Tag Archives: commercial model

Disputes and Issues Resolution – Best Practice for Collaboration (Part 2)

“One is not exposed to danger who, even when in safety is always on their guard.” – Publilius Syrus (circa 60 BC)

ludit lexus

Ludit Lexus  – J.Davies (2020)

Introduction

In part one of our discussion on disputes and issues resolution, we explored strategies for effectively dealing with disputes internally. The key theme here was to resolve issues quickly, fairly and at the lowest possible level.  In some circumstances though internal mechanisms may be insufficient to resolve critical disputes.  In our current volatile and uncertain environment, some aspects of the commercial relationship may not be possible to perform and the contract could be frustrated.[1] Even force majeure can introduce substantial uncertainty to the performance of the contract.  We therefore need to anticipate mechanisms to deal with serious issues that cannot be effectively resolved through internal measures.  We should not rely on litigation or arbitration to seek resolution.  Litigation and arbitration are very time consuming, expensive and uncertain processes that are very unlikely to support future positive relationships. Consequently, we must explore other, less destructive, external resolution mechanisms.

External Disputes Resolution Options

In our first blog we recognised that disputes and issues resolution processes and largely unfettered so long as they do not ‘oust the jurisdiction of the courts’.  This means that we are free to select any form of disputes and issues resolution process so long as the commercial agreement does not fetter any party in pursuing litigation until after the dispute resolution process has run its course. For effective collaborative outcomes we need to adopt the same mantra of disputes and issues resolution principles we explored earlier; that is resolve quickly, fairly and at the lowest level practical.  Once we move to external disputes resolution, solving problems at the lowest level means anything other than arbitration or litigation. Best practice resolution here includes mediation and expert determination

Mediation

The Resolution Institute offers a succinct definition of mediation as follows;

Mediation is a confidential process where an independent and neutral third party assists the disputants to negotiate and reach a decision about their dispute.[2]

The role of the mediator is not to impose a solution or binding outcome, rather the mediator facilities a joint, win-win outcome by exploring issues and positions of the parties collaboratively.

A mediator will only participate in the process if all parties are committed to resolution of issues in good faith.  Mediation is usually the quickest and cheapest of all the external dispute resolution processes and is also more likely to preserve positive business relationships.

Expert determination

For technical disputes, an expert can be employed in a resolution role. Quite often the expert’s ruling is considered binding.  The Australian Institute of Arbitrators and Mediators recommend the following rules apply to expert determination:

  1. The Expert shall determine the Dispute as an expert in accordance with these Rules and according to law.
  2. The parties agree that:
    1. the Expert is not an arbitrator of the matters in dispute and is deemed not to be acting in an arbitral capacity;
    2. the Process is not an arbitration within the meaning of any statute.
  3. The Expert shall adopt procedures suitable to the circumstances of the particular case, avoiding unnecessary delay and expense, so as to provide an expeditious cost-effective and fair means of determining the Dispute.
  4. The Expert shall be independent of, and act fairly and impartially as between the parties, giving each party a reasonable opportunity of putting its case and dealing with that of any opposing party, and a reasonable opportunity to make submissions on the conduct of the Process. [3]

For more complex and long-term commercial arrangements, parties may pre-select the expert for each discipline area. For example, the parties could pre-select an expert for pricing issues, technical solutions, or for contract interpretation.

There are several permutations in how the expert can decide on an issue. In most cases, the expert is free to come to their own conclusions as to how the dispute should be settled. In other cases, the expert may be bound to select a course of action between the ambit of the parties’ positions.

A variation of the expert determination decision making process is final offer arbitration or baseball arbitration.[4] In this situation, an expert is only permitted to select one course of action provided by one of the parties. There is no scope to select within the middle ground. Consider the following example:

A supplier is seeking additional sums related to a substantial contract change proposal initiated by the customer.  The customer is expecting a $100,000 increase in costs associated with the change, whereas the supplier expects the change to incur an additional $500,000 in costs. If the parties wish to resolve this issue via baseball arbitration, then they will need to submit a best and final offer to the arbitrator. Each party does not get to see the final offer from their counterparts.  The arbitrator will estimate the cost of the contract change proposal and will select the best and final offer that is closest to their expert estimate.  In this example, the expert may decide that the additional costs are $250,000. If the customer digs in their heels and sticks to the $100,000 additional sum, but the supplier is more reasonable and adjusts their escalation fee to $300,000 then the arbitrator will select the $300,000 escalation fee since this figure is closest to the arbitrator’s estimate.

