Discretion

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Freedom. Choice. Happiness. Individuality. Optionality, unbound by considerations of what anyone else might think.

The stance one adopts by uttering the expression “I may” (or, if one is legally qualified, “I shall be entitled, acting for the avoidance of doubt in my sole and absolute discretion”.)

A simple idea that lawyers will work hard to make seem difficult.

The two-edged sword of discretion

The pitfalls of being offered unfettered discretion — yes: pitfalls — are a window into how the legal mind thinks.

Let us say a bond issuer is expecting to raise a million pounds, and wishes to make arrangements with its own settlement agent to hold those issued but as yet unsubscribed securities, pending remittance of funds for them by the betrothed subscriber. With all the will in the world, there can be unforeseen delays and so on, so this is not uncommon.

The settlement agent is happy to act, for a suitable fee, but wants the certainty of some end point to its commitment. Now, should it care? Not really; it costs almost nothing to hold an unissued security in a settlement account, and one can extract a fat fee for it. But that is as may be.

To quell its beloved agent’s misgivings, the issuer presents a draft. It says:

“If I have not paid you in 10 days, at your absolute discretion you may cancel the transaction immediately by notice at any time.”

Granted, “at your absolute discretion” adds nothing to “you may”, but we know how craven and paranoid our learned friends can be, so are trying to be accommodating.

The draft comes back marked thus:

“If I have not paid you in 10 days, at your absolute discretion you may must cancel the transaction immediately by notice at any time.”

Now why would an agent prefer to be obliged, rather than simply entitled to act? We think this stems from an ancient, but irrational, fear of mis-exercising a discretion. “What if my action is challenged? I might be found to have breached an implied duty of reasonableness, of good faith, or something like that.”

Rejoining that this is not how implied terms work in contracts will hardly ingratiate yourself to your opponent. Reminding her of The Moorcock [1889] 14 PD 64 may induce her to regard you as bumptious.

“My client wants no debate about whether it should, or should not, have done what it did. If it must act, the decision is out of its hands.”

Yet, manifestly, this leads to worse outcomes. We can picture it: an issue proceeds, there is a subscription hitch that persists a while. Before you know it, day 10 rolls around, whereupon the subscriber, having mounted whatever hurdles lay before it, has has committed to payment in full upon the morrow. Instructions are matched, cabin-doors locked, missiles armed until beloved settlement agent, who knows all of this perfectly well, comes on the line to say, “I am afraid I am obliged to terminate the arrangement. My compliance department says I have no choice. There is no discretion.”

But it leads to worse outcomes for the settlement agent too. It is a regrettable fact that contractual terms get overlooked. Deadlines are missed. Hardening this discretion into a prime directive puts the inattentive agent immediately in breach of contract.

So what, you might say? What damage flows?

Well, let the JC tell you a cautionary tale.

A cautionary tale

As well as lending on margin, a prime broker runs banking services for its customers, who may deposit cash with the prime broker in excess of its formal contractual margin requirements. As with any other deposit accounts, a client may ask for its money — in excess of its margin requirement — at any time.

To allow themselves a degree of operational flexibility, prime brokers tend not to agree timeframes within which they must disburse cash, but by unerring practice it tends to be same day, as long as the request comes in early enough. The broker needs to check the client’s positions, satisfy itself the client is sufficiently margined, make sure the relevant operational teams have what they need and everything is in place to get the money out the door. So, a bit of flexibility, in case things get gummed up or the market is crazy.

Sometimes, more petulant clients ask for a commitment to disburse cash same day; to which the prime broker’s says, “okay, as long as you commit to make your request by ten o’clock in the morning, I will commit to returning it same day.”

Notice the flexibility the parties otherwise have is being eroded. You would think in an environment of trust and good faith you wouldn’t normally like to erode one’s discretions, but prime broking is not always such a place of warmth, sweetness and light.

Now, once upon a time, one such client rolled up, at ten minutes past the agreed deadline for a withdrawal request, and asked its broker for some money back. Quite a lot of money, but it was excess to margin, so you know, that’s how it goes.

The prime broker ran its checks, cleared all balances, checked its margin levels, saw green lights across the dashboard and disbursed the money, exactly as you would expect a good banker to do.

Alas, that was the day in March 2021 on which a peculiar corner of the market melted down taking that client, all its positions, and ten billion dollars of borrowed money across its six brokers, with it. The awful lot of money that that prime broker lost would have been a bit less had it not paid out all that money.

Now, to be clear: our prime broker had been remiss in its risk management: res ipsa loquitur: it lost money: it must have been. It did not see the incipient risk presented to this client by its positions in that peculiar corner of the market. But that was a different business failing. In honouring the withdrawal request, it got things right. Had the failing bit of the risk management operation been on the job, it would have show a red light on that dashboard, the broker would have recalculated required margin and kept the money. But it did not. This was not the cash operator’s fault.

When it came to the inevitable recriminations, the bank’s crack, rear-mounted hindsight division — internal audit, compliance, business management — rolled in. They found the client’s contract, that 10.00am deadline, which they noted had passed. They asked one question: why was no-one monitoring our legal rights? Why did we pay out when we were not obliged to?

Have a guess who they fired.

See also

• Commercially reasonable manner
• In good faith