How to agree on how to resolve disagreements? The use of multi-tiered dispute resolution clauses and split clauses

Multi-tiered dispute resolution clauses (also referred to as “escalation clauses” or “stepped clauses”) generally provide that the contracting parties shall first attempt to resolve any contractual dispute they may have by way of discussion, negotiation or mediation or some other form of alternative dispute resolution (“ADR”) before the dispute can be referred to arbitration or a court of law.

Quick and amicable settlements may well be preferable over time-consuming and expensive dispute proceedings where results are uncertain and more or less beyond the parties’ control. Mediation often provides satisfactory results without compromising an important business relationship. To this end, it is often advisable to use a multi-tiered dispute resolution clause. Caution is advised when drafting them, however. Below is a good example of a poorly drafted multi-tiered dispute resolution clause:

”The Parties shall use their best efforts to reach an amicable settlement to any dispute, controversy or claim arising out of or relating to this Agreement through mutual discussions. Any dispute which is not settled by way of amicable negotiations shall be finally settled by arbitration in accordance with the Rules of [the applicable arbitration institute].”

Clauses such as the one above may lead to difficult questions of interpretation, uncertainty, unenforceability, unrecoverable expenses and even loss of right or loss of access to justice simply because they are silent on many practical questions:

  • How will the discussions or negotiations be conducted?
  • Who exactly will attend the discussions or negotiations and what happens if they are unwilling or unable to attend?
  • How and when will the discussions or negotiations be deemed to have commenced?
  • How long will the parties discuss or negotiate?
  • How and when can the discussions or negotiations be brought to an end without constituting a breach of contract?
  • What do phrases such as “best efforts” or “all efforts” actually require from the parties – especially when the parties are barely on speaking terms?
  • What can be done if the other party refuses to discuss or negotiate?
  • Under which rules (if any) will the mediation proceedings be conducted?
  • How will the mediator be appointed?
  • How and when will mediation be deemed to have commenced?
  • How and when can the mediation proceedings be brought to an end without constituting a breach of contract?
  • When and under which exact circumstances may a party initiate arbitration or court proceedings without committing a breach of breach of contract?
  • If the avenue of settlement has allegedly not been fully exhausted, will the instigation of arbitration or court proceedings constitute a breach of contract even if the right to present claims is about to expire (by virtue of statute or contract)?
  • Will the duty to discuss, negotiate or attend mediation affect a party’s right to apply for interim or precautionary measures (such as seizure of assets or an order to do or refrain from doing something so as to retain the status quo or to prevent a possible harm until the dispute has been finally settled)?

A properly formulated multi-tiered dispute resolution clause should provide clear and unambiguous answers to these questions. This is particularly true if the parties are from different jurisdictions.

Split clauses resemble multi-tiered dispute resolution clauses, and their popularity is likewise increasing. They provide for different procedures (an altogether different dispute resolution mechanism, a different set of arbitration rules, a different number of arbitrators, etc.) for different disputes or for some of the contracting parties. Split clauses, too, pose problems and risks unless they are constructed carefully. An all too common example of a bad split clause reads as follows:

”Any dispute, controversy or claim arising out of or relating to this contract shall be finally settled by arbitration in accordance with the Rules of [the applicable arbitration institute] insofar as its value exceeds 100,000 EUR. If the value is 100,000 EUR or less, the dispute, controversy or claim shall be finally settled by arbitration in accordance with the Rules for the Expedited Arbitration of [the applicable arbitration institute]”

If, for example, the above formulation is used and the parties disagree on the value of the dispute, it may be difficult to decide the applicable set of arbitration rules. Also, if the dispute is complex and important but for some reason lacks clear financial value, a party may claim that the mutual intention was obviously not to refer it to expedited arbitration proceedings and that the clause shall be interpreted accordingly.

Dispute resolution clauses are usually (briefly) discussed in the final stage of the negotiations when the parties are happy to have agreed upon the main commercial issues and when they don’t expect major contractual disputes. Boiler plate dispute resolution clauses or previously used clauses are often used without much attention being paid to whether they are actually appropriate for the contract in question.

Although it may be wise to incorporate dispute resolution clauses that provide for a primary duty to discuss, negotiate or mediate, we recommend that multi-tiered dispute resolution clauses and split clauses are discussed with experienced counsel. They can quickly point out the possible ambiguities and other problems. All dispute resolution clauses should always be read carefully with all the other terms of the contract and reflected against the most likely sources of disputes.