Absolute discretion: does it mean what it says?

A conditional contract containing an absolute discretion for the buyer to decide whether a condition in planning permission is onerous does not necessarily mean that the buyer, effectively, has the power to pull out of the acquisition on a whim in changed market conditions.

This may come as a surprise… Surely ‘absolute discretion’ means what it says on the tin? However, the courts consider the interpretation of contract provisions on a case by case basis and there is a body of case law relating to commercial contracts which confirms that discretion must not be exercised in a way that is based on a whim.

The duty of rationality when exercising a discretion

Following the leading Supreme Court decision in 2015, it is now a well-established rule that there is an implied obligation (unless there are clear contract terms to the contrary) to exercise a contractual discretion in good faith and in a way that is not arbitrary or capricious. This is often called the Braganza duty after the leading case, or the duty of rationality.

The duty to act rationally is not the same as a general duty to act reasonably but it does mean that there should be some logical connection between the evidence and the apparent reason for the decision. So in exercising discretion to decide if a planning condition is onerous, the decision must relate to the planning permission itself and not be because, for example, the price agreed for the site is now too high.

The aspects of acting rationally

To comply with the duty to act rationally, the decision-maker must:

• ask the right question and take the right matters into account;
• avoid a result so outrageous that no reasonable decision-maker could have reached it;
• have evidence to support the decision and to demonstrate that the relevant opinion was held at the relevant time.

Do the words “sole” and “absolute” make any difference?

It is far from clear from the case law that, by adding “sole” or “absolute” discretion, the decision-maker would avoid the duty to act rationally. To put this in another way, does the contract really allow a party to exercise discretion in bad faith or to act arbitrarily or perversely?  

For this reason, the rationality requirement is extremely difficult to exclude and so if a developer wants an absolute right not to proceed with an acquisition once planning permission has been obtained, it is safer to enter into an option agreement.

Have the parties also agreed to act in good faith?

The contract may, of course, also include an express duty on the parties to act in good faith. What this means will depend on the circumstances of each case and the commercial context, but essentially it involves sticking to the spirit of the contract and being faithful to the agreed common purpose. This obligation would provide additional ammunition to a seller who considers that a buyer has exercised its discretion in a perverse manner. 

Market conditions

In strong market conditions, if a buyer exercises its discretion to decide whether a planning condition is onerous and wants to pull out of acquisition for reasons, not in fact directly related to the permission, the seller may well not object as it retains the land with the added benefit of planning permission.  However, in a struggling market, a seller is more likely to argue the point if its potential loss is sufficiently big to take the risk of litigation.

So, a developer should not automatically assume that exercising “absolute discretion” is tantamount to being able to pull out of a contract for a reason wholly unrelated to the subject matter on which it is exercising its discretion.  It may be required to provide evidence for its decision and demonstrate that it took the right matters into account.