Baseball arbitration prevents any one party making outrageous or unfair claims for fear that their claim will be considered less equitable or fair when compared to the other party’s claim. This can be implemented relatively quickly and cheaply provided there is an arbitrator with the necessary skills available.  By design, this approach nudges parties to provide reasonable offers and will likely preserve business relationships.

Conclusions

For resolving disputes and issues, we must first craft a commercial strategy that minimises the likelihood of disputes and issues arising in the first place. Fair and equitable risk allocation, early engagement, and transparency are all tools we can adopt to achieve this. Nonetheless, we need to anticipate disputes arising and ensure our contract has effective internal disputes and issues resolution processes.  With an effective collaborative culture, we should not expert disputes and issues to require external resolution processes, but we should not create a situation where arbitration and litigation is the only step available to us.  Mediation and expert determination should be considered, especially for longer term, strategic relationships.

[1] J. Curle & C. Allin ‘Coronavirus COVID-19 and frustration: Is your contract at risk? (United Kingdom)’ (Mar 2020)  https://www.dlapiper.com/en/chile/insights/publications/2020/03/coronavirus-covid-19-and-frustration-is-your-contract-at-risk/

[2] Resolution Institute (2017)  https://www.resolution.institute/dispute-resolution/mediation

[3] Resolution Institute (2017) https://www.resolution.institute/dispute-resolution/expert-determination

[4] L. Samples ‘Resolving Construction Disputes through Baseball Arbitration’ American Bar Association (2019)

Why We Need the Right Commercial Model to Drive Collaboration

To realise the full benefits of collaborative contracts, we need the right commercial model.  If we rely on transactional ‘boilerplate’ contract terms and conditions, then we are unlikely to achieve the full range of collaborative benefits that we have discussed in earlier blogs.  It is not just the contractual terms that we need to explore but also the market engagement strategy as well.  That is, how do buyers and suppliers interact before contract signature.  This blog subsequently explores strategies for aligning commercial models to best realise collaborative outcomes.

Do We Need a Contract At All?

Businessmen often prefer to rely on “a man’s word” in a brief letter or handshake or “common honesty and decency” – Stewart Macaulay (1963).[1]

In Stewart Macaulay’s seminal paper on non-contractual relationships, he asks the question, “why do businesses use contracts in light of its success without it”.[2] The hypothesis offered by MacCaulay is that contracts and contract law are irrelevant since there are many non-contractual sanctions available to buyers and suppliers to achieve the required business outcomes.  Why then do we need contracts to pursue collaborative contracts where the relationship should be underpinned by trust, a shared vision, and a desire for long term relationships? 

Relying on trust and good-will alone is likely to lead to failure. Contracts are tools to communicate and manage the obligations of parties in concert with the desired collaborative behaviours. We also need contracts to provide a level of certainty to establish insurance requirements, seek financial approvals, and meet statutory obligations (both within the public and private sector).  To pursue a collaborative venture without a contract is a very dangerous proposition and could result in the parties to the relationship accepting significant liabilities, especially with the imposition of the law of equity and quasi-contract obligations.

Commercial Frameworks Designed to Drive Collaboration

Max Abrahamson’s principles can be summarised by the often-used commercial tenet of ‘transfer the risk to the part best able to manage the risk’.[3] For many organisations though, this principle is often ignored.  The temptation to transfer significant risks to suppliers is very alluring, especially where buyers command significant market power.  Such strategies will often erode value for the following reasons:

  1. Suppliers will load their contract prices with substantial contingencies or management reserve to deal with risks. These costs are often passed onto the buyer whether the risk eventuates or not,
  2. Unreasonable risk allocation may result in fewer bids and lessened competition,
  3. Where inappropriate risks are transferred to suppliers, there may be a perverse incentive for suppliers to compromise on quality or behave opportunistically (e.g. bid low and make profit on variations), and
  4. In complex projects, buyers may not have ‘clean hands’ and may not be able to effectively seek remedies under the contract where risks materialise.

