Dispute resolution clauses in the energy sector – why they should be given extra thought.

11 February 2016

Peter Knight, Garreth Wong, Matthew Atkinson

Bird & Bird & First for Disputes

While usually a last resort, formal legal proceedings may be the only way to resolve a dispute and recover damages. The contractual dispute resolution mechanism is an important tool to ensure that any disputes are determined promptly and robustly. Yet these clauses often receive little attention at the drafting stage or may be based on a potentially unsuitable precedent. This article considers the importance and key features of dispute resolution clauses, with particular reference to the energy sector.

One of the main risks with an imprecise or ill-thought through dispute resolution clause is that attempts at resolving disagreements might be disrupted or delayed by a recalcitrant counterparty. For example, the following might occur at the outset of a dispute in the energy sector, where contracts are often between parties in different countries:

  • A counterparty may rely on an imprecise clause to challenge a court or tribunal's jurisdiction, or commence legal proceedings elsewhere on the disputed issues. The result is likely to be an impasse and a costly dispute about jurisdiction, rather than about the substance of the complaint. By such means, the counterparty may delay the resolution of the dispute by several years.
  • In an arbitration context, parties sometimes give little thought to the seat (or legal place) of arbitration, perhaps without understanding its legal significance. If a chosen seat has inadequate or unpredictable court support for arbitration, that might afford an uncooperative counterparty the opportunity to mount spurious court challenges to the arbitration process, perhaps relating to the appointment or qualifications of the arbitrators. Again, by such means the counterparty may be able to delay the resolution of the dispute by several years.

Moreover, the disputes clause may be unclear as to which resolution procedure should apply to a particular dispute. In complex energy transactions, parties often wish to include hybrid, multi-tiered, sole-option or carve-out dispute resolution processes. These can be tailored to provide multiple dispute mechanism processes on an escalation basis and/or require particular disputes to be subject to particular procedures. Most begin with alternative dispute resolution ("ADR") before escalating (or as an alternative) to more formal resolution through litigation or arbitration. There are several well-established means of ADR in an energy context, including compulsory negotiation (often involving increasingly senior personnel after each failed stage), expert determination, mediation and adjudication.

However, it is not always straightforward, particularly when a dispute resolution clause is poorly drafted, to determine which procedure should apply and when. Further, different processes may work well in some situations, but less so in others. Moreover, certain terms (for instance sole-option clauses) are not enforceable in all jurisdictions. Specialist advice should therefore be sought.

In each case, the disputes clause should be produced with close attention to the client's situation so as to make it work best for them. But at a minimum, the clause should:

  1. allow such scope as is desirable to resolve the matter quickly and informally, and
  2. provide for ultimate determination by a court or tribunal with as little room for mischief as possible.

Some say providing for ADR is an unnecessary complication: if the parties are minded to resolve the dispute informally they will do so anyway, while the extra step only adds the potential for disruption and delay. Others say that an early compulsory meeting of senior personnel (or perhaps early mediation) can help focus minds and enable the parties to avoid the cost and inconvenience of litigation or arbitration.

Either way, with a little extra thought, the disputes clause in a contract should be tailored to what will work best in disputes that might arise in the future, perhaps by including optional – rather than compulsory – ADR, by including strict time limits, or even by including more unusual optional processes such as a "blind bidding" settlement process (in which the parties submit settlement offers confidentially, which are intended to result in a binding settlement only if they are within a specified percentage of each other, with any difference split 50/50). It should be possible to achieve this while also minimising the scope for disruption or delay, because even where the parties' bargaining power is unequal and one party is seeking to impose provisions which risk introducing ambiguity, it should in fact be in everyone's interests to arrive at a clause which secures the potential to pursue a claim with certainty in the long-run. This point may need to be spelt out during the process of negotiating such clauses.

As to the ultimate recourse, once any ADR has been exhausted, our experience is that the energy industry tends to favour arbitration rather than litigating through the courts. This reflects (at least):

  1. the preponderance of cross-border transactions in the energy sector, in relation to which a "neutral" tribunal is attractive;
  2. an awareness in the energy sector of the widespread enforceability of arbitral awards;
  3. the possibility of heightened confidentiality and procedural flexibility;
  4. the advantages of being involved in the appointment of the arbitrators; and
  5. the advantages of appointing arbitrators who are either expert in or who have experience of the energy sector.

Arbitration clauses need not be lengthy (as is demonstrated by the standard clauses issued by most institutions) but they must be robust in terms of communicating the parties' intent to arbitrate: which disputes, where, to be determined by whom, in what language and according to which laws and rules? If these matters can be determined at the outset of the contractual process, by parties who are on good terms and eager to negotiate, it will help to ensure any eventual dispute between them is dealt with more smoothly, quickly, and more cost-efficiently.

Transactions in the energy sector often involve complex contractual frameworks, in large part because there is a lot that might go wrong. In that context, the dispute resolution mechanism is worth more than a passing thought as a "midnight clause", or just blind adherence to a potentially unsuitable precedent.