Constraints on contractual powers have long been a topic of debate that has received surprisingly little academic attention in New Zealand. However, this area has recently garnered increased attention due to several recent cases in New Zealand’s courts. We discuss the current state of constraints on the exercise of contractual powers in New Zealand and consider how this area may develop in the future. We also emphasise what is commonly overlooked, or even forgotten: that the only contractual powers capable of restraint through the ‘default rule’ or the ‘Braganza approach’ are terms granting discretionary powers.

Absolute contractual rights vs contractual discretions

What we have seen applied overseas in this area is the ‘default rule’ for constraints on discretionary contractual powers, which was first developed in the UK in Abu Dhabi National Tanker Co. v Product Star Shipping Ltd (No 2) (the “Product Star”) [1]. At its simplest, the default rule implies a term into all contracts conferring a discretionary power on one party, that the discretionary power must not be exercised arbitrarily, capriciously, or unreasonably. This approach draws from the second limb of the Wednesbury test, which determines reasonableness of the outcome reached in the public law judicial review context [2]. While decisions must not be arbitrary, capricious or unreasonable, parties are not compelled to prioritise the other party’s interests at the expense of their own.

Importantly, the default rule is limited to contractual powers that are discretionary and not those conferring absolute contractual powers, although the difference between them is not always easy to determine. The UK case of Mid Essex Hospital Services NHS Trust v Compass Group UK and Ireland Ltd [3] considered this distinction, making several comments tohelp distinguish the two. In particular, Mid Essex held that a discretionary power is not a simple decision whether or not to exercise an absolute contractual right. Instead, a discretionary power involves making an assessment, or choosing from a range of options, and taking into account the interests of both parties. Simply put, not whether to exercise a discretion but how to exercise it. The Court also clarified that where the contract itself expressly provides a contractual mechanism that guides the use of the discretionary power, especially one that is an objective test, there is no basis to imply a different one. While this distinction is difficult, it is important to discern which contractual powers should be qualified by a reasonableness standard and which are absolute contractual powers that should not be so restricted.

For discretionary powers, the default rule was significantly widened by the United Kingdom Supreme Court in Braganza v BP Shipping Limited [4]. Often referred to as the ‘expanded default rule’ or the ‘Braganza approach’, this approach opens the Court’s review to both limbs of the Wednesbury test – requiring the party exercising its contractual power to take into account all relevant matters and disregard irrelevant matters. In essence, this requires the court to review both the substantive decision reached by the party exercising the discretion and the process it undertook to reach that decision.

Importantly, as with the default rule, Braganza relates only to contractual discretions and not absolute contractual powers. It also tends to be most relevant in cases where there may be a conflict of interest or an imbalance of power, such as in the employment context (as was the case with Braganza). Currently, it remains to be seen whether Braganza may be implied into commercial contracts, however, it is likely any adoption of this rule in a commercial context will be the subject of criticism. Given Wednesbury concerned the constraint of powers conferred for the public good, extending this approach to a commercial contract (which confers a self-interested power that conflicts with that of the counterparty) may be an overreach. It is also readily apparent that commercial contracts lack that special type of relationship that Braganza did adding to the view that it may be inappropriate in this setting.

Overview of New Zealand’s Law

In cases of contractual discretion, the New Zealand courts have affirmed the approach of Mid Essex, determining that absolute powers are not reviewable in the same way as discretionary powers. The Supreme Court in Bathurst Resources Ltd v L&M Coal Holdings Limited [5] clarified that where a party has a choice to use a contractual power, this does not make that power discretionary. Notably, the Supreme Court held that “it is true that Bathurst could choose not to take the benefit of cl 3.10, that could be said about most contractual rights. That choice does not convert the contractual right into a contractual discretion” [6].

In cases of discretionary contractual powers, there has been very little consideration of the UK cases and their application in New Zealand. In 2023, in Woolley v Fonterra Co-operative Group Limited, New Zealand’s Court of Appeal considered the expansion of the ‘default rule’ by Braganza and its application in New Zealand for the first time [7].

