Articles. Hugs All Round: Have You Been Sufficiently Friendly to the Other Side? Markus Esly The Arbiter Fall 2014

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1 Hugs All Round: Have You Been Sufficiently Friendly to the Other Side? Markus Esly The Arbiter Fall 2014 In a recent decision, the Commercial Court held that a clause requiring the parties to seek to resolve any disputes by engaging in friendly discussions before commencing arbitration proceedings was enforceable: it prevented anyone from commencing formal proceedings unless and until they had, in effect, had a sufficiently friendly discussion with the other side. These kinds of provisions, requiring discussions or negotiations or attempts to reach an amicable settlement, are sometimes found in tiered dispute resolution clauses as the first step in the contractual mechanism. Until fairly recently, the received wisdom was that English law tended to be against treating such clauses as imposing binding conditions precedent - though, as ever in the law of contract, everything depends on the wording of the clause in question. However, in Emirates Trading Agency Llc v Prime Mineral Exports Private Ltd [2014] EWHC 2104, Teare J upheld such a clause, disagreeing with a number of decisions at first instance that went the other way. The judge reviewed the conduct of the parties during negotiations about their claims, to see whether they had been sufficiently friendly before calling in the arbitrators. One may ask how this can be. Isn t English commercial law supposed to be cold-blooded, rational and unimpressed by warm and fuzzy notions of this sort? The answer lies in the resurgence of the duty to act in good faith. Such a duty can be legally binding even in commercial contracts if it is expressly incorporated. The question, however, is whether the Commercial Court in Emirates went too far in applying this concept to a dispute resolution provision. The old school of thought - certainty is key English law requires contracts and their terms to be (sufficiently) certain for them to be enforceable. It has often been said that an agreement to negotiate, or an agreement to agree something in the future, lack such certainty. In the words of Lord Denning (Courtney & Fairbairn Ltd v Tolaini Bros. (Hotels) Ltd [1975] 1 WLR 297): If the law does not recognise a contract to enter into a contract (when there is a fundamental term yet to be agreed) it seems to me it cannot recognise a contract to negotiate. The reason is because it is too uncertain to have any binding force. No court could estimate the damages because no one can tell whether the negotiations would be successful or would fall through: or if successful, what the result would be. It seems to me that a contract to negotiate, like a contract to enter into a contract, it is not a contract known to the law. Consistent with this approach, English law generally accepts that in commercial negotiations, the parties are essentially trying to get the best deal they can for themselves and owe no duties to their counterparty. Short of fraud and dishonesty, anything goes in negotiations. In a famous decision by the House of Lords (Walford v Miles [1992] 2 AC 126), Lord Ackner noted that: While negotiations are in existence either party is entitled to withdraw from those negotiations at any time and for any reason. There can thus be no obligation to continue to negotiate until there is a proper reason to withdraw. Accordingly, a bare agreement to negotiation has no legal content. The decision of the House of Lords in Walford v Miles has frequently been referred to as confirming the principle that there can be no agreement to agree. So if final drafts of agreements are on the table, ready for signature following months of protracted, expensive negotiations, and you do not like the colour of the tie worn by the other party s CEO to the completion meeting, feel free to walk out on the deal. There should be no legal consequences under English law. The first subtle signs of changes to come? Such statements of principle are, however, all concerned with the question whether there is a binding contract at all. As the Court of Appeal noted almost 10 years ago, an agreement to negotiate in good faith contained in a fully drafted contract is likely to be enforceable (Petromec Inc v Petroleo Brasileiro SA Petrobras [2005] EWCA Civ 891). That case concerned a

