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Fetter not risk it: avoiding penalties and curtailing contractual rights

Jason Rix

Last week, Richard Hooley gave one of his regular talks on recent developments in banking and finance law. Below I have set out a couple of knotty contractual issues I noted down:

  1. “Clever” (or careful) drafting may stop a clause being a penalty (Holyoake v Candy).
    • A requirement to pay a redemption amount on voluntary early repayment of a loan was not expressed to operate on breach and therefore was not a penalty.
    • A loan extension fee was a primary obligation since “in a real and substantive, and not just a formal, sense, this was a payment in return for consideration rather than a payment due under an obligation arising on breach”.
    • A loan extension fee which if paid on time was to be credited against the debt was held “admittedly with some hesitation” not in substance to be a penalty.
    • Interest charged as the price for extending the time of payment did not operate on breach so the penalty rule was not engaged.
    • No submission was made that a default rate of 15% per annum compounded monthly was an extravagant or exorbitant rate for a commercial agreement (and, indeed, the judge noted, it was less than the rate of 20% per annum for the loan).
  2. There have been a number of cases looking whether, and to what extent, a party’s rights under a contract are fettered:
    • A clause that said “The Lender may, at any time, require the Valuer to prepare a Valuation of each Property” did not give the lender a wholly unfettered right to require a valuation. It could not be required, for example, for a purpose unrelated to the lender’s legitimate commercial interests or if doing so could not rationally be thought to advance them (PAG v RBS).
    • The change in wording from “reasonably determines in good faith” in the 1992 ISDA Master Agreement to “act in good faith and use commercially reasonable procedures in order to produce a commercially reasonable result” in the 2002 ISDA Master Agreement had the effect of replacing a requirement for a rational decision with a requirement for an objectively reasonable decision (Lehman v NPC).
    • Likewise, a provision that said “If, with the prior approval of the bank (such approval not to be unreasonably withheld or delayed), the property is sold, you shall immediately repay to the bank the net proceeds of sale” meant the test to be applied was one of objective reasonableness and not rationality (Crowther v Arbuthnot).

 

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  1. Jason Rix says:

    In LBI v Raiffeisen Bank, the Court of Appeal looked once more at contractual discretion. The case concerned default valuation provisions in the Global Master Repurchase Agreement (2000 version) and, in particular, the meaning of “fair market value” in the definition of “Net Value”. The court held that, in the absence of some express or implied limitation in the contract on the exercise of the discretion, as a matter of principle, the only limitation would be the one recognised by Rix LJ in Socimer, that the decision-maker must have acted rationally and not arbitrarily or perversely. On the facts there was said to be no warrant for limiting the width of the discretion provided by the contract wording by requiring the non-Defaulting Party to disregard the evidence of the market merely because it was illiquid or distressed at the particular time.

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