Ontario – BIA trustee cannot delegate claims determination to arbitrator – #695

In Re YG Limited Partnership, 2022 ONSC 6138, Justice Kimmel held that the Trustee appointed under the Bankruptcy and Insolvency Act, RSC 1985, c B-3 (the “BIA“) could not delegate to an arbitrator its authority, pursuant to section 135 of the BIA, to determine and value claims against the debtor. That put the Trustee in the position of an adversary, rather than a decision maker. As such, she found that a continuation of an arbitration to determine damages was not a valid exercise of the Trustee’s authority. She refused to order the Sponsor, who had agreed to indemnify the Trustee for all administrative fees and expenses incurred in relation to the resolution of unresolved claims against the debtor, to fund the administrative fees and expenses connected with Phase 2 of the arbitration (damages) following Phase 1 (liability). The issue of the Phase 1 administrative fees was not before her.

In this case, YG Limited Partnership and YSL Residences Inc. (the “Debtor”) filed Notices of Intention to Make a Proposal under the BIA. The Court approved a proposal (the “Proposal”) and authorized a “Proposal Trustee” to deal with the various claims against the Debtor, some of which were disputed. In the Proposal, a “Sponsor” agreed to indemnify the Proposal Trustee for all of the administrative fees and expenses reasonably incurred in connection with the resolution of any unresolved claims.

In undertaking its work, the Proposal Trustee had to address the largest claim filed against the Debtor. This claim comprised of $1 million for wrongful dismissal damages and $18 million in damages for alleged breaches of an oral profit-sharing agreement (the ” Claim”). The Proposal Trustee decided to arbitrate the Claim because it believed that a determination of these issues required credibility assessments that could be best determined through a hearing with viva voce evidence.

The Proposal Trustee and the individual advancing the Claim entered into an agreement (the “Arbitration Agreement”): (i) to appoint the arbitrator; and (ii) to bifurcate the arbitration proceedings into a liability phase (“Phase 1”) and, if needed, a damages phase (“Phase 2”). While the Proposal Trustee advised the Sponsor that it was making arrangements to arbitrate the Claim, it did not provide the Sponsor with the Arbitration Agreement, nor its specific terms.

Ultimately, the arbitrator determined Phase 1 in favour of the individual advancing the Claim, finding that she was an employee of the Debtor, that she was constructively dismissed, and that there was an oral profit sharing agreement. 

The Proposal Trustee informed the Sponsor of the result and that only $210,000 remained from the original reserve established for the administration of all claims under the Proposal. As such, the Proposal Trustee required additional funds of approximately $1.5 million to administer Phase 2 of the arbitration and the remaining claims against the Debtor. 

The Sponsor, and certain partners of the Debtor (who would be entitled to any remaining cash after all proven claims were paid out), questioned the Proposal Trustee’s handling of the Claim. Ultimately, the Proposal Trustee brought a Motion asking the Court to determine, among other things, whether the commencement and continuation of the arbitration to determine the Claim was a valid exercise of the Proposal Trustee’s power under the Proposal or the BIA

The Proposal provided that the Proposal Trustee was to assess claims in accordance with section 135 of the BIA, which states:

“(1)      The trustee shall examine every proof of claim or proof of security and the grounds therefor and may require further evidence in support of the claim or security.

(1.1)   The trustee shall determine whether any contingent claim or unliquidated claim is a provable claim, and, if a provable claim, the trustee shall value it, and the claim is thereafter, subject to this section, deemed a proved claim to the amount of its valuation.”

Justice Kimmel held that section 135(1.1) of the BIA contained mandatory language that unambiguously required the Proposal Trustee to determine and value claims. The Proposal Trustee defended its process, stating that it was not seeking to dispense with its obligation to determine the Claim; instead, it wished to do so with the benefit of the arbitrator’s decisions in Phases 1 and 2. The Proposal Trustee contended that the broad discretion granted by section 135 meant that it was entitled to use an arbitration process to assist it in developing the evidence and facts required to determine and value a claim. To this end, the Proposal Trustee defended the arbitration process as “fair, reasonable and transparent” and argued that a trustee’s decision on how to value a claim ought to be afforded deference (para. 47). 

As the parties did not dispute the administrative fees and expenses in respect of Phase 1, the Justice Kimmel declined to consider this issue for Phase 1. She also noted that the Proposal Trustee’s participation in Phase 1 of the arbitration may have been sound in that it allowed the arbitrator to make factual findings, which the Proposal Trustee could then consider and take into account in its determination and valuation of the Claim.

However, Justice Kimmel found that Phase 2 of the arbitration, on damages, went beyond a fact finding exercise. This is because a final adjudication on damages by an arbitrator went to the ultimate question of what the Proposal Trustee had to decide—going to the heart of the Proposal Trustee’s responsibility to determine and value the Claim. Justice Kimmel indicated that practically, it would be impossible for the Proposal Trustee to determine the value of the claim in a way that was inconsistent with the arbitrator’s findings, especially given the binding nature of the Arbitration Agreement. As such, proceeding with Phase 2 of the arbitration, in which the Proposal Trustee steps into the role of an adversary instead of decision-maker, is an improper delegation of its authority under section 135 of the BIA.

Therefore, Justice Kimmel held that continuing with Phase 2 of the arbitration was not a valid exercise of the Proposal Trustee’s authority under section 135 of the BIA. She refused to order the Sponsor to fund Phase 2.

Instead, Justice Kimmel held that the Proposal Trustee needed to carry out its own determination as to whether a claim had been proven and, if so, how it should be valued. To do so, Justice Kimmel agreed that the Proposal Trustee had wide discretion to design a process to get the factual and other inputs it needed from witnesses and experts. While the Proposal Trustee expressed its concern that its own process could lead to de novo appeals or challenges, which could end up being as or more expensive than the cost of Phase 2 of the arbitration, Justice Kimmel stated that “[t]here is no crystal ball that can foretell this”.”

Contributor’s Note: In Peace River Hydro Partners v. Petrowest Corp, 2022 SCC 41, the Supreme Court of Canada recently noted the commonalities between arbitration law and insolvency law, including the prioritization of efficiency and expediency and the emphasis on procedural flexibility. This case is interesting because the Proposal Trustee’s suggestion of using arbitration as a tool to assist it in determining and valuing claims is one example of how arbitration and insolvency law could work together. However, the Ontario Superior Court rejected this suggestion where the arbitral process required the arbitrator to determine the entire claim, including damages (or value), since this would amount to improper delegation of the Trustee’s authority.