Dispute Resolution 101 for Counsel Supporting Startups
It was wonderful and enlightening to recently read about the Finland Arbitration Institute’s Helsinki International Arbitration Day (HIAD) conference. Last December, the event convened legal practitioners and experts from all over the world to discuss the latest developments in the fields of international arbitration and mediation.[i] The theme was “starting up,” and as an entrepreneur myself, this struck a chord.
At the conference, speakers explored what arbitration can do to support the startup community, why it is crucial to think about disputes (and how to resolve them) well before they arise, and the importance of tailoring dispute resolution processes to suit the needs of the client.
Here are some considerations for counsel who support startups when it comes to dispute resolution clauses.
Startup founders are optimists by nature. But as a practical matter, every contract can be breached or be susceptible to differences of interpretation after it has been negotiated and executed. Within the legal community, it is understood that savvy founders need to anticipate disputes as the startup grows, and accordingly plan for how those disputes will be managed.[ii] That plan should be recorded in a dispute resolution clause in the initial “founders’ agreement” and in any subsequent contract.[iii]
Here are some important elements to remember when drafting dispute resolution clauses relating to commercial disputes:[iv]
The types of disputes covered by the clause;
The method of dispute resolution (see more below);
The dispute resolution institution (if any);
The specialized rules that will guide the dispute resolution process(es);
The substantive and procedural law that will apply;
Whether the dispute may be managed virtually or whether it must be in person (and if in person, where?);
Language specifying where judgment may be entered; and
How the costs of dispute resolution will be allocated among the parties.
Please note that this is not intended as an exhaustive list, but rather the minimum that should be considered when a dispute resolution clause is under review.
Start with a model clause, then tailor it to fit individual needs.
While model clauses are widely available online, and may serve as a useful guide, these clauses rarely fit perfectly with the parties’ needs and interests. It is worth the time to explore language with your client that accurately reflects the specific needs of the parties for each particular contract when it comes to resolving potential disputes.
On the other hand, bear in mind that simplicity matters. A clause that seeks to specifically script the entire dispute resolution process may be overly rigid, mistakenly conflict with the institutional rules you select, and not account for unforeseeable circumstances. It is often unnecessary to reinvent the wheel when it comes to drafting these provisions - dispute resolution institutional rules usually address party concerns when it comes to process.
On dispute resolution procedures...
Startups.com notes that “[m]any startup founders choose to require that any dispute . . . is settled with binding arbitration, but it’s up to you and your co-founders to decide what you want to do.”[v] In addition to arbitration, you may wish to consider including the following elements in your clause:
· Negotiation stage: Negotiation is an ideal dispute resolution mechanism. It is the least expensive and often most likely to preserve the parties’ relationship. However, emotions sometimes run high, making negotiations difficult. Moreover, negotiation alone is not legally binding unless it is accompanied by the drafting of a new contract or agreement.
· Mediation stage: Mediation is a facilitated negotiation. The facilitator is a neutral third party called a “mediator,” and this person brings structure to the conversation. Dispute resolution institutions have rosters of qualified mediators and provide procedural rules to assist parties. Mediation is a confidential process. But as with negotiation, mediation is also non-binding. (Read my previous blog post here on the “anatomy of a mediation” and here to read more about mediation in the context of international commercial disputes.)
· Arbitration: In arbitration, each party presents their case to a panel of neutral arbitrators (one or three), who then come to a final and legally binding decision on the matter. Successful appeals of arbitrator awards are rare, thus lending a sense of finality that litigation cannot achieve until every opportunity for appeal has been exhausted. Finally, most arbitration institutional rules make clear that arbitration is a confidential process. (Read more on my blog here about rapid “final offer arbitration,” and here for general tips on how parties can maximize efficiency in arbitration.)
