B.C. – doctrine of separability allows receiver to disclaim agreement to arbitrate while litigating main contract – #399

In Petrowest Corporation v. Peace River Hydro Partners, 2020 BCCA 339, B.C.’s Court of Appeal identified the particular status and powers of a court-appointed receiver exercising its jurisdiction under the Bankruptcy and Insolvency Act, RSC 1985, c B-3 and set out the doctrine of separability applicable to agreements to arbitrate.  Their combined application supported the Court’s conclusion that a court-appointed receiver can sue on a contract and also disclaim application of the agreement to arbitrate contained in that contract.  The Court held that doing so did not allow the receiver to “pick and choose” terms in a contract but instead merely recognized that the receiver had the option to pursue or disclaim two (2) separate contracts.

Update: Leave to appeal granted June 10, 2021, Peace River Hydro Partners, et al. v. Petrowest Corporation, et al., 2021 CanLII 49685 (SCC).

The Court was asked to consider whether the appointment of a receiver under the Bankruptcy and Insolvency Act, RSC 1985, c B-3 (“BIA”) had an impact on the application of section 15 of B.C.’s Arbitration Act, RSBC 1996, c 55.  Note: as of September 1, 2020, B.C.’s new Arbitration Act, SBC 2020, c 2 replaced the former Arbitration Act.   

Petrowest Corporation (“Petrowest”) is in receivership.  Its affiliates have been assigned into bankruptcy. A court-appointed receiver commenced an action against appellants, claiming amounts allegedly owing under agreements between appellants and Petrowest/its affiliates.  Appellants resisted, arguing that the arbitration agreement in the contracts required the court to refer the litigation to arbitration and applied unsuccessfully for an order to that effect.  See Petrowest Corporation v. Peace River Hydro Partners, 2019 BCSC 2221. For the earlier Arbitration Matters note on that decision, see “Court asserts inherent jurisdiction under insolvency legislation to override arbitration clauses”.

On appeal, at paras 7-11, the Court of Appeal identified the key elements of Madam Justice Nitya Iyer’s decision in first instance. Iyer J. held that mandatory terms of B.C.’s Arbitration Act, RSBC 1996, c 55 do not prevent courts from exercising their inherent jurisdiction to refuse a stay of court proceedings where provisions of the BIA apply.  Iyer J. listed a number of factors to consider when exercising that jurisdiction.  Iyer J. had held that a trustee in bankruptcy is a party to an arbitration agreement when the trustee institutes litigation to enforce the terms of the main contract in which the arbitration agreement appears.

On appeal, the Court upheld Iyer J.’s decision but for different reasons. The Court held that section 15 was not engaged when a receiver is appointed under the BIA and disclaims an agreement to arbitrate.  “Accordingly, although I follow a different route from that travelled by the judge, I arrive at the same result”.

Paramountcy noted but not in issue – To the extent that section 15 of the provincial Arbitration Act did apply, its interplay with section 72(1) of the federal BIA raised a potential conflict between federal and provincial legislation.  Such a conflict would require the Court to resolve the conflict by applying the doctrine of paramountcy.  See GMAC Commercial Credit Corporation – Canada v. T.C.T. Logistics Inc., 2006 SCC 35 (CanLII), [2006] 2 SCR 123. The Court noted that no issue of paramountcy was raised in first instance and not argued before it.  As a result, “there is little point to undertaking the necessary statutory analysis”.

Correctness standard – Having identified the issue on appeal as a question of law, the Court reviewed on standard of correctness.

Receivership not bankruptcy – In its reasons, the Court clarified the impact of certain factual determinations.  It did acknowledge that Petrowest was in receivership, not bankruptcy, though its affiliates had been assigned into bankruptcy.  Despite the “factual error” made in first instance which determined that Petrowest was bankrupt instead of in receivership, the Court held that the error was “of no practical consequence”.

Moreover, both receivership and bankruptcy come under the umbrella of the BIA, including, with respect to Petrowest, the Receivership Order pronounced by the Court of Queen’s Bench of Alberta In Bankruptcy and Insolvency on August 15, 2017, pursuant to section 243(1) of the BIA.  That order makes all proceedings subject to the supervision of the Court”.

Receivership under BIA – The Court distinguished the courts’ process under the BIA from that under the Companies’ Creditors Arrangement Act, RSC 1985, c C-36 (“CCAA”).  The Court reframed the analysis, from a focus on what the court can do under section 15(2) of the Arbitration Act to the status and powers of receivers/trustees under the BIA.

[41] But the court-supervised restructuring process that takes place under the CCAA is very different from the process that receivers and trustees undertake under the BIA, and the discretion granted by section 11 of the CCAA is quite specific.  The question here is not whether the court has the power to override an arbitration clause and the otherwise mandatory requirement of section 15(2) of the Act; rather, the question is whether the arbitration clause and requirements of section 15(2) are engaged at all.  This focuses on the status and powers of the receiver/trustee, not on the powers of the court”.

