Last week, I presented a seminar on “Negotiating Dispute Clauses” to participants at a conference organized by the International Law Institute in Washington, D.C.  (http://www.ili.org).  My message to those involved in negotiating contracts: do not forget about the disputes clause.

  1. In the Atmosphere of Creating a Deal, No One Wants to Discuss Disputes

Contracts are entered into when there are good relations between parties, and when neither party wishes to consider the possibility of a dispute.  Discussing disputes at this stage is often seen as the stereotypical “pre-nup” situation, awkward and unnecessarily foreboding. Given this atmosphere, the contracting parties often overlook the disputes clause. They tend to either not consider it at all, or consider it only marginally.  This is short-sighted for a number of reasons. Without a solid disputes clause, both parties may incur significant costs and lose valuable time in trying to resolve matters. Worse, they may find themselves trying to settle the disputes in a forum they neither chose nor find hospitable. The process of a “bad” disputes clause can itself exacerbate problems and add to a breakdown in relations. In the event a dispute does arise, an efficient and expeditious contractual disputes process can frequently assist parties in resolving problems quickly and further improve and strengthen their relationship in the event other issues arise.

  1. The Issues to Consider in Drafting a Disputes Clause

Depending on the type of agreement, a disputes clause can be more or less complicated. But regardless of whether the agreement involved is a multi-million dollar international transaction or a small commercial agreement between two parties, there are particular matters that should be considered:

  1. Identify the Parties who might need to use the Disputes Clause?

This will generally be the two parties to the contract. However, in some instances, there may be third party beneficiaries or multiple parties to the contract. How exactly should they be accommodated in the event of a dispute?  Failure to include them in the disputes clause could potentially lead to various disputes in different forums, resulting in inconsistent outcomes. Thus, always consider whether the contract creates rights for or obligations to other third parties and if such parties need to be accommodated in any disputes process.  In this regard, consideration should also be given to having a uniform dispute structure encompassing different parties.  This can be important where there are chains of contracts such as those involving owners, contractors and subcontractors. Different dispute processes in each contract can cause undesirable results, and inefficient dispute resolution.

  1. Clearly Define the Scope of the Disputes Clause?

The parties need to be clear that the dispute clause is applicable the disputes that they want it to cover. Most disputes clauses will cover all disputes, with disputes being defined broadly as any differences between the parties. Further, the scope will not simply be contractual disputes, but all disputes arising out of or related to the contract and the project it covers.  By such language tort claims will also be covered.  But there are situations were the scope might be more tailored and narrow.  Care needs to be taken in these situations to ensure that proper definition of the scope is established.

  1. Define Clearly Dispute Resolution Process

The dispute clause must define clearly and simply the dispute resolution process. Clauses that are pathological i.e., ones that inconsistently call for both litigation and arbitration will be unenforceable.

There are a number of factors to be considered here, some of which are esoteric e.g. benefits between different arbitration rules. Nevertheless, the goal must be to enumerate without contradictory language the methodology for resolving the dispute via any defined intermediary steps up to a final dispute resolution process. This choice is sometimes defined by the applicable law in the context of the transaction.  For example, United States recent Court decisions are impacting the application of arbitration clauses in consumer and person financial services contracts. But when dealing with an international contract with a foreign government, do you want to be before that foreign nation’s courts for resolving disputes?  And, if arbitration is chosen, thought needs to be given to how it is achieved efficiently and effectively, or whether the parties merely desire “privatized litigation”.

One consideration is whether a tiered dispute clause might be desirable i.e., a clause that provides condition precedents beginning senior management negotiations and then mediation until a final resolution process?  Or a clause that divides the dispute process based upon value of the matter in dispute.  Tiered clauses are frequently used in long-term outsourcing contracts where the value of the on-going relationship is particularly important.  Or is a tiered clause not needed because virtually all courts in the U.S. require mediation before a hearing? If a tiered approach is taken, however, clear time lines are needed so that the dispute process does not become unduly delayed in the hands of a recalcitrant disputant.  An alternative to a tiered clause might be a clause that provides for Dispute Review Board or a Dispute Resolution Board.

The place for meetings for negotiations, mediation and the place of final determination, the selection of a mediator and, particularly in an international context, the language to be used in dispute resolution, can all be of importance and require careful consideration.

A choice for arbitration as the final dispute mechanism also brings with it other elements to consider.  These include: how the arbitrator or arbitrators will be appointed; whether the arbitrators need any particular skill set; is the arbitration to be institutional or ad hoc; what discovery rights there may be in any arbitration—whether under the guidance of, for example, IBA Rules on the Taking of Evidence in International Arbitration –and how might an audit clause giving one party access to documents interrelate to the disputes discovery process. Similarly, is the privacy of arbitration enough or is confidentiality also needed?

  1. Conclusion

The failure of parties to properly consider a dispute clause that will work effectively and efficiently in the context of their specific transaction can have significant consequences in terms of (a) delay in resolving a dispute (b) added managerial and legal costs to resolve the dispute (c) and having the dispute heard in the wrong forum which could ultimately lead to an undesirable outcome.

Consideration of dispute clauses at the outset gives parties the control to craft the process as they want it within the bounds of the applicable law, which can greatly assist and ease the process of resolving disputes.