December 6, 2022
Supreme Court of Canada confirms arbitration agreements may be inoperative in insolvency proceedings
By Rachel Nicholson and Alexander Overton
It is common for modern commercial agreements to include mandatory arbitration provisions which direct the parties towards an alternative path for dispute resolution. Arbitration, as opposed to litigation before the courts, can offer a quicker and more flexible dispute resolution mechanism to govern conflicts that may arise in complex contractual arrangements. However, as arbitration agreements have become more widespread, they have begun to contend with the special legislative regimes applicable to insolvency proceedings, which seek to establish a streamlined and centralized process for all disputes before a single supervising judge.
The Supreme Court of Canada’s (“SCC”) recent decision in Peace River Hydro Partners v. Petrowest Corp. (“Petrowest”) tackles this tension head-on. It provides a framework for insolvency practitioners to assess whether an arbitration agreement will create an additional hurdle, or if the court will retain jurisdiction over the dispute, avoiding mandatory arbitration. The SCC’s conclusion that the arbitration agreements were inoperative was consistent with the conclusion reached by Justice Penny, as upheld by the Ontario Court of Appeal, in a recent decision in the receivership proceedings of Mundo Media Ltd. (Re) (“Mundo”) where a similar issue was raised, which is further discussed below.
Peace River Hydro Partners (“Peace River”) was a partnership formed to construct a hydroelectric dam in northeastern British Columbia at the “Site C Project”. Petrowest Corp. (“Petrowest”) was an Alberta-based construction company and a member of the partnership. Petrowest was sub-contracted to perform certain works on the project.
After encountering financial difficulties in 2017, a receiver was appointed over Petrowest by the Court of King’s Bench in Alberta (the “Receiver”). The Receiver brought an action in the British Columbia Supreme Court against Peace River, along with the two other partners in the partnership and their parent companies (although for simplicity, the defendants will be collectively referred to as “Peace River” in this article) to recover amounts alleged to be owing to Petrowest for work completed on the project.
Peace River brought an application to stay the litigation commenced against it by the Receiver on the grounds that the contracts governing the work contained mandatory arbitration agreements (the “Arbitration Agreements”). There were four separate arbitration agreements engaged by the dispute, each with different procedural rules and requirements, and parts of the Receiver’s claim were not covered by an arbitration clause. The Receiver resisted the application, arguing that while Petrowest was a party to the Arbitration Agreements, the Receiver was not. The Receiver further argued that, even if it was a party to the Arbitration Agreements, the Court should find that the Arbitration Agreements were void, inoperative or incapable of being performed.
The British Columbia Supreme Court refused to grant the stay sought by Peace River. The chambers judge agreed with Peace River that the Receiver was a party to the Arbitration Agreements by virtue of acquiring Petrowest’s right to sue on the contracts, and so section 15 of British Columbia’s Arbitration Act was engaged. However, the federal Bankruptcy and Insolvency Act (“BIA”) gave the court discretion to decline a stay of the proceedings. The court had the inherent jurisdiction to disrupt private contractual rights and to control its own process. Fairness and efficiency were suitable considerations for the exercise of the court’s inherent jurisdiction and giving effect to the Arbitration Agreements would have required significant delay and expense to the prejudice of the receivership proceedings. The chambers judge declined to grant the stay application.
At the British Columbia Court of Appeal, the court upheld the decision of the chambers judge, but on different grounds. The appellate court relied on the doctrine of separability, which provides that arbitration agreements constitute separate, self-contained contracts within their containing contracts and as such are severable. The Receiver was not a party to the Arbitration Agreements and was empowered to disclaim Petrowest’s contracts – the Receiver had elected to disclaim the Arbitration Agreements when it commenced legal proceedings rather than engage in arbitration. Therefore, the proceedings were not commenced by a “party” as required by section 15 of the Arbitration Act, and in any event the Receiver’s disclaimer of the Arbitration Agreements meant they were “void, inoperative or incapable of being performed” within the meaning of section 15(2).
