Exercising Contractual Discretion - Why you may not always have a completely free hand

To most of us, it would seem obvious that if a contract says something along the lines of “this may only be done with the consent of a majority of the board of directors of the Company”, then if the consent isn’t forthcoming, you can’t do whatever it was that required the consent.  That’s what the directors of Watchfinder.co.uk Ltd thought when they used what they believed was their absolute discretion to refuse to give consent to the exercise of share options in their company by three individuals.  But the High Court recently held that they did not have the right to do this.  Following a developing thread of case law, the court said such a discretion should not be abused by exercising it in a way which was arbitrary, capricious or irrational. 

Normally, share option agreements allow the option to be exercised when certain clearly defined conditions have been satisfied.  These may be as simple as reaching a certain date, or can be more complex, including performance conditions as well as time limits.  Somewhat unusually, the option agreement granted by Watchfinder.co.uk Ltd to the claimant individuals in this case included a condition that the option could only be exercised with the consent of the majority of the Board.

From the evidence considered by the High Court in Watson and others v Watchfinder.co.uk Limited [2017] EWHC 1275 the Board did not focus their minds on the exercise of their discretion when the claimants sought to exercise the option.  In fact, in his judgement Judge Waksman QC said “The whole matter was dealt with very casually”. 

While every case will turn on its facts, this has served as a useful reminder that many discretions which appear to be granted in clear and uncertain terms in a contract can, in fact, be subject to constraints implied by the law.  The test was set out in another case in 2015 (Braganza v BP Shipping [2015] 1 WLR 1661).  In essence, in the absence of very clear language to the contrary, a contractual discretion must be exercised in good faith and not arbitrarily or capriciously.  The underlying legal objective is that the discretion should not be abused.  In the Watchfinder case, the Board had a clear conflict of interest when considering the exercise of the option because any grant of new shares following the option exercise would dilute the shareholdings of those directors who formed the Board.

The lesson from this case is that if you find yourself in a position where you have the ability to exercise your discretion under a contract, think twice before doing so in a way which may adversely affect the other party to that contract.  You may be perfectly entitled to do what you want, but that will depend both on the consequences of your decision and also on the way the discretion has been worded in the contract.  Even if you are confident that you can do what you want, if your reasoning and the factors taken into account when making your decision are not properly considered and recorded (in case they ever need to be produced in evidence to support your decision) then you could find yourself exposed.