2 clause under which the parties had agreed to negotiate in good faith as regards the reasonable costs that one of them would incur in relation to upgrade works to a chartered vessel. The provision was part of a complex agreement drafted by well-known City of London solicitors. The intention behind the clause was that, once the reasonable costs had been agreed or established, the party incurring these costs ought to be compensated appropriately by the counterparty. English law has, of course, never had any trouble with identifying reasonable costs. The Court of Appeal noted that it would not be unduly difficult to determine to what extent the party seeking to recover the reasonable costs of the upgrade works in question might be entitled to any uplift. Equally, a judge could also determine whether negotiations were terminated in bad faith. Mance LJ perhaps sowed the first seeds of the change in approach that we will come on to, by hinting that Walford v Miles might eventually be reconsidered at the highest level of the English Courts: It would be a strong thing to declare unenforceable a clause into which the parties have deliberately and expressly entered. I have already observed that it is of comparatively narrow scope. To decide that it has no legal content to use Lord Ackner's phrase would be for the law deliberately to defeat the reasonable expectations of honest men, to adapt slightly the title of Lord Steyn's Sultan Azlan Shah lecture delivered in Kuala Lumpur on 24th October 1996 (113 LQR 433 (1977)). At page 439 Lord Steyn hoped that the House of Lords might reconsider Walford v Miles with the benefit of fuller argument. That is not an option open to this court. I would only say that I do not consider that Walford v Miles binds us to hold that the express obligation to negotiate as contained in clause 12.4 of the Supervision Agreement is completely without legal substance. Three examples of dispute resolution clauses that failed for want of certainty English law draws no distinction between contractual obligations relating to the substance of the parties rights and dispute resolution clauses. All contractual terms are governed by the same basic principles of contract law. A good example of the general principles as expounded by Lord Denning and Lord Ackner being applied in the context of tiered dispute resolution clauses can be found in the decision of Colman J in Cable & Wireless Plc v IBM United Kingdom Ltd [2002] EWHC The learned judge was asked to order a stay because a provision requiring mediation had not been complied with. In that context, Colman J held that: There is an obvious lack of certainty in a mere undertaking to negotiate a contract or settlement agreement, just as there is in an agreement to strive to settle a dispute amicably That is because a court would have insufficient objective criteria to decide whether one or both parties were in compliance or breach of such a provision. No doubt, therefore, if in the present case the [clause]had simply provided that the parties should attempt in good faith to resolve the dispute or claim, that would not have been enforceable. The relevant clause however went further, and provided for mediation pursuant to the rules of a well-known institution administering mediation services. These mediation rules set out precisely how a mediator ought to be selected, required the parties to set out their positions in mediation statements and to attend in person before the mediator on the appointed day. There was no difficulty at all in determining whether a party had followed that procedure. There is nothing in the judgment to suggest that a party could not, if they wished, spend the entire mediation sat in silence. They would still have satisfied the condition precedent that Colman J found existed. Two years ago, a less well-drafted mediation clause led to a decision by the Court of Appeal that seemed to settle the law on this point. In Sulamérica CIA Nacional de Seguros SA v Enesa Engenharia SA [2012] EWCA Civ 638, the clause in question provided: 11. Mediation If any dispute or difference of whatsoever nature arises out of or in connection with this Policy including any question regarding its existence, validity or termination, hereafter termed as Dispute, the parties undertake that, prior to a reference to arbitration, they will seek to have the Dispute resolved amicably by mediation.