The SCC dismissed Peace River’s appeal with a five-judge majority opinion, and the remaining four judges concurring in the outcome but for different reasons. Justice Côté, writing for the majority and following the reasoning of the BC Supreme Court, held that the Arbitration Agreements were inoperative in the circumstances despite finding that the Receiver was a party thereto. The SCC established a test to assess whether the court should decline to grant a stay in favour of arbitration for disputes connected to an insolvency proceeding.
The court considered under what circumstances an otherwise valid arbitration agreement was unenforceable in the context of a receivership under the BIA.
Arbitration and Insolvency Law
The court briefly discussed the “competence-competence” principle of arbitration law, which establishes the general rule that an arbitrator has the first opportunity to address a challenge to their own jurisdiction. However, as the dispute at hand involved questions of pure law or mixed fact and law requiring only a superficial consideration of the evidentiary record, it fell into an exception to the “competence-competence” principle and the court was appropriately placed to resolve a challenge to the arbitrator’s jurisdiction.
The SCC noted an increasing tension between arbitration and insolvency law; they each represent diametrically opposed approaches to dispute resolution. Arbitration favours decentralization, while insolvency promotes a centralized forum to determine claims (i.e., the “single proceeding model”). However, the court also remarked on the strong similarities between the two, such as a joint focus on efficiency, expediency, procedural flexibility, and reliance on specialized decision-makers. These shared values weighed in favour of holding parties to their agreements to arbitrate, even within insolvency proceedings.
However, the SCC held that this approach should not be absolute, and exceptional insolvency matters would require that arbitral arrangements be set aside. Where the arbitration would compromise the orderly and efficient conduct of the insolvency proceedings, the “single proceeding model” of insolvency law should be preferred so the court can assert control over the proceedings, ensure the timely resolution of disputes and protect the public interest. This is a highly factual exercise dependent on the circumstances of each case.
Framework for a Stay of Proceedings in Favour of Arbitration
The court reiterated the two-stage framework for assessing whether to grant a stay of proceedings in favour of arbitration.
First, the party seeking the stay (in this case, Peace River) must establish that the technical prerequisites for arbitration are met. The standard of proof at this stage is low – there must be an “arguable case”, as opposed to the general “balance of probabilities” standard.
If this burden is met, the court must grant a stay in favour of arbitration unless a statutory exception to the arbitration applies. Under section 15(2) of the Arbitration Act, this meant the court had to find that the Arbitration Agreements were “void, inoperative or incapable of being performed”. In this second stage, the burden shifts to the party seeking to avoid arbitration on a balance of probabilities (in this case, the Receiver).
Was the Receiver a “Party” to the Arbitration Agreements?
The SCC found that the Court of Appeal had erred in applying the doctrine of separability to the Arbitration Agreements. Separability does not apply where there has been no challenge to the validity of the main contract or to the arbitration agreement. Furthermore, separability was meant to safeguard arbitration agreements, not to attack them – the Court of Appeal’s position that a receiver could unilaterally revoke an arbitration agreement without judicial inquiry into its validity or enforceability would undermine the central purpose of the Arbitration Act.
Relying on ordinary contractual principles, interpretive principles, and the purpose of the Arbitration Act, the court agreed with the chambers judge that the Receiver was a party to the Arbitration Agreements.
Ordinary Contractual Principles
The SCC referenced the long-accepted proposition that an entity connected to a contractual signatory may be bound as a party to a contract through operation of law. The SCC gave two examples: 1) the prohibition against an assignor assigning contractual rights in a way that would “convey the benefits and nullify the burdens”, and 2) the enforceability of arbitration agreements against a trustee in bankruptcy where it elected to adopt a contract containing an arbitration clause. In each example, the non-signatory steps into the shoes of the contracting party and becomes bound by the same terms. The SCC saw no reason why the same should not apply to a receiver suing on a debtor’s rights.
While the Arbitration Act does not define the term “party” (or expressly provide for its application to an entity making a claim under or through a party to an arbitration agreement), the SCC found that holding that the Arbitration Agreements did not bind the Receiver would be inconsistent with the proper interpretation of the relevant statutes.
The SCC held that the Receiver’s proposed interpretation of the Arbitration Act, which was that it was not a party to the Arbitration Agreements, would mean that no non-signatory could ever be a party to an arbitration agreement, as all non-signatories (trustees, agents, receivers, assignees, etc.) may only claim through or under a signatory. This was at odds with contractual doctrine.
