Agreement to attempt to resolve dispute by "friendly discussion" before commencing arbitration proceedings is enforceable
29 September 2014
In the case of Emirates Trading Agency LLC v Prime Mineral Exports Private Ltd  EWHC 2104 (Comm), 1 July 2014, a clause in a contract whereby the parties agreed to "first seek to resolve the dispute by friendly discussion" before commencing arbitration proceedings was held to be enforceable as a condition precedent to arbitration. This decision by Teare J represents a departure from the line of English authority that such clauses are mere agreements to negotiate and therefore unenforceable. As such, the decision presents an important consideration when drafting multi-tiered dispute resolution clauses, giving legal opinions as to their enforceability and advising as to the need to comply with escalation provisions before commencing proceedings.
The dispute concerned an agreement between the applicant and respondent for the sale and purchase of iron ore. The applicant (the purchaser) failed to lift the quantity of iron ore which it was expected to take up, in contravention of the terms of the agreement. The respondent (the seller) served notice of termination and claimed USD 45.5 million in respect of liquidated damages. The respondent gave the applicant 14 days in which to make the payment before it would refer the dispute to arbitration. Payment was not received within that time and the respondent commenced arbitration proceedings.
The agreement contained a dispute resolution clause – clause 11 – which provided a two-tiered mechanism for the resolution of disputes. Under clause 11.1, the parties agreed to "first seek to resolve the dispute or claim by friendly discussion". If the parties were not able to reach a solution within a continuous period of four weeks, the clause provided that "the non‑defaulting party can invoke the arbitration clause and refer the disputes to arbitration." The mechanism for arbitration was set out in clauses 11.2 and 11.3.
The applicant argued that the tribunal had no jurisdiction to determine the dispute on the ground that clause 11.1 provided a condition precedent to arbitration which had not been satisfied. The respondent asserted that the purported condition precedent was unenforceable as it was a mere agreement to negotiate. Alternatively, if it was enforceable, it had been satisfied.
The tribunal agreed with the respondent's case on both its primary and alternative arguments and found that it did have jurisdiction to determine the dispute. The applicant appealed to the High Court under s67 Arbitration Act 1996, seeking an order that the tribunal had no jurisdiction.
Court agrees with the tribunal
The court held that: (1) the obligation to engage in friendly discussions over a four-week period was enforceable and acted as a condition precedent to arbitration; and (2) the parties had satisfied the condition precedent of engaging in friendly discussions for four weeks and therefore were entitled to commence arbitration proceedings. As a result, the arbitral tribunal had jurisdiction to hear and determine the dispute because the obligation to engage in friendly discussions, although an enforceable condition precedent to arbitration, had in fact been satisfied. The application was dismissed.
An enforceable obligation
Teare J adduced three key factors against which a clause requiring friendly discussions as a condition precedent to arbitration should be assessed for enforceability:
- the clause must be complete in the sense that no essential term is lacking and no further agreement is required;
- the clause must be sufficiently certain to enable the parties and the courts to understand precisely what is required in order for the condition to be satisfied; and
- the clause must allow for objective criteria to be identified by the courts by which compliance with the condition can be determined.
These factors were applied in Wah v Grant Thornton  1 Lloyd's Law Reports 11; Cable & Wireless v IBM  EWHC 2059 (Comm); and Walford v Miles  2 AC 128, in which the English court ruled that clauses similar to clause 11 were unenforceable. Teare J, however, upon an examination of the decision of Alsopp P in the Australian case of United Group Rail Services v Rail Corporation New South Wales (2009) 127 Con LR 202, was persuaded that although an "agreement to agree" was unenforceable it did not follow that "an agreement to undertake negotiations in good faith to settle a dispute arising under a contract" must also be unenforceable. Teare J concluded that the agreement in clause 11 to engage in friendly discussions for a continuous period of four weeks satisfied the test for enforceability:
- the obligation to engage in friendly discussions was a complete obligation; it could be enforced by the court without the need to imply further terms. In particular, and in contrast to a mere agreement to negotiate, there was a time limit of four weeks in which friendly discussions between the parties were to take place;
- the requirement for the parties to engage in friendly discussions was sufficiently certain to amount to an enforceable obligation. Since the obligation required the parties to seek to resolve a dispute in the context of the contractual terms between them, the discussions would necessarily concern the rights and obligations arising out of that contract. Rather than there being open-ended discussions regarding each party's commercial interests in isolation, any settlement would reflect the bargain that had been made by the parties;
- the agreement to engage in friendly discussions in good faith has an identifiable standard – "namely, fair, honest and genuine discussions aimed at resolving a dispute" – upon which the court could base its assessment as to whether the agreement had been fulfilled. Teare J emphasised that while in some cases it might be difficult for the courts to identify breaches of agreements to engage in discussions, in other cases they would be readily able to identify conduct which departed from that which could be expected of parties who had agreed to engage; and
- finally, Teare J held that it was in the interest of public policy to enforce the obligation. The parties had freely undertaken to submit to this obligation in their contractual negotiations, and could expect the courts to enforce it. Furthermore, the object of the clause was to avoid expensive and time consuming dispute resolution which is consistent with the public policy of encouraging parties to attempt to settle disputes before resorting to arbitration or litigation.
Having established that the wording of clause 11 amounted to an enforceable condition precedent to arbitration, Teare J considered whether, on the facts, the parties had engaged in "friendly discussion" for a continuous period of four weeks. It was not disputed that the discussions between the parties were "friendly". It was also clear from the facts before the court that "various proposals were aired", amounting to discussions aimed at resolution of the dispute.
As to the time period in which the friendly discussions were to take place, Teare J found that there was no requirement for the discussions themselves to last for a continuous period of four weeks. Rather, the time stipulated in clause 11 simply provided for a period of time to elapse before arbitration could be commenced; thus making the condition complete and sufficiently certain. The wording achieved commercial sense: it ensured both that a defaulting party could not postpone the commencement of arbitration indefinitely by continuing to discuss the claim, and that a claimant eager to commence arbitration had the opportunity to consider such proposals as might emerge from a four-week period in which discussions were to take place.
Comment: The decision represents a departure from what Teare J himself described as the previous "settled state of English law". The previous line of authority had considered these types of clauses to be mere agreements to negotiate and therefore unenforceable. To the contrary, Teare J preferred the reasoning applied in the Australian authority and a finding that a similar clause did amount to an enforceable condition precedent to arbitration. This reasoning was perhaps particularly attractive to the judge in light of the English Civil Procedure Rules and the obligation for parties to engage in settlement attempts before commencing proceedings.
In light of this judgment, transactional and dispute resolution lawyers dealing with these sorts of multi‑tiered clauses should consider carefully any conditions to commencing proceedings and address the risk that proceedings may be deemed invalid if commenced prior to their satisfaction.