Enforceability of arbitration clauses challenged in Canadian receivership proceeding

Parties to commercial arrangements will often determine for efficiency, confidentiality or other reasons that any disputes will be determined by arbitration rather than through a traditional court process. Arbitration provisions are included in those contractual arrangements and, in the ordinary course, parties’ agreements to arbitrate disputes are enforceable and complied with.

In Canada, provincial statutes generally preserve the parties’ agreements to arbitrate. For example, the Arbitration Act of British Columbia provides that if a party to an arbitration agreement commences court proceedings notwithstanding an agreement to arbitrate the matter in dispute, the counterparty to the arbitration agreement may apply to court for an order staying such court proceeding. The court must then make an order staying such court proceedings unless it determines the arbitration agreement was void, inoperative or incapable of being performed.

Arbitration and insolvency

The protections of arbitration agreements in Canada are generally robust, but when one of the parties to a dispute that would otherwise be subject to arbitration is in an insolvency proceeding in Canada, the rules can change and one cannot assume that the parties’ agreement to arbitrate disputes will proceed as expected. 

If the insolvent party is the target of a claim that would otherwise be arbitrated, it is not surprising that the pursuit of such a claim through arbitration against the insolvent party is generally stayed and, further, that the claim normally is dealt with through a centralized claims process in the insolvency proceeding and not through arbitration. This is a sensible and efficient approach to dealing with all claims against an insolvent party in a single forum. A debtor should not be expected to expend extensive estate resources defending claims in various jurisdictions and in venues that may not have a complete understanding of the ongoing insolvency process and all of the interests involved. In Canada, this is often referred to as the ‘single control model’ in insolvency proceedings.

If the insolvent party, or its estate representative, is the party asserting the claim that would otherwise be arbitrated, the appropriate venue to resolve that claim is far less clear. On one hand, the insolvent party or its estate representative could advocate for the matter to be resolved through an expedited court process for speed and efficiency in the context of an insolvency proceeding that must be wrapped up quickly for the benefit of all stakeholders. On the other hand, the counterparty could argue that they would be unreasonably prejudiced if the arbitration agreement on which they relied, and their contractual right to defend a claim against them through an arbitration process, is not respected. 

This second more complex scenario was recently considered in the Canadian context by the British Columbia Court of Appeal in Petrowest Corporation v. Peace River Hydro Partners (Petrowest).

The Petrowest decision

Petrowest Corporation was subject to receivership proceedings in British Columbia, Canada. 

The “receiver” in such a proceeding is an insolvency practitioner, or firm of insolvency practitioners, appointed by the court on application of a secured creditor usually to undertake a court-supervised enforcement and realization process. Generally, the receiver’s activities will involve monetizing the assets of the debtor for the benefit of all creditors, and distributing the realized value to creditors in accordance with their respective priorities. As part of its mandate, the receiver can pursue any claims that may be available to the debtor. The receiver is not bound by the executory contracts of the debtor, and may disclaim those contracts during the asset realization process, though the counterparty to such executory contract may challenge the disclaimer in court based upon, among other things, the equities as between the parties.

The receiver holds a unique position. As described by the British Columbia Court of Appeal, the assets of the debtor do not vest in the receiver and the receiver is not an agent of the debtor, rather the receiver acts “in fulfilment of its own court-authorized and fiduciary duties, owed to all stakeholders”.

In the Petrowest case, the receiver pursued claims under several agreements to which Petrowest Corporation was a party. The agreements in question were principally subcontracts between Petrowest Corporation or its affiliates and Peace River Hydro Partners pursuant to which Petrowest Corporation and its affiliates would perform work related to a construction contract between Peace River Hydro Partners and BC Hydro, as project owner, relating to the construction of a hydroelectric plant. 

The agreements that were the subject of the litigation included provisions requiring that claims by Petrowest Corporation against Peace River Hydro Partners be pursued through arbitration.

The receiver argued that it was not bound by the contractual requirements to arbitrate such disputes, because the receiver disclaimed the agreement to arbitrate, and that such disputes could instead be determined by the court. In Canada, a disclaimed agreement is effectively treated to be at an end.

