They say ‘discretion is the better part of valour’, but beware when using it in contracts

Posted: 18/05/2020

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In the recent High Court decision of TAQA v Rockrose [i] the English High Court rejected arguments that a duty to act rationally and in good faith should be implied into a contract to limit the manner in which a party uses a clear and unambiguous written contractual right to terminate. The case highlights the unwillingness of the English courts to interfere with the exercise of clear contractual rights. It also provides a helpful overview of the law in relation to contractual discretion and good faith.

Background to TAQA v Rockrose

TAQA Bratani, JX Nixon Explorations and Spirit Energy Resources (together, the claimants) and Marathon Oil (Marathon) were parties to several joint operating agreements, whereby Marathon operated multiple oil and gas field blocks in the North Sea. Following the announcement that Rockrose was to acquire Marathon, the claimants became concerned with Marathon’s ability to perform its contractual obligations, and unanimously agreed to replace Marathon with TAQA as the operator. In June 2019 the claimants served notice under the joint operating agreements terminating Marathon’s role as operator. In July 2019 Rockrose acquired Marathon and challenged the validity of the termination on the basis that the claimants’ right to terminate could only be used (i) in good faith; and/or (ii) not arbitrarily or irrationally. The claimants maintained that the clause or contract imposed no express or implied obligation on them to act in good faith, nor for them to provide their reasons for terminating the appointment. The parties’ dispute was brought to the High Court.

How do the courts interpret contracts, implied terms and a duty of good faith?

When a court interprets a contract, it looks at all the clauses together, as well as the specific factual and commercial context. The court will consider: (a) the words’ ordinary meaning; (b) the overall purpose of the contract; (c) the facts known or assumed by the parties when they signed the agreement; and (d) commercial common sense. Crucially, it will not be the intention (or responsibility) of the courts to get a party out of a bad bargain.

In the leading case on implied terms, [ii] the Supreme Court held that an additional term will only be implied into a complex commercial agreement where: (a) it is necessary to give the contract business efficacy or where it is so obvious that it goes without saying; and (b) implying the term would be fair or would have been agreed by the parties had it been suggested to them. The requirement of ‘necessity’ to giving the agreement business efficacy cannot be reduced to what would be ‘useful’ or ‘convenient’, for example. Equally, where legal advisors have negotiated the agreement, the court will usually interpret the written clause as forming the whole picture, and for the parties to have intended there to be no other implied obligation(s) involved.

There is no general duty in English contract law for the parties to act in good faith. However, a court might imply an overarching duty of good faith to the whole of an agreement which comprises a long term relationship involving a substantial commitment (a ‘relational contract’). [iii] Such arrangements are typically based on mutual trust, confidence and loyalty. Examples of relational contracts might include certain joint venture or long-term distributor agreements, although each circumstance will be different. Where good faith is implied, neither party can behave in a way which, in the relevant context, would be regarded as commercially unacceptable by reasonable and honest people.

In addition, implied terms cannot contradict or be inconsistent with express terms. For instance, a recent case confirmed that an overarching duty of good faith will not be implied to the whole agreement where it contains one or more obligations which expressly require a party to act in good faith (ie in specific circumstances). [iv] To impose such an overarching duty would be inconsistent with the express terms.

Separately, the courts can imply a term that qualifies the manner in which a contractual discretion may be exercised. This duty, known as the ‘Braganza’ duty after the leading 2015 Supreme Court case, will only apply to an individual clause which: (a) requires a party to use its discretion to form an opinion or choose from a range of options; and (b) the party’s decision benefits one party and detriments the other(s). [v] It does not apply to an absolute contractual right (a clause requiring no discretion), such as a termination clause. Where a Braganza duty is implied, the party must not exercise its discretion in an arbitrary, capricious or irrational manner. The court will consider two questions: (a) has the decision-maker taken into account something they shouldn’t, or failed to take into account something they should; and (b) was the decision one that a reasonable decision-maker would not have reached?

What did the court say in this case?

In this case, the court held that the claimants validly terminated Marathon/Rockrose’s appointment, and did not need to provide any justification for doing so. The language of the termination clause was clear and unambiguous, and the court considered that the parties had intended the claimants’ right to be absolute. As such, the parties had not intended for the agreements to be ‘relational contracts’ which required them to act in good faith, generally; and there was no need to imply an addition obligation of good faith or rationality into the termination clause to give it business efficacy. Indeed, had the court implied such an obligation to the absolute termination clause, it would suggest that every clause in all agreements should be limited by good faith or rationality. That would be an unwarranted interference in the parties’ freedom to contract.

Notwithstanding this decision, the court did suggest that, even if a party is limited by an implied obligation to act in good faith or rationally, it is not necessarily prevented from acting in a way so as to protect itself against certain financial and operation risks, so long as those risks are genuinely perceived by that party.

Significance

The moral of this story is twofold. Firstly, companies should be careful when incorporating and/or using discretion which is set out in commercial agreements. While such a right may appear to be absolute and unqualified, there are situations where the exercise of such a right might be limited by an implied obligation not to exercise the powers arbitrarily or capriciously and only in good faith. Secondly, if an agreement involves a long-term commitment based on loyalty (a so-called ‘relational contract’), parties could face arguments that such agreement is subject to an implied overarching duty of good faith. The safest and most certain course of action is often to expressly exclude general duties of good faith from the agreement, or to limit its application by identifying specific clauses that the parties intend should be subject to a duty of good faith, such as when negotiating disputed invoices. In any event, seeking legal advice is strongly recommended.

[i] TAQA Bratani Limited, TAQA Bratani LNS Limited, JX Nippon Exploration and Production (U.K.) Limited, Spirit Energy Resources Limited v Rockrose UKCS8 LLC [2020] EWHC 58 (Comm)

[ii] Marks and Spencer Plc v. BNP Paribas Securities Services Trust Co (Jersey) Limited [2015] UKSC 72

[iii] Yam Seng Pte v. International Trade Corp [2013] EWHC 111 (QB)

[iv] Russell v Cartwright [2020] EWHC 41 (Ch)

[v] Braganza v. BP Shipping Limited [2015] UKSC 17.

This article has been co-written with trainee solicitor Laurence Nelson.

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