Neutral Citation Number: [2014] EWCA Civ 302

Case No: A3/2013/1387
IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT
QUEEN’S BENCH DIVISION
COMMERCIAL COURT
THE HONOURABLE MR JUSTICE POPPLEWELL
2011 Folio 312
Royal Courts of Justice
Strand, London, WC2A 2LL

Date: Thursday 20th March 2014
Before:

THE RIGHT HONOURABLE LORD JUSTICE LONGMORE
THE RIGHT HONOURABLE LORD JUSTICE PATTEN
and
THE RIGHT HONOURABLE LORD JUSTICE CHRISTOPHER CLARKE
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Between:

	BARCLAYS BANK PLC	Respondent	
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	UNICREDIT BANK AG (FORMERLY KNOWN AS BAYERISCHE HYPO-UND VEREINSBAND AG) & ANR	Appellants	

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(Transcript of the Handed Down Judgment of
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Mr Robin Knowles QC & Mr Edmund King (instructed by Quinn Emanuel Urquhart & Sullivan) for the Appellant 
Mr David Railton QC & Mr Giles Wheeler (instructed by Addleshaw Goddard LLP) for the Respondents

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Hearing dates: 25th & 26th February 2014

Judgment
Lord Justice Longmore: 
1.	This appeal raises the question of what is “commercially reasonable” in the context of determinations made by parties to financial instruments.
2.	Basel I (1988) and Basel II (2004), the so-called Basel Accords, have sought to achieve a measure of international consistency in relation to minimum capital requirements for banks.  They have been drawn up by a committee of banking supervisory authorities established by the central bank governors of ten separate countries including Germany, Austria and Italy.  The defendants (and appellants) are German and Austrian Banks regulated by what I will call “BaFin” in Germany and what I will call “FMA” in Austria respectively.  They are both controlled by UniCredit SpA which is regulated by the Bank of Italy and it is convenient to refer to the defendants compendiously as “Unicredit”.
3.	A bank which wished in 2008 to transfer or mitigate its credit risk in a pool of assets and in turn reduce its regulatory capital requirements could do so by what is called “synthetic securitisation”.  By using this process, the bank could transfer the credit risk of a portfolio of assets to a third party by the use of credit default swaps or guarantees without removing the portfolio of assets from its balance sheet.  The transfer would, however, enable its capital requirements to be reduced.  In the present case Unicredit transferred the credit risk in certain of their assets to Barclays Bank Plc (“Barclays”) who would make quarterly payments to Unicredit in respect of relevant portfolio losses and in return Unicredit paid quarterly premiums to Barclays.  There were three such guarantees given by Barclays as Guarantor to Unicredit.  The losses which Barclays guaranteed to pay were called “Credit Protection Payments”.
4.	The initiative to execute the first guarantee came from Unicredit SpA in Milan which was under pressure from the Bank of Italy to improve what was called its “tier one capital ratio”.  This improvement was required to be effected by 30th September 2008 which, it will be remembered, was a time of considerable financial turmoil.  By that date the cash securitisation market was effectively closed.  In December 2008 two further guarantees had been agreed and executed.  They were amended and re-stated in April 2009 but nothing turns on that.
5.	The essential structure of the guarantees was that, in exchange for the premiums, Barclays would make quarterly payments to Unicredit in respect of the first losses suffered by reason of credit defaults on a portfolio of obligations designated as the “Reference Portfolio”.  The amount of the premiums payable by the defendants was determined in such a way as, over the lifetime of the guarantees, was intended to exceed the total of the Credit Protection Payments and Barclays would not, therefore, be exposed to the credit risk on the first tranche of the Reference Portfolio.  Nevertheless the structure of the transaction apparently persuaded the regulators that Unicredit had effectively transferred the risk and qualified for “RWA relief”, so called because the banks’ assets were assigned a percentage risk weight reflecting their credit risk.
