When will a discretion to perform a contractual promise be enforceable?

By 17/04/2018Contract
Discretionary-promise

Sometimes a contract will impose a discretionary obligation on a party.  In what circumstances will the Courts require such an obligation to be performed?

In a recent NSW Supreme Court case the Court was required to examine a shareholders agreement which contained terms to the following effect:

  1. The board may request loans from the plaintiff (one of the 2 shareholders) for certain specified purposes and in certain circumstances.
  1. On request of the Board for a loan, the plaintiff must provide a loan on the loan terms.
  1. A request for a loan from the plaintiff required a unanimous resolution of the directors. (The board comprised 2 directors, appointed by each shareholder.)
  1. The directors were required to act in good faith and in the best interests of the company. Subject to this duty a director appointed by a particular shareholder may have regard to and act in the best interests of the appointing shareholder.

Disagreement arose between the 2 shareholder directors.

The Court was invited to determine that the shareholders agreement was void and unenforceable because the Board had an unfettered discretion to request a shareholder loan from the plaintiff.

In particular the defendant submitted that the plaintiff’s director had an unfettered discretion whether to agree to request a loan from the plaintiff, and could therefore thwart the funding process.

Legal principles

  1. A contract is void if it gives a party a true discretion or option whether to carry out what appears to be a promise.
  1. However little is needed to show that a promise is not discretionary or unqualified.
  1. All that is needed is ‘some vestige of an objectively ascertainable obligation’, or that the discretion be contained within confined parameters.

The decision

The Court held that the Board’s discretion whether to request a shareholder loan was controlled by objectively ascertainable criteria:

  • the requirement that funds were needed by the company for certain specified purposes or had been requested in certain specified circumstances
  • the discretion whether to request a shareholder loan was further controlled by each director’s express obligation to act in good faith and in the best interests of the company, subject to the entitlement to have regard to and act in the interests of his appointing shareholder.

Accordingly the Court held that the Board’s discretion whether to request a shareholder loan was not illusory as it was neither optional nor unfettered. The shareholders agreement was therefore not void.

The Court also held that the shareholders agreement was not void for uncertainty. In that regard the Court observed that where possible the Courts will adopt an interpretation that preserves the validity of the contract.

Comment

This case shows that a discretion to perform a contractual promise will generally be enforceable if the discretion is controlled by some objective obligation or must be exercised within certain parameters.

Case citation

Shield Lifestone Holdings Pty Limited v LSKF Holdings Pty Limited [2018] NSWSC 335 (20 March 2018).