Janice Tay provides an overview on the enforceability of multi-tiered dispute resolution clauses

Multi-tiered dispute resolution clauses (or escalation clauses) are clauses in a contract which provide for distinct stages of alternative dispute resolution, such as negotiation and mediation, before a party can commence proceedings in respect of a dispute.
 
Such clauses offer the possibility of a cheaper and faster alternative to arbitration or litigation and enable the parties to attempt to resolve disputes in a non-adversarial setting thus preserving the commercial relationship.
 
One of the key issues is the extent to which these clauses are mandatory and enforceable. What are the consequences if a party ignores the obligations set out therein and who decides on this issue: the arbitral tribunal or courts?
 
This article summarises the approach of different jurisdictions to such clauses.
 
THE MALAYSIAN POSITION
 
The Malaysian courts have taken the view that escalation clauses, where sufficiently clear and allowed by law, are preconditions to be complied with before the commencement of any legal proceedings. Although an arbitral tribunal may rule on its own jurisdiction, a challenge on its ruling may be made to the courts.
 
In the Federal Court decision of Juara Serata Sdn Bhd v Alpharich Sdn Bhd [2015] 9 CLJ 37, the architect issued an interim payment certificate for works done but the defendant refused to pay the same as the plaintiff’s works were deemed incomplete. The plaintiff commenced proceedings in the High Court, claiming for, inter alia, the interim payment certificate sum and the defendant counterclaimed against the plaintiff. The High Court held that the parties were bound by the escalation clause, which required them to first refer their dispute to the architect/consultant for a decision and thereafter to arbitration if no decision is given by the architect/consultant within 14 days. If the aggrieved party fails to refer the dispute on the decision of the architect/consultant to arbitration within the stipulated time, the decision is deemed to be final and binding on the parties.
 
The High Court allowed the plaintiff’s claim and dismissed the defendant’s counterclaim because there were no written instructions from the defendant or the architect concerning the defects in the works. The Court of Appeal affirmed the High Court’s decision.
 
In the Federal Court, the defendant argued that the interim payment certificate was not intended to be final and that it could be challenged in arbitration or the courts. The defendant further argued that the escalation clause had deprived its right to have the disputes heard in the courts and thereby contravening section 29 of the Contracts Act 1950, which does not allow for any contractual provision which purports to forfeit one’s right to pursue legal or arbitral proceedings.
 
The Federal Court, in affirming the decisions of the courts below, held that:
 
1.   The escalation clause had set out in clear terms the steps to be taken in the case of a dispute. This was a plain case where parties are called upon to honour their part of the bargain when they entered into the agreement. The real issue was whether the parties to an agreement were in breach of the terms which they had agreed upon and not the issue relating to the validity and enforceability of an interim payment certificate. The defendant should not be allowed to resile from terms in the agreement which had imposed obligations as that would be tantamount to allowing it to take advantage of its own wrong.
 
2.   Section 29 of the Contracts Act 1950 is not contravened as the escalation clause provided for a two-tiered dispute resolution mechanism. The clause did not impose any absolute restriction on or expressly oust the jurisdiction of the court.
 
In Usahasama SPNB-LTAT Sdn Bhd v Abi Construction Sdn Bhd [2016] 7 CLJ 275, the plaintiff took the position that the notice of arbitration issued by the defendant was premature as the dispute should first be referred to the Superintending Officer prior to arbitration in accordance to the escalation clause and hence, the arbitrator had no jurisdiction to decide the dispute between parties. The arbitrator dismissed the plaintiff’s application holding that he had the jurisdiction to decide the dispute between the parties. Dissatisfied, the plaintiff appealed to the High Court under Section 18(8) of the Arbitration Act 2005 to challenge the jurisdiction of the arbitral tribunal. 
 
The High Court allowed the plaintiff’s appeal and found that both parties had agreed contractually to a precondition to be fulfilled before there could be a valid reference to arbitration. The requirement that the contractor must first refer the dispute or difference to the Superintending Officer for a decision before the dispute is referred to arbitration was clearly in the form of a condition precedent. Until and unless the contractually agreed conditions were fulfilled, the arbitrator concerned could not assume jurisdiction.
 
THE SINGAPOREAN POSITION
 
The Singaporean Courts have held that the courts will respect the parties’ choice of dispute resolution mechanism. Parties must abide by the preconditions which they have agreed to, failing which an arbitral tribunal will have no jurisdiction over the dispute.
 
