Mandatory mediation for commercial disputes in Hong Kong

21 September 2004

Edward Alder, Rosamund Cresswell

In its March 2004 Final Report, the Judiciary’s Working Party on Civil Justice Reform recommended against the introduction of court ordered mandatory mediation in Hong Kong. But the recommendations made in respect of the court’s costs powers combined with recent developments in contract law and practice, may lead Hong Kong through the backdoor to mediation that is all but mandatory.

Introduction

ADR, particularly mediation, has been a key feature of commercial dispute resolution in Australia and North America for 20 years. The United Kingdom, initially a reluctant follower, has seen an enormous increase in interest in commercial ADR in the last five years, so much so that Lightman J (in Hurst v Leeming [2003] 1 Lloyd’s Rep 379) has gone so far as to describe ADR as being at the ‘heart of today’s civil justice system’. This change has come about in part, but not entirely, as a result of the pro-settlement root and branch reform wrought by the Civil Procedure Rules (CPR) in 1999.

For some years, a small but dedicated ADR community has existed in Hong Kong, with the Hong Kong Mediation Council and the Hong Kong Mediation Centre at the forefront. But it is fair to say that, outside the construction industry, commercial ADR remains in its infancy here.

That is no criticism of those involved in ADR in Hong Kong. Indeed, in considering the various objections to mandatory mediation put forward in its public consultation, the Working Party (at paras 870ff of the Report) rejected an argument that Hong Kong lacks sufficient ADR ‘infrastructure’ to support regular court referred mediation. The point is more a reflection of prevailing attitudes amongst litigation lawyers and commercial litigants themselves.

This is set to change. Court encouraged or enforced ADR will increase once the Report’s recommendations are implemented, and in the meantime recent local and overseas case law has served to dispel remaining doubts over the Hong Kong courts’ attitude to the enforceability of pre-commitment to ADR by contract.

The Judiciary’s Report

The Position in England under the CPR

In England the courts are now required by CPR 1.4(2) (Court’s duty to manage cases) para (e) to encourage parties to use ‘an ADR procedure’ if appropriate and to facilitate such procedures. This is the first ever mention of ADR in any court rules in the UK.

The CPR again mentions ADR in the context of the ‘case allocation’ stage of proceedings. Under Part 26, once a Defence is filed the parties are each required to file an ‘Allocation Questionnaire’ for use at a hearing at which the case will be allocated to one of the procedural ‘tracks’.

CPR 26.4 provides that a party may include in its Allocation Questionnaire a request that the action be stayed while the parties try to settle through ADR. The rule permits the court, either upon such a request or on its own initiative, to stay the action for a month.

The effect of ADR on costs orders is discussed below, but it is worth noting here the powers of the English courts as regards costs. Under CPR 44.3(2) the general rule is that the unsuccessful party is to pay the costs of the successful party ‘but… the court may make a different order’. Under CPR 44.3(4) the court in making any costs order must have regard to ‘all the circumstances of the case’ including the conduct of the parties before, as well as during, the proceedings and in particular the extent to which the parties followed any relevant pre-action protocol.

These powers plainly allow the court to take into account the parties’ attitudes towards ADR when making costs orders.

The English courts do not, as yet, make truly mandatory ADR orders. However, orders are regularly made which put considerable pressure on the parties to attempt settlement via ADR by exposing unreasonable conduct to the court and putting the parties at risk of adverse costs orders where they are unable to provide the court with a satisfactory explanation as to why ADR was not attempted or successful.

The Commercial Court Guide contains a draft ‘ADR Order’ for use at the case management conference (which is some time after the ‘allocation’ hearing). The Commercial Court and the Technology and Construction Court now regularly make orders in this form and it provides, by stages, for the appointment of a mediator, the taking of ‘such steps as the parties may be advised’ to resolve the dispute by mediation and the informing of the court at a resumed hearing of what steps were taken and why they failed.

The draft ADR Order does not in fact provide for a stay of proceedings as envisaged in CPR 26.4, nor does it give express warning of the likely costs consequences of failure to follow the procedures. However, in practice a litigation timetable that provides for ADR in its early stages amounts in effect to a stay.