The Court of Appeal put the issue simply as follows:

The receiver has adopted the [subcontracts with Peace River Hydro Partners] and is suing on them…Can the receiver sue on the contracts and yet disclaim the arbitration clauses [contained in those same contracts]?

The Court of Appeal determined that a receiver cannot pick and choose among the terms of an agreement that it wishes to enforce and those that it wishes to disclaim. Otherwise, the receiver could fundamentally alter the commercial deal the parties agreed to by preserving favourable terms and disclaiming unfavourable terms. That cannot be an acceptable result as it unduly sacrifices the certainty that contracting parties require from their legally binding commercial arrangements.

Notwithstanding this determination, the Court of Appeal also determined that the receiver in the Petrowest case could still avoid the application of the arbitration clauses found in those contracts on which the receiver wished to sue.

One may ask how a receiver could seek to pursue a claim under Petrowest Corporation’s contract while disclaiming the arbitration obligations that are found in that same contract. The court provided two reasons for this conclusion:

1. The doctrine of separability. The Court of Appeal explained that under this doctrine arbitration clauses are not simply a term of the contract in which they reside, but are instead an independent agreement. The court concluded that it is open to the receiver to disclaim the arbitration agreements notwithstanding that it has adopted the contracts containing those arbitration agreements for the purpose of suing on such contracts. This flows from the separability of the arbitration agreements. The disclaimer of the arbitration agreements leaves the receiver free to pursue these contractual claims through a court process.
2. The position of the receiver. The receiver is pursuing the claims in this case but the receiver is not a party to the arbitration agreements, which were agreements by Petrowest Corporation itself. As a result, the receiver is not bound by the arbitration agreements and is not compelled by applicable provincial arbitration statutes to proceed through the arbitration process.

The Court of Appeal’s decision is not the end of the line, however. This matter will be considered further by the Supreme Court of Canada in the near future. Leave to appeal to the Supreme Court of Canada has been sought and granted.

Implications for commercial arbitration matters

The Petrowest decision will be relevant to parties to agreements with Canadian counterparties that contain arbitration clauses. Those parties may not be able to rely upon arbitration clauses when defending claims by the receiver of an insolvent Canadian counterparty. 

The court in Petrowest notes that the analysis would be different in a debtor-in-possession restructuring scenario, where the debtor itself is pursuing contractual claims. However, even in a debtor-in-possession restructuring, the debtor itself has the ability to disclaim agreements. When considering a disputed disclaimer in a debtor-in-possession context, the court is to review, among other things, whether the disclaimer would enhance the prospects of a viable compromise and whether the disclaimer would likely cause significant financial hardship to the counterparty. If these criteria are met, then a disclaimer of an arbitration agreement within a debtor-in-possession restructuring can also be feasible.

The following may be issues to be considered further following the Petrowest decision.

First, the scope of the doctrine of separability. The Court of Appeal explained that typically the doctrine is employed to preserve the effect of an arbitration agreement and the jurisdiction of the arbitrator even where a party impugns the validity of the contract in which it is found. It is not clear from the court’s analysis if the doctrine necessarily must apply in all cases where a receiver is seeking to avoid the application of an arbitration clause. 

Second, while a receiver may disclaim agreements, the authority to disclaim is not unlimited. Where a disclaimer is disputed, the receiver is to consider, among other things, equitable considerations and interests in in the context of the receiver’s value maximization exercise. The court will similarly consider the equities between the parties if the disputed disclaimer is brought to court for determination. The appropriate balancing of these interests will be a continuing consideration in future cases. If there were compelling reasons to objectively favour an arbitration process over a court process (such as efficiency or speed), this would be a relevant factor for consideration.

Third, drafters of arbitration clauses in the Canadian context should consider including secondary jurisdiction clauses to respond to situations where arbitration provisions are not enforceable or are disclaimed.

Parties with an interest in these issues will be watching closely for any further guidance from the Supreme Court of Canada.