Appellants argued that litigation on the contracts commenced by the receiver “is in no meaningful way distinguishable from such litigation commenced directly by the respondents pre-insolvency”. The Court disagreed. The Court drew a bright line around the power of a receiver to disclaim contracts, distinguishing that power from the trustee’s more limited options. “Unlike the debtor/bankrupts, the receiver is an officer of the court.  Moreover, as Bennett points out (at 231), the receiver is not an agent of the debtor or any other parties, but “is a principal entrusted to discharge the powers granted to the receiver bona fide””.

Petrowest had no capacity to claim against appellants under their contracts but this incapacity did not extend to the receiver.

[43] Turning to the position of Petrowest, I observe that as a result of the receivership order, Petrowest had no capacity to claim against the appellants under their contracts.  While, nominally, the claims remain those of Petrowest and its affiliates, only the receiver can commence action and move the claims forward (see Bennett at p 257).  Thus, in clause 3(j), the receivership order empowered and authorized the receiver, among other things, “to initiate, prosecute and continue the prosecution of any and all proceedings…with respect to the Debtors, the Property or the Receiver”.

[44] In doing so, as we have seen, the receiver acts not as agent of the debtor (Petrowest), who has been legally paralyzed from acting, but rather acts in fulfilment of its own court-authorized and fiduciary duties, owed to all stakeholders.  Petrowest, on the other hand, can do nothing”.

The Court observed that, for the purpose of section 15(1) of the Arbitration Act, the party which commenced the litigation on the contracts was the receiver.  The Court disagreed that this also meant that it was a party to agreement to arbitrate contained in those contracts.

Disclaiming contracts – The Court agreed that a receiver is entitled to disclaim the debtor’s executory contractual obligations but “this concept does not form a basis for allowing the receiver freedom to pick and choose among the terms of a contract the receiver seeks to enforce”.  Rather, the question and the answer flowed from the nature of an agreement to arbitrate.

Doctrine of separability – The Court held that the doctrine of separability stipulated that an agreement to arbitrate is a separate contract and, as such, can be disclaimed separately from the main contract in which it appears. “This raises for consideration the doctrine of separability, by which arbitration clauses have long been recognized as forming not simply a term of the contract, but an independent agreement”.

The issue had not been argued in first instance or in the initial materials filed on appeal. At the invitation of the Court, appellants and respondents each filed argument addressing the impact of the doctrine of separability on the receiver’s authority to disclaim contracts.

The respondents maintain that the doctrine is irrelevant given the power of the receiver to disclaim contracts generally.”  The Court disagreed, having already resisted recognizing a “pick and choose” approach to contractual terms.

The appellants accept that the doctrine is relevant, but maintain that it does not permit the receiver to avoid the arbitration agreements in the contracts it seeks to enforce”.  The Court again disagreed but for different reasons than those addressing respondents’ arguments.

The Court focused on the use of the term “arbitration agreement” rather than mere “clause”.  See Gulak v. Breckenridge, 2015 BCSC 153 which reiterated the definition at section 1 the Arbitration Act and the use of the term “arbitration agreement”.  The Court readily dismissed any parallel with other cases in which a party tried unsuccessfully to avoid application of an agreement to arbitrate contained in a contract on which it sued.  Referring to the facts in 681210 Alberta Ltd v. 1335422 Alberta Ltd, 2016 ABQB 407, the Court distinguished the status of a mere contracting party from that of a court-appointed receiver. “The case is accordingly akin to one where the dispute is between the parties who entered into the contract.  In such a case, neither has the power that a receiver has to disclaim an executory agreement”.

In addition, the Court mentioned those situations in which invalidity of the agreement to arbitrate did not affect the validity of the main contract.  With reference to E.J.R. Lovelock Ltd. v. Exportles, [1968] 1 Lloyd’s Rep. 163, the Court noted that “[t]he point is that the arbitration agreements are independent and separable”.

Combing receivership status and separability doctrine – Having identified the particular status and powers of a court-appointed receiver exercising its jurisdiction under the BIA and set out the doctrine of separability, the Court then combined their application to determine that a court-appointed receiver can sue on a contract and also disclaim application of the agreement to arbitrate given that it is dealing with two (2) contracts.

[55] In my view, in the factual situation we are dealing with here, it is open to the receiver to disclaim the arbitration agreements notwithstanding that it has adopted the containing contracts for the purpose of suing on them.  This flows from the receiver’s particular powers and position, and the separability of the arbitration agreements.

[56] I conclude that section 15 of the Act is not engaged because, by exercising its power to commence these proceedings, the receiver has by that act disclaimed the arbitration agreements between Petrowest and affiliates and the appellants.  Accordingly, the action has not been commenced by a party to the arbitration agreements within the meaning of section 15(1) of the Act, and in any event, due to the receiver’s disclaimer, the arbitration agreements have become “void, inoperative or incapable of being performed” within the meaning of section 15(2)”.

urbitral notes – First, for recent statements on the doctrine of separability, see Uber Technologies Inc. v. Heller, 2020 SCC 16 para. 221.