3 The mediation may be terminated should any party so wish by written notice to the appointed mediator and to the other party to that effect. Notice to terminate may be served at any time after the first meeting or discussion has taken place in mediation. If the Dispute has not been resolved to the satisfaction of either party within 90 days of service of the notice initiating mediation, or if either party fails or refuses to participate in the mediation, of if either party serves written notice terminating the mediation under this clause, then either party may refer to the Dispute to arbitration. The Court of Appeal was invited to uphold the clause, on the basis that it identified at least three clear conditions precedent to commencing arbitration proceedings, in the form of a notice stating that a dispute would be referred to mediation, and either (based on the final paragraph of the clause): a failure to reach a settlement after 90 days; a party failing or refusing to participate in the mediation; or either party serving notice that the mediation is terminated (having participated to some extent). The Court of Appeal found that the clause was unenforceable, despite acknowledging that whoever drafted the clause had plainly intended for it to be enforceable, and had very probably thought that this had been achieved. The key factor that swayed the Court of Appeal to reach its conclusion was that no mediation provider was identified, and there was no procedure for a mediator to be selected: The most that might be said is that it imposes on any party who is contemplating referring a dispute to arbitration an obligation to invite the other to join in an ad hoc mediation, but the content of even such a limited obligation is so uncertain as to render it impossible of enforcement in the absence of some defined mediation process. The clause therefore had no legal effect whatsoever: it did not require either party to serve a notice, nor did it require the parties to simply wait for 90 days before going to arbitration. Not long after Sulamérica was decided, the High Court had occasion to review another clause, which on its face required discussions at the management level before a dispute could be referred to arbitration. In Wah v Grant Thornton International Limited [2012] EWHC 3198, a number of parties had entered into a partnership agreement to establish a partnership governed by Hong Kong law. That partnership became a member of Grant Thornton s international network of offices. Grant Thornton International Limited ( GTIL ) was the umbrella organisation overseeing that network. GTIL expelled the Hong Kong partnership, which led to litigation. All parties to the claim, including GTIL, had agreed to the following as part of dispute resolution procedure in the contract: (a) Any dispute or difference shall in the first instance be referred to the Chief Executive in an attempt to settle such dispute or difference by amicable conciliation or an informal nature. The conciliation provided for in this Section shall be applicable notwithstanding that GTIL may be a party to the dispute or difference in question. (b) The Chief Executive shall attempt to resolve the dispute or difference in an amicable fashion. Any party may submit a request for such conciliation regarding any such dispute or difference, and the Chief Executive shall have up to one (1) month after receipt of such request to attempt to resolve it. (c) If the dispute or difference shall not have been resolved within one (1) month following submissions to the Chief Executive, it shall be referred to a Panel of three (3) members of the Board to be selected by the Board, none of whom shall be associated with or in any other way related to the Member Firm or Member Firms who are parties to the dispute or difference. The Panel shall have up to one (1) month to attempt to resolve the dispute or difference.

4 (d) Until the earlier of (i) such date as the Panel shall determine that it cannot resolve the dispute or difference, or (ii) the date one (1) month after the request for conciliation of the dispute or difference has been referred to it, no party may commence any arbitration procedures in accordance with this Agreement. Hildyard J held that this clause was unenforceable, describing the process that it envisaged as even less certain than an agreement to negotiate, which is plainly unenforceable. Considering that the clause had been carefully drafted out, with the intention that it should be mandatory, it is interesting to see just how the learned judge arrived at this conclusion. Having reviewed the authorities concerning dispute resolution provisions that provide for mediation, conciliation or negotiation, Hildyard J commented that while the courts would strive to give effect to clauses that the parties wanted to be binding, there was often a difficulty in taking what they had agreed and giving it some objective and legally controllable substance. Agreements to agree, or to negotiate in good faith, were unenforceable, because their content cannot be sufficient defined. The only exception to this is where a clause provided for agreement on a reasonable price. Ultimately, the question was whether each particular clause was sufficiently certain. As regards a dispute resolution clause: In the context of a positive obligation to attempt to resolve a dispute or difference