In Ismail v. First York Holdings Inc., 2023 ONCA 332, the Court of Appeal for Ontario upheld an order denying the appellant’s motion to stay an action in favor of arbitration under s. 7 of the Arbitration Act. The motion judge had denied the order because the motion was based on an arbitration clause in an agreement that was never legally formed. This deprived the alleged arbitration clause of any legal force. This case illustrates one of the rare instances to which the doctrine of separability of the arbitration agreement cannot extend.
Justice Feldman, writing for the Court of Appeal, first found that the appeal was not barred by s. 7(6) of the Arbitration Act, which provides that there is no appeal from a decision on a motion to stay. Here the underlying motion was refused because the arbitration clause was void ab initio. Despite this, Justice Feldman ultimately dismissed the appeal, finding that the motion judge did not err in his decision to focus solely on a single agreement, nor in his finding that since that agreement lacked any legal force, the arbitration clause could not “survive” the challenge to the underlying contract.
The underlying dispute – The Plaintiff Mr. Ismail was a businessman and the manager of a Saudi Arabian medical supply company, TART Medical Est. (“TART”). Mr. Abied was a businessman and controlled the operations of an Ontarian medical device distributor, Defendant First York Global Holdings Inc. (“FYGH”). As part of their business dealings, Mr. Ismail appointed Mr. Abied as his attorney for property with authority to sign agreements on his behalf. Mr. Abied signed and executed three agreements on behalf of both parties: (1) a Purchase of Business Agreement for FYGH (“FYGH Agreement”); (2) a Shareholders’ Agreement wherein Mr. Ismail purchased 20% of FYGH’s shares; and (3) a Purchase of Business Agreement for another company National Trade of Canada (“National Trade”), in which Mr. Ismail also purchased 20% of its shares (“National Trade Agreement”). National Trade was never incorporated and as a result, no shares were issued. It is this third agreement, the National Trade Agreement, that contained the impugned arbitration clause.
On January 14, 2022, Mr. Abied brought a motion seeking a stay of the claims under s. 7 of the Arbitration Act in favour of mediation/arbitration. The grounds of the motion relied on two identical mediation/arbitration clauses contained in the FYGH and National Trade Agreement.
The Motion Judge decision – Justice Roger considered only the National Trade Agreement and denied the motion. From the Court of Appeal decision, it appears that Justice Roger had accepted the respondent’s argument that the only agreement in issue had been the National Trade Agreement because of the way the matter was plead. He found that National Trade was never an incorporated entity and therefore never had any shares to transfer. As a result, there was no consideration for the National Trade Agreement, the contract did not exist, and thus there was no arbitration agreement on which to rely to stay the claims.
On Appeal – Mr. Abied appealed. On appeal the Court considered three questions.
Question 1 – Does s. 7(6) of the Arbitration Act preclude the appeal? – No. Justice Feldman, writing for the Court, held that s. 7(6) was not engaged in this case because when a stay is refused based on a finding that no arbitration agreement exists, that refusal is not grounded in the Arbitration Act. Thus, the appeal could proceed. This is in line with the court’s previous jurisprudence: see, for example, Toronto Standard Condominium Corporation No. 1628 v. Toronto Standard Condominium Corporation No. 1636, 2020 ONCA 612; Huras v. Primerica Financial Services Ltd. (2000), 137 O.A.C. 79 (C.A.), 2000 CanLII 16892.
Question 2 – Did the motion judge err by failing to stay the action based on the arbitration clause contained in the FYGH Agreeement? – No. Justice Feldman found that the motion judge had accepted the respondent’s argument that the only agreement in issue had been the National Trade Agreement because of the way the matter was plead and that this was a correct conclusion.
Question 3 – Did the motion judge err by finding that the National Trade Agreement did not exist because National Trade was never incorporated and its shares did not exist and, therefore, there was no contract and no arbitration agreement? – No. The appellant made three arguments as to why the motion judge erred in determining that no contract or arbitration clause existed. First, because the agreement was to transfer shares in the future, the fact the company did not exist when the agreement was made was irrelevant. Second, the surrounding circumstances were not considered (that the appellant drafted both the National Trade Agreement and FYGH Agreement and used similar language for both). Therefore, the motion judge should have overlooked the language stating that National Trade was an existing corporation. Third, the arbitration clause should have been upheld under s. 17(2) of the Arbitration Act, which sets out the principle of separability. It states: “If the arbitration agreement forms part of another agreement, it shall, for the purposes of a ruling on jurisdiction, be treated as an independent agreement that may survive even if the main agreement is found to be invalid.”
Justice Feldman addressed the first two arguments by noting that the motion judge began by considering the five-question test set out in Haas v. Gunasekaram, 2016 ONCA 744 at para 17:
- Is there an arbitration agreement?
- What is the subject matter of the dispute?
- What is the scope of the arbitration agreement?
