An all too often underestimated means for settling disputes is the appointment of an expert (or binding advisor). Contract drafters do not see the clear advantages or even fail to recognise its effectiveness in various cases.
This blog highlights its use and gives some guidelines for drafting expert settlement clauses.
It is important to distinguish dispute settlement by arbitration from expert-determination proceedings. Arbitration is suitable when the parties have a true dispute, in terms of differing opinions on the interpretation of a contract, disputes as to whether one party can be held liable or if there is a deadlock in decision making. In the last case, a more sophisticated mechanism such as mediation or a dispute board would probably be even more desirable. Expert determination proceedings are relevant in relation to matters that require the establishment of facts. Accordingly, many argue that arbitration rather relates to legal issues whereas expert determination relates to a matter of fact. Of course, the parties may be in dispute on the establishment of a certain value, amount or quality level, and most disputes can be traced back to questions of how much should a party pay, but on the basis of the distinction legal vs. factual question, in practice it is very well possible to determine the appropriate procedure to the issue at hand.
The appropriateness of expert determination is often overlooked. Typical examples of matters that can be subjected to expert determination are:
- the determination of the final purchase price (and purchase price related elements) under a share or business purchase agreement;
- the question whether or not the delivered products or services meet the agreed product specifications;
- the determination of the amount of damages;
- the determination of a root cause of certain damages (e.g., whether a defect in a delivered product was caused by a hidden defect in the product itself or by external circumstances);
- the valuation of important assets or of a business or legal entity in the event of an exit procedure (e.g., if a party terminated a joint venture or if a partnership share needs to be bought out);
- if it is undesirable that a party gets access to confidential information of the other party (e.g., determinative sales or turnover figures in connection with a royalty audit).
The questions for the expert must be rather straightforward and should not involve assessments that may trigger elaborate discussions between the parties or otherwise a judgement as to what is ‘reasonable’ or ‘appropriate’ under the circumstances. This does not mean, of course, that an expert should not be reasonable or should disregard all circumstances. It also does not mean that an expert’s opinion may not contain any speculative elements. Furthermore, a careful expert will likely give each party an opportunity to explain the case (and respond to the explanations of the other party) before reaching a final determination.
What is important in the case of expert determination clauses is that:
- the expert’s involvement is based on clear (objective) triggering criteria;
- the expert’s independence from both parties is properly secured, although the expert who is engaged for an audit of the other party’s books and records would only need to be “reasonably acceptable”;
- the expert’s appointment should take place expeditiously, implying that the contract should provide for clear deadlines to object or agree on a proposed appointment and, failing consensus, for (the chairman or president of) a named authoritative expert institute that will make the appointment in case of disagreement; and
- high level expert determination principles, the failure of which may likely give rise to disputes between the parties, are clarified beforehand (and ideally in the contract itself).
- the expert should have adequate access rights to the information needed for its determination, subject to such information being kept confidential (including, in some instances, vis-à-vis the other party). Such information or access should be given promptly.
- It may be desirable to provide for an allocation of the costs of the expert, depending on the outcome of the expert’s determination. In case of a royalty audit, it would be appropriate to allow for a threshold for any excusable misstatements or relief.
In case of an audit right, it would be appropriate to limit the frequency of subsequent audits if a preceding audit did not reveal any significant irregularities. It is common to provide that such audit should take place during normal business hours and, depending on the nature of an audit and the matters to be audited, to require reasonable prior notice.