The decision in CLEAResult Canada Inc. v. Santomero, 2024 ONSC 6054 reinforces the principle that courts will generally uphold private dispute resolution mechanisms unless there is prima facie evidence that the process is fundamentally flawed (see para. 67). Here, the court held that the more expeditious, efficient and simple process before an accounting expert (BDO Canada LLP) to determine the Reverse Earn-out Amount in an M&A dispute was to proceed in tandem with other litigation between the parties, and was not to be held up by that litigation.
Here, the vendors attempted to delay the expert determination process that was to proceed before BDO to determine a Reverse Earn-Out Amount under the parties’ Share Purchase Agreement (“SPA”) on the basis that litigation commenced by the vendors alleging that the purchaser had breached certain SPA covenants that affected the ability of the Company to meet certain EBITDA thresholds the Reverse Earn-out Amount Calculation. The applicant/purchaser accordingly commenced an application to require the respondents/vendors to move forward with the BDO process. The Court granted the application, citing Deluce Holdings Inc. v. Air Canada, 1992 CanLII 7654. To restrain the expert determination process, there would have to be strong prima facie evidence that the process was fundamentally flawed. The vendors failed to meet this threshold because BDO had authority to request financial records and determine necessary accounting adjustments that would address the vendors’ concerns about access to documents. Any contractual breaches by the purchaser could be litigated separately later, without delaying the proceeding before BDO.
Background to Dispute – On June 27, 2022, the vendors sold their interests in Eco-Fitt Corporation (the “Corporation”) to the purchaser under the SPA. A component of the purchase price was a Reverse Earn-Out Payment, calculated based on the Corporation’s post-closing earnings before interest, taxes, depreciation, and amortization (“EBITDA”) over two Earn-Out Periods. The SPA provided a contractually agreed-upon dispute resolution process before an Independent Auditor under sections 2.8 and 2.9, which required (see paras. 19-20):
- each Party to furnish to the Independent Auditor with all working papers, schedules and other documents, accounting books and records and information relating to the items in dispute, that are available to that Party or its auditors;
- the Parties to instruct the Independent Auditor that time is of the essence in proceeding with its determination of any dispute;
- absent any manifest error, the determination of the Independent Auditor would be final and binding on the Vendors and the Purchaser.
The parties agreed that the Independent Auditor, in making its determination of any dispute, would be acting as an expert and not as an arbitrator.
Section 2.11 of the SPA outlined the Reverse Earn-Out Payment Covenants of the Purchaser, and section. 7.3 outlined an indemnity by the purchaser to the vendors for any breach or non-performance by the purchaser of any covenant under section 2.11. Lastly, section 7.11 provided that the provisions of Article 7 were the sole remedy available to any vendor and the purchaser for any claim for breach of covenants, representation, warrant, obligation or provision (paras. 21-24).
To foreshadow the outcome: the application was about the interplay between the indemnity claim for breach of section 2.11 and the calculation of the Reverse Earn-out Amount under section 2.9, and which should proceed first.
The purchaser submitted its first Reverse Earn-Out Calculation on March 30, 2023, stating that no amount was payable for the first period (para. 25(b)). The vendors issued an Objection Notice on May 19, 2023, detailing concerns with the first Reverse Earn-Out Calculation and with the purchaser’s conduct in connection with the covenants contained in section 2.11(a) of the SPA.
On July 11, 2023, the purchaser wrote to BDO to appoint it as the Independent Auditor to resolve the dispute over the Reverse Earn-Out Amount).
On July 28, 2023, the purchaser delivered its second Reverse Earn-Out Statement for the second Earn-Out Period. The vendors delivered their second Objection Notice as a result, raising similar objections as before).
On August 29, 2023, the parties jointly signed the BDO Engagement Letter, asking BDO to determine all identified items in dispute.
On November 1, 2023, the vendors commenced a court action, alleging various breaches of the purchaser’s covenants (the “Other Disputes”). They wanted the action to be decided before BDO determined the Reverse Earn-Out Amount. After receiving conflicting instructions from the parties on December 12, 2023, BDO advised the parties that without “instructions to be provided unanimously by the vendors and purchaser” it could not proceed .
The Application – The purchaser commenced an application to enforce the provisions of section 2.9 of the SPA. It sought an order directing the parties to jointly instruct BDO to carry out its mandate set out in the BDO Engagement Letter, which followed the process described in section 2.9 of the SPA. (Originally, the applicant had asked for an order directing BDO to undertake the evaluation, but the Court held that this order could not be made as BDO was not before the court and did not have notice of the application.)
The relevant issue before the court was the appropriate priority, timing and sequencing for the resolution of the existing disputes (para. 39).
Analysis – The vendors argued that before BDO could adjudicate the Reverse Earn-Out Calculations, the other disputes under the SPA needed to be determined by the Court. They tendered evidence from an expert witness who opined that BDO did not have the information that would be needed to make a reliable determination of the Reverse Earn-Out Calculations prescribed by the SPA.