[221] The doctrine of separability is “one of the conceptual and practical cornerstones” of arbitration law which plays an important role in ensuring the efficacy and efficiency of the arbitration process: Born, vol. I, at pp. 350-51 and 401. According to this doctrine, an arbitration clause should be analyzed as a separate agreement that is ancillary or collateral to the underlying contract: Bremer Vulkan Schiffbau und Maschinenfabrik v. South India Shipping Corporation Ltd., [1981] A.C. 909 (H.L.), at p. 980; see also Heyman v. Darwins, Ltd., [1942] A.C. 356 (H.L.); Prima Paint Corp. v. Flood & Conklin MFG. Co., 388 U.S. 395 (1967), at pp. 402 and 404; Fiona Trust and Holding Corp. v. Privalov, [2007] UKHL 40, [2007] 4 All E.R. 951. Put another way, an arbitration clause should be considered “autonomous and juridically independent from the main contract in which it is contained”: A. J. van den Berg, ed., Yearbook Commercial Arbitration 1999 (1999), vol. XXIVa, at p. 176, as quoted in Born, vol. I, at p. 350.

[222] The separability doctrine is a logical extension of the rule created by this Court in Dell which states that a challenge to an arbitral tribunal’s jurisdiction should be considered first by the tribunal itself because arbitral tribunals have the competence to determine their own jurisdiction: paras. 84-85. I will refer to this holding as the “rule of systematic referral”. The same statutory provisions which ensure an arbitral tribunal’s competence to determine its own jurisdiction also ensure its competence to determine the invalidity of the underlying contract by providing that the arbitration agreement should be treated as an independent agreement for the purposes of such a determination: Arbitration Act, s. 17(1) and (2); UNCITRAL Model Law, art. 16(1). Given that the legislature saw fit to give the arbitral tribunal the competence to decide these questions, the legislative choice embodied in s. 17(2) should receive the same respect as the one embodied in s. 17(1). The relationship between this “competence-competence” principle and separability is highlighted by the fact that they are both provided for in art. 16(1) of the UNCITRAL Model Law.

[223] National courts around the world nearly uniformly recognize the separability doctrine, even where no legislation provides for it: Born, vol. I, at p. 361 and 390; R. Feehily, “Separability in international commercial arbitration; confluence, conflict and the appropriate limitations in the development and application of the doctrine” (2018), 34 Arb. Intl. 355, at pp. 356-57. In addition, some superior and appellate courts in Canada have already recognized the doctrine: see, e.g., Krutov v. Vancouver Hockey Club Ltd., 1991 CanLII 2077 (B.C.S.C.); NetSys Technology Group AB v. Open Text Corp., 1999 CanLII 14937 (ON SC), 1 B.L.R. (3d) 307 (S.C.J. Ont.), at para. 21; Cecrop Co. v. Kinetic Sciences Inc., 2001 BCSC 532, 16 B.L.R. (3d) 15, at para. 25; James v. Thow, 2005 BCSC 809, 5 B.L.R. (4th) 315; Haas v. Gunasekaram, 2016 ONCA 744, 62 B.L.R. (5th) 1.

[224] The Arbitration Act and the UNCITRAL Model Law codify one aspect of the doctrine, that is, the preservation of an arbitral tribunal’s jurisdiction to rule on the validity of the underlying contract on the basis that the arbitration agreement is to be treated as a separate and independent contract for such purposes. However, the separability doctrine has wider significance. More broadly, the doctrine holds that an arbitration agreement is invalidated only by a defect relating specifically to the arbitration agreement itself and not by one relating merely to the underlying contract in which that agreement is found: Fiona Trust, at paras. 32-35, per Lord Hope; Feehily, at p. 373; Born, vol. I, at pp. 351, 457 and 466-69. In effect, the separability doctrine “immunizes the arbitration clause, protecting it from flaws or defects” in the underlying contract: Feehily, at pp. 371 and 373. Nonetheless, there may be instances where the same circumstances which impugn the validity of the underlying contract also call the validity of the arbitration agreement into question: Fiona Trust, at para. 17, per Lord Hoffmann”.

Second, in its reasons, the Court referred to situations in which the agreement to arbitrate may be void but the main contract remains unaffected.  The reverse situation arises as a common issue where a party resists arbitrating disputes under a contract it claims is void.  For recent comments on that issue viewed from the B.C. courts, see Northwestpharmacy.com Inc. v. Yates, 2017 BCSC 1572.

129. With respect, these positions are not supported by either the evidence or the law on the meaning of “void, inoperative or incapable of performance” in the context of an application for a stay.  To begin, allegations of fraud do not necessarily render the arbitration agreement void or inoperative for the purposes of a stay application: James, supra at para. 99.  Rather, the “doctrine of separability” applies: an arbitration clause remains operative even where the validity or existence of the contract itself is challenged or it is argued that it may be rescinded for fraud (James, supra at para. 83).  It is only where the allegation of fraud directly impeaches the arbitration clause, as separate from the contract as a whole, that the court may decline the stay.  In that case, there must be sufficient materials before the court on which to base a summary determination that the arbitration agreement itself is void (James, supra at para. 99). Otherwise, the issue of the validity or existence of the contract remains with the arbitrator for determination”.