When parties enter into a contractual relationship, they tend not to assume that a dispute will arise and often fail to give full consideration (if any) to an appropriate dispute resolution clause (DRC). A well drafted DRC will serve to substantially reduce the amount of time and costs spent arguing over the issue of governing law, jurisdiction and procedure before the substantive issue in dispute is addressed. In addition, if the DRC is tailored to the needs of a business it may give it an advantage over the opposing party.
In this briefing we will explain why a DRC should be given the same consideration as other key commercial contract terms and provide practical considerations when drafting DRCs.
Distinction between governing law & jurisdiction clauses
The DRC is entirely separate to a governing law clause, although they must be considered together. The governing law clause sets out the substantive law which applies to the agreement, whereas the DRC specifies the forum in which the parties want any dispute arising under the agreement to be resolved (otherwise known as the jurisdiction clause).
Parties are generally free to choose which law will govern their relationship and any dispute arising out of it, even if the dispute itself is conducted within a different jurisdiction. Where both parties are based in the same country, they will almost always agree that the law of that country will govern their relationship (although in many cases this will be implied and there may be no express governing law clause).
Where parties are based in different countries, a decision has to be made as to the most appropriate governing law and jurisdiction. Certainty of both of these key issues will reduce the risk of dealing with the law and legal process of an unfamiliar country. Without an express choice, there is a risk that if each party has its own terms and conditions the governing law and jurisdiction provisions will be inconsistent thereby creating the risk of satellite litigation.
The jurisdiction clause will determine the scope of the disputes that are covered by it and the parties should give careful consideration to exactly what they are referring to. For example:
- Do they want all disputes covered by the DRC or just those relating to a particular obligation?
- In which forum do the parties want a dispute to be determined? (Factors to consider include convenience, confidentiality, preferred judicial process and/or ease of enforcement.)
- Exclusive or non-exclusive? (Jurisdiction may be exclusive, where all disputes must be resolved in the chosen country, or non-exclusive where depending on the nature of the dispute the parties have the choice of forums. Notably, the jurisdiction does not have to be the same as the governing law.)
Choice of forum – arbitration, litigation & alternative dispute resolution (ADR)
The key question is whether any dispute should be referred to court (litigation), arbitration or whether there is an alternative way of resolving the dispute (such as mediation or expert determination). As is always the case, there are pros and cons to each forum. Below we will compare arbitration and litigation and later in this article we will address the various forms of ADR.
International arbitration awards (decisions) are generally easier to enforce than court judgments, particularly when dealing with disputes outside the EU. Although there is no worldwide regime for the enforcement of international arbitration awards, the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (the New York Convention) provides an enforcement regime to which (as at June 2014), 148 of the 193 United Nation member states are signatories. If you are considering agreeing an arbitration clause, you should always check whether any award will be enforceable in the country of the counter-party.
There is no such international equivalent for the enforcement of court judgments. Within the EU there are reciprocal arrangements for the recognition and enforcement of judgments but beyond the EU enforcement is often a protracted and expensive process.
Privacy & no precedent
In litigation, statements of case can be obtained from a court (unless the court orders otherwise); most trials are open to the public and judgments are published. The advantage of arbitration is that hearings are held in private. Documents disclosed during the proceedings and the awards (decisions) are generally confidential. It may be prudent to ensure that any DRC specifying arbitration states that the proceedings and any award are to remain confidential unless both parties agree otherwise.
In some instances, the lack of confidentiality may be a good reason to choose litigation over arbitration: if the subject matter of the dispute becomes public knowledge, this may put further pressure on the opposing party to settle.
As an arbitration award is confidential to the parties it does not give rise to any binding precedent. Where you enter into many similar agreements (which may give rise to similar disputes in relation to questions of interpretation) it may be preferable to choose litigation in order to obtain a potentially binding interpretation of the contract.