The Judiciary’s Recommendations on ADR

The Working Party considered ADR in s 29 of its Report. Six possible models or approaches to ADR (or mediation specifically) were considered. The proposals were:

63. making mediation (specifically) mandatory in defined classes of case

64. giving judges a discretion to require parties to resort to a mode of ADR and to stay proceedings in the meantime

65. enabling one party to compel the other(s) to resort to a mode of ADR and obtain a stay of the proceedings in the meantime

66. enabling the Director of Legal Aid to make attempting ADR a condition of legal aid in appropriate cases

67. making it clear in the Rules that an unreasonable refusal of ADR or unreasonable conduct during ADR puts the guilty party at risk of a costs sanction

68. enabling the court to facilitate voluntary mediation.

The Working Party rejected the first three and accepted the last three in Recommendations 141, 143 and 138 respectively.

In essence, full court ordered ADR and the approach (which found favour in England) of enabling parties to seek, or the court to impose, a stay to enable ADR to take place were rejected. The Working Party reached the view that, for moment at least (see the words ‘at present’ in Recommendation 142), the costs sanction route is most appropriate for Hong Kong.

ADR and Costs

The Judiciary’s Recommendations on Costs

The newly framed powers of the English courts to award costs are set out above. Here the existing principal governing rules on costs, RHC O 62, r 3(2), remains the same as those in England before the CPR were implemented.

It may be observed that even under the existing rule, the Hong Kong courts clearly already possess the power to deny a ‘successful’ party its costs where it is appropriate in all the circumstances of the case (which are not confined to the situation where a payment into court has been made).

However, in view of the extent to which existing costs practices are entrenched and the considerable body of case law on the subject, the Working Party was, no doubt, correct to take the view that only a rewriting of the rules on when costs should not follow the event would enable our courts to begin using costs sanctions as an effective motivator for the greater use of ADR.

The Working Party laid out the following framework for the requirements of such a rewriting:

(a) rules setting out a procedure for a party formally to request mediation and by reference to which a ‘refusal’ to mediate could be identified

(b) rules identifying a sufficient attempt at mediation so as to eliminate the risk of any adverse costs order for a successful party

(c) development of an ‘approach’ to deciding when a refusal of mediation is reasonable

Paragraph 858(j) of the Report states that what constitutes a reasonable refusal to mediate should be determined by the Hong Kong courts developing standards inductively and seeking appropriate guidance from jurisprudence in England and elsewhere. Some such cases, principally the well-publicised decision in Dunnett v Railtrack plc [2002] 1 WLR 2434, were discussed in the Report itself.

Definitive appellate guidance has now arrived in the form of the recent decision of the English Court of Appeal in Halsey v Milton Keynes General NHS Trust [2004] EWCA (Civ) 576 handed down on 11 May 2004.

Halsey v Milton Keynes General NHS Trust

This was a decision in consolidated appeals in two cases with different facts, both of which squarely raised the question of when a successful party should be deprived of its costs on the grounds of a refusal to take part in ADR. The English Law Society, the Civil Mediation Council, the ADR Group and CEDR all intervened in the appeal for the purpose of filing submissions.

The court first considered true mandatory mediation and reached the conclusion that, in view of the jurisprudence of the European Court of Human Rights on when agreements to ‘arbitrate’ can constitute an unfair restriction on the right of access to the courts, it is almost certainly beyond the powers of the English courts to order parties to ‘mediate’ against their will.

It was common ground (presumably amongst all parties and interveners) and the court accepted that parties may take whatever position they want in ADR and if the matter does not settle that is not an issue for the court. The court emphasised that the trial judge should not know and should not investigate why the process did not result in success.

The court held that whether a party has acted unreasonably will always depend on all the circumstances of the case but went on to enumerate the following non exclusive list of factors which will be relevant:

(a) The nature of the dispute. The court recognised, as even the most ardent proponents of ADR do, that some cases are unsuitable for mediation, for example test cases on the meaning of legislation.

(b) The merits of the case. A reasonable belief in the existence of a strong case will be relevant, for example a claim (or now, in England at least, a defence) fit for summary judgment. This would certainly be a factor in Hong Kong where the Working Party has recommended that the present very high threshold for obtaining summary judgment not be lowered.