6.	The judge explained that this structure did not mean that Barclays assumed no risk because (1) they agreed to accept the risk of the “super senior” tranche of the portfolios (said to be “a very remote risk”) and (2) if interest rates increased in a dramatic way, there could be a difference between Barclays’ total exposure on the first tranche and the premiums they received (said to be “unlikely”).
7.	The lifetime of two of the guarantees was 11 years and 19 years for the other guarantee, but provisions were agreed entitling Unicredit (in events that were likely to happen) to bring them to an end after a period roughly equivalent to the weighted average life of the loans in the portfolio which was expected to be about 5 years.  Barclays could therefore expect to earn five years worth of premium and fees under the guarantees.  Clause 12.1 of the guarantees granted this right of optional termination in four separate events, two of which required Barclays’ prior consent
“such consent to be determined by [Barclays] in a commercially reasonable manner.”
It is this clause which is at the centre of the dispute between the parties.  The two events requiring Barclays’ consent were Regulatory Change and what was called a “10% Clean-up Call Event”.  The other two events, not requiring Barclays’ consent, were the Substitution Event Date and the Weighted Average Life Termination Date both defined in the guarantees.  The three guarantees referring to the respective defendant as “the Bank” and Barclays as “the Guarantor” were on essentially identical terms and I will therefore only quote the terms of the guarantee given to the German bank.
8.	The full clause 12.1 is as follows:-
“12. OPTIONAL EARLY TERMINATION
12.1 Optional Early Termination by the Bank
If:
(a)	the Substitution Event Date occurs, provided that:
(i)	the balance of the Accumulation Ledger minus the Maximum Pending Credit Protection Amount is greater than zero as at that Substitution Event Date; or
(b)	a Regulatory Change occurs in respect of the Bank, provided that the Bank has obtained the prior consent from the Guarantor, such consent to be determined by the Guarantor in a commercially reasonable manner; or
(c)	a 10% Clean-up Call Event occurs, provided that the Bank has obtained the prior consent from the Guarantor, such consent to be determined by the Guarantor in a commercially reasonable manner; or
(d)	the Weighted Average Life Termination Date occurs, provided that the balance of the Accumulation Ledger minus the Maximum Pending Credit Protection Amount is greater than zero as at that Weighted Average Life Termination Date,
and provided further that the Bank has obtained such consents to terminating this Guarantee as it has deemed necessary (in its sole and absolute discretion) which may include, but is not limited to, consent of the Federal Financial Services Supervisory Authority [BaFin] or any successor thereof,
the Bank may, by not less than 5 Business Days notice to the Guarantor, and provided that the event described in sub-paragraphs (a) to (d) is then continuing, designate any of the applicable Substitution Event Date, Weighted Average Life Termination Date or, in the case of paragraphs (b) and (c), the next following Payment Date as an Optional Early Termination Date.”
9.	It is agreed that at the date of each guarantee, Barclays entered as profit in their books the discounted value of 5 years’ fees and it is also agreed that a Regulatory Change occurred within the definition of that term in the guarantees.  On 14th June 2010 the defendants sought Barclays’ consent to an early termination on 30th June 2010 as a result of Regulatory Change.  Barclays responded on 23rd June 2010:-
“Although early termination of the Agreement was contemplated in the Agreement, it is clear that the parties intended the Agreement to continue for a substantial period of time.  Unicredit cannot reasonably expect Barclays to consent to termination so early in the term of the Agreement, in circumstances where this would deprive Barclays of a significant proportion of the overall revenue that it had bargained for and thus result in material economic detriment to Barclays.”
Unicredit responded by saying that it was not reasonable for Barclays to refuse consent in circumstances in which the Regulatory Change resulted in Unicredit no longer receiving capital relief by virtue of the guarantees.  They said that Barclays unreasonable refusal was a waiver of the consent requirement and 30th June was to be designated as the Optional Early Termination Date.  Unicredit ceased paying premiums on that date and contend that the guarantees ended on that date.  Barclays have always maintained that the guarantees have not been terminated and remain in force.
