Dispute resolution escalation clauses – be clear when drafting escalations, particularly when all roads lead to arbitration

The importance of clearly drafted escalation clauses is particularly relevant where the final and binding end point is arbitration, to avoid an admissibility challenge for having not complied with the escalation steps prior to commencing an arbitration.

Escalate clearly

Often known as "midnight clauses", because they are often included in an agreement at the last minute, some dispute resolution clauses are better than others. This is particularly true where the dispute resolution clause provides a multi-tiered process for escalating disputes through to a final and binding resolution process.

For example, the parties may agree upon an escalating dispute resolution process which provides that upon a dispute arising:

• a dispute notice must be issued, setting out the issues in dispute and calling for a meeting between the parties in an attempt to amicably resolve the dispute by negotiation;
• if those negotiations are not successful, a mediation is to be conducted (i.e., a neutral individual will assist the parties with exploring settlement);
• only if the mediation does not resolve the dispute, are the parties permitted to commence formal, binding and final, proceedings (such as litigation or arbitration).

In principle, Australian courts will enforce escalation clauses and hold parties to them. However, unless drafted carefully, an escalation clause may be found to be uncertain and unenforceable when one of the parties later refuses to follow the process.

Consider the following tips aimed at ensuring the clause is clear and enforceable:

1. Include clarity around timing of the various tiers with the aim of mitigating the risk of a situation in which a party refuses to engage in the process and the next tier cannot be initiated or it is not clear when a tier has been completed/complied with. For example, it is sensible (and common) to stipulate that any initial negotiation after the issue of a dispute notice is to be held within a specific amount of time and to be attended by a certain level of decision maker (e.g., CEO).
2. Ensure the clause prescribes within its terms the process for each tier, because an "agreement to agree" on process may be unenforceable. For example, in WTE Co-Generation v RCR Energy Pty Ltd [2013] VSC 314, a clause in a building contract which provided "[i]n the event the parties have not resolved the dispute then within a further 7 days a senior executive representing each of the parties must meet to attempt to resolve the dispute or to agree on methods of doing so" was found to be uncertain and void.
3. Specify whether there are any exceptions to having to follow the procedure, such as permitting the parties to seek urgent interlocutory relief for certain kinds of events or disputes. If it does not, an aggrieved party may be left to pursue its dispute through the agreed procedure.

The clear and careful drafting of escalation clauses is, unsurprisingly, important with respect to avoiding falling into dispute about how to resolve a dispute. This is particularly important where arbitration is provided for as the final "tier".

Precondition(s) to arbitration

What happens if the escalation clause is not complied with before commencing an arbitration?

This question has been considered in several UNCITRAL model law jurisdictions, including Australia. The central issue arising in those cases is whether compliance (or a failure to comply) with preconditions to the commencement of arbitration as contained in a dispute resolution cause is a question of jurisdiction or admissibility.

The 2022 Hong Kong Court of Appeal decision of C v D [2022] HKCA 729 considered an allegation that a party had not complied with the procedure set out in the escalation clause prior to commencing arbitration which, inter alia, involved a claim under Article 34(2)(a)(iv) of the UNCITRAL Model Law that the arbitral procedure, including the escalation provisions set out in the dispute resolution clause, had failed to be completed with or been complied with. The Hong Kong Court of Appeal held:

"…there is a substantial body of judicial and academic jurisprudence which supports the view that ‘non-compliance with procedural pre-arbitration conditions such as a requirement to engage in prior negotiations goes to the admissibility of the claim rather than the tribunal’s jurisdiction."

As a question of admissibility rather than jurisdiction, if an escalation clause has not been complied with, it is a question which can be decided by the arbitral tribunal and not a matter available for de novo review by a Court upon any jurisdiction challenge. If an arbitral tribunal finds that the escalation clause has not been complied with, it may order that the arbitration be stayed until the preconditions are completed, or factor in the failure to comply and make costs orders accordingly. The arbitral tribunal may even consider dismissing the claim as having been made prematurely.

Included in the body of case law referred to and relied upon by the Hong Kong Court of Appeal was the 2021 Australian judgment of Rees J in the New South Wales Supreme Court decision of The Nuance Group (Australia) Pty Ltd v Shape Australia Pty Ltd [2021] NSWSC 1498 (Nuance) where her Honour considered the difference between an issue of jurisdiction and an issue of admissibility.

In Nuance, an arbitral award was challenged on the basis that a claim was time barred. Justice Rees noted that "a challenge to a claim referred to arbitration on the basis that it is time barred is not a challenge to the jurisdiction of the arbitrator." Her Honour referred to the 2020 Singapore Court of Appeal decision of BBA v Baz [2020] SGCA 53, summarising that it had been held there that "the fact that a claim made in an arbitration turns out to be time barred does not deprive the arbitrator of jurisdiction." Her Honour continued:

"Jurisdiction is concerned with the power of the tribunal to hear a case; jurisdictional challenges relate to the interpretation and application of the jurisdictional clause that a claim should not be arbitrated due to a defect in, omission to, consent to arbitration and success of the challenge necessarily negates consent to the forum."

Other Australian cases to have considered the question of proceeding with an arbitration where there is said to have been a failure to comply with the procedural preconditions include Australian Maritime Systems Ltd v McConnell Dowell Constructors (Aust) Pty Ltd [2016] WASC 52 which concerned an agreement to design, supply, and install harbour navigation aids. The applicant sought a declaration that it had been released from all obligations and liabilities to the respondent. The respondent sought a stay of that application on the ground that the applicant had failed to comply with the dispute resolution escalation clause. The Western Australian Supreme Court held that, on the balance of convenience, it was appropriate to order a stay of the proceedings until the dispute escalation process was engaged in and completed and referred the parties to arbitration if resolution was not achieved.