- Does the dispute arguably fall within the arbitration agreement?
- Are there grounds on which the court should refuse to stay the action?
Since the motion judge found in answer to question 1 that no arbitration agreement existed, and because the stay provision in s. 7(1) requires the existence of an arbitration agreement, no further analysis was needed. Justice Feldman found that it was open to the motion judge to reach the conclusion that the National Trade Agreement was not a legally binding contract based on the evidence before him. Because the contract was for the sale of shares (which shares did not exist) it lacked both the underlying subject matter of the contract and the consideration required for a legally binding agreement to take effect. The evidence included: (1) the fact that National Trade did not exist and was never incorporated; (2) the National Trade Agreement included the warranty that the corporation was incorporated, and that Mr. Abied was the owner; and (3) that Mr. Abied confirmed by affidavit that the National Trade Agreement “was never implemented or proceeded with”. This addressed the appellant’s first and second submissions.
The appellant’s third argument was that even if the National Trade Agreement did not exist, s. 17(2) of the Arbitration Act means the arbitration clause is upheld as an independent agreement allowing the arbitrator to determine their jurisdiction. Justice Feldman found this argument incorrect in law.
Justice Feldman noted that s.17 is essentially a codification of the separability doctrine arising from Heyman v. Darwins Ltd.,  A.C. 356 (H.L.) which stands for the proposition that when a contract is breached and becomes invalid – as opposed to the contract never existing at all – the agreement to arbitrate remains. The dispute over whether the arbitrator has jurisdiction can then be referred to arbitration. Justice Feldman noted that “the agreement to arbitrate cannot “survive” where there was no contract to survive from. In those circumstances, s. 17(2) has no application.” Therefore, Justice Feldman found that the motion judge was correct in not referring to s. 17(2).
First, this case considers the doctrine of separability of the arbitration agreement from the main contract, which is one of the defining features of arbitration. The doctrine of separability in the Ontario Arbitration Act is based on the similar provision in Article 16 of the Model Law as well as on international jurisprudence, including Heyman v Darwins Ltd.,  AC356 (HL). The doctrine of separability applies where there is a challenge to the arbitrator’s jurisdiction on the basis that the underlying agreement is invalid. For that purpose, the arbitrator will treat the arbitration agreement as an independent agreement that may survive even if the main agreement is found to be invalid. In Heyman v Darwins Ltd. this was said to be justified on the basis that the underlying agreement sets out the rights and obligations of the parties, but the arbitration clause is different. It embodies the agreement that if a dispute arises, it shall be resolved by arbitration. The arbitration provision survives to allow the dispute to be referred to an arbitrator to determine jurisdiction, and if there is jurisdiction, to decide the dispute. The Supreme Court of Canada recently considered separability in Peace River Hydro Partners v. Petrowest Corp., 2022 SCC 41, and emphasized its protective function (See also – Arbitration Matters Case 682: Supreme Court – Peace River v Petrowest Part 1: Separability Clarified?). As this case makes clear though, the underlying contract must have existed for the arbitration clause to be formed in the first place, and for the doctrine of separability to apply.
This case is in line with other cases which have held that an appeal is allowable from a decision finding no existing arbitration agreement (See also – Arbitration Matters Case 385: Ontario – appeal court reaffirms jurisdiction for appeal of stay decision where decision holds arbitration agreement does not apply).
Second, this case also shows the importance of attention to detail in drafting motions. Although the parties had a second agreement (the FYGH Agreement), which contained an arguably valid arbitration clause, the Court did not consider that agreement since it was not referred to in the original motion.
Finally, the Court in this case relied on the test for a stay under Article 7 of the Arbitration Act set out in Haas v. Gunasekaram, 2016 ONCA 744, instead of the new test in Peace River Hydro Partners v. Petrowest Corp., 2022 SCC 41 at paras 76-90. The likely explanation for this is that the decision in Petrowest was released only a few days before the appeal was argued and was not the test applied by the motion judge.
In Peace River Hydro Partners v. Petrowest Corp, the Supreme Court of Canada modified the test and set out a two-part framework for determining whether a stay should be granted in favour of arbitration. First, the applicant must show an arguable case that the technical prerequisites for a stay are met:
- an arbitration agreement exists;
- court proceedings have been commenced by a “party” to the arbitration agreement;
- the court proceedings are in respect of a matter that the parties agreed to submit to arbitration; and
- the party applying for a stay in favour of arbitration does so before taking any “step” in the court proceedings.
If these prerequisites are met, a stay will be granted unless the party seeking to avoid it can prove, on the balance of probabilities, that a statutory exception applies as set out in s.7(2) of the Arbitration Act (legal incapacity, invalidity, subject matter incapable of being arbitrated under Ontario law, undue delay, or the matter is appropriate for default or summary judgment).
The author wishes to thank Lukas Milne for his assistance.