Does The UNCITRAL Model Law Apply To A Claim Under The Consumer Protection Act?

The Queen’s Bench Court for Saskatchewan recently applied the Saskatchewan International Commercial Arbitration Act (SICAA) and the UNCITRAL Model law annexed to that Act and stayed an action based on the Saskatchewan Consumer Protection Act and a contract which was apparently between two Canadian entities.

The decision in Zwack v. Pocha is important for two reasons.

First, the plaintiffs’ action was stayed because another company from the state of Washington said that it was also a party to the agreement.

Second, the action was stayed despite the terms of the Saskatchewan Consumer Protection Act (CPA).  In previous cases, such as Seidel v. TELUS, plaintiffs were held to be entitled to bring claims in court under the provincial CPA despite the presence of arbitration clauses.

Accordingly, the decision in Zwack v. Pocha helps us explore the boundaries of the claims that fall within “international commercial arbitration” and are governed by the Model Law, and those that are not.

Factual Background

The plaintiffs in Saskatchewan wanted to build a cottage based upon plans and materials made by Lindal Cedar Homes, a company located in the State of Washington.  They entered into a sales agreement with Lindal’s local Saskatchewan dealer, Prairie Cedar Homes.  The sales agreement stated that Prairie Cedar Homes would sell the materials to the plaintiffs.  The agreement also stated that Lindal’s responsibility was to manufacture and ship the materials and building plans, to honour its warranty and to mediate and arbitrate disputes with the client, and that “Lindel will accept this agreement when the President/CEO of Lindal sends a written confirmation and warranty number.”  The agreement contained a clause which required any disputes to be mediated “before the American Arbitration Association (in Canada, the appropriate Provincial arbitration act)”, and if not successful, required any dispute to be arbitrated “by the American Arbitration Association(“AAA”) (in Canada, the appropriate Provincial arbitration act)”.  The agreement further stated: “If the dispute involves Lindal, mediation and arbitration will take place in King County, Washington and the laws of the state of Washington will apply.”  Lindal said that it was party to the agreement by reason of delivering a written confirmation of the agreement and a warranty.

The construction of the cottage led to acrimony between the parties. Ultimately, the parties separated and the plaintiffs engaged another contractor to complete the building.  They then sued Prairie Cedar Homes, Lindel and the original building contractor. Lindel brought a motion to stay the action based upon the arbitration clause in the agreement and the Model Law attached to SICAA.

The Decision

The judge held that the plaintiffs were bound by the arbitration clause and stayed the action. In arriving at that conclusion he noted that, while Lindel was not an original signatory to the agreement containing the arbitration clause, Lindel asserted that it was a party to that agreement by reason of its confirmation of the agreement and the warranty it issued pursuant to the agreement. The plaintiffs themselves agreed that Lindel was a party to the sales agreement; they agreed that Lindel was entitled to rely upon the arbitration clause if it was applicable; and they agreed that the SICAA applied to the issues raised in Lindal’s motion. Accordingly, these issues were conceded by the plaintiffs and were not determined by the court.

The judge also held that, in accordance with Article 16 of the Model Law, the arbitral tribunal was to decide any jurisdictional issues, not the court.  The court referred to the decision of the Supreme Court of Canada in Seidel v. TELUS 2011 SCC 15 which adopted the competence-competence principle which is directly set forth in Article 16.

The plaintiffs asserted that their claims of negligence and vicarious liability were not captured by the arbitration clause.  However, the arbitration agreement referred to “any dispute”, and the court held that the application of interpretation principles – including contra proferentum – did not remove the dispute from the ambit of the clause.  Moreover, the articles of the Model Law demonstrated the wide ambit of international commercial arbitration, which includes “all or certain” disputes, whether “contractual or otherwise.” (articles 7(1) and 16(1).

The court held that the CPA did not render the arbitration clause inapplicable to the dispute. Unlike the provisions of the British Columbia CPA which were in issue in Seidel v. TELUS, the Saskatchewan CPA makes a distinction, the court determined, between proceedings brought by the director under that Act and proceedings brought by members of the public; only the proceedings brought by the director were public interest claims.

Moreover, the court found that section 44 of the Saskatchewan CPA does not eliminate the arbitration of claims which are subject to the CPA.  Section 44(1) states that any agreement which “implies that …any right or remedy provided by this Part do not apply…or …any right or remedy provided by this Part in any way limited, modified or abrogated” is void.  Section 44(2) says: “Notwithstanding subsection (1), where the parties to a dispute pursuant to this part are able to resolve their dispute through mediation, arbitration or another process, the parties’ rights pursuant to this Part are extinguished respecting that dispute.”  The court found that “s. 44(2) expressly extinguishes Part III rights in favour of arbitration.”

Discussion

There are two interesting aspects to this decision:

The first aspect involves the related issues of whether the arbitration was truly an “international arbitration”, and whether, if the action had been brought only against the Saskatchewan agent, Prairie Cedar Homes, a stay motion would have been successful.

Section 1(3) of the Model Law attached to SICAA says that “an arbitration is international if:

(a) the parties to an arbitration agreement have, at the time of the conclusion of that agreement, their places of business in different States; or

(b) one of the following places is situated outside the State in which the parties have their places of business:

(i) the place of arbitration if determined in, or pursuant to, the arbitration agreement,

(ii) any place where a substantial part of the obligations of the commercial relationship is to be performed or the place with which the subject-matter of the dispute is most closely connected….”

One may wonder at the outset whether the SICAA and the Model Law should apply at all since the plaintiffs were not in business and were buying a cottage for their own use.  If SICAA did not apply then the Saskatchewan Arbitration Act would have applied.  As the court noted, under the Arbitration Act, the court had a discretion to stay or not stay the action while under the SICAA there was no such discretion.

Clause (a) of the Model Law raises the issue of who were parties to the arbitration agreement “at the time of the conclusion of that agreement.” Arguably, Lindel was not a party to the agreement at the time of the conclusion of the agreement, if the agreement was “concluded” when first signed by Prairie Cedar Homes.  If Lindel was not such a party, then clause (a) would not apply since the other parties were located in Saskatchewan.

Clause (b) is obviously intended to apply if all the parties have their place of business in the same State. If Lindel had not been sued, then sub-clause (b)(i) would not have applied as the place of the arbitration was not mandated to be in the state of Washington if Lindel was not sued.

Sub-clause (b)(ii) also might not apply unless Lindel’s obligations were in issue.  The state of Washington might well be the place where Lindel carried out its obligations, and the place to which the agreement was closely connected, if Lindel’s obligations were in issue.  Obviously, Washington is outside the State of the place of business of the plaintiffs and Prairie Cedar Homes, namely Saskatchewan and Canada. But if Lindel was not sued and if Lindel’s obligation were not relevant to the dispute and only the obligations of Prairie Cedar Homes were relevant, then sub-clause (b)(ii) might not be engaged.

So the facts of this case raise the interesting issue of whether, under the Model Law, the “international commercial” nature of the agreement is to be determined once and for all at the time of the agreement, or whether that nature can be determined or influenced by the location of the actual parties to the actual dispute.  If the latter is so, then plaintiffs may arguably avoid being involved in an international arbitration in another country by only suing domestic parties with domestic obligations, even though the arbitration agreement is also with international parties.

The second issue is whether the court correctly held that the CPA authorized the arbitration of claims falling within that Act, notwithstanding the plaintiffs’ objection.  Section 44(1) assumes that there is an existing agreement which that section renders void.  An arbitration agreement would be the very sort of agreement to which one could argue that the sub-section applies.

Section 44(2) says “notwithstanding section 44(1)” if the parties are “are able to resolve their dispute” through arbitration, their rights under Part III are extinguished.   It could be argued that the words “are able” refer to a dispute that is actually and consensually arbitrated; that the point of sub-section 2 was to ensure that the parties can’t have two kicks at the can; and that it was not intended to include arbitration agreements per se within subsection 2 since, if it had been so intended then the sub-section would have said “where parties to a dispute pursuant to this Part have agreed to resolve their dispute through mediation, arbitration or another process…”  It could be argued that the reference in this subsection to the ability of the parties to resolve their dispute by arbitration, not their agreement to do so, is quite striking.  Those making that argument could also submit that provincial legislatures do not have different intentions on this issue and that consumer protection legislation should be read consistently across Canada to exclude arbitration.

In the result, the decision demonstrates that the ambit of the Model Law may be a matter of controversy.  Exactly what sort of arbitration agreement is an “international commercial” arbitration agreement may be disputed, and that issue may be influenced by the nature of the dispute that arises. In addition, a controversy may arise as to whether the Model Law requires arbitration in the face of provincial consumer protection legislation.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 10

Zwack v. Pocha 2012 SKQB 371

Arbitration – International Commercial Arbitration – Competence-Competence – Interpretation of Arbitration Agreement

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                January 4, 2013

www.constructionlawcanada.com
www.heintzmanadr.com

 

Two Construction Lien Issues: Architect’s Pro-Forma Certificate Is Invalid; GST Must Be Added To Holdback

The Ontario Superior Court recently decided two important issues relating to construction liens. In Wellington Plumbing & Heating Ltd. v. Villa Nicolini Incorporated, the court held that a late-issued pro forma architect’s certificate was invalid, and that GST must be added to a holdback.

Factual Background

Villa Nicolini constructed a retirement home in Vaughan. The project started in 2007 and was to be completed by the fall of 2008. In the spring of 2010, construction was 75% complete and numerous trades were unpaid and had registered liens.

The mortgagees exercised their rights to sell the project lands. To convey title to the purchaser, the mortgagees vacated the registered liens by posting a letter of credit to stand as security for the lien claims in place of the project lands.  The amount of the required holdback was in dispute between the lienholders and the mortgagees.

The lien claimants said that the required holdback was $497,236 while the mortgagees said it was $285,140. The difference between the two figures was due to the parties’ answers to two questions.

First, were the architect’s certificates of completion validity issued?  If not, as the lien claimants submitted, then the releases of holdback based on those certificates did not count toward the holdback and the mortgagees would have to add them to the holdback which had been made by the owner.

Second, was GST required to be maintained as part of the holdback?  If so, as the lien claimants submitted, the amount of GST would have to be added by the mortgagees to the holdback.

The mortgagees argued that the amount of the required holdback was reduced by about $212,000 paid by the owner to subcontractors in accordance with certificates issued by the architect during the project. Those certificates were issued under section 25 of the Construction Lien Act. That section allows the owner to pay subcontractors whose work has been certified by the “payment certifier” as being complete.  The payment certifier is normally the architect or engineer hired for the project.  Section 25 says that, on the basis of such a certificate of completion, the owner may pay the subcontractor “without jeopardy” and the payments reduce the holdback required to be maintained under the Act.

Section 33(2) of the Act says that “where a sub-contract is certified to be completed, the sub-contract shall be deemed to have been completed on the date of certification.”  Section 33(4) says that “within seven days of the date the sub-contract is certified to be completed, the payment certifier or the owner and the contractor, as the case may be, shall give a copy of the certificate” to the sub-contractor, the owner and the contractor.

