Standing neutrals – common sense for preventing contract disputes

Let's face it. You need not be a Nobel-prize-winning economist to know that contracts are inherently incomplete.² No lawyer has yet crafted the perfect contract that will anticipate every eventuality. Problems, complexities, unexpected events are always around the corner. Conflicts arise.  Consider one expert’s remark…

"All complex contracts will be incomplete. There will be errors, omissions, and the like."  Oliver Williamson, 2009 Nobel Laureate in Economic Sciences

Incomplete or erroneous contracts can cause what another Nobel Laureate - Oliver Hart - calls shading.³  It happens when a party isn’t getting the outcome he or she expected from the deal and feels the other party is to blame or has not acted reasonably to mitigate the losses.

The aggrieved party often subtly cuts back on performance, sometimes even unconsciously, to compensate. Imagine, for example, a supplier of engineering services submits a proposal in a competitive bidding process and wins the contract. If demand is lower during the contract term than the buyer stated in the RFP or if the scope expands in an unanticipated area -- the supplier’s profit will take a hit.

Suppose the buyer refuses to adjust the supplier’s fee or the statement of work. In that case, the supplier may try to recoup losses by replacing, for example, the expensive A team assigned to the project with its less costly C team.

Shading can be so pervasive in long-term, complex deals that the tit-for-tat behavior becomes a death spiral. Oliver and Moore’s expanded theory³ focuses on contracts as reference points.  This new perspective emphasizes the need for mechanisms to continually align expectations—or update reference points—as unexpected events occur and need updating over time.

How can standing neutrals prevent disputes or conflicts?

Today there is a clear, unmistakable, and evolving trend toward incorporating proactive approaches for preventing and managing disputes into all business relationships. This recent trend is aptly termed “the Prevention Movement.”  The International Institute for Conflict Prevention & Resolution (CPR),⁴ an independent nonprofit organization established in 1979, bloomed out of this fundamental mindset shift that began in the mid-1970s.  Because the CPR promotes the prevention and resolution of conflict, it reinforces shifting the focus from dispute resolution upstream to dispute prevention using prevention techniques.⁵

A classic standing neutral can be thought of as the “referee” or “bridge builder.”⁶  Classic standing neutrals serve as real-time dispute resolutions throughout a relationship. But unlike a mediator or an arbitrator, they are "standing” - meaning they are pre-selected and are continually involved with the contracting parties to provide quick and real-time resolution of a conflict before it becomes a dispute.  Because the standing neutral plays a permanent role, he or she can act immediately to help the parties resolve issues before they become a dispute or even conflict. 

The construction industry began using standing neutrals in the late 1970s with great success. In fact, they are required for any construction project funded by the International Monetary Fund.⁷ While a standing neutral can be one person, typically, the construction industry uses a board of three neutrals (known as a Dispute Review Board or DRB) because of the large and complex nature of construction projects. DRBs are part of the construction team and typically meet with the contracting parties at pre-assigned governance intervals (e.g., monthly reviews).  The DBR members actively review issues, share their opinions with the contracting parties, and, in some cases, have the authority to make a binding recommendation. 

Over the years, standing neutrals have evolved into a more modern and proactive approach.

A successful standing neutral process requires only three rules for success:

1. early mutual selection,
2. continuous involvement, and
3. real-time action on issues before they become full-blown disputes.

When you combine these three rules (as described below) into a standing neutral process, you are essentially establishing the top strategies for resolving issues early. A well-designed standing neutral process embeds its customized rules as a foundation for all parties' ongoing governance.

Early Mutual Selection involves the parties selecting an expert in the industry applicable.  The standing neutral should be selected jointly by the parties at the beginning of the relationship to involve them in the ongoing governance mechanisms. This approach creates a collaborative atmosphere and avoids adversarial jockeying and delays associated with finding a suitable mediator or arbitrator after controversy arises. 