Arbitration generally allows the parties to agree a suitable procedure, hold hearings in a neutral country and appoint their preferred arbitrators. Arbitrators are not bound by rigid rules of procedure. Disputes proceeding through the courts tend to be governed by strict rigid procedure and rules, which may not necessarily be appropriate for the particular issues in question.
Multiple agreements & parties
Litigation allows disputes related by multiple agreements to be joined and /or consolidated and dealt with at one hearing. Arbitration only has jurisdiction over the parties who have entered into the arbitration agreement. Where there are multiple parties and agreements (as is often the case in the financial and shipping industries) there is a risk of parallel proceedings and inconsistent outcomes. Provision for joinder and consolidation in arbitration can be made but requires careful consideration and drafting.
Parties should consider the most appropriate DRC when first entering into the commercial relationship and adopt the same throughout. In the absence of a clear DRC which covers all of the contracts, the court, as set out in UBS AG & Anor v HSH Nordbank AG , will look at the “contract to which the claim was most closely related and apply the dispute resolution clause in that contract“. This was also applied in Deutsche Bank AG v Sebastian Holdings Inc  in which the court considered “the initially agreed position and whether, chronologically, subsequent clauses have altered this“. If there are inconsistent DRCs, then there is the potential for costly satellite litigation concerning the appropriate forum for any dispute.
It is accepted that court judges are experts in the law of their country but not on technical issues. In many cases the courts will require expert witnesses to advise them on technical matters. This can add substantial costs to the proceedings, especially when each party calls its own expert, and there is no guarantee that the court will fully get to grips with the real issues. If the parties anticipate a dispute concerning particularly technical issues, arbitration will permit them to choose a tribunal with the relevant technical expertise.
Parties are often reluctant to enter into court proceedings in foreign jurisdictions, fearful of an unfamiliar process and the risk of bias. Arbitration has the advantage that it can be held in a neutral country (preferably with a sophisticated legal system and independent judiciary). Popular arbitration seats include London, Hong Kong, New York, Geneva, Paris and Singapore.
Finality of decision
The circumstances where an arbitrator’s award can be appealed are very limited and parties can expressly agree that they cannot appeal an arbitral award, which often means that payment of an award of damages is far quicker. Conversely, most court judgments can be appealed, which creates further uncertainty, delay and incurs more costs.
Judges are more likely to be robust in imposing sanctions on delaying parties in litigation (by imposing costs sanctions and or striking out a statement of case).
Arbitrations may be conducted under the rules of an institution such as the London Court of International Arbitration or the International Commercial Court, or under rules agreed between the parties. Arbitrators are generally more reluctant to intervene in procedural matters and for this reason it is harder to progress a dispute against a reluctant party than it is in litigation.
Litigation has a full range of interim measures available to determine matters such as a preliminary issue or a summary judgment at an early stage. Arbitral tribunals rarely determine claims and defences on this basis. As such, if the claims are likely to be indisputable then court proceedings may be preferable.
Disclosure in arbitration is usually at the tribunal’s discretion, whereas in litigation in England and Wales disclosure is an unavoidable part of the process and is often a time consuming and expensive exercise (although the court has recently sought to take a more tailored case-by-case approach to disclosure in higher value cases). That said, a compulsory disclosure process may reveal the ‘smoking gun’ which would not necessarily come to light during arbitration.
One common misconception in favour of arbitration is that it is cheaper and faster than litigation. In practice this is not the case: it is not a cost saving mechanism. The arbitration process has slowed to that of a similar pace to the court and arbitration expenses have dramatically increased. It is entirely possible that arbitration will cost more than litigation through the courts.
The decision as to which forum to choose should be carefully decided based on each the factors outlined above.
Alternative Dispute Resolution (ADR)
Although ADR is often treated with some scepticism, it can nevertheless be a cost-effective way to achieve a creative, commercial solution and can be particularly useful if the parties in dispute wish to preserve a commercial relationship. As such, DRCs are becoming more complex to encompass ADR.
