Ontario – No contracting out of the Model Law – #752

In EDE Capital Inc. v Guan, 2023 ONSC 3273, Justice Vermette dismissed a set-aside application on the basis that the applicant had failed to make out a breach of procedural fairness or lack of jurisdiction. In doing so, Justice Vermette also held that the applicable legislation in this case was the Model Law, despite the fact that the parties’ arbitration agreement referred to the domestic arbitration act. 

Background to dispute – EDE Capital Inc. (“EDE”), had solicited investments from individuals who ultimately became shareholders in EDE. It had provided a term sheet to the shareholders, stating that the proceeds of the investments would be used to support and expand the business of EDE’s subsidiaries, and to register as a securities dealer with the Investment Industry Regulatory Organization of Canada (“IIROC”). In March 2018, the shareholders had invested a total of $1,050,000 in EDE in a private placement offering, and EDE had transferred the proceeds of that offering to its trading account. These funds were soon intermingled with the proceeds of buying and selling other securities. 

In September 2018, the shareholders of EDE executed a Shareholders’ Agreement. Later that year, when the EDE fund performance suffered, EDE elected not to pursue IIROC registration and instead kept the proceeds of the private placement offering in its trading account to preserve its value. When the shareholders inquired about the status of the IIROC  registration, EDE’s representatives advised that those plans were on track. 

Ultimately, EDE admitted that it had not pursued IIROC registration and that it had traded the proceeds of the private placement offering. Several shareholders demanded their money back, and EDE refused to return the funds. Instead, it invested those funds in a subsidiary, making substantial returns. 

The arbitration – In June 2020, the shareholders commenced an arbitration against EDE which referenced Article 21 of the Model Law on International Commercial Arbitration (“Model Law”), as set out in Schedule 2 to the International Commercial Arbitration Act (“ICAA”), claiming that the ICAA applied to the arbitration. One shareholder resided in China, while the other shareholders resided in Canada.

However, the Shareholders’ Agreement contained an arbitration clause that referred to the Arbitration Act, 1991 (Ontario). In EDE’s Statement of Defence, it denied that the ICAA applied.

The arbitration proceeded by way of bifurcated proceedings: a liability hearing and then a damages hearing. On June 23, 2021, the arbitrator issued a partial award on liability (the “Liability Award”).

As part of the Liability Award, the arbitrator noted that the shareholders had initially requested a ruling on whether the Arbitration Act or the ICAA applied to the proceedings, but had withdrawn that request as it had not been necessary to resort to the provisions of either act over the course of the arbitration.

The arbitrator found that EDE’s refusal to pursue IIROC registration was a breach of the Shareholders’ Agreement. The arbitrator also found that EDE had made misrepresentations to the shareholders and that its conduct was oppressive. 

The parties proceeded to a damages hearing, and the arbitrator issued an award on damages on December 23, 2021 (the “Damages Award”). The arbitrator ordered the return of the initial $1,050,000 invested by the shareholders and disgorgement of EDE’s “ill-gotten” trading profits. The arbitrator also accepted the shareholders’ expert evidence on how to calculate the disgorgement, namely by using the first-in, last-out methodology. 

EDE applied for a correction of the Damages Award under section 44(1)(b) of the Arbitration Act on the basis that the first-in, last-out methodology was inconsistent with certain findings in the Liability Award and that it was inappropriate for comingled funds. The arbitrator denied the request for correction, however, in doing so, did not explicitly determine whether the Arbitration Act applied to the arbitration. Instead, as the Court summarized at paragraphs 53-54:

“The Arbitrator first addressed the threshold issue of the legislation applicable to the issue before her. She stated the following: ‘The issue at this stage of the proceedings is not which legislation governs in the sense of recourse to the courts and control of the arbitral procedure. The governing legislation is determined by operation of law and is not selected by the parties to the arbitration. That issue is one for a court to determine in the event it becomes necessary and is not relevant to any of the issues in dispute in the arbitration. Accordingly, this decision should not be read as making any determination as to this issue.’

The Arbitrator stated that the issue before her was whether the domestic legislation had any place in the procedure for the arbitration itself, which required an interpretation of the arbitration agreement. She found that the arbitration agreement evidenced the parties’ intent to apply the Arbitration Act to the day-to-day procedure of the arbitration. She stated that the section 44 procedure was part of that agreed procedure and was not inconsistent with the provisions of the ICAA.”

Thus, even after the denial of EDE’s section 44(1)(b) application, the question of the applicable act remained an open issue. 

The set-aside application – EDE brought an application to set aside the Liability and Damages Awards on February 2, 2022 under section 46(1) of the Arbitration Act. With respect to the threshold issue of whether the Arbitration Act properly applied, EDE asserted that the ICAA did not apply because the parties had agreed that the Arbitration Act would apply in the Shareholder’s Agreement. EDE made the alternative argument that the arbitration was not properly “international” because the one shareholder who resided in China had only just moved back to China at the time she signed the Shareholders’ Agreement, and so China was not her “habitual place of residence.”

EDE also submitted that the arbitrator had breached the requirement for procedural fairness under section 46(1) of the Arbitration Act by reopening issues in the damages proceedings that had been determined by the Liability Award, and by making findings in the Damages Award that were inconsistent with the Liability Award, which EDE had sought unsuccessfully to correct. EDE also asserted that the arbitrator had exceeded her jurisdiction because her decision on the disgorgement methodology affected the profits of non-party shareholders, and re-opened liability issues once she was functus on the liability issues.

