B.C. – case reflects versatile advocacy effective in preserving opportunity to arbitrate dispute – #093

Asian Concepts Franchising Corporation (Re), 2018 BCSC 1022 serves as fresh reminder that effective arbitration practitioners must navigate well-beyond the safe harbours of their own practice area. Practitioners must also venture into court litigation and appreciate the impact of specialized legislation such as the Bankruptcy and Insolvency Act, RSC 1985, c B-3 (“BIA”) and the Arthur Wishart Act (Franchise Disclosure), 2000, SO 2000, c 3 (“Wishart Act”) to ensure that developments outside their arbitration do not compromise resolution of the dispute being arbitrated. The versatility of that advocacy rewards by preserving the claim underlying the arbitration.This note is not about the specialized legislation but about how being adept at arbitration is not in and of itself sufficient to being effective in arbitration. Rather, good advocacy skills and strategic court applications – all on bright display in Asian Concepts Franchising Corporation (Re) – are part of the arbitration practitioner’s skill set. The note does sketch the court procedure and substantive law applicable to the parties’ specific fact situation. It does so only as background to the take away that knowing one’s arbitration practice area is only part of the delivering on the promises of arbitration.

The case involved Adrenaline Drive Inc. (“Adrenaline”), franchisee, and Asian Concepts Franchising Corporation (“ACFC”), franchisor, who had entered into a September 9, 2008 Master Developer Agreement (“MDA”) for the operation and development of a chain of trade-marked restaurants located in northern Alberta, Saskatchewan and Manitoba (the “Territory”). By February 2012, Adrenaline had opened over 25 locations in the Territory, earning average monthly royalty payments of $35,000.00.

In January-February 2012, ACFC ceased paying royalties to Adrenaline. Two days after having purported to terminate the MDA on February 27, 2012, ACFC notified all franchisees in the Territory that the franchises had been assigned to WB Franchising Ltd. (“WB Franchising”).

The MDA contained an arbitration clause requiring that arbitration “take place in British Columbia” and Adrenaline initiated arbitration against ACFC.

Adrenaline also commenced litigation in Alberta’s Court of Queen’s Bench against its co-contracting party ACFC as well as against WB Franchising and Mr. Scott Bender (“SB”). Adrenaline claimed liquidated damages of $166,774.82 and unliquidated damages of $8 million. SB was alleged to be the directing mind of ACFC and WB Franchising as well as a third corporation, 0839297 B.C. Ltd. (“839”), which held the franchise’s trademark. Adrenaline based its court litigation on the following allegations as framed by Madam Justice Shelley C. Fitzpatrick:

[10] Adrenaline alleges that Mr. Bender’s scheme involved: firstly, terminating the master development agreements, including Adrenaline’s MDA, so that the income or royalty streams would revert to ACFC; and, secondly, arranging to transfer the trademarks, franchise agreements and the other assets required to operate the Wok Box franchise from ACFC to WB Franchising. Adrenaline alleges that WB Franchising paid a small amount for the tangible assets and that it paid nothing for the transfer of the franchise agreements and intellectual property that WB Franchising received from ACFC.

ACFC filed a notice of intention to make a proposal under section 50.4 of the BIA, promptly staying Adrenaline’s arbitration under section 69(1) of the BIA.

The case dealt with Adrenaline’s efforts to preserve its claim under arbitration and avoid the effect of a vote in support of a proposal presented by ACFC to its creditors.

In the BIA proceedings, ACFC filed two (2) proposals pursuant to section 62: the first on December 20, 2013 (“First Proposal”) and an amended one on February 14, 2014 (“Amended Proposal”).

ACFC’s First Proposal disclosed unsecured claims of $361,312.74 and secured claims of $610,000.00 and stated that “related third parties” would provide at least $300,000.00 to “create a pool” to pay unsecured creditors.

The Amended Proposal contained what Fitzpatrick J. identified as “some unusual aspects” which she reproduced in part:

1. In this Proposal:
(e) “Contributors” means WB Franchising Limited and 0839297 B.C. Ltd., who have Claims or potential Claims for indemnity against the Debtor. …

15. Unsecured Creditors will accept the payments provided for in this Proposal in complete satisfaction of all their Claims, as against the Debtor or any of the Contributors …. all of which shall be released upon payment of the amounts provided for in this Proposal ….

16. Upon performance by the Debtor of its obligations under this Proposal, each and every Director of the Debtor shall be released from any and all demands, claims, debts, judgments and other recoveries on account of any potential, contingent or actual statutory liability of whatever nature ….”

At a meeting of the creditors, ACFC’s Amended Proposal was accepted by (i) 98% of the creditors in terms of the aggregate value of claims and (ii) 13 of 14 in terms of number of creditors. Adrenaline was the only creditor to vote against the Amended Proposal. Fitzpatrick J. recognized Adrenaline’s motivation in contesting the Amended Proposal.