To illustrate the significant problems with inappropriate risk allocation, a research report by the Construction Industry Institute identified that:

Inappropriate allocation of risk resulted in a 14 percent increase in costs to projects. Of this amount, the customer was liable for 78 percent of the cost increase.[4] 

The other key problem we face with risk transfer in contracts is that the contract may only effectively deal with known risks. That is, uncertainty[5] may not be adequately addressed. If we want to pursue collaborative outcomes, then we naturally need to adopt a more collaborative approach towards risk management.

Commercial Strategies That Encourage Collaboration

We know that transactional boilerplate contracts that aim to shift the maximum amount of risk to suppliers will thwart collaboration, but what strategies can we adopt to maximise collaborative outcomes? Whilst not exhaustive, the following themes emerge in successful collaborative ventures.

Early industry engagement. Early and holistic identification of risks and opportunities will foster collaboration and ensure subsequent risk allocation and sharing strategies are fair and equitable.

Prudent and Equitable Risk allocation. To encourage collaboration, we should not place too much risk on suppliers.  Where substantial contract value is at risk then suppliers will be more likely to be risk averse and will not effectively pursue innovation and ‘best for project’ outcomes. Consistent with a shared vision, all parties should have reasonable ‘skin in the game’.

Joint Management and Ownership.  Joint management and ownership does not mean that the parties should embark upon an incorporated joint venture or alliance agreement. Joint management means that the parties work collaboratively on a ‘best for program basis’ to deliver joint outcomes. This may involve joint decision making for key areas, joint risk management, co-location of key team members, and shared systems (which ensure there is a single source of truth).

Transparency. Collaboration is far more likely when parties have full visibility of risk, issues, and opportunities throughout the contract lifecycle. Open book financial reporting, and shared risk logs all support the development and maintenance of trust.  Transparency also supports the collaborative contracting aim of no surprises.

Effective Disputes and Issues management. A commercial framework is needed that ensures disputes and issues are resolved at; the lowest level, quickly, and equitably. 

If we want to sabotage our efforts to drive collaborative outcomes and erode value then I would recommend the following commercial strategy:

  • Do not engage with industry at any stage. Ignore industry’s wealth of knowledge and their understanding of the risks in their core business.
  • Insist upon ‘unlimited liability’ for all risks and place as much of the contract value at risk as possible.
  • Insist upon unilateral, unfettered rights such as; ownership of all supplier background Intellectual Property, step-in /subrogation rights for minor breaches, and an on-demand performance guarantees.
  • In the tendering stage, apply onerous conditions of tender on suppliers (with sanctions for breach) but at the same time claim that the customer is not bound by this same ‘tender process’.
  • Make sure the tender evaluation criteria places a very high weighting on price and ensure that the contract duration is for as short a term as possible.
  • Ensure all issues and disputes are resolved through litigation.

Summary

If we wish to pursue effective collaboration and reap the known benefits of collaborative contracts, then we must select an appropriate commercial model.  Having the right culture, motivation, leadership and commitment to collaboration alone is insufficient. Trying to apply a collaborative framework with a transactional, arms-length commercial model is akin to putting ‘lipstick on a pig’.


[1] Stewart Macaulay, “Non-Contractual Relations in Business: A Preliminary Study American Sociological Review” 1 February 1963, Vol.28(1), p55.

[2] Ibid., p 62.

[3] Max Abrahamson, “Risk Management” (1984) 1 (3) International Construction Law Review 241, 244. 

[4] CCI Research Report RR210-11 “Contracting to Appropriately Allocate Risk” (2007) summarised in Altman R., Cruz J., Halls, P “One-sided Contracts: Do They Pay Off?” ACCL Vol 11 1 (2017) p 169.

[5] This includes both ontological uncertainty (the unknown unknowns) and epistemic uncertainty (risks are known but likelihood and consequence cannot be quantified).