Dispute escalation provisions and International Arbitration - a rising threat in Canada?

In this article, Clyde & Co explores the enforceability of contractual pre-arbitration steps and whether failure to meet such steps could result in an arbitration clause becoming unenforceable. Eric van Eyken, Senior Counsel in Clyde & Co’s Montreal office, and Mark Mandelker, Associate in Clyde & Co’s Toronto office, consider this subject from the Canadian perspective on conditions precedent.

Canadian courts, both provincially and federally, have recognized the importance of alternative dispute resolution (“ADR”) mechanisms insofar as they can “assist in the efficient, speedy and just resolution of disputes.”[1]  Such alternative mechanisms include negotiation, informal claim determinations by a third party (for example, by a relevant tradesperson), mediation, and arbitration.  In this regard, parties may seek to outline in a contract certain mandatory procedures to try to resolve disputes prior to going to arbitration.  These clauses are sometimes referred to as “tiered dispute resolution clauses”.  As one leading Canadian scholar has noted, “there is little Canadian law as yet on the extent to which provisions for negotiation or mediation will be enforced as a true condition precedent.”[2]  Nonetheless, it should be noted that in investor-state arbitrations, the Government of Canada’s position is that pre-conditions to arbitration, including cooling off-periods, are an absolute bar to arbitration and parties contemplating such claims against the Canadian state should take care to satisfy these conditions to avoid lengthy jurisdictional disputes.[3]

In the absence of appellate case law on the question, the analysis of whether a tiered dispute resolution clause (or any particular step noted within the clause) is enforceable requires consideration of whether the clause is sufficiently clear as to whether the procedures are “true conditions precedent” to an arbitration.  Where pre-arbitration procedures are deemed to be true conditions precedent and are not followed, the arbitration clause can be unenforceable.

The Ontario Commercial Mediation Act[4] has adopted a rather pragmatic approach to the interaction between mediation and arbitration. Section 11(1) of that Act identifies that “the parties may agree not to proceed with arbitral proceedings […] before the mediation is terminated.”. Section 11(2) however clarifies that “an arbitrator or court may permit the proceedings to proceed and may make any order necessary if the arbitrator or court considers, (a) that proceedings are necessary to preserve the rights of any party; or (b) that proceedings are necessary in the interests of justice.” This exception would apply such that both the courts and arbitrators can waive mandatory mediation provisions and allow an arbitration to commence where it is necessary or just to do so.  However, the Act also resolves any potential conflict in this regard by, at Section 11(3), stating “that the commencement of any arbitral or judicial proceedings is not of itself to be regarded as a termination of the agreement to mediate the commercial dispute or as the termination of the mediation.”  Nova Scotia has adopted a similar statutory framework.[5]

Under Quebec civil law, while parties “must” “consider” mediation before proceeding with other dispute mechanisms, it is also the case that a “party may withdraw from or put an end to the mediation process at any time at its own discretion and without being required to give reasons.”[6]  Further, Quebec Courts have enforced arbitration clauses as a defence to litigation even where mandatory mediation has not taken place, sending the parties to arbitration.[7]

1. Requirements to Negotiate Pre-Arbitration

In Canada, an “agreement to agree” (or an “agreement to negotiate”) has occasionally been held to be unenforceable.[8]  The concern is that such agreements often lack certainty with respect to the specific obligations of each contractual party.[9]  Nonetheless, where the agreement is sufficiently certain as to the obligations on each party, either by the plain language of the agreement or the factual circumstances surrounding the agreement, a requirement to negotiate can be upheld.[10]

Some Canadian legal commentators have suggested that, in light of the Supreme Court of Canada’s dictate that there is an obligation to perform a contract both honestly and in good faith,[11] where parties are bound in contract to negotiate or participate in mediation, they must be so bound unless the wording in the agreement is unclear.[12]  Such was the case in SCM Insurance Services Inc. v Medisys Corporate Health LP[13] where the motion judge found that the parties to the subject agreement intended to create “an enforceable obligation to negotiate…” due to the presence of sufficiently clear language and valid consideration.[14]  The obligation was stated to be as follows: “…while the terms of the 2012 Agreement did not obligate Medisys to agree to whatever price or other terms the plaintiffs considered reasonable, Medisys was required to refrain from adopting a negotiating position that ‘eviscerates or defeats the objectives of the agreement that they have entered into.’”

