UK: Lender Discretions: Understanding The Limits

Last Updated: 31 July 2014
Article by Adam Pierce

Most facility agreements give the lender certain discretions. Sometimes the agreement will say the lender must exercise a discretion reasonably. But what if it doesn't? Adam Pierce explains the extent to which implied terms may limit a lender's discretions, with particular focus on some recent cases.

No arbitrary, capricious or irrational use of discretions

In the 2013 case Mid Essex Hospital Services NHS Trust v. Compass Group, the Court of Appeal noted that where a contract gives a party a discretion which "involve[s] making an assessment or choosing from a range of options" it is "extremely difficult to exclude" an implied term that the discretion will not be exercised "in an arbitrary, capricious or irrational manner" (a rationality implied term). So to what extent are the rights a lender typically enjoys subject to a rationality implied term?

The right to accelerate

Lenders usually have a contractual right to demand repayment on an event of default. Is this a discretion, and so limited by an implied term? The Mid Essex case (which concerned an analogous situation) suggests a court would not usually imply any limits on this right to accelerate.

In Mid Essex, if a contractor's performance fell below required levels, its counterparty (an NHS Trust) had a right to deduct amounts from the price payable under the contract. The Court of Appeal held there was no implied term limiting the Trust's right to deduct. Once the right arose, the Trust had "a simple decision whether or not to exercise an absolute contractual right". No implied terms were necessary.

It would seem logical to apply a similar approach to a lender's right to accelerate.

Approving conditions precedent

Where a borrower has to deliver conditions precedent "in form and substance satisfactory to the lender", this involves the lender "making an assessment" - to use the wording in Mid Essex. So the lender's freedom to reject a condition precedent will usually be limited by a rationality implied term.

The lender is free to take an unusually cautious approach in ensuring the conditions precedent adequately protect it. But it cannot arbitrarily refuse to accept conditions precedent simply to avoid having to lend.

Discretion to change commercial terms

Where a lender has a discretion to set or change the commercial terms of the loan, a court will generally apply a rationality implied term to that discretion. This was the approach of the Court of Appeal in the 2002 case Paragon Finance v. Staunton, where a facility agreement gave the lender a unilateral right to change the rate of interest.

However, the court took a different approach in the non-banking 2012 case Yilport Konteyner Terminali v. Buxcliff. Yilport agreed to carry out urgent work on a damaged ship. The work had to be arranged at such short notice that the only thing the parties managed to agree about the price was that it was to be determined by Yilport. The court held that Yilport's charges had to be reasonable. Unconvincingly, it distinguished between the more limited rationality implied term applied in previous reported cases on the basis that the cost was such a central part of the commercial terms (arguably the interest rate on a loan is similarly central).

However, other than in similarly extreme circumstances (an urgent loan arranged at short notice with key terms to be set by the lender(?)) it seems unlikely a court would apply a similar test to lender discretions under a facility agreement.

Lender consents

Most facility agreements include negative undertakings: things the borrower must not do or allow to happen. A lender generally has complete discretion whether or not to waive these undertakings. What if the agreement states that the borrower must not take a particular action "without the consent of the lender"?

For some types of consent, there is likely to be an implied term limiting the lender's discretion. In the 2012 case Commercial First Business Ltd v. Atkins, a landlord had borrowed money under a loan agreement. This required him to obtain the consent of the lender before granting new leases. The court held that a lender cannot "unreasonably withhold" its consent to this type of request.

The court's reference to reasonableness suggests a lender's freedom to withhold consent in these circumstances is more restricted than it would be if it were merely subject to a rationality implied term. The difference may not be as significant as it would first appear. For example, the court made clear that a lender "need usually only consider his own interests". This implied term does not create an even balance between the interests of lender and borrower.

Parties should not assume this implied term always applies where there is a lender consent mechanism. A court may sometimes interpret a clause prohibiting an action without the lender's consent in the same way as an absolute prohibition, if an absolute prohibition would make sense in the context of the agreement.  However, if lenders want to be sure that borrowers are subject to an absolute prohibition, they should avoid adding "without the consent of the Lender" to the negative undertakings in their agreements.

Law stated as at 30 July 2014.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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