Legal Briefing

Contractual discretion: how should it be exercised?

The In-House Lawyer Logo

Corporate and commercial | 01 June 2015

Contractual terms granting discretion for a party to determine unilaterally the outcome of a matter in prescribed circumstances are not an uncommon feature in commercial contracts. In fact, such clauses can be immeasurably helpful in enabling the contracting parties to operate on a day-to-day basis without the need to refer continually to the other for agreement.

In recent years, however, the courts have sought to influence the operation of contractual discretion by imposing obligations of good faith on the contracting parties in certain situations. The decision 
of the majority in the Supreme Court 
case of Braganza v BP Shipping Ltd 
[2015] earlier this year appears to further advance the case law on the subject by setting out the standards to which a party must adhere when exercising such contractual discretion.

The facts of Braganza v BP Shipping Ltd

Mr Renford Braganza was employed as the chief engineer on an oil tanker, managed 
by BP Shipping Ltd (BP) and located in the mid-North Atlantic, when he went missing on 11 May 2009. In accordance with Mr Braganza’s contract of employment (the Contract), his widow was entitled to death in service benefits in the event that Mr Braganza died during the course of his employment. However, and crucially, the Contract stated that:

‘For the avoidance of doubt, compensation for death, accidental injury or illness shall not be payable if, in the opinion of the Company or its insurers, the death, accidental injury or illness resulted from amongst things, the Officer’s wilful act, default or misconduct whether at sea or ashore…’

In short, if it was found that Mr Braganza had committed suicide while onboard the oil tanker, then his wife was not entitled to any death in service benefits which may otherwise have been payable. An investigation was therefore undertaken by BP to try and determine the cause of Mr Braganza’s disappearance. A report was subsequently produced which identified six factors supportive of suicide and concluded that the most likely scenario was that Mr Braganza had jumped overboard deliberately. This report was forwarded to senior management within BP, who consequently determined that there had been wilful default, in accordance with the meaning prescribed by the Contract, and therefore death in service benefits were 
not payable to his widow.

As a result of this finding by BP, Mrs Braganza brought a claim in contract against it for death in service benefits, together with a claim in tort for damages under the Fatal Accidents Act 1976 and the Law Reform (Miscellaneous Provisions) Act 1934, alleging that her husband’s death was caused by negligence on the part of BP.

The appeal

In the first instance judgment of the Commercial Court, Mr Justice Teare held that there was ‘very real uncertainty’ over the circumstances leading to the disappearance of Mr Braganza on the morning in question. However, it was found that the real issues to be tried were whether BP had a duty to exercise its discretion reasonably when determining the outcome of its investigations and, if so, had BP’s opinion that Mr Braganza had committed suicide in fact been formed reasonably taking into account the relevant evidence.

Teare J found that in the present circumstances ‘reasonable’ was to accord with the sense in which the expression was used in Associated Provincial Picture Houses Ltd v Wednesbury Corporation [1948], namely that the decision must not be an irrational one. As the clause of the Contract in dispute was, by nature, an exclusion clause, the burden of proving that the opinion was a reasonable one lay with the employer. The effect being that BP must be able to show that, in exercising its contractual discretion, it took into account all rational possibilities and excluded other irrelevant matters.

In applying this test, it was found that the investigation team’s report and conclusion could not be regarded as sufficiently cogent evidence to justify senior management, and hence BP, in forming the positive opinion that Mr Braganza had committed suicide.

While it was not suggested by the Court that BP’s decision was arbitrary or perverse, it was instead found that it was unreasonable in the Wednesbury sense, having been formed without taking relevant matters into account or seriously considering the real possibility that Mr Braganza had suffered an accident, which led to his having fallen overboard. As a result, Mrs Braganza’s claim in contract succeeded (although her claim for damages for negligence was bound to fail; in the same way that the Court was unable to say with certainty that Mr Braganza had committed suicide, equally it could not find on the balance of probabilities that an accident had occurred as a result of some failing on the part of BP).

The appeal from Teare J’s decision was allowed by the Court of Appeal, who overturned the first instance decision on the grounds that it was ‘not entirely clear’ whether Teare J had considered that BP’s failure to direct itself as to the need for cogent evidence before making a finding of suicide was in itself enough to render its opinion unreasonable. Mrs Braganza appealed to the Supreme Court.

The Supreme Court allowed Mrs Braganza’s appeal by a majority of three to two. The lead judgment was given by Lady Hale, with whom Lord Hodge gave a concurring judgment and Lord Kerr agreed. A dissenting judgment was given by Lord Neuberger, with which Lord Wilson agreed.

Giving the majority judgment, Lady Hale stated that the standard required when reviewing a contractual decision is akin to that adopted for judicial review of administrative action. In making this decision, she found that the Court was, in these circumstances, able to imply a term into the Contract that the decision-making process be:

‘… lawful and rational in the public law sense, that the decision is made rationally (as well as in good faith) and consistently with its contractual purpose’.

This test, it was held, had two limbs:

  1. the decision-making process (whether the correct issues had been considered by BP when reaching the decision); and
  2. the outcome (whether, even if the correct issues had been contemplated by BP, the finding that Mr Braganza had committed suicide was so far-fetched that no individual acting reasonably could have made such a decision).

Having considered these two limbs carefully, the majority agreed with the findings of Teare J at first instance. In addition, it was found that the positive finding of a conclusion of suicide should be held to a higher evidential standard of inquiry than a simple finding that the cause of death could not be concluded on. The Court held that in deciding that Mr Braganza had committed suicide, BP had not acted rationally or reasonably as required by Wednesbury. Instead, BP ought to have asked itself whether the evidence was sufficiently cogent to overcome the inherent improbability of suicide (which ultimately it was not, as there were no positive indications of suicide on the facts).

The tangible difference between the majority and the minority in this case was the judges’ willingness to interfere with the decision of the individual bestowed with the contractual discretion. This was particularly so in circumstances which deprived a bereaved widow of a significant death in benefit payment. However, arguably the most critical issue to arise from the Supreme Court’s decision is that the less likely a given factual conclusion is, the larger the weight of evidence that will be required to support it.

Comment

The Supreme Court found in this case that a clear conflict of interest existed for BP, who was charged with making a decision that would affect the rights of both parties to the Contract. In this case, the Court felt that the conflict was further heightened as a result of the significant imbalance of power between the contracting parties, as is so often the case in contracts of employment, necessitating the inclusion of an implied term of reasonableness. However, it was held that the term to be implied in any given contract was to depend upon on the terms of the particular contract involved. This leads one to question whether the courts would be as willing to imply a term that the result of contractual discretion be objectively reasonable in commercial contracts also, where the parties’ bargaining powers are generally considered to be more equal. It seems from the judgment of Lady Hale that such an outcome ‘is drawing closer and closer’.

From a practical perspective, this case is likely to mean that even a term granting ‘absolute and sole discretion’ in a contract will have to be exercised in a manner that is objectively rational if it is to be considered to comply with the standard of review adopted in the judicial review of administrative action. Failure to comply 
with such a standard may make the exercise of such discretion easier to challenge in the future.

It therefore seems fair to say that, 
while there are many statements in 
the reported cases mentioned to the 
effect that the principles are well-settled and well-understood, this case illustrates 
that all is not as clear as it might be.