Interpreting Contracts - meaning of ‘commercially reasonable’

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This is the third instalment of our Interpreting Contracts series, following on from our blog post “Interpreting contracts – can you vary a non-variation clause?” 

Where one party is given a contractual discretion as to how a right is exercised, the contract often provides that such discretion must be exercised in a ‘commercially reasonable’ manner.  This note summarises the leading case on the meaning of ‘commercial reasonableness’.

In Barclays Bank PLC v Unicredit Bank AG & ANR [2014] EWCA Civ 302, the Court of Appeal considered whether Barclays had been “commercially reasonable” when withholding its consent to early termination of guarantees and whether Barclays was entitled to take primary account of its commercial interests when determining whether to consent to the termination.

Background

Unicredit entered into three guarantees with Barclays whereby Unicredit transferred some of the credit risk on one of its loan portfolios to Barclays, in return for which Barclays received quarterly payments and a fixed quarterly fee.  The lifetime of two of the guarantees was 11 years and the other 19 years, but provisions included which entitling Unicredit to bring them to an end after a period of about 5 years.  Barclays could therefore expect to earn five years’ worth of premium and fees under the guarantees.

Each guarantee contained an early termination clause which entitled Unicredit to terminate the guarantees in the event of certain regulatory changes.  The termination right, however, was subject to Barclays’ consent which required Barclays to consider whether to give such consent in a ‘commercially reasonable manner’. 

Unicredit sought early termination under this provision and Barclays refused to give its consent unless it was paid the five years' fees it had expected. Unicredit refused and alleged that Barclays had acted in a commercially unreasonable manner by refusing consent.

Judgment

Longmore LJ, who gave the judgment found that Barclays’ actions had been commercially reasonable and held that:

  • the termination clause in question was to be regarded as equivalent to conferring a discretion to which the principles of Wednesbury reasonableness apply, namely that the exercise of the discretion is not "so unreasonable that no reasonable authority could ever have come to it";
  • the clause imposes an obligation on the decision-maker to act in a commercially reasonable manner, but that does not mean that the outcome must be commercially reasonable for all the parties.  However, if it is not, this would cause one to look critically at how the decision was made; and
  • any ‘commercial man’ asked to determine whether his consent be given to a decision would think it commercially reasonable to have primary regard to his own commercial interests.  It would be very difficult for the decision maker to assess the interests of the other party or weigh those interests up in comparison with his own.

The Court of Appeal acknowledge that the use of the phrase ‘commercially reasonable’ in this context was intended to be a control exercise, therefore outright refusal of consent or indeed a demand for a return not reasonably anticipated by Barclays may not have been ‘commercially reasonable’.  The Court acknowledged that Barclays’ assessment of its loss of profits (being 5 years’ of fees) was a rough and ready assessment as it did not account for any savings it would make as a result if early termination.  However, as Unicredit had not made any counteroffer, and the calculation would not have been an easy one to make in any case, Barclays did determine whether or not it should consent to early termination in a commercially reasonable manner.

Lessons learned

Whilst the judgement does not set out a general test for ‘commercial reasonableness,’ it does provide helpful judicial guidance on when a party will not be acting in such a manner. 

Before including the phrase ‘commercially reasonable’ to elicit a particular behaviour in an agreement, the parties should consider how it will apply and would be advised to spell it out in the agreement.  For example, depending on the context in which this term is used, the parties may want to consider setting out what the deciding party must take into account when making its decision in order for it to be commercially reasonable.