This blog was co-authored by Adrienne Hendricks, Trainee Associate and Adriaan Lourens, Candidate Attorney.
The Supreme Court of Appeal recently reaffirmed the principle that a contracting party exercising unilateral discretion must do so in good faith, with reasonable judgment, and without arbitrariness (the arbitrio boni viri principle).
A major retail franchisor and its franchisee entered into a credit facilities agreement in terms of which the franchisor had a discretion to vary or terminate the terms of the credit facilities without prior notice to the franchisee. The franchisor exercised its discretion to unilaterally vary the terms of the agreement. The franchisee challenged this variation, arguing that the discretion was not validly exercised in accordance with the arbitrio boni viri principle.
The franchisor unsuccessfully argued that the principle did not apply because each time the franchisee accepted the credit facility, a new contract was concluded. The court held that the credit facility agreement was “indicative of a fixed arrangement”. Consequently, the franchisor’s discretion had to be exercised in good faith, reasonably, and without arbitrariness. The court left open the question of whether the arbitrio boni viri principle applies to a contractual discretionary power explicitly intended to be completely unfettered.
Similarly, in the recent English case of MacDonald Hotels Ltd v Bank of Scotland PLC, their High Court considered the exercise of a lender’s discretionary powers in facility agreements. The case involved the borrower mortgaging its assets in favour of the bank as security for its debts under two facility agreements. Under the facility agreements, the bank had the discretion to determine whether and the terms on which the borrower could dispose of its assets. The bank refused to consent to the borrower disposing of its assets.
The English High Court held that the lender did not have an absolute right to refuse its consent – the lender’s discretion was subject to an implied duty to act reasonably in good faith. The court found that the bank could not refuse consent arbitrarily or for reasons unconnected from its commercial interests. Instead, its discretion must be exercised in good faith and reasonably. The court concluded that it is an implied term of the facilities agreement that a lender cannot refuse consent “for a reason or reasons unconnected with what it perceived to be its own commercial best interests or … when no reasonable entity in the position of [the lender] could have refused consent.” The court read a term into the contract that the lender could not withhold consent unreasonably. Besides the above reasoning, the court in MacDonald Hotels held that an implied term that a discretion is not exercised in an arbitrary, irrational or capricious manner cannot be read into a contract to qualify expressly unqualified contractual rights.
Both cases illustrate that unilateral discretionary powers in financing agreements (such as the power to refuse the assignment of a borrower’s rights under security agreements, restrict the disposal or encumbrance of a borrower’s assets or amend a borrower’s memorandum of incorporation), must be exercised in good faith, reasonably, and not arbitrarily, in order to mitigate legal risk. This principle applies to loan facilities subject to South African law and English law (which usually is the governing law for loan facilities given by foreign lenders to African borrowers).
Whilst the South African case did not address whether the arbitrio boni viri principle applies to contracts which envision a completely unfettered discretion, under South African law such an “absolute” discretion will be subject to considerations of public policy and bad faith.
English courts have held that reading in an implied term to qualify the exercise of an “absolute contractual right” would not be permitted. Thus, contracting parties should carefully consider the drafting of contractual clauses to capture their intention whether to create an absolute contractual right.
The full judgments can be accessed here:
Macdonald Hotels Ltd & Anor v Bank of Scotland PLC (Rev1) [2025] EWHC 32 (Comm) (24 January 2025)