TRANSACTIONAL: Corporate/London: U.K. Commercial contracts - withholding your consent by Hywel Jones

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Suppose you are negotiating an energy production joint venture or other joint agreement (governed by English law). You want to veto certain actions of your counterparty and so propose that these actions cannot be taken without your “prior consent in writing”. Eventually, in a compromising move, you agree to add “such consent not be unreasonably withheld”. Hopefully, this will never lead to a practical problem, but if it does, do you know what you have agreed to?

The legal principles governing the withholding of consent were developed by English courts in the context of landlord and tenant disputes (the tenant’s ability to assign or sublet are typically limited by the requirement to obtain landlord’s consent). They had not been applied to commercial contracts until relatively recently:

  • British Gas Trading Ltd v. Eastern Electricity Plc & Ors [1996] EWCA Civ 1239
     
  • Porton Capital Technology Funds and Others v. 3M Holdings Ltd and 3M Company [2011] EWHC 2895 (Comm).

Do you have to prove you were acting reasonably in withholding your consent?

No, it is for your counterparty (the party seeking approval) to prove that you were acting unreasonably. Of course, it is open to contracting parties to agree that the person refusing consent must show he has done so reasonably.

Reasonable from whose perspective?

It has to be reasonable from your perspective. It is not necessary for you to prove that the conclusions which led you to refuse consent were justified, if they were conclusions that might be reached by a reasonable man in the circumstances. You will be entitled to have regard to your own interests and you are not required to balance these interests with those of your counterparty. In other words, although the test of reasonableness is objective, the court will look at it in the context of the particular party withholding consent.

However, there are limits:

  • You will not be entitled to refuse consent on grounds that have nothing whatever to do with your contractual relationship in regard to the subject matter of the contract or by so doing seek to obtain some collateral benefit or change the original terms of the contract.
     
  • There may be situations where there is such a disproportion between the benefit to you and the detriment to your counterparty if you withhold consent that it is unreasonable for you to refuse consent.

These are the principles, but how they are applied will always depend on the particular facts.

In the British Gas case a long-term gas supply contract required the customer's consent to any assignment of the supplier's rights and obligations under the contract “such consent not to be unreasonably withheld.” The Court had to consider whether it was reasonable for the customer to withhold its consent where the supplier, British Gas, was undergoing a reorganisation and the resulting change in control would entitle the customer to terminate the contract in any event, unless the contract was first assigned. The customer saw a commercial advantage in using the change of control as an excuse for terminating the contract. Recognising this, the judge, applying the landlord and tenant authorities, concluded that consent to the assignment was being unreasonably withheld.

In the Porton Capital case, 3M UK purchased Acolyte Biomedica. Acolyte's only commercial product was a test process and related technology for detecting infectious diseases. The purchase price was paid in cash and a further payment based on net sales in the future. Under the acquisition agreement, 3M UK undertook:

  • to procure that "without the written consent of the vendors, which shall not be unreasonably withheld … [Acolyte] shall not cease to carry on its business or the business of the development and marketing of the [Acolyte products] …" (clause 4.14(i)).
     
  • obligations in relation to the marketing and sale of [Acolyte products] (intended to protect the sellers' interest in receiving the net sales payment).

The business was not successful. 3M UK sought the sellers’ consent to cease the business, offering them partial compensation under the earn-out provision (on the basis that the market’s and product’s own failings meant that sales would never have qualified for the maximum payment). The sellers refused to give their consent unless they received the maximum compensation under the agreement. Ignoring this, 3M UK ceased the business so there were no future sales to be considered under the earn-out, claiming the sellers had unreasonably withheld their consent and therefore they had been entitled to act.

The judge held that the sellers had acted reasonably when they withheld their consent under clause 4.14(i). He confirmed that in determining what is reasonable, the sellers could have regard to their own interests in earning as large an earn-out payment as possible. They were not required to balance their own interests with those of 3M UK, or to have any regard to the costs that 3M UK might be incurring in connection with the ongoing business of Acolyte. 3M UK argued that it was likely that, had the sellers been running the business, they would have closed it down given the losses incurred, but the judge held this made no difference - the fact was that they had sold the business on the terms of the acquisition agreement.

Practice tips:

  • To avoid uncertainties as to what will be considered reasonable, you should consider if there are any specific circumstances in which (1) from the counterparty’s perspective, consent either cannot be refused or is deemed to be given or (2) from your perspective, withholding consent will always be reasonable e.g., on technical capability or financial grounds.
     