The lien claimants argued that the architect’s Certificates of Completion did not comply with Act for three reasons:

(i) The certificates of completion were not in the prescribed form (Form 7 under the Act);

(ii) The certificates were not delivered in accordance with Section 33(4);

(iii)  The certificates were prepared after the holdback funds had already been released.

Issue 1:              Were the Certificates of Completion Valid?

The court held that, on the facts, each of these deficiencies actually existed. The court then considered whether those facts rendered the certificates invalid.

The court held that the form of the certificates did not make the certificates invalid. While the Act should be strictly construed so far as the existence of liens is concerned, the Act should otherwise be given a purposive interpretation. The difference in form was a minor irregularity and there was no evidence of any actual prejudice. As a result, the failure to strictly comply with the forms required by the Act did not invalidate the certificates.

As to the second ground, the court declined to decide whether the certificates were invalid, due to its finding on the third ground.  However, the court was troubled by the lien claimants asserting this ground of invalidity since, as the court said:

“the lien claimants now before the Court were never entitled to receive notice of the Certificates of Completion. It makes little sense that they should be able to complain about the non-delivery of a certificate that they were never entitled to receive, when the parties actually entitled to receive them are not complaining.”

On the third ground, the court held that the certificates were invalid.  The court explained its decision as follows:

“I have found that the Certificates of Completion in this case were issued by the architect as an after-the-fact attempt to cure payments improperly made to sub-contractors before the certificates were issued. At the time the payments were made, they were made in violation of section of the Act. There is no mechanism in the Act to cure a violation of s. 25 by a subsequently issued Certificate of Completion. Accordingly, even if [the mortgagee] was able to invoke s. 25 of the Act, I find as a fact that Villa violated the section by releasing funds before the Certificates of Completion were issued. Section 25 requires strict compliance with s. 33(1). The release of holdback funds without compliance with s. 33(1) is fatal.”

The court was concerned that the result might appear to be unfair to the mortgagees.  It concluded, however, that the mortgagees knew that they would inherit the owner’s holdback obligation whatever it might be, that “there is nothing unfair in requiring an owner to comply with the provisions of the Act” and that the subcontractors were not obtaining a windfall because there would in any event be a significant shortfall in the amounts owing to them.

Issue 2:              Was GST a required part of the Holdback?

The lien claimants asserted that GST must be added to the basic holdback obligation of the owner, and therefore, the mortgagees. They said that the contract included GST of 6%, that they were obliged to remit GST to the Canada Revenue Agency as a percentage of their gross sales and that the amounts they receive by way of holdback funds would be reduced by the GST.

No case authority was cited to the court which was directly on point, although the Master’s office regularly calculates holdbacks inclusive of GST.  The court acknowledged that “the Act does not mention GST as a component of the basic holdback.” However, GST funds are trust funds and they must be remitted to the CRA.  If the holdback does not include GST then the parties receiving the holdback will not, on a net basis, receive the 10 percent holdback prescribed by statute.  In the course of the project the owner would normally hold back from the progress payments to the contractor the statutory 10 percent plus GST, and pay that holdback amount, including the GST, at the end of the project.  Accordingly, it is appropriate that the mortgagee should pay the GST into court, and the court so ordered.

Conclusion

These two issues are of practical importance to the building industry and to lenders. Certificates of completion allow a building project to proceed smoothly by permitting the owner to pay subcontractors during the job without fear of having to repay those monies again later.  But the court will not permit that permission to be abused.  If the certification process is a mockery, and if certificates are later issued to paper over payments made without adherence to the statutory procedures, they will be ineffective.

There may be border line situations.  What if the architect actually scrutinizes the subcontractor’s work and decides it is complete and so advises the owner before the payment is made, but writes up the certificate of completion sometime later?  What if the architect writes up the certificate and gives it to the owner before inspecting the work and being satisfied that the work is complete, and then inspects the work later and is so satisfied?  Do these situations offend the Act?  This decision has opened these issues to judicial scrutiny.  The limits of validity of certificates of completion will depend on the extent to which the certificate satisfies or abuses the real purposes of the Act.

The requirement that the holdback include GST, or now HST, seems appropriate, especially when the contract itself refers to HST. This requirement will likely impose an obligation on mortgagees to pay the HST into court to discharge liens since it is doing nothing more than the defaulting contractor would have done if it had paid the holdback to the contractor, that is, pay the holdback and the HST.

Wellington Plumbing & Heating Ltd. v. Villa Nicolini Incorporated, 2012 ONSC 5444

Building Contracts  –  Subcontractor  –  Certificates of Completion  –  Holdback

Thomas G. Heintzman O.C., Q.C., FCIArb                                                     December 28, 2012

Supreme Court Denies Leave In Tender Case – Refuses To Re-Write History

The Supreme Court of Canada has recently refused leave to appeal in Trevor Nicholas Construction Co. Ltd. v. Canada. In doing so, it has upheld the decisions of the Federal Court Trial Division and Federal Court of Appeal which declined to permit a bidder to rely on after-the-fact information to overturn an invitation to tender.  These decisions, and the Supreme Court’s decision not to allow an appeal, may signal a growing unwillingness of courts to disturb the tender process based upon facts or events occurring after the tender is completed.

Background Facts

This is a long story, starting 23 years ago in 1989. The summary judgment motion judge summarized the facts as follows.

In 1989 and 1990, Trevor Nicholas submitted the lowest bid on two invitations to tender for dredging contracts issued by Public Works Canada.  In each case, Public Works Canada advised Trevor Nicholas that it was “by-passed” in favour of the second lowest bidder based upon its previous work and apparent incapacity.  Trevor Nicholas submitted bids on three further projects between 1990 and 1993. It was the lowest bidder but was by-passed for the same reasons.

In 1995, Trevor Nicholas sued the federal Crown and alleged that the defendant had treated the plaintiff unfairly during the first four tenders.  Trevor Nicholas also claimed that the Crown had breached an implied term of the contracts which were created when the plaintiff delivered four fully qualified low tenders.

In May, 2001, the Federal Court granted summary judgment dismissing the plaintiff’s claim under the implied term theory.

In January 2011, the balance of the plaintiff’s claim was dismissed on summary judgment, on the ground that there was no genuine issue for trial with respect to the plaintiff’s claim that the defendant breached its obligation to treat the plaintiff fairly. The Federal Court of Appeal upheld that decision and the Supreme Court of Canada has now denied leave to appeal from that decision.

The Federal Court of Appeal’s decision

The Federal Court of Appeal quoted, and agreed with, the following portion of the trial judge’s reasons which stated the ingredients of the duty of fairness in an invitation to tender.  The Federal Court of Appeal underlined the concluding portion of the quote:

“The defendant’s implied obligation to treat the plaintiff fairly flows from its “obligation to treat all bidders fairly in the sense of not giving any of them an unfair advantage over the others” and not unfairly preferring one bidder over another… In assessing whether this obligation was breached, it must therefore be determined whether the plaintiff was treated unfairly, relative to other bidders. This assessment should include a determination as to whether the By-Pass Decisions were made on the basis of considerations that were extraneous to those set forth or implied in the tender documentation…. In my view, the assessment should also include a determination as to whether the defendant was biased against the plaintiff or made one or more of the By-Pass Decisions in bad faith, for example, by basing any of the By-Pass Decisions on facts that the defendant knew or ought to have known were untrue at the time those decisions were made. [underlining added]”

The central argument of Trevor Nicholas was that the Crown knew or should have known at the time of the tender that the information which the Crown relied upon to by-pass Trevor Nicholas was false.  Trevor Nicholas attempted to show the falsity of that information, and the Crown’s contemporary knowledge of it, through cross examination of witnesses on the summary judgment motion. Its difficulty was that all the facts that it relied upon were dated long after the invitation to tender.  Trevor Nicholas was attempting to show that, by virtue of those facts long after the tender, the Crown knew or should have known of the falsity at the time of the tender. But it had no information that the Crown did know that falsity at the time of the tender.

The trial judge and the Federal Court of Appeal were not prepared to allow Trevor Nicholas to proceed to trial on the issue of fairness when Trevor Nicholas based its case on facts occurring long after the tender, and sought to extrapolate backwards from those facts to show unfair conduct by the Crown at the date of the tender.  As the Federal Court of Appeal said:

“[T]he plaintiff had no direct evidence to show that when making his decision not to accept the plaintiff’s tenders, the decision-maker knew that the information before him was incorrect or based upon irrelevant factors. At best, the plaintiff’s evidence took issue with the accuracy of various opinions placed before the decision-maker…[T]he Judge wrote that there was nothing in the plaintiff’s motion record:

[…] that would indicate or suggest in any way that the defendant knew, at the time when it made the By-Pass Decisions, that any of the facts upon which it relied in making those decisions were false, erroneous or misleading. Despite my repeated requests during the oral hearing, the plaintiff was not able to identify any basis for this claim, other than its mere belief that the defendant knew that some of those facts were false.”

The Crown led evidence to show that, at the time of the tenders, it retained and relied upon independent experts to evaluate the bids.  The tender documents explicitly stated the past performance of bidders, and the similarity of work previously undertaken by bidders to the proposed work, would be considered.  The summary motion judge concluded that, in all the circumstances, Trevor Nicholas had not shown that there was any genuine issue for trial on the issue of fairness. The Federal Court of Appeal agreed.

Discussion

The decision brings to an end 23 years of disputes and litigation over tenders. There have been 20 reported decisions in the two actions brought by Trevor Nicholas over these tenders. This is a remarkable amount of unsuccessful litigation.

One can well understand the frustration of a contractor repeatedly losing out on invitations to tender on which it was the low bidder.  This frustration is then fed by discovering later facts which demonstrate, in its view, that the decisions to by-pass it were unjustified.  In invitations to tender, bidders are outsiders to the decision-making process.  When they are excluded for subjective reasons, such as unsuitability or incapacity, there is a natural tendency to blame the process and to jump to the conclusion that the process was unfair.

But the invitation to tender process cannot be run by “monday morning quarterbacking.”  Business is business, and courts are not going to paralyze the tender process by raising the spectre of penalizing owners if facts are later discovered which call into question the wisdom of the tendering decision.  Fairness will be judged by the fairness of the process, and the later discovery of new facts does not render a prior process unfair.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.), Chapter 1, section 1§1(f)    

Trevor Nicholas Construction Co. Ltd. v. Canada, 2012 FA 110

Building Contracts  –  Tenders  –  Fairness  –  Duty of Care  –  Remedies

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                                          December 9, 2012

www.constructionlawcanada.com

www.heintzmanadr.com       

When Is An Officer, Director Or Controlling Person Liable For A Construction Lien Trust Fund Claim?

