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02 July 2015 | Nick Cooper, Clayton Utz / Kate McNally, Clayton Utz

Dispute resolution clauses: approach with care

It is common for contracts to contain dispute resolution clauses. It is just as common for these clauses to be given little consideration during the drafting phase -- with potentially costly consequences.

This article highlights the key considerations that should be taken into account when drafting -- and ultimately enforcing -- dispute resolution clauses.

Litigate or arbitrate?

The first point to consider is whether the clause is appropriate for the type of dispute that is likely to arise under the contract.

For example, what if the parties are based in Australia and the most likely dispute to arise under the contract is about payment?

In this situation, the more commercial approach is probably to litigate rather than arbitrate. If the party claiming breach of contract institutes court proceedings seeking payment under the contract and the other party has no defence, the claimant can apply for summary judgment. If it is successful, the dispute could potentially be resolved within 6 months, and at minimal cost. Arbitration on the other hand is likely to involve higher costs as the parties must pay for the services of the arbitrator (often a former judge or barrister). Costs can escalate further if the parties cannot agree on an arbitrator.

Conversely, arbitration may be appropriate if the most likely dispute will require consideration of commercially sensitive information, such as trade secrets. This is because arbitration is conducted in a private forum, and is confidential to the parties.

Consider the subject matter

It is also important to consider the subject matter that is covered by the dispute resolution process. It is likely to be broad and include any dispute concerning the subject matter of the contract. Accordingly, the parties to the primary contract will need to resolve all of their disputes as required under the contract.

Where other parties and contracts are involved

What about the situation where a party to the primary contract has sub-contracted outwork to a third party? If there is an obligation under the primary contract to arbitrate a dispute but no corresponding obligation under the sub-contract, the third party may not be able to be joined to the arbitration. In these circumstances, separate court proceedings would have to be instituted against the third party. In a worst case scenario, the party who sub-contracted out the work may end up with an arbitral award against them -- even if they are unsuccessful in separate court proceedings against the third party. Further, the costs associated with the separate court proceedings would be considerably higher than if the parties had been able to deal with the claim against the third party in the single arbitration proceeding.

To avoid this situation, the primary contract should include a clause to the effect that the contractor must ensure that any of its contracts with sub-contractors are to be resolved using the same dispute resolution method set out in the primary contract, and involving all parties.

Preliminary settlement discussions

Dispute resolution clauses often contain words to the effect that senior representatives of the parties will meet and "use their best endeavours" to settle the dispute before issuing court or arbitration proceedings. This is a sensible approach. A meeting between appropriate representatives has the ability to resolve the dispute, or at least narrow the issues, more effectively than exchanges of written correspondence.

However, the clause should clearly set out the requirements. Otherwise, a party may delay matters by claiming the criteria remain unsatisfied. The clause should at a minimum identify the attendees, address the question of confidentiality and the number of meetings to be held, and include a "drop dead" date.

What about a winding up?

Where a debt is owing under a contract, a creditor may attempt to wind up the debtor by first issuing a statutory demand. The debtor may apply to set aside a statutory demand on the basis that there is a "genuine dispute" over the existence of the debt.

The courts have held that a party may initiate the winding up process even if the relevant contract contains an arbitration clause:

...it is unlikely that a court would set aside a statutory demand on the bare ground that the service of the demand or the commencement of winding up proceedings in consequence of it, violated an arbitration clause. The question is a little artificial, because the application of the arbitration clause is likely to arise for consideration only if there is a dispute between the parties, and once there is a genuine dispute the court will set aside the statutory demand on that ground. – [SMEC International Pty Ltd v CEMS Engineering Inc (2001) 19 ACLC 1309]

That is, parties cannot by private agreement circumvent the winding up process.

Enforcement of arbitral awards

The value of any judgment or award depends on whether it is able to be enforced. It can be difficult to enforce an Australian judgment against a foreign entity unless that entity has substantial assets within Australia or is based in a state with which Australia has a reciprocal arrangement for the enforcement of civil judgments. A list of the jurisdictions which have reciprocal enforcement arrangements with Australia is set out in the Foreign Judgments Regulations 1992 (Cth). There has been recent publicity regarding an Australian company's inability to enforce an Australian arbitral award -- which had been endorsed by the High Court of Australia -- in China. Luke Nottage, Professor of Comparative and Transnational Business Law at Sydney University, observes that while "courts in jurisdictions that have adopted the New York Convention generally understand" their role is chiefly to implement verdicts, problems can still arise if the courts are "...inefficient or unfamiliar with international arbitration law and practice".

At least theoretically, enforcement of international arbitral awards in countries which have adopted the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (known as the "New York Convention") is a more certain and straightforward process. Enforcement in those countries will usually proceed without the need to revisit the substantive disputes which have already been heard and determined in the arbitration. There are now over 150 signatories to the New York Convention.

However, the ability to enforce an international arbitral award will ultimately depend on the stance adopted by the courts in the state where enforcement is sought. Great care should be taken to ensure that the arbitration clause is drafted in such a way as to maximise the prospect that any award will be enforced by the courts of the state where enforcement action is likely to be taken. That should include a careful consideration of the "seat" or place of the arbitration and the nominated arbitral institution (if any). That is because some institutions are viewed more favourably than others and, in certain instances awards in arbitrations which have proceeded without the assistance of a recognised institution (known as ad hoc arbitrations) will not be enforced at all.

Getting it right

When drafting a dispute resolution clause, consider these four key points:

  • What are the likely type of disputes that may arise under the contract?
  • Is the clause clear about what needs to be achieved in each stage of the resolution process and the timeframe?
  • Do you want to arbitrate or use the public court system?
  • What are potential problems with enforcement?
  • Addressing these questions upfront will hopefully result in a more effective and commercial resolution process in the event a dispute arises under the contract.

Note: Originally published Inhouse Counsel newsletter, July 2015, Volume 19, No 5