  • The counterparty should also consider the possibility that you might give your consent, but give it subject to conditions and should, therefore, extend the reasonableness requirement to any such conditions e.g., “and such consent shall not be given subject to unreasonable conditions”
     
  • Also, the counterparty should ensure that the clause covers “unreasonable delay” and should consider adding a timetable by which a decision should be made.

Will you be in breach of contract if you unreasonably withhold your consent?

This will depend on how your contract is worded.

There is authority, in the context of a tenant’s covenant not to assign a lease without the landlord’s consent “not to be unreasonably withheld,” that these words do not comprise a contractual undertaking by the landlord to act reasonably. (Treloar v. Bigge 1874] L.R. 9 EXCH 151).

What’s the position if your counterparty goes ahead anyway?

This will depend upon what the consent is required for.

For example, in a joint venture context, if your counterparty needs your consent to terminate a third-party contract, then if you refuse consent and the counterparty goes ahead, the counterparty will run the risk that it will be in breach of contract and that you will be entitled to sue him for damages. If the provision is incorporated in the Articles of Association of a company, then it may be that the act itself will be void - ultra vires the company.

Particular issues will arise if the consent relates to the ability of your counterparty to assign its rights under the contract with you. If there is no reasonableness qualification in your contract, then the position will be as follows:

  • the assignment will still be effective as a contract between the purported assignor, your counterparty, and the assignee (Tom Shaw & Co v. Moss Empires (1908) 25 TLR 190);
     
  • however, the assignment will be invalid as against you - the assignee will not be able to enforce those rights against you (Linden Gardens Trust Ltd v. Lenesta Sludge Disposal Ltd [1994] 1 A.C 85); and
     
  • your counterparty will be in breach of contract although it will be unlikely that you will be able to sue for damages as you will not have suffered any loss (because the assignment will be invalid).

If, however, your contract provides that your consent to the assignment cannot be unreasonably withheld then the assignment will not be valid until after, either you give your consent, or the courts decide that it is unreasonable to refuse consent (by awarding a declaration).

Your counterparty must actually seek your consent before attempting to assign: it is not sufficient to assume consent will not be withheld (Hendry v. Chartsearch Ltd [1998] C.L.C 1382).

There is also case law (Don King Productions Inc v. Warren [2000] Ch 291) suggesting that assignments carried out without the required consent could operate instead as a declaration of trust by the assignor in favour of the assignee of the rights assigned.

Practice tip:

To circumvent the creation of a trust in favour of an assignee, consider adding:

“If a party purports to assign, transfer, create any encumbrance in or over, or deal in any other manner with this Agreement or a right or obligation under this Agreement in breach of Clause [requirement to obtain consent], then the parties agree that no trust (constructive or otherwise) shall arise as a consequence and the assignor shall not be deemed to hold the benefit of this Agreement, or any right under this Agreement, for the purported assignee, transferee or any other person as a result.”

If the clause is silent, do you have to act reasonably in giving your consent anyway?

English law does not impose on the parties to a contract any duty of good faith or duty to act reasonably. However, a court will imply terms into a contract if it is so obvious that “it goes without saying”, or where it is necessary to give the contract business efficacy and have been ready to imply a duty to act reasonably in withholding consent in some real estate cases.

In Town Quay Developments Ltd v. Eastleigh Borough Council [2008] EWHC 1922 (Ch), a developer owned a mill site. The title documents included a right for the mill site owner to build a road across adjoining land owned by the local authority with the consent of the authority, but contained no express requirement for the authority to act reasonably. The developer obtained planning permission to develop the mill site and needed to exercise the right to build the new road. The authority refused consent and the developer argued the Council was unreasonable. The court decided that a requirement for the authority to act reasonably was implied. The question was whether the agreement made business sense if the authority could act unreasonably. Both sides clearly accepted that a road might be built. It would make no sense if the authority could prevent the developer exercising this right by an arbitrary refusal. The court felt that this would have been so obvious to the parties at the time that they would not have thought it necessary to make an express statement that the authority had to act reasonably.

Practice tip:

Try to avoid this uncertainty by adding a provision such as this:

“Except where this Agreement expressly requires a party to act fairly or reasonably (including any provision which does not allow a party to unreasonably withhold, condition or delay its consent or approval), a party may exercise any discretion given to it under this Agreement in its absolute discretion and the exercise of that discretion shall not be challengeable on grounds that the party did not exercise its discretion fairly or reasonably.”


Weems, Philip R (#0256)

Hywel Jones
London
+44 20 7551 7569

hjones@kslaw.com
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Published In: Business Organization Updates, General Business Updates, Energy & Utilities Updates, Finance & Banking Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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