Continuous involvement requires a standing neutral in ongoing governance. The standing neutral helps parties immediately address and resolve issues to prevent them from escalating into disputes. This involvement ensures prompt resolution of any disputes, avoiding the need for more costly mediation, arbitration, or litigation. The standing neutral has ongoing involvement with the parties during the life of the contract or project, including receiving periodic progress reports and occasionally meeting with the parties who do not have any immediate dispute or taking prompt action on any issues that are arising.

Because standing neutrals are embedded in the relationship, they can offer prompt advice and render decisions if needed. They

• have a "hands-on" approach, which earns trust quickly as being fair and impartial;
• continuously monitor the dynamics and progress of the relationship;
• coach each party about potential opportunistic behaviors; and
• hear every dispute that occurs throughout the history of the relationship.

This ongoing relationship promotes more candid discussions and incentivizes parties to self-monitor their behaviors to avoid opportunism and shading behavior. Ultimately, the standing neutral can influence positive actions that improve contract performance by taking prompt action on any issues that arise.

Real-time action on issues refers to the process of maintaining cooperative relationships between parties by proactively aligning their interests. The standing neutral plays a crucial role in this process by helping parties resolve issues in the earliest stage through informal communication, without the participation of lawyers. If parties cannot resolve, the standing neutral may render an impartial recommendation, which is typically non-binding.

Although the recommendations of the standing neutral are typically not legally binding, parties may choose not to accept them or pursue more formal dispute resolution processes. In some cases, the parties may decide to make the standing neutral’s recommendations binding, which in essence, makes him or her the standing neutral and standing arbitrator.  My research suggests it is better not to make recommendations binding to allow a more collaborative approach.

Why does a standing neutral work so well?

First, merely appointing a standing neutral can significantly impact reducing or eliminating friction between parties to a contract. Research dating back to 1933 supports this.  Their  "Hawthorne Effect" shows that watching can affect behaviors.⁸   Simply the presence of a knowledgeable third-party observer encourages objectivity and teamwork, leading to improved performance and strengthened relationships.

More recent research by Adobor and McMullen finds that "the sheer presence of a third-party fosters self-monitoring of behaviors."⁹ This is supported by Duke University’s behavior economists Dan Ariely who has shown that the presence of others causes people to behave more honestly and reign in unethical behavior such as cheating.¹⁰

When the third-party observer is knowledgeable in the technical subject of the agreement and approves (likes) the agreement itself, there mere presence of this third party could increase the likelihood of more honesty from all parties. Simply put, establishing a standing neutral can change the relationship and attitudes among all parties, which can increase confidence and create a shift from "dispute-resolver" to "mutual friend."  Both a standby dispute resolution process and a successful prevention process can result.
 

The trend is rising

Although there are skeptics, the Prevention Movement is rising and taking hold, as evidenced by the 2017-2018 Global Pound Conference (GPC) Series held worldwide.¹¹ Conference stakeholders included users of dispute resolution services, their advisors and lawyers, providers of both adjudicatory and non-adjudicatory services, plus the researchers and educators who influence the users of dispute resolution services.

During the conference, major stakeholders in the dispute resolution field revealed the following consensus. 

• Dispute resolution should be conceived and practiced earlier in the trajectory of risks that can develop into conflict, escalating from differences of opinion to arguments, aggression, and finally, disputes that must be dealt with through formal dispute resolution efforts.
• Pre-dispute or pre-escalation techniques are the most promising and valuable methods for improving the future of dispute resolution and should prevent disputes.
• Where possible, risks should be understood and addressed in advance so problems never arise.
• Where efforts to prevent problems fail, steps should be initiated to deescalate, contain, or provide “real-time” resolution of conflicts so the costs, hostilities, and delays of formal dispute resolutions can be avoided.

Conclusions from the Global Pound Conferences demonstrate that the Prevention Movement is no longer just an aspiration of a few visionaries but one seen as needed in today’s modern economy.