What are the limits of the trust fund liabilities under the Construction Lien Act? Those liabilities do not just apply to a contractor or subcontractor engaged in a building project.  Those liabilities may also apply to an officer or director or a person controlling the company.

But can an officer, director or controlling person be liable even if it is not proven that the contractor or subcontractor actually breached the trust fund obligations while that person was in office? And who has the burden of proving those facts? Those were the issues which the Ontario Court of Appeal dealt with in Belmont Concrete Finishing Co. Limited v. Marshall.

Section 8 and 13 of the Construction Lien Act

 In Ontario, section 8 of the Construction Lien Act creates the basic trust fund obligation of contractors and subcontractors engaged in building projects. Under that section, monies owing to or received by a contractor or subcontractor on account of the contract or subcontract price constitute trust funds for the benefit of its subcontractors and suppliers of services and materials to the improvement. The contractor or subcontractor is not entitled to appropriate any of those funds for its own use until its subcontractors and suppliers are paid.

 The trust fund obligations of contractors in section 8 are re-enforced by section 13 of the Act. That section imposes a liability on “every director or officer of a corporation” and “any person, including an employee or agent of the corporation, who has effective control of a corporation or its relevant activities.”  Liability arises under section 13 if that person “assents to, or acquiesces in, conduct that he or she knows or reasonably ought to know amounts to breach of trust by the corporation of the obligations under section 8 of the Act.

The underlined words are the important ones.  The statutory liability of the director, officer or controlling person depends upon a breach of trust by the corporation, and upon the person assenting to or acquiescing in that breach.

Factual Background

 Between 2001 to 2003, the general contractor received funds for several projects.  Those funds were trust funds under the Act.  The general contractor dispersed them in breach of trust. As a result, the supplier Belmont Concrete Finishing was not paid.

At the end of May 2002, the respondent Marshall took control of the general contractor sufficiently for s. 13 purposes. Only after May 2002 was he in a position with the general contractor so that he could have known or reasonably should have known about, and could have assented to or acquiesced in, any breach of trust by the general contractor that took place after that date.

The trial judge made no finding as to when the general contractor’s breaches of trust took place, and whether they occurred before or after May 2002. The Court of Appeal held that there was no evidence to support the allegation that any breaches of trust occurred “on the respondent’s watch.”

Decision of the Court of Appeal

 The Court of Appeal set out the three part test that applies to the potential liability of a person under section 13.  The court said that, for that liability to be imposed upon a person, it must be shown that:

“(1)       there is conduct by the corporation that amounts to a breach of trust;

(2)         the person is a director or officer of the corporation, or in effective control of it; and

(3)         the person knows or ought reasonably to know that the conduct amounts to a breach of trust and assents to or acquiesces in that conduct.”

The court then held that the supplier Belmont Concrete Finishing, which asserted that there had been a breach of the trust fund obligation by the contractor, had the burden of proving that breach. It was not Mr. Marshall, the court held, that had that burden of proof. The court explained its decision as follows:

“The appellants argue that the onus is on the respondent to fill this evidentiary void. I do not agree. Unlike s. 8 of the Act, s. 13 is not about liability as a trustee. It is about an individual’s liability for breach of trust by the corporation. The onus for the elements required by s. 13(1) is on the party seeking to attach liability to the individual…Since there was no evidence that any of the breaches of trust by the general contractor encompassed by the summary judgments took place after the end of May 2002, there was no basis to find that the respondent could be held liable for them under s. 13 of the Act.”

The Court of Appeal then considered whether Mr. Marshall could be held responsible for the payments that were made by the general contractor to him.  The court concluded that, unless it were proven that the funds used to make those payments were trust funds – and there was no proof that they were -the mere fact that payments were made by the general contractor to Mr. Marshal could not support a claim under section 13. The court said:

“There is simply no evidence that the funds used for these payments by the general contractor were funds impressed with a trust in favour of the appellants. Without such evidence, the payments to the respondent cannot serve as the basis for his liability to the appellants for breach of trust under s. 13.”

Accordingly, the Court of Appeal dismissed the claim of the supplier against Mr. Marshall.

Discussion

This decision shows the difficulties in proving a trust fund claim against an individual under section 13.  Two hurdles have to be overcome.

First, the claimant must show that there were trust funds which were received or receivable by the contractor or subcontractor, and were diverted.

Second, the claimant must show that, at the time the trust funds were diverted, the defendant officer, director or control person was in a position to know that the funds were trust funds and were being diverted, so that he or she could be said to have assented to or acquiesced in the diversion of those funds.

Section 13 does not state any burden of proof.  So the burden of proof is entirely a matter for the courts to decide.  In the present case, the Court of Appeal declined to put the burden of proof of these elements on the defendant officer, director or control person because that person is not being sued for breach of trust.  Rather, that person is being sued for assenting to or acquiescing in a breach of trust.  So, while a trustee may have a burden of explanation, a person assenting to or acquiescing a breach of trust does not.

Some may question whether this allocation of the burden of proof is fair.  It is true that, apart from claims against trustees, normally the burden of proof is on the claimant.  But courts often place the burden of explanation on the defendant when the defendant has special knowledge of the circumstances.  In the case of a claim against an officer, director or control person of a company, the claimant supplier has no knowledge of the facts relating to the receipt and disbursement of the trust funds by the contractor or subcontract, which are the key elements of the claim.  One might say that the officer, director or control person should have the burden of proof at least during that person’s “watch.”

At the very least this decision shows that extra care must be taken during a building project or during an action to enforce rights under section 13, in order to find and preserve the evidence necessary to establish those rights.  During the project, a supplier may be able to obtain information about the payments to the contractor or subcontractor.  If payments fall behind, then the supplier or subcontractor should be pro-active in taking steps to preserve evidence of any improper diversion of trust funds, by making inquiries of and notifying the owner or superior contractor of the supplier’s claim.

If a trust fund claim is brought, then it may be brought under section 8 against the defaulting contractor or subcontractor, and under section 13 against the director, officer and controlling person.  The claimant will have to conduct careful examinations for discovery and carefully demand production of documents.  By doing so, it may be able to establish that trust funds were diverted and that the defendant director, officer or control person assented to or acquiesced in that diversion.

The bottom line is that the effective scope of section 13 is only as good as the evidence.  That’s not a novel proposition but in the context of section 13 it’s a challenging one.

Belmont Concrete Finishing Co. Limited v. Marshall, 2012 ONCA 585. 

Building Contracts – Construction Liens – Trust Funds – Officers, Directors and Controlling Persons

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                            December 1, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

Can An Arbitration Award Be Set Aside For Unreasonableness?

If an arbitration agreement states that there is to be no appeal from the award under the agreement, can a party seek judicial review on the ground that the award is unreasonable?

In Dunsmuir v. New Brunswick, [2008] 1 S.C.R. 190, the Supreme Court of Canada set out a comprehensive analysis for the judicial review of the decisions of administrative tribunals.  The Court held that there are two tests for determining the legal validity of the decisions of those tribunals: correctness and reasonableness.  Generally speaking, the Court held that an administrative tribunal cannot, by legal error, assume a jurisdiction it does not have.  True questions of statutory jurisdiction must be correctly decided by the tribunal, and therefore may be reviewed on the basis of correctness.  All other decisions will not be set aside unless they are unreasonable, with the degree of deference being shown to the tribunal’s decision depending on the nature of the decision (the “Dunsmuir test”).

Is the unreasonableness test a proper one to apply to an arbitral award when the parties have agreed that there shall be no appeals from the award?  That is the question that was raised in the recent case of Parmalat Canada Inc. v. Ontario Teachers’ Pension Plan Board. While the court did not refer to or address this issue in its decision, this case provides a good opportunity to discuss whether the Dunsmuir test should apply to the review of an award under a commercial arbitration agreement.

Factual Background

During 2003 to 2005, Parmalat Canada refinanced itself to avoid default on its financial obligations.  Its predicament arose from the financial collapse of its Italian parent. Parmalat Canada entered into a Credit Agreement with Ontario Teachers’ Pension Plan Board (Teachers) whereby Teachers provided $530 million in financing to Parmalat Canada.

One of the agreements which Parmalat Canda and Teacher entered into was a Liquidity Payment Agreement (“LPA”). Under the LPA, Parmalat Canada agreed to pay Teachers a Liquidity Payment equal to 10 per cent of the value of Parmalat Canada if a Liquidity Event occurred within seven years of the closing of the Credit Agreement.  That closing occurred on June 29, 2004.  The definition of Liquidity Event included an “Indirect Change of Control” which included “any Person or Persons, acting jointly and in concert, acquiring, directly or indirectly, ….securities or the right to vote securities of Parmalat Italy carrying any number of votes where thereafter a majority of the board of directors of Parmalat Italy are nominees of such Person or Persons.”

On June 28, 2011, or one day before the seventh anniversary of the closing of the Credit Agreement, a slate of director nominated by Group Lactalis S.A. was elected to the board of directors of Parmalat Italy. In March 2011, Lactalis had acquired 28.97 % of the shares of Parmalat Italy.  That purchase enabled Lactalis to elect its slate of directors, who were elected on June 28, 2011.

The Arbitration

Teachers then commenced an arbitration asserting that a Liquidity Event had occurred and that Parmalat Canada was required to pay the Liquidity Payment to Teachers.  Teachers relied upon the plain language of the agreement and asserted that, under that language, a Liquidity event had occurred and the Liquidity Payment was due to it.

Parmalat Canada took the position that a significant liquidity or realization of value must result from any transaction for it to qualify as a Liquidity Event. It argued that there must be a value realization and/or liquidity, which in turn would fund the Liquidity Payment, for a Liquidity Event to have occurred.

The Arbitrator found that the acquiring shareholder Lactalis, being able to elect its slate of directors on June 28, 2011, thereby gained control of Parmalat Italy. The Arbitrator applied the plain reading of the agreement and concluded that a Liquidity Event had occurred. Under the LPA, the decision of the Arbitrator was final and binding with no appeal.

Does Dunsmuir Apply?

Parmalat Canada applied to the Superior Court to set aside the arbitrator’s award under section 46 of the Ontario Arbitration Act, 1991.  Among other arguments, it submitted that the arbitrator’s decision was unreasonable. It relied on the Dunsmuir decision of the Supreme Court of Canada, and other decisions of the Supreme Court in which that court had applied the Dunsmuir test in its review of two arbitration decisions.  Parmalat Canada referred to my article of January 22, 2012 in which I reviewed those two decisions and discussed the potential application of Dunsmuir outside the administrative law context.

Parmalat Canada also relied upon the decision of the Ontario Court of Appeal in Smyth v. Perth and Smith Falls District Hospital (2008) 92 OR 3d 656 in which the Court of Appeal applied Dunsmuir in its review of an arbitration decision.

