Don't wait until it's too late - drafting dispute resolution clauses that work

Let's face it, the dispute resolution (DR) clause is not the most glamorous aspect of a commercial document. They're a bit like a pre-nuptial agreement - nobody wants to be the first to raise the topic, and "we probably won't need it in any event".

As a result, DR clauses often don't get the drafting attention they deserve. A poorly drafted DR clause can seriously undermine the efficient and cost effective resolution of a dispute - months, and dollars, are often wasted on a dispute over how the dispute is to be resolved! A timely reminder of such problems is the very recent Court of Appeal decision in Porter & Ors v Gullivers Travel Group Ltd¹, where the proceedings may well have been avoided had the DR clause been drafted in a different way. In this article, Bell Gully senior associate Sally Fitzgerald provides some insight into how to avoid some common drafting errors when using DR clauses in commercial contracts.

If there is no DR clause in your agreement, then the default position is that either party may commence court proceedings in relation to a dispute. A DR clause can contain any one or more of the following processes as an alternative or precursor to litigation: mandatory negotiation (often "escalating" to higher levels within the respective parties), mandatory mediation, expert determination and arbitration.

Negotiation between the parties will result in resolution of the dispute if the parties agree on a settlement. Mediation involves a third party assisting with the negotiations, and will only result in resolution of the dispute if the parties agree on a settlement. Expert determination is used for fast track resolution of certain specific disputes: valuation, accounting or similar "technical" disputes (for example, the dispute to be referred to an expert in the Gullivers Travel Group case concerned a price adjustment mechanism in a contract for the sale and purchase of a travel business). Arbitration is the only true alternative to litigation, in that it is an adversarial process that results in a third party issuing a binding decision.

First consideration: do you really want a DR clause?

Too often, DR clauses involving long and tortuous steps that must be followed before a dispute can be litigated or arbitrated are included in commercial agreements. These are often included as a matter of course, with little thought given as to how it might work in practice.

For example, when the parties end up in a dispute, often they will have been negotiating the issue for some time before one party "triggers" the formal DR clause process. Once that occurs, the parties may be required to engage in weeks, if not months, of further mandatory negotiations (often with a number of different layers) before a formal claim can be issued. Such "forced" negotiations are often used by one party as a delaying tactic.

Another example is requiring compulsory mediation at a very early stage of the dispute. The feedback from leading mediators is that too many disputes are being taken to mediation "undercooked" - usually as the result of a mandatory mediation clause. Whilst there is no doubt that mediation is a very effective means of resolving disputes, it is more likely to be so further down the track in the dispute process. At the outset of a dispute, a party often doesn't have a full understanding of its own position (both factual and legal), let alone the other party's position. Like mandatory negotiation, mandatory mediation at an early stage of a dispute is often used by one party as a delaying tactic.

So before putting a multi-tier DR clause into a contract, think carefully about whether it is really necessary. If you do want such a clause, take note of five drafting tips.

Drafting tip number 1 - keep any "multi-tier" DR clause short and simple

A key issue with "multi-tier" clauses is the length of time it can take to work through the various steps involved. Such escalating negotiation clauses often involve second, third, or even fourth, layers which can take weeks, or longer, to complete.

Sometimes, it may be helpful to have a round of formal, mandatory negotiations (for example, to get the dispute away from those with a personal interest in it), but do all disputes really have to be elevated to the CEOs level, for example?

If mandatory negotiation is included, make sure the various steps are kept to an absolute minimum, and that fixed and short time limits are set before the parties can move onto the next stage (the parties can always agree at the time to extend time periods, if the process is going well). The process should take days, not weeks or months, to complete.

Drafting tip number 2 - remove all references to "reasonable endeavours", "amicable negotiations", "good faith negotiations"

Consider the following clause:

"In the event of a dispute, the parties shall use all reasonable efforts to amicably resolve the dispute through good faith negotiations. If the dispute is not so resolved then...."

What does this mean? What does it require the parties actually do? By what standard is compliance to be measured? How long must the negotiations go on for? Is it enforceable in any event?

DR clauses often contain provisions similar to this. However, such clauses often add nothing to the process, and can cause serious problems. For example, there are a number of cases where one party has sought to delay the dispute resolution process by seeking to argue that the parties have not yet engaged in "amicable" negotiations, and therefore the dispute cannot yet go to the next level of the DR clause.

The recent Court of Appeal decision in Gullivers Travel Group is a prime example. The DR clause in that case required the parties to "use their best endeavours to resolve the dispute by negotiation in good faith", before the dispute could be referred to an expert for determination. That lead to one of the parties seeking court orders to restrain the dispute being referred to the expert on the basis the parties had not yet engaged in "good faith" negotiations (primarily that one party had failed to hand over documents which were said to be essential to enable "good faith" negotiations to take place). This issue resulted in High Court and then Court of Appeal court proceedings, all of which could probably have been avoided had the clause been drafted without reference to such subjective, and ultimately "vague" requirements.

The upshot is that clauses like this may well be unenforceable, as they are too uncertain (akin to an agreement to agree). Despite this, however, if a party wants to derail and delay the efficient resolution of a dispute, a DR clause containing terms such as "amicable" or "good faith" negotiations will be a useful starting point!

