The English High Court in UK Acorn Finance Limited v Markel (UK) Limited¹ ruled that a contractual clause requiring something to be established “to [the Defendant’s] satisfaction” required the Defendant to act “rationally” in making that determination. The case provides key guidance on when a duty of rationality will be implied into contracts. The judge also advised that decision makers under this type of clause require adequate training on best practices to be followed when making their determinations.

Background

The case concerned an insurance policy which contained an Unintended Non-Disclosure clause. In the event of a non-disclosure, the insurer would waive its right to avoid the policy provided the insured could establish “to [the Defendant’s] satisfaction” that the non-disclosures were innocent or free from fraudulent conduct or intent to deceive.

Certain non-disclosures came to light following the notification of a claim and, after some exchanges of correspondence, the insurer concluded that it was not satisfied those non-disclosures were made innocently and so purported to avoid the policy.

The claimant argued that the ‘establish to the Defendant’s satisfaction’ wording did not give the insurer an unfettered right to determine the matter and the decision making process was, instead, subject to a standard of rationality which had not been met.

The court ultimately determined that a duty of rationality was to be implied into the decision making process and that the insurer’s decision maker had failed to meet that standard.

“Rationality” under English law

Following the UK Supreme Court decision in Braganza v BP Shipping Limited & Ors², it is now well-established that, absent clear language to the contrary, where a party to a contract has the power to exercise a discretion or form an opinion as to a relevant fact, that power must be exercised rationally.

The standard of “rationality” to be applied is often known as “Wednesbury Reasonableness”, taken from a public law case of that name. The test is best expressed in the negative: A decision will be irrational only if (i) the decision maker takes into account matters that are irrelevant to the decision to be made or, otherwise fails to take into account matters that are relevant; and/or (ii) the decision maker reaches a decision that no other decision maker, acting reasonably, could have reached.

The decision maker does not have to reach the most reasonable result possible but simply has to reach a result that is in the range of results a reasonable decision maker could have reached.

Since Braganza, a number of cases have looked at the circumstances in which a duty of rationality will be implied and also at the scope for the court to question the inputs into a decision making process.

When will “rationality” be implied?

In the cases since Braganza, the English courts have sought to clarify the limits on when rationality will be implied. In UBS AG v Rose Capital Ventures Limited and others³, the court held that a right to terminate a loan was an absolute right not subject to rationality. In doing so, it made clear that (i) the usual test for implication of contract terms would need to be met - the duty of rationality would need to be necessary for the operation of the contract or so obvious it went without saying; and (ii) a duty of rationality was more likely to be implied into relational contracts where the duty was required to protect a party with weaker bargaining power.

The judge in Acorn found that the words “you are able to establish to our satisfaction” placed the burden on the insured to prove that any non-disclosure was innocent and also made clear that it fell to the insurer to determine whether the non-disclosure was, as a matter of fact, innocent or otherwise. It was, therefore, not open to the court to determine that issue itself. The judge went on to conclude that, in those circumstances, neither party could sensibly be treated as having intended to permit the defendant to make decisions that were arbitrary, capricious or irrational.

The ruling in Acorn suggests that where words such as “to our satisfaction”, “sole judge” or “in our sole opinion” are used in contracts, the right to make those determinations will almost certainly be subject to a duty of rationality.

The standard to be met

While the test for rationality in the context of commercial contracts is now reasonably well established, there has been uncertainty as to how far the courts will be prepared to unpick the decision making process as opposed to the result. The courts have previously been reluctant to become involved in a detailed assessment of whether the determining party took into account all relevant factors and ignored all irrelevant factors.

In Acorn the court reaffirmed the principles that a contractual decision maker cannot be expected to apply the same rigorous standards of investigation that would be expected of a court of law and also that, if it appears the result would not have been substantially different even taking account of any error in the process, the court will not generally interfere with the decision.

Notwithstanding this, it concluded that the decision-making process adopted by the insurer had been flawed and that the decision reached fell outside the range of reasonable conclusions. In doing so, the court highlighted that, in general, the more serious the allegation, the less likely it is to have occurred and the stronger the evidence necessary to conclude that the allegation has been established.

On the facts, the judge in Acorn concluded that it is inherently more likely that a misrepresentation is made innocently or negligently rather than dishonestly and that the decision maker had failed to take this into account when conducting his investigation. In that context, the court found both that the decision making process was flawed and that the conclusion reached had been outside the range of reasonable outcomes.

In reaching these conclusions, the judge was at pains to point out that he made no personal criticism of the decision maker himself and sounded a note of advice that parties who are granted similar contractual discretions should ensure that the individuals charged with making the determination are provided with appropriate training and guidance on the process to be followed.

Conclusion

Acorn highlights an issue that is becoming increasingly prevalent post-Braganza. Parties need to be mindful that, even where it appears they have an absolute discretion, it may be subject to limits. It is important to identify where this type of discretion arises and to provide decision makers with appropriate guidance and training to reduce the risk of decisions being challenged.

Footnotes
1) [2020] EWHC 922 (Comm)
2) [2015] UKSC 17
3) [2018] EWHC 3137 (Ch)