Further, the British Columbia legislature had concurrently passed the International Commercial Arbitration Act (“ICCA”) with the Arbitration Act on the same subject matter and the two had to be interpreted in harmony. As the ICCA defines a party as including “a person claiming through or under a party”, the Arbitration Act also includes such entities.
Purpose of the Arbitration Act
Finally, the court held that the central purpose of the Arbitration Act, that parties abide by valid arbitration agreements, would be frustrated if the Receiver was held not to be a party to the Arbitration Agreements. To find otherwise would effectively prevent the arbitration of any dispute should a contracting party enter receivership, offending the core arbitral principles of party autonomy, limited court intervention, and competence-competence.
Factors for Assessing whether an Arbitration Agreement is Inoperative
After stating that a receiver’s unilateral disclaimer could not render an arbitration agreement “void, inoperative or incapable of being performed” and stating that the preferable procedure would be for a receiver to bring a motion for directions seeking judicial determination of the applicability of any arbitration agreement, the SCC held that a court may use its statutory jurisdiction under the BIA to decline to enforce an arbitration agreement. The court can find an arbitration agreement inoperative under section 15(2) of the Arbitration Act where arbitration would compromise the orderly and efficient resolution of a receivership.
The court provided five non-exhaustive factors to consider in determining if an arbitration agreement should be held to be inoperative in an insolvency proceeding:
Effect of arbitration on the integrity of the insolvency proceedings.
If the agreement would compromise the objective of the insolvency proceedings (i.e., the orderly and expeditious administration of the debtor’s property), it may be inoperative. In the case at hand, enforcing the Arbitration Agreements would have required the Receiver to participate in four different arbitrations with at least seven counterparties. Funding for the proceedings would have come directly from the Petrowest estate to the detriment of its creditors. Not all of Petrowest’s claims were subject to arbitration, possibly necessitating a court proceeding in any event and creating a real risk of piecemeal decisions with conflicting outcomes.
Relative prejudice to the parties from the referral of the dispute to arbitration.
The benefit of overriding the arbitration agreement should outweigh the prejudice caused. A single judicial proceeding would be the most efficient and cost-effective route. Peace River was unable to identify any prejudice it would suffer if the Arbitration Agreements were rendered inoperative, in favour of a determination within the single insolvency proceeding.
The urgency of resolving the dispute.
The court should prefer the more expeditious procedure. The SCC accepted the chambers judge’s finding that the receivership could not distribute proceeds until the dispute with Peace River was resolved. The parties had conceded that a court proceeding would be more expeditious.
- The applicability of a stay of proceedings under bankruptcy and insolvency law.
The legislation may impose a stay that precludes any proceedings, including arbitral proceedings, against the debtor. This factor did not apply as the proceedings were commenced by the Receiver on Petrowest’s behalf.
Any other factor the court considers material in the circumstances.
While the SCC did not identify further factors, it left the door open for refinement of the test.
The SCC dismissed the appeal brought by Peace River. The Arbitration Agreements were inoperative due to their potential impact on the orderly and efficient resolution of the Petrowest receivership proceedings and Peace River’s application to stay the litigation brought by the Receiver was refused.
The ruling in Petrowest settles the debate on the interaction between insolvency and arbitration law. The “single proceeding model” that has characterized insolvency proceedings for decades continues to provide compelling grounds to centralize all claims against a debtor, or by a debtor in certain circumstances, within the court where they can be addressed on an expedited, cost-efficient basis. Furthermore, the SCC has clarified two critical points.
First, arbitration cannot be used as a sword against a debtor by virtue of the insolvency stay. All proceedings against a debtor are stayed in the insolvency proceedings and would-be claimants can no longer take their disputes before an arbitrator.
Second, where the debtor or a court-appointed officer initiates proceedings, it will have to satisfy the court that the circumstances warrant exercise of statutory jurisdiction to find an arbitration agreement inoperative. The Arbitration Agreements in Petrowest would have caused serious complexity, expense, and delay to the receivership proceedings in a process the court described as “chaotic”. Absent any contention of prejudice by Peace River, the stream-lined process of a court resolution was the obviously preferable option. This inquiry is highly fact specific.