amicably before referring a matter to arbitration or bringing proceedings the test is whether the provision prescribes, without the need for further agreement, (a) a sufficiently certain and unequivocal commitment to commence a process (b) from which may be discerned what steps each party is required to take to put the process in place and which is (c) sufficiently clearly defined to enable the Court to determine objectively (i) what under that process is the minimum required of the parties to the dispute in terms of their participation in it and (ii) when or how the process will be exhausted or properly terminable without breach. The clause in question did not pass that test. The learned judge found that the process of dispute resolution that the Chief Executive was to undertake was insufficiently certain. It was not enough to prescribe that he or she should attempt to resolve the dispute in an amicable fashion. One was left not knowing precisely what that meant: for example, were the parties to participate in this, and if so, how? The next step, also described in insufficiently certain terms, was the reference to the Panel. Again, the clause made reference to attempts to resolve the dispute, but did not go on to explain the nature and quality of the attempts that should be made in this context. The new approach in Emirates Against that background, on 1 July 2014, Teare J handed down his judgment in Emirates, finding that the following provision was sufficiently certain to be enforceable: 11.1 In case of any dispute or claim arising out of or in connection with or under this [agreement]... the Parties shall first seek to resolve the dispute or claim by friendly discussion. Any party may notify the other Party of its desire to enter into consultction [sic] to resolve a dispute or claim. If no solution can be arrived at in between the Parties for a continuous period of 4 (four) weeks then the non-defaulting party can invoke the arbitration clause and refer the disputes to arbitration. The dispute arose under a contract for the sale of iron ore. The claimants, the buyers, failed to take delivery of agreed quantities under the contract on several occasions. On 1 December 2009, the sellers served notice of termination by reason of the buyer s failure to take delivery goods (or pay the price), and claimed the sum of US$ 45.4 million in liquidated damages under the contract for sale. In June 2010, the sellers referred the matter to arbitration. The buyers objected, arguing that the tribunal had no jurisdiction because the sellers had not engaged in friendly discussions between December 2009 and June The sellers, in turn, argued that the clause in question was incapable of giving rise to any enforceable obligation. As the learned judge noted, the buyers set out to persuade him not to follow what appeared to be the settled state of English law - and they succeeded. Teare J undertook a full review of the authorities, including Australian and Singaporean decisions. One particular decision of the New South Wales Court of Appeal (United Group Rail Services v Rail Corporation New South

5 Wales (2009) 127 Con LR 202), considering a clause requiring a genuine and good faith negotiation with a view to resolving the dispute, was expressly at loggerheads with Lord Ackner and Walford v Miles, but was nonetheless quoted extensively by the Commercial Court in Emirates. A number of propositions from this Australian decision were referred to with apparent approval by Teare J (who described them as cogent reasoning ). One particular passage (striking at least to any English contract lawyer with a traditional outlook) noted that an obligation to undertake honest and genuine discussions about something in an attempt to reach an identified result was not incomplete. Courts could assess the value of negotiations (which might turn out to be successful or unsuccessful), just as they can assess the value of a lost commercial opportunity, as illustrated by Chaplin v Hicks [1911] 2 KB 786, where damages were awarded for the lost opportunity to appear in a beauty contest. It is to be noted that the beauty contest in Chaplin v Hicks would have been decided, and a winner declared, through the relevant procedure. The outcome of commercial negotiations on the other hand depends on agreement, and one party can always (even unreasonably) refuse to agree something. In the context of good faith negotiations to resolve a commercial dispute, however, a party did not have complete freedom to disagree. Such negotiations were limited and defined (and parties were constrained) by the underlying bargain as embodied by their contract. As the New South Wales Court of Appeal noted: the constraint arises from the bargain the parties have willingly entered into. It requires the honest and genuine assessment of rights and obligations and it requires that a party negotiate by reference to such. A party, for instance, may well not be entitled to threaten a future breach of contract in order to bargain for a lower settlement sum than it genuinely recognises as due. That would not, in all likelihood, reflect a fidelity to the bargain. A party would not be entitled to pretend to negotiate, having decided not to settle what is recognised to be a good claim, in order to drive the other party into an expensive arbitration that it believes the other party cannot afford. If