Good faith in secured finance?

The court implied a good faith term constraining a lender’s discretion to refuse a borrower's request to dispose of assets in a secured financing context. 

A power to consider requests for disposals 

A facility agreement between Bank of Scotland, as secured lender, and Macdonald Hotels, as borrower, stated that Macdonald could not dispose of any relevant assets (including by charging them) without the bank's consent. The bank refused a proposal by Macdonald to mortgage a relevant asset to a third-party lender in exchange for GBP29m to finance Macdonald’s debt to the bank. Macdonald claimed this breached an implied term in the agreement that the bank should act in good faith and not arbitrarily or capriciously when deciding whether to grant consent to a disposal (also known as a Braganza duty).

Constrained by an implied term 

Noting the existence of a mortgage relationship between the parties, the court discussed whether there might be a “mortgage exception” to the implication of terms. Under this exception, obligations between the parties would arise as incidents of the mortgage relationship rather than as implied terms. However, the term requiring the bank’s consent for a disposal was found to relate to the parties’ contractual relationship, not their mortgage relationship, and so any “mortgage exception” did not apply to prevent the implication of a term. 

The court found that, as a matter of interpretation, the provisions permitting disposals subject to the bank’s consent were not absolute in a way that would exclude any Braganza duty. Moreover, it was necessary to imply a term that, when considering a request for consent to a disposal, the bank was not entitled to refuse for reasons unconnected to its commercial interests or to refuse consent when no reasonable entity in the position of the bank could have refused consent. 

Which the bank hadn’t breached

The court found that the bank's refusal of Macdonald’s proposal did not breach this implied term. The proposal would have involved a third-party junior lender being granted security senior to that of the bank. The background of Macdonald’s repeated delays in payment also had to be considered. The bank had therefore been entitled to reject the proposed refinancing and insist on repayment under the original terms.

Judgment: Macdonald Hotels v Bank of Scotland