A Place for the Product Star

product-star-mmI have been working on my book Extra-Contractual Remedies, and exploring the thought that The Product Star is a case that has been rather overlooked in construction law. There is a passing reference in the BLR commentary on Balfour Beatty v Docklands Light Railway, but that is about it.

Given the endorsement of the principle by the Supreme Court a few weeks ago, I wonder if might be time for more attention.  I know it is a shipping case. But even so…

My draft is currently thus, on this topic:

The Rational Exercise of Contractual Powers – The Product Star

1                    There are a number of commercial cases which show that a party with a contractual right to exercise a discretionary power may be subject to an implied obligation to exercise that power rationally. This line of authority stems from this passage in The Product Star[1], sometimes known as the “default rule”[2]:

Where A and B contract with each other to confer a discretion on A, that does not render B subject to A’s uninhibited whim. In my judgment, the authorities show that not only must the discretion be exercised honestly and in good faith, but, having regard to the provisions of the contract by which it is conferred, it must not be exercised arbitrarily, capriciously or unreasonably. That entails a proper consideration of the matter after making any necessary inquiries. To these principles, little is added by the concept of fairness: it does no more than describe the result achieved by their application.

2                    In 2014, the Supreme Court endorsed the rule in British Telecommunications Plc v Telefónica O2 UK Ltd[3]

As a general rule, the scope of a contractual discretion will depend on the nature of the discretion and the construction of the language conferring it. But it is well established that in the absence of very clear language to the contrary, a contractual discretion must be exercised in good faith and not arbitrarily or capriciously: Abu Dhabi National Tanker Company Ltd v Product Star Shipping Ltd (No 2) [1993] 1 Lloyd’s Rep 397, 404 (Leggatt LJ); Gan Insurance Company Ltd v Tai Ping Insurance Company Ltd (No 2) [2001] 2 All ER (Comm) 299, para 67 (Mance LJ); Paragon Finance Plc v Nash [2002] 1 WLR 685, paras 39-41 (Dyson LJ).

3                    Whilst this principle has been applied in other commercial contexts[4], it has had little airing in the construction context, which is perhaps surprising since it is by no means uncommon for owners to reserve for themselves all sorts of discretionary powers in construction contracts. Perhaps the reason is to be found in the independent jurisprudence that has grown un in construction law which is to very similar effect, and particular the principles that:

·         Courts generally have power to open up certificates – Beaufort Developments (NI) Limited v. Gilbert-Ash NI Limited[5];

·         Certifying owners are bound to do so honestly, fairly and reasonably –  Balfour Beatty v Docklands Light Railway[6]

·         A failure by an independent certifier to act fairly and properly applying the provisions of the contract constitutes a breakdown of contractual machinery – John Barker v London Portman Hotel[7].

4                    Usually, these other principles will be more useful to a contractor than The Product Star line, and in particular, where there is a power for a court or arbitrator to open up certificates, that power does not require it to be shown that the certificate about which the contractor complains was arbitrary, capricious or unreasonable – it is sufficient that the court or arbitrator takes a different view from the certifier. Indeed, the courts have emphasised that The Product Star principle is not to be invoked lightly; thus in Ludgate Insurance Co Ltd v Citibank NA[8] the Court of Appeal said:

It is very well established that the circumstances in which a court will interfere with the exercise by a party to a contract of a contractual discretion given to it by another party are extremely limited…These cases show that provided that the discretion is exercised honestly and in good faith for the purposes for which it was conferred, and provided also that it was a true exercise of discretion in the sense that it was not capricious or arbitrary or so outrageous in its defiance of reason that it can properly be categorised as perverse, the courts will not intervene.

5                    Further, whilst The Product Star has been applied in a variety of circumstances, it has met some resistance in the PFI context. Thus in Mid Essex Hospital Services NHS Trust v Compass Group[9], the Court of Appeal overturned the first instance application of the principle; Jackson LJ said that the principle is limited to cases in which the contract would not make sense without it[10], and has no application where is the discretion is simply as to whether to exercise an absolute contractual right[11].

6                    As against those considerations, there may be a very powerful reason why The Product Star principle might be invoked in an appropriate case, namely that it is “extremely difficult”, if not utterly impossible[12], to exclude, at any rate in England.  “Very clear language” may suffice.[13] Exclusion clauses, including those which purport to put the exercise of discretionary powers by the owner outside the reach of challenge, are now very common, particularly in aggressively drafted bespoke contracts, and so a principle that cannot easily be excluded may be of particular interest to a contractor who is faced by the unreasonable exercise of a power against him, and a contract which purports to make that discretion absolute. For this reason, it is worthwhile considering with some more care how the principle measures up against typical construction contract scenarios.

7                    The Product Star case itself concerned a charter party; the vessel should not be required to proceed to any port which the master or owners in their discretion considered dangerous.  Both the Commercial Court and the Court of Appeal held that a refusal to proceed to the port of Ruwais[14] on account of supposed war risks was a breach of contract.  In Horkulak, the principle was applied to a provision in a contract of employment for a discretionary bonus.  In Socimer, the principle was applied to a contract for the sale of assets between banks which entrusted the task of valuation to one party.  In JML Direct a contract gave the defendant satellite television service provider the discretion to decide what logical channel numbers should be allocated to the plaintiffs shopping channels; again that discretion was found to be subject to The Product Star principle.

