Canada – Court of Appeal Upholds “Single Proceeding” Insolvency Model Over Recourse to Arbitration

This article was first published on the Arbitration Matters blog, here.

In Mundo Media Ltd. (Re), 2022 ONCA 607, Court of Appeal for Ontario Justice Julie Thorburn dismissed a motion for leave to appeal a decision denying a motion to stay a receiver’s court proceeding. The Appellant/Moving Party sought the stay on the basis of an international arbitration agreement. Justice Thorburn found no reversible error in the motion judge’s choice to apply the “single proceeding model”, applicable in insolvency proceedings, with the effect that the Appellant/Moving Party, one of the insolvent company’s debtors, could not require the receiver to arbitrate its claim rather than litigate it. Together with the Superior Court’s decision below, this decision provides important guidance on the interplay between arbitration agreements and claims advanced in the bankruptcy and insolvency context.

Background – Mundo Media Ltd. (“Mundo”) was placed in receivership pursuant to section 243 of the Bankruptcy and Insolvency Act [“BIA”]. The receiver opted to bring a motion in the insolvency proceeding (in Mundo’s shoes) against Spay Inc. (“SPay”) for payment of unpaid invoices totaling US$4,124,000. The invoices related to contracts Mundo and SPay concluded in 2017, before the receivership. The parties’ contract contained an arbitration agreement calling for arbitration seated in New York.

SPay moved to stay the court proceeding pursuant to Art. 8 of Schedule II to the Ontario International Commercial Arbitration Act, 2017 [“ICAA”], which adopts the UNCITRAL Model Law on International Commercial Arbitration (with its 2006 amendments). Art. 8(1) requires the court to stay a proceeding falling within the arbitration agreement’s scope unless the court finds the arbitration agreement is “null and void, inoperative or incapable of being performed”.  

Lower Court Decision – Justice Penny of the Ontario Superior Court of Justice (Commercial List) (the “SCJ Judge”) dismissed SPay’s stay motion. He recognized that Art. 8 of the Model Law generally requires the Court to refer a dispute to arbitration if it falls within the arbitration agreement’s scope. However, he determined that the arbitration agreement in the Mundo/SPay contract was “inoperative”.

The SCJ Judge based this conclusion on the well-established “single proceeding model” applicable in bankruptcy and insolvency matters. Acknowledging the stay analysis under Art. 8 of the Model Law imposes a relatively low burden on the moving party, the SCJ Judge nevertheless concluded the single proceeding model was a policy barrier preventing referral to arbitration in the circumstances:

Requiring the Receiver to commence arbitration proceedings in New York would be unfair to Mundo’s creditors and inconsistent with the object of the BIA to, among other things, enhance efficiency and consistency and avoid the chaos and inefficiency of multiple proceedings and of potentially sending the Receiver ‘scurrying to multiple jurisdictions’.

SPay sought leave to appeal the SCJ Judge’s decision to the Court of Appeal for Ontario pursuant to paragraph 193(e) of the BIA.

Court of Appeal Decision– Justice Thorburn began by setting out the three-part test for leave to appeal under paragraph 193(e) of the BIA as set out in Business Development Bank of Canada v. Pine Tree Resorts Inc., 2013 ONCA 282:

[30]      First, the proposed appeal must be prima facie meritorious; that is, the proposed appeal must raise “legitimately arguable points … so as to create a realistic possibility of success on the appeal. This can include a finding that the decision “(a) appears to be contrary to law, (b) amounts to an abuse of judicial power or (c) involves an obvious error causing prejudice for which there is no remedy”. Of course, this assessment needs to be conducted against the backdrop of s. 243 of the BIA, which has been interpreted to give supervising judges a broad mandate to resolve issues in bankruptcy. Commercial list judges with experience in insolvency proceedings are alive to the legal and business realities faced by debtors, creditors and the receiver, and substantial deference is therefore owed to their decisions.

[31]      Second, the proposed appeal must raise an issue or issues of general importance.

[32]      Third, the proposed appeal must not unduly delay the progress of the proceedings.” (Internal Citations Omitted)

Justice Thorburn found SPay failed on the first prong of the analysis.

She first considered SPay’s position that the SCJ Judge erred in law by deciding the “issue of arbitrability”. SPay argued that “mandatory arbitration provisions shall apply absent ‘very clear language’ to the contrary”. Based on the cases cited, this appears to be an argument predicated on competence-competence. A review of the SCJ Judge’s reasons suggests SPay did not raise this position in the Court below.

