Contractual discretion - lost at sea?

Contracts often include terms that give discretion to one of the parties to make a decision affecting the other party. Does that mean that the party with the discretion can use it freely? Apparently not, according to a recent Supreme Court case.

This case arose from tragic circumstances - the overnight disappearance of a Chief Engineer, Mr Braganza, from an oil tanker in 2009. Once his disappearance was noticed, teams of investigators looked into the incident, trawling through his belongings and correspondence, interviewing other staff and inspecting the ship. They finally concluded that the most likely of the various possibilities was that Mr Braganza had thrown himself overboard.

Why did this matter? His contract of employment provided that compensation payable to his widow would not be paid: "...if in the opinion of the Company or its insurers, the death, accidental injury or illness resulted from… the Officer's wilful act, default or misconduct...". Mr Braganza's employer, BP concluded that the death resulted from a wilful act and so no compensation was payable.

The Supreme Court judges agreed that where a contract gives power to a party to make decisions which affect both parties the discretion was limited ‘by concepts of honesty, good faith, and genuineness, and the need for the absence of arbitrariness, capriciousness, perversity and irrationality'. The standard is very like that expected of government bodies when making executive decisions, although exactly how close these standards are is not entirely clear from the judgment.

What are the implications for commercial contracts?

Parties including a discretion for one party in a contract should remember that these cannot be exercised completely freely. When drafting a clause of this type you could consider including a procedure of some kind to support the decision making, or a list of criteria that will be taken into account.

And a party that is exercising a contractual discretion should consider keeping records of the evidence on which it is basing the decision and the factors it has relied on. A particularly contentious issue could be referred to an independent expert for an outside view.

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