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02 Aug 2023

Good faith v contractual discretion: context is king (Sibner v Jarvis Capital)

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A lender has successfully appealed a decision to set aside statutory demands made against two guarantors, following the borrower's default. At first instance, the court set the statutory demands aside on the basis that there was a realistic prospect of demonstrating that the lender had breached an implied duty of good faith or 'some other Braganza1 style duty'. However, on appeal this somewhat surprising (not least because the argument was not actually raised by the defendants) decision was overturned.

In this article, we explore the judgment in Sibner v Jarvis Capital Ltd and another [2022] EWHC 3273 (Ch), and consider in what circumstances the exercise of a contractual discretion will be restricted by an implied duty to act in good faith, or a duty to act without being 'arbitrary, capricious or irrational'.

Key takeaways

  • The courts are reluctant to imply terms into a contract and will be slow to imply duties which fetter the exercise of absolute rights (including rights to terminate), as this would interfere with the parties' freedom of contract.
  • A lender exercising an unqualified and absolute contractual discretion following an event of default will not usually be subject to an implied duty of good faith, nor an obligation not to act arbitrarily, capriciously or irrationally.

The facts

The contracts

Sibner Capital Ltd (the Lender) provided finance to Oak End Way Developments 2 Limited (the Borrower), in connection with a property development. The loan was guaranteed by Jarvis and Hughes (the Guarantors). As well as the facility agreement (the Facility), all three parties entered a joint venture agreement with the property owner (the JV).

The Facility was split into two tranches, each financing a different phase of the development project. Tranche A was a loan of £425,000, due to be repaid by 1 December 2020. The Facility specified that Tranche B was not to be drawn down until Tranche A had been repaid.

The terms

The dispute concerned two contractual clauses: one in the Facility and the other in the JV.

Clause 5.3 of the Facility stipulated that "the lender may in its absolute discretion" accept a lesser payment of Tranche A on the repayment date, and thereby release Tranche B. This was subject to conditions, including that the sum paid was at least £300,000, and that the balance of the Tranche A loan should then be treated as drawn down under Tranche B.

In the JV, Clause 5.1 required the parties to act in good faith. However, Clause 5.2 specified that this requirement did not prejudice or restrict the Lender's rights under the finance documents, including any rights arising following an event of default.

The dispute

In December 2020, the Lender exercised its discretion under Clause 5.3 of the Facility and agreed to accept £380,000 from the Guarantors in repayment of Tranche A. The Lender imposed additional conditions, including that the balance be paid by the end of January 2021.

However, those conditions could not be met: one, for example, involved evicting a tenant from the development property, which was not possible at the time due to Covid restrictions. The Guarantors argued that these conditions were intentionally stringent, and that the Lender was trying to cause them to default.

Ultimately, the balance of Tranche A was not paid in January 2021, and the Lender served statutory demands on the Guarantors the following month. The Guarantors applied, successfully, to a District Judge to set aside those statutory demands. The Lender appealed to the High Court (Chancery Appeals Division).

Decision

The issues

The Lender raised several issues on appeal, including that, at first instance, the good faith argument upon which the decision was based was not actually raised by the Guarantors. While the court agreed that this constituted a procedural irregularity, it proceeded to consider the issue, given that by the time of the appeal, all parties had had the opportunity to address it. The appeal focussed on three key questions:

  1. Was the Lender's discretion to accept a lesser sum under Tranche A an absolute discretion?
  2. Was the Lender subject to any implied duty of good faith?
  3. Was the Lender subject to any good faith/Braganza style duty when exercising its discretion?

The Lender argued that it was not subject to any good faith/Braganza duty, as its right to exercise its discretion under the Facility was absolute.

The Guarantors argued that the Lender was subject to such duties and had breached them for the following reasons:

  1. It had forced the Guarantors into default by failing to provide a redemption statement based on the lesser payment (the Guarantors required this statement to take out a loan from another lender);
  2. The Lender had imposed conditions that the Guarantors would be unable to comply with; and
  3. The provisions on default interest amounted to penalties.

Analysis

The court held that the Lender had an absolute contractual discretion, which was 'not expressly qualified in any way'. An absolute contractual right should be identified by considering the 'process of construction which takes account of the characteristics of the parties, the terms of the contract as a whole, and the contractual context' (Equitas Insurance Ltd v Municipal Mutual Insurance Ltd [2019] EWCA Civ 718). Further, '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' (Greenclose Limited v National Westminster Bank Plc [2014] EWHC 1156 (Ch)).

Another relevant factor in the decision was that the contract was a commercial contract, which was drawn up with legal advice and made between experienced commercial parties. '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 relations and extending Braganza to such provisions would be an unwarranted interference in the freedom of parties to contract on the terms they choose' (TAQA Bratani Ltd v Rockrose [2020] EWHC 58).

While the analysis that the duty did not apply was clear, interestingly the court acknowledged that, had a duty of good faith or a Braganza duty been found to apply, the Guarantors could reasonably have argued that the Lender breached those duties by intentionally imposing conditions which would trigger a default.

However, that finding had no relevance in circumstances where the contract went 'out of its way' to make clear that the Lender's right was an absolute discretion. It was also relevant that Clause 5.2 of the JV had specifically provided that the obligation to act in good faith should not affect the Lender's rights under the Facility.

Comment

This judgment highlights the fact that the commercial relationship between the parties is a relevant factor in the analysis of whether the good faith/Braganza style duties apply, as well as the actual words used in the contract. This finding is echoed in the recent New Zealand judgment in Philip John Woolley v Fonterra Co-Operative Group Limited [2023] NZCA 266, which also considered the way in which the Braganza duty should apply to commercial contracts which are not employment contracts and therefore involve 'a relational contract of a different character'. Although the New Zealand court did not determine whether the Braganza duty applied, it considered the scope of the doctrine and in particular the relevance of the parties' relative bargaining power.

A judgment from the Employment Appeal Tribunal in June 20232 also noted that 'it is important not to lose sight of why the implied term is being relied on'. As in Sibner, the Tribunal emphasised that Braganza is 'not […] an invitation to subject any discretion […] to an implied term that it will not be exercised unreasonably' and asserted the importance of the language used to draft the right.

Authors: Ed Davis, Harriet Campbell and Jen Cohen

 

1 Braganza v BP Shipping Ltd [2015] UKSC 17

2 Mr A Manning v Walker Crips Investment Management Ltd [2023] EAT 79

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