(c) Other settlement methods having been attempted unsuccessfully. Chiefly, the making of reasonable settlement offers in normal bilateral negotiation.

(d) The costs of formal mediation being disproportionate high. This is only likely to be an issue in cases involving relatively small sums with short time estimates for trial and which are already well advanced by the time mediation is proposed.

(e) Delay in seeking mediation.

(f) Whether mediation has a reasonable prospect of success. The burden should not be on the party refusing ADR to satisfy the court that mediation had no reasonable prospect of success. It is always difficult to prove a negative, but in any event this approach would push the balance too far in the loser’s favour.

The court added as an additional unnumbered factor that where the court has actively encouraged the parties to attempt ADR, the form and strength of that encouragement will also be a factor. For example, the making of an ADR Order in the Commercial Court form (referred to above) will be highly significant.

The decision will be regarded as authoritative in England for some time and is likely to come to represent the law in Hong Kong in due course.

Committing to ADR by Contract

A second and no less important channel for quasi-mandatory mediation has been gathering steam alongside the procedural developments. Increasingly, contracts for large projects, particularly in the technology and construction spheres, are incorporating ADR clauses.

A typical ADR clause, if there is such a thing, will provide that where a dispute arises the parties must follow and exhaust a prescribed route through a particular ADR procedure(s), typically mediation, before commencing litigation or perhaps arbitration. (It is important to distinguish these clauses from those mandating certain ‘binding’ forms of non-litigation dispute resolution, chiefly ‘expert determination’. Such clauses are clearly enforceable and the results of the processes are binding on the parties.)

ADR pursuant to such a clause will always be voluntary in the sense that the parties consented to the inclusion of the clause in the agreement, and thus the process, at the outset of their relationship. However, a party might easily change its mind after the agreement is signed as to the suitability of ADR to particular disputes. If the court is to enforce the clause in such a situation, it will be ordering the party to undertake, what is by nature, a voluntary process against its will.

The chief legal issue with such ADR clauses is whether they may be enforced in the same manner as arbitration clauses, that is to say where one party commences litigation (or arbitration) without first exhausting the relevant ADR procedure, the other party may seek a stay of the proceedings.

The formal mechanism for staying litigation in favour of arbitration in art 8 of the UNCITRAL Model Law will not apply to a mere ADR clause. Any application for a stay has to rely on the inherent jurisdiction of the court to order a stay in order to prevent an abuse of its process.

The chief theoretical objection to the enforceability of such clauses at common law is that ADR clauses may be inherently unenforceable as a matter of contract law in that they are ‘agreements to agree’, or at least ‘agreements to negotiate’, which have long been held to be unenforceable in common law jurisdictions.

The common law aside, Hong Kong’s legislative policy is undoubtedly to encourage mediation and the existing arbitration legislation assists in the enforcement of contract mandated mediation in at least two respects.

First, ss 2A(1) and (3) of the Arbitration Ordinance supplement, which might otherwise be incomplete ‘conciliation’ clauses, by providing a mechanism for appointing conciliators in the absence of agreement and a time yardstick by which to determine when ‘conciliation’ has failed so that arbitration may commence.

Second, ss 2A(2) provides that where an arbitration agreement provides for the appointment of a ‘conciliator’ and that the person shall act as arbitrator if conciliation fails, no party may object to that person acting as an arbitrator on the ground that he previously acted as a conciliator.

This was designed to remove any right to take common law objections to such a procedure on the grounds that the person should be disqualified from sitting as arbitrator due to having had access to without prejudice discussions or having shown technical bias in the sense of having expressed views tending to prejudge issues.

However, these statutory provisions apply only to conciliation provisions within an ‘arbitration agreement’ proper and within the meaning of a 7 of the Model Law. They would not apply to an ADR clause if the agreement provided for ADR then court litigation in the event of the failure of the ADR procedures.

Even if ADR clauses are unenforceable on this basis (or any other basis), they nonetheless have profound value in simply putting ADR on the agenda. Where such a clause exists, a party can suggest ADR to the other by simply referring to the contractual provisions without any of the customary fear (if indeed it remains customary) that suggesting ADR may be interpreted as a sign of weakness.

