Contractually Mandated Pre-Litigation Dispute Resolution Mechanisms Are Fraught With Peril

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Your company is entering into a contract with a new business partner and everything looks rosy. As a savvy General Counsel, however, you know that even the best of situations can turn sour a few months or a few years into the relationship. Coincidentally, you just read an article by Attorney David Tang in which he suggests including a clause in business contracts mandating that before a lawsuit or arbitration can be filed, the parties must first (i) have senior principles of the contracting parties meet to try to resolve the impending dispute; and, if that fails, (ii) engage in formal mediation.

The theory behind such multi-tiered pre-litigation dispute resolution mechanisms is straight-forward and quite laudable: if the parties can resolve a dispute without resorting to litigation or arbitration, they likely will save themselves a lot of pain, anxiety and, most of all, money. In reality, however, forcing people to engage in settlement discussions may actually cause one party or the other to lose substantive rights. Take this real life example that I lived about 12 years ago….

My client engaged me to sue its business partner and obtain a temporary restraining order to enjoin him from engaging in conduct that would irreparably harm the client. I filed my Complaint, Motion for TRO and related papers on Monday and was in Court Wednesday afternoon ready to argue that injunctive relief was needed immediately because it was publicly confirmed that the defendant was about to engage in conduct that would irreparably harm my client.

I felt pretty good at the hearing because the defendant had not filed any opposition, and no counsel appeared on his behalf. As I prepared to wind up my oral presentation, things took a decidedly negative turn. The Judge interrupted me and said: “What do you say about paragraph 3 of the contract?” I got a pit in my stomach because I knew what paragraph 3 said:

If a dispute arises that the parties cannot resolve amongst themselves, they shall engage in mediation before a mutually acceptable mediator. No lawsuit can be filed until at least 45 days after such mediation has been demanded.

I did the only thing I could at that point: I argued that such a clause could not possibly have been meant to apply to a situation like the one before the Court because, doing so, would have eviscerated my client’s ability to obtain the fruits of the contract for which it had bargained. Luckily for me (and my client), the judge accepted my argument and granted the injunctive relief that I was seeking. No doubt, however, many other judges would have told me to come back in 45 days – and poured salt in my wounds by commenting that it was my client’s standard form agreement that included paragraph 3.

Sure, this particular horror story would have been averted if the contract included a carve-out in the event that a party was seeking injunctive relief. But if such a carve-out is utilized, the other party could up the ante (and increase the litigation costs) by arguing that the motion for injunctive relief was filed in a bad faith effort to circumvent whatever procedures the contract mandated must take place prior to filing suit.

While I suppose there could be rare situations where having a contractual mandate to meet and confer or mediate before filing suit is the only way to get parties to engage in such a process and that process might result in a settlement, I can’t think of one. Plainly, if, after a dispute arises, the parties want to engage in some sort of formal or informal dispute resolution process prior to filing suit, they certainly are free to do so. Forcing parties to engage in a process that only can work if all of them want to participate, however, not only smacks of irony, but also seems unlikely to result in anything other than delay and added expense.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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