It is approaching midnight in a stuffy conference room. Lukewarm buffet food competes for space with financial projections and position papers, as phones are checked for the umpteenth time that hour. A knock at the door portends the waste of collective weeks' work and a ratcheting up of cost and pressure if the "last, final and best" offer has been rejected and proceedings are issued. But the sage messenger-cum-counsellor brings good news: a deal has been reached – subject to a smidge more movement and terms being finalised on a hastily negotiated settlement agreement. Neither party feels satisfied exactly, but each knows that this is better than the alternative.

Such is the common experience of mediation, which through an alchemy of clear-headed analysis, personal interaction and lots (and lots) of waiting around is remarkably effective at bringing about peace. As a result of its remarkable track record, as we discuss in a recent entry in our Black Box Tips series, parties are increasingly looking to build mediation into the foundations of contracts.

Step-by-step

A tiered dispute resolution (DR) clause may require the parties to escalate any dispute through a three-step process:

• Step 1 – Negotiation: usually with little or no formality, although the clause may specify the level to which a dispute must be escalated, by requiring talks to take place between senior management, directors or even CEOs.
• Step 2 – Mediation: following a more structured process and facilitated by a trained mediator.
• Step 3 – Litigation or arbitration: if the dispute has not been resolved by negotiation or mediation.

Sophisticated, long-term contracts may contain more complex DR processes. Technical issues might be carved out for determination by an expert; a fast-track process created for other types of dispute; and a committee established to issue non-binding decisions. The result is something of a choose-your-own-adventure DR journey where (seemingly) no two disputes take exactly the same path.

What could go wrong?

The danger is that an ill-conceived, badly drafted or overly complex DR clause can have exactly the opposite effect to that intended. If one party is set on bringing or resisting a claim, requiring the parties to go through hoops before that happens can simply add time, cost and frustration, which can actually reduce the chance of settlement at the point when the parties are more likely to be ready to give concessions and engage in discussions. 

Another danger, as the recent case of Children's ARK Partnerships (CAP) v. Kajima Construction illustrates, is that the court might not actually find the clause to be binding. The dispute in this case related to a design and build contract for the Royal Alexandra Hospital for Sick Children in Brighton. The principal contract was between the NHS Trust and Children's ARK, which entered into a contract on similar terms with Kajima to carry out the design and construction. 

The DR clause required any dispute to be referred to a "liaison committee" before proceedings could be issued (alongside fast-track, expert determination and optional mediation provisions). When CAP issued a claim that was close to the end of the limitation period, Kajima applied to strike the claim out on the basis that it had not first followed the DR procedure.

Unenforceable

The court dismissed Kajima's challenge, finding that the clause was not sufficiently certain to be enforceable. The main flaws with the contractual mechanism were that:

• the liaison committee only comprised members of the NHS Trust and CAP. It was difficult to equate this with a process that was intended to resolve disputes between CAP and Kajima, and
• there was no clear process for a dispute to be referred to and resolved by the committee. As a result, it was not clear when a reference would be considered to have been made, or the committee stage to have failed, such that proceedings could be issued.

Although ultimately of no effect in this case, the court found that had the clause been enforceable, it would have operated as a condition precedent before a claim could be brought. The judge would have had discretion to either stay the claim to allow the parties to comply with the DR clause or to take the more draconian step of striking out the claim. In this case, the fact that the claim would have been time-barred was one reason why the court would have simply stayed proceedings, which is the most common outcome where one party attempts to litigate in breach of a DR clause.

Learn the lessons

As we have previously explained, although litigation is often the furthest thing on parties' minds when entering into a contract, disputes are a fact of life and it is important to consider carefully the full range of options as to how any dispute will be resolved. Alongside choice of law, jurisdiction and the question of litigation or arbitration as the final forum, a modest investment of time drafting a suitable DR clause can deliver outsized returns in terms of time and cost saved if a claim can be settled through mediation rather than litigation. A few simple tips can help keep you on the right track:

• Horses for courses: think about what would work best for each contract. Is there a suitable senior figure on each side to whom disputes should be referred? Occasionally it can make sense to include more than one tier of commercial negotiation but usually it is best to stick with one. Expert determination for some disputes can work well and is commonplace in construction disputes, where technical valuations are best done by a non-legal professional, but is less likely to work well in a sale of goods contract.
• Be specific: as Children's ARK shows, while courts are supportive of DR clauses, the mechanisms they set out need to be properly defined in order to be enforceable. How can you tell that a dispute has been referred to negotiation (as opposed to general commercial discussions)? How long should each stage last? What are the consequences if one party refuses to engage in a particular step?
• Keep it simple: a DR smorgasbord may seem like a good idea, but each step carries with it the potential for argument. In most cases, a clearly drafted two- or three-stage DR clause will be all that is needed. It is always open for parties to agree to mediation or expert determination after a dispute has arisen (although while this often happens with mediation, it is less common for expert determination).

If you would like to find out how the world's biggest law firm can help you to draft the right clauses for your contracts and mitigate your supply chain risks, please get in touch with Sarah Rutnah or your usual Dentons contact.