8                    Prima facie, it is hard to see that the provisions in these cases are distinguishable from those common found in construction contracts, whereby the owner or her agent is given contractual powers, not only to value the contractor’s work, but to decide a host of other matters, such as the contractor’s entitlement to extension of time, whether to accept the contractor’s programme, whether to allow subcontracting, to determine which of conflicting contractual provisions is to prevail, and many others. Sometimes, the clauses use the word “discretion” and sometimes they do not: nothing seems to turn on this distinction[15].

9                    The Product Star doctrine is not fully settled, and is still evolving. In an appropriate case, it may well have a place in a construction case, enabling a contractor to recover damages representing the cost of work he would not otherwise get paid for: it is suggested that fertile ground would be a case where

·         The contract confers a power on the owner or her agent that affects whether or not the contractor is entitled to payment for a particular part or aspect of his work;

·         The owner or her agent exercises, or refuses to exercise, that power in a way that is grossly unreasonable;

·         The effect of such exercise or refusal to exercise makes a commercial nonsense;

·         There is no express contractual mechanism whereby that nonsense may be effectively remedied.

10                In Australia, the courts have neither clearly adopted nor rejected The Product Star line; rather, they have tended to make their analysis along good faith grounds (there being less resistance in Australia than in England to a generalised doctrine of good faith in commercial dealings).  In Thiess Contractors Pty Ltd v Placer (Granny Smith) Pty Ltd[16] the court considered a clause – clause 6.5.1 – which conferred a contractual power to terminate a mining contract:

“[Placer] may, at its option, at any time and for any reason it may deed advisable, cancel and terminate the Contract, in which event [Thiess] shall be entitled to receive compensation as follows:”

The court declined to apply The Product Star principle:

It is true that in the present case, Placer had a discretion whether or not it would terminate the contract. But cl 6.5.1 provided it with an absolute and uncontrolled discretion which it was entitled to exercise for any reason it might deem advisable. That is a contractual right which relieved Placer from any obligation to have regard to Thiess’ interest.

In my view, the distinction between Product Star (supra) and this case serves only to emphasise the strength of Placer’s position.

11                Conversely, in The Australian Rail, Tram and Bus Industry Union of Employees, West Australian Branch -v- Public Transport Authority of Western Australia[17]  the principle was accepted without question:

Reference was also made by the Union in its submissions, to the implied obligation of good faith, and the obligation on an employer to not exercise its managerial discretion arbitrarily, capriciously, unreasonably or for a collateral purpose: Horkulak v Cantor Fitzgerald International [2004] EWCA Civ 1287; Abu Dhabi National Tanker Co. v Product Star Shipping Ltd. (The “Product Star”) (No. 2) [1993] 1 Lloyd’s Rep 397; Foggo v O’Sullivan Partners (Advisory) Pty Ltd (2011) 206 IR 87. As to the latter proposition, there can be no question that in a case where discretion is to be exercised, it should not be arbitrary or capricious. How the exercise of the discretion is to be regarded in this context will also depend on the terms of the relevant contract, and all of the circumstances of the case.

12                The position in New Zealand not well established by authority, but is said by Justice Kos to be that The Product Star principle applies by default.[18]


[1] Abu Dhabi National Tanker Co v Product Star Shipping Ltd (The “Product Star”) [1993] 1 Lloyd’s LR 397 at page 404 per Leggatt LJ, Balcombe and Mann LJJ agreeing.
[2] See Constraints on the Exercise of Contractual Powers; Justice Stephen Kos (2011) 42 VUWLR 17.
[3] [2014] UKSC 42 at [37] per Lord Sumption,  Lords Neuberger, Mance, Toulson and Hodge agreeing.
[4] See Horkulak v Cantor Fitzgerald International [2004] EWCA Civ 1287, [2005] ICR 402, Socimer International Bank Ltd v Standard Bank London Ltd [2008] EWCA Civ 116, [2008] 1 Lloyd’s LR 558, JML Direct Ltd v Freestat UK Ltd [2010] EWCA Civ 34 and Yam Seng PTE Ltd v International Trade Corporation Ltd [2013] EWHC 111 (QB) at [145].
[5] See page 59 below.
[6] See page 107 below.
[7] See page 162 below.
[8] [1998] Lloyd’s Rep IR 221 (CA) at [35]–[36] per Brooke LJ.
[9] [2013] EWCA Civ 200; see page 394 below.
[10] Ibid at [82]
[11] Ibid at [91]
[12] Ibid at [83].  For an entirely contrary view from New Zealand, see Constraints on the Exercise of Contractual Powers, supra
[13] See British Telecommunications Plc v Telefónica O2 UK Ltd, supra at [37].
[14] Ruwais is a refinery town 240 km west of Abu Dhabi.
[15] See JML Direct, ibid at [14].
[16] [1999] WASC 1046.
[17] [2014] WAIRComm 91at [14].
[18] See Contraints on the Exercise of Contractual Powers, supra. See also Todd Pohokura Limited v Shell Exploration NZ Limited [2010] NZHC 1134 at page 489 below.

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