimited company incorporated under the law of England and Wales) (In Administration) v Exxonmobil Financial Services BV [2016] EWHC 2699 (Comm); Lehman Brothers Special Financing Inc v National Power Corporation, Power Sector Assets and Liabilities Management Corp [2018] EWHC 487 (Comm); and Lehman Brothers Finance AG (In Liquidation) v Klaus Tschira Stiftung [2019] EWHC 379 (Ch).
  4. Nash v Paragon Finance Plc (formerly National Homes Loans Corp) [2001] EWCA Civ 1466.
  5. MacDonald Hotels Limited v Bank of Scotland Plc [2025] EWHC 32 and Crowther & Anor v Arbuthnot Latham & Co. Ltd [2018] EWHC 504 (Comm).
  6. CMC Spreadbet Plc v Robert Tchenguiz [2022] EWHC 1640 (Comm) and De Boinville v IG Index Limited [2021] EWHC 3326 (Comm).
  7. BHL v Leumi ABL Ltd [2017] EWHC 1871 (QB).
  8. See Horkulak v Cantor Fitzgerald International [2004] EWCA Civ 1287 at [30].
  9. Absent any clear words to the contrary, consistent with the principles of implication of terms.
  10. Braganza v BP Shipping Limited and another [2015] UKSC 17.
  11. Nash v Paragon Finance v Plc (formerly National Homes Loans Corp) [2001] EWCA Civ 1466 (a decision about a lender’s discretion to vary interest rates).
  12. Socimer International Bank Ltd (in liquidation) v Standard Bank London Ltd (No. 2) [2008] EWCA Civ 116 (a decision involving a bank’s discretion to value assets in the context of a forward sale agreement following the liquidation of the counterparty).
  13. See Braganza at [19]-[30] and the authorities cited therein. See also Westlb AG v Nomura Bank International Plc [2012] EWCA Civ 495 at [32] referring to Socimer.
  14. See, for example: Socimer International Bank Ltd (In Liquidation) v Standard Bank London Ltd (No.2) [2008] EWCA Civ 116; Westlb AG v Nomura Bank International Plc and another [2012] EWCA Civ 495; Braganza; Lehman Brothers International (Europe) (In Administration) v ExxonMobil Financial Services B.V. [2016] EWHC 2699 (Comm); and LBI EHF v Raiffeisen Zentral Bank Osterreich [2017] EWHC 522 (Comm).
  15. Lehman Brothers Special Financing Inc. v National Power Corporation, Power Sector Assets and Liabilities Management Corp [2018] EWHC 487 (Comm).
  16. See MacDonald Hotels Limited v Bank of Scotland Plc [2025] EWHC 32 (Comm) at [153]-[157] and the authorities cited therein. See also UBS AG v Rose Capital Ventures Ltd [2018] EWHC 3137 at [58].
  17. Westlb AG v Nomura Bank International Plc [2012] EWCA Civ 495 at [60] (referring to Socimer).
  18. CMC Spreadbet Plc v Robert Tchenguiz [2022] EWHC 1640 (Comm) and De Boinville v IG Index Limited [2021] EWHC 3326 (Comm).
  19. For example, in the context of a close-out valuation, the actual value of the securities or assets, as opposed to, say, which result would be in its own financial interest.
  20. Lehman Brothers Special Financing Inc. v National Power Corporation, Power Sector Assets and Liabilities Management Corp [2018] EWHC 487 (Comm) at [79].
  21. See, for example, CMC Spreadbet Plc v Robert Tchenguiz [2022] EWHC 1640 and MacDonald Hotels Limited v Bank of Scotland Plc [2025] EWHC 32 (Comm).
  22. This can include “micro” factors that relate specifically to the contracting parties, but can also include reference to prevailing economic/global conditions and the impact on financial markets.
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