There are many potential ADR mechanisms (the most popular of which are outlined below). One key feature about all of them is that ADR will not give rise to a binding and enforceable judgment or award against one of the parties, as in litigation and arbitration, although agreements or decisions reached through ADR are (subject to the usual laws of contract) binding as between the parties.
Early Neutral Evaluation (ENE)
ENE is a popular form of ADR in construction and technology disputes. It is a confidential, fast and cost-effective process where the parties obtain from an independent person (often a recently retired judge) a realistic view on the strengths and weaknesses of their cases and anticipated outcome if the dispute proceeded to trial. The evaluation can encourage a party to desist from pursuing a claim and/or reach an early settlement. Alternatively, they can rely on it as a basis for commencing proceedings and applying for summary judgment.
The general rule is that the opinion is not binding, and the parties use it to negotiate settlement terms. However, the parties can agree to settle the dispute on the basis of the evaluation provided.
Expert determination is another cost-effective form of ADR that produces a binding decision. It is most often used where a technical/scientific professional opinion is needed on a discrete issue. For example, where some form of valuation is required or where there are questions about the preparation of completion accounts on a business sale.
Expert determination is perceived as having the following advantages over arbitration and/or litigation as:
- It allows for the appointment of a specialist to resolve the dispute
- Like ENE it enables the parties to have an independent assessment of a key issue at an early stage of the dispute, quickly and at a comparatively limited cost
- It is confidential and helps to preserve commercial relationships
- It can save costs of the parties instructing their own independent expert witness
- An expert can be sued for negligence by a party if they do not exercise the appropriate skill and care in reaching their decision, although their decision remains final and binding.
Mediation is the most common and successful form of ADR. It involves the use of an independent mediator who actively facilitates voluntary settlement by bridging gaps between the relevant parties and encouraging them to reach settlement.
The mediation process and any settlement (which is recorded in a binding agreement) remain completely confidential unless the parties agree otherwise. A mediation clause in a contract can be a very powerful tool. If a party fails to participate in mediation, then a court is likely to make an adverse costs order against them (on the basis that they were acting unreasonably). However, it is important to note that when drafting a DRC which refers a dispute to mediation, a court will only enforce the clause if it is clear that the parties must attend mediation. As set out in Cable & Wireless v IBM United Kingdom , the court will not enforce an ‘agreement to agree to attend’.
Whilst mediation is a more expensive form of ADR (given the preparation required; the involvement of the parties and their legal advisers for at least a day and the mediator’s fees) its success rate is undeniable. In 2013 over 70% of disputes referred to mediation settled on the day.
Adjudication is often seen as a quick and cost-effective way of resolving a dispute. However, whilst it is significantly cheaper than arbitration or litigation, unless the dispute relates to a construction claim (where adjudication is a statutory requirement pursuant to the Housing Grants, Construction and Regenerations Act 1996), it is not always the most effective form of ADR.
The dispute is referred to an independent and neutral adjudicator, often an expert in the subject matter of the dispute, who considers the arguments put forward by both parties and has 28 days in which to issue a decision.
If adjudication is the preferred form of ADR, in the DRC the parties can:
- agree the adjudicator in advance or specify from which body they should be appointed
- agree whether the decision should be final, temporarily binding or merely advisory
- decide whether the adjudicator will consider the entire dispute or only specific issues.
Further, the parties can decide whether the adjudicator has the power to award costs to the winning party. Importantly, unless prohibited in the DRC, the adjudicator’s decision can be appealed and referred to litigation/arbitration. The court/arbitration could then overturn the decision.