Smyth concerned an arbitration relating to the appointment of a doctor to the staff of a hospital. The arbitration agreement provided that there was to be no appeal to the court from the arbitrator’s decision.  The arbitrator decided that the doctor should be given the opportunity to resign or his appointment to the hospital should be terminated.  The doctor sought to have the award reviewed under section 46 of the Ontario Arbitration Act, 1991.  The superior court judge applied the test of correctness, held that the arbitrator had incorrectly exercised his jurisdiction and overturned the arbitrator’s decision.  The Court of Appeal applied Dunsmuir, held that the reasonableness test should apply, found that the arbitrator’s decision was reasonable and set aside the superior court judge’s decision.

In my article of January 22, 2012, I commented on the decisions of the Supreme Court of Canada in  Nor-Man Regional Health Authority v. Manitoba Association of Health Care Professionals, 2011 SCC 59 and Newfoundland and Labrador Nurses Union v. Newfoundland and Labrador (Treasury Board) 2011 SCC 62. In both those cases, the Supreme Court upheld a labour arbitration award applying the reasonableness standard in Dunsmuir.  I said in my article that those cases are powerful supports for person seeking to uphold arbitration awards.

None of these cases involved commercial arbitrations.  In none of these decisions did the court determine whether the reasonableness test is a proper test for the review of the decisions of arbitral tribunals under commercial arbitration agreements, particularly when the parties have agreed that there is no appeal from an arbitral decision. That issue remains to be decided by Canadian courts.

What are the arguments for and against the application of a reasonableness test to commercial arbitrations?

The Rationale For Applying Dunsmuir

The arguments for the application of a reasonableness test have been stated in Dunsmuir and the other Supreme Court of Canada decisions applying Dunsmuir.  A quote from Dunsmuir was cited in Smyth and sets out its rationale:

 Reasonableness is a deferential standard animated by the principle that underlies the development of the two previous standards of reasonableness: certain questions that come before administrative tribunals do not lend themselves to one specific, particular result. Instead, they may give rise to a number of possible, reasonable conclusions. Tribunals have a margin of appreciation within the range of acceptable and rational solutions. A court conducting a review for reasonableness inquires into the qualities that make a decision reasonable, referring both to the process of articulating the reasons and to outcomes. In judicial review, reasonableness is concerned mostly with the existence of justification, transparency and intelligibility within the decision-making process. But it is also concerned with whether the decision falls within a range of possible, acceptable outcomes which are defensible in respect of the facts and law.

 In Nor-Man, the Supreme Court of Canada explained the reason for applying the reasonable test from Dunsmuir as follows:

 The standard of reasonableness, on the other hand, normally prevails where the tribunal’s decision raises issues of fact, discretion or policy; involves inextricably intertwined legal and factual issues; or relates to the interpretation of the tribunal’s enabling (or “home”) statute or “statutes closely connected to its function, with which it will have particular familiarity” (Dunsmuir, at paras. 51 and 53-54; Smith, at para. 26).

Similarly, in Newfoundland and Labrador Nurses Union, the Supreme Court of Canada said the following in support of its application of the Dunsmuir reasonableness standard to a labour arbitrator’s decision, referring to Professor Dyzenhaus’ explanation of Dunsmuir:

 This, I think, is the context for understanding what the Court meant in Dunsmuir when it called for “justification, transparency and intelligibility”. To me, it represents a respectful appreciation that a wide range of specialized decision-makers routinely render decisions in their respective spheres of expertise, using concepts and language often unique to their areas and rendering decisions that are often counter-intuitive to a generalist. That was the basis for this Court’s new direction in Canadian Union of Public Employees, Local 963 v. New Brunswick Liquor Corp., 1979 CanLII 23 (SCC), [1979] 2 S.C.R. 227, where Dickson J. urged restraint in assessing the decisions of specialized administrative tribunals. This decision oriented the Court towards granting greater deference to tribunals, shown in Dunsmuir’s conclusion that tribunals should “have a margin of appreciation within the range of acceptable and rational solutions” (para. 47).

 These expressions of the rationale behind the reasonableness test are largely based upon the statutory jurisdiction of administrative tribunals.  Even labour arbitrators are usually exercising their authority in the context of arbitration mandated by statute. The statutory source of jurisdiction justifies the court imposing a standard of reasonableness on the arbitrator’s reasons for decision.

Does this rationale apply when the parties have quite voluntarily chosen arbitration as their dispute resolution mechanism and have agreed that there shall be no appeal to the courts?

The Rationale For Not Applying Dunsmuir

The argument that it does not can conveniently be started by examining the Ontario International Commercial Arbitration Act (ICAA) and the Model Law attached to it.  That Model Law has been adopted by many countries around the world. Pursuant to that Model Law, international commercial arbitration decisions are rendered and enforced around the world. Under Article 34(1) of the Model Law, recourse to a court against an arbitral award may be made only by an application for setting aside in accordance with that article. No right of appeal is provided in the Model Law. Article 34(2) of the Model Law says that an award may be set aside by the court only on the following grounds:

 (i) a party to the arbitration agreement was under some incapacity; or the said agreement is not valid under the law to which the parties have subjected it or, failing any indication thereon, under the law of this State, or

(ii) the party making the application was not given proper notice of the appointment of an arbitrator or of the arbitral proceedings or was otherwise unable to present his case, or

(iii) the award deals with a dispute not contemplated by or not falling within the terms of the submission to arbitration, or contains decisions on matters beyond the scope of the submission to arbitration, provided that, if the decisions on matters submitted to arbitration can be separated from those not so submitted, only that part of the award which contains decisions on matters not submitted to arbitration may be set aside, or

(iv) the composition of the arbitral tribunal or the arbitral procedure was not in accordance with the agreement of the parties, unless such agreement was in conflict with a provision of this Law from which the parties cannot derogate, or, failing such agreement, was not in accordance with this Law; or

(b) the court finds that:

(i) the subject-matter of the dispute is not capable of settlement by arbitration under the law of this State, or

(ii) the award is in conflict with the public policy of this State.

This is a pretty comprehensive list of grounds to set aside an award.  Yet, nothing in Article 34(2) says that the substance of the award must be correct or reasonable, or that the arbitral tribunal must be correct or reasonable except with respect to jurisdiction or one of the other matters expressly stated in Article 34(2).  Indeed, under Article 31(2) with the consent of the parties the arbitral tribunal need give no reasons. It must be assumed that the drafters of the Model Law envisaged that, sometime and somewhere, an international commercial arbitration panel might issue an award which was legally or factually incorrect or unreasonable.  But no relief on those grounds was afforded in the Model Law.

If a Canadian court is asked to apply the Dunsmuir test to an award of an international commercial arbitration, on what basis could it do so?  Would it say that simply because the award is unreasonable, then under Article 34(2)(iii) it does not fall within the terms of the submission to arbitration, or it contains decisions on matters beyond the scope of the submission to arbitration, or deals with matters not remitted to the tribunal?  Can that be said when the Model Law does not require that the award be reasonable or correct?

Of course, if there is a true jurisdictional challenge to the award, then Article 34(2) (iii) will apply and the court will have to decide that issue using an appropriate jurisdictional test.  But apart from that situation, the application of the reasonableness standard to the merits of the arbitral award does not appear to fit comfortably within Article 34.

If Canada applies a reasonableness standard to international arbitration awards outside of true jurisdictional issues, then it may apply a test that no other country applies to the Model Law, even though that Law was adopted by many countries for the purpose of uniformity.

Turning to the domestic Ontario Arbitration Act, 1991, section 46(1) states that an arbitral award may be set aside on the following grounds:

1.   A party entered into the arbitration agreement while under a legal incapacity.

2.   The arbitration agreement is invalid or has ceased to exist.

3.   The award deals with a dispute that the arbitration agreement does not cover or contains a decision on a matter that is beyond the scope of the agreement.

4.   The composition of the tribunal was not in accordance with the arbitration agreement or, if the agreement did not deal with that matter, was not in accordance with this Act.

5.   The subject-matter of the dispute is not capable of being the subject of arbitration under Ontario law.

6.   The applicant was not treated equally and fairly, was not given an opportunity to present a case or to respond to another party’s case, or was not given proper notice of the arbitration or of the appointment of an arbitrator.

7.   The procedures followed in the arbitration did not comply with this Act.

8.   An arbitrator has committed a corrupt or fraudulent act or there is a reasonable apprehension of bias.

9.   The award was obtained by fraud.

10.  The award is a family arbitration award that is not enforceable under the Family Law Act.

Once again, this section provides a very comprehensive basis for setting aside arbitral awards, but does not state that correctness and reasonableness are separate tests for doing so.  Except as a test to determine whether the arbitral tribunal had jurisdiction to determine the dispute or whether the tribunal has applied one of the other factors mentioned in section 46(1), the reasonableness test does not seem to fit well within that subsection.

Section 46 is found within a particular statutory setting as a separate test.  Section 6 says that courts shall not intervene except for express statutory purposes.  Section 45(1) provides a right to seek leave to appeal from an arbitral award unless the parties have agreed otherwise.  Section 45(2) and (3) allow the parties to agree on an appeal on questions of law and fact.  So the parties are afforded by statute the broadest right to agree on recourse to the courts to review the award.  When the parties agree that there will be no appeal, they know that the award could possibly be in error or unreasonable, but they chose expedition and finality over legal perfection.  In that context, a review of the decision based on reasonableness –outside the pure jurisdictional context under section 45(1).3 – seems difficult to justify.

The Parmalat Decision

Returning to the Parmalat Canada decision, Parmalat Canada argued that the interpretation of the LPA was unreasonable as it allegedly did not take into account the meaning of the word “liquidity” and common sense need for a transaction or other liquidity event to fund the Liquidity Event.  Fitting that argument within the specific grounds for review found in section 46 of the Arbitration Act, 1991 was the challenge.  Justice Cumming found that the arbitrator’s decision was reasonable so he did not have to decide whether the award could be set aside if it was unreasonable.

Conclusion

The challenge for those who support the application of the Dunsmuir test to commercial arbitrations is to show that the administrative law rational for Dunsmuir applies to commercial arbitrations, and that the test can be useful or justified notwithstanding the limited right of courts to review awards of domestic and international arbitrations.

The challenge for those who oppose the application of Dunsmuir to commercial arbitration awards is to show that the administrative law rational for Dunsmuir does not apply in the commercial arbitration setting, and that the grounds for reviewing a commercial arbitration are sufficiently and definitively stated in the arbitration statutes and leave no need or room for Dunsmuir except in relation to true jurisdictional issues.

So far, there has been no real debate on these issues. In Smyth, the Dunsmuir test was applied to an arbitration in a hospital setting, as a convenient and apparently governing authority but without considering whether the rationale and the statutory setting justified that application outside a pure jurisdictional dispute. Let the debate begin.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.), chapter 10

Parmalat Canada Inc. v. Ontario Teachers’ Pension Plan Board, 2012 ONSC 5981

Arbitration  –  Review of Award  –  Jurisdiction of Arbitral Tribunal  –  Reasonableness

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                November 24, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

Six Points To Consider Before Commencing An Arbitration

On October 10, 2012, I gave a speech at an Advocates’ Society program.  The program was  entitled Arbitration is the New Black.  My presentation focused on seven issues which should be addressed when a party is contemplating the commencement of an arbitration.