In Woolley, the contractual discretion under scrutiny was Fonterra’s decision to suspend the collection of milk under a milk supply agreement with a dairy farmer, Mr Woolley. The milk supply agreement gave Fonterra the ability to suspend milk collection in certain circumstances, including in response to environmental sustainability issues. Fonterra suspended the agreement in response to an Environment Court decision that prevented milking until Mr Woolley could show his effluent disposal system met his resource consent. 

Fonterra’s ability to suspend milk collection was characterised by the Court of Appeal as a contractual discretion rather than an absolute contractual right. This characterisation enabled the implication of a term pursuant to the default rule or the more expansive Braganza rule (if the Court chose to do so) and distinguished the facts of the case from those in Bathurst.

In Woolley the Court of Appeal assumed that the default rule applies in New Zealand, without expressly deciding so. In respect of the expanded default rule, the Court considered that the appeal was not the appropriate forum to endorse or reject the Braganza approach. In particular, the Court noted that the case concerned an ordinary commercial contact rather than that special, relational contract like the employment contract considered in Braganza. It recognised that an endorsement of the expanded default rule would be “a significant development in contract law”, and, for now, noted that a view on Braganza must await another day.

The Woolley decision therefore left New Zealand’s law in a state of uncertainty – that the default rule likely applies, and the expanded default rule could apply. It is, therefore, unsurprising that plaintiffs in subsequent cases have attempted to rely on causes of action that require the use of a contractual discretion to be reasonable.

One such example of this is the recent Court of Appeal decision in Bank of New Zealand v Christian Church Community Trust [2024] NZCA 645, where the Christian Church Community Trust (Gloriavale) submitted that it is arguable that the default rule applies in New Zealand, with the result that BNZ must exercise its power of termination honestly and in good faith, and must not exercise the power arbitrarily, capriciously or unreasonably. Gloriavale also said it was arguable that the Braganza approach applied, with the result that BNZ is required to consider all relevant matters, and not consider irrelevant matters before exercising its power to terminate Gloriavale’s accounts. 

Like Woolley, the Court of Appeal in Gloriavale declined to determine whether the default rule or the Braganza approach apply in New Zealand as it considered an interlocutory appeal not to be the appropriate forum. It also considered that the terms of the contract were so clear and express so as to override the implication of the default rule / Braganza in any event.

Key takeaways

Following Woolley and Gloriavale, it is clear that parties will continue to test the law in this area. We expect this may be particularly so where a party regrets entering a contract or where a contractual power has been exercised to their detriment. 

What parties should keep in mind, however, is the distinction between an absolute contractual right and a discretionary right. The dividing line between the two is often difficult to draw and is therefore ripe for argument. Disputes may be won or lost depending on the court’s characterisation of a contractual power and, as demonstrated in Bathurst, the court will not imply a standard of reasonableness into an absolute contractual power. This distinction should be front of mind for drafters, parties and litigators involved in contracts governed by New Zealand law.

Parties should keep in mind that the default rule may be displaced by express terms to the contrary or by a contractual mechanism that guides the use of a party’s discretionary power. There may, however, need to be some care taken when drafting to ensure that contractual discretion retains the flexibility it requires while also trying to avoid the default rule. In the future, we expect to see litigation where express contrary terms and their relationship with the default rule (or even Braganza) are tested.

Despite there being no clear endorsement of the default rule in New Zealand, parties to an ordinary commercial contract should keep in mind that their conduct may be subject to a reasonableness standard when exercising a discretion conferred upon them. As it is likely that the default rule applies in New Zealand, parties should be discouraged from exercising their discretion arbitrarily, capriciously or unreasonably. Given New Zealand’s courts reluctance to imply the Braganza rule into commercial contracts, however, commercial parties in New Zealand should feel comfortable continuing to give considerable weight to their own interests.

Ultimately, the current climate in New Zealand is welcome news for those seeking to rely on black and white contractual clauses. For discretionary powers, we look forward to seeing the courts continue to balance the risk of abuse of contractual power with the freedom of contract.

Footnotes:

1. [1993] 1 Lloyd's Rep 397 (CA).
2. Associated Provincial Picture Houses Ltd v Wednesbury Corporation [1948] 1 KB 223.
3. [2013] EWCA CIV 200.
4. [2015] UKSC 17, [2015] 1 WLR 1661.
5. [2021] NZSC 85.
6. at 279.
7. [2023] NZCA 266.