DRCs – drafting considerations
Notice of dispute
Parties may wish to limit the scope for pursuing claims by requiring a contractual notice to be served specifying the claim within a certain time as a precondition of issuing proceedings. (This may be used to reduce or alternatively extend a limitation period). There is a raft of litigation concerning the invalid service of a notice of dispute in commercial contracts due to the failure to include provisions for the service of a notice and/or adhere to them. Including a clause to specify how a party must give notice of a potential dispute can minimise the risk of satellite litigation and of missing key deadlines. The DRC should specify:
- The form of the notice required. (For example, is a preliminary notice outlining brief details of the proposed claim sufficient, or is a formal letter of claim required to provide a detailed explanation of the alleged claim and losses?)
- The methods of accepted service. (In large organisations it is easy for a letter to be misplaced and service by more than one method, such as post and email, may be preferred)
- To whom and where the notice should be served. (Often it will be forwarded directly to a company’s registered office but there is no reason why the notice should not be sent to the legal department or for the attention of the Directors and/or Company Secretary)
Dispute escalation procedure
If the parties wish to explore forms of ADR to avoid recourse to court/arbitration, then a dispute escalation procedure can be incorporated into the DRC, which requires both parties to explore numerous settlement methods (generally increasing in formality at each stage) before a party can commence proceedings. Typical escalation procedures, and the most effective, usually begin with meetings between the directors and/or in-house lawyers, followed by an agreed form of ADR (such as mediation or expert determination).
Careful consideration should be given to an appropriate escalation procedure. If it is overly complex and burdensome it may cause significant delays and unnecessary costs.
Complying with a DRC can be a lengthy process, especially if a detailed escalation procedure applies. If the contractual and/or statutory limitation period is about to expire, should the parties ignore the DRC and initiate proceedings?
In the absence of any other agreement a party should commence a claim within the relevant limitation period. The parties can agree to extend the time for service of the claim (with the approval of the court) in order to comply with the DRC. In such circumstances the court is unlikely to penalise the party for issuing protective proceedings.
The issue of limitation should be considered when drafting a DRC to avoid this scenario and the costs associated with the preparation and issue of court proceedings. A DRC can include a “standstill agreement” whereby the parties agree that, if limitation expires whilst they are engaged in the DRC process, neither party can rely on limitation as a defence in any subsequent proceedings. This affords the parties the time to fully explore settlement before being drawn into litigation. Although, note that if the parties wish to include a standstill agreement, it is vital to ensure clear and precise drafting to cover the dispute between the parties to which the agreement relates.
Arbitration/litigation and ADR clauses are not mutually exclusive and it is prudent to consider whether multi-tiered or carve out clauses should be included. For example, the parties could agree to mediate in the first instance and then proceed to arbitration if that is unsuccessful. The English court will penalise a party that refuses to embrace ADR (such as mediation) especially if they have agreed to do it in the DRC, and it is likely that ADR would at least be suggested by the respective legal advisers in the course of a dispute in any event.
Whilst there is concern that ADR can add an extra layer of costs and cause delay, if the parties’ views are so entrenched that mediation would be a waste of time and costs, they can agree to waive the obligation by mutual consent and then reconsider it at a later date.
There must be a clear agreement to refer a dispute to arbitration. The DRC should:
- Incorporate wording such as “disputes relating to” or “arising in connection with” the contract (to encompass both contractual and non-contractual claims)
- Specify the rules that are to govern the arbitration (such as the London Court of International Arbitration or International Commercial Court)
- Specify the seat of the arbitration and the preferred number of arbitrators
- Define the choice of language (for all written submissions and hearings)
- Consider multiple parties and/or related contracts so that joinder and consolidation is possible
- Exclude rights to appeal to the extent permitted by the laws of the relevant state
- Include a confidentiality provision for all documents disclosed and awards made.
Given the number of factors involved in any potential dispute, careful consideration must be given to DRCs to establish at the earliest possible stage exactly what is most suitable for a business and to ensure the clause is enforceable. Proper consideration of the various options and a well drafted DRC can place a business in a strong position as and when disputes arise.
This article does not constitute legal advice. Specific legal advice should be taken before acting on any of the topics covered.