Examining discretionary decisions under commercial agreements (BHL v Leumi ABL Ltd)

Simon Mills of Five Paper examines BHL v Leumi ABL and suggests the case serves as an important example of the extent to which courts appear willing to scrutinise the exercise of discretionary powers in a commercial context.

Original news

BHL v Leumi ABL Ltd [2017] EWHC 1871 (QB), [2017] All ER (D) 04 (Aug)

The Mercantile Court allowed BHL’s claim that, on the true construction of a receivables finance agreement (RFA) between the defendant company, Leumi ABL Ltd (Leumi) and Cobra Beer Ltd (Cobra), which subsequently went into administration, Leumi had not been entitled to charge a collection fee of 15% on receivables on Cobra Beer’s sales ledger, in circumstances where BHL had agreed to indemnify the defendant in respect of sums due under the RFA, and had paid the defendant £950,000 in response to its demands for outstanding collect-out fees.

What was the background to the case?

The claim concerned the collection charges of Leumi claimed under a RFA entered into with Cobra. On 29 May 2009 Cobra was restructured and, as part of the restructuring, BHL agreed to indemnify Leumi in respect of any sums due under the RFA.

On 3 June 2009 Leumi commenced a collect-out of the Cobra receivables, which were then worth about £10.5m. Leumi eventually collected about £8.1m. The collect-out was relatively swift and by late January 2010 Leumi had concluded that it had already conducted a reasonable collection process and it turned its attention to BHL for payment under the indemnity.

In order to effect the collections, Leumi had hired two of Cobra’s principal credit controllers, and it engaged the services of a third-party collection company and those of its solicitors, Hammonds (now Squire Patton Boggs (UK) Ltd). All the costs and fees incurred in engaging these third parties were charged to Cobra’s current account. Leumi also increased the discount charge by 2% to cover its anticipated operating expenses in administering and collecting the receivables. Notwithstanding all these costs, there should still have been sufficient value in the ledger for Leumi to collect-out and charge something extra for any further costs of collection that it may have incurred.

In spite of the relative success of the collect-out, by 2012 there remained a substantial shortfall on the current account, largely because Leumi charged additional collection fees at a rate of 15% of all receivables collected, ostensibly for its own internal costs of collection. Due to the speed of the collect-out, these additional collection fees quickly amounted to £1.2m plus VAT.

Following demands made by Leumi, on 11 November 2010 and 9 May 2011 BHL paid a total of £950,000 in relation to the outstanding collection fees. Subsequently, BHL engaged lawyers and commenced a claim seeking return of the £950,000 on the grounds that it had made the payments in the mistaken belief that the sums were payable, when in fact they were not—this involved a challenge to the basis upon which the collection fees had been charged.

What were the legal issues the court had to decide?

Leumi’s additional collection fee was chargeable under a clause that provided that Leumi would be ‘entitled to charge [Cobra] an additional collection fee at up to 15% of amounts collected by Leumi…’

BHL argued that Leumi was not entitled to charge the full 15% collection fee on the grounds that:

  • it was only entitled to charge its actual costs and expenses of collection at the end of the collect-out, and that the reference to ‘up to 15% of the amounts collected’ was simply a ceiling on the amounts that could be claimed (the construction argument)
  • the clause was an unenforceable penalty
  • the discretion to charge up to 15% of the amounts collected had either not been exercised, or if it did exercise a discretion, then it did so irrationally
    What did the court decide, and why?

The detail of the construction argument was fact-specific and did not find favour with the judge, HHJ Waksman QC.

The judge also rejected the argument that the clause was an unenforceable penalty. He did so by reference to the recent decision of the Supreme Court in Makdessi v Cavendish Square Holdings BV [2015] UKSC 67, [2015] All ER (D) 47 (Nov). Again, his reasons were highly fact-specific, linked as they were to the detailed provisions of the clause in question. This led him to conclude that:

  • first, Cobra’s obligation to pay the collection fee was a primary and not a secondary obligation in that it was not akin to a sum payable instead of damages, and
  • secondly, even if Cobra’s obligation was secondary, the fact that the fee was to be arrived at in the exercise of a discretion meant that it could not be a penalty.

The judge then moved on to the most important feature of the case—Leumi’s decision to charge the full 15% collection fee. Leumi had the right to charge an additional fee which was to be applied as a percentage of the collected receivables going forward, but how should that discretion be exercised?

The judge considered that it was first necessary to identify the ‘target’ of the clause, ie what was the clause directed at? Leumi eventually argued that the fee had no ‘target’ at all—it was not even directed to what the anticipated costs and expenses might be, rather it gave Leumi the right to charge what it liked, provided that it had assumed the role of collecting the receivables and the 15% ceiling was not exceeded. The judge rejected this interpretation of the clause as commercially absurd in that it would give Leumi an untrammelled discretionary power. He held that the ‘target’ of the clause was the recovery of further costs and expenses to be incurred by Leumi as the now collector of the receivables.