Starting the arbitration seems like the easiest thing in the world.  After all, the parties already have an arbitration agreement which provides for the arbitration.  So what is the big deal?

That approach can lead to real problems.  The commencement of arbitration is as important a step in the proceeding as the commencement of an action in court.  In fact, it’s more important because in the case of arbitration, there is no court in which to issue the initiating document.  Therefore, no court official determines that the document initiating the arbitration is proper.  The party starting the arbitration may be lulled into a false sense of security by the arbitration agreement and may be unaware of the formalities and the choices that are inherent in the arbitral process.

Here are Seven Points to Consider before Commencing an Arbitration:

1.      The limitation period

Some may think that the arbitration is not subject to limitation periods. It is. A limitation period for an arbitral claim may be established in two ways.

First, the arbitration agreement may itself contain a limitation period.  For example, insurance policies often contain limitation periods.  If the period is missed, the claim may be lost.

Second, an arbitral claim will be governed by the general law of limitation of actions.  In Ontario, section 52(1) of the domestic Arbitration Act, 1991 provides that the law with respect to limitation periods applies to an arbitration as if the arbitration were an action and the claim made in the arbitration were a cause of action.  Section 4 of the Ontario Limitations Act, 2002 establishes a general limitation period of two years from the date of discovery of the claim. So, unless another statutory limitation period applies, a domestic arbitral claim governed by Ontario law must be commenced within two years of the discovery of the claim.

As far as international commercial arbitrations are concerned, the Ontario International Commercial Arbitration Act (ICAA) does not establish a limitation period for the commencement of an arbitral claim nor refer to a general limitation period.  If the arbitral claim is subject to Ontario law, then the Ontario Limitations Act, 2002 will presumably apply. There may be arguments about which limitation law applies to a claim in an international commercial arbitration.  The law of the place of the arbitration or the substantive law applicable to the contract are two candidates and the debate may be resolved differently by the courts in different jurisdictions.  So the limitation issue may have to be considered carefully in international commercial arbitrations.

Before leaving the limitation issue, it is well to remember that there is a limitation issue at the other end of the arbitration proceeding, namely, the limitation period for the enforcement of the award. For domestic arbitrations, section 52(3) of the Ontario Arbitration Act, 1991 provides that an application to enforce the award must be made within two years of the date that the applicant receives the award.

The Ontario ICAA does not contain a limitation period for the enforcement of the award. The general two year general limitation period in Ontario Limitations Act, 2002 will presumably apply if the award is sought to be enforced in Ontario.  In Yugraneft Corp. v. Rexx Management Corp., [2010] 1 SCR 649, the Supreme Court of Canada held that Alberta’s general two year limitation period applied to the enforcement in Alberta of an international commercial arbitration award made in Russia. Alberta had no limitation period that specifically applied to international arbitrations.  The Supreme Court held that the application for enforcement of the foreign arbitral award was an application for a “remedial order” within the meaning of the Alberta limitation statute, and therefore subject to the two year limitation period together with the discoverability rule.  It was not a judgment or court order subject to the 10 year period.

The mediation period

 A contract containing an arbitration clause may also contain a mediation clause.  The mediation clause may affect the commencement of the arbitration in two ways.

First, the mediation may be a precondition to the commencement of the arbitration.  If it is, the arbitration may be premature if mediation is not undertaken.  However, the mediation clause may be a permissible procedure, not a required procedure.  In this case, the failure or refusal of the parties, or one of them, to participate in mediation will not be a bar to the commencement of the claim.

Second, and as a corollary to the first point, if the mediation is, or is not, conducted, the limitation period can be affected.  If mediation is a requirement then the limitation period will not commence until the mediation is completed.  If the mediation is not required, then the limitation period will be running while the parties are fussing about mediation.

These issues were dealt with by the Ontario Court of Appeal recently in L-3 Communications Spar Aerospace Limited v. CAE Inc., 2011 ONCA 435, 2010 ONSC 4133, (reviewed by me in www.heintzmanadr.com, July 17, 2011) and Federation Insurance Co of Canada v. Markt Insurance Co of Canada, 2012 ONCA 218 (reviewed by me in www.heintzmanadr.com, May 5, 2012).

In the first case, mediation was held to be required.  Therefore, the cause of action did not accrue until the mediation was conducted, and therefore the action was still commenced in time.  In the second case, mediation was held not to be required.  Accordingly, the limitation period was running during the mediation and had expired by the time that the arbitration was commenced.

In Ontario, section 11 of the Limitations Act, 2002 provides that the limitation period does not run during any period in which the parties have agreed to have an independent third party resolve the claim or assist them in resolving it. The section does not necessarily avoid the issue of whether there was an agreement to mediate and whether that agreement requires mandatory mediation.

A further complicating factor is whether the mediation agreement is enforceable.  In Sulamerica CIA Nacional De Seguros SA & Ors v Enesa Engenharia SA & Ors [2012] EWCA Civ 638 (which I reviewed in www.heintzmanadr.com, July 5, 2012) the English Court of Appeal held that a mediation clause is not enforceable unless the clause contains a minimum amount of procedural certainty.  The Ontario Court of Appeal’s decisions referred to above did not consider this issue. We can expect some party to assert in the future that the mediation agreement was not enforceable and therefore the limitation period was running during the mediation and expired before the arbitral claim was commenced.

 2.      The Commencement of Arbitration

The claimant in the arbitration must make sure that it uses the proper document and procedure to start the arbitration.  If it does not, then no arbitration will have been commenced and the limitation period may expire in the meantime.

Section 23 of the Ontario Arbitration Act, 1991 states three ways in which an arbitration may be commenced:

first, by serving a notice to appoint or participate in appointment of the arbitrator

second, by serving a notice requiring another party to appoint the arbitrator and

third by serving a notice demanding arbitration

Under article 21 of the Model Law attached to the Ontario ICAA, the arbitral proceeding is commenced by a request for that dispute to be referred to arbitration being received by the respondent.

The decision of the Ontario Court of Appeal in Penn-Co Canada (2003) Ltd. V. Constance Lake First Nation, 2012 ONCA 430; (reviewed by me in www.heintzmanadr.com, August 27, 2012) is a reminder of the importance of serving the right document.  One of the parties had undertaken a good deal of activity relating to the arbitration, including the commencement of court proceedings.  But the Court of Appeal held that it had not served a document qualifying as the commencement of the arbitration. Its later attempt to do so was served outside the limitation period.

3.      Objection to Jurisdiction

An objection to jurisdiction must be made on a timely basis. Under section 17(3) of the domestic Ontario Arbitration Act, 1991, the objection must be made no later than the beginning of the hearing, or if there is no hearing, no later than the first occasion on which the party submits a statement to the tribunal.  In addition, the objection to jurisdiction must be made as soon as the jurisdictional matter is raised, although the tribunal has the authority to consider a later objection if it considers the delay to be justified.

Under Article 16(2) of the Model Law attached to the Ontario ICAA, a plea that the arbitral tribunal does not have jurisdiction must be raised no later than the submission of the statement of defence, and a plea that the arbitral tribunal is exceeding the scope of its authority must be raised as soon as the matter alleged to be beyond the scope of its authority is raised during the arbitral proceedings. The arbitral tribunal has authority to admit a later plea if it considers the delay justified.

These time limits are not necessarily the same. In particular, the claimant should be aware of the requirement in the Ontario ICAA to raise a pre-existing jurisdictional objection at time of the delivery of the Statement of Defence.

4.      Appointing the arbitral tribunal

a.      Need for speedy appointment

Before the arbitral tribunal is appointed, there is no way to determine anything within the arbitration.  The respondent cannot be compelled to deliver a defence.  An order that the proceeding has been validly commenced cannot be obtained, and other interlocutory matters cannot be dealt with. So appointing the arbitral tribunal is a key step in the arbitration.

Under section 10 of the domestic Ontario Arbitration Act, 1991, if the parties disagree about the identity of the single arbitrator or the chair of the arbitral tribunal, the Ontario Superior Court has power to appoint the tribunal. If the Ontario ICAA applies, then under article 11(4) of the Model Law attached to that statute, the Ontario Superior Court has a similar power to appoint the arbitral tribunal.

If the arbitration is held under the auspices of one of the arbitration institutions (such as the LCIA, ICC or BCICAC), then those organizations will appoint the arbitral tribunal, subject to the input of the parties as their rules may allow. An advantage of these arbitral institutions is that their appointment process may avoid lengthy court proceedings to appoint the arbitral tribunal. A disadvantage may be the lesser input of the parties into the selection of the tribunal.

b.      Discussions with the potential arbitrators

Selecting an appropriate arbitrator or chair of the arbitral tribunal will obviously be important. Identifying and avoiding conflicts of interest of arbitrators is equally important. For this reason, there may be legitimate reasons to write to or speak with a candidate for appointment.

However, these contacts are fraught with peril as they may create circumstances that themselves give rise to an appearance of bias. Thus, if the candidate is asked his opinion about the merits of the dispute, that conversation could well prejudice the candidate’s appointment.

The Chartered Institute of Arbitrators has guidelines about this process which are very helpful. They may be viewed on the Institute’s website: www.ciarb.org.

 

 c.   Agreement Appointing Arbitrators

If the arbitrators are appointed by way of agreement, the negotiation of that agreement is a good opportunity to address issues which were not dealt with in the arbitration agreement.  With a dispute now in existence, arrangements can be put in place to ensure that the arbitration is conducted cost effectively.

Those arrangements may include: the rules of procedure, so that rules appropriate for the specific hearing are used, not the rules of court; the confidentiality of the arbitration; and choice of law.

5.      The First Pre-Hearing Meeting

A significant advantage of arbitration is that it allows the parties to use a process which is suitable for the actual dispute and which will ensure that the dispute is resolved in a cost- effective manner. The time to start that process is the first meeting with the arbitral tribunal.

At the first meeting, the following procedures can be settled:

The schedule of all events and the date of the final hearing
The nature and dates for the exchange of pleadings
The scheduling of motions
The scope of documentary production and agreement on joint books of exhibits
Limits on discovery, or elimination of discovery
Preliminary lists of witnesses, including experts
The arbitration hearing briefs
The number of days of hearing

At the end of the first pre-hearing meeting, the arbitral tribunal can issue a Procedural and Schedule Order dealing with all these matters.

In order to obtain the maximum buy-in to this process, the parties should be present in person at the first pre-hearing meeting.

6.      Interim Relief

Finally, before the arbitration is commenced, consideration should be given to the necessity to obtain interim relief.

Various factors may relate to that relief: whether the relief must be obtained against third parties; whether the opposing party will likely refuse to obey an order granting the relief; and whether the relief must be enforced outside the jurisdiction of the court or the place of the arbitration.

