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Do you have to be reasonable when exercising a contractual discretion?

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18/12/2014

This is a question which the courts have been asked to consider several times over the last few years (see our previous articles How does a party comply with a contractual obligation to act ‘in good faith’? and Do you need to act reasonably when terminating a contract) and it has been raised again in the case of Bluewater Energy Services BV v Mercon Steel Structures BV and others [1].

The Bluewater group of companies were engaged by Russian oil company Lukoil to design, construct and install a tower based soft yoke mooring system as part of the development of an oil field in the Caspian Sea.

Under the contract, Bluewater was entitled to terminate the contract if, having been provided with a notice of default, Mercon failed to “immediately commence and …proceed with action satisfactory to Bluewater to remedy such default”.

The works were delayed and Bluewater served a notice of default on Mercon on 23 January 2009 followed by a notice of termination on 3 February 2009. Mercon claimed that Bluewater had not validly terminated the contract as it was only entitled to do so if Bluewater’s failure to be satisfied with the action Mercon had taken was objectively reasonable.

The court rejected Mercon’s argument and held that the question of whether Bluewater was satisfied was to be determined on a subjective rather than objective basis. However, the court went on to find that Bluewater’s ability to come to a decision on whether it was satisfied was limited by reference to the “concepts of honesty, good faith and genuineness and the need for the absence of arbitrariness, capriciousness, perversity and irrationality”.

There seems to be a growing role for the doctrine of good faith in English law contracts, as, whilst parties are generally free to exercise their contractual discretion as they see fit, the courts appear to be increasingly prepared to place limits on that discretion where they feel that a party has not acted in good faith.

Unusually the contract also contained a liquidated damages clause in connection with a key personnel clause, for more information please see our article Are you irreplaceable?.

[1] [2014] EWHC 2132 (TCC)

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