The judge also held that Leumi’s discretion was qualified: the power had to be exercised in a manner that was not arbitrary, capricious or irrational in the public law sense, namely having regard to relevant and not irrelevant materials and then performing a proper estimating exercise.

This type of contractual discretion has recently been considered by the Supreme Court in Braganza v BP Shipping [2015] UKSC 17, [2015] All ER (D) 185 (Mar). The judge in the Leumi case referred to the limitation on the exercise of the discretion as ‘the Braganza Duty’ and said:

‘The fulfilment of that duty will entail a proper process for the decision in question including taking into account the material points and not taking into account irrelevant considerations. It would also entail not reaching an outcome which was outside what any reasonable decision-maker could decide, regardless of the process adopted. However, the duty does not mean that the court can substitute what it thinks would have been a reasonable decision.’

A proper estimating exercise is one of process not result. The problem was that, as a matter of practice, Leumi had ‘always charged the maximum where the provision gave a fee which could be ‘up to’ a particular percentage’. The judge concluded that this was not a real exercise of a discretion at all:

‘The question is not whether Leumi decided to charge 15%—it plainly did—but whether there was any real exercise of the discretion granted by [the clause] and in my judgment it is obvious that there was not.’

However, the judge did not stop there. He also found that if there was an exercise of the discretion, it was wholly arbitrary, irrational, and manifestly failed to take into account important factors because Leumi did not:

  • attempt to calculate its likely costs and expenses or to use data from its experience of previous collect-outs
  • consider the extent to which any collection process was likely to be materially carried out by third parties
  • consider whether a short delay in setting the charge would give it an important breathing space in which to form a more informed view as to the proper percentage to be applied
  • attempt to undertake a process by which some sensible estimate of costs could be reached by reference to how much it needed to raise in the collections process to collect-out, how long it thought the process might then take, and in the light of all that, what its own justifiable internal costs might be.

As a result, Leumi’s decision to charge a collection fee amounting to 15% of the amounts collected could not stand.

Where a discretion has not been exercised the court cannot substitute its own view of what would have been a reasonable decision, but the judge must put himself in the shoes of those making the decision, and consider what decision, acting rationally, and not arbitrarily or perversely, they would have reached.

In this case, that meant the judge was entitled to determine what percentage would or could Leumi have arrived at, had it sought to apply the discretion in a lawful manner.

As a starting point, and as a useful sense-check for a calculation of estimated costs, the judge considered the amount of actual costs and expenses that Leumi had incurred, and held they were £33,260.

The judge then had to determine the highest percentage fee which Leumi could have charged without being in breach of its Braganza Duty. He considered that rational way for Leumi to proceed was to delay setting the fee until the end of June when the perceived uncertainty in the collect-out would have been much clearer.

Of course, the question was not what Leumi’s actual costs were, but what percentage could Leumi have chosen, if acting rationally, to charge in order to cover its anticipated costs of collection. Taking a broad brush approach and giving Leumi the benefit of the doubt, the judge held that 4% was the maximum it could have charged in order to remain in compliance with its Braganza Duty. After the relevant adjustments to Cobra’s current account had been made, it transpired that BHL had overpaid by £735,000 and Leumi was owed nothing for its counterclaim.

To what extent is the judgment helpful in clarifying the law?

The Leumi case is an example of how first instance judges take the lead from higher courts and fashion the law in order to arrive at a just outcome. In purporting to exercise a discretion Leumi had charged a fee for its anticipated costs of collection that was many times the actual costs incurred. However, it been stated in Braganza that it may well not be appropriate to apply to contractual decision-makers the same high standards of decision-making as are expected of the modern state. The judge accepted that potential limitation, but stated:

…in this case the decision-maker is a large sophisticated organisation with very considerable experience of performing collect-outs so this point cannot be taken too far.

What practical lessons can those advising take away from this judgment?

The Leumi case is an important example of the extent to which courts appear to be increasingly willing to scrutinise the exercise of discretionary powers in a commercial context. It will be of interest to all those involved in making and challenging discretionary decisions made under any commercial agreement. Only time will tell whether or not the case will be seen as a step towards more a robust approach to the consideration of such decisions.

In the specific context of receivables finance, the Leumi case will perhaps give food for thought to those acting for the paying party, whether that is the customer company itself (including any administrator or liquidator in an insolvency setting), or any other liable third party (eg directors under a personal guarantee). The case highlights the fact that collection charges imposed by factors may be challengeable if the factor has a discretionary power to set the level of the charge and either fails to exercise the power at all, or does so on an improper basis.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

First published on Lexis PSL Restructuring & Insolvency

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