Rather than including vague and uncertain language - which may ultimately be meaningless - instead give the parties something concrete to do. Specify that they must meet, for example, at least two times within a specified time period before the dispute can be progressed to the next stage. And if one party does not comply with such a process, they cannot later set up that failure to prevent the other party from taking the dispute to the next level - a fundamental principle of contract law is that a party cannot benefit from their own wrong.

Drafting tip number 3: Getting the mediation clause right

If you are going to include mandatory mediation, make sure the clause works. To be enforceable, a mediation clause must be sufficiently certain, and this will require some drafting as to the mediation process and in particular, how the mediator is to be appointed. The parties usually specify that the mediator is to be appointed by the agreement of the parties. The clause should then address what happens if the parties cannot agree. Usually this will be by way of specifying that the mediator is to be appointed by a named institution, such as the Arbitrators' and Mediators' Institute of New Zealand Inc (AMINZ). It will also be helpful to adopt a set of mediation rules and incorporate them by reference into the clause, for example, the AMINZ Mediation Protocol.

Drafting tip number 4 - be aware of what disputes you are actually sending to expert determination, and that the process is final

As noted at the outset, expert determination is a useful process for a "fast track" resolution of certain technical disputes. If a dispute is referred to an expert, it is often resolved on the papers, sometimes with short submissions from the parties, in accordance with a procedure adopted at the discretion of the expert, and often within a very short time period. The expert is usually not legally trained, but will be someone with suitable qualifications for the particular dispute - for example, an accountant, an engineer or a valuer. As will be apparent, expert determination is not suitable for full scale disputes which involve complex legal and factual issues.

Despite this, however, parties often end up referring a much wider class of dispute than intended to expert determination, sometimes all disputes under the agreement. This is the result of poor drafting of an expert determination clause. There are a number of cases where the parties have spent months, and thousands of dollars, before the courts, arguing over whether a particular dispute can be brought before the court or, in accordance with the DR clause, must be referred to an expert for resolution.

For example, in a recent contract the author worked on, the contract contained a payment adjustment formula (contained in clause 23), with various inputs to the formula that were to be agreed by the parties. The parties intended that, if they could not agree on a particular input, the value of the input would be determined by an expert. The expert determination clause, as originally drafted, read:

"All disputes concerning payment shall be referred to an expert for determination in accordance with this clause."

As will be appreciated, most disputes under a contract involve a dispute over payment!

A further attempt was as follows:

"Any dispute concerning clause 23 will be referred to an expert for determination in accordance with this clause."

Again, this was too wide, as a dispute might arise as to whether clause 23 had been triggered in the first place, or a dispute as to the interpretation of clause 23.

A more suitable clause which captured only the disputes the parties intended to send to the expert was as follows:

"Any dispute concerning the value of the inputs to the payment formula contained in clause 23 will be determined by an expert in accordance with this clause."

In addition to defining the scope of disputes to be referred to the expert, the clause should set out some of the basic provisions concerning process, including, like a mediation clause, a process for appointing the expert. The clause will also normally specify the qualifications or experience the expert must have.

One other point to bear in mind about expert determination is that it can be very difficult to overturn an expert determination if you are not happy with the outcome. In short, the only grounds on which an expert's determination can be overturned are fraud, partiality or some kind of "jurisdictional" error which takes the determination outside what the expert was mandated by the contract to actually determine. A mistake, even a serious mistake, will not by itself be sufficient to have an expert's decision overturned. The courts have refused to imply a term into an expert determination clause that the determination must be reasonable and free from error.²

Drafting tip number 5 - if choosing arbitration, keep the clause short and simple, and be sure to address the "arbitration basics"

If all else fails and a dispute is to be finally resolved by arbitration, the agreement will need to contain an arbitration clause. Arbitration is a consensual process, and thus a dispute cannot be arbitrated other than by way of agreement of the parties.

An arbitration clause should address the following issues:

• the fact that the dispute is to be referred to arbitration;

• the number of arbitrators - usually one or three (do not, for obvious reasons choose an even number of arbitrators!);

• a process for the appointment of the arbitrator, including if the parties fail to agree on the arbitrator (the default position under the Arbitration Act 1996 is that the High Court can appoint the arbitrator, but it will be quicker and cheaper to have an institution, such as AMINZ, act as the default appointing authority);

• incorporate by reference any chosen arbitration rules;

• specify the place of arbitration - useful in the context of a domestic transaction, and crucial in a cross-border transaction; and

• in the context of a cross-border transaction, specify the language of the arbitration (you don't want to have to be the party who pays for translating all their documents).

An arbitration clause along the following lines is all that should be required:

"Any dispute, difference or claim arising out of or in connection with this agreement, or the subject matter of this agreement, will be referred to and finally resolved by arbitration in accordance with the [specify particular arbitration rules] (Rules). The tribunal will consist of [a sole arbitrator/three arbitrators] appointed in accordance with the Rules. The place of arbitration will be [specify place]. The language of the arbitration will be [English]."

In the event the arbitration is to take place in New Zealand (and therefore the New Zealand Arbitration Act is to apply), the parties should consider contracting out of or into various "optional" provisions contained in the Act, for example, appeals on points of law.

Finally, dispute resolution in cross-border transactions is a complex area. Specialist advice should therefore be sought on DR clauses for such transactions.

¹ [2007] NZCA 345; 14/08/07

² Legal & General Life of Australia Ltd. v Hudson Pty Ltd (1985) 1 NSWLR 314

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.