Supreme Court clarifies the limits on contractual discretion

A recent decision of the Supreme Court1 has confirmed that the limits on contractual discretion include a requirement to take relevant issues into account and that the discretion is not exercised irrationally.

This will be of interest to those involved in the drafting of commercial agreements and those involved in making the decisions under such agreements.

Contractual discretion

Where a party exercises its discretion under a contract (even if that discretion is expressed as "at its sole/absolute discretion", etc), it must be exercised without arbitrariness, capriciousness, perversity or irrationality. (This should be contrasted with the exercise of "reasonable discretion", which applies additional limits on the discretion in that the reasonableness of the decision reached is then considered by reference to external, objective standards).

The Supreme Court has confirmed that the reference to "irrationality" in the context of contractual discretion is analogous to the judicial review standard of "Wednesbury unreasonableness", ie that contractual decisions will be subject to the same review as administrative decisions.

Importantly, the Wednesbury test has 2 limbs:

•  firstly, that the decision maker has considered those matters it ought to have taken into account (and excluded those matters it ought not to have considered); and
• secondly, even if proper matters considered, was the decision reached so unreasonable that no reasonable decision maker could ever have come to that conclusion. 

Previous cases on the exercise of contractual discretion have typically focussed on the second limb, by considering whether a decision was "arbitrary, capricious, perverse or irrational", but the Supreme Court has clarified that the first limb also applies in the context of commercial agreements. 

Impact

Whilst it remains a high threshold to challenge an exercise of discretion, it's important to bear in mind that it's not just a question of irrationality, you must also consider what issues should be included and excluded when making a decision.  This decision may encourage or make it easier to mount such challenges, as counterparties will raise the question of what material was (or was not) before the decision maker at the time of the decision.

As well as the general point on contractual discretion (on which the Supreme Court was agreed), it is worth noting that comments in the majority judgments suggest that: more scrutiny of a decision may be appropriate in the context of employment contracts; and that the more unlikely the outcome of a decision, the more cogent must be the evidence to support such a decision (although two of the Lords dissented on both these points).

¹ Braganza v BP Shipping Limited and another [2015] UKSC 17