Dispute escalation clauses: lessons from the Court of Appeal

Nick McQueen and Inam Hasan highlight important lessons to learn from a recent Court of Appeal case in the construction sector on the enforceability and effect of dispute escalation clauses.

Dispute escalation clauses (or ‘tiered’ dispute resolution clauses) can be a useful tool. They can be structured to allow time for and/or mandate the use of negotiation, mediation or other forms of Alternative or Negotiated Dispute Resolution (ADR/NDR) before a dispute proceeds to formal litigation or arbitration.

Why is this case of interest?

When a party issues proceedings in breach of a dispute escalation clause, the court is ordinarily likely to stay those proceedings until the dispute resolution procedure set out in the clause is completed. One reason the recent case of Kajima Construction Europe (UK) Limited and Kajima Europe Limited v Children’s Ark Partnership Limited [2023] EWCA Civ 292] is of interest is how the Court of Appeal dealt with two complicating factors.

Firstly, the prescribed dispute resolution procedure was described by the High Court judge as a condition precedent to court proceedings, so that contractually it should have been completed before any proceedings were started. Because of this, Kajima sought to strike out the claim in its entirety, arguing that the court either had no jurisdiction or, if it did, it shouldn’t exercise it. Secondly, if the claim was struck out, it appeared likely that any fresh claim would be statute-barred. Merely staying the proceedings would therefore deprive Kajima of a limitation defence.

The decision is also a cautionary reminder to contracting parties of the importance of sufficiently clear drafting if they want their dispute escalation clause to be enforceable. As the judge giving the leading judgment said in this case: “Whilst the court has to endeavour to enforce the agreement between the parties, it should not overstrain to do so, so as to arrive at an artificial result.”

In summary, the Court of Appeal upheld the High Court’s decision that the dispute resolution procedure in this case was unenforceable for uncertainty. And while a stay of proceedings is the usual remedy, it’s not a “default remedy” in the sense of an automatic or inevitable relief which the court will grant where a party has ignored a contractual dispute resolution procedure. The right remedy will always turn on the individual facts.

Deprivation of a limitation defence is an important element of the balancing exercise that a court will undertake, but it can’t be decisive on its own. In the only case authority identified where proceedings were struck out, deprivation of a limitation defence was only decisive because it was balanced against the judge’s finding of unreasonableness on the claimant’s part. That wasn’t the case here. The proportionate order was for a stay.

It’s notable that despite the parties settling the matter out of court 12 days after the hearing, the Court of Appeal nonetheless proceeded to finalise and hand down the judgment, noting that the points raised were of some importance generally.

What practical advice arises?

To be enforceable, dispute escalation clauses must be precise and clearly drafted, setting out each party’s obligations during an intended ADR/NDR process. The key is to consider what the parties want to achieve when agreeing to a dispute escalation clause and exactly what the contract must expressly state in order to make this intention effective.

Parties should make sure the clause: provides for a certain and unequivocal commitment to commence the ADR/NDR process (if that’s what’s intended); sets out clear steps that each party is required to take to effect the process; and defines the extent of the process sufficiently so that the parties know exactly the point at which they have a right to start formal litigation or arbitration proceedings.

The process to be followed doesn’t have to be formal, but it must be sufficiently clear and certain, without requiring any further agreement between the parties (an ‘agreement to agree’ will be unenforceable). That means that all steps in the process, including machinery for the appointment of any mediator or other expert, must be comprehensively specified. This may include incorporating the procedures of an external ADR/NDR body. The clause should also address matters such as clarification of the issues in dispute, confidentiality, any time limits and the consequences of any failures to comply with the clause.

This case highlights the importance of making sure that dispute escalation clauses are drafted with the specific contract in mind. Think carefully, for example, before simply copying the clause from a head contract into a subcontract.

Parties faced with a limitation deadline should try to engage with any contractual dispute resolution process and seek to agree a standstill arrangement. If that isn’t possible, the best course is likely to be to commence proceedings and ask the court for a stay. Always seek specialist advice.

Remember that, when deciding what order to make, the court will take into account the reasonableness of the party’s conduct – what reasons did they have for breaching the terms of the dispute escalation clause and commencing proceedings?

What were the facts of this case?

Children’s Ark Partnership (CAP) entered into a project agreement with an NHS Trust to redevelop a hospital. CAP subcontracted Kajima to undertake the design and construction works. The project agreement and construction contract contained substantially the same dispute escalation clause which provided that all disputes were to be referred first to a ‘Liaison Committee’ – comprising representatives of CAP and the Trust – for resolution. The Liaison Committee was to seek to resolve any referred dispute within 10 business days, and its decision would be final and binding unless otherwise agreed.

Following the Grenfell Tower tragedy in 2017, 10 years after the initial works were completed, checks were undertaken in respect of the cladding and fire-stopping works at the hospital. Kajima was notified of concerns and agreed to conduct remedial works at its own cost, without admission of liability. The original limitation period expired in April 2019, but as a result of the remedial works, the parties entered into several standstill agreements which had the effect of extending the limitation period. When Kajima indicated that it wouldn’t enter into any further standstills, CAP commenced proceedings and sought a stay until the parties had engaged with the Liaison Committee.

Why was the dispute escalation clause unenforceable?

Taken together with other factors, the five reasons noted by the High Court judge led the Court of Appeal to similarly conclude that the clause was unenforceable:

• There was no meaningful description of the process to be followed. It was unclear how the Liaison Committee would seek to resolve the dispute, particularly in the absence of Kajima, one of the parties to the construction contract. There was no obligation on the Trust (which was represented on the Committee) to play its part in any particular way.
• There was no unequivocal commitment to engage in any particular ADR/NDR procedure. In circumstances where Kajima was not obliged to take part in the process, and had no right to do so, it was impossible to see how the process could be said to “provide a means of resolving disputes or disagreements between the parties amicably“. Among other things, the Court of Appeal referred to case law which talks of the need for a binding contractual process to contain a definable minimum duty of participation.
• It was unclear how a dispute between CAP and Kajima should be referred to the Committee.
• It was unclear what impact any decision of the Committee had on Kajima. If “the parties” referred to were the Trust and CAP, then the process had no final binding effect on Kajima and so was rendered pointless. If “the parties” was a reference to CAP and Kajima then it would subject Kajima to a final and binding decision from a committee of which it wasn’t a member.
• It was unclear when the process of referral to the Liaison Committee ended, so it was unclear when the condition precedent was satisfied. The Court of Appeal rejected Kajima’s argument that the condition precedent to litigation was limited to the initial referral.

Nick McQueen is a Commercial Dispute Resolution Partner and Inam Hasan is a Construction & Engineering Associate at Walker Morris.