· All of the above? A “step clause” provides for a tiered dispute resolution process. For example, you and your client may decide that any dispute should be resolved by arbitration as a last resort, only after initial attempts at settlement though other processes — such as negotiation or mediation — have failed. In drafting a step clause, be sure to include dates for when each “step” begins and ends.
Does it send a bad message to include a dispute resolution provision when your client is starting out the relationship?
Humans are fallible and capable of disagreement, especially when the stakes are high. In addition, starting a business is stressful and things can get lost in translation. For those reasons, it’s very likely that some commercial dispute(s) will arise between founders, shareholders, and other stakeholders too. Thus, including a dispute resolution clause in a founders’ agreement and in any subsequent contract is simply the smart thing to do.
For further introductory resources, you may wish to consult the following:
· The American Arbitration Association and the International Center for Dispute Resolution (AAA/ICDR) both provide guides to drafting dispute resolution clauses. You may find AAA’s here (plus free webinar), and ICDR’s here.
· The International Chamber of Commerce (ICC) also offers free clause drafting advice for mediation and arbitration.
· The International Institute for Conflict Prevention and Resolution (CPR) offers free samples clauses and model language on their website.
· Lawline CLE on Dispute Prevention & Resolution Strategies for In-House Counsel
Special thanks to Gloria J. Medina for her assistance in researching and writing this piece.
[i] Sanna Kaistinen et. al., Start-Ups and Arbitration: A Report From Helsinki International Arbitration Day (HIAD) 2021, Kluwer Arbitration Blog, http://arbitrationblog.kluwerarbitration.com/2021/12/24/start-ups-and-arbitration-a-report-from-helsinki-international-arbitration-day-hiad-2021/(Dec. 24, 2021). [ii]See e.g. Why You Badly Need A Founders' Agreement For Your Startup, Mondaq, https://www.mondaq.com/nigeria/executive-remuneration/898268/why-you-badly-need-a-founders39-agreement-for-your-startup (“It is essential to include the method to be adopted in resolving disputes as conflicts are usually inevitable in any business. The mode of dispute resolution could be Alternative Dispute Resolution (ADR), litigation, or any other means of dispute resolution. Because a dispute resolution clause done wrongly–and indeed any clause at all–could make or mar the startup, getting the drafts right is imperative.”). [iii]Note: a founders’ agreement is the contract that establishes the founders’ basic rights and obligations at the early stages of a company’s formation. According to Forbes, not having a founders’ agreement in place is the #1 legal mistake startup founders make.[iii] Later on, as the company grows, other sorts of agreements with their own dispute resolution clauses will be necessary. For example, “[s]hareholder agreements are central documents for start-ups, especially when the first round of external investors joins the company. They typically deal with three main areas: 1) decision making; 2) transfer of shares; and 3) non-compete provisions. See, e.g., Panel: Arbitration And Shareholders’ Agreements (Investor’s And Founder’s Perspective), Start-Ups and Arbitration: A Report From Helsinki International Arbitration Day (HIAD) 2021, Kluwer Arbitration Blog, http://arbitrationblog.kluwerarbitration.com/2021/12/24/start-ups-and-arbitration-a-report-from-helsinki-international-arbitration-day-hiad-2021/(Dec. 24, 2021). [iv] See AAA Drafting Dispute Resolution Clauses: A Practical Guide, https://www.adr.org/sites/default/files/document_repository/Drafting%20Dispute%20Resolution%20Clauses%20A%20Practical%20Guide.pdf (last visited February 2, 2022) [v]How to Create a Founders Agreement for Your Startup, Startups.com, https://www.startups.com/library/expert-advice/startup-founders-agreement (last visited Jan. 19, 2022); see alsoCofounding A Startup? Make Sure Your Partnership Agreement Covers These 12 Key Points, Forbes, https://www.forbes.com/sites/allbusiness/2022/01/17/co-founding-a-startup-make-sure-your-partnership-agreement-covers-these-12-key-points/?sh=47c634c87f62 (last visited Jan. 19, 2022).