a party recognises, without qualification, that a claim or some material part of it is due, fidelity to the bargain may well require its payment. That, however, is only to say that a party should perform what it knows, without qualification, to be its obligations under a contract. Illustrating this by way of an example, if a party in the course of good faith negotiations demanded 1 million, having been advised or otherwise believing that it was only due 500,000, then it would be in breach of any obligation to negotiate in that manner. That was not quite, however, how Teare J saw it. Having concluded that the obligation to seek to resolve disputes by friendly discussions was really the same as an obligation to seek to do so in good faith (referring to the masterly discussion by Leggatt J in Yam Seng Pte Ltd. v International Trade Corporation Ltd. [2013] EWHC 111 (QB) on such implied duties of good faith in English law), Teare J concluded that a party negotiating with a view to a settlement in good faith was entitled to take into account not just its entitlement under the contract, but also its wider commercial interest. In his view, the passage cited above from the judgment of the New South Wales Court of Appeal about constraints in negotiations imposed by the underlying bargain was unrealistically narrow, and in English law, the matters that parties could take into account (or legitimately raise ) when negotiating a potential settlement in good faith were unlimited (though presumably honesty or a genuine belief in an entitlement would always be required). In conclusion Teare J disagreed with a number of decisions at first instance, including Wah v Grant Thornton, and summarised his reasoning as follows: The agreement is not incomplete; no term is missing. Nor is it uncertain; an obligation to seek to resolve a dispute by friendly discussions in good faith has an identifiable standard, namely, fair, honest and genuine discussions aimed at resolving a dispute. Difficulty of proving a breach in some cases should not be confused with a suggestion that the clause lacks certainty. In the context of a dispute resolution clause pursuant to which the parties have voluntarily accepted a restriction upon their freedom not to negotiate it is not appropriate to suggest that the obligation is inconsistent with the position of a negotiating party. Enforcement of such an agreement when found as part of a dispute resolution clause is in the public interest, first, because commercial men expect the court to enforce obligations which they have freely undertaken and, second, because the object of the agreement is to avoid what

6 might otherwise be an expensive and time consuming arbitration. On that basis, the judge found that the clause prohibited arbitration proceedings unless friendly discussions had taken place and the dispute was not resolved after a period of four weeks had elapsed since the commencement of such discussions. The Commercial Court then went on to consider, on the facts, whether the parties had, in effect, been sufficiently friendly. To succeed, the buyers needed to take the position that they had been friendly (acting in good faith), but that the sellers had not. The judgment does not contain much in terms of detail of what was said during the relevant meetings about the liquidated damages claim for US$ 45 million. The judge did not review the arguments for and against that claim, nor was there any discussions of what specific proposals or counterproposals were made, or should have been made as reasonable or friendly, bearing in mind the parties contractual entitlements or their commercial imperatives. The absence of such discussion in the judgment may be a reflection of the claim in question having been fairly simple in legal terms: it does not seem that the buyers had a good reason for not taking delivery of the goods, other than their apparent inability to pay. The gist of the judge s findings on the facts was that the buyers had genuinely sought to find other parties who could take the shipment and somehow pay for it, but had ultimately failed to do so. Had such other willing buyers been found, the contract would have continued - either on the assumption that there would have been some kind of on-sale, or that the new buyers might have taken over the contract. It appears to have been common ground that meetings in December 2009 were friendly. There were then further meetings and discussions between the parties prior to the reference to arbitration in June 2010, and there was no indication that the sellers had acted in bad faith during those meetings. Having won an impressive victory on the law, the buyers lost on the facts. A critical review: did Emirates go too far? The decision in Emirates has given rise to considerable debate. It undoubtedly represents a departure from other decisions on similar clauses. The decision of the House of Lords in Walford v Miles was distinguished, on the basis that their Lordships were concerned with the question whether an agreement to agree could ever lead to a binding contract (the entire course of discussions was subject to contract ). In Emirates, there was already a binding contract in place. That may be a distinction that can be drawn, but there is something to be said for the view that the principle of certainty should apply to each and every clause in a