When a lender can’t just say ‘no’

In this bulletin we look at a case where the High Court considered the application of the “duty of rationality” – otherwise known as the Braganza duty – in the context of secured lending, and we discuss some of the drafting implications.

Background

The Braganza duty, named for the 2015 case of Braganza v BP Shipping Ltd [2015] UKSC 17, provides that a party to a contract has an implied obligation that, in the absence of clear language to the contrary, a contractual discretion must be exercised in good faith and not arbitrarily or capriciously. Note that this does not mean that there is a general duty of good faith under English law. The application of the Braganza duty is quite specific, as we shall see.

The claim

The case of Macdonald Hotels Ltd v Bank of Scotland Plc [2025] EWHC 32 (Comm) concerned a loan facility where the lender held security over a number of the borrower’s real estate properties. The facility agreement included a clause prohibiting the borrower from disposing of, or granting security over, any of these properties other than as specified in a long list of exceptions. As is not uncommon in such clauses, the final exception was a general catch-all – “any other [disposal/grant of security] with the prior written consent of the [lender]”.

Both parties were concerned with the level of debt burden on the borrower – but not amounting to an event of default – and there were ongoing discussions as to how to improve its financial situation.

The borrower proposed a partial refinancing with a third party which would have entailed the lender permitting the borrower to grant security to that third party over a certain number of the borrower’s hotels. The lender refused to grant consent, and the borrower alleged that it was therefore forced to sell three of its hotels to bring down the debt. The borrower claimed that, if consent had been granted, the borrower would have been able to avoid or delay selling the hotels at what it maintained were undervalues because they were sold at a time in the economic cycle when hotel values were historically low. The damages claim ran to tens of millions of pounds.

The basis of the borrower’s claim was that the lender had breached an implied term, which was:

“necessary to give business efficacy to the contract and/or fell to be implied as a matter of law, that the lender would (i) act in good faith and not arbitrarily or capriciously in exercising that discretion, including exercising its discretion consistently with its contractual purpose; (ii) would take into account all relevant considerations and not take into account any irrelevant considerations, and (iii) would not use the discretion for an improper purpose.”

The judgement

The key points from the lengthy judgement can be summarised as follows:

• Applying the correct rules of construction, an implied term cannot contradict an express term
• There is a fundamental distinction between (a) a decision whether or not to exercise what is an absolute contractual right, for example an unqualified right to terminate without cause, and (b) what is a discretion conferred by agreement on one party to a contract
• In the case of the absolute contractual right, the Braganza duty does not apply
• On the other hand, a discretion involves a party “… making an assessment or choosing from a range of options, taking into account the interests of both parties …” where it would be wrong “… to read the contract as permitting the party in question to exercise its discretion in an arbitrary, irrational or capricious manner… “. In this case, the Braganza duty does apply.
• Making this distinction is not always easy. In this judgement, the court took the view that the parties had not needed to include the catch-all consent provision at the end of the clause in question. If they had not included it, then the borrower would have had to request a variation to the contract which the lender would clearly be entitled to refuse without explanation. It followed, in the court’s view, that by including the catch-all consent provisions, the parties had intended it to be a discretion to be exercised by the lender and to which the Braganza duty therefore applied.
•  The key finding in the judgement is this passage: “The parties having expressly agreed that [the lender] could agree a change in the Security, that necessarily implied that [the borrower] was entitled to seek such a change — something that was intended to benefit at least, and perhaps only, [the borrower]. Whilst I accept that in considering such a request, [the lender] (a) was free to act in what it perceived to be its own best interests; (b) was not obliged to balance its interests against those of [the borrower], when arriving at a conclusion or (c) do anything other than exercise its own judgment (necessarily arrived at by its officials and subject to its own internal management controls) in arriving at a conclusion. However, neither party could have intended that [the lender] would be entitled to refuse consent for a reason or reasons unconnected with what it perceived to be its own commercial best interests or to refuse consent when no reasonable entity in the position of [the lender] could have refused consent.” The court then concluded that, on the facts, the lender had not been in breach of this duty.

Drafting considerations

It is important to bear in mind that, by including this sort of catch-all provision, a lender is later exposed to a potential claim for breach of the Braganza duty. Whilst a lender no doubt intends to act reasonably, this should make it think very carefully in exercising such discretion. They will not wish to become embroiled in litigation, even if they are ultimately successful. Can this risk be avoided by clever drafting? One might think that inserting the words “absolute discretion” or “sole discretion” would suffice. However, there have been a number of cases where it has been held that the Braganza duty applies, notwithstanding the use of these expressions.

It has also been suggested that the Braganza duty could be nullified by including an express provision such as “the exercise of this right is not to be treated as a discretion” or “the lender is entitled to exercise this right in an irrational manner” or similar. Such qualifications may, of course, not be commercially acceptable and, in any event, we are not convinced that they would find favour with a court.

The safest course, it seems, is to make sure that this sort of catch-all provision, which is commonplace in many standard form documents, is not included and that any request for its inclusion should be resisted. If the borrower subsequently wants consent to an action which falls outside the scope of the list of permitted actions, it will need to request an amendment to the contract, as suggested in the judgement, which the lender would be free to refuse.

A borrower’s lawyer, of course, should look out for and push for such a catch-all provision. Finally, it should be noted that these considerations apply not only to consent provisions relating to disposals and encumbrances but to other types of discretionary clauses, whether in loan agreements or other types of commercial contract.