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Exercising discretion: what are the limits?

30 September 2014

Commercial contracts often contain clauses allowing one party to exercise its discretion when making a decision, which will undoubtedly have an impact on the other contracting party.

In a recent case, the court considered whether the exercise of such a 'discretion' clause, in the context of termination, was subject to any limitation.

Bluewater Energy Services BV v Mercon Steel Structures BV and others

A Russian oil company, Lukoil, employed Bluewater Energy Services BV to design, construct and install a soft yoke mooring system (SYMS) for use at an oil field in the Caspian Sea.

In March 2007, Bluewater entered into a contract with Mercon Steel Structures BV to fabricate the SYMS. The contract provided for a commonly used two stage termination process whereby Bluewater was required to provide Mercon with a notice of default, resulting in termination if Mercon did not immediately proceed with 'action satisfactory to Bluewater'.

Separately, the contract contained a general 'good faith' obligation that "honesty, fairness and integrity shall be paramount principles in the dealings between the parties."

The sub-contract works were delayed and Bluewater sent a notice of default on 23 January 2009 followed closely by a notice of termination on 3 February 2009. Mercon argued that the action satisfactory to Bluewater had to be objectively reasonable, so that it was not a question of Mercon's remedial actions having to be satisfactory purely in the subjective opinion of Bluewater.

The court rejected Mercon's argument. It found that the question was simply whether Bluewater could show that it was dissatisfied and this was a matter for Bluewater's subjective view.

However, the court did find that the exercise of subjective discretion was not unfettered. 

It was subject to the concepts of honesty, good faith and genuineness and the need to avoid arbitrariness, capriciousness, perversity and irrationality, which would be implied into the discretion clause.

This limitation was supported by the express 'good faith' obligation in the contract but was not dependent on such an express obligation and would have been implied in any event.

Steven Carey, Head of our Construction, Engineering & Projects team, commented:

"This case demonstrates that the courts are not afraid to 'amplify' discretion clauses. If parties intend to confer an absolute discretion, it seems very clear wording would be needed. It is also a further illustration of when a general 'good faith' obligation might take effect and serves as a reminder that parties need fully to consider the consequences of including such a clause." 

This article was written by Christopher Busaileh. 

For more information please contact Christopher on +44 (0)20 7427 4546 or christopher.busaileh@crsblaw.com.