Where the language is insufficiently clear, however, a court may not enforce negotiation steps as conditions precedent.  For example, in Alberici Western Constructors Ltd. v Saskatchewan Power Corporation,[15] the chambers judge refused to find that a disputes clause requiring the parties to “make all reasonable efforts to resolve all disputes and claims by negotiation…” was a true condition precedent to arbitration.  In so doing, the chambers judge noted that “[s]tronger language would be required to draw such an interpretation.”[16] 

In addition, some Canadian Courts have treated “pre-condition” clauses as extending prescription and limitation periods, finding that where a clause requires negotiations before arbitration is entered into, the limitation period to commence arbitration does not start unless there has been a negotiation.[17] In our view, the true impact of so called pre-conditions can be to effectively prevent the commencement of the limitations clock, such that respondents should avoid a strategy of running out the clock where there is a tiered dispute resolution clause.

2. The “True Condition Precedent” Requirement

As noted above, in order to be enforceable, a particular step in a tiered dispute resolution clause must be considered to be a true condition precedent (i.e. mandatory) to the arbitration.  Certainly, the issue of sufficient clarity, described above, is relevant.  However, in addition to that, a review of the relevant agreement as a whole may be necessary to decide whether a particular step is mandatory in the dispute resolution procedure or is an otherwise independent step.  For example, in Urban E. Homes Ltd. v Condominium Corp. No. 0313563,[18] the builder of a condominium development challenged the condominium corporation’s initiation of arbitration proceedings on the basis that the parties were first obligated to participate in a conciliation procedure.  The motion judge held that the conciliation procedure was mandatory with respect to warranty obligations between the parties but was independent of the dispute resolution process.  In other words, the condominium corporation’s failure to engage in the conciliation procedure was fatal to any attempt to rely on warranty obligations outlined in their agreement, but there was no mention in the dispute procedure clause mentioning any such obligation.  As a result, the arbitration could proceed, despite the failure to engage in conciliation.

Pre-arbitration steps are not only found in contract, but many also be found in legislation.  Care should be taken to consider the relevant legislative scheme to determine whether such a requirement exists.  For example, until 2016, the Ontario Insurance Act[19] provided that “no person may … refer the issues in dispute to an arbitrator … unless mediation was sought, mediation failed….”[20]  Failure to comply with such a step can estop a party from bringing its claim via arbitration or to the court.[21]

3. Who Decides?

We are unaware of any Canadian authority as to whether a pre-condition to arbitration is a question of jurisdiction or procedure. To the extent it is a question of jurisdiction, under Supreme Court guidance, “in any case involving an arbitration clause, a challenge to the arbitrator’s jurisdiction must be resolved first by the arbitrator.  A court should depart from the rule of systematic referral to arbitration only if the challenge to the arbitrator’s jurisdiction is based solely on a question of law.” Accordingly, “where questions of mixed law and fact are concerned, the court hearing the referral application must refer the case to arbitration unless the questions of fact requiring only superficial consideration of the documentary evidence in the record.”[22] Whether a party has complied with a pre-condition to arbitration would generally be a pure question of law or one required only superficial consideration of the facts (i.e. did a negotiation/mediation, cooling off period take place) and as such in our view would be decided by the courts. However, to the extent that a court would consider this a question of arbitration procedure, Canadian courts systematically refer such questions to the arbitrator.

4. Drafting Considerations

Due to the paucity of relevant case law, no specific language suggestions to include in a tiered dispute resolution clause can be offered.  However, some general principles can be highlighted.  When drafting such clauses, care should be taken to fully describe, with as many particulars as possible, the obligations of the parties prior to engaging in arbitration steps in order to increase the likelihood of enforcement of such steps.  References to chosen procedural rules could be useful in this regard.  Additionally, specific triggers or mechanisms to begin or end any particular pre-arbitration step should be clearly defined.

The importance of getting this right cannot be overstated.  In Canada, if you initiate arbitration proceedings prior to completing any mandatory pre-arbitration steps and have the arbitration struck due to a failure to comply with the required procedure, you may be totally barred from bringing the claim in the future due to the expiry of a limitation period or stipulated timelines in the agreement.[23]