The Exercise of Contractual Discretion

Woolley v Fonterra Co-Operative Group Ltd: The Exercise of Contractual Discretion‍

On 29 June 2023, the New Zealand Court of Appeal delivered its judgment in the case of Woolley v Fonterra Co-Operative Group Ltd [2023] NZCA 266. In its judgment, the Court considered the approach to the exercise of contractual discretion in New Zealand, including the test adopted by the United Kingdom Supreme Court in Braganza v BP Shipping Ltd [2015] UKSC 17, [2015] 1 WLR 1661. A summary of the key facts of the matter and important points in the Court's decision follow.

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Relevant facts

The case centres on a milk supply agreement between Mr and Mrs Woolley and Fonterra. Mr and Mrs Woolley owned and operated dairy farms in the Marlborough and Tasman regions, including the Glenmae farm. Under the milk supply agreement, Fonterra could suspend milk collection in certain circumstances, including where environmental sustainability issues arose or where there was a failure to comply with resource consents.

On 4 April 2014, the Environment Court issued an enforcement order ceasing the milking operation at Glenmae, pending certification by a registered engineer that the effluent disposal system at Glenmae was functioning properly in accordance with a resource consent (the "Enforcement Order") . Following the issuance of the Enforcement Order, Fonterra suspended milk collection from Mr and Mrs Woolley's farm. The Woolley's obtained a certificate from a registered engineers and provided that to the local council which had sought the Enforcement Order. However, the company refused to withdraw the suspension notice until further ruling by the Environment Court on the issue of the certificate's compliance with the Enforcement Order.

High Court Judgment

In this proceeding, Mr Woolley alleged that Fonterra was in breach of the supply contract by refusing to collect milk from Glenmae in the 2014/15 season. He said that he had complied with the Enforcement Order and that it was therefore unreasonable for Fonterra to continue with the suspension. He alleged that the process followed by Fonterra when exercising its contractual discretion was unreasonable.

In the High Court, Justice Isac was faced with the issue of what the relevant approach to the review of contractual discretion in the context of commercial contracts should be. His Honour considered the following two approaches to the exercise of contractual discretion:
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1. A party must not exercise a contractual discretion arbitrarily, capriciously, in bad faith, or unreasonably in the sense that no reasonable contracting party could have so acted. As to whether a party has acted "unreasonably", the court can only assess whether the substance of the decision is reasonable, and not the decision maker's process – this approach is referred to as the default rule; and
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2. When reviewing the exercise of contractual discretion, the test for reasonableness is the same test for reasonableness used in judicial review of decisions made by public bodies. This test requires an assessment of both the substance of the decision, and the process by which the decision is made – this was the approach adopted by the UK Supreme Court in the Braganza case, which we refer to as the expanded default rule.

Justice Isac observed that: "There can be no doubt that Braganza has charted a new approach to the review of contractual discretions, but there has been no explicit endorsement in New Zealand of the United Kingdom Supreme Court’s approach, and — perhaps more crucially — it remains questionable whether it can be applied in more commercial contexts, as is evident from some decisions post-Braganza."

The Judge concluded that for commercial contracts, such as the milk supply agreement in the present case, the default rule is more appropriate, where the object of the discretion will more generally be self-regarding and in conflict with the counterparty. This adequately balances the risk of abuse of power with freedom of contract.

His Honour suggested the Braganza approach should be confined to "other-regarding" powers, namely those which involve some positive duty of the decision-maker to have regard to the interest of the counterparty, such as in employment contracts and in the context of trusts.

Justice Isac did not draw a bright line between a breach of the default rule and a breach of an expanded default rule. Although the Judge declined to adopt the expanded default rule from Braganza, the Judge nonetheless proceeded to consider whether Mr Woolley’s claim would succeed under the expanded default rule. Ultimately, His Honour held that Fonterra's decision to suspend milk collection was not unreasonable, taking into account all of the circumstances of the case.

Mr Woolley then appealed to the Court of Appeal on several grounds, including that Fonterra’s refusal to pick up Mr Woolley’s milk was a breach of the terms of its supply contract with him. In that regard, the Court had to address the issue of whether continued suspension of milk collection was a breach of  the implied term that Fonterra would exercise its power to suspend milk collection reasonably. It is that ground of appeal that is the focus of this article.

Court of Appeal Judgment

The Court of Appeal observed that:‍

"The issue which divided the parties was whether, and if so in what circumstances, the development of that rule recognised in Braganza (the expanded default rule) applies in New Zealand. That issue has not previously been addressed by the New Zealand senior courts. Nor, like the traditional default rule, does it appear to have been the subject of academic discourse here. More specifically, the question is whether the contractual power to suspend milk collection must be exercised by Fonterra “reasonably” by reference to both the first and second limbs in Associated Provincial Picture Houses Ltd v Wednesbury Corporation, that is by reference to both process and outcome."

In the course of the proceeding, Fonterra conceded that it must not exercise its discretion “arbitrarily, capriciously, in bad faith or unreasonably, albeit only in the sense that no contracting party could have rationally so acted”.

The Court assumed, but without expressly deciding, that the default rule applies in New Zealand. This was on the basis that neither party challenged the application of the default rule. Applying the default rule to the facts of the case, the Court agreed with the High Court's finding that the continued suspension was not unreasonable: "In these circumstances we consider that Fonterra’s decision to maintain the suspension of milk collection from Glenmae for the time being was not only rational but unsurprising".

The Court then continued to consider whether the expanded default rule should apply in this case. The Court considered that this appeal "was not an appropriate vehicle for either general endorsement or rejection of the Braganza approach". The Court noted that this case concerned an ordinary commercial contract; not an employment case like in Braganza, which involved a relational contract. Further, the extent of analysis on this issue on appeal fell well short of what would be required for such a significant contract law development.

Having found that the decision by Fonterra to maintain the suspension was not unreasonable, the Court dismissed the appeal.

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Conclusion

The Court of Appeal's judgment leaves unanswered the application of the Braganza approach in New Zealand. It is likely that the default rule remains to be the relevant approach in New Zealand when assessing the exercise of contractual discretion in the context of an ordinary commercial contract.

Therefore, a party to an ordinary commercial contract should keep in mind that in exercising a discretion conferred to them under the relevant contract, they must not exercise that discretion arbitrarily, capriciously, in bad faith or unreasonably, in the sense that no rational contracting party could have made that decision. However, the Fonterra decision does recognise that, for now at least, it remains open to a contracting party exercising a contractual discretion reasonably, in the context of a primarily commercial relationship, to continue to give considerable weight to its own interests, as a matter of substance, provided that proper consideration has been given to the matter after making necessary inquiries.

If you are seeking advice or have any questions about this topic, please contact:

‍Craig Andrews (Partner) on (09) 306 6745 (candrews@mcveaghfleming.co.nz)

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© McVeagh Fleming 2023

This article is published for general information purposes only.  Legal content in this article is necessarily of a general nature and should not be relied upon as legal advice.  If you require specific legal advice in respect of any legal issue, you should always engage a lawyer to provide that advice.

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