In interpreting the SPA to determine the priority, timing, and sequencing of the disputes, the Court found that, while the SPA did not explicitly define these aspects, it established that the resolution of disputes within the purview of the Independent Auditor should be expedited and not be delayed or bogged down by the complications and delays of a judicial process (para. 63). In reaching this conclusion, the court made various findings:
- the disputes under BDO’s purview were accounting issues that were the subject to the SPA’s alternative dispute resolution mechanism and were exempt from judicial determination by the court under section 8.12 of the SPA (paras. 47-48);
- the vendors’ request for judicial direction on Reverse Earn-Out Payment Amounts would require the parties to retain expert accountants to inform the courts, making the process inefficient and contrary to the parties’ agreed streamlined expert procedure (para. 52);
- the SPA’s express choice for an expert adjudicator under section 2.9 strongly indicated that judicial involvement was unwarranted, relying on KMH Cardiology Centres Inc. v. Lambardar Inc., 2022 ONSC 7139 to establish that referring disputes to independent experts reflected the parties’ intent to resolve them swiftly and efficiently outside civil proceedings (paras. 53-54); (that case is discussed in case note #708, Ontario – ‘Parochial’ perspective on expert determination rejected.)
- requiring that the expert-focused dispute resolution process await the outcome of another dispute would result in competing experts addressing questions that overlap the very questions to be determined by BDO – undermining the intended expeditiousness and efficiency of the prescribed process under section 2.9 of the SPA (para. 64).
To get around the clear contractual distinction between the two dispute resolution mechanisms and the express agreement that dispute resolution by BDO proceed quickly and unencumbered, the vendors argued that the purchaser’s breaches of its Covenants had frustrated their right to a fair arbitration of the dispute by BDO as it is impossible to reliably determine EBITDA. These breaches, they argued, amounted to repudiatory breaches of the agreement under section 2.9.
However, the Court found that, to restrain an arbitration proceeding in circumstances where the foundation of the arbitration agreement is under attack, there must be some prima facie evidence that impeaches the arbitration mechanism, as determined in Deluce Holdings Inc. v. Air Canada, 1992 CanLII 7654. The vendors failed to meet the threshold established in Deluce, which required proof that the arbitration mechanism itself was unfair. BDO had full discretion to determine what information it needed and adjust EBITDA accordingly (paras. 67-68).
Additionally, the Court found that allowing BDO to proceed with its determinations ahead of the judicial process could only benefit the vendors, despite their opposition; the Reverse Earn-Out Calculation could never result in a negative payment (para. 70). Lastly, BDO’s determination would be a relevant data point for the court’s adjudication of the Other Disputes, better positioning them to determine whether steps were taken by the purchaser to suppress or eliminate the Earn-Out Payment (para. 72).
Reading the SPA as a whole and within its contractual context, the Court held that the appropriate priority, timing and sequencing for the resolution of the existing disputes was for them to proceed in tandem but not necessarily on the same timelines. The Court granted the application and required the parties to instruct jointly BDO to undertake the expert evaluation process agreed to at section 2.9(c) of the SPA (para. 73).
Contributor’s Notes
First, this decision reinforces the principle that courts will generally uphold private dispute resolution mechanisms unless there is prima facie evidence that the process itself is fundamentally flawed. Courts are reluctant to interfere with an agreed-upon arbitration or expert determination process unless it is shown to be incapable of delivering a fair resolution. For this principle, the Court relied on Deluce, where the court stayed an arbitration procedure in favour of a court hearing since allowing the arbitration to continue would have been oppressive to Deluceco’s rights as a minority shareholder (Deluce para. 79).
While the outcome in Deluce was different than in this case, the principle remains that there would need to be evidence of unfairness to prevent a dispute resolution process agreed upon by two parties from proceeding. In Toronto Standard Condominium Corporation No. 1628 v. Toronto Standard Condominium Corporation No. 1636, 2021 ONCA 360, the court similarly distinguished Deluce, finding that the arbitration in issue should proceed as the case involved a “very broad arbitration clause” in comparison to the “very narrow [arbitration clause]” in Deluce (para. 31).
Case Note#731,B.C. – No power to stay arbitration under Model Law , also addresses Deluce. That case note concerned Johnston v Octaform Inc., 2023 BCSC 311, in which the court considered Deluce but distinguished it in refusing to stay an arbitration. The case note queries whether Deluce remains good law in the face of the Supreme Court of Canada’s decision in TELUS Communications Inc. v. Wellman, 2019 SCC 19, where the Supreme Court held that courts must refer to arbitration the matters properly falling within an arbitration agreement.
Deluce appears to be good law (at least in cases regarding the appointment of experts, since recall that the parties expressly provided that this was an expert determination not an arbitration). Having said this, it would be he helpful for later jurisprudence to reconcile the mandatory language in TELUS with the test in Deluce, which appears to allow arguments based on whether the contemplated dispute resolution process is flawed.
Secondly, this case is important because it provides helpful guidance to corporate litigators regarding the dispute resolution mechanisms frequently found in transactional agreements, where there is a general litigation (or sometimes arbitration) clause for breaches of indemnities with carve outs for disputes relating to calculation of EBITDA to an independent accountant, either as arbitrator or expert.
This case makes it clear that the work of the independent accountant should not be held up by allegations of breaches of covenants which may take much longer to proceed through the courts than the time required for the expert or arbitrator to determine whether an earn-out is payable under an agreed-upon formula. Parties to a transaction who want a different sequence or order should expressly provide for this in their agreements.