Ontario – amendment to pleading in court cannot include claim subject to arbitration – #234

In Paul Sun v. Duc-Tho Ma, 2019 ONSC 4586, Master Alexandre Kaufman denied leave to amend Defendant’s counterclaim because, inter alia, the proposed claim was subject to arbitration.  Despite mandatory wording in the applicable Rules of Civil Procedure, RRO 1990, Reg 194 that a court shall grant leave to amend at any stage of an action, Master Kaufman held that a claim subject to arbitration effectively did not meet ‘a basic threshold of legal soundness’ and was ‘not tenable in law’.

Plaintiff and Defendants, along with a third person, founded IronYun Corporation (“IYC”) which develops facial recognition software and is registered in the Cayman Islands.  Each shareholder designated a nominee corporation to which shares would be issued.  Plaintiff designated PAKK LLC (“PAKK”) and Defendant designated IZ Incorporated (“IZ Inc.”).  Each shareholding comprised 1,000,000 series A preferred shares issued in return for a corresponding $200,000.00 U.S.  The parties’ January 23, 2015 shareholder agreement (“SA”) contained an agreement to submit “any dispute, controversy or claim arising out of or relating to” the SA to arbitration in Taiwan.

At the time the shares in IYC issued, Defendant did not have the funds available so Plaintiff agreed to loan Defendant the funds.  If the funds were not repaid, Defendant would transfer his shares to Plaintiff in payment of the debt.  When Plaintiff demanded payment, Defendant claimed Plaintiff had never advanced the funds and that the shares had never been issued to Defendant.  Defendant alleges that he was made to execute a promissory note under duress.  The litigation before the Ontario Superior Court concerned the promissory note.

Defendant sought to amend his counterclaim in the Superior Court litigation to (i) add a claim for misappropriation of shares and (ii) add PAKK as a defendant to his counterclaim.

In support of his amendment, Defendant alleged that he recently learned that all of IZ’s shares had been transferred without his knowledge or consent to PAKK, controlled by Plaintiff.

Plaintiff disputed Defendant’s claims, explaining that PAKK had paid for additional shares and that the reduction in IZ’s shareholding stemmed from a share retraction clause in the SA when an officeholder is terminated for cause.  Plaintiff also argued that Defendant’s proposed claim was subject to arbitration in Taipei, as per the SA, and not litigation in Ontario.

Rule 26 of Ontario’s Rules of Civil Procedure (“Rules”) stipulate that, at any stage of the action, the court shall grant leave to amend a pleading on such terms as are just, unless prejudice would result that could not be compensated for by costs or an adjournment.  Despite the mandatory language, Master Kaufman reminded that the court can refuse an amendment if it did not meet certain thresholds.  Citing Plante v. Industrial Alliance Life Insurance Co., 2003 CanLII 64295 (ON SC) para. 16, Master Kaufman held that the court “is entitled to inquire into the merits of the proposed amendment to ensure that it meets a basic threshold of legal soundness” and “will not permit an amendment if it is not tenable in law”.

In the circumstances before him, Master Kaufman agreed with Plaintiff and refused Defendant’s amendment, for two (2) reasons.

First, Defendant did not have standing in his personal capacity to assert a claim on behalf of IZ.

He selected IZ Incorporated as the corporation to which his founder shares would be issued, no doubt for valid tax planning reasons. But that decision carries with it the consequence that any claim by IZ Incorporated must be asserted by that corporation, which has a separate legal personality from that of the defendant.  Pursuant to the common law rule in Foss v. Harbottle, a shareholder in a corporation, even a controlling or sole shareholder, does not have a personal cause of action for wrong done to the corporation. This rule respects a basic principle of corporate law, namely that a corporation has a legal existence separate from that of its shareholders.

Second, the dispute covered by Defendant’s amendment was subject to the SA’s arbitration agreement. Because the parties have their place of business in different countries and the place of arbitration is in Taiwan, Master Kaufman held that that the International Commercial Arbitration Act, 2017, SO 2017, c 2, Sch 5 (“ICAA”) applied.  The ICAA provides that the Model Law on International Commercial Arbitration, adopted by the United Nations Commission on International Trade Law on 21 June 1985, as amended by the United Nations Commission on International Trade Law on 7 July 2006 (“Model Law”) (also available as Schedule 2 to the ICAA) has the force of law in Ontario.  Master Kaufman referred to article 8 of the Model Law which stipulates that the court shall refer the parties to arbitration unless the court finds that the agreement to arbitrate is null and void, inoperative or incapable of being performed.

Defendant did not argue that the SA was null and void, inoperative or incapable of being performed and invoked the SA in support of his claims.

Master Kaufman refused to permit the amendment, anticipating that, should he do so, “the Court would be faced with a motion to stay the counterclaim in favour of arbitration”.

As a result of dismissing the application to amend, other pending motions became unnecessary, such as substituted service, production of documents from PAKK, and varying the timelines.

urbitral note – Article 8 of the Model Law overrode the mandatory language of Rule 26 obliging a court to grant leave to amendments.  The agreement to submit disputes to arbitration lead to the conclusion that a claim covered by the arbitration agreement did not ‘meet a basic threshold of legal soundness’ or ‘is not tenable in law’.  Master Kaufman was also influenced by the likelihood of a successful application to stay the counterclaim.  That application would render the claim ‘not tenable in law’ and unable to ‘meet a basic threshold of legal soundness’.

Setting aside the influence that pleading in the name of another had, the decision underlines that an arbitration agreement will override mandatory wording provided elsewhere in the Rules, despite a close relationship between claims, facts and even witnesses.  The arbitration agreement serves to affect not only whether a claim subject to arbitration can be placed before a court but also the scope and content of pleadings of those claims validly before the court.