No simple answer can be given about whether it is better to obtain interim relief from the court or the arbitral tribunal, but an informed decision should be made about that issue. Some of the factors that may be considered include the following:

  1. If the motion for interim relief is made to the superior court, then there will be no arguments about the limits of the court’s jurisdiction since the court has plenary powers. There may be a debate about whether the arbitral tribunal has the jurisdiction to grant the particular interim relief which is being sought.

Article 17 of the Model Law attached to the Ontario ICAA says that unless otherwise agreed by the parties, the arbitral tribunal may order such interim measure of protection as the arbitral tribunal may consider necessary in respect of the subject-matter of the dispute, and appropriate security be provided in connection with that measure. Section 18(1) of the Ontario Arbitration Act, 1991 says that an arbitral tribunal may make an order for the detention, preservation or inspection of property and documents that are the subject of the arbitration or as to which a question may arise in the arbitration, and may order that security be provided in that connection.  These provisions do not purport to give the arbitral tribunal unlimited interim powers. Therefore, the respondent to the motion may assert that the arbitral tribunal does not have jurisdiction to grant the particular interim relief claimed on the motion.

2.  If it is likely that the opposite party will abide by the order and the parties simply need a preliminary ruling on a matter, and if a faster hearing can be obtained before the arbitral tribunal than before a court, then the motion likely should be brought to the arbitral tribunal.

3.  If the order must be enforced against third parties, then a motion to the court may be more appropriate because an arbitral award is not enforceable against third parties.  In Farah v. Sauvageau Holdings Inc., 2011 ONSC 1819 it was held that an arbitrator did not have authority to grant a mareva injunction against a third party. However, it still may be necessary to first obtain an order against the opposing party from the arbitral tribunal, to show that the arbitral remedy has been exhausted and that the opposing party is bound by that order.

4.  If the order must be enforced out of the jurisdiction of the place of the arbitral tribunal, a court motion may be more appropriate in order to obtain an order that another court will enforce.  An interim arbitral order which is not a final award of the arbitral tribunal may not be enforceable outside the place of the arbitration. While section 9 of the Ontario ICAA says that an order of the arbitral tribunal for an interim measure of protection is subject to the provisions of the Model Law as if it were an award, a court in another jurisdiction may not consider it to be so.  So the law of the place of the arbitration and the place where the interim order of the arbitral tribunal will have to be enforced must be considered to determine whether the interim award will be enforceable.

Commencing an arbitration is not a simple process. There are at least seven matters to consider before doing so. By thinking about them beforehand, the claimant can be ready to bring the claim to a successful conclusion, at least from a procedural standpoint.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 10.

Arbitration  –  Commencement  –  Appointment of Arbitrators   –  Limitation Periods  –  Mediation- Jurisdiction  –  Interim Relief

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                               November 18, 2012

www.constructionlawcanada.com

www.heintzmanadr.com

Is The Person Who Ultimately Pays A Guarantor Entitled To The Securities Held By The Guarantor?

Bonds and other forms of guarantees and indemnities are commonly used on construction projects. If a contractor applies for a performance bond, the bonding company will require the contractor to indemnify the bonding company. The bonding company may also require the principal shareholder of the contractor to guarantee the contractor’s obligation and to directly indemnify the bonding company. The bonding company may also take security over the contractor’s assets as a further condition of providing the bond. If the principal shareholder of the contractor is required to indemnify the bonding company, is that shareholder entitled to the security obtained by the bonding company over the contractor’s assets?

Normally speaking, one would think so. By indemnifying the bonding company, the indemnifying party should be subrogated to all the rights of the bonding company, including the security held by the bonding company.

But the English Court of Appeal held to the contrary recently in Ibrahim v. Barclays Bank Plc. There were two significant features of the indemnity and guarantee documents in that case, and they resulted in Mr. Ibrahim not being entitled to exercise rights under the securities which were originally available to the guarantor.

Those features of the Ibrahim decision must be carefully scrutinized by any persons about to give or to guarantee a bond. A bonding company, or a person holding competing security to the bonding company, may want to duplicate the features found in the documents in the Ibrahim case in order to avoid those securities passing to the third party which agreed to indemnify the bonding company. On the other hand, a third party who is indemnifying the bonding company may want to avoid those features in order to obtain the securities held by the bonding company.

Factual Background

LDV was an English van manufacturer. In 2008, it was in severe financial condition. Weststar was interested in purchasing the shares of LDV, but it needed a due diligence period to examine LDV’s affairs. Barclays was LDV’s banker. It was agreeable to advance further moneys to LDV during the due diligence period provided that the repayment of its further loan to LDV was guaranteed by a department of the British government, BERR. As a condition of providing its guarantee of LDV’s obligation, BERR demanded a letter of credit from a bank, UBS. UBS in turn demanded a guarantee from the principal shareholder of Weststar, Mr. Ibrahim. These arrangements were put in place.

The agreement between Barclays and BERR provided that “unless and until the Guarantor Liabilities have been paid and discharged in full and [BERR] has no further actual or contingent liability under or in respect of the Guarantee”, Barclays and BERR were to share in the recovery from the assets of LDV under the security which Barclays held over LDV’s assets. USB and Mr Ibrahim were not parties to those arrangements.

As a result of the due diligence conducted by Weststar, it decided not to proceed with the purchase of the shares of LDV and LDV went into insolvency. Barclays called on BERR ‘s guarantee of LDV’s obligation to repay the monies it had advanced to LDV. BERR in turn called upon UBS to pay under its letter of credit, and UBS demanded the Mr. Ibrahim pay under his guarantee. Having paid UBS, Mr Ibrahim asserted the right to exercise the rights accorded to BERR under its agreement with Barclays and to share in the recovery which Barclays had made under the security it held over LDV’s assets.

At trial, Mr. Ibrahim asserted his claim by way of subrogation to BERR’s rights. By the time the appeal was heard, Mr. Ibrahim had obtained an assignment of BERR’s rights under its arrangement with Barclays and asserted that BERR had a right, and that he had the same right by way of assignment, to share in the recovery from LDV’s assets.

The Decision

The English trial division and Court of Appeal held that Mr. Ibrahim had no right to share in the recovery made by Barclays from the assets of LDV, for two reasons.

First, they held the effect of the payment by UBS to BERR was that BERR was paid in full in respect of the obligation of LDV. Under the wording of the Barclays-BERR agreement, that payment discharged the obligation of LDV even though the proceeds came from UBS, and not LDV. Therefore, under the Barclays-BERR agreement, BERR’s rights to share in LDV’s assets had come to an end.

Second, the Court of Appeal held that the letter of credit given by UBS to BERR was an “autonomous instrument” which stated that the obligation to pay accrued when the Secretary of State certified that amounts were due in respect of the LDV debt and that it would discharge the LDV debt. Therefore, the payment by UBS to BERR under that letter of credit did discharge the LDV debt to BERR, and under the Barclays-BERR arrangement BERR had no further right to share in Barclays’ recovery from LDV’s assets.

Mr. Ibrahim argued that the payment by UBS did not discharge LDV’s obligation to BERR. He argued that a payment by a third party of a debtor’s obligation to the creditor does not discharge the debt, that the debt remains alive and that the third party can assert the creditor’s rights against the debtor by way of subrogation or assignment.

A considerable amount of old English legal authority was reviewed by the court. The point of the review was to determine the circumstance in which a debt is considered to be discharged by a payment made by a third party. Having reviewed those cases, the Court of Appeal concluded that when the third party has an obligation to pay the debtor’s obligation by reason of some outstanding obligation to do so, then the debtor’s obligation to the creditor is discharged but the third party has a direct right to recover from the debtor.

In the second situation, when the third party has no such obligation and makes the payment voluntarily, the debt is not discharged unless the payment is made as agent for the debtor, and the third party can bring a subrogated claim against the debtor based on the continued existence of the debt.

Since UBS’s payment was made under an obligation to do so contained in the letter of credit, and in any event UBS’s payment was not made as an agent for LDV, the English Court of Appeal held LDV’s obligation to BERR had been satisfied. Therefore, under the particular wording of the Barclays-BERR agreement, BERR had no further right to share in Barclays’ recovery from LDV’s assets.

Discussion

This decision has a number of lessons for those using bonds, guarantees and indemnities.

First, a third party who is providing a guarantee to the bonding company should examine the securities which the bonding company is taking. If those securities provide that upon payment to the bonding company the loan is effectively discharged, then that is not a good provision so far as the third party is concerned. Or if upon payment by the third party to the bonding company, the bonding company loses its security or its security is in any way impaired, the guaranteeing party will want to change that wording to ensure that its payment does not discharge the debt or impair the security which the bonding company is holding. Indeed, the third party may want to require the bonding company not to impair any securities obtained by it and to ensure that any securities held by it shall remain in effect and be transferred to the third party guarantor.

The time to do so is, of course, at the time of the initial guarantee. Mr Ibrahim may have been in a position at the outset to insist that Barclays agree that he would share in the LDV asset recovery if, through UBS, he effectively paid LDV’s obligation to BERR. If Barclays was willing to make that arrangement with BERR, it may have made that arrangement with Mr. Ibrahim who was the principal in Weststar and was providing the guarantee which supported the loan arrangement.

Similarly, when a shareholder of a contractor is asked to give a guarantee for the contractor’s performance bond, and the bonding company also asks for security over the contractor’s assets, the time when the application for the bond is made is the time for the shareholder to examine that security The guaranteeing shareholder will want to ensure that, if the guarantee is called upon and paid by the shareholder and not the contractor, the contractor’s debt will not be considered to have been paid or the security impaired, and that the security will be available to the shareholder who pays the bonding company. On the other hand, the contracting company itself, or those with a financial interest in that company including its other secured creditors, may have an opposite interest and may wish the security to terminate if the bond is paid by the guaranteeing shareholder.

Second, the Ibrahim decision may suggest that a letter or credit or negotiable instrument has an independent role which can nullify or impair the rights of the ultimate third party guarantor.

This suggestion could be supported from the absolute nature of these instruments. A guarantor such as BERR may wish to have the certainty of an unconditional promise to pay without any requirement to account for securities to which it is entitled. BERR may not have wanted any obligation on its part to bargain with Barclays to retain rights to a continued share in LDV’s asset after it was paid. If this is so, then bonding companies may wish to use these sorts of instruments and third party guarantors will want to avoid them.

However, others may argue that this suggestion is based on an incorrect reading of the Ibrahim decision. It can be argued that the wording of the particular letter of credit, when combined with the particular wording of the Barclays-BERR agreement, simply led to the conclusion that, once BERR was paid by UBS, BERR had no further rights under that agreement and therefore neither did Mr. Ibrahim either by way of subrogation or assignment. If so, then a third party guarantor will want to avoid the particular wording of the documents in the Ibrahim case, while a bonding company may want to use that wording as a useful precedent.