The Judgment
10.	In the light of earlier correspondence between the parties the judge held (para 43) that Barclays’ refusal of consent was not to be regarded as a refusal to consent on any terms but as a statement that the price of its consent was that it should be paid the balance of its fees for a five year period discounted for present payment, just as had been posted in its books.  He also held that (para 41) it would have cost Barclays about €7.45 million to close out the existing hedge transactions entered into as a result of the guarantees, although Barclays would have been saved about €2.5 million in future payments if the guarantees had terminated at 30th June 2010.  He further held (para 46) that Unicredit’s reaction to Barclays’ letter of 23rd June was not to offer any payment to Barclays as the price of its consent to early termination.  That was despite Unicredit’s later concession in the face of the court (recorded in para 69 of the judgment) that it would have been reasonable for Barclays to recover its out of pocket costs of unwinding the hedges in place, at least if those costs exceeded the amounts saved as a result of early termination, as the judge had found they did.
11.	The judge held in broad terms that Barclays had withheld its consent to early termination in a commercially reasonable manner and that the defendants’ purported designation of 30th June 2010 as the Optional Early Termination Date was invalid and of no effect.  He held importantly that Barclays were entitled to take primary account of their own interests in determining whether to consent to termination.
12.	Barclays had also alleged that it was a common understanding between the parties that the guarantees would last 5 years and that they would therefore receive premiums over that 5 year period.  This was the foundation of a plea by Barclays of estoppel by acquiescence or estoppel by convention.  The judge accepted that that was Barclays’ understanding but he said it was not a shared understanding.  The plea of estoppel accordingly failed.  But the judge regarded the fact that Barclays had had that understanding as supporting his view that Barclays had refused their consent to an early termination in a commercially reasonably manner.
The submissions on appeal
13.	Unicredit have 3 grounds of appeal saying that the judge was wrong:-
i)	to hold that Barclays was entitled to give precedence to its own commercial interests and thereby to exclude the interests of Unicredit in refusing to consent to early termination;
ii)	to hold that Barclays was entitled to demand a sum equal to the entire (discounted present value of the) fees that it would have received if the guarantees had continued for five years; and
iii)	in failing to give effect to an Entire Agreement clause which provided:-
“20.1 Entire Agreement
This Guarantee, together with the Credit Support Agreement, constitutes the entire agreement and understanding of the parties with respect to its subject-matter and supersedes all oral communication and prior writings with respect thereto.”
14.	There was considerable debate before us and below on the question whether clause 12.1(b) was to be regarded (1) as conferring a contractual discretion on Barclays so that the principles of contractual discretion cases applied, as exemplified by Abu Dhabi National Tanker Co v Prudent Star Shipping Ltd (The Product Star (No. 2) [1993] 1 Lloyds Rep 397 or (2) as equivalent to conferring a discretion to which the principles of AP Picture Houses v Wednesbury Corporation [1947] 1 KB 223 applied or (3) as analogous to landlord and tenant cases, such as International Drilling Fluids Ltd v Louisville Investments (Uxbridge) Ltd [1986] 1 Ch. 513, in which there is a covenant against e.g. assignment without the consent of the landlord “such consent not to be unreasonably withheld”, or (4) as requiring Barclays to make an objectively “commercially reasonable” determination.  Although interesting this debate was not, in my view, ultimately helpful since the meaning of the clause has to be determined as a matter of construction of this particular contract in its particular context.
The construction of clause 12.1(b)
15.	The critical factor in the present case is that the person who has to act in a commercially reasonable manner in determining whether consent is to be given is “the Guarantor” namely Barclays itself.  It is from Barclays that consent is to be obtained and it is Barclays who has to determine whether that consent is to be given, albeit in a commercially reasonable manner.  It is the manner of the determination which must be commercially reasonable; it does not follow that the outcome has to be commercially reasonable although, if it is not, that would no doubt cause one to look critically at the manner of the determination.
