Let’s talk about it

In what will be regarded as a controversial decision, the High Court decided in August that an obligation to enter into “friendly discussion” before embarking on arbitration was an enforceable term of a contract (Emirates Trading Agency LLC vs Prime Mineral Exports Private Ltd). It was previously generally regarded that an agreement to settle disputes by negotiation was unenforceable. With multi-tiered dispute resolution clauses being common in construction contracts, the decision is clearly significant.

For example, the JCT 2011 forms state that if disputes cannot be resolved by “direct negotiations”, then the parties “shall give serious consideration” to a request for mediation. More generally, contracts often refer to whether any dispute “shall” or “may” be referred to arbitration, and in this case the court commented on how the choice of words here is key to whether arbitration is mandatory or optional.

The dispute resolution clause in the extant agreement provided that “in case of any dispute or claim … the parties shall first seek to resolve the dispute or claim by friendly discussion. Any party may notify the other party of its desire to enter into consultation to resolve a dispute or claim. If no solution can be arrived at between the parties for a continuous period of four weeks, then the non-defaulting party can invoke the arbitration clause and refer the dispute to arbitration”.

There were a number of meetings during which settlement options were discussed but these ultimately failed. In the subsequent arbitration, the arbitrators found that they had jurisdiction, as there was no enforceable obligation to enter into friendly discussions, but that even if there was, it had been complied with.

The claimant challenged the arbitrators’ award, alleging that the relevant clause was a condition precedent that had not been satisfied and, therefore, the arbitrators did not have jurisdiction. Dismissing the application, the High Court concluded that the arbitrators did have jurisdiction because the clause was an enforceable condition precedent, which had also been satisfied because friendly discussions had taken place.

The use of the word ‘shall’ in the dispute resolution clause indicated that the obligation was mandatory

The judge took the view that the use of the word “shall” in the dispute resolution clause indicated that the obligation was mandatory and that friendly discussions were a condition precedent to the right to refer a claim to arbitration. The judge distinguished previous case law where similar clauses had been held to be unenforceable due to incompleteness and uncertainty, stating that “an obligation to seek to resolve a dispute by friendly discussions in good faith has an identifiable standard, namely, fair, honest and genuine discussions aimed at resolving a dispute”.

The judge also considered that the use of the word “shall” indicated that the parties had intended the obligation to engage in “friendly discussions” would be mandatory. By comparison, the use of the word “may” in relation to other obligations was held to indicate that these were optional.

In reaching his decision, the judge noted that where commercial parties have entered into obligations, they reasonably expect the court to uphold those obligations. Further, there was obvious commercial sense for the dispute resolution clause: arbitration can be expensive and time consuming, so it was far better to try to avoid it by friendly discussions.

The case demonstrates an increasing openness to the concept of good faith in a commercial context. English law has traditionally reasoned that such a duty is uncertain and contrary to the entitlement of parties to pursue their commercial self-interest in negotiations. Certainly the judge here preferred the reasoning of the courts of Australia and Singapore, where such clauses are common and have been held to be enforceable.

As many construction contracts contain multi-tiered dispute resolution clauses, employers and contractors need to consider the wording of such clauses carefully. First, parties should identify whether such obligations are mandatory (such as “shall give serious consideration” to a request for mediation in the JCT 2011 forms) or merely optional (for example “a party may refer a dispute to arbitration”).

Second, they should be alive to the possibility that, where such clauses contain obligations to comply with various steps prior to commencing any arbitration, and are limited in time, the courts may now view these clauses as a condition precedent in order to avoid what might otherwise be expensive and time-consuming arbitration or litigation.

Following this decision, it would be dangerous to pay mere lip service to obligations which require good faith (such as “serious consideration” to a request for mediation under the JCT 2011 forms) as failure to comply may result in a successful challenge to an award, or the refusal of enforcement.

Lyn Crawford is a consultant in the Global Group at international law firm DAC Beachcroft