Whichever way one reads the Ibrahim decision, it serves as a warning to all those involved in bonds and other sorts of indemnities and guarantees. If the bonding company holds securities for the bonded obligation, then the parties should clearly understand the rights of a third party in that security if the third party has the ultimate obligation to indemnify the bonding company.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed., chapter 9

Ibrahim v. Barclays Bank Plc., [2012} EWCA Civ 640

Building Contracts – Bonds – Remedies

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                                                         November 11, 2012

www.heintzmanadr.com
www.constructionlawcanada.com

If You Want Specific Performance, Do You Still Have To Mitigate Your Damages?

Is a party to a contract obligated to mitigate its damages at the same time that it is asking the court to order specific performance? Since the party wants the contract performed, not damages for non-performance, the obligation to mitigate seems to be totally inapplicable.

Yet, in Southcott Estates Inc. v. Toronto Catholic District School Board the Supreme Court of Canada has just held that a plaintiff seeking specific performance may have an obligation to mitigate.  If it doesn’t do so, and the court holds that specific performance should not be granted, then the plaintiff may be awarded very little if any damages.

Building contracts do not often give rise to claims for specific performance. That is because a court cannot readily supervise the conduct of a construction project.  But specific performance is a remedy which is often sought by developers who assemble land for the purpose of construction projects.  So the decision in Southcott has direct implications for companies involved in the assembly of land for building projects.

Factual Background

Southcott was a single purpose company which was part of the Ballantry Group of Companies.  The Toronto Catholic District School Board agreed to sell to Southcott a property which was surplus to its needs. Southcott intended to develop the property for residential purposes.  It was a condition of the agreement that the School Board obtain a severance from the Committee of Adjustment on or before the closing date. The School Board failed to have a development plan prepared and failed to obtain the severance. When the closing date arrived, the School Board refused Southcott’s request to extend the closing date.  The School Board declared the transaction to be at an end, and returned Southcott’s deposit.

Southcott commenced an action for specific performance or, in the alternative, for damages. Southcott succeeded on the merits of the action, and the real question was whether it was entitled to specific performance or damages.

Southcott admitted that it didn’t intend and never tried to mitigate its damages.  It said that it was incorporated solely for the purposes of this project and had no assets other than the money provided by Ballantry. Southcott said that it neither intended to nor tried to purchase other land, especially having regard to its involvement in this action. At trial, the School Board led evidence that 81 parcels of vacant development land in the Greater Toronto Area (GTA) were sold between the date of breach and the date of trial. That land was suitable for residential development. In fact during that period other companies in the Ballantry Group purchased lands which were similar to the subject property.

The Decision

The Supreme Court noted that, in Asamera Oil Corp. v. Seal Oil& General Corp, [1979] 1 S.C.R. 633, it had dealt with the obligation to mitigate in relation to a claim for specific performance.  The Asamera case dealt with an investment contract, not real estate.  In Asamera, the court had said that the plaintiff needed to show “some fair, real, and substantial justification” before a claim for specific performance could be insulated from the obligation to mitigate. If the plaintiff could show some “substantial and legitimate interest” in seeking specific performance as opposed to damages, then the plaintiff might justify its inaction in failing to mitigate.

The Supreme Court also noted that, since its decision in Semelhago v. Paramadevan, [1996] 2 S.C.R. 415, a plaintiff could not assert that every piece of land was “unique” and insist on specific performance of a contract to purchase that piece of land.

The Court then proceeded to deal with three issues:

First, the fact that Southcott was a single purpose company did not exempt it from the general principles applicable to specific performance and mitigation of damages. If it were otherwise, everyone would establish single purpose companies to exempt themselves from these general principles.

Second, Southcott did not have a sufficient justification for its failure to mitigate its damages. The Court said:

“The trial judge made clear findings that the land was nothing more unique to Southcott than a singularly good investment and that this was not a case in which damages were too speculative or uncertain to be an adequate remedy. The unique qualities related solely to the profitability of the development for which damages were an adequate remedy … A plaintiff deprived of an investment property does not have a “fair, real, and substantial justification” or a “substantial and legitimate” interest in specific performance… unless he can show that money is not a complete remedy because the land has “a peculiar and special value” to him…. Southcott could not make such a claim. It was engaged in a commercial transaction for the purpose of making a profit. The property’s particular qualities were only of value due to their ability to further profitability. Southcott cannot therefore justify its inaction.”

Third, the Supreme Court held that there was evidence to support the Court of Appeal’s conclusion that Southcott had suffered no damages.  It agreed with Southcott that the mere fact that Southcott had admitted it did not mitigate its damages did not throw the burden of proof on the damages issue onto Southcott.  Since mitigation of damages was at issue, the normal burden of proof remained on the defendant, the School Board.  However, taken as a whole and in the light of purchases by other Ballantry companies of similar land during the same period, there was evidence to demonstrate that Southcott had suffered no damages.

Discussion

The Southcott decision shows that the plaintiff – and the defendant – rolls the dice on the same “uniqueness of the property” issue, both for the specific performance claim and the damage claim. If the property isn’t really unique, then the plaintiff won’t be awarded specific performance.  If the property isn’t really unique, then the plaintiff will be denied damages if it doesn’t mitigate. So the parties had better get that issue right, or someone is either going to win or lose both issues. In effect, the plaintiff is either going to obtain specific performance, or (if the damages could have been mitigated) little or no damages.

The second lesson to learn from Southcott is that the uniqueness cannot be solely based on value.  Value can be as much translated into a damage award as into an award for specific performance.  If the property is really valuable, or more convenient, or more developable, in relation to other available properties, then those advantages can be awarded by way of damages.  They may not be an excuse for the plaintiff not searching for reasonable alternative properties.

See Heintzman and Goldsmith on Canadian Building Contracts, 4th ed.

Chapters 5 and 6, part 1.

Southcott Estates Inc. v. Toronto Catholic District School Board, 2012 SCC 51

building contracts – remedies – claims – specific performance – damages

Thomas G. Heintzman O.C., Q.C., FCIArb                                                       October 28, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

Andrews v ANZ: What Are The Consequences For Building Contracts?

The recent decision of the Australia High Court in Andrews v. Australia and New Zealand Banking Group Ltd. is important for the building industry.  While it dealt with a banking contract, the principles it applied are directly relevant to building contracts.

The central decision in Andrews v. ANZ is that the doctrine prohibiting contractual penalties applies both to conduct which is a breach of contract and conduct which is permitted under the contract.  But in its review of the whole history of the law of penalties, the court draws conclusions which are of much wider consequence.  The court explains that non-monetary consequences of a contract are included in the doctrine against penalties.  That conclusion could have a dramatic impact on building contracts.  The court also clarifies the difference between a “condition” in a contract and a “condition” in a bond, and decides that these words do not have the same meaning in both settings.  Since bonds are an essential element in building projects, this decision should be well understood by those engaged in those projects.

Factual Background

The decision in Andrews v. ANZ arose from a motion to strike out certain claims in a class action relating to banking contracts.  The contracts permitted, but did not require, the bank to impose certain fees if the customer undertook, or asked the bank to undertake, various transactions. The transactions included:

  • requesting the bank to consider a withdrawal or payment which would result in an overdraft in the account; or
  • requesting the bank to honour a transaction that resulted in an overdraft.

The transactions were not contrary to the banking contract.  The fees might be payable by the customer if the bank considered the requested transaction, even if the request was denied.

In its motion to strike, the bank argued that the rule against penalties did not apply to these amounts on the ground that the rule against penalties did not apply when, as in this case, the triggering conduct was not a breach of contracts.  The Court of Appeal agreed.  The High Court reversed that decision, holding that the fact that these fees “were not charged by the respondent upon breach of contract by its customers and that the customers had no responsibility or obligation to avoid the occurrence of events upon which these fees were charged, do not render the fees incapable of characterisation as penalties.”

The High Court also held that the doctrine against penalties applies to non-monetary conduct.  The contract may state that a party will do something (the primary event) and then stipulate a further event if the primary event does not occur (the secondary obligation).  Neither event need be a monetary one for the doctrine against penalties to apply. Thus if the primary event is the transfer property, the doctrine can apply.  If the secondary event is the transfer of property, likewise the doctrine can apply.  In either situation, if the secondary event is totally disproportionate to the real consequences of the failure to perform the primary event, the secondary event can be examined to determine if it is really a penalty.  If it is, then it is unlawful.

The Consequences of Andrews v. ANZ  for Building Contracts

There are four important consequences of the decision in Andrews v. ANZ.

1.      Doctrine Against Penalties applies to more than Breaches of Contract

The central conclusion in Andrews v. ANZ is, of itself, extremely important for the law relating to building contracts.  All the clauses in a building contract which provide for monetary payments should be closely examined to see if they impose unlawful penalties. Even those clauses which do not give rise to a breach of contract should be examined.  If those payments are out of line with the actual detriment arising from the relevant conduct, potentially they are penalties and unlawful, whether or not they are in relation to a breach of contract.

2.      Doctrine Against Penalties applies to Non-Monetary Conduct

According to Andrews v. ANZ, this principle applies to any provision in a contract, not just those which involve monetary payments.  In the context of building contracts, this approach could have a wide and uncertain application. What sort of non-monetary consequences fall within it?  If a bidder submits an erroneous bid (the primary event), could a court hold that disqualifying the bidder (the secondary event) is unlawful as a penalty if it is shown that the error in the bid caused little harm to the owner and the disqualification of the bidder is a disproportionate “penalty”?  If an owner gives a “cure notice” and then terminates the contract, could the termination amount to a penalty if it was disproportionate to the damage suffered by the owner?  It may seem ridiculous to include those examples within the doctrine against penalties, but it is difficult to draw a clear line between what non-monetary consequences fall within that doctrine in the construction setting.

3.      Doctrine Against Penalties may not apply to Additional Obligations

The High Court expressly recognized that there may be an exception to the penalty doctrine arising from what it called a consensual “additional obligation.”  The High Court said that if the amount which the party must pay (or other secondary event) as a consequence of the conduct in question is really the result of a new contract, then the penalty doctrine may not be engaged.

Thus, the fee for the overdraft to the banking customer might be seen as really arising from a new contract and a new and additional privilege purchased by the customer.  Similarly, a distributor of films to a theatre owner might stipulate that the theatre owner would pay four times the original single-screening fee for extra showings of the film. The High Court said that those extra fees might amount to the purchase of additional privileges which fall outside the doctrine against penalties. It did not decide whether the banking fees in question fell within this exception and left that issue to the trial judge.

How would this exception apply to building contracts? If the building contract said that for every day of delay by a contractor, the contractor shall pay the owner $500,000, is that provision a penalty or an “additional obligation.”  If instead, the contract stated that if the contractor wished to extend the period of completion, then he may apply to the owner for permission to extend, and the parties agree that a new contract containing any such permission shall be made at a cost of $500,000 per day, would that be a penalty or an additional obligation?