Justice Thorburn rejected this argument. She observed that the receiver, whose authority emanates from the court’s order, was an officer of the Ontario Superior Court. As a result, only that Court could decide, as a matter of law, “whether the receiver has the authority to prosecute the debt through the single proceeding model”. Like the SCJ Judge, Justice Thorburn relied on the exception to systematic referral under Art. 8 of the Model Law, namely when the arbitration agreement is, among other things, “inoperative”. Applying something of a bankruptcy and insolvency analytical overlay, she interpreted Art. 8’s application in the context of the Court’s supervisory role under section 243 of the BIA to conclude the motions judge was correct in refusing to enforce the arbitration agreement:

[36]      The court must therefore assess the limits on the receiver’s powers pursuant to the court order, including whether the presence of an arbitration clause precludes the receiver from asserting claims by the debtor against third parties not involved in the insolvency proceeding under the agreement in which that clause is found.

[37]      Moreover, although article 8 of Schedule 2 to the ICAA requires a stay in favour of the arbitration agreement, the legislation expressly provides room for courts to “find that the agreement is … inoperative”. This express carve-out, read in conjunction with the broad discretion that courts exercise under s. 243 of the BIA in supervising bankruptcy matters, enables bankruptcy courts to preclude the operation of the ICAA by virtue of the operation of the single proceeding model.” (Emphasis added; internal citations omitted)

Justice Thorburn then considered SPay’s second ground of appeal—whether the SCJ Judge erred in concluding SPay was not a “stranger to the bankruptcy”. If SPay were a stranger to the bankruptcy, it would have been appropriate to refer the parties to arbitration since the single proceeding model would not apply. In assessing this argument, Justice Thorburn considered the single proceeding model’s purpose, which is to “bring efficiency to the insolvency process and maximize returns for the benefit of all creditors”.

As in the Court below, SPay asserted it was a stranger to Mundo’s bankruptcy because: 1) it has not filed a claim against Mundo; and 2) it proposes to assert set-off, but as a defence rather than as a claim. There was also no assertion that SPay’s set-off would exceed Mundo’s claim, effectively rendering it a counterclaim. In that regard, the receiver purported to use the single proceeding model as a “sword”, not as a “shield”, which SPay argued was an error of law.

SPay conceded that had it commenced a claim against Mundo, it would be subject to the single proceeding model. This concession, which was sensible given the jurisprudence, turned out to be dispositive. For Justice Thorburn, it was irrelevant that SPay sought to employ what was effectively a cause of action in the form of a defence. The end result was that if SPay succeeded, it would have reduced or eliminated its liability to Mundo. This would significantly impact Mundo’s estate and, as a consequence, other creditors’ rights.

Recognizing Canadian law draws a distinction between set-off pleaded in defence versus as a counterclaim, Justice Thorburn held that distinction lacked the same doctrinal heft in the bankruptcy context. In supporting this conclusion, Justice Thorburn relied on the Court’s earlier decision in 3113736 Canada Ltd. v. Cozy Corner Bedding Inc., 2020 ONCA 235:

“[47]      As noted by Zarnett J.A. of this court, “Although equitable set-off is a defence, … [i]t is a way of raising, as a defence, a plaintiff’s liability to take into account a loss it occasioned to the defendant in reduction of the plaintiff’s claim. It is often referred to as a ‘claim for equitable set-off’.

[48]      It would seem therefore that the format of the proceeding is not determinative. The fact that a claim is made by a third party by way of a set-off to recover monies from a debtor may be of great significance to all creditors in the single proceeding model; this is particularly so where the debtor’s largest account receivable is at stake. To approach this matter differently would defeat the purpose of the “single proceeding model”, which is intended to “avoid the inefficiency and chaos” of a decentralized receivership process”. (Internal citations omitted)

On the facts, SPay was Mundo’s largest debtor. This meant the outcome of the claim (and SPay’s set-off) would loom large over the estate’s administration as a whole. Justice Thorburn relied on the Supreme Court of Canada’s decision in Sam Lévy & Associés Inc. v. Azco Mining Inc., 2001 SCC 92 for the proposition that, as Mundo’s largest debtor, SPay was “far from being a ‘stranger’ to the bankruptcy”.

In response to the notion that the single proceeding model is traditionally viewed as a “shield” not a “sword” (i.e., applies to prevent a receiver or bankruptcy trustee in the defendant position from having to defend claims in multiple jurisdictions), Justice Thorburn found no principled reason why that distinction should matter in this case. However, she was careful to note that a bankrupt’s debtor raising a set-off defence does not automatically justify applying the single proceeding model. In that regard, the SCJ Judge’s conclusion rested largely on factual findings about the SPay dispute’s impact on Mundo’s overall estate. Justice Thorburn recognized that she owed the SCJ Judge deference on his findings about the strong connection between SPay’s dispute with Mundo and the receivership as a whole.

Having rejected both of SPay’s legal arguments, Justice Thorburn concluded SPay had not demonstrated a prima facie meritorious case. This was sufficient to dispose of the motion. She nonetheless summarily addressed the other two prongs of the leave analysis.