This decision reflects and expands on Justice Pepall’s holdings in Canada (Attorney General) v. Reliance Insurance Company where, on a motion for directions, the court similarly held that a court-appointed liquidator under the Winding Up and Restructuring Act was not subject to arbitration agreements that would have sent it to three separate jurisdictions to collect receivables. In that case, Justice Pepall relied on the “single proceeding model” and the additional delay and expense to the debtor’s estate the arbitrations would cause as grounds to refuse a stay that would have permitted arbitration.
Other Recent Cases
The Ontario Court of Appeal’s recent decision in Mundo also finds support in the SCC’s later decision in Petrowest. A key point of contention in Mundo was whether the “single proceeding model” could be used to centralize the pursuit of claims by the receiver against a third party. In that case, the court-appointed receiver brought a motion to collect a receivable owing to Mundo Media Ltd. by SPay Inc (“SPay”). In response, SPay brought a motion to stay the Receiver’s motion to collect, on the basis that the underlying contracts contained a provision requiring mandatory arbitration in New York, despite the main receivership proceeding taking place in Canada, thereby triggering Ontario’s ICAA (which applies to international arbitration agreements).
The chambers judge, Justice Penny, noted that the UNCITRAL Model Law on International Commercial Arbitration, which is incorporated by reference into Ontario’s ICAA, requires the court to refer a matter to arbitration upon a party’s request if the parties and the matter in dispute are subject to an arbitration agreement and the arbitration agreement “is not null and void, inoperative or incapable of being performed” (which is identical to the language referenced in Petrowest). Justice Penny held that the arbitration agreement was inoperative by virtue of the “single proceeding model”, which applied in the circumstances to the claim commenced by the receiver against SPay, as SPay was not a “stranger to the bankruptcy” given the circumstances of the case.
The court relied on the statutory exception in Ontario’s ICCA and the discretion granted to the court under section 243 of the BIA in the same manner as the SCC later found in Petrowest. The decision was affirmed by the Ontario Court of Appeal, which cited delay, additional costs and the deterioration of assets of the receivership as further grounds for refusing a stay in favour of arbitration. In relying on Justice Penny’s reasoning, the Court of Appeal noted that “if SPay’s dispute with Mundo is not brought within the single proceeding model, the purpose of this model, to avoid the chaos and inefficiency of a decentralized receivership process, would be defeated”.
The SCC decision has confirmed both Justice Penny’s and Justice Thorburn’s reasoning that the principles underlying the “single proceeding model” govern, to bring such disputes within the jurisdiction of the court.
However, given the lengths the SCC went to describe the commonalities between insolvency law and arbitration and its reminder that these shared values could lead a court to hold parties to their agreement to arbitrate, debtors and court-officers should be cautious to assume that an arbitration agreement will always be held to be inoperative or invalid. Where an arbitration agreement offers a uniform, efficient resolution of disputes it may be more likely to be enforced in debtor or court-officer initiated proceedings, despite insolvency.
 Rachel Nicholson and Alexander Overton practice at Thornton Grout Finnigan LLP in Toronto. Their bios are available here and here, respectively.
 Royal Bank of Canada v. Mundo Media Ltd., 2022 ONSC 2147 [“Mundo”], aff’d 2022 ONCA 607 [“Mundo ONCA”]. Thornton Grout Finnigan LLP acts as counsel to the Court-appointed Receiver in Mundo.
 Petrowest SCC, supra note 1 at paras. 39 & 41 – 43.
 Ibid at paras. 60 – 71.
 In this case, the court relied on its jurisdiction under sections 183 and 243 of the BIA.
 Petrowest SCC, supra note 1 at paras. 73 – 74.
 Ibid at paras. 167 – 168.
 Ibid at paras. 104 – 110.
 Ibid at paras. 111 – 115.
 Ibid at paras. 116 – 118.
 Ibid at paras. 123 – 124 & 152.
 Mundo, supra note 2 at para. 7.
 Mundo ONCA, supra note 2 at para. 57.