16.	One then has to ask whether, in determining whether or not to consent to early termination, Barclays can take account of its own interest in preference to the interest of Unicredit.  To my mind the answer is that it can, because any commercial man whose consent to a course of action is required but to whom the determination (whether to give that consent) is entrusted would think it commercially reasonable to have primary regard to his own commercial interests.
17.	Mr Robin Knowles QC for Unicredit submitted that the purpose of requiring the determination to be made by Barclays in a commercially reasonable manner was to require Barclays to have regard to the interests of Unicredit as its counterparty in order that a mutual (or a mutually satisfactory) outcome could be achieved.  Attractively as the submission was put, it is impossible to see how it could work in practice.  Bankers, as commercial men, have a keen instinct for where their own interests lie.  But if they are asked to have regard to the interests of the other party to the contract, how do they begin to assess what those interests are, let alone weigh those interests in comparison to their own interests?  If the clause is to work in the way Mr Knowles suggests, there would have to be some method of discovering and assessing the counterparty’s interests.  The obvious way to do so would be to ask the counterparty what their interests were.  But is Barclays to be expected to take the answer at face value?  That might be beneficial to the counterparty but not be a balanced or accurate assessment of the counterparty’s interest.  Could Barclays ask that the counterparty’s account of its own interests be backed up with documentary evidence?  If so, it might be a long process; if not, it might lead to an unfair result.  If this sort of exercise were envisaged, one would expect a neutral third party to be allotted the task of determining whether consent should be given but that is not what the clause says.
18.	Of course the requirement that consent be determined in a commercially reasonable manner must be intended to be a control exercise of some kind.  If, therefore, Barclays had said that they would not consent at any price or if it had said that they wanted 11 years’ (or 19 years’ as the case might be) fees as being the full term of the guarantees, that might well not have been “commercially reasonable”.  But that is not this case.
19.	It is not easy to express a test for commercial reasonableness for the purpose of this (let alone any other) contract but I would tentatively express it by saying that the party who has to make the relevant determination will not be acting in a commercially reasonable manner if he demands a price which is way above what he can reasonably anticipate would have been a reasonable return from the contract into which he has entered and which it is sought to terminate at an early date.
20.	If, therefore, it is necessary or helpful to determine into which of the 4 categories, set out in paragraph 14 above, the present clause falls, I would assign it to category (2) as I think the judge did in para 67(4) of his judgment.  This seems to me to accord, moreover, with previous decisions of this court or similar clauses such as Ludgate Insurance Co v Citibank N.A. [1998] Lloyd’s Rep I.R. 221, paras 35-36 per Brooke LJ, Gan Insurance Co Ltd v Tai Ping Insurance Co Ltd (No. 2) [2001] 2 All E.R. Comm 299 paras 64, 67 and 73 per Mance LJ, Paragon Finance Plc v Nash [2002] 1 WLR 685 para 41 per Dyson LJ and Socimer Bank Ltd v Standard Bank Ltd [2008] Bus L.R. 1304 paras 61-66 per Rix LJ.  This latter authority indicates that there is in any event little difference between categories (1) and (2).
21.	Mr Knowles submitted that the words “commercially reasonable” were used in many contexts (he instanced the definition of “Close-Out Amount” in the ISDA 2002 Master Agreement) and submitted that they should, therefore, be construed in an objective sense or at least in a sense that required the determiner of the question of consent to make its determination by balancing the parties’ interests.  But I do not think it useful to construe the words in this contract by reference to their use in other contexts, nor do I think it by any means inevitable that the construction put on the words in this case will necessarily apply in those other contexts, which may anyway use slightly different words.  Parties to contracts such as these (or, indeed, ISDA contracts) can, in any event, look after their own interests and contract on different terms if they wish to do so.
Commercially reasonable demand in fact?
22.	It follows that the price which Barclays demanded as the price of its consent cannot be said to have been determined by it in a commercially unreasonable manner.  It was entitled to have regard to its own commercial interest; it did not refuse consent outright; the price it sought was not out of line with the reasonable return it could have expected had the contract run its expected course.  The fact that Unicredit could probably have determined it after 5 years as of right only serves to underline that not unreasonable expectation.