On the second prong—whether the appeal raised issues of general importance—Justice Thorburn acknowledged that SPay raised three issues meeting that threshold: 1) when the single proceeding model renders an arbitration clause in an international commercial agreement inoperative; 2) when a party is a “stranger” to the bankruptcy; and 3) whether having the arbitral tribunal determine “arbitrability” would be impracticable. However, this was irrelevant given her findings on the first prong.

Finally, on the third prong—whether the appeal would unduly delay the proceedings—Justice Thorburn concluded the appeal would cause undue delay. This militated against granting leave to appeal.

Justice Thorburn dismissed the motion for leave to appeal, with costs.

Contributor Notes:

First, this decision brings to the fore the difficulty courts face when called upon to balance two strong but competing legislative policies, both well entrenched in the jurisprudence (including that of the Supreme Court of Canada). It is difficult to conjure a better example than the tension between arbitration legislation’s policy of near systematic referral to arbitration (see for example: TELUS Communications Inc. v. Wellman, 2019 SCC 19), and bankruptcy and insolvency law’s policy favouring a centralized and harmonized approach to litigating matters touching a bankrupt’s affairs (see for example: Century Services Inc. v. Canada (Attorney General), 2010 SCC 60). One might be tempted to think of the competing concerns as, on the one hand, respect for party autonomy and contractual freedom (arbitration) and, on the other hand, the orderly administration of justice (insolvency proceedings). But this appears to be a false dichotomy.

Indeed, respect for arbitration agreements also produces a salutary impact on the administration of justice; it helps unclutter the law courts of disputes parties can (and are willing to) resolve in an alternative forum. In the age of R. v. Jordan, 2016 SCC 27, and considering endless stories of hearings adjourned because the court administration could not produce a judge and/or courtroom, arbitration represents a real boon to the justice system in what most practitioners would agree is a time of great need.

On the other hand, there is sound wisdom behind the single proceeding model. Bankruptcy and insolvency matters necessarily implicate the immediate and often substantial interest of various stakeholders. Most of these stakeholders will be strangers to the arbitration agreement in question. Where enforcing an arbitration agreement threatens to hinder not only the administration of justice, but also the interests of other stakeholders in the bankruptcy sandbox, one could argue that the arbitration agreement is inoperative because applying it would offend what proponents of this view might say is an overriding public policy.

The arbitration/insolvency debate is an important one, and this decision is neither the first nor last salvo (see for example: Petrowest Corporation v. Peace River Hydro Partners, 2020 BCCA 339, Supreme Court of Canada decision pending, which touched on the applicability of the arbitration agreement separability principle in this context).

Second, query whether there is a happy medium. In some cases, it might be possible to allow the matter to proceed to arbitration, but based on a procedure the court is satisfied will produce speedy and efficient adjudication. At first glance through an arbitration-focused lens, this seems like an unsavoury option. It invites the court’s significant intrusion into the arbitration procedure, something over which the arbitral tribunal should have broad discretion and flexibility, subject to the parties’ agreement. This is out of step with the court’s ordinary approach to supporting, rather than micromanaging, the arbitral process. At the same time, if the choice is between no arbitration and arbitration in a format satisfactory to the court, parties wanting to arbitrate might be able to live with the latter.

Third, as a procedural matter, the motion for leave to appeal was taken under paragraph 193(e) of the BIA. The question arises as to whether an appeal of the SCJ Judge’s decision would have been possible had the arbitration agreement fallen under Ontario’s domestic arbitration legislation, the Arbitration Act, 1991.

The ICAA is silent as to whether a decision on a stay motion is appealable. This means it presumptively is, in accordance with the Ontario Courts of Justice Act. In contrast, the Arbitration Act, 1991 generally bars appeals of decisions on stay motions (subsection 7(6)). The exception is where the motions judge determines the arbitration agreement does not apply to the dispute, or that one of the litigants is not a party to the arbitration agreement (see for example: Huras v. Primerica Financial Services Ltd., 2000 CanLII 16892 (ON CA), 137 O.A.C. 79, paras. 8-11). That was not the case here. The SCJ Judge did not find the dispute fell outside the subject-matter scope of the arbitration agreement in the Mundo/SPay contract. Rather, he found the agreement, though otherwise applicable, was inoperative.

Although a technical point, it is important to recall the stay is not brought under the BIA, but under the applicable arbitration statute (in Ontario, either the ICAA or the Arbitration Act, 1991). In light of the prohibition against appeals in subsection 7(6) of the Arbitration Act, 1991, SPay could not have sought leave to appeal the SCJ Judge’s decision had the arbitration agreement been domestic rather than international.

Fourth, for a note on the Superior Court’s decision in this matter, see Ontario – Receiver not bound by international arbitration clause with foreign seat – #626.

author

James Plotkin

James Plotkin is a bilingual associate in Gowling WLG’s Ottawa office, practising in the Advocacy and Intellectual Property groups. His practice focuses on commercial litigation and arbitration (international and domestic), intellectual property litigation and administrative law. James has argued before the Supreme Court of Canada, the Federal Court of Appeal…

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