The Court reviewed two issues:

1) Is the Arbitration Act or the ICAA applicable to the arbitration?

2) Should the Awards be set aside under the applicable law?

What Act applies? The Court first determined that the law applicable to the proceedings was the ICAA, and that any set-aside application thus had to be determined under the Model Law. An arbitration falls under the ambit of the ICAA if it is “commercial” and “international.” The Court readily accepted that an investment transaction met the definition of “commercial” for the purposes of the ICAA. The Court then considered the “international” requirement under Arts. 1(1), 1(3)(a), and 1(4)(b) of the Model Law, at paragraph 83:

“An arbitration is international if the parties to an arbitration agreement have, at the time of the conclusion of that agreement, their places of business in different countries. If a party does not have a place of business, reference is made to the party’s habitual residence. See Articles 1(1), 1(3)(a) and 1(4)(b) of the Model Law.”

The Court noted that the shareholder who resided in China had submitted uncontested affidavit evidence that China was her place of residence at the time she signed the Shareholders’ Agreement, and so the arbitration met the “international” requirement. As the Model Law governed the Shareholders’ Agreement, the parties were not entitled to opt out of it or select the Arbitration Act as the governing law. Citing Popack v Lipszyc, 2015 ONSC 3460, the Court noted:

“[90] Courts have recognized that the Model Law includes mandatory provisions that cannot be excluded by agreement of the parties. Thus, the parties cannot contract out of the ICAA and the Model Law, including Article 34 of the Model Law, for all purposes.”

Grounds for the set-aside application – Given that the Model Law applied, the Court reframed EDE’s application as a set-aside application under Article 34(2)(a)(ii) and 34(2)(a)(iii) of the Model Law on the basis that EDE had not been able to present its case for reasons of fairness, or that the arbitrator had exceeded her jurisdiction. 

The Court began by setting out the applicable test for setting aside an arbitral award for reasons of procedural fairness, which sets  a very high threshold. Citing the Court of Appeal’s decision in Consolidated Contractors Group SAL (Offshore) v Ambatovy Minerals SA, 2017 ONCA 939, Justice Vermette noted at para. 95:

“Courts have held that to justify setting aside an arbitral award under Article 34(2)(a)(ii) of the Model Law for reasons of fairness or natural justice, the conduct of the arbitral tribunal must be sufficiently serious to offend our most basic notions of morality and justice. Judicial intervention for alleged violations of the due process requirements of the Model Law will be warranted only when the tribunal’s conduct is so serious that it cannot be condoned under Ontario law.”

With respect to EDE’s claims that the arbitrator exceeded her jurisdiction, the Court relied on the tests set out in Alectra Utilities Corporation v Solar Power Network Inc, 2019 ONCA 254 and  Parc-IX Limited v The Manufacturer’s Life Insurance Company, 2021 ONSC 1252, noting at para. 100 that: “… jurisdiction is determined not by asking whether the arbitrator made a correct decision, but by asking whether the arbitrator had the authority to make the inquiry that they made.

After reviewing these tests, the Court rejected EDE’s set-aside application. EDE’s arguments were premised on its position that it was not possible to adopt the first-in, last-out methodology for disgorgement of profits because the funds were co-mingled. However, the Court noted that this premise related to the merits of the arbitrator’s decision and thus was not reviewable under a set-aside application. 

The Court also noted that this methodology was put forward by the shareholders’ expert, and so EDE had an opportunity to put forward an alternative methodology, cross-examine the expert, and make submissions on this methodology. Thus, EDE was able to present its case on the issue. Because the arbitrator had considered the co-mingling of the funds, EDE could not argue that the arbitrator re-opened this issue or made inconsistent findings on this issue in the Damages Award. 

The Court also held that EDE did not provide evidence to establish that the arbitrator exceeded her jurisdiction in the Damages Award by affecting non-party shareholders or by re-opening liability issues.

Contributor’s Note:

Two things arise from this decision. 

First, parties cannot contract out of the Model Law if the matter falls withinthe purview of the ICAA. This is not surprising, considering among other things, the interplay between section 2(1) of the domestic Arbitration Act and section 2(2) of the ICAA, and other lower court pronouncements that parties cannot waive the application of the international arbitration act where it applies (see for example previous Arbitration Matters Case Note: B.C. – parties cannot waive application of International Commercial Arbitration Act because its application is mandatory – #059

It appears that other provinces approach this problem slightly differently (see for example section 1(7) of the International Commercial Arbitration Act, RSBC 1996, c 233, which provides that any reference to the domestic Arbitration Act in an arbitration agreement respecting an international commercial arbitration will be deemed to be a reference to the international arbitration statute).

Second, this case is consistent with prior court decisions maintaining a high bar for set-aside applications. This case serves as yet another caution against disguising substantive arguments on the merits as grounds for a set-aside application. Some recent case notes tackle his subject, including:

Ontario – Court affirms narrow jurisdiction to set aside an arbitral award – #729

Ontario – Challenge to award for procedural unfairness and insufficient reasons dismissed – #732

Ontario – Set-aside application can’t bootstrap appeal– #707.