The Negative Pledge: prohibition without the lender’s prior consent (at their…not so…sole discretion)
(Macdonald Hotels Ltd v Bank of Scotland Plc)
The negative pledge in finance documents seeks to give a lender absolute discretion over a borrower granting further security over its assets, to protect the lender’s own security, or so we thought, until Macdonald Hotels Ltd v Bank of Scotland Plc shined a spotlight on the topic and called into question this absolute discretion.
Factual Background
A borrower owning a number of hotels claimed it had been forced to dispose of three of its hotels by the defendant bank acting in bad faith.
The bank had provided lending services to the borrower with security taken over the borrower’s hotel portfolio. Following the financial crisis in 2008/09 the bank decided to reduce its loan book size including by disposing of assets and paying down debt.
The borrower wanted to refinance another one of its hotels rather than dispose of the hotels financed by the bank. The finance documents, however, contained the usual negative pledge, being a restriction on the borrower granting security over its assets “without the prior written consent” of the bank. After lengthy commercial discussions, the bank ultimately refused its consent and the hotels financed by the bank were then sold, with the borrower claiming loss of opportunity as a result.
Braganza duty
The borrower argued that the discretion of the bank to refuse consent to granting third party security should be subject to the implied duty set out in the Braganza v BP Shipping Limited [2015] case, being that a lender should:
- act in good faith and not arbitrarily or capriciously in exercising its discretion and exercise its discretion consistently with its contractual purpose;
- take into account all relevant considerations and not take into account any irrelevant considerations; and
- not use the discretion for an improper purpose.
The bank countered that the discretion for consent was an absolute right of the bank and even if the Braganza duty was implied, it had not breached the duty in reaching its decision to refuse consent.
Court Decision
The High Court judge held that the Braganza duty was implied in the agreements. It was noted by the judge that the prohibition expressly stated that such restriction would not apply with the bank’s prior written consent. It followed, therefore, that the parties agreed that the borrower might request that consent and that “No reasonable person with all the background knowledge of the parties could have thought the Bank was entitled simply to refuse to consider the request or refuse it for reasons unconnected with its commercial best interests. Had that been the parties’ intention then there would have been no purpose in inserting the provision concerning permission, because it is always open to a party to a contract to request a variation to it … A more cautious lender might have omitted the express permission qualification and left the borrower to seek a variation to the agreement.”.
Although ultimately, on the facts of the case, the judge held that the bank had acted in accordance with the Braganza duty and its own legitimate interests, and was entitled to refuse its consent to the borrower, the express inclusion of the lender’s consent right actually limited the lender’s ability to refuse its consent.
Implications
The consequences for the drafting in finance documents (and potentially all commercial arrangements) are potentially significant. Adding any sort of proviso along the lines of ‘without the prior consent of the lender’ may weaken a lender’s right to refuse consent to a disposal or granting of security (and arguably, any other restrictions).
There are also views that adding caveat wording to a consent proviso, such as ‘in the sole discretion of the lender’, would also be interpreted in a similar way and therefore not enough to argue that the Braganza duty should not apply.
Although the case here did not cover a clause with drafting that consent should not be ‘unreasonably withheld’, the judgment suggests that there is always a duty on a lender to not act unreasonably in withholding its consent where any proviso for requiring prior consent is included.
Considerations for Lenders
In reality, a lender is unlikely to ever make a decision that is against its own commercial interests (and the court made clear that a lender only needs to consider its own commercial interests and not those of the borrower).
However, a lender’s right to refuse consent to a disposal and a negative pledge are standard and fundamental rights for which it will likely want to retain its full discretion to protect its security interests. As such, there are steps lenders can take to protect their position following this judgment:
- Where genuine sole discretion on consent is imperative to a lender, it is vital that they do not accept any caveat along the lines of ‘except with the prior consent of…’ (sole discretion or otherwise). This exclusion would support a lender’s argument that it is able to refuse consent, even if arguably such refusal is not in its best commercial interests.
- Lenders should also consider recording in detail any decisions made regarding consents and how such conclusions were reached, so they’re able to evidence that the consents are reasonable and in their own commercial interests.
The judgment has certainly provided food for thought for both lenders and their legal advisors alike as to which restrictions are most important to a lender to retain absolute control over and how these clauses will be drafted from now on to protect such control.
Disclaimer
This note reflects the law as at 19 March 2025. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.
