Key Points: The inclusion of an ADR clause during the negotiation of the broader commercial agreement allows the parties to design their own bespoke ADR process.

The term Alternative Dispute Resolution, or ADR, covers a broad range of procedures designed with the aim of resolving commercial disputes without resorting to traditional litigation. As the complexity and expense involved in litigation has grown, so too has the popularity of ADR procedures which, when genuinely undertaken, have the potential to resolve disputes more quickly and cheaply than going to court.

ADR comes in many forms, but generally speaking there are two types:

  • Non-binding - where the parties seek to resolve the issue through a form of negotiation, with a result being binding only if the parties come to an agreement. The most common form is the usual negotiation which occurs between parties in dispute. More structured alternatives are available which go beyond simple negotiation, such as conciliation and mediation in which the parties attempt negotiations under an agreed structure, usually with procedures and timeframes which have been mutually agreed.
  • Binding - the more formal version of ADR, where the resolution process leads to a result which can be imposed and is binding on the parties. Binding ADR includes such ADR processes as arbitration and expert determination, and can be controlled by statutes such as the Commercial Arbitration Act 1984 (NSW).

In this article we look briefly at non-binding ADR and how it can be incorporated into a commercial agreement by way of a contractual term.

We will return to binding forms of ADR in the next edition of LDR Insights.

For convenience in this article, where we refer to "ADR" or "ADR clauses", we are speaking about a form of "non-binding" ADR. However, as we will discuss, a contractual requirement to participate in a non-binding ADR process, before the parties engage in formal ADR or litigation, is invariably obligatory/mandatory.

How do contracts impose a non-binding ADR process?

When a dispute between parties to a contract arises, an ADR clause may require those parties to engage in a process of negotiation, mediation or conciliation before the dispute proceeds to a more formal determination (for example, arbitration or litigation before a court).

The benefits of this are readily apparent. A relatively informal setting can lead to compromises which might not have otherwise arisen in the adversarial atmosphere of formal litigation. Even if the matter ultimately proceeds to litigation, the ventilation of arguments and issues as part of the ADR process may clarify or reduce the scope of the dispute.

The inclusion of an ADR clause during the negotiation of the broader commercial agreement allows the parties to design their own bespoke ADR process. For example, the parties may choose to include the involvement of an independent intermediary who may be well versed in the subject matter of the dispute. An appropriately structured ADR process can limit the time and expense involved in such discussions, but also preserves each party's right to proceed to either binding ADR or litigation should the non-binding ADR process prove fruitless.

However, an ADR process is only as good as the contractual clause which imposes it. A good ADR clause will set out clearly the form of ADR process and the terms on which it will take place. It will set the scope of issues which can or must be addressed and prescribe how the matter will progress or escalate if agreement is not reached. Importantly, an ADR clause should not attempt to displace a court's ultimate authority to deal with matters of law, but rather require the parties to attempt to resolve their differences before embarking on litigation.

Are non-binding ADR clauses themselves enforceable?

ADR clauses are, at the end of the day, a contractual mechanism. The failure of a party to adhere to an ADR process as required by a contract is properly characterised as a breach of that contract.

However, an ADR clause will not stop either party from commencing proceedings against the other. Instead, the strength of the ADR clause will determine whether the court, upon commencement of those proceedings:

  • stays the proceedings to allow the ADR process to take place (essentially ordering that the parties perform this part of the contract, or rejecting a party’s attempt to use litigation as an abuse of process to circumvent the ADR clause), or
  • chooses to embark upon determining the substantive dispute (that is, rejecting the ADR process as an unenforceable aspect of the contract).

When considering whether to require the parties to undertake the ADR process, the court will consider a number of factors in relation to the clause itself:

  • Scope - Is the dispute in question within the scope of the ADR clause?
  • Certainty - Does the ADR clause provide sufficient certainty as to what each party must do as part of the ADR process? If the clause requires additional agreement between the parties before the process can begin, is unclear as to how the arbiter is to be chosen or paid, or fails to sufficiently set out the rules by which the ADR process will be conducted, the court may choose not to enforce the ADR clause.
  • No ouster - Does the clause characterise the ADR process as a condition precedent to litigation, or does it seek to oust the jurisdiction of the court in relation to the matter? As a matter of public policy the courts will not enforce an agreement which operates to remove a party’s freedom to approach the court. Rather, the ADR process must be described as a precondition to litigation.
  • “Good faith” - Is the ADR clause void for uncertainty because it imposes a duty on the parties to conduct the ADR process in “good faith”?

The term “good faith” has historically proven difficult when used in ADR clauses. Single judges of the NSW Supreme Court have differed considerably on the subject. Some have found that the term “good faith” lacks sufficient certainty, as parties who agree to mediate in good faith may not feel so magnanimous once a dispute arises, or on the basis that the court lacks the ability to measure whether a party has acted in good faith. Another disagreed, on the basis that a duty of “good faith” is not inconsistent with self-interest.

Recently, the NSW Court of Appeal, in United Group Rail Services Ltd v Rail Corporation New South Wales [2009] NSWCA 177, has sided with the latter view, saying that negotiating in one’s best interests and doing so in good faith are not mutually exclusive, and that a reference to “good faith” could be taken to mean honest and genuine negotiation, without engaging in underhanded tactics. However, the framework within which good faith negotiations take place must be sufficiently detailed - “good faith” negotiations cannot take place in a vacuum.  

Isn’t an ADR clause just a form of agreement to agree?

A complicating factor in non-binding ADR processes is that an enforceable ADR clause may require the parties to attempt to agree a resolution to the dispute in the context of the ADR process.

It has often been held that an “agreement to agree” - under which parties agree to come to an agreement on an issue at a later time - is void as incomplete. The decision in United indicates that an agreement to negotiate, in the context of an appropriately drafted ADR clause, is distinguishable from an agreement to agree, and enforceable.