The High Court recently provided reassurance to lenders by holding that a Braganza duty did not apply to a secured lender when exercising its discretion to demand full repayment of a loan.
The Braganza duty explained
A contract may give a party the power to make decisions which affect both parties to that contract. Here there is clear potential for a conflict of interest but a court will be reluctant to interfere with the agreement reached between the parties. Instead, a court will look to ensure that the powers afforded by a contract are not abused and it may do this by implying a Braganza duty into the contract. A Braganza duty requires discretion to be exercised in a way that is not irrational, arbitrary, capricious and/or unreasonable.
In other words, there must be a proper, rational decision making process. In Braganza, the court found that the decision making process itself should be reviewed – did the decision maker take into account all the relevant factors and disregard any irrelevant factors?
The duty is different to the already established duty to act reasonably. A Braganza duty is subjective (the duty to act reasonably is objective). It applies a minimum standard to the decision-making process. It also introduces an element of good faith to the process.
Usually, the duty is implied into contracts where there is a potential for a conflict of interest and is intended to prevent a party from abusing its decision making powers.
With great power…
The Braganza duty has been considered in the context of lender decisions in a variety of scenarios and so is one lenders should be aware of – in one case that examined collection fees, it was held that a lender should not be given an ‘untrammelled discretionary power’ to charge the maximum fee it contractually could. Another case looked at a lender’s power to commission valuations at the cost of the borrower and held that it could be inferred that the power was intended to be ‘exercised in pursuit of legitimate commercial aims, rather than, say, …maliciously’.
A Rose by any other name…
In the recent case referred to above, the High Court held that the Braganza duty did not apply to a secured lender when it was exercising its ‘absolute discretion’ to demand full repayment of a loan.
The loan agreement in question gave the lender an absolute discretion to require repayment on three months’ notice. The loan was uncommitted and ‘on demand’.
Taking into account the unequivocal words the parties agreed, the nature of the contract they entered into and the relative equality of their bargaining power there was no basis for implying a Braganza term. This case involved a secured lender but it would appear that the conclusions reached could also be applied to unsecured lenders.
The case provides us with some useful principles relating to the application of a Braganza duty:
- not every contractual power or discretion will be subject to a Braganza duty limitation. The language of the contract will be an important factor;
- it is most likely to apply to decisions which affect the rights of both parties to the contract where the decision-maker has a clear conflict of interest. The type of decision where one party is given a role in the on-going performance of the contract; such as where an assessment has to be made. This can be contrasted with a unilateral right given to one party to act in a particular way, such as right to terminate a contract without cause;
- the nature of the contractual relationship, including the balance of power between the parties should be taken into account. It is more likely for a Braganza term to be implied in a contract of employment than in other less ‘relational’ contracts such as mortgages;
- the scope of the term to be implied will vary according to the circumstances and the terms of the contract.
Even though the Braganza duty did not apply in this instance, the Rose Capital case does remind us that secured lenders still owe a slightly different, more limited duty of good faith. This duty does not arise from an implied term, but instead from the creation of a mortgage.
This blog post was written by Alexandra-Lee Tennick, trainee solicitor, Banking & Finance.
For further information, please contact:
Richard Sealy, partner, Banking & Finance