How discretionary is a discretion?

March 2018

How discretionary is a discretion?

Rating system:
Reading time (1-10 minutes): 3
Sophistication level (1 (idiot) – 10 (expert)): 5
Entertainment value (1 (turgid) – 10 (side-splitting)): 5

In this recent case, Watson was a director of a company which provided services to Watchfinder, which trades luxury pre-owned watches. Watchfinder granted Watson an option to buy shares in it. The option said that ‘The Option may only be exercised with the consent of a majority of the board of directors of the Company’ (ie Watchfinder). Watchfinder said that this meant that the board had an unconditional right to veto the exercise of the option.

What did the court say?

The court disagreed. It said that the right of veto was discretionary, and that a party exercising a contractual discretion has to exercise it in a way that is not arbitrary, capricious or irrational. Also, the directors should go through a decision-making process, taking account of material points and disregarding immaterial ones, and reaching an outcome that was not unreasonable. The court didn’t actually say what kind of basis to refuse consent might be reasonable, although it said the board could veto the option if it did not think that Watson made a significant contribution to the progress or growth of Watchfinder.

Comments:

The court followed the law set out by the Supreme Court in 2015 in the case of Braganza v BP Shipping. This was a tragic case where the chief engineer on board a BP oil tanker disappeared overnight. No one was sure why, but BP after investigation said the most likely reason was suicide, which meant that under his employment contract (‘if, in the opinion of the Company or its insurers, the death…resulted from…the Officer’s wilful act, default or misconduct…’) his widow wasn’t entitled to certain death benefits. The initial court said BP was not entitled to form the opinion it did. The Court of Appeal disagreed. And finally the Supreme Court by a 3-2 majority finally said that BP should have sought more cogent evidence of suicide than it had before reaching its opinion. The case is an example of the courts struggling to work out how far they should go in adopting quite developed legal principles of judicial review of administrative action by public bodies into the context of private business contracts. And probably also an example of how courts like to try to come to the decisions they want to come to…

If the option had been subject to Watchfinder’s shareholders’ consent it would have been simpler. The shareholders could have happily vetoed as they are entitled to protect their interests, eg not to have their shareholdings diluted. But here, saying that the discretion was that of a majority of the board, ie the decision-making body of the company, seems no different to saying that it was the company’s discretion.

The clause is certainly not one I would have advised Watson to rely on! It would be easy for a party in Watchfinder’s position to effectively decide that they don’t want to give their consent, and then put together a whole lot of reasons together which they can minute at a board meeting, going through the motions that that they are taking serious account of the things they need to consider bearing in mind their duties as directors

Quite often where contracts have clauses saying that something is dependent on a party’s consent, you add some wording saying that any consent should not be unreasonably withheld or delayed. Otherwise you would have thought that the party could simply withhold consent for no good reason at all. But if the parties have clearly tried to set out some form of agreement contemplating something that might happen, this case shows that you can get some form of protection even if you don’t add a specific requirement for reasonableness. But the sensible thing to do (for the option holder) would clearly be to set things out in the contract itself as specifically and clearly as possible, eg here, to set out what kinds of grounds might be acceptable for the board to decline to allow the exercise of the option. Or, ideally, set out some clear conditions of exercise which do not involve the exercise of any discretion at all.

Case: Watson v Watchfinder.co.uk (2017)