Exercising discretion rationally
BHL v LEUMI [2017]
This is a useful example of how contractual parties should exercise discretion in contracts. The Court found that a lender had not behaved rationally when exercising its contractual discretion to impose certain fees so it had to refund the fees charged which were considered to be excessive.
Facts:
- Cobra Beer (“C”) entered into a type of financing arrangement with Leumi (“L”) whereby it assigned its unpaid invoices, called ‘receivables’, to L at a discount for immediate cash to provide working capital (“Agreement”). L was entitled to a fee while C retained responsibility for collecting the receivables unless a termination event occurred.
- C entered administration, which was a termination event under the Agreement, and around the same time, one of C’s shareholders, BHL (“B”), agreed to indemnify L for any shortfall it suffered under the Agreement as C owed significant sums to L.
- L then sent a notice in accordance with the terms of the Agreement that required C to repurchase the receivables which C failed to do.
- Shortly afterwards L notified C that it would be charging collection fees of up to 15% of the sums collected by it, which it was entitled to do under the terms of the Agreement. The relevant clause in the Agreement read:
“If [L] requires the Client to repurchase any Receivables and the Client fails to do so within 7 days of such demand, [L] will be entitled to charge the Client an additional collection fee at up to 15% of amounts collected by [L] thereafter. This collection fee is in addition to any other fee payable by the Client to [L] under this Agreement. The Client expressly acknowledges that such fee constitutes a fair and reasonable pre-estimate of [L]’s likely costs and expenses in providing such service to the Client”.
- L applied the full 15% fee to the sums it collected and claimed the fee under the indemnity given by B. B complained the fees were excessive and extortionate but it paid £950,000, believing it had a contractual obligation to pay the fees under the Agreement.
- The Court was asked to decide:
- Penalty clause: Did the relevant clause contain an unenforceable penalty?
- Exercise of discretion:
- If L had discretion to charge an additional fee, did it exercise it properly?
- Using that discretion, was L only entitled to the actual costs of collection subject to a ceiling of 15%?
- Or could L only charge a fee based on its estimated or actual costs but which could go no higher than 15% and, if so, how should it be calculated?
- Or could L charge any fee it liked without reference to its actual or estimated costs subject only to a 15% limit?
- If L had failed to exercise its discretion properly, did it have any claim at all to costs?
- Could and should the Court fix an alternative fee based on what L could lawfully have charged at the time?
- Mistake: Was the payment made by B caused by a ‘mistake’ and could it therefore be claimed back by B?
Decision:
The Court commented on these issues as follows:
- Penalty clause: The relevant clause was found not to contain a penalty. This was because the fee was not expressed to be a payment for breach of contract. Instead, it was stated as an obligation on C to pay an amount if L exercised its right to terminate the Agreement.
- Exercise of discretion:
- The clause meant L could use its discretion to set a percentage for the additional fee which could be applied to all subsequent sums it recovered. It was not, as B contended, a clause which only allowed L to recover its actual costs of collection which could only be established at the end of the process; it could be set in advance. However, that discretion needed to be exercised in a way that was not ‘arbitrary, capricious or irrational’ (following the Supreme Court decision in Braganza v BP Shipping (SC) [2015], known as the 'Braganza duty').
- L was not entitled to simply charge what it liked. The Court found on the facts that L had simply charged 15% without looking at what the actual or likely costs of collection would be and without considering charging less than the maximum. rationally with reference to objective criteria.
- Since the clause gave L a power to set a percentage fee in advance, there had to be some justification for how the fee was set otherwise it could be exercised unjustly or in an abusive manner. The fulfilment of the ‘Braganza duty’ entailed a proper process for the decision in question including taking into account the material points and not taking into account irrelevant considerations. It would also involve not reaching an outcome which was outside what any reasonable decision-maker could decide, regardless of the process adopted. However, the duty does not mean that the Court can substitute what it thinks would have been the most reasonable decision.
- L was nevertheless still entitled to costs under the relevant clause of the Agreement.
- The Court heard expert evidence and carried out a detailed calculation based on the hourly rates of relevant employees to determine rationally what the maximum estimate of L's costs would be. It concluded that 4% (which came to £320,000) was the absolute maximum that L could have charged if it had complied with its ‘Braganza duty’.
- Mistake: The Court found that B paid the fees in the sincere belief that they were due under the Agreement and so the mistake had effectively caused the payments. The fact that B complained the fees were excessive and unfair did not change that mistaken belief. The individuals involved seemed to genuinely consider that the sums demanded were payable and could only be challenged with ‘difficulty’, based on legal advice they had received.
- Conclusion: B was therefore able to recover the fees it had paid above the amount calculated at 4%, which was the sum that L should have properly charged for its estimated fees in accordance with its ‘Braganza duty’.
Points to note:
- Where any decision includes some element of discretion, it is important to show that you have thought about it and can produce a record of your decision, including the reasons for it and the evidence upon which it was based.
- The “genuine, fair and reasonable pre-estimate of [L's] likely costs and expenses” wording, which is commonly used in commercial contracts to help try and circumvent the rule against penalties, is of dubious value in that context. This is especially the case if a party has not exercised its discretion in accordance with the ‘Braganza duty’.
- If possible, try and avoid wording which leads to uncertainty. In this case, by drafting the clause with an upper limit, almost inevitably the drafters were inviting an argument about what the right level of the collection fee should be. Whilst this may be not be possible in some situations, consider whether it might be better to specify a more definite figure in the contract to minimise the scope for such arguments.
- This is another case on the exercise of discretion, following Watson v Watchfinder [2017], showing that it is wise to take care to exercise discretion in a way that is consistent with the ‘Braganza duty’.