Additionally, where the courts have the discretion to order ADR or stay litigation to facilitate ADR, such a clause will be a powerful signal to the court that the matter or relationship at hand may well be one fit to be dealt with by ADR.

Agreements to Negotiate

The traditional position at common law, in England, Australia and Hong Kong, has undoubtedly been that bare ‘agreements to agree’ and ‘agreements to negotiate’ are unenforceable - Courtney and Fairbairn v Tolaini Brothers (Hotels) Limited [1975] 1 WLR 297 and Walford v Miles [1992] 1 WLR 174 (HL). ADR clauses, the argument goes, are nothing but agreements to negotiate and ought to be unenforceable on that basis.

The reasoning behind this stance is twofold. First, it is impossible to say in any given case what stance or stances the party in default ‘ought’ to have taken in the hypothetical negotiations and it is therefore difficult to identify when a party is in breach of the obligation to negotiate. Second, even where a party is clearly in default of the obligation to negotiate, it is impossible to say what would have happened in the negotiations that ought to have taken place and thus what damages the other party ought to receive.

However, the case law on this topic has been developing in all three jurisdictions. Agreements to negotiate, and agreements to use reasonable endeavours to agree are now, it seems, potentially binding in both England and Australia, particularly when (a) there is some mechanism or objective standard that may be invoked in the negotiations, and/or (b) the obligation is coupled with some other obligation that is readily enforceable.

In Coal Cliff Collieries Pty Ltd v Sijehama Pty Ltd (1991) 24 NSWLR a 10-page Heads of Agreement (HOA) was signed for a joint venture for a coal mine. The key clause said that the parties would ‘proceed in good faith to consult together upon the formation of a more comprehensive and detailed JV agreement’. The document then set out further detailed principles of the proposed relationship.

The plaintiffs’ case was that the HOA formed a binding ‘contract to negotiate’; a detailed agreement on the basis of the substantive principles. They accepted that the HOA was not binding as a preliminary JV contract with a more detailed document to supersede it. In effect, they were contending this was a standalone ‘negotiation framework’ agreement under which the chief obligation was to put negotiated flesh on the agreed bones.

The Court of Appeal held that while a bare agreement to agree is certainly as unenforceable in Australia as in England, a duty to negotiate can, in certain cases, be enforceable (by declaration or, in case of breach, an award of damages). The clearest such case is where a third party has power to impose a solution in the event of no agreement between the parties.

But in the case at hand, the parties had not intended the obligation to negotiate to be enforceable. The document in question failed to meet the usual requirements for any document to be a contract because the content of the obligation was too vague and uncertain and on a true construction it was not intended to be legally binding. The court considered that it would be ‘extremely ill equipped’ to fill in the blanks that the parties themselves had been unable to complete despite three years of negotiations.

But the position is not entirely settled amongst appellate judges in Australia. In Coal Cliff, itself the court was overturning a carefully reasoned first instance judgment and Handley JA dissented considering that a promise to negotiate cannot be enforced. In Kurnell Developments Pty Limited & Anor v Orica Australia Pty Limed [1999] NWSCA 163 Powell JA said he agreed with Handley JA's reservation in Coal Cliff, although in the same case Giles JA did not, and he noted that it appears from Australia & New Zealand Banking Group Limited v Frost Holdings Pty Limited [1989] VR 695 that the position in Victoria is different.

The ‘agreement to negotiate’ objection might not be relevant at all to certain types of ADR clauses. It was established as long ago Scott v Avery (1865) 10 ER 1121 that a contract term that makes compliance with a certain procedure a condition precedent of commencing proceedings is enforceable. So an agreement merely to defer litigation for a standstill period, or an agreement requiring a party to obtain the evaluation or assessment of a third party as a condition precedent to commencing proceedings, ought to be readily enforceable.

Cable & Wireless

In Cable & Wireless plc v IBM United Kingdom Limited [2002] All ER (D) 277 the court considered an application for proceedings to be stayed while an ADR procedure mandated by an agreement be completed.

