Dispute resolution in business partnerships

One of the most nettlesome challenges business partners face when entering into a new venture is selecting an appropriate dispute resolution mechanism.

The topic is inherently difficult for many entrepreneurs and executives because it requires them to address the possibility of failure at the outset of a relationship they necessarily believe will succeed. As a result, many joint venture associates and business partners simply gloss over the issue, refusing even to address it.

If their clients are willing to listen, many lawyers offer the standard list of dispute resolution mechanisms: arbitration, mediation and buy/sell arrangements, also referred to as Russian roulette or Texas shootout provisions.

Although the terms “arbitration” and “mediation” are typically met with disinterest, “Russian roulette” and “Texas shootout” almost always pique interest. Yet that interest generally fades when the parties delve into the mechanics of the buy/sell arrangement. Business partners need a better alternative. Fortunately, there is one known as the possession arrow.

I observed the following interaction among three children at their school bus stop. As the bus rounded the corner, John, age 8; Annie, 6; and Ben, also 6, scrambled in line. Ben was disappointed that John was first, particularly because John went first the previous day. Ben appealed to his father to intercede, which he declined to do, suggesting instead that the children work it out. John offered to play rock-paper-scissors to decide the order, but that didn’t appeal to Annie. Neither the children nor their parents thought it was a good idea to set the order based on who got to the bus stop first. As the bus pulled up, the children agreed out of desperation to take turns going first, something they have continued to do.

Although taking turns as a method for resolving significant commercial disputes seems at first blush unsophisticated and arbitrary, it can work well if structured thoughtfully. In its most basic form, the possession arrow method authorizes one party to make the final decision on the first deadlock and gives the other party the power to decide the next one.

The approach requires business partners to establish fundamental principles to guide their behavior when confronted with a particularly difficult issue that could lead to a deadlock. The parties must make a covenant agreeing to be bound by those fundamental principles with respect to their joint decision-making and individual conduct when they are empowered to break a particular deadlock. The fundamental principles should include an obligation to deal in good faith and commitment to advance positions that are in the venture’s best interests, not the individual’s. It is sometimes also appropriate to include a requirement that the parties take positions consistent – to the extent that it is commercially feasible – with their most recent past practices.

When using the possession arrow, the parties must also determine who will be empowered to break the first deadlock. In some cases, the parties might be able to agree immediately. In other cases, the parties might decide to give the arrow to the one who did not declare the deadlock.

An effective dispute resolution mechanism should encourage cooperation to avoid deadlocks, foster commercially reasonable conduct and lead to outcomes that allow the parties to move forward. The possession arrow meets each of these criteria. The children and parents at the bus stop recognized that arbitration, mediation and game-playing were inferior to taking turns. It is time for business partners to do the same.

By David Charles, Special to Washington Technology. Lessons from the bus stop in dispute resolution. David Charles is a partner in the Corporate and Securities-Technology practice at Pillsbury Winthrop Shaw Pittman LLP.

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