23.	Mr Knowles submitted that it would have been more reasonable for Barclays to have required payment of their notional loss of profit over the period of 5 years rather than 5 years of fees.  But in the first place that was never an offer made by Unicredit who never made any counter-offer at all and, secondly, it would not have been an easy calculation to make.  I have already mentioned that Unicredit conceded that Barclays could, on any view, have sought to recover the cost of unwinding the hedges already in place (to the extent that such costs exceeded any gains made by early termination) but that was not on offer either.  As it was Barclays claim for the present value of 5 years’ worth of fees without any deduction for the excess of the costs of closing the existing hedge transactions over the amounts saved by early termination seems to be a rough and ready assessment of its loss of profit.  In these circumstances, it is, in my judgment, impossible to say that Barclays did not determine whether or not it should consent to early termination in a commercially reasonable manner.  On the contrary, in my judgment, it made its determination in what was a commercially reasonable manner.
24.	Mr Railton QC for Barclays submitted that the lack of any offer or counter offer from Unicredit meant that Barclays determination had automatically been made in a commercially reasonable manner and that that would be the case, even if Barclays had not initially made the first offer of the sum for which they would give their consent.  I would not accept either of those submissions.  I have already said that the wording of the clause is intended to be a control exercise, even if it is not a rigorous one.  If Mr Railton were correct, it would amount to giving Barclays a virtual carte blanche to do what it wanted and that cannot be correct.
Entire Agreement and Understanding Clause
25.	The judge, while holding that Barclays’ understanding that the contract would last for 5 years and that they would receive 5 years of fees was not an understanding shared by Unicredit, nevertheless considered that understanding to be part of the background against which Barclays made their determination to withhold consent to early termination in a reasonable manner.  Mr Knowles submitted that to use Barclays’ understanding in that way was inconsistent with the Entire Agreement Clause which provided that the terms of the written guarantee constituted “the entire agreement and understanding of the parties with respect to its subject matter”.
26.	On the facts of this case, this is something of a non-point.  The question is whether Barclays determined to refuse their consent in a commercially reasonable manner.  That question cannot realistically be decided by reference to the relevant party’s understanding of the length of time for which the contract would last.  If the understanding is not commercially reasonable, the fact that it was the understanding of Barclays would not make the determination one which was reached in a commercially reasonable manner.  No more is it the case that, if the understanding is commercially reasonable, Barclays can rely on their own understanding to that effect to make their determination a determination which is reached in a commercially reasonable manner.
27.	Perhaps more to the point is this.  The entire agreement clause is concerned with identifying the terms of the contract.  The use of the phrase “constitute the entire agreement and understanding” is intended to exclude any evidence or argument to the effect that the terms of the contract are to include any mutual understanding that is not recorded in the contract.  It is not intended to exclude admissible evidence or argument about the way in which parties exercise rights given to them by the terms of the contract.
28.	Courts have tended to construe entire agreement clauses strictly.  A clause framed in the way in which it is framed in the contract with which this case is concerned would not, for example, preclude a claim for misrepresentation because that is not a claim which depends on a term of the contract which is not expressed in the contract, see Axa v Campbell Martin [2012] Bus L.R. 203 paras 84 and 95 per Rix LJ.  Consistently with this approach, the clause has, in my view, no relevance to the way in which parties may exercise rights given to them by the contract.
29.	Even if, however, this is wrong and the clause is to be construed as precluding any reliance by Barclays on its own understanding of the length of time the contract was likely to last, that cannot decide the case in favour of Unicredit.  The question still remains whether Barclays determination to require 5 years’ premiums was reached in a commercially reasonable manner.  For the reasons given earlier, it was and the fact that the judge may have had regard to an irrelevant matter in reaching his own conclusion does not make any difference to that.
Conclusion
30.	I would therefore dismiss this appeal. 
Lord Justice Patten:	
31.	I agree.
Lord Justice Christopher Clarke:
32.	I also agree.