Under a ‘Global Framework Agreement’ local IBM entities were to provide outsourced IT services to local C&W entities throughout the world under ‘Local Services Agreements’ (LSAs). An LSA had been signed for the UK. Disputes arose as to certain ‘benchmarking’ procedures that had been carried out by a third party in order to fix the charges and reimbursements for the services. The LSA contained the following:

The Parties shall attempt in good faith to resolve any dispute or claim arising out of or relating to this Agreement or any Local Services Agreement promptly through negotiations between the respective senior executives of the Parties which have authority to settle the same pursuant to Clause 40.

If the matter is not resolved through negotiation, the Parties shall attempt in good faith to resolve the dispute or claim through an Alternative Dispute Resolution (ADR) procedure as recommended by [CEDR]. However, an ADR procedure which is being followed shall not prevent any Party or Local Party from issuing proceedings.

C&W declined to refer the dispute to ADR and IBM sought a stay of the proceedings that had been commenced.

C&W submitted that the clause was unenforceable because it lacked certainty and was no more than an agreement to negotiate. It also submitted that since the last line of the clause expressly contemplated the issuing of proceedings while the ADR procedure was followed, it could not have been intended that the clause was to be enforceable by stay.

Colman J began by rejecting the submission that just because simultaneous court proceedings were contemplated the ADR clause was not intended to be enforced.

He accepted as ‘well established’ the traditional view, based on Courtney & Fairbairn Ltd v Tolaini Brothers (Hotels) Ltd [1975] 1 WLR 297 and Walford v Miles [1992] 2 AC 128, that agreements to negotiate are not binding in English law. However, he held that here the parties had gone further than providing merely for negotiation by stipulating a detailed procedure for ADR. He said:

The engagement can therefore be analysed as requiring not merely an attempt in good faith to achieve resolution of a dispute but also the participation of the Parties in a procedure recommended by CEDR. Resort to CEDR and participation in its recommended procedure are, in my judgment, engagements of sufficient certainty for a court readily to ascertain whether they have been complied with. … This may seem a somewhat slender basis for distinguishing this type of reference from a mere promise to negotiate. However, the English courts should nowadays not be astute to accentuate uncertainty. For the courts now to decline to enforce contractual references to ADR on the grounds of intrinsic uncertainty would be to fly in the face of public policy as expressed in the CPR … The reference to ADR is analogous to an agreement to arbitrate.

He therefore granted a stay. This decision makes it clear that in England ADR clauses are unlikely to fail on the sole ground that they are agreements to negotiate.

The earlier English decision of Halifax Financial Services Limited v Intuitive Systems Limited [1999] 1 All ER (Comm) 303, in which an ADR clause in a software development agreement was found to be unenforceable, was not cited.

While the decision is of benefit to commercial court users as an indicator of the policy the courts will adopt, it does not seem to have helped IBM. It was reported in a later judgment ([2003] EWHC 316 Comm) that the mediation did not result in settlement.

Hyundai

Cable & Wireless has now received consideration in Hong Kong. In Hyundai, Vigour had employed Hyundai under various agreements for construction work. The agreements included complex dispute resolution clauses common in the construction industry providing for referral of disputes initially to the Architect for written decision. Such decisions were to be binding unless a party commenced arbitration. A reference to arbitration could include a request for conciliation, i.e. mediation, although that was not obligatory.

The parties got into a dispute over the Architect’s assessment of certain requests for extensions of time and liquidated damages. Hyundai considered that Vigour owed it HK$900 million while Vigour considered that Hyundai owed it HK$200 million in liquidated damages. Hyundai issued notices of arbitration to prevent time expiring.

Various correspondence then passed between the parties. Vigour indicated that it was prepared to negotiate, but not ‘with a gun to its head’ and Hyundai would have to ‘give up’ the right to arbitrate if it wished to resolve the disputes by talking. Hyundai agreed to this course of action and the parties signed an agreement in the following unhappy terms:

The parties will not continue arbitration and will not bring any arbitration or court action forever and any right to sue each other will not be exercised any more mutually and the parties will start to discuss together to resolve any differences under or in connection with the above contracts and any arguments that may come up now and in the future for anything about the above contracts that can not be finalized will be resolved and decided by the managing directors of the ultimate shareholder group of the highest level provided failing an ultimate agreement then both parties shall agree and submit to Third Party Mediation procedure which shall be conducted and completed as soon as possible and in any case no party will exercise the right to sue against each other. (the ‘March Agreement’).