[17] Accordingly, if the creditors accept the Amended Proposal and it is approved by this Court in accordance with the BIA, Adrenaline’s ability to pursue its claim in its Alberta action or the arbitration proceedings will be adversely affected, if not eliminated, as against certain persons. This will include Adrenaline’s ability to pursue WB Franchising and 839 (since they are “Contributors” under the Amended Proposal). It will also affect Adrenaline’s ability to pursue ACFC’s directors, being Mr. Bender and Lawrence Eade.

Following the vote, Adrenaline undertook two steps to preserve its litigation and arbitration.

First, it challenged the valuation of its own claim. The Trustee had valued Adrenaline’s $8 million claim at $65,720.00 or less than 1% of the stated value. Adrenaline challenged the valuation in court which resulted in Adrenaline’s claim climbing to $1,122,720.25. See Asian Concepts Franchising Corporation (Re), 2017 BCSC 1452, para. 123. Increasing the value of its own claim would help it reverse the result in (i) above.

Second, Adrenaline challenged the valuation of another creditor’s claim, WB Heartland Restaurant Inc. (“Heartland”), which voted in support of the Amended Proposal. Eliminating another creditor would assist in reducing the number of creditors, though not enough to change the results in (ii) above, but would further assist in reversing the result in (i) above.

Heartland’s first proof of claim dated January 7, 2014, comprised of two parts – Part A section 6(6) of the Wishart Act and Part B under section 7(1) – and totalled $2.3 million. Part A, valued at $1,383,186.77, consisted of (a) out of pocket monies paid to ACFC for the setting up of the franchise; (b); inventory; (c) equipment and supplies; and (d) other “losses” incurred in acquiring, setting up and operating the franchise, which were said to include “operational losses” of $347,500.54 and “lease indemnity costs” of $523,318.04. Part B consisted of “damages of $1 million”.

Heartland’s then filed a second proof of claim dated February 27, 2014 in which it reduced the amount to $1.6 million. It attached the same Schedule “A” as included with its first proof of claim, indicating total claims of $2.38 million, but with no particular clarity about which claims had been deleted or reduced to account for the overall reduction in the amount claimed.

Fitzpatrick J. dealt with Adrenaline’s application under section 135(5) of the BIA to reduce Heartland’s claim. Section 135(5) authorizes a court to expunge or reduce a proof of claim. Adrenaline bore the burden to prove on a balance of probabilities that Heartland’s claim should be reduced, as set out in Purdy (Re) (Trustee of), 1997 CanLII 2168.

While the Trustee’s valuation of Heartland’s claim is entitled to deference, Fitzpatrick J. determined that the standard to apply to the Trustee’s valuation is reasonableness.

[56] Applying administrative law principles to this standard, the question will be whether the process employed by the trustee in coming to a valuation of a contingent or unliquidated claim was justified, transparent and intelligible and whether the decision, based on discretion, falls within possible acceptable outcomes: Transglobal Communications Group Inc., Re, 2009 ABQB 195 (CanLII) at para. 73.

[57] However, it will not be sufficient for the Trustee to simply show that she conducted a reasonable process and came to a reasonable decision based on that process. Adrenaline may show that the claim lacked merit or was not properly supported such it should not have been allowed. It is common sense that allowing a claim that lacked merit or had insufficient support could not have been reasonably done by the Trustee using its discretionary powers under the BIA: Marsuba Holdings Ltd, Re1998 CanLII 5248 (BC SC), 1998, 8 C.B.R. (4th) 268 at paras. 14–17 (B.C.S.C.).

Fitzpatrick J. also determined that the court’s review under section 135(5) is more a de novo hearing than a true appeal.

[62] In an application under s. 135(5), a creditor is challenging the decision of the trustee after having had no knowledge of the process and basis upon which the earlier decision was made. In that event, such as here, a creditor is completely in the dark about the process undertaken by the Trustee until disclosure and after the Trustee’s decision was made. To restrict the process to only what was before the Trustee would unduly hamper the ability of that challenging creditor to put evidence before the Court relevant to the claim and its validity. In that event, restricting such a challenge as under a true appeal would be unfair in the extreme.

Fitzpatrick J. identified a two-part “robust process” to which BIA claims are subject. First, every creditor must prove its claim with relevant and probative evidence. Second, the Trustee has the duty to examine each proof of claim, including the grounds and documentation supporting the claim and, if unsatisfied, exercise its ability to require more evidence.

The bulk of Fitzpatrick J.’s reasons deal with her analysis of the process to which the Trustee subjected Heartland’s claim. See paras 75, 81, 84-100. The details of her analysis are beyond the application of the case to the practice of arbitration. It is sufficient to note that Fitzpatrick J.’s analysis lead her to conclude that the Trustee had not properly exercised its discretion, determining that the Trustee had “largely abandoned its role within the proposal process”. Fitzpatrick J. then undertook her own valuation of Heartland’s claim at paras 101-147, and determined the value of Heartland’s claim at $809,382.00.

The reduction of another creditor’s claim would assist Adrenaline in a future vote on the Amended Proposal for the value of the votes but not the number of the votes for or against. The result of Adrenaline’s court litigation and its use of the BIA and Wishart Act reflects effective advocacy to keep a party’s arbitration from being extinguished by developments outside the arbitral process.