Handling Potentially Complex Disputes: Multi-Tiered Dispute Resolution Clauses

Key Point

• A carefully drafted multi-tiered dispute resolution clause guides parties through a structured process, ultimately increasing their chances of reaching an early settlement.

The increasing globalisation of business has caused many large national construction corporations to search for new opportunities in foreign states. Construction is no longer a local industry and international projects provide construction companies new scope for growth and diversification. However, the growth of international construction projects has given rise to proportionate growth in the number and complexity of matters which require consideration when drafting contractual provisions for resolving disputes which may arise.

One solution that has emerged to handle the potentially complicated disputes of the type that often arise in large construction projects is the multi-tiered dispute resolution clause (MTDRC). MTDRCs require parties to engage in distinct and escalating (in terms of seniority of participants or level of resources required) stages or "tiers" culminating in final and binding resolution by arbitration or litigation. The various stages may include:

• negotiation by project personnel
• negotiation by senior executives
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• mediation
• non-binding independent expert appraisal
• mini-trial
• expert determination (binding or non-binding); or
• arbitration or litigation.

MTDRCs may require parties to participate in every stage of the process or may prescribe that different categories of disputes are dealt with differently. For example, disputes involving technical questions may be referred to expert determination, while disputes relating to legal issues such as contract interpretation proceed straight to arbitration.

A brief examination of the benefits and risks of MTDRCs will identify the issues which ought to be considered when drafting a dispute resolution clause.

Large international or domestic construction contracts are complex and fraught with the possibility of conflicts between a number of parties. Arbitration and litigation are of course effective tools for dispute resolution, but they can be costly and time consuming.

The use of multi-tier processes encourages parties to give early consideration to issues and requires them to engage in good faith negotiations, prior to positions becoming entrenched and before substantial legal costs are incurred. In many cases, this results in cost effective and efficient dispute resolution.

A carefully drafted MTDRC guides parties through a structured process involving a timetable and professional experts before arbitration or litigation is undertaken. This can ultimately increase the parties' opportunities for an early settlement which will save time and money. MTDRCs provide alternatives to arbitration and litigation which may resolve disputes, large or small, cost-effectively and efficiently.

The use of a MTDRC, however, can have its drawbacks. Criticisms of MTDRCs include uncertainty concerning enforceability, the scope of requirements of certain stages, the potential for multiplicity of proceedings which may overlap factually or legally, and the inability to compel third parties to participate in the dispute resolution process.

While terms such as negotiation, mediation and expert determination are well understood, the procedures for each vary substantially, and the drafting must satisfy certain criteria in order to ensure certainty and enforceability. In the absence of a clearly specified timetable and procedures, parties can end up in dispute about whether or not a step in the dispute resolution clause has been satisfied.

The enforceability of arbitration agreements is a well-established in practice, and on an international level is supported by conventions such as the New York Convention. The question with MTDRCs is whether tiers prior to arbitration are enforceable and also whether the inclusion of tiers preceding arbitration affects the enforceability of the arbitration tier.

Various courts internationally have adopted different approaches regarding enforceability. Some jurisdictions only consider the arbitration stage enforceable, while others like Australia consider the prior stages enforceable if the MTDRC provides a clear obligation on the parties to follow the pre-arbitration procedures.

If the earlier tier is a clear and determinative pre-condition to arbitration, a court or tribunal will likely forego jurisdiction until the pre-condition tier has been followed. This has been the trend in Australian court decisions like Hooper Bailie v Natcon Group (1992) 28 NSWLR 194, and Aiton v Transfield [1999] NSWSC 996. However, if the earlier tier is not sufficiently clear and determinative (emphasising the need for proper drafting), a court or tribunal may assume jurisdiction and the earlier tier will be bypassed.

The use of subjective criteria to determine participation in or completion of tiers is another issue to be aware of. Using terms such as "good faith" to describe satisfactory completion of negotiation or mediation stages creates problems of interpretation in different legal jurisdictions. A MTDRC requiring parties to negotiate in good faith before progressing to the next tier can create disputes in relation to the clause itself, instead of assisting parties in resolving disputes as demonstrated in the Aiton case.

Australian courts have held that a requirement to negotiate or mediate is enforceable provided the process is sufficiently defined. The good faith obligation has not been expressed as going so far as to restrain a party from acting in legitimate self-interest. Rather, self-interest may be pursued in negotiations or other tiers as long as there is not an underhanded or ulterior motive.

Some guidelines for an enforceable MTDRC from the Aiton case (which considered the enforceability of a mediation tier of a MTDRC) include:

• the clause should operate to make the completion of preliminary tiers a condition precedent to arbitration or court proceedings
• the processes established by the clause must be certain. There should be no part of the clause that needs further agreement between the parties or it will be considered an unenforceable agreement to agree
• the processes for selection of mediators or experts and their remuneration should be specific, with a mechanism for selection by third parties if necessary
• the clause should include the mediation process in detail, or incorporate rules by reference. The mediation model to be followed should also be stated; and
• each level of the multi-tier process should include a clear trigger (usually by way of time limits within which a decision or an agreement has to be reached).

There is scope for multiplicity of dispute resolution processes with a MTDRC. Disputes may arise at different times under a contract, meaning that the dispute resolution process will be commenced by the parties for each dispute when it arises. This leads to multiple processes for disputes with the same subject matter.

Another example is where different categories of disputes are dealt with differently under a MTDRC. If disputes arise simultaneously or sequentially and there are technical questions for which the MTDRC prescribes expert determination and contract interpretation questions for which the MTDRC prescribes arbitration, there will be multiple processes for disputes with the same subject matter. Not only is it inefficient for the parties to be managing multiple processes, but there is also the risk that each of the processes will yield inconsistent determinations.

A MTDRC is only binding on the parties to the contract containing the MTDRC. This means that when disputes arise between the parties and there are related disputes to be resolved with a third party, for example a subcontractor or a guarantor, the third party will not be bound by the MTDRC. The third party may be subject to a dispute resolution clause under a separate relevant contract to which it is a party, but this gives rise to a multiplicity of processes. By ensuring that dispute resolution processes are consistent in contracts relating to the same transaction and ensuring there is provision for disputes under the separate contracts to be heard together, this problem is minimised.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.