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The Danger of Confusing Discretion with Autonomy
When it comes to exercising discretion in a business contract, a board may believe that all that’s required is to achieve a majority decision. The reality is not that straightforward and the recent case of Watson and others v Watchfinder.co.uk Ltd highlighted the need to ensure that all discretionary powers are exercised rationally, justifiably and in a way that can be evidenced in court.
Discretion refers to the power of a nominated party to make decisions on a specific matter, using his or her own opinion. To understand what this somewhat abstract definition means in a legal context, we can look at the case of Watson and others v Watchfinder.co.uk Ltd.
Watchfinder.co.uk Ltd (Watchfinder) entered into an agreement with the business development consultancy Adoreum Partners (Adoreum), which was hired to provide consultancy services for which it received a monthly retainer fee. Separately, Marcus Watson, Rob Hersov and Twysden Moore (Watson and Others), directors of and shareholders in Adoreum, entered into an option agreement with Watchfinder, which provided them the option to subscribe for new shares in the company. The option agreement went on to state that:
“The Option may only be exercised with the consent of a majority of the board of directors of the Company.”
When Watson and others attempted to exercise their option, Watchfinder refused to issue the shares stating simply that the directors did not consent. Following this decision, the option holders brought a claim for specific performance, requiring Watchfinder to allow them the shares in question.
To reach its judgement, the Court considered the clause referred to above.
The Court’s decision
The Court determined that the clause could not be interpreted as an unconditional right to veto an allotment of the shares. If the board had absolute discretion as to whether the shares were issued, the option itself would be meaningless, giving rise to “commercial absurdity”.
Crucial to our understanding of discretion, the Court ruled that “discretion should not be exercised in a manner that was arbitrary, capricious or irrational in the public law sense”.
In addition, the option agreement wasn’t a standalone option and it formed part of a wider package of remuneration agreements between Watchfinder, Adoreum and Watson and others.
In other words, discretion must not be applied indiscriminately: decisions must be judicious, fair, rational and justifiable within the context of the transaction as a whole.
Making judicious decisions
Although terms such as judicious, fair, rational and justifiable provide some clarification as to how to exercise discretion, there remains room for confusion. To make the process clearer, the Court described using a “proper process” to aid discretionary decisions, taking into account “the material points.” So, how does this work in practice?
To assess whether discretion has been properly exercised, one must establish why the board received this discretion. This can be done by establishing whether the board used a “target” against which to make the decision.
Here, the Court found that the board did not establish a target but that, in the context of the transaction, they should have applied a backward-looking assessment. In particular, the court stated:
“Considered against the background evidence, the “target” for consideration was whether the claimants had made a real or significant contribution to the progress and growth of the defendant. The defendants had given no real consideration to that issue and had reached a decision that was arbitrary.”
Consequently, the Court decided to “proceed as if consent had been given and the claimants were accordingly entitled to specific performance.”
The case of Watson and others v Watchfinder.co.uk Ltd makes it clear that decisions must be carefully, rationally and fairly made, and that if a party doesn’t apply consent properly it will be deemed by the Court to have given consent. What’s more, there are no chances to reconsider.
- Think about discretion rationally, prudently and objectively.
- Ensure you can justify your decision in a manner appropriate to the transaction, such as through a board resolution or similar – and provide a record showing how the discretionary outcome was reached.
- Apply this guidance equally to all discretions, not just transactions.
For more information about discretion within business agreements or to discuss a specific query, please get in touch with John Richardson on 0117 930 9522.