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Avoiding the Pitfalls of Stepped Dispute Resolution Clauses

The dispute resolution clause in commercial contracts is very often inserted at the last minute without much attention given to the implications of the particular language contained in the clause.  It is increasingly common to see "stepped" dispute resolution clauses, whereby the parties agree to mediate disputes arising under the contract and, if mediation fails to resolve the dispute, to arbitrate.  The popularity of stepped clauses is due in part to the fact that they make a quick, inexpensive resolution possible through mediation, but provide arbitration as a fallback mechanism for dispute resolution.  While wholly reasonable on their face, stepped dispute resolution clauses can have surprising consequences when a business relationship sours.

Some federal courts, including the First Circuit, have ruled that, if parties to a stepped dispute resolution clause fail to engage in mediation, neither party can be compelled to arbitrate.  In HIM Portland, LLC v. DeVito Builders, Inc., 317 F.3d 41 (1st Cir., 2003), the plaintiff commenced a case in federal district court and then, pursuant to the Federal Arbitration Act, moved to compel the defendant to arbitrate.  The contract between the parties included a stepped dispute resolution clause requiring mediation before arbitration.

The First Circuit affirmed the District Court's denial of the plaintiff's motion to compel arbitration because neither party had requested mediation, which the Court held was a condition precedent to the parties' arbitration agreement.  Thus, even though the parties' contract demonstrated a clear intent to resolve disputes by engaging in mediation and then, if necessary, arbitration, the First Circuit ordered the parties to pursue their claims in court.  The Court wrote: "Where contracting parties condition an arbitration agreement upon the satisfaction of some condition precedent, the failure to satisfy the specified condition will preclude the parties from compelling arbitration and staying proceedings under the FAA."  Put simply, in HIM Portland, the parties failed to fulfill the condition precedent of mediation, and wound up being forced to litigate their dispute in court. 

The dispute resolution clause at issue in HIM Portland included an unusually specific reference to mediation as a condition precedent to arbitration: "Claims, disputes and other matters in question arising out of or relating to this Contract...shall...be subject to mediation as a condition precedent to arbitration or the institution of legal or equitable proceedings by either party."  Stepped dispute resolution clauses do not often identify mediation as a condition precedent, thus parties to a stepped clause should consult experienced counsel before pursuing their claims in a forum which may, down the line, foreclose their ability to compel their adversary to arbitrate. 

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