Lenders’ right to withhold consent not absolute: what borrowers should be aware of

When borrowing from a lender, it is common practice for loan agreements to include restrictions on selling or granting further security over the borrower’s assets without the lender’s consent. But what happens if a lender refuses to give that consent? Is their decision final, or do borrowers have any recourse?

A recent dispute between a borrower, Macdonald Hotels Ltd, and a lender, the Royal Bank of Scotland, and its subsequent court ruling provides valuable precedence.

Background on Macdonald Hotels Ltd v the Bank of Scotland

Macdonald Hotels Ltd (the borrower) accused The Bank of Scotland (the bank) of acting in bad faith when it refused to approve the borrower’s request to grant security to another lender. Macdonald Hotels Ltd had a facility agreement with The Bank of Scotland, which prohibited asset disposals or the creation of security without the bank’s prior approval. The borrower argued that the bank’s refusal to consent breached an implied term requiring the bank to act in good faith, as outlined in the Braganza v BP Shipping Ltd case.

The Court’s Ruling: refusal was not an unqualified right

The court ruled that a lender’s discretion to withhold consent is not unlimited. It recognised an implied term preventing a lender from refusing consent:

• for reasons unrelated to its own commercial best interests, or
• when no reasonable lender in the same position would have withheld consent.

However, the court found that the bank had not acted in bad faith or arbitrarily in refusing the borrower’s request. The decision aligned with the bank’s commercial interests, as it sought to reduce the borrower’s overall indebtedness and improve its debt-to-EBITDA ratio. EBITDA ratio measures ‘Earnings Before Interest, Taxes, Depreciation, and Amortization’ and is recognised as a good indicator of a company’s financial performance.

Furthermore, the borrower’s claim was time-barred due to the limitation period of six years, as the agreement did not qualify as a deed for all parties involved. Consequently, the claim was dismissed, and the bank’s actions were deemed justified.

What the Macdonald Hotels Ltd v the Bank of Scotland ruling means for borrowers

This ruling provides borrowers with some protection against arbitrary refusals by lenders. While lenders do have broad discretion; their decisions must be commercially reasonable. If a lender’s refusal appears unjustified, capricious, or unrelated to its legitimate business interests, borrowers may have grounds to challenge it.

Conclusion

Since restrictions on the sale of assets and granting security without the lender’s consent are common in loan agreements, this case sets an important precedent. The court’s recognition of an implied term could influence how other similar contractual clauses are interpreted, ensuring that lenders exercise their discretion reasonably and in good faith.

Our Real Estate Finance team acts for both borrowers and lenders and aims to make transactions happen as smoothly and quickly as possible, whether it be development finance, bridging finance or longer term borrowing. If you have any questions in connection with the above, please get in touch with our Real Estate Finance team.