BEWARE: Pre-Conditions to Arbitration

I’m a strong supporter of stepped dispute resolution clauses in contracts. Business people want a chance to negotiate or mediate a solution to their problems before handing things over to lawyers for arbitration or litigation.

I often recommend stepped clauses to clients when we were negotiating technology contracts. And I still recommend them as a mediator and arbitrator.

But several speakers at the CanArb Week conference earlier this fall reminded us of some of the potential pitfalls of these clauses. And some recent court decisions have highlighted the risks.

One of the most serious is the risk of inadvertent (or intentional) delay – or complete frustration – of the dispute resolution process, if the clause is not written carefully.

The question of whether a particular step is a “condition precedent” to arbitration can be hard to answer.

For example, in Ontario the Insurance Act says that “…if the insurers are unable to agree with respect to indemnification [for statutory motor vehicle accident benefits], the dispute shall be resolved through arbitration under the Arbitrations Act.” The courts have concluded that this wording requires insurers to arbitrate their disputes, but it doesn’t require them to make any particular effort to negotiate an agreement before arbitrating. Markel Insurance Company of Canada v. ING Insurance Company of Canada2012 ONCA 218 (CanLII)

Contrast that with the decision earlier this year in Maisonneuve v. Clark, 2021 ONSC 1960 (CanLII), where the court concluded that the wording in a dispute resolution clause was a condition precedent to arbitration. The clause was included in a settlement agreement, to deal with any issues that might arise in completing the terms of the settlement, which involved the division of various business assets between the parties. They anticipated that there might be issues relating to various costs and expenses at the time of the division.

The clause said: “If the parties are unable to resolve the [dispute] as between them, then the [dispute] shall be fully and finally referred to the Arbitrator for resolution.”

The court focussed on the “if…then” wording and concluded that when the parties signed the agreement they intended that an attempt would be made to resolve the dispute amicably before engaging in litigation.

“The language chosen is both prospective and conditional,” the judge concluded. [para 58]

As a result, the time period for giving notice of arbitration did not begin to run while a party refused to discuss a possible settlement.

A recent case from Hong Kong illustrates the importance of the actual wording of the escalation clause in determining whether the steps are voluntary or mandatory.

The case, (C v D [2021] HKCFI 1474), involved a contract with a dispute resolution clause that said “the Parties shall attempt in good faith promptly to resolve such dispute by negotiation”. It went on to say that “[e]ither Party may, by written notice to the other, have such dispute referred to the Chief Executive Officers of the Parties for resolution”. (emphasis added)

If there was no resolution, the matter would go to arbitration.

One party had delivered a letter to the other “in a final effort to resolve this issue and avoid further legal proceedings.” It wasn’t resolved, and that party gave notice of arbitration. When the tribunal was appointed, other party objected that there was no good faith attempt to negotiate and that the CEOs hadn’t been directly involved. They said the tribunal had no jurisdiction to proceed because the preconditions had not been met.

The tribunal determined that the interpretation of the dispute clause was a matter for the tribunal to decide and that pre-conditions had been met. The first step (good faith attempt to negotiate) had been satisfied with the letter offering to resolve the dispute. The second step (reference to the CEOs) was not a pre-condition because the clause said “may.”

The tribunal went on to make an award in favour of the claimant and, unsurprisingly, the respondent tried to have it set aside. The court referred to a number of cases and academic authorities in support of the conclusion that the question of compliance with mandatory escalation or other preconditions is one for the tribunal to decide, not a question of jurisdiction. Therefore, the tribunal’s determination on those issues should be decisive and final.

The decision is a welcome endorsement of both the arbitrator’s authority to determine procedural threshold questions at the start of the arbitration and courts’ deference to those determinations after the fact.

But consider the cautionary tale in PQ Licensing S.A. v. LPQ Central Canada Inc., 2018 ONCA 331 (CanLII), where it took more than 10 years just to get to the starting gate in what should have been a very straightforward dispute resolution process.