contract. If ten clauses in an agreement are properly drafted, and are certain and enforceable, that of itself may not be a good reason why an eleventh provision, which is missing a key term, ought to be treated differently. It is also not obvious that the decision of the Court of Appeal in Sulamérica left Teare J a great deal of room for reaching his conclusion, as he in fact decided. Both Cooke J at first instance and the Court of Appeal noted that the clause in Sulamérica lacked a definitive or unequivocal undertaking to refer matters to mediation - the clause only said that they will seek to have the Dispute resolved amicably by mediation. As the Court of Appeal put it: The most that might be said is that it imposes on any party who is contemplating referring a dispute to arbitration an obligation to invite the other to join in an ad hoc mediation, but the content of even such a limited obligation is so uncertain as to render it impossible of enforcement in the absence of some defined mediation process. The clause in Emirates referred to seek[ing] to resolve the dispute or claim by friendly discussion. That wording ( seeking ) is not unequivocal or definitive, but this did not cause Teare J concern. Since this point is one of construction and depends on the wording of the particular contract, in the final analysis Sulamérica would not have been binding on Teare J, though any distinction would be a fine one. The judge in Emirates decided that the distinguishing factor in Sulamérica, which was fatal to that clause, was the absence of any way of determining the mediator. Since friendly discussions do not require any such third party to oversee them, Teare J felt able to uphold the clause in Emirates. At the same time, Teare J found that the reference to friendly in the clause imported an obligation of good faith. Applying that approach to the clause in Sulamérica (which referred to an amicable mediation), it could be argued that the parties were obliged, in good faith, to ask any of the well-known mediation institutions to provide them with a mediator if they could not agree on one, so as not to frustrate the

7 obvious intention behind the clause. Teare J did not, however, proceed down that route. Arguably, on Teare J s reasoning, a clause providing for an amicable mediation imposes restraints on the parties and ought to require them at least to pick up the phone to an appointing body to ask for a mediator, because the object of the agreement is to avoid what might otherwise be an expensive and time consuming arbitration. Perhaps the most potent criticism of the decision in Emirates is that it has undesirable practical consequences. If clauses are construed in this way, then this requires a review of evidence by the courts of what the parties said or did in settlement negotiations. What if those discussions take place on a without prejudice basis so that no Court or tribunal ought ever to hear of the content of these discussions? Frank and open discussions during, and concession made in, without prejudice meetings may provide the best chances of reaching a commercial settlement. A party may either use the cloak of without prejudice discussions to hide negotiations that are in bad faith, or may be prevented from rebutting an allegation that it was guilty of bad faith during without prejudice meetings. Either way, this presents difficulties. Finally, it is not at all clear how a review or analysis of whether on the facts of the case, a party in fact negotiated in good faith would proceed in circumstances where the claim is more complex than that in Emirates. Would the Court have to review the comparative legal merits of positions taken? Suppose a party insists on its claim, makes no concessions and demands to be paid in full, genuinely believing that it has a cast iron claim. Does such a party run the risk of appearing to be unreasonable because of an underlying assumption that striving for a settlement in good faith brings with it a readiness to make at least some concession (after all, the object is to avoid an expensive arbitration, according to Teare J)? What if that party is subsequently entirely vindicated by the tribunal? Taking a step back, it does not seem desirable that a court or even a tribunal should be asked to consider the substance of what parties were saying to each other in any settlement discussions. Emirates seems to create more problems than it solves, and it remains to be seen whether other English Courts (including the Court of Appeal) will take the same view. Other articles from this issue of The Arbiter: Can Your Emergency Wait 17 Days? Witnesses Say the Funniest Things Click here to contact Markus Esly. Click here to download the full issue. A past performance or prior result is no guarantee of a similar future result in another case or matter. Hunton Andrews Kurth LLP is responsible for the content of this website. Hunton Andrews Kurth LLP is a Virginia limited liability partnership. Hunton Andrews Kurth, the Hunton Andrews Kurth logo, Hunton AK and the Hunton AK logo are service marks of Hunton Andrews Kurth LLP. Hunton Andrews Kurth (UK) LLP is authorized and regulated by the Solicitors Regulation Authority of England and Wales (SRA Registration No ). Andrews Kurth Kenyon DMCC is registered and licensed as a Free Zone company under the rules and regulations of DMCCA. Attorney Advertising.