When individuals wish to join forces in business and form a limited liability company, they should put together a written operating agreement for their entity, and take care to consider each provision carefully, as the final document will govern their rights and responsibilities and will fundamentally steer the course of the relationship between them.
One of the most important provisions of an operating agreement is the dispute resolution clause, which dictates the mechanism by which members will address issues between them that arise out of the agreement. These issues may involve disagreements over the effect and meaning of clauses in the agreement, or they may involve other disputes arising out of the agreement, such as breaches of duties, voting deadlock, or basic operational and managerial concerns.
Members should pay special attention to drafting a clear dispute resolution clause to address the disagreements that may arise between them. All too often, a poorly articulated dispute resolution clause can lead to unforeseen conflicts between members in the future.
Dispute Resolution clauses should also include the applicable governing law that the parties will apply to any disputes, and the procedural steps required for initiating and enforcing the dispute resolution process. Moreover, there are many different types of dispute resolution that members may or may not wish to incorporate into their dispute resolution clauses. Chief among those are:
- Negotiation: The members may take it upon themselves to try to negotiate an agreed outcome to resolve the dispute without the involvement of any third parties. The members may negotiate directly with each other or may elect to do so through counsel. Often, an operating agreement will outline a period of time under which members must commence and conclude direct negotiations.
- Mediation: The members may decide to require mediation, a process that involves an independent third party who mediates between the members to try to assist them in reaching a negotiated resolution. A good mediator will advise each party of the strengths and weaknesses of their respective positions, and often, parties will select lawyers and/or former judges to serve as mediators. The parties, again, may or may not have legal representation in mediation. While a mediator can help spur the parties toward a resolution, they do not have authority to issue a binding decision. Mediation can provide an excellent mechanism to reach mutually agreeable resolution that parties can accept. A negotiated resolution in, or outside of, mediation can also curtail the significantly larger expense of arbitration or litigation and reduce the damage to the relationship between the members that can occur in protracted disputes. On the other hand, failed mediation runs the risk of increasing the time, cost, and hostility that the parties face.
- Arbitration: This arbitration process involves appointing a private, independent, third party (the arbitrator) to issue a binding decision that will resolve the dispute between the parties. Like mediators, arbitrators are often lawyers and/or former judges. The benefits of arbitration include the parties having the ability to select arbitrators by mutual agreement, undergoing a streamlined process that may take less time with more flexibility in the enforcement of procedural rules, and reaching a binding a decision not subject to appeal (typically this provision is negotiated into arbitration provisions). Parties to arbitration, however, may find a downside in the relative lack of formality, the fact that the arbitration itself often does not save significant costs when compared to litigation (absent appeal), and the inability to appeal an adverse decision.
- Litigation: This is the process that most people are familiar with, which involves resolving the dispute between parties in Court. An operating agreement that provides for litigation as the method of dispute resolution will often specifically identify the proper forum.
Members preparing an operating agreement should carefully consider their expectations for addressing disputes – whether they expect negotiation before mediation, whether they want to require formal mediation before any arbitration or litigation, whether they want arbitration or litigation as the final binding process, and what timelines they want to attach to each of these steps. While parties can utilize negotiation, mediation, and arbitration or litigation as part of the dispute resolution process, they must typically choose between either arbitration or litigation as the ultimate forum to decide the conflict. Drafting a good dispute resolution clause can be complicated, and interpreting those clauses is no less complicated and important.
If you need assistance with the drafting, interpretation, and/or enforcement of an operating agreement, including dispute resolution clauses, please do not hesitate to contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.