Factual and Procedural Background
This opinion concerns extensive litigation between two banks, hereinafter referred to as Seller and Buyer, which had been engaged in forward sale transactions of emerging market securities. Prior to the Buyer's liquidation, the Buyer defaulted on its obligations, owing the Seller approximately US $24.5 million as "Unpaid Amounts" under a contractual agreement dated 8 November 1996 (the "agreement"). The agreement required the Seller to value a portfolio of forward sale securities ("Designated Assets") on the termination date (20 February 1998) and to either liquidate or retain these assets to satisfy the amounts owed.
The Seller did not conduct a valuation as required but instead sold parts of the portfolio over months and credited proceeds to the Buyer incrementally. The Buyer entered liquidation shortly after the termination date. The Buyer's liquidator later complained about the lack of valuation, leading to proceedings initiated in April 2003. The Buyer claimed a surplus was due based on valuations at termination, while the Seller contended it acted appropriately and was itself owed money.
The construction of the valuation clause was determined as a preliminary issue by Mr Justice Cooke in 2004, who held that the Seller was obliged to value the assets as at the termination date, not to account for actual sales proceeds over time. Subsequent valuation disputes and procedural issues were tried before Mrs Justice Gloster in 2005, who found in favor of the Buyer on key valuation and set-off issues, awarding a substantial sum plus interest.
The Seller appealed with leave granted, focusing on three main issues: (1) whether the valuation obligation was subjective (the Seller's honest valuation) or objective (a reasonable market valuation), (2) whether certain credits should have been set off against the Unpaid Amounts at termination, and (3) procedural questions related to the admissibility and challenge of valuation evidence.
Legal Issues Presented
- Whether the Seller's valuation obligation under the agreement required an objective, reasonable market valuation ("should have" valuation) or only an honest, subjective valuation that the Seller would have made ("would have" valuation).
- Whether other credits owed by the Seller to the Buyer should have been immediately set off against the Unpaid Amounts as of the termination date, affecting the calculation of surplus assets.
- Procedural issues: (a) whether the Buyer was entitled to rely on an implied term imposing an objective valuation duty despite prior construction recognizing Seller's discretion; and (b) whether the judge was entitled to reject the Seller's valuation evidence in the absence of cross-examination.
Arguments of the Parties
Appellant's Arguments (Seller)
- The valuation obligation was one of subjective discretion vested in the Seller, to be exercised honestly and in good faith but without an implied term requiring an objective market valuation.
- The contractual language and context, including definitions and the nature of the assets (volatile and illiquid emerging market securities), support a valuation exercise within Seller's wide discretion.
- The analogy with mortgagee duties and the imposition of a duty of reasonable care was inappropriate and inconsistent with the commercial context and contract terms.
- The Seller's valuation witnesses provided relevant evidence of how the valuation would have been conducted, which should not have been rejected without challenge.
- The credits in question were not due until after the termination date and would have been set off only after valuation, not before; thus the Buyer's primary case on set-off was unsustainable.
- The implied term relied upon by the Buyer was not pleaded in time and was introduced late, unfairly changing the nature of the trial and evidence.
Respondent's Arguments (Buyer)
- The valuation obligation should be subject to an implied term requiring the Seller to perform the valuation reasonably, with reasonable care, and based on objective market criteria to prevent abuse of Seller's discretion.
- The contractual discretion was insufficient protection against unfair undervaluation, especially given Seller's ability to issue a conclusive certificate of deficiency.
- The duty analogous to that of a mortgagee in equity justified imposing a standard of reasonable care and an obligation to obtain a fair or true market value.
- The credits owed by Seller should have been set off against the Unpaid Amounts at the valuation date, reducing the amount owed and leading to a surplus requiring return of certain assets.
- The Seller's valuation evidence was partisan and self-serving, justifying its rejection even without cross-examination.