ABOUT THE AUTHOR

Kate Vitasek is a world authority on highly collaborative win-win relationships for her award-winning research and Vested^® business model. Author of seven books and a faculty member at the University of Tennessee’s Haslam College of Business, she has been featured on CNN International, Bloomberg, NPR, and Fox Business News. She is WCC Fellow and was recently inducted into the International Association for Outsourcing Professional Hall of Fame.

END NOTES

1. Preventing Adversarial Supplier Relationships: A Standing Neutral Has Significant Promise, Forbes online article March 31, 2022
2. Oliver E. Williamson, “Outsourcing: Transaction Cost Economics and Supply Chain Management,” Journal of Supply Chain Management 44, no 2; April 3, 2008. Available at: https://onlinelibrary.wiley.com/doi/full/10.1111/j.1745-493X.2008.00051.x
3. Oliver Hart and John Moore, “Contracts as Reference Points,” The Quarterly Journal of Economics CXXIII, No. 1; February 2008. Available at: https://scholar.harvard.edu/files/hart/files/contractsasreferencepointsqje.pdf
4. International Institute for Conflict Prevention & Resolution (CPR)
5. The Global Pound Conference series was inspired by Harvard law professor Roscoe Pound and the name of a 1976 conference named for him; it was an impetus for the growth in the popularity of arbitration and mediation in the USA. See “Global Pound Conference,” at https://en.wikipedia.org/wiki/Global_Pound_Conference
6. See David Obstfeld, “Social Networks, the Tertius Iungens Orientation, and Involvement in Innovation,” Administrative Science Quarterly, March 2005. Available at: https://journals.sagepub.com/doi/10.2189/asqu.2005.50.1.100. See also Elizabeth Long Lingo and Siobhan Mahoney, Nexus Work: Brokerage on Creative Projects, Administrative Science Quarterly, March 2010. Available at: https://journals.sagepub.com/doi/abs/10.2189/asqu.2010.55.1.47?related-urls=yes&legid=spasq%3B55%2F1%2F47
7. EHW Chan, CKL Chan, MJ Hills, “Construction Industry Adjudication: A Comparative Study of International Practice,” Journal of International Arbitration, 2005, v. 22, no. 5, p. 363-374. Available at: https://www.deepdyve.com/lp/kluwer-law-international/construction-industry- adjudication-a-comparative-study-of-0MtQSJlEds
8. See Elton Mayo, “The Hawthorne Experiment. Western Electric Company (1933)” Chapter 3 in Classics of Organization Theory, 2016, p.134-141. Available at: https://www.cengage.co.uk/books/9781285870274/ 1
9. S. Ayal, F. Gino, R. Barkan, and D. Ariely, “Three principles to REVISE people’s unethical behavior,” November 2015, Perspectives on Psychological Science, 10(6): 738-741. Available at: https://www.researchgate.net/publication/284184987_Three_principles_to_REVISE_people's_unethical_behavior  
10. S. Ayal, F. Gino, R. Barkan, and D. Ariely, “Three principles to REVISE people’s unethical behavior,” November 2015, Perspectives on Psychological Science, 10(6): 738-741. Available at: https://www.researchgate.net/publication/284184987_Three_principles_to_REVISE_people's_unethical_behavior
11. The Global Pound Conference series (GPC) was a series of conferences about alternative dispute resolution (ADR) held in many cities in several countries in 2016/2017. The title of the conference series was "Shaping the Future of Dispute Resolution & Improving Access to Justice".[1]. It was organized as an initiative of the International Mediation Institute (IMI). The series was inspired by Harvard law professor Roscoe Pound and a 1976 conference[2] named for him, which was an impetus for the growth in the popularity of mediation in the USA. The GPC series brought Global Pound Conferences to multiple locations around the world in 2016 and 2017, with the aim of raising awareness about the various dispute resolution methods available. It brought together users, providers and advisors to discuss the future direction of ADR.[3]. After ending, the GPC platform changed to become the Global Pound Conversation, a blog and research series covering changes and developments in mediation and alternative dispute resolution around the world.