Dentons

A contractual provision to the effect that a party's consent should not be unreasonably withheld is a familiar one. When will it be unreasonable to refuse consent and how will reasonableness be tested? In Crowther v. Arbuthnot Latham & Co Ltd [2018] EWHC 504 (Comm) the court considered such wording in the context of a facility agreement which provided that the borrowers could sell property held as security with the approval of the bank, such approval not to be unreasonably withheld. Reasonableness was to be assessed objectively, requiring the court to look at the background and purpose of the provision. It held that in this case it had been unreasonable for the bank to refuse consent where its refusal was not based on the sale price.

Factual background

The claimant borrowers brought mis-selling claims against the defendant bank. The litigation was settled on the terms of a consent order. Under the settlement the bank agreed to continue a loan for €5.9 million for a new five-year term. The bank held a property in France, worth around €4 million, as security. The consent order inserted the following provision into the facility agreement:

"If, with the prior approval of the bank (such approval not to be unreasonably withheld), the property is sold, [the borrowers] shall immediately repay the bank the net proceeds of sale."

A third party offered to buy the property for a price in excess of €4 million, which was in line with valuations at that time. The bank refused to give its approval for the sale unless the borrowers provided further security for the shortfall in the security of c.€1.7 million. The sale was lost as a result. The borrowers' position was that the requirement for further security as a condition of the bank's consent was illegitimate and was not a reasonable basis for withholding its consent. 

The borrowers therefore sought the court's declaration that:

  • the bank's refusal to approve the sale was in breach of the terms of the agreement (as amended by the consent order); and
  • the borrowers were entitled to sell the property at fair market value without providing additional security.

Decision

The key issue, as the judge put it, was what was the proper scope of the bank's "reasonableness veto"? This required looking at the purpose of the provision. The borrowers argued that this was about ensuring that the sale was at fair market value, whereas the bank's contention was that the scope was wider, and could include other aspects of the creditor and debtor relationship. The judge emphasised the importance of interpreting the provision in its own particular contractual, factual and commercial context.

In determining what was the proper test to apply in assessing reasonableness, the court referred to Straudley Investments Ltd v. Mount Eden Land Ltd [1996] EWCA Civ 673, a landlord and tenant case, which had considered a similarly worded clause. The Mount Eden case suggested that the correct test in the present case was an objective assessment of reasonableness. 

The court rejected the bank's contention that some form of rationality test applied – either in the Wednesbury sense, or the analogous concept of a duty of rationality in relation to a contractual discretion (the so-called "Braganza duty"). Nor did the court agree that in this case it was a question of whether one party's commercial interests needed to be balanced against the other's, as in the Barclays v. Unicredit case, which involved an entirely different sort of provision in a different context (consent to early termination of the contract): Barclays Bank plc v. Unicredit Bank AG [2014] EWCA Civ 302.

In order to assess reasonableness objectively, the court was required to examine the background and purpose of the provision and to determine whether, in the particular circumstances, the bank's decision was one that a reasonable man could have taken.

The court observed that, generally, a secured creditor will not object to the disposal of security, provided it is not undervalued and the proceeds are used to discharge the debt. It was hard to see why the scope of the provision in this case should go beyond a concern to permit the sale of the property at a proper price.

The provision in this instance was intended to preserve the lender's rights, not to increase them. At the time the provision had been agreed, the bank had known that the property would not provide security for the whole of the borrowers' indebtedness and that a sale could result in an unsecured shortfall. Whilst the bank's desire for further security was understandable, this was collateral to the purpose of the provision. That purpose was to enable the disposal of the property at a fair market price. Whilst it might be reasonable to postpone the sale if this resulted in a better price, there was no suggestion that a better price could in fact have been achieved. Viewed in its context, the provision required the reasonableness of any refusal to consent to be determined by reference to whether the sale was at arm's length and at fair market value.

The court concluded that the bank's refusal was not based on any issue about the price of the property (which it had said was agreeable), or on the possibility of its value increasing in time. The bank was instead seeking to improve its security position. The court therefore held that the bank had acted unreasonably in refusing to approve the sale and had therefore breached the terms of the loan agreement. 

Implications

Although each case will be determined on its own facts, the decision suggests that in the context of an express provision requiring approval not to be unreasonably withheld, reasonableness will be tested objectively. 

In the circumstances of this case, applying the objective test, the court was clear that it was not open to the lender to refuse to consent to the disposal of the property on grounds that were not based on its sale price. Had the lender considered the price to be below fair market value or had reason to think that a delay in selling might see an increase in the property's value, refusing consent may have been reasonable.

It goes without saying that lenders should take care to ensure that any security is sufficient to cover a borrower's indebtedness as it is unlikely that they will be able to rely on withholding consent to its disposal if the sale is at a fair market value. As the judge in this case observed, if the bank had wanted security for the entirety of its loan, it could have asked for it when negotiating the terms of its facility (at the time of the settlement).

 

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