4.      “Conditions” in Contracts and Bonds are Different

There is a further aspect of the decision in Andrews v. ANZ which is of interest to the building industry, and that is its discussion of “conditions” in contracts and bonds. The High Court pointed out that the word has an entirely different meaning in a contract than in a bond.

As the court said, in a contract the word “condition” refers to a term of the contract which is “vital, important or material.”  By using this word, the parties have agreed that the breach of this term amounts to a repudiation and permits the other party to accept the repudiation and terminate the contract.  In other words, in a contract conduct which does not comply with a “condition” is necessarily a breach of contract, and indeed a serious one.

In a bond, however, the word “condition” performs another function.  Like a contract, the bond seeks to “secure performance of the condition, but instead of attempting to secure this result by exacting a promise from the obligor to perform the condition, there is an acknowledgment of indebtedness –in effect a promise.” In Roman and early English law, a bond might be payable in full, no matter what damages the obligee might really suffer. That result was later modified by equity, through decisions which evolved into the doctrine against penalties, to ensure that the payment under a bond could be no more than the real loss of the obligee.

In addition, the High Court noted that the “condition in the bond may be any occurrence or event which need not be some act or omission of the obligor, analogous to a contractual promise by the obligor.” Moreover, the condition in the bond need not be the payment of money, and could relate to the transfer or vesting of interests in land. Indeed, “the cases do not establish any general proposition as to the contractual character of the condition in a bond.”

This discussion of bonds supported the High Court’s conclusion that the doctrine against penalties relates to conduct which does not necessarily amount to a breach of contract and to consequences that do not necessarily involve monetary payments.

In the result, the decision in Andrews v. ANZ provides a good review of the law of bonds and the use of the word “condition” in bonds.  That word designates a circumstance which is the basis for the obligation in the bond. That circumstance need not be a breach of a contract.  It can be whatever conduct the bond is intended to secure.

Conclusion:

Andrew V. ANZ results in a sweeping application of the equitable doctrine against penalties. The decision holds that the doctrine applies to all contractual conduct, including both breaches and permitted conduct and both monetary and non-monetary consequences. Whether this approach will be followed in Canada is uncertain. As a matter of logic and principle, it makes sense.  But the decision raises challenges when applied to building contracts.  And it raises difficult questions about where the boundary line is between conduct which falls within the doctrine against penalties and conduct which does not.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.) at Chapter 6, para 2(b)(i)(B) and Chapter 9

Andrews v. Australia and New Zealand Banking Group Ltd., [2012] HCA 30

Building Contracts  –  Bonds  –  Penalties  –  Damages  –  Remedies for Breach of Contract

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                  October 20, 2012

www.heintzmanadr.com

www.constructionlawcanada.com

 

The New Canada-China Foreign Investment Agreement: Will The UNCITRAL Arbitration Rules Result In Enforceable Justice?

Canada has recently signed a Foreign Investment Promotion and Protection Agreement (FIPA) with the People’s Republic of China.  Under the Agreement, a complaining investor is entitled to submit a claim and have it dealt with under the UNCITRAL Arbitration Rules.  The real questions about this Agreement are:

  • Will the UNCITRAL Arbitration rules in FIPA provide real and enforceable protection for  Canadian investments in China?
  • Will the UNCITRAL Arbitration Rules be sufficient to overcome Canadian concerns about the lack of responsiveness of the Chinese government to domestic public opinion and the lack of independence of the Chinese judiciary?

Parliament and the Canadian public have not had a large role in the discussions about the wisdom of entering into the FIPA with China and the wisdom of the specific terms of that Agreement.  The Agreement was signed in Vladivostok, Russia on September 9, 2012 and may come into force after it has been tabled with Parliament for 21 sitting days.  The Agreement may be seen at https://www.international.gc.ca/trade-agreements-accords-commerciaux/agr-acc/fipa-apie/china…

Protections in the Agreement

Part B of the FIPA with China contains broad expressions of protection to investors from one country when they are investing in the other country.

Part B contains:

Article 4:                     guarantees for fair and equal treatment of investments

Article 5:                     most-favoured-nation treatment

Articles 6 and 11:        treatment no less favourable than that accorded to nationals

Article 7:                     protections for senior management and boards of directors

Article 10:                   protection against expropriation except for a public purpose and only with compensation

Article 12:                   protections for the free transfer of capital, profits, dividends and similar payments without delay

Article 15:                   the dispute resolution mechanism between Canada and China as the Contracting Parties.

The protections for Canadian investors contained in Part B may be ineffective without a Chinese government encouraged by public opinion to adhere to these protections.  After all, remedial protections are of little use if governments actually do renounce their contractual obligations.  Canadian investors may not view the Chinese government as under any compulsion of domestic public opinion to continually and fully implement these protections in the future.  Indeed, the real impetus for China (or indeed any country) to adhere to its obligations under bilateral treaties may be international opinion.

Remedial protections in any agreement are ineffective if no system for enforcing a judgment is available.  The need for effective enforcement may be greater to the extent that a government is not compelled by domestic public opinion to adhere to its agreements. Canadian investors might not view an action in the Chinese courts as leading to an impartial access to justice if the protections are withdrawn.

In this setting, the remedial aspects of FIPA are critically important from a perceptual standpoint, but not a complete answer from an enforcement standpoint.

Dispute Resolution System in the Agreement

Part C of the Agreement contains the dispute resolution system for an investor of a contracting party which wishes to assert a claim against the other Contracting State.

Before submitting a claim, the disputing investor must give notice of intent to submit a claim to arbitration, and consultations between the disputing parties must be held within 30 days of that notice unless the disputing parties agree otherwise.

Before submitting its claim, the disputing party must agree to arbitration under this Part of the Agreement, and at least six months must have elapsed from the date of the events giving rise to the claim and at least four months from the notice of intent to submit the claim to arbitration.  A three year limitation period is established, and the claim must be made within three years of the date when the investor first acquired or should have first acquired knowledge of the alleged breach and knowledge of the alleged loss or damage. (Article 21)

Annex C.21 requires that a Canadian investor wishing to make a claim under the Agreement shall first participate in the “administrative reconsideration procedure” that is apparently available in China, and withdraw any claim in a Chinese court.

Article 22 of the FIPA provides that the investor can submit the claim under any one of three regimes:

  1. The ICSID Convention, provided that both Canada and China are parties to that Convention.  That Convention is the Convention on the Settlement of Investment Disputes between States and Nationals of other States, made at Washington, D.C. in 1885. While China has ratified this Convention, Canada has signed but not ratified the Convention because several of the provinces have not approved it. The English version of the ICSID Convention can be viewed at the ICSID’s website: https://icsid.worldbank.org/icsid
  2. The Additional Facility Rules of ICSID, if one of Canada or China is not a party to the ICSID Convention.  China is a signatory to the ICSID Convention, so investors could use the Facility Rules if they wish to do so.  The Additional Facilities Rules can also be viewed at ICSID’s website. Those rules provide an ad hoc form of arbitration similar to the UNCITRAL Arbitration Rules.
  3. The UNCITRAL Arbitration Rules, being the Arbitration Rules adopted by the United Nations Commission on International Trade Law, as amended from time to time.  The UNCITRAL Arbitration Rules can be viewed at UNCITRAL’s website:  http.www.uncitral.org

Article 24 of the FIPA provides that the arbitration shall be heard by three persons, that the arbitrators are to be experienced in international law, trade, investment or dispute resolution and that they are to be independent of the contracting governments and disputing parties. If the dispute relates to financial institutions, then the parties may agree that, in addition, all the arbitrators shall have expertise or experience in financial institutions. At a minimum, however, the chair person is required to have that expertise or experience.

Under Article 26, claims with questions of fact or law in common can be consolidated.

Articles 27 to 32 of the Agreement provides for such matters as the production of documents of, and the participation and submissions by third parties, the public access to the hearings and documents, governing law, interim measures and the enforcement of an Award.

Article 32(4) requires Canada and China to provide for enforcement of the award in its respective territory. This is the sole provision in the FIPA that deals with enforcement of awards.  This provision cannot be enforced by the investor, and can only be enforced by the other Contracting State.  So it will be imperative for Canada to ensure that a system is implemented in China for the enforcement of awards under this FIPA, and to monitor the effectiveness of that system.

The UNCITRAL Arbitration Rules

The availability of the UNCITRAL Arbitration Rules should provide a good measure of administrative law fairness to the arbitration proceedings under the FIPA.  Those Rules were adopted by the United Nations Commission on International Trade Law (UNCITRAL) which is the same body that developed the UNCITRAL Model Law. Among the countries that have adopted it, the Model Law provides a common basis for the conduct and enforcement of international commercial arbitrations, no matter where the arbitrations are conducted.  The origins of the UNCITRAL Model Law are found in the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention).  The Model Law can also be viewed on UNCITRAL’s website.

The UNCITRAL Arbitration Rules were developed for use in international commercial arbitrations.  First adopted in 1976, these rules have been successfully used for many years to ensure fairness in the conduct of international commercial arbitrations.  It is the statutory adoption of the Model Law in the countries which have adopted that Law, not these Rules themselves, that requires courts in those countries to enforce the arbitral award.

The UNCITRAL Arbitration Rules go a long way to guaranteeing procedural fairness in the process leading to an award in the arbitration process provided to investors under FIPA. However, one aspect of the dispute resolution system in FIPA cannot be addressed by those Rules, and that is the enforcement of the arbitral award.  As noted, Article 32 (4) of the FIPA requires Canada and China to provide for the enforcement of an award in each of their territories.  Only Canada, and not a Canadian investor, can require China to implement such a system in that country. Only Canada, and not a Canadian investor, can commence proceedings under FIPA if such enforcement does not occur.

Until a tried and true enforcement mechanism is established by China, Canadian investors may be reluctant to conclude that the UNCITRAL Arbitration Rules, tried and true as they are, will ensure that the Chinese government complies with FIPA, or if it does not, that an arbitral award will actually result in compensation.

Conclusion

The UNCITRAL Arbitration Rules have been used in international commercial arbitration for many years, and also in other bilateral trade and investment agreements.  However, their use in the agreement with China is significant since Canadian investors may be concerned about the responsiveness of the Chinese government to domestic public opinion and about the independence of Chinese courts compared to those in other countries with which Canada has bilateral treaties.

The use of the UNCITRAL Arbitration Rules in the FIPA with China will go a long way to giving confidence to Canadian investors that they will obtain procedural fairness in the arbitration of a dispute arising under the FIPA with China.  However, procedural fairness is no substitute for actual adherence of governments to their agreements.  The real issues will be whether both the Chinese and Canadian governments fully implement FIPA and whether awards made by the arbitral process are enforced.

Thomas G. Heintzman O.C.,Q.C., FCIArb                                                                                                     October 7, 2012

www.heintzmanadr.com
www.constructionlawcanada.com