Arbitration agreements may be inoperative due to receivership proceedings: Supreme Court of Canada

Parties often include arbitration clauses in their contracts on the expectation that their contractual disputes will be resolved through confidential arbitration in their preferred venue. The Supreme Court of Canada’s recent Peace River Hydro Partners v. Petrowest Corp., 2022 SCC 41 (Petrowest) decision illustrates that this expectation might be upset when arbitration law collides with insolvency law. Where one counterparty enters insolvency proceedings—whether in bankruptcy, CCAA or receivership—the other party could find its arbitration agreement considered inoperative and its dispute instead resolved in court.

What you need to know

• The Supreme Court held that when a party is subject to a receivership, counterparties with the debtor company may be unable to rely on an arbitration clause if they are sued by the debtor. A court has the power to declare an arbitration clause “inoperative” and require the suit to be heard in court instead of before an arbitrator, without the arbitrator first determining jurisdiction as is usually the case.
• There is no automatic rule that arbitration clauses in a receivership or insolvency are inoperative or inapplicable. This is not a sufficient reason to avoid arbitration. To declare an arbitration agreement inoperative, the party seeking to avoid arbitration must show that the arbitration would compromise the integrity of the parallel insolvency proceedings. A court must consider:
  • (i) the effect of the arbitration on the integrity of the insolvency proceedings; (ii) the relative prejudice to the parties; (iii) any urgency; and (iv) the effect of any existing insolvency stay.
• This test is relevant to suits or proceedings brought by a debtor; it does not modify bankruptcy or insolvency stays of proceedings prohibiting bringing arbitration claims against a debtor.
• To avoid having an arbitration agreement rendered inoperative, contracting parties may want to ensure that their agreed arbitration procedures are as simple, efficient and cost-effective as possible and establish that they will be prejudiced if the arbitration agreement is not honoured (for example, by a loss of confidentiality in court proceedings).
• The Supreme Court’s approach to this “single proceeding” model of insolvency law in receiverships expands on the Ontario Court of Appeal’s recent Mundo Media Ltd. (Re), 2022 ONCA 607 decision from earlier this year, which we summarized in our previous bulletin.

The details

Background

This case addresses a party’s ability to rely on a contractual arbitration clause and resolve its contractual disputes through arbitration when a receiver is appointed over the insolvent counterparty and commences a suit against it.

Petrowest Corporation (Petrowest) was a publicly traded, Alberta-based construction company focused on industrial and civil infrastructure projects in Western Canada. Among its other projects, Petrowest was a member of Peace River Hydro Partnership (PRHP), through which it performed construction work on the “Site C” hydroelectric dam project in Northeastern British Columbia.

In 2017, the Court of King’s Bench of Alberta appointed the Receiver over Petrowest and its corporate group. The Receiver commenced an action before the BC Supreme Court against PRHP, along with PRHP’s two other members and those members’ parent companies (collectively, the Defendants), for the recovery of amounts allegedly owing to Petrowest for performance of subcontracted work in respect of the Site C project. The Defendants brought an application for a stay of the Receiver’s action on the basis that the various contracts governing Petrowest’s work contained mandatory arbitration clauses.

Importantly, those contracts contained four separate arbitration processes—each with its own rules, procedures and panel requirements—that were triggered by the Receiver’s claims. The disputes would nonetheless still require court proceedings because some of the Receiver’s claims were not covered by an arbitration clause.

At first instance, the application judge declined to grant the Defendants’ requested stay. She found that, while section 15(1) of the B.C. Arbitration Act (which was replaced by new legislation in 2020) required the court to stay the Receiver’s action in favour of arbitration, the Bankruptcy and Insolvency Act gave the court discretion to not stay the proceedings—discretion that she exercised because the proposed arbitration process would have been slow and expensive, holding up distributions to creditors in the receivership and bankruptcy proceedings.

The BC Court of Appeal upheld the application judge’s decision, but with different reasoning. It held that an arbitration clause is a “self-contained” agreement within a larger contract, meaning the arbitration clause is severable from that main contract. The Court determined that because the Receiver’s powers included the power to disclaim contracts, and the Receiver had implicitly disclaimed the applicable arbitration clauses by the act of commencing legal proceedings rather than proceed to arbitration, the arbitration clauses were “void, inoperative or incapable of being performed” for purposes of section 15(2) of the Arbitration Act.

The Defendants appealed the Court of Appeal's decision.

Key issue

The key issue was whether a Receiver could avoid an arbitration clause on a claim that it commenced under a contract containing an arbitration clause. The answer is that under certain conditions a court may determine, in the context of a receivership, that an arbitration clause is inoperative.

The Supreme Court of Canada's decision

The Supreme Court dismissed the appeal, with five judges supporting a majority opinion and four judges supporting a concurring decision (i.e., reaching the same resolution of the appeal, but on different grounds).

While traditionally arbitration and insolvency were seen to be at odds, the Court noted that arbitration law and insolvency law have much in common. Each prioritizes efficiency and expediency; procedural flexibility is a hallmark of both arbitration and insolvency law; and both often rely on specialized decision makers to achieve their respective objectives. In many cases, these shared interests will converge through arbitration, and parties should be held to their agreement to arbitrate notwithstanding ongoing insolvency proceedings. Valid arbitration agreements are generally to be respected.