In International Research Corp PLC v Lufthansa Systems Asia Pacific Pte Ltd and Another [2014] 1 SLR 130 (CA), whilst the enforceability of the multi-tiered clause was not the subject of the appeal, the Court of Appeal took the opportunity nonetheless to note that it would have upheld the multi-tiered clause if it had been challenged. The Singapore Court of Appeal held that the multi-tiered clause was sufficiently certain to be enforced.
 
THE ENGLISH POSITION
 
In Walford v Miles [1992] 2 AC 128, the House of Lords held that an agreement to agree or to negotiate in good faith is not enforceable. Accordingly, the English courts have generally been reluctant to recognise multi-tiered dispute resolution clauses as giving rise to enforceable agreements to engage in informal dispute resolution before recourse to formal proceedings.
 
In Sulamerica CIA Nacional De Seguros SA v Enesa Engenharia [2012] EWCA Civ 638, the Court of Appeal held that an obligation on the parties to “seek to have the Dispute resolved amicably by mediation” was unenforceable because it did not define the parties’ rights and obligations with sufficient certainty to enable it to be enforced. The clause did not set out a mechanism to appoint a mediator or any defined mediation process.  As such, the failure to mediate was no bar to commencing arbitration.
 
In Wah (Aka Alan Tang) & Anor v Grant Thornton International Ltd & Ors [2012] EWHC 3198, the claimants brought a claim in the High Court challenging the arbitration award and alleging that the requisite steps to enable a process of pre-arbitration conciliation were clearly prescribed and were conditions precedent before an arbitral reference could be made. As they were not fulfilled, the reference was thus invalid, so that the arbitration tribunal did not have jurisdiction to hear the dispute.
 
Mr Justice Hildyard stated that the overarching test of enforceability is “whether the obligations and/or negative injunctions it imposes are sufficiently clear and certain to be given legal effect”. The Judge found that the clause was too equivocal in terms of process required and too nebulous in terms of the content of the parties’ obligations to be given legal effect.
 
However, the recent case of Emirates Trading Agency LLC v Prime Mineral Exports Private Limited [2014] EWHC 2104 (Comm) signals a shift in the English courts’ approach. The Court held that the dispute resolution clause requiring the parties to resolve a dispute by “friendly discussions” within a limited period and in good faith before the dispute could be referred to arbitration was enforceable.  This decision departs from the general principle that an agreement to negotiate is unenforceable.
 
THE AUSTRALIAN POSITION
 
In WTE Co-Generation v RCR Energy Pty Ltd [2013] VSC 314, a dispute arose between the parties and litigation was commenced by the plaintiff. The defendant applied to stay the litigation because the dispute resolution clause had not been complied with and the plaintiff opposed the same on the basis that the dispute resolution clause was uncertain and unenforceable. 
 
The Court held that the dispute resolution clause constituted “an agreement to agree” because the clause left the method of resolving dispute to a further agreement.
 
The Court stressed that “as a minimum, what is necessary for a valid and enforceable dispute resolution clause, is to set out the process or model to be employed, and in a manner which does not leave this to further agreement. It is not for the court to substitute its own mechanism where the parties have failed to agree upon it in their contract. To do otherwise would involve the court in contractual drafting, which is a distinctly different exercise from contractual construction of imprecise terms.”
 
THE HONG KONG POSITION
 
In Hyundai Engineering & Construction Co Ltd v Vigour Ltd [2005] 3 HKLRD 723, the Court of Appeal considered the enforceability of an agreement for negotiation and meditation. The Court of Appeal concluded that the agreement to negotiate was unenforceable as the negotiation provision was no more than an agreement to agree and the mediation provision was imprecise.
 
CONCLUSION
 
The approach by the courts in the different jurisdictions highlights the importance of meeting all the preconditions set out in a multi-tiered dispute resolution mechanism before initiating legal or arbitration proceedings.
 
The failure to comply with such clauses may result in a challenge to the arbitral tribunal’s jurisdiction. In the worst-case scenario, one might even be faced with a successful arbitral award later being challenged for lack of jurisdiction in a setting aside application or an opposition to enforcement.
 
The cases also illustrate that if one is minded to incorporate a multi-tiered dispute resolution mechanism in a contract, it is crucial to draft such clauses with clarity and sufficient detail to avoid the preconditions to arbitration or legal proceedings being held to be unenforceable as an agreement to agree or too imprecise for enforcement. It is advised to have a clearly defined process that includes the relevant representatives and obligations which are not too onerous with a time limit for compliance.