In 2008, the parties entered into an agreement to develop 13 franchised food outlets in Ontario and Quebec.

In 2009, the franchisee tried to rescind the agreement, claiming violations of the Ontario franchise disclosure act. The franchisor disputed the rescission.

Almost two years after that, in late 2011, the franchisee started an action in the Ontario court. The franchisor objected, citing the requirement in the agreement to mediate, then arbitrate, any dispute. The franchisee said the mediation clause was invalid because it required mediation outside Ontario (contrary to Ontario franchise law), and in any case the whole agreement was void. The franchisor said the mediation clause was not void and proposed mediation in Toronto. It said it would ask the court to stay the action if the franchisee didn’t agree to mediate first, then arbitrate any unresolved issues.

In 2013, the court action was dismissed for delay. The franchisee tried to revive it. The franchisor again relied on the arbitration clause, but said the franchisee was out of time to arbitrate. The court stayed the action on the basis of the ADR clause in the contract, and referred the limitation issue to the arbitrator.

The parties appointed an arbitrator, who had to decide whether the arbitration was out of time because it hadn’t been started within two years of the original rescission notice in 2009.

In 2016, the arbitrator decided the arbitration was not time-barred. He concluded that the mediation clause was a condition precedent to arbitration, and had the effect of suspending the limitation period, which did not begin to run until the mediation step was completed.

The franchisor’s appeal of that decision to the Superior Court was dismissed in January 2017 and a further appeal to the Court of Appeal was dismissed in 2018. Both courts agreed that the arbitrator’s decision was a reasonable interpretation of the parties’ original agreement.

So, after almost 10 years of delay, maybe the parties could get on with arbitrating their dispute. (The question of whether the parties still had to try to mediate before they could proceed with the arbitration doesn’t seem to have been dealt with, either by the arbitrator or by the two levels of court.)

Lessons learned from these cases?

  • Words matter: Don’t say “shall”, if you mean “may”! And if the clause says the parties will “negotiate in good faith” before taking another step, what do they have to do? Better to just say “attempt to negotiate”. Adding “good faith” just opens the door to more disputes over intentions. (And to the extent that good faith is now part of Canadian contract law generally, those words are probably not necessary anyway…)
  • Use an objective escalation trigger: I think it’s better to say: “If a dispute arises and is not resolved by the parties, then…”, rather than “if the parties are unable to resolve the dispute…” In the first case, it’s either resolved or not; in the second, who’s to say whether to parties are able to resolve it?
  • Make some steps optional: This may not be as effective as requiring parties to participate in negotiation or mediation, especially if one or the other is likely to be unwilling to play, but at least it will encourage them to think about settlement and it won’t prevent going straight to arbitration or litigation if necessary.
  • Don’t have too many steps: Generally, two or three steps is plenty. In a project agreement (e.g. technology or construction), there may already be a couple informal escalation stages before dispute is declared. For example the agreement may call for site managers to meet to discuss a problem, then escalate to a senior project manager if they can’t agree. But when it comes to the dispute resolution clause, the steps should be limited to a final escalation to a senior executive who can resolve the matter, then to mediation and, finally arbitration.
  • Set time limits: Deadlines always get everyone’s attention. Usually, the shorter the better, if escalation steps are mandatory. I’ve seen agreements that require steps to be taken within as little as 24 or 48 hours for urgent matters. That may not be enough time to resolve anything, but it’s enough to know whether it’s worth the effort to try, and it doesn’t hold anything up if either side is not co-operating. The parties can always agree to extend time limits if they think they’re making progress.
    (And when setting time limits, don’t forget you also need be clear on when the clock starts to run.)

These are just a few of the traps that can be avoided by thoughtful drafting of a dispute resolution agreement. There are certainly risks with escalation clauses, but on the whole I think that they are a highly effective dispute resolution tool.

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