More correspondence was exchanged with a view to resolving the disputes, but further disputes arose as to whether the correspondence was itself in compliance with the March Agreement. Hyundai, no doubt regretting having been so co-operative in agreeing to the wording of the March Agreement, commenced proceedings for declarations that it was unenforceable. Vigour cross-claimed for declarations that the arbitration agreements had been revoked and an injunction preventing Hyundai from continuing the arbitrations was used.

Vigour contended that by the March Agreement Hyundai had forever given up the right to arbitrate in return for the chance to negotiate a more favourable outcome than the Architect’s certificates.

However, Reyes J found as a matter of construction that it would require ‘far clearer’ words than those in the March Agreement before the court could find that a person has given up substantial rights to sue in respect of any matter.

Reyes J then considered Hyundai’s arguments that the March Agreement was unenforceable as an agreement to negotiate and void for uncertainty because it did not identify any specific procedure or time frame for the proposed negotiations or mediation.

He considered Halifax and Kenon Engineering Limited v Nippon Kokan Koji Kabushiki Kaisha, HCA No 3492 of 2002, English and Hong Kong first instance decisions in which the court had declined to stay litigation in favour of an ADR procedure. Both appeared to have been decided chiefly on the basis that the respective clauses fell short of arbitration clauses and thus did not qualify for a stay and in both cases negotiation had been tried but failed. He agreed with the exercise of discretion in both cases but found neither helpful on the law.

Reyes J said that on the enforcement of agreements to negotiate or mediate as a matter of principle he preferred Cable & Wireless to Halifax. Although not necessary, Reyes J said he would be prepared to go one step further than Cable & Wireless. Colman J had suggested that a duty to negotiate in good faith is always unenforceable, yet an agreement to negotiate on the basis of clearly identified procedures such as CEDR rules is sufficiently certain to be enforced. Colman J said that even ‘an unqualified reference to ADR’ entails a ‘sufficiently certain and definable duty’ to be enforceable. He conceded that the distinction between a duty to negotiate ‘in good faith’ and a duty to negotiate in accordance with a defined procedure (or a procedure capable of definition) may be ‘slender’.

Reyes J had difficulty distinguishing between the two processes. What, he asked, is the practical distinction between negotiation pursuant to an identified mediation procedure on the one hand and negotiation ‘in good faith’ or negotiation in accordance with such mediation procedure as the parties ‘acting in good faith might reasonably agree’ on the other hand? If the court can enforce the former, it should be able to enforce either of the latter two processes.

Reyes J concluded that even accepting Courtney and Walford as correct, there is probably no hard and fast rule that agreements to negotiate or mediate in good faith are per se unenforceable. The court must instead look at each situation and ask whether it is possible to frame objective criteria against which a party's reasonable compliance with the particular obligation can be assessed.

Applying those conclusions to the matter before him, Reyes J held that although no specific mediation procedure had been identified in the March Agreement, the parties came under a duty to act reasonably to ensure that mediation took place in the event that negotiations broke down. The failure to identify a procedure or a time frame was not fatal to the enforceability of the obligation.

Conclusions

Finally, in a reference which brings this article full circle, Reyes J in Hyundai referred to the Report and said that Recommendation 143 fortified his view on the March Agreement. Where parties had agreed to mediate in good faith, it would be odd and contrary to common sense for the law to say that if one side flaunts the agreement by not participating in mediation at all, the bargain cannot be enforced. It would be equally strange for the court to say that in all cases agreements to mediate are unenforceable, while reserving to itself a power to penalise a party in costs for failing to mediate when reasonable so to do.

There can be little doubt that mediation is set to embark on a new phase of life in Hong Kong and the courts will strive to play their part at every opportunity.

First published in the June 2004 issue of Hong Kong Lawyer.