Ontario – Court rejects cross-applications to appoint valuators as the arbitrator – #593

In MacBryce Holdings Inc. et al. v. Magnes Partnership et al, 2022 ONSC 321, Justice Gilmore of the Ontario Supreme Court of Justice refused competing applications by parties to appoint their respective proposed candidates as arbitrator. Each proposed arbitrator was also a qualified valuator, whose mandate was to determine the fair market value (“FMV”) of shares pursuant to a shareholders agreement. Justice Gilmore rejected the argument that the conduct of the arbitration was to be confined to a more truncated and informal process of reviewing existing valuation reports, which was the process as set out in the agreement. She found that the parties clearly agreed upon an arbitration, rather than a valuation, which invoked certain procedural protections. She ordered that the parties choose an arbitrator (who would be neither of their proposed candidates) and gave further directions on the conduct of the arbitration.

This case involved the interpretation and application of the Magnes Shareholders Agreement (the “MSA”), which governed the Magnes Group Inc. (the “Company”). Three shareholders owned approximately 30% of the shares in the Company (the “Selling Shareholders”) and were also employees. Their employment was terminated. Pursuant to the MSA, this termination triggered provisions that entitled a group of “Purchasing Shareholders” to purchase shares from the Selling Shareholders.

The MSA set out a procedure for determining the FMV of the shares, providing among other things:

  1. The Company shall instruct a Valuator to prepare a valuation report. The MSA defined a “Valuator” as “an independent qualified business valuator who is at arm’s length from the parties, and who is experienced and qualified in insurance brokerage valuations”;
  2. If the Selling Shareholders and Purchasing Shareholders do not agree on the Valuator’s determination of FMV, they can either agree to appoint a second Valuator to make a determination of FMV or give a Notice of Dispute;
  3. Once a Notice of Dispute is delivered, then the purchase price of the shares will be determined as follows:

“(i) They shall elect to use one arbitrator to make a determination of the Fair Market Value of the Shares. The arbitrator shall be a partner (current or former) from any major national Canadian firm of Chartered Accountants appointed with the agreement of both parties (failing agreement in connection with which arbitrator will be appointed on application to a Judge of the Ontario Court (General Division)).

(ii) The arbitrator will review all material documentation including the first and, if applicable, the second valuation reports when making his/her determination of the Fair Market Value of the Shares. The Fair Market Value arrived at by the arbitrator will constitute the purchase price, which will be final and binding upon the parties.” (para. 8)

The MSA was clear that the first and possibly second Valuator(s) who determined the FMV of the shares in accordance with the process above were each acting as an expert, not an arbitrator within the meaning of the Arbitration Act, S.O. 1991, c-17 (“the Act“).

A first valuation report was prepared and delivered to the Selling Shareholders. It valued the shares at approximately $18 million. The Selling Shareholders disagreed with this price. After failed negotiations, the Purchasing Shareholders delivered a Notice of Dispute and proposed an arbitrator who was a partner at KPMG. The Selling Shareholders proposed a partner at PriceWaterhouseCoopers, who had experience acting as both valuator and arbitrator.

The group of Selling Shareholders and Purchasing Shareholders each brought competing applications to the Court to appoint their respective arbitrator candidate. The Purchasing Shareholders also requested further directions, including that the Court fix a valuation date and declare that the “arbitration” was not an arbitration within the meaning of the Act. They argued that the MSA contemplated an expedited and streamlined process that did not include a formal hearing or reasons for decision. Instead, they argued, the arbitrator should apply his professional expertise to review the valuation report(s) before him and determine the FMV. The Selling Shareholders disagreed, contending that this truncated process would deprive them of their right to present their views on the FMV.

Justice Gilmore found in favour of the Selling Shareholders, relying on Sport Maska Inc. v. Zittrer, [1988] 1 S.C.R. 564, where the Supreme Court of Canada highlighted the importance of identifying the function the parties intended to entrust to the third party in their agreement: was it an agreement to arbitrate or simply one to obtain a professional opinion?

She found that the MSA made clear that an arbitrator was to be appointed to determine the FMV, and that, the arbitrator was not a valuator—which terms were expressly differentiated and defined. She found that the parties intended an arbitration to follow the valuation(s), which invoked the protections of the Act. Those included section 19 of the Act, which ensured procedural fairness (i.e. the right to be treated equally and fairly and to be given an opportunity to present one’s case and to respond to the other party’s case).

As such, Justice Gilmore ordered that:

  1. The parties enter into an arbitration, conducted in accordance with the Act, to determine the FMV of the shares;
  2. The parties shall choose a third party arbitrator who meets the requirements of the MSA to act as arbitrator, but he or she cannot be either of the two proposed candidates. If the parties fail to agree, the parties may reappear before Justice Gilmore;
  3. In accordance with the competence-competence principle, the arbitrator shall determine any dispute arising out of the arbitration process and the valuation date. The arbitrator shall conduct a pre-arbitration hearing to determine the valuation date of the shares;
  4. Once the valuation date has been determined by the arbitrator, the parties shall retain their own experts to prepare and exchange expert reports on the FMV of the shares within 30 days. After this exchange, the parties shall negotiate for a period of 10 days to seek a resolution without a full arbitration hearing; and
  5. If no resolution is reached, the parties shall attend for arbitration based on a process and schedule determined by the arbitrator.

Contributor’s note:

First, shareholders’ agreements of closely-held companies frequently contain staged valuation/arbitration clauses to provide for the determination of the FMV of shares being transacted between the shareholders. This case provides a useful example of the difference between the valuation and arbitration process, particularly where the context may appear muddled by the requirement that the arbitrator be an accounting professional (as opposed to the norm of a legal professional).

Second, while Justice Gilmore found that an arbitration was clearly contemplated, and deferred the procedure to the arbitrator (citing section 6 of the Act as a ground to limit court intervention), it is interesting that she nonetheless set out a detailed procedure as to how the arbitration ought to be conducted.

Third, it is also interesting that Justice Gilmore refused to select either arbitrator candidate, even though she: (i) found that both were partners of a major Canadian firm of Chartered Accountants (para. 6), which was a qualification the MSA required; and (ii) nothing in the Act requires that the arbitrator have legal training (para. 25). Justice Gilmore did not provide a reason for rejecting both candidates, other than her finding that the procedure contemplated was not a valuation, but an arbitration pursuant to the Act (para. 56).