Dispute Escalation Mechanism: A Curate’s Egg?

A dispute escalation clause is a contractual provision that establishes a predefined process for resolving disputes between parties. It typically outlines a series of steps that are to be followed before formal legal action can be initiated. These steps often include adjudication, mediation, or other forms of Alternate Dispute Resolution (ADR), with litigation or arbitration as a last resort. Escalation clauses are designed to encourage early resolution, reduce costs, and preserve business relationships by fostering collaboration and communication.

The benefits of escalation clauses

Construction, energy and infrastructure projects are inherently complex, involving multiple stakeholders, tight schedule, and significant financial investment. Including an escalation clause in a construction contract ensures timely and efficient resolution of conflicts that may arise during the project’s lifecycle.

This approach aligns with the CPR, which encourages the use of ADR to resolve conflicts efficiently and cost-effectively. Parties maintain commercial relationships and save money on expensive formal dispute resolution procedures.

Choosing an effective form of escalation clauses and negotiating the terms tailored to the project is pertinent. Keeping in mind variables like involvement of multi-parties including sub-contractors and funders, as well as the size and nature of the involved stakeholders puts a party in a better position to actively manage and resolve disputes as they arise.

Where can they go wrong?

While escalation clauses in construction contracts are designed to facilitate efficient conflict resolution, there can be several potential pitfalls. For example, the parties may exploit the structured steps – like the timeline for mandatory mediation or adjudication, leading to procedural delays resulting in prolonging the resolution process rather than resolve dispute in good faith.

If the mechanism is ambiguous or poorly drafted, it can lead to disputes over responsibilities, resolution timelines, or the enforceability of decisions, further complicating matters rather than resolving it. There is also the risk that parties may view the resolution mechanism as a mere formality, which often results in delaying meaningful engagement until commencement of litigation or arbitration.

If the engagement with the mechanism fails to produce a binding outcome, and parties resort to litigation or arbitration, the mechanism is rendered ineffective and results in wasted time and resources. Mindful drafting tailored to project’s complexity and value, and a commitment to genuine collaboration are essential to mitigate these risks and ensure that an escalation clause serves its intended purpose.

Courts’ contrasting views on early engagement

The judiciary’s approach to an escalation clause has evolved significantly in recent years, reflecting a growing recognition of its role in reducing costs, proactively managing cases and alleviating court backlogs. However, courts have not always been consistent in their treatment of an escalation clauses, particularly in cases involving contractual dispute escalation clauses. Three relevant cases in the matter—James Churchill v Merthyr Tydfil County Borough Council (2023), DKH Retail Ltd & Ors v City Football Group Ltd (2024), and Lancashire Schools SPC Phase 2 Limited v Lendlease Construction (Europe) Limited (2024)—illustrate the contrasting judicial perspectives on the enforceability and utility of ADR.

A pro-ADR stance: James Churchill v Merthyr Tydfil County Borough Council^[1] and DKH Retail Ltd & Ors v City Football Group Ltd^[2]

In James Churchill v Merthyr Tydfil County Borough Council, the court took an important step beyond merely encouraging ADR—it actively emphasised the obligation of the parties to engage in ADR before proceeding with litigation. The Court relied on Civil Justice Council’s June 2021 Report on Compulsory ADR as well as exercising its own discretion and at [58] concluded that:

“…the court can lawfully stay existing proceedings for or order, the parties to engage in a non-court-based dispute resolution process.”

This case illustrates a significant shift in the court's approach to dispute resolution, as it takes a proactive stance in mandating ADR rather than leaving it as an optional or encouraged alternative.

To give effect to the landmark judgment of Churchill, in October 2024, the CPR was amended to compel even unwilling parties to engage in ADR. However, neither Churchill nor the amendments to the CPR are prescriptive on the details as to when and how the courts can mandate the ADR.

This approach was endorsed in DKH Retail Ltd & Ors v City Football Group Ltd where at [38] the court noted

“Experience shows that mediation is capable of cracking even the hardest nuts.”

The court refused the argument that given the case complexity and the parties’ stances, mediation would have a low prospect of success and ordered the parties in the pre-trial review, at [43] to mediate with a view to resolve the dispute. It should be noted that, postscript to the judgment recorded that the parties have subsequently settled their dispute, proving the efficacy of the process.

A cautionary tale: Lancashire Schools SPC Phase 2 Ltd v Lendlease Construction (Europe) Ltd and Others^[3]

In contrast, the case of Lancashire Schools SPC Phase 2 Limited v Lendlease Construction (Europe) Limited highlighted the judiciary’s reluctance to enforce an escalation mechanism that lacked clarity or practicality. The dispute arose from a construction contract that included a tiered dispute escalation clause, requiring the parties to attempt adjudication before proceeding to litigation.

One of the issues in the matter was whether engaging in adjudication before litigation was a condition precedent to litigation.

The court held at [54]:

“On a proper construction of clause 68, I am wholly satisfied that adjudication is a condition precedent to litigation. That is to say that the parties have clearly agreed that, under the Project Agreement, before one party may start legal proceedings against the other, it must first have adjudicated the dispute…”

Interestingly, even after the court ruled that adjudication was a condition precedent to the commencement of litigation, exercising its discretionary powers, the court declined to stay the litigation for adjudication to take place. It emphasised that while ADR is encouraged, contractual mechanisms must be clear and precise to be enforceable.

Moreover, in this particular case, the court’s view was that adjudication, and the enforcement of the dispute escalation clause was not suitable at this stage. The mechanism in question was not drafted in a way that was specific to the complexities and the multi-party nature of the projects and likely disputes arising out of it. This decision serves as a cautionary tale for parties drafting dispute escalation clauses, underscoring the importance of specificity and practicality in ADR provisions.

Conclusion

The contrasting views in Churchill, DKS Retail and Lancashire Schools illustrate the judiciary’s nuanced approach to escalation clauses and ADR. While courts are eager to promote ADR as a means of reducing costs and proactively managing disputes, they will not enforce mechanisms that lack clarity or practicality. These cases serve as a reminder that escalation clauses are most effective when supported by well-drafted, enforceable provisions or the courts may step in and order ADR themselves. In order to give themselves the best chance of timely and cost-effective resolution, parties should ensure that their escalation clauses are both robust and project specific to harness their full benefits.