Table of Precedents Cited
| Precedent |
Rule or Principle Cited For |
Application by the Court |
| Abu Dhabi National Tanker Co v Product Star Shipping Ltd (The "Product Star") [1993] 1 Lloyd's Rep 397 |
Limits on contractual discretion: must be exercised honestly, in good faith, and not arbitrarily, capriciously, or unreasonably (Wednesbury standard). |
Used to illustrate that Seller's discretion is subject to good faith and rationality, limiting abuse but not imposing an objective valuation duty. |
| Ludgate Insurance Co Ltd v Citibank NA [1998] Lloyd's Rep IR 221 |
Courts rarely interfere with contractual discretion if exercised honestly and in good faith; unreasonableness must be extreme. |
Supported the principle that Seller's broad discretion in valuation should be respected absent bad faith or perversity. |
| Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No 2) [2001] EWCA Civ 1047 |
Withholding approval or exercising discretion must be in good faith and not arbitrary or unreasonable in a Wednesbury sense. |
Reinforced the limited scope of judicial review of contractual discretion, distinguishing it from an objective duty of care. |
| Paragon Finance plc v Nash [2001] EWCA Civ 1466 |
Discretion to vary terms subject to implied term of reasonableness analogous to Wednesbury unreasonableness. |
Clarified that reasonableness in contractual discretion is limited to rationality, not an objective standard of care. |
| Cantor Fitzgerald International v Horkulak [2004] EWCA Civ 1287 |
Where contractual discretion is not exercised, courts must put themselves in decision-maker's shoes to decide what decision would have been made. |
Applied to valuation exercise: court must determine what Seller would have done honestly and rationally, not impose its own objective valuation. |
| Lion Nathan Ltd v CC Bottlers Ltd [1996] 2 BCLC 371 (PC) |
On implied terms requiring reasonable care, courts must choose the figure a reasonable person would have produced absent breach; cannot assume highest figure. |
Referenced to illustrate limits of implication and objective assessment of valuations or forecasts. |
| Phillips Electronique Grand Public SA v British Sky Broadcasting Ltd [1995] EMLR 472 (CA) |
Conditions for implying terms: necessity, reasonableness, obviousness, clarity, and consistency with express terms. |
Guided the court's approach to whether an implied term requiring objective valuation was justified or necessary. |
Court's Reasoning and Analysis
The court began by reaffirming the preliminary construction by Cooke J that the Seller had a wide discretion to value the Designated Assets on the termination date, subject to acting honestly and in good faith, and that the valuation exercise lay "entirely in the Seller's hands". This discretion was not unfettered but limited by established legal principles preventing arbitrary, capricious, or perverse exercise of discretion.
The court examined the Buyer's contention that an implied term should be introduced requiring the Seller to perform the valuation with reasonable care and on an objective basis to prevent abuse of discretion. The court applied established principles of contractual implication, emphasizing necessity, clarity, and consistency with express terms.
It was concluded that the implied term sought was neither necessary nor sufficiently certain. The agreement, carefully negotiated between sophisticated parties, expressly conferred discretion on the Seller, and the valuation clause was silent on procedural mechanisms. Imposing an objective valuation duty would rewrite the contract and undermine the agreed allocation of risk, especially given the volatile and illiquid nature of the assets involved.
The court rejected the analogy drawn by the Buyer and the trial judge with the duties of mortgagees in equity, noting that the agreement did not create a mortgage and that such duties arise from legal principles distinct from contractual implication.
Regarding the set-off of other credits against the Unpaid Amounts, the court found no evidential basis to conclude that the Seller would have set off credits not due until after the termination date before performing the valuation. The evidence showed that set-off would have occurred after valuation and only to the extent of any deficit.
Procedurally, the court found that the Buyer's late introduction of the implied term and objective valuation test was unfair to the Seller, who had prepared evidence on the basis of the previously accepted subjective discretion. The Buyer's deliberate decision not to cross-examine the Seller's valuation witnesses further undermined its ability to challenge their evidence fairly. The trial judge erred in rejecting unchallenged evidence on grounds of incredibility or bad faith without appropriate procedural safeguards.
In summary, the court held that the Seller's valuation obligation was to exercise its discretion honestly and in good faith, not to achieve an objective market valuation. The implied term requiring reasonable care and objective valuation was not justified. The Buyer's set-off argument failed on the evidence. The procedural handling of the valuation evidence was flawed, necessitating a new trial on valuation.
Holding and Implications
The court's final decision was to allow the appeal in favor of the Seller on all issues argued.
Holding: The implied term requiring the Seller to perform an objective valuation with reasonable care is rejected. The Seller's valuation obligation is limited to an honest and good faith exercise of its contractual discretion. The Buyer's claim based on an objective valuation and immediate set-off of credits is not supported. The trial judge erred in rejecting unchallenged Seller evidence without cross-examination.
Implications: The judgment of the trial court is overturned. The parties must have a new trial concerning the valuation of the Designated Assets at the termination date, applying the correct legal test of subjective discretion subject to good faith. The Buyer's primary claim for surplus based on the set-off of credits is dismissed. No new precedent is established beyond reaffirming established principles limiting judicial intervention in contractual discretion and the strict requirements for implying terms into commercial contracts.