However, the Court held that at times insolvency matters may necessitate the rejection of arbitration in favour of a centralized judicial process. This is true where arbitration would compromise the orderly and efficient conduct of the insolvency proceedings. Insolvency law’s strong preference for resolving all disputes involving a debtor in a centralized judicial forum—known as the “single proceeding” model—may overcome the widely-accepted presumptions that parties are to be held to their arbitration agreements. That was true here, even though the Receiver commenced a separate civil action and was not proceeding solely in the receivership proceedings.

The Court describes provincial legislation nationwide as “pro-arbitration.” The Court reaffirmed the competence-competence principle: in most circumstances where an arbitrator’s jurisdiction is challenged, arbitrators should be allowed to rule first on their own jurisdiction. However, courts may resolve jurisdictional questions without recourse to the arbitrator if the challenge involves pure questions of law, or questions of mixed fact and law “requiring only superficial consideration of the evidentiary record”¹. That was the case here.

Generally, there are two elements that a court considers when determining whether to stay a court proceeding in favour of arbitration. First, the party seeking the stay must establish that the technical prerequisites for arbitration are met (for example, that an arbitration agreement exists and that the other party is a “party” to the arbitration agreement). This is a low bar: the applicant must only show an arguable case. Unless certain statutory exceptions to arbitration apply, the court must issue a stay in favour of arbitration. These statutory exceptions are interpreted narrowly: arbitration is not appropriate if the arbitration agreement is “void, inoperative or incapable of being performed”.

In the receivership context, the Supreme Court held that an arbitration agreement is inoperative where enforcing it would compromise the orderly and efficient resolution of insolvency proceedings.

The Court noted that determining whether an arbitration agreement would compromise insolvency proceedings is a highly fact-specific analysis. Accordingly, the Court provided five non-exhaustive factors to consider in making the determination and applied those factors to the facts at hand:

1. The effect of the arbitration on the insolvency proceedings. An arbitration agreement may be inoperative if it would lead to an arbitral process that would compromise the objective of the insolvency proceedings: the orderly and expeditious administration of the debtor’s property. Here, the parties’ chosen arbitration procedures were “chaotic.” They would have required the Receiver to participate in at least four different arbitrations and a further court proceeding, resulting in piecemeal decisions and a serious risk of conflicting outcomes. Arbitration would have also been significantly more expensive than a resolution in the single receivership proceeding, with the Receiver’s funding coming from Petrowest’s estate to the detriment of creditors.
2. The relative prejudice to the parties from the referral of the dispute to arbitration. An agreement to arbitrate should be discarded only where the benefit of doing so outweighs the prejudice. Here, a single proceeding would be the more efficient and cost-effective route for both sides of the dispute. The Defendants failed to demonstrate that they would suffer any prejudice if the dispute were to be resolved in court.
3. The urgency of resolving the dispute. The court should generally prefer the more expeditious procedure.  It was impossible to distribute the proceeds of Petrowest’s estate to creditors until the dispute was resolved. Accordingly, this urgency militated in favour of finding the arbitration agreements inoperative.
4. The applicability of a stay of proceedings under bankruptcy or insolvency law. Insolvency legislation imposes a stay of proceedings that precludes any proceedings, including arbitral proceedings, against the debtor. Such a stay would itself render the arbitration agreement inoperative. This did not apply here because the proceeding was commenced by the Receiver acting on the debtors’ behalf.
5. Any other factors the court considers material in the circumstances. While the Court did not state what these additional factors might be, this “catch-all” language leaves some room for parties to maneuver in future decisions.

The Court ultimately determined that the proposed arbitration would have compromised the orderly and efficient resolution of Petrowest’s receivership proceedings. The arbitration clause was therefore inoperative. A stay was not appropriate and the action would continue in court.

Implications

The Supreme Court of Canada’s guidance emphasizes the importance this Court places on arbitration agreements. Nonetheless, parties may not be able to rely on their arbitration clauses when facing an insolvent counterparty. Insolvency law’s preference for resolving disputes in a single proceeding, and the efficiency, expediency and lower costs that flow from this approach, can provide strong grounds to refuse a stay in favour of arbitration, despite a contractual agreement to the contrary. The pull of this single proceeding model is particularly strong where the proposed arbitration would be expensive, inefficient or “chaotic,” and where there is otherwise no serious prejudice to the party seeking to rely on it.

However, the Supreme Court noted that this analysis is highly fact-specific, which leaves room for parties to strengthen their future cases in favour of arbitration. Where parties intend for their arbitration agreements to be honoured in an insolvency context, they may want to plan ahead by: (i) ensuring that their proposed arbitration is as simple and efficient as practicable; (ii) where possible, executing a single “master” arbitration agreement that governs all disputes under their contracts, rather than inserting different arbitration clauses in different agreements; and/or (iii) considering any unique circumstances that would result in prejudice if the arbitration were not honoured (for example, the loss of confidentiality in court proceedings).