The inclusion of alternative dispute resolution (ADR) clauses in commercial contracts is a common practice. The ADR process provides contracting parties with alternative means of resolving commercial disputes without resorting to litigation which, in most cases, saves time and cost.

In this Bartier Bulletin, we look at aspects of ADR and also highlight the importance of early, and proper consideration of ADR clauses during contract negotiations.

Unlike in litigation, the process is confidential and the parties themselves are able to decide the rules and procedures for resolving their dispute and to select a mutually acceptable neutral third party to determine issues or facilitate their resolution.

However the benefits of an ADR provision will be lost if the parties fail to give proper attention to the terms of an ADR clause and do not fully understand its implications when they include the clause in their contract.  It might be too late to address any misunderstandings or fill in the gaps in an inadequate ADR mechanism after a controversy arises.

Can you ignore an ADR clause?

Although an ADR process is “alternative” by definition, an ADR procedure prescribed by the contract may be mandatory to follow. The failure to comply with a dispute resolution clause is a breach of contract.If the contract requires that any issues arising under it must be resolved in accordance with an ADR procedure set out in the contract, the parties should not engage in litigation before the ADR procedure has been exhausted.  Proceedings commenced in breach of that requirement may be permanently stayed with a costs order made against the party who started action.

In Cessnock City Council v Aviation Leisure Corporation Pty Ltd, the parties (Cessnock and ALC) simultaneously entered into a management agreement, an agreement for lease and a licence.

The management agreement, agreement for lease and licence operated interdependently so that a breach or termination of one would constitute a breach or a termination of the other. The agreement for lease contained an ADR clause which restrained a party from beginning legal proceedings in connection with a dispute under the agreement and required the dispute be referred to an expert for determination.

Cessnock terminated the licence (thus terminating the other agreements as well) on the ground that ALC breached the terms of the licence and sent a letter of demand to ALC claiming damages.  ALC denied the claim. Cessnock brought proceedings against ALC in the Supreme Court of NSW.  ALC filed an application seeking an order to stay the proceedings permanently on the grounds that they were legal proceedings in connection with a dispute under the agreement for lease and had been commenced in breach of the ADR clause.

The Court held that the dispute between Cessnock and ALC did arise under the agreement for lease and that the proceedings were brought in connection with that agreement. Justice Hammerschlag said that Cessnock was bound by the terms of the ADR clause and was not able to start legal proceedings unless the dispute had first been decided by an expert.  His Honour made an order for a permanent stay of the proceedings.

Be mindful of a binding result

Another important aspect of an ADR clause which is often overlooked by parties is that the result of an ADR procedure may be final and binding on the parties, i.e. the parties may be prevented from challenging the determination in a court if they are not happy with the outcome.

This has recently been reinforced in the High Court decision of Shoalhaven City Council v Firedam Civil Engineering Pty Limited.  The parties (Shoalhaven and Firedam) entered into a design and construction contract.

A dispute arose under the contract relating to variation and extension of time claims made by Firedam.  Shoalhaven responded by claiming an entitlement to damages due to delayed completion.  An expert was appointed under the ADR clause in the contract to determine the issues.  The contract stipulated that the expert’s determination was to be final and binding if the aggregate liability of one party to the other did not exceed $500,000.

Firedam challenged the expert’s determination in the Supreme Court of NSW on the ground that the expert’s reasoning for his determination was inconsistent.  Ultimately, the matter went to the High Court which dismissed Firedam’s challenge and restated that where a contract provides for expert determination to be ‘final and binding’, even if the expert makes a mistake, the decision can only be challenged if the expert has acted outside the powers given to him by the contract or when the determination is otherwise tainted by some illegality. 

Complete all agreement schedules precisely

Care needs to be taken in completing schedules that comprise part of ADR clauses so that the provision has the effect intended by the parties.  The parties often fail to identify the monetary limits or other specific items typically included in schedules to a contract.  Items should not simply be left blank or marked “N/A”.  

In New South Wales v- UXC Limited, the parties (NSW and UXC) entered into an IT contract that included an ADR procedure which obliged the parties to refer disputes to an expert for determination.  The expert determination was to be final and binding unless the amount assessed as payable by the expert exceeded the amount prescribed in the schedule to the contract (“the award cap”).  The parties did not specify any amount in the schedule, i.e. the relevant section was left blank.

NSW terminated the contract for breach and claimed damages against UXC.  UXC challenged NSW’s right to do this and the dispute was referred to an expert who made a determination in favour of NSW for over $2.5 million.

NSW brought proceedings in the Supreme Court to recover the amount determined by the expert, and UXC sought to challenge the expert’s determination.

UXC argued that as no award cap had been identified in the schedule, it should be interpreted as meaning $0. On that interpretation the expert’s determination would not be final and binding. UXC also contended that the ADR clause was invalid because it sought to exclude the jurisdiction of the Court.

The Court however held that the absence of a specified limit in the schedule meant that there was no award cap and therefore no limit on the amount for which an expert determination would be final and binding. The Court also held that the clause did not oust the jurisdiction of the Court because parties are generally free to specify the way their rights and liabilities under their contract are to be determined. 

The message

When including an ADR clause in a contract, it is essential to ensure that the clause is drafted with clarity, precision and meets the intended purpose.  A poorly drafted ADR clause may result in delay, expense and inconvenience – the very opposite of the desired result.